Clap your hands if you believe in the Central Bank Fairy

08/14/2012 4:55 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

If you’re trying to figure out the direction of the stock market over the next month or so, it’s important to remember that a majority of professional investors still believes in the Central Bank Fairy.

The Central Bank Fairy, as the story goes, can make stocks levitate by simply sprinkling them with stimulus dust.

And the fairy meets in Europe on September 6 and in Washington, D.C., on September 13. And this very busy fairy might even have time, many investors believe, to stop off in Beijing this month too.

One reason that global stock market so easily shook off the twin disappointments of Mario Draghi and Ben Bernanke’s decision to do nothing in August was because both central banks get another shot at turning words into deeds in September.

If you look at indicators such as the move by hedge funds to cover their shorts on European stocks, it’s clear that a lot of investors are willing to bet that Draghi will actually deliver this time on his pledge to defend the euro with all available means. The proportion of shares on loan in the Stoxx Europe 600 Index, a good indication of the interest in borrowing shares to sell short, has dropped to 2.9% from 3.4% in May, according to Markit Economics, Bloomberg, and JPMorgan Chase. Macro hedge funds, which position their portfolios in order to take advantage of big trends—such as a fall or rise in the euro—have badly lagged the passive indexes recently (macro hedge funds are up 0.1% in 2012 versus an 8.1% gain in the MSCI world index of stocks in developed economies, according to Bloomberg) because they missed out in the Mario Draghi rally in European shares. And it now looks like they’re buying European shares to make sure they don’t get caught short by central bank moves in September.

Could work. The last time hedge funds closed short bets this fast, according to Bloomberg, was in April 2009. That shift preceded a 35% rally in the Stoxx Europe 600.

But then again, may be not. Draghi has made it clear that the European Central Bank won’t move to buy Spanish or Italian government debt until those countries make a formal request for that help from the European Financial Stability Facility, and so far both Italy and Spain are showing significant reluctance to make that request until they know what conditions might be attached. So far, the Spanish and Italian governments are saying that they’d rather muddle on by themselves, thank you, than submit to a full Greek-style program of oversight.

Which means that Draghi could essentially do nothing again in September.

Which would leave global stock markets betting on the U.S. Federal Reserve to announce a significant program of quantitative easing (QE3) two months before the U.S. election. My best guess still remains that the Fed will signal its intention to do something—after the election—at its September 13 meeting—but actually do nothing.

So the question isn’t really whether or not the Central Bank Fairy will deliver in September—because I think the answer to that is almost certainly No. Instead the question is whether or not markets can will themselves to believe after yet another set of announcements likely to be long on rhetoric and short on anything concrete.

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