August 29, 2012
Economies in China and Europe have weakened, and the U.S. has slogged through slow growth and high unemployment, yet stocks have climbed a shocking 10 percent since June on the expectation that the Federal Reserve and its counterparts in Europe would soon offer a helping hand.
Now the assumptions behind the summer romance with stocks are about to be tested, with possible disappointment in store for investors.
On Friday, Federal Reserve Chairman Ben Bernanke speaks at a Fed retreat in Jackson Hole, Wyo. — an annual event that has, on occasion, triggered tremendous stock market rallies. Then in early September, European financial leaders take the stage with much-anticipated meetings.
Investors have bet that the leaders finally will lay the path out of Europe's debt crisis and relieve the recession that is pulling down global powerhouses like Germany and China with weak countries like Spain and Greece.
But before Bernanke speaks Friday, analysts already are toning down expectations.
"We do not expect Chairman Bernanke's speech on Friday morning to shed much additional light on the near-term tactics of monetary policy," Goldman Sachs economist Jan Hatzius said in a note to clients Tuesday. Although he thinks the Fed eventually will initiate more stimulus through bond buying known as "quantitative easing," he says the end of December or early 2013 is more likely than a September date.
That could test investors' patience and send stocks into retreat.
Although the U.S. economy is growing at a sluggish 1.5 percent, some data have shown slight improvement lately, including Tuesday's Case-Shiller report on rising home prices. With the improvement, there has been increasing debate by Fed officials about whether the Fed should use more stimulus to try to tame unemployment.
Strategist Ed Yardeni compared the debate to "a feud between the Hatfields and the McCoys."
In Europe, European Central Bank president Mario Draghi cooled expectations on rescue proposals for the eurozone when he announced Tuesday that he is not going to Jackson Hole as planned. He had been expected to speak, and investors had hoped to hear hints about a coordinated plan in Europe to keep borrowing costs low for debt-laden countries and capping interest rates. Without that help from united European countries, some have argued that such countries as Spain and Italy will sink deeper into recession.
But all proposals are controversial, with sharp debate and political division throughout Europe. In Germany, a European bailout fund supported by eurozone countries is being challenged in Germany's Constitutional Court. Troubled countries such as Spain and Italy would apply to the European Stability Mechanism (ESM) bailout fund, if they deemed it necessary.
But if Germany's Constitutional Court finds Germany's support for the fund illegal when it rules Sept. 12, bailouts will not occur as planned because Germany is the country with the deepest pockets.
The expected court decision in mid-September could reopen questions about the eurozone's fate and likely shake investors.
Instead of providing hints on any proposal at Jackson Hole, Draghi said Tuesday that he will be too busy to attend. Analysts debated whether that signaled Draghi might not live up to the high hopes that powered a European stock rally after Draghi said in July he would "do whatever it takes to preserve the euro."
"Quite literally, markets are hanging on the implementation of those words," Citigroup strategist Hans Lorenzen said in a report to clients Tuesday. He noted that Draghi's July comment was a "game changer" for nervous investors in stocks and risky bonds as "Draghi cleverly managed to keep the market in suspense through August." He allayed "the summer turmoil that had been widely anticipated," Lorenzen said.
"It is hard not to wish that the summer holidays could go on longer," said Matt King, Citigroup credit strategist. "Mostly, we are concerned that as politicians return from holiday, the bill that governments are facing remains extremely large … and a slew of upcoming events seem likely to highlight the difficulty they will have paying it."
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