Ongoing recapitalization of the eurozone financial system and the likelihood of a soft landing in China have reduced two of the key risks facing investors. These positive developments, combined with the continuing U.S. recovery, have paved the way for a 20%-30% rally in global markets since last fall. We expect the rally may carry on, possibly for a couple of more quarters, driven by abundant liquidity and negative real interest rates.
While we have pulled back from the deep abyss of a eurozone breakup, the global outlook is definitely not all rosy. Anaemic growth is a global issue, as is the pile of unsustainable debt on both public and private balance sheets. Deleveraging has come a long way in some jurisdictions, including the U.S., but it has barely begun in others. Maintaining growth during the deleveraging process is critical, and remains highly dependent on both policy stimulus and liquidity. The global economy is fragile and a policy mistake―for example, a premature push for rapid fiscal consolidation―risks tipping the global economy back into recession as it did in 1937-38 and for Japan twice during its long and continuing battle with deflation. Given the rhetoric around the U.S. election, and the record of bungling of eurozone politicians, a policy mistake is a clear danger.