Midcap & Company

As August drew to a close, investors stayed on the sidelines and stocks remained in a fairly narrow trading range, as Wall Street tried to figure out whether the economy is set to make a "hard" or "soft" landing. Many experts don’t anticipate any real clarity on the issue for quite awhile, as the market shakes off summer’s slower pace after Labor Day and economists digest a myriad of data.

Why the indecision? The key issue that currently concerns Wall Street is inflation and, with it, worries over how the Federal Reserve proposes to reduce it. To complicate matters, many traditional economic indicators used to predict these factors are at odds. Rising levels of housing stock suggest a slowdown in inflation is on the horizon, while June’s Consumer Price Index (CPI) numbers suggest that inflation is on the increase. If you are confused, don’t be alarmed. You’re not alone. Sentiments in the conference room and on Wall Street are all over the map. Many economists have taken issue with Fed Chairman Bernanke’s optimism, noting that core inflation is already hovering above Bernanke’s unofficial target of 2 percent a year (that forecast excludes food and energy prices).

Employment Numbers Hold The Key
However, amidst the morass of conflicting opinions and contradictory data, many experts are looking to the employment numbers to cast some light on where we might be headed. Historically, the peak in interest rates usually coincides with a trough in the jobless rate. Accordingly, Wall Street would be cheered to see a trend of positive job creation - a modest trend that would not send unemployment rates into a sharp decline. This type of scenario minimizes the Fed’s impact and allows for a soft landing - a mild slowdown that curbs inflation without creating the loss of many jobs. On the other hand, lower unemployment and weaker job creation would be expected to send stock prices lower.

Reversal of Global Trends
Trends outside the U.S. are also making the Fed’s job more complicated. Economists suggest that major shifts in global investment patterns are likely to have significant impact on U.S. inflation rates. The era of low-cost goods from China and other countries may be ending as global commodity prices and oil prices escalate. Along with costlier goods, the U.S. may also be about to see some curtailment in the flow of investment from poorer countries as these nations find ways to spend and invest their savings on-shore. The consequences of such action would be far reaching. Bear in mind that the flow of money from poorer nations may have helped reduce long-term interest rates in the U.S. by as much as 1.5 percentage points in recent years - a significant impact when mortgage rates are about 6 percent. A reversal in global investment, and a growing reluctance to finance the U.S.’s burgeoning trade deficit, would have major implications for the U.S. economy and the markets.

With few experts willing to go out on a limb with market forecasts, what’s an investor to do? Perhaps this is one of those times when a defensive strategy makes sense - an emphasis on solid, larger companies with consistent (albeit modest) earnings growth. Some suggest that investors look to consumer staples, noting that although people might hold back on purchasing a new plasma TV in uncertain times, they still have to buy grape jelly and laundry detergent.