London, German and French markets reach two-year high as sentiment rises

Investors piled into equities sending markets to two-year highs yesterday as most of the major macro-economic risks that threatened to derail the recovery now appear to be receding.

The London, German and French markets reached two-year highs yesterday, with most European markets also having a good day, as investor sentiment improved on the temporary resolution to the US debt ceiling negotiations.

Just as US fiscal cliff negotiations had weighed on markets towards the end of last year, looming fiscal cliff negotiations had the potential for political gridlock and ensuing economic uncertainty. But the White House and US Congress have agreed a three-month extension to these talks. The markets are taking the view a resolution will be found before then to raise the US government’s $16.4tn debt ceiling.

Lorcan Roche Kelly, chief European strategist, with the US hedge fund Trend Macro, argues that investors are confident that most of the downside risks are in the past and there will be some sort of a recovery from now. “Investors are now looking at stocks in terms of future returns.”

But there will be no major switch from bonds to equities, says Mr Roche Kelly. The twin threats of a euro break-up and haircuts applied to eurozone debt have been greatly reduced. And with Spanish debt yielding above 5%, these are attractive returns for investors, he adds. Moreover, corporate bonds continue to rally.

“I don’t think we are in a market bubble either. There is nothing immediately that looks as if it will stop the market recovery. But it will be a gradual recovery. We won’t see the 2007 market highs anytime soon,” he says.

Investors will be also be looking closely at the Italian elections next month and the German elections later this year. It doesn’t look like either plebiscite will return eurosceptic parties or signal a change in eurozone policy.

Regional elections in lower Saxony on Sunday marginally returned the two main national opposition parties — the Greens and the SPD.

“Almost nine months ahead of the next national elections the only certainty is that nothing is certain. The CDU, and above all Angela Merkel, remain highly popular. This popularity, however, is clearly no guarantee for another term in office for Angela Merkel.

“Yesterday’s elections also illustrate that even sharing this popularity with the liberal party by ‘lending’ votes might not be enough. More rescue packages or a search for new strategic coalition partners might be needed. Otherwise, the chancellery could get an unexpected new landlord in September,” said Carsten Brzeski, a Brussels-based economist with ING.