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Dead and alive

Are the equity markets half-dead or halfalive? Or, as with Schrodinger’s cat, both at the same time?

The second week of October extended the rally in equity markets and other “risk-on” assets from the lows at the end of September. On the week the MSCI all countries index was up by 4.2 per cent in sterling, led by the developed markets, in particular Europe excluding UK (up by 5.2 per cent) and Latin America (up 5.9 per cent), with strong returns from the energy, materials and IT sectors.

Japan is now the laggard, down by 0.8 per cent in sterling.

Bonds eased off once again, with the US 10-year yielding 2.25 per cent, up from 2.08 per cent a week ago and up from 1.91 per cent at the start of the month. Commodities were positive once again. Oil (West Texas Intermediary) was up by just under 5 per cent and copper was up by 4 per cent.

Markets have rallied very strongly from deeply oversold levels. The MSCI all countries index is up by 5.9 per cent so far this month but still down by 7.6 per cent in 2011. The S&P is up by 8 per cent in dollar terms in October, the Nasdaq bettering that at 10.5 per cent and the DAX up by 8.5 per cent in euros.

The prospect – once again – of a solution to the eurozone crisis and the absence of nasty surprises has reassured investors and worried those who don’t own – or who are short of – European financial stocks.

The outlook for the US improved with further encouraging data on retail sales and unemployment claims.

In Europe, Slovakia eventually approved the European financial stability facility changes and the international “troika” representatives, made up of the EU, the IMF and the ECB, approved the release of the €8bn funding tranche that keeps Greece afloat. The eurozone’s “big plan” is now labeled the “grand plan” by the media and is rumoured to be “a big bang” grand plan.

The next three weeks will be likely to see a hiatus in bad news and increasing anticipation from investors as the recent meeting of G20 finance ministers rolls into the meeting between Merkel and Sarkozy, then the EU summit – when the member states are set to agree the “grand plan”.
And finally all is planned to be unveiled at the Cannes G20 meeting on the weekend of November 3 and 4.

Investors may well be suffering from crisis exhaustion. As long as it is clear that the EU will act to protect the banking system and ringfence Greece, any deeper concerns about the mechanics of the plan and the longer-term (2012) implications for eurozone growth will be overlooked and a rally sustained.

It may take some time for a recalibration of expectations, switching from the fear of a permanent loss of value caused by Greek default and banking writedowns, to the increased uncertainty of future returns.

Rupert Caldecott is head of private clients and chief investment officer of the global asset allocation team at Dalton Strategic Partnership

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