There have been substantial swings in financial markets over the past few days. October was a significant risk-on month in general, with this week exemplifying that trend. Many equity markets and aggregated commodity indices are back within 5% or so of their pre-sell-off levels. However, there remain some important differences in how markets look now compared to the end of July. There has been an interesting divergence between the performance of government bonds and equity markets, credit spreads are much higher, although equities have rallied and, most importantly, Spanish and Italian bond yields remain at unsustainably high levels.

There were some positive steps forward announced at the European summit covering Greek debt, bank capitalisation and the extension of the European Financial Stability Fund. However, the European sovereign debt crisis is not over and there are still some hurdles remaining. Concerns about global growth hung above markets throughout the summer. However, third quarter GDP figures from China and the US among other indicators suggest that at the moment, there is little sign of recession outside of Europe.

We believe the downside growth risks and European policy risks that were so aggressively priced into markets during the summer are off the table for the moment. However, we would emphasise that these risks have not disappeared completely and market pricing now offers less protection for adverse shocks.

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