The Waiting Game
August 27, 2012

This summer has been a sizzler for stocks and commodities with an unusual new collaborator helping to lead the charge—a spate of bad news. But in this new-fangled world of investing, dreary conditions are fueling expectations that central banks will ride to the rescue once more, providing much needed economic stimulus. Any sign that central bankers are not content to sit idly by while their economies muddle along their current path of slow growth and high unemployment will be eagerly watched. The first such indication could come as early as this coming Friday, when U.S. Federal Reserve chairman Ben Bernanke delivers a speech at Jackson Hole, Wyoming to a gathering of the world's top economists.

Since the June low, the S&P 500 is up 10.6%, Germany's DAX index has risen 17%, while the bond markets of Europe’s periphery have front run the ECB's comment that they stand ready to do “whatever it takes” to save the euro. In the past two months, West Texas Intermediate, a crude oil benchmark has rallied nearly 25%, while corn is up 29%, soybeans have rallied 18% and gold has broken above its 200-day moving average. Increasingly, investors have adopted the view that world’s most important central banks are about to take decisive action with a powerful round of stimulus—sooner rather than later.

Despite the already unprecedented expansion of central banks’ balance sheets and the massive governmental outlays, not to mention the enormous debts and deficits that are excessive by any post-war standard, hope for further stimulus runs deep. The Fed has kept its key interest rate at zero percent and promised to leave it there through 2014, while at the same time spending $2 trillion in bond buying programs in effort to lower borrowing costs. And where has all of this activity gotten us? The market is no higher than twelve years ago and the pace of growth is the most dismal on record three years into a recovery.

Investors remain remarkably complacent despite a calendar that is chock full of policy event risk over the next month. Given the level of optimism in the markets, investors could be in for a rude awakening if Bernanke’s speech in Jackson Hole doesn’t at least hint at forthcoming quantitative easing. But beyond this, the next big watershed for the markets will be the September 12 th ruling by the German Court on the constitutionality of Europe's fiscal compact and the ESM. On the same day, the Netherlands holds its parliamentary elections, with EU memberships and bailouts shaping up to be major issues and on the 13 th of September the FOMC meeting takes place. The VIX, an important measure of investor anxiety, recently hit 13.5, a low not seen since mid-2007.

This complacent attitude flies in the face of the deteriorating global manufacturing sector, with PMI data continuing to tumble, corporate M&A and dividend hikes in the rear view mirror and the Shanghai stock market in intensive care. The news isn’t altogether bad, with some positive data points emerging for the U.S. economy. There's been better-than-expected jobs gains in July and new urgency among European policy makers for a solution to their debt crisis, coupled with some upbeat news on U.S. housing.

While the path is likely to get a little rougher for investor over the next few months, the most likely outcome is a muddle through market where policymakers do just enough to keep the bears at bay. It might be time for investors to reduce their exposure to the utility and telecom sectors, which offer little growth and are looking pricey by historical standards. Instead, investors could look toward technology, both software & services as well as, hardware, where valuations are more attractive and there's visible growth ahead, not to menti on the possibility for share buybacks and dividend increases.

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