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Greetings,

“I am of the opinion that the policy of having such low interest rates is
certainly not a lasting state of affairs. This is a special situation that can be
explained from a special circumstance – the danger of slipping into deflation - and this danger is now gone” – Ewald Nowotny, ECB Governing Council – May 19, 2015

Nowotny has made cringe-worthy quotes like this before, but this statement seemed destined to leave egg on his face from the moment it left his lips. Ostensibly, the unprecedented volatility in German Bunds was sparked by a stronger-than-expected inflation print for May, but let’s not forget that the Eurozone’s core CPI was a mere 0.9% Y/Y vs. 0.6% in April. CPI in Germany was only 0.7% in May, which includes a bump from higher gasoline prices. The Weimar Republic this is not.

In fact, Germany’s stagnant prices are even more alarming when you consider it’s been using an artificially weak currency for over 15 years. The EUR has transformed Germany into such an export juggernaut that its trade surplus hit a record high in May – despite weak global demand. While the media still blames Greece for any price fluctuations in Europe, perhaps the real story is in Germany.

Last Thursday, as I was getting ready to short EWG (German ETF), some broker flow crossed my screens showing huge buying volume in the stock. Since 2012, EWG has only traded more than 15 million shares on 8 occasions, and on Thursday 18.25 million shares traded hands. Thinking that I had missed something, I took the flow into consideration, violating one of my cardinal rules and decided to hold off. It was a dumb move then and it looks even dumber now. EWG ended up finishing lower on the day (closing lower on high volume is usually bearish), and has since dropped nearly 4%.

Can’t dwell on it for too long though, and I’ve since established a short position. The DAX, which surged nearly 30% after the ECB announced its QE program in January, still needs to fall another 6.5% before reaching its 50-week moving average – so there’s still plenty of opportunity.

I still don’t believe a “Grexit,” in and of itself, would be a problem. Rumors of bank runs in Greece are irrelevant, because capital has been fleeing Greek banks for years. However, Greece leaving the Eurozone would set a tricky precedent for systemically important countries like Spain to bail as well. I suspect that Greece-related headlines will remain abundant, and they will be anything but supportive for German shares. On top of that, strong growth data is unlikely to boost German stocks if it translates into higher Bund yields. The DAX peaked around April 10, right as Bund’s began their spiral because the German economy is not nearly strong enough to tolerate higher rates. The ECB might think it has conquered deflation, but that’s hardly the only headwind facing Europe.

The Cup & Handle Fund is up around 0.5% on the year, and +15.0% since August (inception). The portfolio took a small hit last week betting on stronger retail sales through rates. My retail sales view was correct, but the market didn’t respond as expected. I also sent out my monthly letter for June last week, but the pick has yet to move in either direction. If you’d like to start receiving these letters click here.

Today’s letter will cover several topics, including:

• On the Home Front
• Seoul Searching
• The Magazine Cover Indicator
• Chart of the Week

With that I give you this week's letter:

June 16, 2015

As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

Until next time, tread lightly out there,

Michael Lingenheld

Managing Editor – Cup & Handle Macro