Both Equity and credit markets ended the week substantially higher. The good news started in Europe last week with the speech from Draghi. Then we had the approval of the rescue mechanism by the German Constitutional Court. On Thursday it was the FED. Bernanke did not disappoint, the open market operations can indeed be considered a determined quantitative easing measure (QE3). Not only that, in his speech, Bernanke highlighted that this had nothing to with monetary policy (on this last point he also said that he was committed to keep very low interest rates until 2015). He actually said this QE3 had to do with unemployment, he will inject money in the system until he sees a lower unemployment level.
This policy action by the FED and the ECB take place in a decelerating world where many investors scratch their heads and try to determine what will happen in the real growth engines of the world, such as China, Brazil and some other large emerging markets. The good news is that there is also very aggressive local policy action in these countries. China is a good case study, we may spend some time on it in the coming days.
The question is… will policy action by worldwide leaders be able to offset the poor macro outlook? Classic textbook says yes, policy action leaders to macro improvement, macro improvement leads to corporate profits. Investors should buy shares.
But there are still important threats out there. One of them is the convoluted political situation in Europe, where local governments are pressured by their own political situations (with a special mention to Germany which does not know if the way forward is to lead or to leave the euro), and where the decision making process is complex and slow. These issues are likely to generate an intense and volatile newsflow in the next few months, which could have an impact on the market. Spain formally asking for financial aid or the ever deteriorating situation of Greece may be the catalysts for the next panic episodes.
Meanwhile, the markets have rallied on very low volumes. S&P is only 6% off the all-time high. Spanish equity market is up 33% from its low in the beginning of August. European banks 40% up. And guess what… investors have missed the rally, particularly in Europe. The market has moved a long way up with very little money being transacted. All institutional investors will be benchmarked against the indices at year end, and they will not look good. Seems that the old “sell in May and go away “ did not work well this time. With this situation, many investors will be forced to play the equity market in the last quarter to chase performance. In fact, they are likely to use what is known as “high beta” stocks, which amplify the market move (either up or down) in order to catch up with the market. This is in itself a great supporting technical factor for the equity markets which will see significant inflows.