I read an interesting call today from Toro about shorting the Euro off the top he believes the currency has set against the dollar, and – if he’s correct – there are plenty of side effects with important applications to the equity markets. He notes estimates that the purchasing power parity value of the dollar is $1.10-$1.20 against the Euro, and that the large differential on the short end of the yield curves between the US and Europe should converge as the ECB loosens.

Given how everyone and their mother has been short the dollar, a reversal in that trade would create a dramatic shift in the markets not only because of all the other trades that are associated with it (i.e. long commodities), but because currency changes have actual macroeconomic impacts. The dollar strengthening against the Euro would put even more pressure on commodity bulls to keep prices elevated, especially if the dollar rally isn’t caused so much by an economic resurgence stateside as it is by economic weakness across the pond. Depending upon how other sectors are acting, this could set off a crucial leadership shift away from basic materials, which would suddenly be on the wrong side of the macro trade. Where this money would flow is another question – tech tends to be a combination play on an early-cycle economic recovery, as well as a weak dollar – so I might have to revise my view of that should the Euro continue to decline. Utilities look reasonably priced from a yield perspective, and could look downright cheap if a combination of cost side-benefits from falling commodities combines with stickiness on the (lagging) rate increases that they’ve had to lobby to push through stick. Still, utilities aren’t the kind of leadership of a healthy market…

An alternative would be the light cyclical industrial stocks begin to catch a bid, though this might be dependent on the benefits of the deflation of the commodities run-up outweighing the downsides of a stronger dollar making their product more expensive overseas. The one stock I continue to like in this area is Ingersoll-Rand (IR), whom I think made a series of vastly underappreciated acquisitions, in the process becoming the best company in the profitable climate control business.