Market review quarter 3 2010

'I used to be decisive, but now I am not sure' would be an appropriate sentence to describe Mr. Market during this third quarter of 2010. The MSCI World Index ($) was up 8% in July, fell nearly 4% in August and rallied 9% in September, mirroring the 'risk on, risk off' mindset that has characterised investor sentiment. In the US, better than expected second quarter earnings coupled with relatively robust GDP readings underpinned rising asset prices early in the quarter, however, weak unemployment and housing data in the US spooked market participants in August. Confidence started to wane and, together with anaemic wage growth, the lack of a 'feel-good' factor was clearly harming the future prospects for US consumer spending. Fears about the arrival of a 'double-dip' recession escalated as commentators voiced concerns the US government appeared unlikely to be in a position to provide an offset to the problems building, given the political stalemate developing in Washington. The Fed chairman, Ben Bernanke, succinctly summarised the outlook for the US economy as being 'unusually uncertain' and, ironically, his rhetoric thereafter was taken by markets as a signal the Fed would be prepared to do whatever was necessary to address economic weakness. Through September, markets rose sharply in anticipation of the arrival of 'QE2' - this being an extension of the quantitative easing, or money-printing programme, used at the peak of the crisis to arrest the sharp decline in economic activity.

Reflecting on matters closer to home, European investors have also had to face waves of corporate and economic newsflow, which have boosted or weakened sentiment on a monthly basis. The stand-out economic news came from Germany which expanded by 2.2% from the first quarter to the second, its fastest pace since reunification. The catalyst for this export-led recovery was a weaker euro, and anecdotal evidence that some German car-makers could not make cars fast enough to keep up with demand from Asia, particularly China, was indicative of the contrast in economic fortunes being enjoyed by the East compared to the West. The negative news continued to surround the deficit-funding difficulties faced by countries such as Greece, Spain and Ireland, with the latter's rescue of its banking sector likely to be a millstone around the country's finances for years to come.

In the UK, the impact of the measures announced in the Emergency Budget was digested during the quarter. The chancellor announced additional consolidation measures of £40bn to those already announced by his predecessor, bringing the total to £113bn. The Comprehensive Spending Review (due 20 October) has been in the minds of investors, particularly given the Office of Budgetary Responsibility's estimate that this will bring 490,000 public sector job cuts by 2014. With the standard rate of VAT rising from 17.5% to 20% at the beginning of 2011, fears have built around the durability of the recovery and a second tranche of quantitative easing has been under discussion within the Monetary Policy Committee (MPC). Stubbornly high inflation does run the risk of the committee losing credibility if it were to start buying gilts again, however, the fragility of the economy together with its own assertion inflation will start to fall, does give the committee some room for manouevre. UK government bond markets, like those in the US and Germany, have re-priced in anticipation of intervention by central banks.

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