YESTERDAY, global equity markets were giving back some of the extraordinary gains made during October. Yet despite this, the month-long rally has been impressive while extremely unpleasant for stock market bears. Technically, a number of major stock indices broke through significant resistance levels. By the end of last week the FTSE, S&P and Dow had all traded back above their respective 200-day moving averages, typically a signal to fund managers to add to their equity market exposures in the expectation of further gains into year-end.
Many sell-side analysts were quick to point out that the EU summit had helped to dispel doubts over policymakers’ determination to deal with the European debt crisis. While there was evidence that the stock market rally which followed the summit was the result of short-covering, they pointed out that this typically preceded fresh buying. In some ways, Europe’s leaders did do more than expected. After all, going on previous form, the odds were stacked on them passing the buck to the G20 and the IMF. Consequently, it was a positive surprise when they managed to put numbers to bank recapitalisations (€106bn), the Greek haircut (50 per cent) and leveraging the European Financial Stability Facility (EFSF – €1 trillion). The problem is that all three figures are close to the minimum estimates of what is required to deal with the escalating debt crisis. Once again, European leaders remain trapped in the mindset that they can defeat the evil speculators (who they blame for all their problems) by using accounting tricks to shore up market confidence. But investors may be unwilling to fall for this again.
Aside from the likelihood that Ireland and Portugal will now seek relief from their own unsustainable debt burdens, key to the success or failure of the EU’s plans is the willingness of countries with large foreign exchange reserves to help leverage the EFSF. Brazil is wary, and yesterday China’s state media said it would not be “saviour” to Europe. No doubt these are the first bids in the poker game that will play out at this week’s G20. In the meantime, keep an eye on the Italian 10-year bond yield as it continues to rise above 6 per cent. If bonds remain under pressure, equities may soon follow them down.