Summary
* Many economies are picking up; most of all the US and the UK. Therefore, the financial markets are anticipating an end to the period when more money was created than the real economy could absorb, causing asset prices to soar.
* Equities are becoming oversold. Before long, a rally could be on the cards. Nevertheless, there is a more than 50/50 chance that we are seeing the start of a bear market (i.e. price drops exceeding 20%).
* We think the emerging economies and the weak Eurozone countries will be hardest hit.
* Likely, prices will plunge until the economic prospects of various countries are impaired. If so, central banks may reopen the liquidity spigots. We think the ECB and the Bank of Japan will take action long before the Fed does.
* Weirdly, in this situation the yields on 10-year US and German government bonds could drop. After all, they are seen as safe havens in tumultuous times. Most other bonds are considered risky so these yields will not fall far; they could even start to rise.
* In our view, it is unwise to assume that the yen will continue to weaken. We expect the Japanese currency to strengthen in the coming months, on the back of unwinding carry trades.
* Growth differentials between the US and Europe, an improving US trade balance, and rising Eurozone tensions could put downward pressure on EUR/USD, albeit gradually. The pair has not dropped yet; mainly because central banks in the emerging markets are selling dollars on a large scale in order to defend their currencies.