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The waiting game

It is important not to read too much into the American mid-term election results. That the incumbents on Capitol Hill were bound to get a drubbing was never in doubt. The actual outcome was not as bad as the Democrats might have feared. Nor is such an experience unique, even if it did serve as a reminder that in US politics, the economy is everything.

Of greater significance was last week’s announcement that more money will be thrown at the economy to stimulate recovery – the second tranche of quantitative easing, or QE2.

This was much-anticipated by the Fed and in the end the market was not disappointed, with even more money being thrown at the economy than had been expected. Now we have to hope it works. Markets clearly think it will, judging by the initial response.

As a consequence, there is evidence perhaps that an appetite for risk has returned. Several stockmarkets are standing at year-to-date highs and investors in the US are at their most bullish since before the credit crunch kicked in.

Indeed, according to the American Association of Individual Investors, holdings of cash are now at their lowest level for more than a decade. The last time private investors held so little cash was as the dotcom bubble burst and the new millennium bear market got under way.

Contra-cyclical investors will claim that such indicators are a sure sign that the music is about to stop and you should head for the door.

Certainly, the obverse indicator – the peak of bearish sentiment – took place just two days before the market bottomed in March 2009. On March 5, 2009, this particular survey recorded the lowest level of bullishness in almost 20 years – and what a time to buy that proved to be.

But the results season has again demonstrated that corporate America is in rude health. Profits continue to come in ahead of expectation and the bulls will argue that valuation levels, far from being stretched, are below long-term averages.

Even so, there is surprisingly little caution around, given the uncertain economic outlook and the fact that at least part of the rise in markets can be laid at the door of the liquidity being pumped into the system by the Fed. Not that the institutional market is behaving in quite the gung-ho fashion that private investors seem to be adopting. There is concern around, in part due to worries that nobody really knows what the long-term effects of QE2 will be.

It has been tried before. In 1932, the Fed employed it to try to turn around the Great Depression. In 2001, Japan used it to try to stimulate a flagging economy with little real success. We will only learn how efficacious this ploy is with the benefit of hindsight.

Investors, too, will need a bit of patience. December is not far away – historically a month when markets rise on low volumes. We could even have a good Christmas, with consumers spending ahead of next year’s VAT hike. And the traditional effects of printing money – rising inflation – might be more evident in the New Year.

Even so, I have a sneaking feeling that the more buoyant conditions helped along the way by events in the US might most usefully be turned to advantage by taking a few profits.

Brian Tora is a consultant to investment managers, JM Finn & Co



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