It is probably with a cruel sense of irony that my high school French teacher dragged me through a section of French Literature called the Theater of the Absurd (Théâtre de l’Absurde). Samuel Beckett’s play “En attendant Godot” formed a part of that journey for me. The play centers around two characters who are, as the title suggests, waiting for Godot. The play drags on for pages and pages of tedious back and forth between Vladimir and Estragon and a few others who wander along the road. The frequent refrain meant to justify all this nonsense is that, well, they are waiting for Godot. Needless to say, the play ends without an appearance from Godot.

The reason I have channeled this unpleasant memory from decades past is because it helped me zero in on my feelings of frustration. My French teacher sandbagged me with Samuel Beckett’s dreary drama just as the leadership of the US and EU has inflicted the Absurd saga of the twin sovereign debt dramas upon me as an investor. While many will see the congressional action over the weekend as the end of the US part of the play, the one thing I learned in French class those many years ago is that we are only finishing Act 1. After a short relief rally, the market should fizzle as the audience (investors) realizes that there is an Act 2 and that the action is unlikely to prove any more inspiring than Act 2 of Beckett’s play.

The European story is perhaps more depressing because even when the Greek Sovereign Debt Crisis Drama runs out of steam (we are only at August Euro Beach Holiday intermission), there are plenty of other European venues ready to stage the play. Right now, it looks set for a five city run.

Why only the end of Act 1?

Because, if one actually reads what has been agreed (Bloomberg article), the headline figures barely last much past the second paragraph. Super committees will be set up and no doubt overlooked. Automatic cost controls will be established and no doubt ignored. Both sides can declare victory because very little has actually been achieved except for an agreement to allow the Treasury to borrow more money.

What should an investor do?

Probably raise cash into the “relief rally” that will kick off this week. If this weekend deal is the trigger event for the fall rally that we were looking for, then this rally will be a weakling.

Wait for the next boot to drop (which may be a threatened Moody’s downgrade) before loading up on risky assets with the cash you raise in the coming week. The Fund King Ratings are anemic, which is to be expected at this point. However, looking up from the figures, we appear to be stuck in the Theater of the Absurd waiting for this play to end. It will end at some point and not necessarily with a cataclysmic bang that will drive the price of Gold to $5,000 an ounce. At that point, we as investors can get on with our lives.

As Europeans prepare to decamp to the beaches for their August holidays, the newsflow on the festering Greek Sovereign Crisis has taken a temporary, slightly positive spin. However, just like a band aid applied on the beach before one goes swimming in the ocean, don’t expect the latest “fix” to last for very long. Greece is in an untenable position and it will remain so until one of two things happen soon: either they are allowed to write off a significant portion of their debt and remain in the Euro or they are allowed to leave the Euro and write off a significant portion of their debt. The first solution will require the EU to backstop the Greek, German and French banks that hold the bulk of the Greek Government Debt. The latter will also require a backstop of banks (French and German) but will leave the Greeks with a newly devalued drachma with which to rebuild their shattered economy. Given the risk of contagion, the French and Germans would like to keep Greece in the Euro simply to reduce the damage of a cascade of sovereign debt crises that wait in the wings.

On the US side, the faux debt crisis is coming to a head as political strategists on both sides try to divine whom the voters will blame more next November for a government shutdown. The last time, Newt Gingrich ended up with the most egg on his face but that was during a relatively buoyant economic backdrop. Although the New York Times and other feel that there is a natural “out” in the form of the 14th Amendment (click here for a quick read), this political “chicken race” will come right down to the deadline of August 2nd. As those of us old enough to remember the aftermath of the Clinton/Gingrich Government Shutdown of late 1995, the long term impact will probably be negligible even if the government has to furlough workers in the first week or two of August.

While the debt crisis continues to unfurl across the developed markets, listed companies are quietly racking up decent profits as the benefits of globalization accrue to those companies who were able to take advantage of emerging market demand. A quick glance at the P/E ratios across the globe shows most markets trading in the low to mid teens. Although “low to mid teens” is hardly a screaming bargain, it is a respectable level to support an autumn rally if the Europeans can keep from scaring investors too badly. Adherents of the Fed Model might get a bit more excited but since the interest rates are being artificially held down, the validity of the Fed Model at this stage is at best qualified. Should the 10 year treasury trade at the S&P 500’s current 7.45% earnings yield (from current 3%) to bring the two into line or should the S&P 500 more than double to make up the difference? The answer is somewhere in between but it does suggest that valuations of US Treasuries vs. US Blue Chip stocks are a bit out of line. A return to the mean is not out of the question and should prove profitable for those willing and able to move with the markets.

What should investors do now?

For now, the Fund King System is signaling a risk-off, wait on the sidelines approach. Biotech (XBI) and Pharmaceuticals (XPH) are still at the top of the Global ETF portfolio with Eurocrat suspicious Gold (GLD) rounding out the top three. But none of the readings are particularly strong at the moment, signalling a lack of conviction amongst institutional investors.

A number of subscribers have asked why I have been slack about writing the newsletter this summer.

The answer is simple, there really isn’t much new and fresh to talk about. The problems that stand before us are unchanged from the beginning of the year. That realization hit home when I watched a good presentation on the web which was recommended to me recently. The presentation was done in late January but could have just as easily aired yesterday.

While I try to be an optimist and remember that recessions are very good times for innovation and new leading companies to emerge, I cannot help but pay attention to the doomsayers who are correct in pointing out that the developed world is still in a long term, debt-laden situation that will only deteriorate as the demographics continue to shift toward older voters who expect to be taken care of in their old age.

Perhaps that is why two of the bright spots in the Global ETF Portfolio are the Biotech ETF – XBI and the Pharmaceuticals ETF – XPH.

So, as a result, the Fund King System is throwing up some perfectly dreary numbers and telling us that there is nothing terribly compelling for your risk capital at the moment.

If you want to see a market snapshot, we have broken down the Fund King rankings of the ETF market by market capitalization on this page. The 100th largest ETF this week, for example, is ACWI at $1.9bn. The 250th largest is PDP at $523m and the 500th largest is HHH at $131m. As you can see, the only ETFs showing any decent ratings are the leveraged ones. Overall, that does not fill us with tremendous confidence for the medium term outlook.

For me, the only bright spot is that the market is starting to pay close attention to unemployment. Not only is this a perennial lagging indicator but it is a very poorly constructed data series at the best of times and almost always wrong at turning points. Therefore, I find it highly amusing that investors are trying to catch a turnaround in underlying economic growth using a statistic which has failed so spectacularly in the very recent past.

Why is that a bright spot? Because it means that a large number of “smart money investors” are once again focused on the wrong thing. The current high level of reported (and underreported) unemployment is unfortunate but it is the wagging tail of the economic dog. A more sensible leading indicator to follow would be retail sales in the US. And on that score, it looks like some of the negative numbers could turn a bit more positive if you look at the work being done by the Consumer Metrics Institute. Nothing to “bet the farm” on this week but it is encouraging to see the line of their main indicator making a move for the Growth side of the chart.

What should an investor do?

Sometimes it is hard to do nothing but that is what the Fund King ratings suggest (as they have since April). There should be opportunities in the autumn and perhaps one of the catalysts to kick start a fresh round of investment will be the end of the faux crisis gripping Washington DC with regards to the debt ceiling.
The Euro Crisis should quiet down as Europeans take the traditional August holiday. The crisis will still be there when everyone gets back in September.

Continue to build up cash and wait for opportunities to emerge in the coming months.

When the weather is not cooperating in Southern California this time of the year, the natives will regale you with the atmospheric conditions that produce the dreaded June Gloom conditions. If you happen to have just spent the winter in Chicago or Boston, you might be wondering what all the fuss is about.

Gloom hangs over the markets today. The natives are swooning at every jobs figure that does not defy gravity and the European crowd are indulging in dramatic pratfalls that make their soccer (sorry, football) melodramatics look prim and restrained. For Europeans, the crisis that was “Made in America” does not fully explain how Greece ended up in so much trouble. The Europeans are trying desperately to avoid answering the hard questions that are being asked by the voting public and the bond market.

From a macroeconomic point of view, the global economy is still recovering from a severe financial crisis. That recovery has actually been delayed by all the public funds and government projects that have sought to cushion the blow to the economy and its citizens. Throwing more debt on the pile of debt that got us into trouble in the first place has not worked. The Austrian School of Economics was first and most vocal in pointing out that the bad debts had to wash through the system before the economy could return to a healthy basis and start growing again. However, the thought of letting the market clear out the bad debt was a political non-starter in countries as diverse as China, the US, Brazil, France, Germany and the UK.

But now, after three years of pump priming, disaster management and wishful asset valuations, the markets are finally getting a chance to sort out some of the wreckage. The FED has admitted that its monetary stimulus has not produced the desired results and the Germans are starting to talk about how private investors may end up wearing real losses when Greece’s debt is restructured (and/or defaulted upon). The US housing market is still trapped in suspended animation but, with the Case Shiller index double dipping, it should not be long before real solutions are proposed and acted upon.

What does this mean for investors?

In a word: Patience.

Although we mentioned that it looked like another “Sell in May and Go Away” year, we did not take nearly enough of our own advice and our portfolios have suffered accordingly. Investors who joined the rally late (in the early part of this year) will be keen to sell into any rallies now that the markets have “confirmed” their initial bias that risk assets are to be avoided. A quick break to the upside will be smothered very quickly.

On the downside, most of the bad news in the market is actually pretty old news. The problems in the developed markets have been worked over for several major news cycles: American mortgages underwater, sovereign debt issues in Europe and budget deficits almost everywhere. In the developing markets, the worries about inflation, hot money, loose monetary policies and rising currencies are not fresh. All of this means a simple relapse into 2008/9 conditions, while not impossible, are nonetheless extremely unlikely. There is plenty of money swirling around the system to capitalize on any sizable dips in the financial markets.

Resurgence in Biotech

Although it is too early to say for sure how strong the trend is, we have noticed a fairly broad improvement in the biotech (XBI), medical devices (IHI) and health care (XLV) sectors. The numbers are not conclusively high at this point but they are better than most of the alternatives in the market.

Some market observers have cherry picked past data and noted that times of economic distress are often also times of tremendous technological innovation as well. Perhaps the energy released by a Schumpeterian “Creative Destruction” wave is fueling innovation in the biotech and medical devices sectors. Or it could be simple rotation into what could be viewed as a more defensive sector in the US at this point.

There is no question that the medical/pharmaceutical/health care complex in the United States is ripe for innovation. Andy Kessler has explored this area since at least 2007 with the central thesis that the delivery of medicine and health care ought to enjoy some of the liberating innovation and efficiency gains that we have seen in the IT sector since the invention of the integrated circuit. Was he a bit early? Perhaps, although there is no question the cracking of the human genome is just now starting to pay dividends in terms of new medicines and delivery systems wending their way through the drug approval process.

Have some cash ready for Autumn Opportunities

So, we may have some excitement on the biotech front. We will definitely see some frothy IPOs in the social networking space (Linked In, GroupOn, Facebook…) which might help spark some small return of investor appetite for risk. And we can definitely look forward to a good scare on the European sovereign debt crisis and some worries about China’s rediscovery of the business cycle which will frighten investors back to the sidelines. Therefore, until the RSI numbers start to improve into the 20’s, there is no rush to get back into the market.

If the second half of “Sell in May…” hold true, there should be some good opportunities in the fall. Keep a bit of cash available and be ready to rotate into different asset classes after the summer torpor lifts.

When FEZ came into the top 3 in my Seeking Alpha portfolio at the end of last week, I have to admit that I felt a little leery. After all, “the market” as defined by the mainstream financial press was still digesting the latest rehash of the slow motion market meltdown in Greek sovereign debt. Surely the system was wrong on this one.

But, when you look at the Euro Stoxx 50 components, the picture is not dire at all. Two-thirds of the index is concentrated in France (37%) and Germany (31%) (see info page here) and looking at the top holdings, these are mostly household names that will benefit from a global recovery. OK, not a hugely compelling story to get the pulse raising at this juncture in the market.

So grudgingly I swapped out of my DBB (Base Metals), which had not performed, and put the proceeds in FEZ (Europe Blue Chips) on Monday because I could not come up with a good reason to fight the system on this change. The result? From Monday close to Friday close, FEZ returned a none too shabby 4.5%.

The result is important for two reasons.

Firstly, the return was split evenly between index and foreign exchange returns. Over the four days, the index gained 2% while the change in the Euro/USD exchange rate accounted for 1.8% of the return. Forex moves are very hard to predict accurately but they are driven by investment flows and Central Bank reactions. And, as you can see in this small example, the result of their actions are reflected in the changing price and can have an important impact on returns. Is the Euro going up or is the US dollar just sinking to new lows? Probably more of the latter than the former as the US Treasury and FED talk about a strong US dollar but act as though they want to bring the value down. Does it matter? Yes, but by the time one has clarity, the market will be preparing for the next move.

Secondly, the move was not foreshadowed by some major research report or market buzz. If there was a table pounding report saying something like “Now is the Time to Buy into Euro Blue Chips”, I certainly missed it. If there was a big “Buy the Euro now” call, it did not make the mainstream financial press. The fact that these companies are soldiering on with the global recovery while their governments and Central Banks attempt to deal with the financial situation as best they can is just not very compelling financial news. It is much more exciting to concentrate on how the Greeks will default and how the True Finn party will manage to throw a wrench into any Europe wide solution.

What does this mean for users of the System?

While certainly not every switch will work out as well as DBB to FEZ did in just a few days, the purpose of the System is to provide an unemotional signal to help you keep your money working in the most promising corners of your investment universe. Sometimes, as in the case of Blue Chip Euro stocks, it is not immediately apparent. But the point of this post is that you need to let the System do its job. Often a move will happen in a market first and the analysis follows later. Waiting for everyone around you to confirm that a particular trade is a winner can be a good way to buy into a crowded trade at a high point. While we want to participate in trades for as long as there is decent momentum, we do not want to have the buy and sell decisions driven by emotions. Our very human need to travel within the safety of the crowd is one of the primary reasons why investors buy at high prices in a bullish euphoria and sell at depressed prices in a bearish funk. The point of investing is to make money…emotions just get in the way.