Market participants were quite nervous at the start of September. A sluggish U.S. economic recovery, the euro zone debt crisis and concerns over a hard landing in China were the reasons keeping investors on the edge. Investors were hoping that global central banks would implement aggressive measures to spur growth, and central banks did deliver.
Central banks' moves this month, including the Federal Reserve's aggressive bond buying program, gave investors confidence. But concerns over global economic growth have resurfaced in the last few days, overshadowing central banks' moves.
The European Central Bank (ECB) was the first among major central banks to announce aggressive measures this month. The ECB, which in the past has been cautious in implementing a more accommodative monetary policy, this month surprised us by announcing an unlimited bond buying program to bring down borrowing costs for Italy and Spain, the eurozone's third and fourth-largest economy.
A week after the ECB's bold measures, the Fed announced its own bond buying program. Fed Chairman Ben Bernanke had already said at the central banks' meeting in Jackson Hole, Wyoming, in August that he was open to another round of quantitative easing. But there was still speculation over when QE3, as the latest bond buying program is called, would be implemented. Weak non-farm payrolls data for August prompted the Fed to announce QE3 at its most recent FOMC meeting. QE3 turned out to be the Fed's most aggressive bond buying program, with the central bank committing to buy $40 billion of mortgage backed debt every month, until there is a significant improvement in the economy.
The Bank of Japan became the latest central bank last week to announce monetary easing measures.
The central banks' moves, especially the ones from ECB and the Fed, pushed stocks to multi-year highs in the U.S. this month. But, the initial euphoria over central banks' moves is starting to fade.
The focus has once again turned from central banks to the prospects for the global economy. Based on recent data from major economies, the prospects for the global economy are not so good.
Let's start with the world's second-largest economy, China. Recent economic data from the country continues to point to a slowdown. This is a concern, considering that China has been an engine of global economic growth in the last few years. But the bigger concern for me is the lack of action from Chinese policymakers to spur economic growth. What is holding back Chinese policymakers from announcing growth-boosting measures?
A leadership change, scheduled for later this year, is probably one reason why Chinese policymakers have been cautious. The other reason I think is that the export and investment-led growth model is not working anymore. With the U.S., Japan and the eurozone, China's biggest export markets, struggling, China has been forced to rethink its growth model. Indeed, export and investment-led growth was never going to be sustainable, and China has to boost consumer spending to spur economic growth; however, this may take a while. FedEx Corp. (FDX) CEO Fred Smith last week said that consumer consumption in China is not increasing at a significant rate, contrary to everybody's hopes. It is no surprise then that FDX gave a bearish outlook for the global economy last week.
Even if the transition to a domestic consumption led economy is successful, China is not likely to grow at the pace it did in the past two decades.
Coming to the eurozone, as I mentioned above, the ECB's move did boost investors' confidence, but political stalemate in the eurozone continues, which means that we are still far from a resolution to the eurozone debt crisis. Speculation over Spain's bailout has added to the uncertainty. Even if European policymakers are successful in resolving the debt crisis, lack of growth will remain a concern. A report released on Monday showed that German business confidence fell unexpectedly.
The situation in the U.S. is relatively better compared with the eurozone. QE3 was a brave move by the Fed, but it will take time to show results. Meanwhile, the fiscal cliff remains a big worry.
So What Should You Buy and Sell?
I would definitely recommend gold despite the recent pullback. With central banks printing money to spur economic growth, the precious metal looks to be the best bet.
Holdings of gold-backed exchange traded products have continued to rise, indicating the bullish sentiment. As of September 21, holdings of the world's largest gold-backed exchange traded fund, the SPDR Gold Trust (ETF) (NYSE: GLD) stood at the highest level since July 2010.
Another reason I am bullish on gold is an expected rise in demand for the precious metal from India, which until recently was the world's largest (recently overtaken by China) consumer of gold. Higher gold prices and weakness in the rupee had hurt demand for the precious metal in India. But recent economic reforms announced by the Indian government have pushed the rupee higher against the dollar. Also, with the festival season in India just starting, demand is likely to pick up.
Among U.S. stocks, as I said before, homebuilders look good even at current levels. Quarterly results announced by Lennar Corp. (LEN) and KB Home (KBH) recently have once again confirmed the recovery in the housing market.
I am bearish on diversified miners such as Freeport-McMoRan Copper & Gold Inc. (FCX), BHP Billiton (BHP), and Rio Tinto, and other mining stocks such as Alcoa Inc. (AA), as well as steel manufacturers such as AK Steel Holding Corporation (AKS). The reason obviously is the slowdown in China. Although monetary easing measures from global central banks are positive for these stocks, weakness in the Chinese economy is likely to keep prices for industrial commodities in check. I would look to move into these stocks only if there is any hint of monetary easing measures from China to spur growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.