Pessimism has crept into world markets over Euro zone solvency an may push into further negative territory in short term, experts believe

Written by Ray Clancy

Monday, 31 May 2010 12:00

World markets are becoming too pessimistic as the recent bout of volatility has pushed them into correction territory, according to analysts.

Scepticism over the effectiveness of the €750 billion Euro zone stabilisation package has failed to quell market concerns over solvency issues and there have been renewed signs of stress affecting interbank markets, which has led to some analogies being drawn with events surrounding the collapse of Lehman Bros in 2008.

These factors, combined with concern over regulatory change and political interference, as well as tensions over North Korea, have led to widespread risk aversion, and the most serious setback seen in market confidence since the trough in equity markets in March 2009.

‘For investors, there is much to fret about. Risks are numerous and significant. Levels of leverage remain extremely high and it is clear that the solution of gearing up the public sector balance sheet to relieve stress in the private sector is not one which is sustainable and, indeed, is beginning to be tested,’ said Paul Niven, Head of Asset Allocation at F&C.

‘There is increasing pressure for action to address the fiscal position of governments but the good news at present is that there is little sign of a generalised sovereign funding crisis as yields on developed market government bonds have been pushing lower, despite concerns over solvency in peripheral Europe,’ he added.

From Niven’s perspective, the overall growth picture still looks reasonably good and the market is now becoming too pessimistic. Earnings expectations continue to be upgraded and corporate fundamentals are strong. There has been such a marked de-rating in markets that Niven believes equities are, once again, offering good value against competing asset categories.

Niven anticipates that the markets can become cheaper still and there is a real risk that a negative feedback loop to the real economy and corporate sector develops, particularly if stress within the banking sector intensifies and if credit markets once again begin to close.

Additionally, Niven is concerned that the market has not seen the levels of capitulation and panic which typically signify a major market bottom. Nonetheless, with strong lead indicators and global PMIs, he believes there is potential for significant pickup in corporate investment spend and ongoing signs of improvement in labour markets, combined with a soft landing in China and improving inventory cycle. As such, Niven sees little signs of the feared ‘double dip’ at present.

‘Markets may well push further into negative territory in the short term, flushing out any remaining optimism, but contrarian investors may also look for a signal that European authorities really are looking to aggressively tackle their problems as pressure will be mounting on the ECB to move towards more robust intervention,’ Niven concluded.