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The ECB, QE3 and the Risk Quotient

September 5, 2012
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We are just one day away from the highly anticipated decision from the European Central Bank (ECB) regarding its plans to implement the steps necessary to keep the euro-zone together. The smart money here is betting that ECB President Mario Draghi will come through with a bond-buying scheme that backstops fiscally challenged Greece, Spain and Italy, and keeps them solvent. Doing so will preserve the euro, and the European Union (EU), and that’s what most in the EU want. 
 
As for the markets, traders want to see some specifics from Draghi, and not merely some reassurances that the ECB is prepared to bail out the region. There have been far too many disappointing promises over the past year by European leaders for the market to have any faith in their pronouncements, so now it’s time to put up or shut up. Will this happen? We’ll find out tomorrow, but if history is any harbinger of things to come, I suspect the market could be disappointed.
 
Either the ECB won’t announce plans that are "big enough" to help the region, or they won’t announce any specific plans at all. If this happens, look for stocks in Europe to sell off, and look for risk capital to return to the safety of traditional danger-free zones such as long-term U.S. Treasury bonds.
 
Here at home, we are about a week away from the Federal Reserve’s decision on any new monetary stimulus, also known as quantitative easing, or "QE3." Last Friday, Fed Chairman Ben Bernanke delivered a much-anticipated speech at a central banking conference in Jackson Hole, Wyo. As expected, the Fed chairman let the world know that he stands ready to pump more money into the banking system should the economy weaken more, and/or if the jobs picture doesn’t begin to improve significantly. 
 
 
 
After reading Bernanke’s comments, I came away with a sense that nothing has really changed. The Fed will implement some new type of quantitative easing, IF the economic data gets worse. That economic data could get worse as soon as this Friday, when the U.S. Labor Department issues its August jobs report. If that number is down significantly, look for more QE next week. If, however, the data points are much improved, any new stimulus could be delayed.
 
As you can see by the chart here of the S&P 500, stocks now are trading near their 52-week high, and just above the critical 1,400 level. Indeed, the run higher since June has been due in large part to the prospect of more money printing by the Fed. If, however, the central bank disappoints, investors who have a lot of exposure to stocks are going to get caught in the selling wave.
 
It is for this reason that I urge you to remain cautious here in front of both the ECB and the Fed. Once these decisions are in plain sight, you can make a clear choice about how to proceed with your money. Until then, the risk quotient is just too high.