What next for U.S. and European markets?

With the FTSE All share, Dow Industrials and S&P 500 all either close to or at 52 week highs and the U.S market showing very strong gains for year to date (S&P 500 up 16.5%), the big question is, how much further do markets have to go this year?

As the previous post on the blog has said, with the Federal Reserve unveiling and effectively “open ended” QE3, and with the Eurozone debt crisis seemingly in retreat for now following the European Central Bank’s intervention, the sense of optimism seems palpable. The bulls are in the driving seat…

In early September, Mario Draghi, President of the European Central Bank (ECB) said the bank would purchase unlimited government bonds from Eurozone members at their request with the overall objective of preserving the Euro. On September 12, the German constitutional court dismissed a complaint filed by 37,000 Germans arguing that the establishment of the European Stability Mechanism (ESM) was against the country’s constitution and so ensuring that Draghi’s intervention methods remain and preserving the mantra that the ECB “would do whatever it takes” to preserve the euro.

The major indices may have further to go but perhaps not too much further, with some major technical hurdles to cross, particularly in the US market.  With institutional investors showing big gains in S&P 500 stocks, the temptation may to bank some profits in the short term on this stimulus induced rally in the North American market and redeploy it elsewhere. If further progress can be made in Europe on tackling the overwhelming issue of sovereign debt, gains in European stocks may be more likely, but much depends on Spain in the short term.

Spain’s continued issues caused by the bursting of the property bubble haven’t gone away and its leadership continues to avoid asking for help from the ECB, partly because Spanish bond yields have moved sharply into reverse (5.8% compared with 7.6% in July) in recent weeks but also to avoid a politically uncomfortable bail out. In order to accept money from the ECB,  Spain would need to agree to accept strict policy conditions, in essence, further austerity measures and oversight by the European Commission, ECB and IMF. 

The bears may be in hibernation for now, but perhaps the eurozone debt crisis hasn’t been confined to history just yet. I for one am not making oversize bets that’s the markets will continue their run of recent weeks, especially in the US. Steady as she goes, as far as I can see in big caps, but riskier assets may well now catch up, so expect some action in the small cap sector in particular.

Contrarian Investor UK