Global markets weekahead: Good riddance Q3, hello Q4

After the battering that stocks, commodities and many currencies have taken in the past week, there is little wreckage to cling to at the end of a traumatic third quarter.

October, traditionally the slow start of a year-end risk rally, cannot come soon enough. Not that it is guaranteed, of course. Or that it might even come close to making up for the turmoil since July.

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With a week to go, the quarter is the second worst for global stocks in the 23-3/4 years that the MSCI all-country world share index has been running. The index is down nearly 20 per cent in the past three months but, perhaps more pertinently, has lost some 23 per cent since hitting a three-year high in May - putting it, by tradition, into bear market territory.

The coming week is not likely to offer too much to switch that around.

In Focus: Eating gold

Policymaker speeches may prod more market volatility and an Italian debt auction will take the temperature of the euro zone crisis, but there is little prospect of a striking move forward in the battle to dig Europe and the global economy out of trouble. The Reuters asset allocation poll for September on Thursday should show how investors have positioned themselves during the most recent blast of risk aversion.

One big issue will be whether large investors see the current market turmoil as part of a deeper, long-lasting imbalance in the world financial system, or as an opportunity. Aaron Gurwitz, chief investment officer of Barclay's Wealth, said during the past week that equities were now cheap even if the developed economies slip into a mild recession.

Not so golden after all

"We are recommending (to clients) that they can take a little bit more risk than normal," he said. "By historical standards, equities are cheap... even if we were going into a downturn. Companies have done very well."

GATHERING GLOOM
Companies will begin reporting their Q3 earnings in a week or so. Thomson Reuters Proprietary Research shows S&P 500 company earnings are expected to have grown 13.7 per cent year-on-year in the quarter. That would follow an 11.9 per cent increase in the second quarter. But that's for later. What is exercising investors at the moment is the state of the world economy.

The Federal Reserve's gloomy assessment during the past week combined with poor manufacturing surveys in other major players, notably China and the euro zone.

Chris Probyn, chief economist at State Street Global Advisors, described developed world economies this week as "like flying an aeroplane just at about stall speed and very close to the ground."

His view was that this situation will remain for a while, with developed economies pulling world growth down to around 4 per cent next year, slightly higher than trend but nearly all the result of emerging economies.

But the United States, Europe and Japan are all suffering from demand that has been damaged rather than simply delayed as is normally the case in downturns. This means growth is not responding to monetary policy. Various September sentiment and inflation reports will provide more evidence of how close Europe in particular is to a new recession.

"Imagine driving a sled," Probyn said. "You can rein in the dogs or let them out. Well in the global financial crisis a whole bunch of those dogs was shot. Demand was destroyed and it doesn't matter how much you let out those reins - nothing is running." That might go some way to explain why financial markets did not react positively to the Fed's launching ‘Operation Twist' in the past week, essentially deciding to sell or not roll over short-term debt and buy long-term bonds instead in order to keep borrowing costs low.

The same probably goes for the Group of 20 major economies' pledge to prevent Europe's debt crisis from undermining banks and the global economy.

BREATHE DEEP
The euro zone debt crisis indeed rumbles on. Yesterday brought with it more reports that Greece's finance ministers an orderly default was one of three possible scenarios facing his country.

The minister, Evangelos Venizelos, later denied the reports, although as a scenario it is by no means something that analysts, investment banks and fund managers have ruled out.

Having said that, Greece's current debt swap plan has made progress and the coming week should see the release of the next aid tranche from the International Monetary Fund, European Union and European Central Bank.