Wobbles, but an improving backdrop

By Jeremy Gaunt, European Investment Correspondent

LONDON (BestGrowthStock) – Financial markets remain in a jittery mood heading into the new week although riskier assets such as emerging market stocks are well off their lows and expectations of future volatility have come back down to earth.

A new worry about debt default in Hungary and some moderately disappointing U.S. jobs data on Friday acted as a brake on what had been a gradual return of composure after a rough couple of months.

But the underlying mood among investors is still one of slowly developing optimism.

This is in part because despite various ructions in markets, long-term investors have hung on to their belief that the world economy is generally in recovery mode.

Friday’s U.S. jobs data were not as positive as analysts had hoped for but still indicated improvement from past months, adding to an overall picture of steady, if uninspiring, growth.

Reuters latest polling on global GDP underlined this.

They showed economists now expecting 4.1 percent growth this year, up from a 3.6 percent projection in January, and 3.8 percent next year, down slightly from 4.0 percent.

Perhaps more significantly, the range of projections for growth next year both narrowed and rose, suggesting that optimism is beginning to outweigh pessimism.

“We have seen a strong rebound driven by fiscal measures and a restocking of inventories,” said Alessandro Bee, an economist at Bank Sarasin in Zurich.

He expects a slowdown of the current rate of growth toward the end of the year and into the early part of next year, but nothing in the way of a double dip.

“We are optimistic that it will be kind of a mid-cycle slowdown. Monetary conditions are still very supportive,” Bee said.

This relatively positive macroeconomic backdrop has allowed investors to get over some of their worst fears about European debt defaults, not withstanding dire circumstances in economies such as Greece and Hungary.

Since hitting a year low on May 25, world stocks (.MIWD00000PUS: ) are up some 6 percent with the more volatile emerging market component (.MSCIEF: ) gaining more than 8 percent.

Some technical specialists, such as Richard Ross of Auerbach Grayson, even see buy signals emerging.

“Wednesday’s 95 percent upside volume day on the (New York Stock Exchange) added to the litany of evidence in support of our view that the painful May correction has run its course and a powerful advance has commenced,” Ross said in a note.

Significantly, the CBOE volatility index (.VIX: ), the so-called fear gauge of stock market expectations, has fallen back to around 30 from a level near 50 that was implying major trouble ahead for equities and riskier assets in general.

Investors, meanwhile, are re-assessing their earlier fears about a major economic catastrophe springing from debt problems in the Europe.

“We do not expect an economic stalemate like in the aftermath of the Lehman failure,” Klaus Wiener, head of research at Generali Investments in Cologne, said in a note.

“The growth impact is without doubt negative, but there are offsetting factors as well: a weaker euro, strong reactions of the monetary policy, and the fact that sovereign credit risk is not an issue in Asia (ex Japan).”

BACK TO BASICS

This is not to say that all is back to normal. Far from it. Investors still have a large number of questions even beyond the ones surrounding the euro zone.

“Will the U.S. deal with its fiscal burden? What is the inflation outlook for the major economies? How far will the regulatory pendulum swing?” said Andrew Milligan, head of strategy at Standard Life Investments in Edinburgh.

“On balance, investors are still pretty nervous.”

Reaction on Friday to gloomy prognostications from Hungarian officials underlined the fragility of market sentiment.

The focus is what will happen to leading banks if Hungary defaults or if the fall in the forint fuels a rise in loan delinquency among Hungarians who have borrowed heavily in euros and Swiss francs.

The coming week will offer a range of events to keep investors on their toes, including speeches on Wednesday by Federal Reserve Chairman Ben Bernanke in Richmond, Virginia and European Central Bank President Jean-Claude Trichet in Frankfurt.

On Thursday, Trichet will hold a news conference after the ECB makes its latest policy decision. The Bank of England and ECB hold rate meetings, with both expected to stay on hold.

The Fed also releases its Beige Book on Wednesday, offering anecdotal hints about current economic conditions in the world’s largest economy from the Fed’s various districts.

Euro zone and other European Union finance ministers, meanwhile, meet at the beginning of the week where it is almost inevitable that they will discuss Hungary, Greece and possibly even the tumbling euro.

The single currency has fallen some 16 percent against the dollar so far this year and is currently trading around $1.20, a four-year low.

Brown Brothers Harriman suggested on Friday that the fall was welcome news to the euro zone because of its implications for exports. It said there was “malign neglect” in the euro’s fall as opposed to the oft-cited “benign neglect” said to be practiced by the United States.

Stock Market Research

(Editing by Mike Peacock)

Wobbles, but an improving backdrop