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Rallying on solution hope

17 October 2011 By Ian Campbell

Markets have rebounded strongly from the brink of a bear market. Investors are putting a lot of faith in the euro zone deploying a “big bazooka” to solve its debt crisis. But a European solution is hard to deliver. The risk is that next weekend’s euro zone summit will disappoint – and the rally will fade.

This month’s rebound has been impressive. In intraday trading on Oct. 4 the S&P 500 index was down more than 20 percent from its April 29 peak – the classic definition of a bear market. Since then, however, the S&P rallied by 14 percent in less than two weeks, spurred on by hope that plans to recapitalise Europe’s banks was a sign the euro zone was finally getting to grips with its problems. Stocks around the world have benefited: the MSCI all-country world index rose by 5.4 percent in the second week of October, its best performance for over a year.

The rush to cover short positions probably added to the bounce. The Commodity Futures Trading Commission on Oct. 14 reported that traders’ net short positions in the euro had fallen by 10.7 percent in a week. The euro, which had plunged from $1.45 on Aug. 29 to $1.32 on Oct. 3, has recovered to $1.38. A softer dollar has also favoured commodity prices which rose by 6.9 percent between Oct. 3 and Oct. 14, according to the Reuters Jefferies index.

However, the rally will only have legs if euro zone leaders actually deliver the promised comprehensive solution at their summit in Brussels. The omens are mixed. True, governments appear to have reached some sort of consensus on a plan that involves a bigger haircut for Greek creditors, bank recapitalisation, and leveraging the European Financial Stability Facility bailout fund. But such a plan must still clear multiple hurdles before it can begin to be implemented. And the euro zone’s track record on taking decisive action is far from encouraging.

Wolfgang Schaeuble, Germany’s finance minister, has warned the measures are not an ultimate solution to the crisis. Investors should take note. If hopes are dashed, the recovery of the past fortnight could easily reverse.

 

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