When Expectations are Too High

This Tuesday and Wednesday are important. Tuesday is the election (people expect a Republican victory) and on Wednesday the Federal Reserve will in all likelihood announce another round of quantitative easing (QE) in which it will purchase Treasury securities in the open market. This much-anticipated round will raise bond prices, lower long-term rates a bit and perhaps boost the economy. The idea is to lower the returns on risk-free investments so much that we'll do something riskier. Another Fed goal is to raise the inflation rate. Investors are beginning to anticipate that and long-term interest rates are edging higher. Again, investors expect action by the Fed.

Expectations are often more important than the here and now. Whether is it good or bad for the country, Fed accommodation and huge Republican gains with an extension of the Bush tax rates expected by nearly everyone. Those are baked in the cake, as they say. But suppose nothing gets done in the lame duck session, which means taxes will be going up on January 1. Suppose the Fed buys fewer Treasurys than the market expects. Maybe Republican gains will not be quite as huge as most foresee. Any or all of those events would rattle the market. Stocks will not do well, at least temporarily. When expectations for important matters are as one-sided as they are today, the stage is set for disappointment.

There is a Wall Street adage, "Buy the rumor, sell the news." That may happen even if investors' high expectations are met. But profit taking would be short lived. Stocks do very well after mid-term elections regardless of the outcome. Ultimately, investing is about future earnings and earnings are strong.

Consult your financial advisor before purchasing any security.