Summer School

September 24, 2012

This week should be a good time to ponder what we all learnt this summer and what this means for investing going forward.
-David Kelly, chief global strategist, J.P. Morgan Funds


One lesson was the ability of the U.S. economy to grow despite a global economic slowdown, chronic political uncertainty and a generally very gloomy mood.  A key contributor to this resilience has been a long-awaited rebound in housing and numbers due out this week should support this theme.  In particular, while the FHFA House Price Index may not see any further gain following a 4.0% leap over the prior five months, the Case-Shiller Index should reinforce the theme of rising prices.  New Home Sales could reach their highest level since an incentive-juiced April 2010, with New Home Inventories establishing yet another record low.  Meanwhile, Pending Home Sales could also rise to their highest level in over two years.


The gain in home prices and equity markets in recent months does appear to be boosting confidence and both the Conference Board's Consumer Confidence Index, due out on Tuesday, and the University of Michigan's Consumer Sentiment Index, due out on Friday, should show some improvement over low levels in August. 


Durable Goods Orders, on Thursday, will portray a sharp slowdown in manufacturing.  However, this will largely reflect a huge monthly swing in Boeing aircraft orders - elsewhere a clearer picture of the health of manufacturing will be provided by a relatively flat Chicago Purchasing Managers' Index.  Meanwhile, Consumer Income and Spending numbers should confirm that they both improved August. 


A second lesson was that central banks, while not good at stimulating economies, are very good at removing tail risks.  This has been most notable in the case of the ECB which has succeeded first through the Long Term Refinancing Operations (LTRO)   program and then through the Outright Monetary Transactions (OMT) Program in stabilizing both European banks and, to some extent, the peripheral sovereign bond market.   One measure of this is the Spanish government bond market where 10-year yields ended last week at 5.76% down from 7.62% just two months earlier.  This week, the Spanish will announce the results of an audit of Spanish banks to try to ascertain how much extra capital they need as well as set the stage for a perhaps more general Spanish aid package.  However, given the ECB's success in recent months in stabilizing European markets, the choreography in the Spanish aid request should be not be too alarming to markets.


The final lesson of the summer is that investors should resolve not to try to time when to get in or get out of markets but rather invest based on long-term fundamentals and valuations.  Many said that the markets were going to move sideways or that you should "sell in May and go away".  Both the prescriptions and prognostications proved to be in error.  The truth is that the market environment remains sluggish and uninspiring.  However, relative valuations favor stocks while investor allocations in recent years have tended to favor bonds.  With tail risks waning, this remains a time when many investors should consider moving away from overly-conservative portfolios to rectify this still-glaring imbalance.