Hard to imagine with financial markets still buoyant and newspapers full of tales of bonus greed, but there is still the possibility that captialism will end.  At least there is according to prestigious investment consultants Watson Wyatt in their latest study called "Extreme Risks".

The firm listed the demise of the system of private ownership as one of 15 threats to investors and the global economy that probably won't happen but which it reckons are worth worrying about anyway. The idea behind the report is that such things as climate change, the break up of the euro zone and war are always worth being included in an investment risk management process.

As for the future of capitalism:

In our view, the most likely scenario is moving along from one end of a spectrum where market is king (minimum regulation) towards the other end, where we could see more onerous regulations and government intervention in, and control of, the economy. The extreme risk, however, is the demise of the capitalist system and the end of the market as the primary means of resource allocation.

And the impact:

The economy would be likely to run a higher risk of failure and economic growth would be sluggish in the long run due to lower productivity.  Centrally controlled economies tend to be characterised by shortages, which are inherently inflationary. Private investment activities would collapse or even be terminated. The end of capitalism is simply the ultimate extreme risk. The economy is likely to be associated with extreme uncertainty and a large amount of wealth destruction during the transition period.

Watson Wyatt does try to give its free market clients some hope, suggesting that buying gold may be one way to hedge against the propect of capitalism's demise. But it admitted that in such a circumstance investors would probably be more concerned about the return of their investments rather that the return on them.

(Illustration called The Communist Party, from Threadless)

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The discrediting of the efficient markets theory in the aftermath of the financial crisis appears to have been accompanied with growing support for the view that rather than efficient in nature, financial markets are predisposed towards the formation of bubbles.

A bubble can simply be defined as an occurrence that begins when the price of an asset has been driven significantly above it "fair" value. According to the efficient markets theory this would not happen.

If bubbles are a natural outcome of financial market activity it is relevant to ask whether the very loose fiscal and monetary policies of many central banks and governments are presently sowing the seeds of the next bubble.

Even though the real economies of the U.S., UK, Eurozone and Japan continue to be defined by expectations of rising unemployment and falling real wages, access to cheap money has already helped restore the profitability of many investment banks.

In turn, this has fed risk appetite which is evident in the rally in stocks since the spring, increased demand for "risky" currencies and a recovery in commodities prices. Brent oil has rallied by 128 percent from its 2009 low. The ability of oil to rally despite the existence of oil supplies well above the seasonal average suggests there is already speculative element in this market which could be in danger of driving prices above their fair value.

This week’s meetings of the Federal Reserve, the Bank of England and the European Central Bank have focussed attention not so much on rates, but on the extraordinary policy decisions taken by these central banks in the wake of the financial crisis and whether conditions are ripening in favour of a gradual withdrawal of some of these policies.

The Fed last week ended its $300 billion treasury bond purchasing plan, though it will carry on buying mortgage backed securities. The Bank of Japan last week announced that it will stop buying corporate bonds at year end. The Reserve Bank of India also removed emergency support measures last week.

This week there is speculation that the ECB could announce that it will hold no more 12-month cash tenders next year. By contrast the Bank of England is expected to increase quantitative easing at the November 5, Monetary Policy Committee meeting. Supporters of quantitative easing continue to stress that the lack of clear inflation pressures suggests there is room for these plans to be extended.

However, the lack of response in either money supply or inflation indices could equally be illustrating that these plans are not having a significant impact on the real economy and are therefore no longer appropriate. The paring back of these plans are likely to have an impact on the ability of some banks to turn an easy profit and thus should rein in risk appetite and limit speculative and "bubble" forming activity.

Unfortunately, a bubble can only be truly confirmed after it has burst; a characteristic with clear destabilising consequences. If bubbles are natural phenomena within financial markets, the need for tighter regulation and ongoing reviews of processes that oversee the financial system are absolutely necessary.

This conclusion, while in complete contrast to the implications of the efficient markets theory, ties in very well with the political desire to reform the banking regulatory framework in order to protect the tax payer from future hefty bank bail-out costs. The banking landscape, while already vastly different from just two years ago could continue its transformation for years.

researchEMEA@forrex.com

Britain’s FTSE 100 seems to be almost impervious to any bad data that can be thrown at it. GDP data shocked the market showing the UK unexpectedly contracted in the third quarter.

Sterling tumbled more than a cent against the greenbackand gilts jumped while the FTSEurofirst 300 pan-European equity index trimmed gains considerably.

But Britain’s FTSE shrugged it off, hugging its 1 percent gains in the face of data which shows the UK economy is still ailing badly.

 It is the cosmopolitan nature of the FTSE which is keeping it buoyant. Miners and energy firms make up over 32 percent of the index, while miners banks, also very much global institutions make up a further 16 percent.

Howard Wheeldon on BGC Partners says:

“The FTSE is a function of globalalisation and trading conditions and growth elsewhere in the world have more of an impact than domestic growth. If the global recession is over and demand is picking up internationally, it’s all the more reason to close your eyes to
what’s going on in the tiny island that it happens to be registered in.”

By any standard the second quarter of 2009 was remarkable. Here are some numbers to chew over as the third quarter gets under way:   

— World stocks as measured by the MSCI All-Country World Index had their best quarter since the benchmark was first compiled in 1988.

    — The world index gained 21.2 percent for the second quarter. Its nearest “competitor” was the fourth quarter of 1998 when it rose 20.66 percent.

    — Much of the index’s gain this quarter came in the first two months. The index was essentially flat in June as investors began trading in a tight range.

    — Emerging markets were the main driver. MSCI’s sub-index for the sector gained 34.3 percent for the quarter, also a record high. Asian shares have been among the stars, with the MSCI Asia-Pacific ex-Japan index rising 33.7 percent. This was more than twice the gain on the U.S. Standard & Poor’s 500 index.

    — A big decliner was volatility. The Chicago Board Options Exchange Volatility Index, often called Wall Street’s fear gauge, fell below 30 percent at the end of the quarter to its lowest level since before the collapse of Lehman Brothers.

    — Over the quarter the VIX has lost 40.3 percent, reflecting growing confidence among investors that equities have ended the tumble of the past year or so.

    — One of the biggest percentage gainers was oil. New York crude gained around 42.2 percent on expected demand from a recovering world economy. Other commodities also made strong gains, with copper up 23.4 percent.

    — Hopes for a global recovery and rising concerns about future inflation — linked to the oil price surge and super-easy credit policy — pushed government bond yields and mortgage rates higher. Ten-year U.S. Treasury yields jumped 87 basis points over the quarter to 3.54 percent, having topped 4 percent at one point in early June. Ten-year euro zone government yields ended the quarter 39 basis points higher at 3.38 percent.

    — A growing appetite for higher-yields boosted demand for emerging market debt. Emerging sovereign debt spreads narrowed 212 basis over U.S Treasuries according to JPMorgan.

    — Investors ended the quarter clearly committed to future gains in higher-yielding assets. Reuters asset allocation polls for June showed cash reserves at a 23-month low, a sign that money was being put to work. EPFR Gobal data showed that about $130 billion has exited safe-haven money market funds in the year to date, but that is still less than a third of the $455 billion of cash that flocked to those funds in 2008 as a whole.

(Reuters photo: Gary Hershorn)

Some more bits and bobs to capture the current mood among investors:

– MSCI’s all-country world stock index has recaptured all of its 2009 losses and is now working on recouping last year’s. It is up 6 percent for this year.

– Fund researchers EPFR Global notes investors are moving at pace out of cash into emerging market equity and bond funds. In the week to May 6 a net $3.6 billion moved into various emerging stock funds. Money market (cash) funds saw outflows of $1.6 billion.

– State Street says there has been a “sea change” in investor behaviour. In April cross-border flows that it tracks suggested the most risk-seeking investment regime since May 2008.  “Institutions are buying emerging markets aggressively, adding to entrenched positions in Latin America and diversifying into emerging Asia,” it says.

– It is all obvious from the front end of the financial sector’s credit default swaps, according to Royal Bank of Scotland’s Alan Ruskin. Essentially, the hyper-stress is easing. “If financials grease the wheel that is the real economy, it is easy to see where the equity ebullience has come from,” Ruskin says.

– Merrill Lynch’s Global Wealth Management says it is still worth putting all this in context. “Equities are still 30 percent below the levels ruling on the eve of Lehman’s collapse.  Some European markets have suffered much deeper falls. Implied default rates in the corporate bond markets are still more pessimistic than the worst experience in seventy years,” it tells its clients.

(Reuters photo: Goran Tomasevic)

Five things to think about this week:

VALUATIONS
- The MSCI world stocks index has rebounded 37 percent since March, the VIX fear gauge has hit its lowest level since September 2008, and positive earnings surprises in Europe are marginally outstripping negative ones. But there are serious questions over the equity market’s ability to sustain its rise.

MACRO SIGNALS
- Trade data from the U.S., Canada and the UK, all out in this week, will be combed for signs of any recovery in global commerce. Also due are flash GDP data from the euro zone, industry output for the U.S., France, Italy, the euro zone and the UK, and Japan machinery orders.  
  
QUANTITATIVE EASING
- The ECB has finally shown willingness to deploy unconventional easing measures but it’s hard to judge the success of such steps. Narrowing credit spreads, stock markets’ bounce and gains in emerging market assets all show efforts to restore confidence in the financial system are having an effect. But if getting and keeping bond yields down is the yardstick for success, it’s unfortunate that 10-year UK and U.S. government bond yields are back up to levels seen before the announcement of quantitative easing in those countries. And diminishing returns on further balance sheet expansion raise questions over how much more money central banks can print before inflation fears start to preoccupy policymakers and markets.
  
COMMODITIES
- Confusion over the reasons for the commodities rally has reduced the usefulness of commodities prices as indicators of the industrial outlook. An apparent economic recovery in China has helped to boost the CRB commodities index by 21 percent from February’s lows. But how much does the rise reflect a change in supply/demand for commodities, and how much is it simply due to idle money flooding back to unstable markets? Similarly, why has spot gold remained strong above $900 as jitters over the financial system decrease? Gold could be reflecting expectations that recovering economies will boost physical demand for the metal, but it may also be responding to fears of currency debasement after central banks’ radical monetary easing.

EMERGING MARKETS 
- Rising commodity prices and an easing dollar have offered a perfect environment to re-enter emerging markets. The coming week’s  EBRD meeting will focus attention on central and eastern Europe and how it is coping with a nasty period of refinancing (albeit less dire than the IMF initially estimated).

The financial deluge will bare real gems for investors flush with cash, but watch out for the rubbish, the super-rich have been told at a Geneva conference. The first round of quarterly results has brought some pleasant surprises, but investors should be cautious and cherry pick if they want to hit the jackpot, was the mantra.

 ”It’s not just because we had a year of correction that the next year will be positive,” said Ariel Sergio Goekmen, an economist and a director at Credit Suisse’s head office who looks after wealthy families’ investments. “The recession could be deeper than one expects. We have not yet seen the darkest side of the night.”

(Reuters photo: Sukree Sukplan)

The steady stream of less-bad-than-expected economic data has evidently been working as a builder of optimism. Confidence in improved economies and financlal market conditions is growing.

One of the biggest surprises has been Germany's ZEW economic sentiment survey -- which polls analysts and economists in Europe's largest economy. Not only did the index jump this month, it entered positive territory for the first time since July 2007. That was before the credit crisis hit.

U.S. financial services firm State Street also reports that the mood among institutional investors in North America, Europe and Asia is at a nine month high. The main point about this survey is that it is extraplolated from the actual buying and selling patterns within $12 trillion that State Street holds for investors as a custodian.

So, things are on the up. But would that not be expected given the huge amount of money being pumped into the world economy by governments and central banks? Or after global stocks have risen close to 30 percent on a period of about six weeks?

What is always unclear when it comes to sentiment indicators is whether they point to someting new or just reflect exisiting circumstances.

But maybe it does not matter. If people think that things are going to get better, doesn't that just mean they are more likely to?

(Photo: Jeremy Gaunt)

Another month and another Reuters asset allocation poll. This time saw investors in United States, Europe and Japan lifting their equity holdings and cutting back slightly on bonds.  Fits with what has been happening on global financial markets, where MSCI’s main world stock index is heading for its best month in at least six years.

So the big question is what happens now. Is this a bear market bounce that will soon dissipate?  Or is it the start of something bullish that will last?

Bond yields are on the rocks, prices are hitting the steepest slopes and credit derivatives are at an impasse. So what better way to spend the time than to join 200 bond traders for a skiing weekend in Switzerland?

Throwing caution, and the global financial crisis, to the winds, the International Capital Market Association, the self-regulatory organisation for capital markets, is holding its annual ski weekend in the Swiss resort of Villars, “set on a sunny plateau above the Rhone Valley, with superb views over the
Vaudois Alps”.

The association has been running ski events for members for over 30 years. “A packed programme of outdoor activities and entertainment starts with the welcome drinks and dinner on Friday evening … and gets into full swing with racing on Saturday.”