What's next for global equity markets?

By Chris Tedder, Research Analyst, Forex.com

In Europe, equities are feeding off the positive risk sentiment in the region. Media reports suggest that Greece may be on the brink of agreeing with private sector bond holders, ensuring that Athens's second bail-out package will be finalised and ensuring the country has the required funds to meet its debt requirements. Additionally, IMF Chief Lagarde announced that she would put forward a proposal for a massive EUR 620 billion increase in funds to be used to help the Eurozone should more funding problems arise.

However, the risk rally might be over extended. Even if the IIF and the Greek government reach a deal, there is still no guarantee that there will be 100% participation. In fact, we don't see how there could be a 100% participation rate given that some of the debt holders likely hold credit default swaps (CDS), which give these holders an incentive not to participate. Furthermore, a lot of debt holders are not represented in the talks, so there is no way of knowing if they will participate. Even if a plan does get full participation, Greece's problems are far from over, because any more loans with likely come with contingencies for tighter fiscal conditions, further restricting economic growth.

Furthermore, there are also a lot of questions about Lagarde's proposed fund injection. For instance, there is still a lot of uncertainty about where the funds will come from; the IMF head stated that she would like to see Bric nations and Japan increase their contributions, but both China and Japan have not committed to add more yet. Nevertheless, any boost to the fund will likely have to come from the US, who is the largest contributor to the IMF, but convincing Washington to take out the money clip could prove to be an uphill battle.

US optimistic on domestic economy

The US is being lifted by optimism that the domestic economy will be able to weather the EU crisis, made evident by around a 3.33% ytd rise in the Dow Jones index and an approximate gain of 4.50% ytd for the S&P 500. More evidence can be found in recent earnings reports, which suggest that companies in the US are navigating these tough times, with 22 out of 35 corporations that have reported results between January 9 and January 19 beating projections on a per-share earnings basis.

Sentiment in the world's biggest economy is also being bolstered by improving labour market conditions. Recent figures out of the US showed that jobless claims dropped to their lowest level since early 2008, beating expectations to come in at 352K, after payrolls grew by 200,000 in December. So, combined with the fact that the government has a big bazooka in QE3, there is some potential for upside for US stocks, but it will likely be dependent on the ability of the domestic economy to decouple from events in Europe.

China cuts should stimulate growth

As well as the US and Europe, China also has the ability to dominate investor sentiment, especially in economies throughout Asia who rely heavily on it for trade. It is clear that the world's second biggest economy is going through a cooling off period, as Beijing attempts to rein in inflation and property prices. Since 2006 the Chinese government has increased the required reserve ratio for major banks to a high of 21.5% in 2011 from 7.5%.

However, China is now in the process of loosening these anti-inflation measures in order to combat the effects of the European debt crisis and relatively weak levels of global growth. As a result, the RRR now sits at 21% and we are predicting more cuts after the Chinese New Year, in an effort to stimulate growth and avoid a hard landing. This should provide a nice boost for equity markets in Asia that depend on China's lust for resources.

Overall, stocks markets are being lifted by sentiment which could easily turn negative, and if we believe the World Bank's growth forecasts, the global outlook for 2012 is fairly weak. Accordingly, we are nervous about the short-term future of equities, stemming from the uncertainly that surrounds the European crisis and the ability of equity markets outside of Europe to avoid being dragged down by negative sentiment from the Eurozone.