Market Comment 1 February 2012

Notwithstanding our concerns about the increased chances of a technical consolidation or a small correction this week, markets have continued to rise. The primary driver has been expectations of the long-awaited restructuring of Greek debt. Whilst this strong and steady market move is welcome, I am slightly concerned at its failure to consolidate more healthily, after all, as the saying goes: "what goes up also comes down."

The details of the Greek restructuring have been increasingly leaked to the press over the last few days. We are now expecting old bonds to be exchanged for 30yr bonds with a coupon of around 3.6% plus a GDP enhancement, so there would a bonus pay-off if the Greek economy performs better than currently expected.

At today's prices, then, it seems that the Greek restructuring should be full expected, and already accounted for in the market. When it is confirmed, markets might either take the chance to consolidate (for example if the impact on Greek banks is extreme), or continue to move up more slowly (the jump we previously expected is now probably in market prices).

The downside risk is that the market will see through the current European rescue steps and not give the economic union the benefit of the doubt. After all, the Euro Summit continued to focus on fiscal measures, which are negative for growth. Also, (bearing in mind all this austerity) it remains uncertain that even the Greek problem has been addressed with this restructuring, since the European loans and ECB holdings will not be restructured alongside private investor exposure.

So, the European problem is far from resolved, but we believe the ECB's ongoing liquidity campaign serves to reduce the chances of a dramatic collapse of short-term confidence. Hence, we continue to recommend using any declines as a chance to build exposure to risky assets.

In other news, the US Fed has remained a supportive force, which has been welcome news as we receive a mini-flow of less positive data there. Not only has the FOMC extended the period of near-zero interest rates, but in his press conference last week Chairman Ben Bernanke also expressed a readiness to further stimulate the economy unless he sees improvement in growth soon.

Meanwhile, China has reopened cautiously after New Year festivities. Emerging markets are the leading equity group year-to-date (up 11.2% versus 6.1% for Eurostoxx 50 and 4.4% for S&P 500). We remain positive on EM as an asset class, and on China and Brazil in particular. But, global equity markets remain correlated. If Europe or the US consolidates, EM will probably pause too.