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First published in Great Britain in 2011Copyright Harriman House Ltd

The right of George G. Blakey to be identified as the author has been asserted in accordance with the Copyright, Design and PatentsAct 1988.

ISBN: 978-0-85719-292-9

British Library Cataloguing in Publication DataA CIP catalogue record for this book can be obtained from the British Library.All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of the Publisher. This bookmay not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it ispublished without the prior written consent of the Publisher.No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in thisbook can be accepted by the Publisher, by the Author, or by the employer of the Author.

Registered to a.mudassar88@gmail.com

About the Author

George G. Blakey is a stockbroker of many years experience. In the past he has worked for a numberof banks and investment groups as a financial analyst and was Research Partner with stockbrokersLyddon & Co.

Although no longer in the City, George has retained his membership of the Securities Institute and theSociety of Investment Professionals. He has an M.A. in Economics and Law from Trinity College,Cambridge. He is the author of A History of the London Stock Market 1945-2009 (9781906659622),World Financial Markets in 2010 (9780857190987) and World Financial Markets in 2012(9780857192936).

Registered to a.mudassar88@gmail.com

World stock indices in 2011

I have included price charts the major international stock indices for reference.

Figure 1 FTSE100

Figure 2 FTSE250

Figure 3 Standard & Poors (S&P) 500

Figure 4 NASDAQ

Figure 5 Hang Seng

Figure 6 Nikkei 225

Registered to a.mudassar88@gmail.com

Quarter one, January to March

The Way BackThe break above 6000 for the FTSE100 on Christmas Eve 2010 seemed to have confirmed the besthopes of the bulls, as did the rapid reversal of the hundred points loss in the closing days of the yearwith a 150 points gain in the first two trading days of 2011. A 6% surge in the price of BP, taking itback to almost 500p, helped the FTSE higher. The index of the 100 leading UK shares also benefitedfrom gains on Wall Street after a dramatic improvement in US jobs data as private sector hiringrecorded a much higher than forecast increase.

However, a statement from the US Federal Reserve (Fed) to the effect that it was not convinced thatthe recovery was sufficiently established to scale back its $600 billion bond purchase operation,coupled with disappointing non-farm payroll figures for December, were enough to halt the NewYear rally.

More cautious commentators welcomed the pause, seeing it as a confirmation of their view that therampant bullish sentiment so evident at the turn of the year was yet another case of irrationalexuberance on the part of investors. These investors had apparently come to regard a near-zeromonetary policy backdrop as normal interest rates remained at 0.5% in the UK and between therange of 0% to 0.25% in the USA throughout the quarter simply because it had been in place for solong. Misplaced enthusiasm had powered stock markets back to their pre-Lehman levels but giventhat such artificial and deceptively benign conditions could not continue indefinitely, investors werefailing to price in the consequences of a return to the real normal of market-set interest rates.

Inflation Fears IncreaseBy mid-January, the FTSE100 was clearly having difficulty hanging on to 6000 plus territory,unsettled by the December inflation figure of 3.7% which had sent sterling to a two-month high of$1.60 on counter-inflationary rate rise expectations. Semi-official pronouncements that core inflationremained subdued and that volatile food and energy price increases would soon drop out of theheadline calculation were not very convincing for consumers, all of whom were affected by suchallegedly transitory factors.

Furthermore, the oil price was back to almost $100 again, even in the earliest stages of economicrecovery, and the extraordinary rises in soft commodity prices over the past year showed no sign ofgoing into reverse in the face of rising demand from the vast and growing populations of thedeveloping world. In any case, to claim that inflation was more of the cost/push variety thandemand/pull was no consolation for consumers unable to negotiate wage increases to maintain theirliving standards. Just to complicate matters, a much worse than expected GDP figure for the fourthquarter of 2010 of -0.5% raised double dip fears and weakened the case for a rate rise.

In the euro zone, inflation had risen above the ECBs target for the first time in more than two years.

Despite this, markets took heart from evidence of the broadening economic recovery in Germany andits beneficial effect on France (the two countries are each others biggest export markets), and theregion as a whole. The euro responded positively to this performance by its core economies,regaining the $1.36 level for the first time since November 2010. Hopes of a resolution of thesovereign debt crisis were boosted, with Germany, Atlas-like, playing a supportive role.

Confidence over the sovereign debt issue had ebbed and flowed in preceding months, and a contraryview held that the German public had no stomach for their country playing such a role. This campwere of the opinion that the ECBs bail-outs to date had both compromised its integrity and exhaustedits firepower, and the weakest of the peripheral states would find it impossible to power their wayback to growth while instituting austerity programmes at the same time as paying well over the oddsfor funding.

Banks In LimboUS markets fared better than their European counterparts, helped more by good earnings reports frombig name companies like GE, IBM and Apple (the last named now with a market capitalisation of$320 billion, making it the second biggest company in the world after Exxon Mobil) than by economicdata on employment and housing, which remained inconclusive.

Banks lagged the rest of the market, depressed by a sharp drop in fourth-quarter trading revenue atGoldman Sachs and raising fears that regulatory changes would mean that US banks no longerpossessed a licence to print money a privilege now strictly reserved for the Fed. Bumper resultsfrom JP Morgan made no difference to this gloomy outlook for the banks, argued Lex in the FT, andthe column branded CEO Jamie Dimons accompanying statement that the future was extremelybright as delusional at a time when policy rates were zero, a state of affairs that could not continueindefinitely.

Management changes among the giants of the technology sector, namely Hewlett Packard, Google andmost notably Apple, whose founder and presiding genius, Steve Jobs, announced that he was takingindefinite leave of absence on medical grounds, saw these companies stock prices trimmed back.That left the NASDAQ Composite at the end of January some 70 points shy of its peak for the monthat 2685 while the S&P500 remained just short of the 1300 mark and the Dow held steady at justbelow 12,000.

London markets also limped towards the closing days of January, hobbled by the banks, which werenow threatened by the proposals of the Independent Commission on Banking. The Commission waschaired by the outspoken Sir John Vickers, who seemed to have called the bluff of the banking lobbyby saying that that the financial crisis had exposed a damagingly rickety structure at the heart of thefinancial system. The Commissions key proposals were to split customers savings and loans awayfrom high risk investment banking operations and thus obviate the need for the taxpayer to provide agenerous safety net when things go wrong.

The unexpected fall in fourth-quarter GDP continued to raise problems for the UKs coalition

government by giving weight to the argument that its proposed austerity programme was certain tostifle growth. The well-respected outgoing chairman of the CBI, Sir Richard Lambert, then added hisvoice to those of the opposition by claiming that the government lacked a policy for growth. Againstsuch a barrage of criticism, the FTSE100 was considered to have done well to stay close to the 6000level, but some justification for this resilience was demonstrated in the first days of February with therelease of Purchasing Managers Index (PMI) data for the manufacturing sector showing the sharpestincrease since the series began in 1992.

A similar jump in the data for the services sector, coupled with a better than expected run of resultsfrom leading companies like BT, Vodafone, Unilever and Compass, generated a dramatic boost toinvestor sentiment and 6000 now began to look more like a floor than a ceiling for the FTSE100.Backed by the seemingly unstoppable rise in metal prices, mining stocks were responsible for a goodproportion of the rise in the index, in the company of mega-cap multinationals. BP failed to add itsweight to the rise, with its price pulling back from the 500p line as commentators expressed doubtsabout the wisdom of the companys decision to throw in its lot with Russia on the Arctic explorationventure.

Power To The PeopleWith markets in London and New York apparently poised to continue their advance, it was the cue forgeopolitical factors to come into play and induce at least a pause. The trigger was provided by eventsin Tunisia where a popular uprising, as distinct from a politically-inspired one or a military coup,managed to overthrow a long-established authoritarian regime. Given that the conditions thatprovoked the uprising namely high unemployment, especially among the young, widespread poverty,political repression and blatant corruption in the ruling elite obtained in countries throughout NorthAfrica and the Near and Middle East, many commentators believed that Tunisians had created anexample to be followed by oppressed masses elsewhere in the region, major oil-producing countriesincluded.

Such foreboding soon appeared to be fully justified when within days protestors took to the streets ofCairo and all the major cities of Egypt, calling for the resignation of President Mubarak and thedismantling of his regime. Efforts to quell the uprising failed and with international opinion fullybehind the protestors, the President was left with little option but to bow to their demands and handover interim control of the country to the army.

Western stock markets initially saw this as a satisfactory end to a potentially dangerous crisis andedged up to new highs, but unrest spread like wildfire across the region affecting Algeria, Libya,Oman, Yemen, Jordan and Bahrain. Ironically Irans President Ahmadinajad, who had praised theEgyptians for toppling their pro-American, pro-Israeli leader, now found himself facing the samedemands as his political opponents flooded onto the streets. Thus far from ending the crisis, thesuccess of the Tunisian and Egyptian protesters had encouraged others to take the same course andraised uncertainty in the region to a new and much higher level.

Oil Prices On The RiseOne certainty to come out of the turbulence in the Middle East was a rise in the price of oil, with itsconcomitant impact on inflation. In the UK, petrol prices surged to new highs as Brent crude topped$104 a barrel, helping the CPI to record a 4% rise in January (twice the Bank of Englands targetfigure) and apparently confirming predictions that the rate would reach 5% later in the year. Thetiming of the Banks first increase in base rates from the level of 0.5%, where they had been for twoyears, now became the big question following the Governors cryptic comment that inflation wouldfall to 2% in 2012 if interest rates rose in line with market expectations.

The doves on the Monetary Policy Committee still outnumbered the hawks and while downgradedgrowth forecasts for 2011, together with rising unemployment, supported their reluctance to raiserates, their assertion that rising food and energy prices were a passing phase continued to be less thanconvincing. The ECB took a similar view and calmed rate-rise expectations by saying that the priceincreases that had pushed the euro zone inflation rate up to 2.4% were essentially short term andwould soon abate.

Stock markets seemed content to go along with this recipe of interest rates being kept at exceptionallylow levels until such time as growth was seen to be firmly established. As for inflation, the officialview was that it would remain subdued while growth was modest and could be countered by raterises in due course as it picked up in line with growth. As Chuck Prince of Citigroup might have putit, While the music is still playing, equity investors can keep dancing.

Emerging markets, with their near-double digit growth rates, took inflation much more seriously.China, in particular, had manifested its concern by raising bank reserve requirements five times in2010 and interest rates twice in February 2011. A number of commentators questioned how Westernmarkets would react to the withdrawal of stimulus and the imposition of austerity programmes which their governments insisted was necessary if their countries were to lay the foundations for areturn to sustainable growth paths. The implementation of similar restrictive measures in the BRICsand other emerging markets had led to their underperformance in recent months in relation to themarkets of the developed world, sparking a massive outflow of funds from the former to the latter.

Time For ReflectionBy the beginning of March even the most convinced of bulls were ready to admit that the bull marketthat had seen the S&P500 actually double from its low point of two years ago was due for at least apause and even a sizeable reaction. The bears were less hesitant in their view of where the marketswere headed. Their key argument continued to be that the economic recovery to date had been astimulus-induced pick-up from a low base and that the rising stock market associated with it waslargely liquidity-driven and influenced by the absence of acceptable returns in any other investmentmedium.

As long as ultra-accommodative monetary policies continued the bears agreed that stocks could keeprising, but the soaring oil price had now put a cap on market levels just as it had on a fragile

recovery. Furthermore, now that the post-colonial winds of change had spread to Libya and Bahrain,there was every prospect they would engulf the whole region.

Dj Vu All Over AgainThe situation in the Near and Middle East led to comparisons with 1973, when Arab oil producerswrested control of oil production and pricing away from Western companies, precipitating a globaleconomic crisis and the collapse of stock markets everywhere. Colonel Gaddafi had been a keyplayer at the time, having nationalised all BPs interests in Libya in 1972 and then expropriated 51%of US oil companies assets in May 1973, prior to leading the embargo on oil exports to the West onthe outbreak of war with Israel in October. It was argued that the situation in 2011 had the potential tobe much more serious.

In the 1970s the oil producing states, imbued with anti-Western, anti-Israeli fervour, had presented aunited front against what they saw as the exploitation of their principal resource, but at least Westernconsumers knew that even at sharply higher prices, oil would continue to flow. Coups in the regioncame and went but if one authoritarian ruler was replaced by another, it would be one guaranteed togive continuity to a political system and a sectarian balance that had endured for centuries, thusensuring a stability of sorts.

This time around, it was argued, things could work out very differently. The masses of the street wererebelling not against their former colonial masters and Western domination but against their ownrulers who had kept them in ignorance, poverty and servitude for centuries. Earlier generations hadseemingly accepted their fate but dramatic technological advances mean that citizens of thesecountries in the 2011 have been made aware of life in the outside world by satellite television and theinternet as well as being given the means to unite and communicate their discontent via mobile phonesand social networks.

The result could easily be the disintegration of the traditional social and political order in the area,which would mean the inevitable introduction of a new era of uncertainty and instability in a regionthat provides 30% of global oil supplies and contains 60% of the worlds proven reserves.

Black Swans RisingAs March wore on, the 6000 level on the FTSE100, that of 12,000 on the Dow and 1300 on theS&P500 began to look like battle lines. The bull forces were supported by the positives of strongcorporate earnings (for now), mergers and acquisitions and share buybacks, and some evidence thatthe recovery was gaining a foothold. The bears countered with the negatives of sharply rising pricesfor oil and practically every other commodity, continuing sovereign debt problems in the euro zone asbond yields crept ever higher, and the impending exit from a uniquely artificial monetary and fiscalframework.

Ongoing turmoil in the Arab world and a downgrading of Portugals credit standing by the ratingsagencies seemed to support the arguments of the bears and by mid-March the aforementioned battle-line levels had been breached, taking the FTSE to 5775, the Dow to 11,993 and the S&P500 to 1296.

If this was not enough to shake bullish confidence, Japan was rocked by a category 9 earthquake,resulting in a tsunami that devastated the countrys north-east coast, swamping a nuclear reactor in theprocess and causing a radiation leak.

Given that Japan is the worlds third largest economy (only recently pushed out of second position byChina), the disaster was regarded as dealing a major blow to global recovery prospects and stockmarkets everywhere plunged, taking their cue from a record 10.5% drop in the Nikkei. Instant actionby the Bank of Japan in the form of a $225 billion cash injection for the economy and massiveintervention by the central banks of the G7 to drive the yen lower it had risen sharply onexpectations that Japanese insurance companies and other institutions would have to repatriate fundsto meet claims and reconstruction costs were enough to reassure investors and markets rallied.

Even the declaration of a no-fly zone over Libya and the accompanying military action failed to dentinvestor confidence and by the end of the third week of March, markets had recovered nearly all thelosses incurred amid the tumult of the week previous.

Heads In The SandSince all the bearish factors that had precipitated the market falls were still present in spades, thisresilience was seen as surprising by even the most ardent bulls. After all, it was universally agreedthat a rise in oil prices posed a major threat to economic recovery and now with the Japanese disasterboosting the anti-nuclear lobby and prompting the shelving of nuclear plant construction plans acrossthe world, dependence on oil had been hugely increased. Furthermore, natural disasters andrevolutions in faraway countries were matched by worsening difficulties on the home front relating totackling unsustainable budget deficits.

Thus, in the US, the inability of Congress to agree over the vital spending cuts needed to meet theadministrations deficit reduction targets was having a knock-on effect at local levels as federalagencies were forced to curtail work already in progress, freeze hiring plans and withhold grants,none of which was doing anything for the all-important employment numbers.

In the UK, the Chancellor was in receipt of criticism from all sides for delivering a budget thatignored the warning lights flashing in the economy and for sticking to his plan to cut public sectorborrowing while simultaneously trying to promote private sector growth, a policy considered by theOffice for Budget Responsibility to have no likely impact on long-term growth potential. The failureof the Portuguese government to gain parliamentary support for its proposed austerity measures andthe protest march through central London on 26 March were also seen as warning lights, remindingthe coalition government that proposals are one thing and the ability to implement them quite another.

In the final week of March, equity markets continued to rate the importance of mildly encouragingmanufacturing, service industry and employment data, and strong (but historic) corporate earningsreports, more highly than the possible, even probable, fallout from revolutions in the Middle East,natural disasters in Japan, and renewed sovereign debt crises in the euro zone. As a result, theFTSE100, after being down 5% two weeks earlier, ended the first quarter virtually unchanged at

5903, a performance matched closely by the FTSE250 at 11,591.

On Wall Street, the Dow, which had dipped below 11,600 intraday in mid-March, recovered by theend of the month to 12,319, gaining 6.5% since the beginning of the year while the S&P500 was up5.6% at 1325, and the NASDAQ Composite was up 4.8% at 2781. The bulls looked forward to180,000 or more US monthly job gains being reported on 1 April, which would serve to confirm thatthe recovery was slowly but surely underway and get the second quarter off to a good start. The bearsremained convinced that the markets failed to see the big picture and were pricing in a lot of goodthings that were not going to happen.

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Quarter two, April to June

Against the windIn response to the US monthly job gains for March coming in well above best expectations at 216,000and a fall in the unemployment rate from 8.9% to 8.8%, stock markets around the world madesignificant gains, following the lead of Wall Street. The Dow plussed 57 points to 12,376 and theS&P500 was up 7 to 1332, while in London the FTSE100 rose 101 points to top 6000 again, reaching6009.

Most market commentators appeared to believe that the mid-March slide had been the expectedcorrection and the advance was now ready to continue. More cautious observers, however, pointedout that if the contributing factors to the nightmare week in early March were not still making theheadlines, that did not mean they had lost their potential to seriously damage the global economy andtheir stock markets. The oil price, in particular, at $108 a barrel for West Texas Intermediate (WTI)and $122 for Brent crude, was now at a two and a half year high, which meant that the cost ofproduction was rising for practically every commodity and manufacture. This made stock marketupticks on the release of mildly encouraging industrial and employment data almost irrelevant.

Consumers in the UK were already being hit by inflated fuel and food prices resulting in majorretailers like Marks & Spencer, Mothercare and Dixons downgrading their outlook for the rest of theyear as disposable incomes shrank. This situation could only get worse as austerity measures began tobite and tax and spending changes took effect in the new financial year.

Against such a background, a rising stock market seemed to make little sense unless, of course,investors were looking for further doses of QE and an indefinite postponement of interest rate rises,with politics continuing to trump economics. The ECB (European Central Bank) now complicated thepicture by breaking ranks with the Fed and the Bank of England by raising rates from 1% wherethey had been since May 2009 to 1.25% in response to the Eurozones inflation figure for Marchcoming in at 2.6% compared with the 2% target.

The move inevitably attracted some criticism for making life more difficult for the strugglingperipheral countries of the area, especially now that Portugal had joined the bail-out queue.However, most serious commentators welcomed the rate rise as the first sign of a return to normalmonetary policy by a leading Western central bank at a time when the Fed and the Bank of Englandwere still flying blind with practically zero interest rate levels and hoping for a happy landing. Evenwith inflation at 4.4% in March, more than twice the Bank of Englands target, the MPC still left ratesunchanged at 0.5% on the same day that the ECB had decided to raise its policy rate, while inWashington the administrations obsession with not taking any action that could threaten a fragilerecovery had pushed the prospect of any boost from a practically zero interest rate to the end of theyear and even into 2012.

Indeed, it now looked as if for simple reasons of political acceptability, the perpetuation of a low

interest rate environment was a necessary accompaniment for the imposition of unpopular austeritymeasures. Unfortunately, a side effect of this strategy was that investors with access to cheap fundingwere only too ready to take risks in pursuit of a decent return, all too often targeting commodities asthe ideal inflation and dollar hedge.

Thus, correlations between asset classes went out of the window with hot money flowing intoequities, oil, gold and silver, and industrial metals, as investors placed their bets on the red and theblack. That such an investment strategy should be successful today argued for the adoption of onewinning formula put forward in the eighties by a veteran stockbroker who had seen it all: Carefullyweigh every factor influencing your decision to buy or sell, make up your mind as to the only logicalcourse of action to follow and then do precisely the opposite.

Faites vos jeauxIf this continuation of an ultra-accommodative monetary policy was considered to be a more thanadequate explanation and justification for rising stock markets, then rising prices for oil and other keycommodities, for which such a policy was in part responsible, ran counter to this trend. Not onlywere they bad for business but their inflationary impact would in time pressure governments to revisethe interest rate policy. However, this apparent contradiction was one which investors seemedcontent to live with and stock markets forged ahead throughout April, largely under the influence ofstrong earnings and outlook statements for major US companies.

By the end of April the Dow at 12,810 and the S&P500 at 1363 were standing at their best levelssince June 2008 while the FTSE100 had reached 6069, a performance the bulls interpreted asindicative of all the known knowns of negative news being priced in. The bears, on the other hand,maintained that the continuing flow of easy money was floating all ships and that with oil at $114(WTI) and $126 (Brent crude), gold at a new nominal high of $1570 and silver at $50, in the contextof the dollar at a three-year low, stock markets were riding for a fall.

The bears acknowledged that the markets had staged an impressive recovery from a sharp setbackearlier in the month after Standard & Poors had downgraded the outlook for US debt to negative,seemingly when the move was seen as strengthening the chances of the administration being able toimplement a realistic deficit reduction strategy. However, at the same time, the bears believed that therecovery owed more to an over-optimistic bias on the part of investors convinced that the Fed wouldkeep the party going, come what may. They also interpreted the equally rapid rebound after thedramatic one-day collapse in the price of oil and a broad range of commodities as likely to be short-lived, given that it was attributed to a recovery in these prices and thus hardly a cause for investors tocelebrate.

Similarly, while the April job gains coming in well above expectations was a plus for the markets inthat it bolstered economic recovery hopes, the slide over the past month of 40 basis points in the US10-year T-bond yield to 3.15% was hardly a vote of confidence in the return to growth story of theworlds number one economy. And since, by contrast, bond yields in the peripheral Eurozonecountries were going through the roof, it was difficult to avoid the conclusion that deficit problems in

the developed world were simply a matter of scale. We are all Greeks now but some of us are moreGreek than others; a dollar-denominated Treasury bond was seen by many as the only safe port in alikely coming storm.

If rising US bond prices appeared to have wrong footed outspoken bond bear Bill Gross of PIMCO,he was not dissuaded from continuing to build up his short position, convinced that the USgovernment had no politically acceptable option save to eventually inflate its way out of its self-imposed debt trap. A renewed slide in commodity prices in the second week of May ensured thatinvestors remained nervous and the markets were in no mood to resume their advance. Indeed, after abrief flurry over 6000 again, a move attributed to the lessening of contagion fears on the news thatGreece was to get another 60 billion from the ECBs emergency fund, the FTSE100 fell back onsecond thoughts that more money for Greece meant that the problems for the PIIGS (Portugal, Italy,Ireland, Greece and Spain) were even worse than originally believed.

Furthermore, the London market received no encouragement from the Bank of England when itannounced a revision of its growth forecast for the current year to just below 2% and to 2.5% in2012. In the context of the April inflation figure coming in at a higher than expected 4.5%, this put theUK economy in a poor light when compared with Germany, reporting first-quarter growth of 1.5%,and France, which reported first-quarter growth of 1%.

Commodities on the rackMeanwhile, a marked revival in the dollar in tandem with Treasury bond prices in response to theshadow cast over the Euro by ongoing sovereign debt problems of the weaker members of the singlecurrency was wrecking the risk-on strategy of traders and speculators who had stocked up oncommodities as a dollar and inflation hedge. By mid-May, falls in mines and oils in the wake of theslump in commodity prices had pulled the Dow below 12,500 and the FTSE100 back to around 5900.Both indices rallied strongly though thanks to their weighting in resource stocks, which recovered inline with rebounding oil and metal prices.

If institutional investors had any doubts about the durability of the commodities boom, they were notevident in the IPO of Swiss-based mining and commodity colossus, Glencore, which enjoyed a four-fold oversubscription for the 6.7 billion tranche on offer at 530p, the top end of the indicated pricerange. Financial columnists were much more critical, citing the buccaneering reputation of thedirectors and the politically-unstable areas of the world in which it operated, but the sheer size of thecompany at some 40 billion, ensuring its instant entry into the FTSE100, simply made it too big forthe institutions to ignore. However, after an initial surge the shares ended their first week of trading ata small discount to the offer price, a performance sparking comment that such a major launch oftenmarks the high point in an industrys fortunes.

Just as high profile and engendering as much enthusiasm but even more scepticism than Glencore wasthe IPO of LinkedIn (www.linkedin.com), the business-oriented social network group described byone City writer as populated by business people who one has no interest in making friends with.Nevertheless, placed at $45, the shares soared to $122 on the first day of dealing before settling at

$93, giving the company a valuation of nearly $9 billion. The fact that such numbers represented amultiple of 40 times revenues and 200 times earnings in 2010 invoked comparisons with the worstexcesses of the internet bubble of 1999/2000. However, LinkedIns fans saw its share priceperformance indicating the reception likely to be accorded to other social media groups planning tocome to market, namely Facebook (www.facebook.com), Groupon (www.groupon.com) and Twitter(www.twitter.com).

The FTs Long View column saw this wild enthusiasm for internet offerings as of the same nature asthe startling rise and fall in the price of silver up 63% in less than five months and then falling 35%in a matter of days and linked this sort of investor behaviour with the significant decline in a broadrange of commodity prices in recent weeks which cast doubt on the prospects for economic growth.They interpreted this as a sign that investors were finding it ever harder to make money and weregetting a little desperate.

PIIGS cant flySuch runaway enthusiasm was not mirrored in the broader market which was more concerned with anapparently deteriorating sovereign debt situation in the peripheral Eurozone. As Greek ten-year bondyields soared to a record 16.5% after another ratings agency downgrade of the countrys debt, arestructuring was widely seen as inevitable with all that it would imply for the rest of the PIIGS.Spains ten-year bond yields rose to a near record of 5.5% against a background of more anti-government protests in Madrid and a trouncing for the ruling Socialists in regional elections, andStandard & Poors then stoked anxieties even further by downgrading the outlook for Italys debt fromstable to negative, much to the annoyance of the countrys finance minister. Contagion was once againthe name of the game as despite the best efforts of the ECB, a renewed sovereign debt crisis inGreece had put Spain and Italy in the spotlight and their bond yields continued to rise, although withthe offset of falling yields for those countries judged to be at the other end of the stability spectrum.

Stock markets in Europe reacted negatively to these developments with widespread falls of 1% andmore, giving the lead to Wall Street already overshadowed by the failure of the latest round of dataon employment, housing and industrial production to show that the long-awaited recovery wastaking hold before the Feds bond-buying programme expired at the end of June. Asian markets alsofell back, depressed by evidence of a slowdown in China as the governments counter-inflationmeasures began to work, and Japan slipping back into recession.

At the start of the final week of May, the Dow had pulled back to 12,381, the S&P500 to 1317 and theNASDAQ Composite to 2788, while the FTSE100, at 5835, had left 6000 far behind. In Asia,Japans Nikkei Dow had fallen to 9460 as its run of natural disasters began to reveal their impact oncompany profits, and in China the stock indices in Shanghai and Hong Kong continued to erode.Indian markets were not immune from downward pressures as the authorities run of interest raterises to curb inflation took their toll and the BSE Sensex slipped below the 18,000 level. The solebeneficiaries of this renewed wave of risk-aversion gripping stock markets everywhere were thestandard and supposedly safe havens of the dollar, Treasury bonds, the Swiss franc and gold.

US data disappointJust as investors were regretting not having adopted the time-honoured Sell in May strategy,markets rebounded strongly on the last day of May, taking the Dow up 128 to 12,569 and the S&P500up 14 to 1345, while the FTSE topped 6000 again before settling at 5990. However, since therationale for the rebound reportedly the news that Germany had agreed to extra funding for theGreek bail-out was carrying more weight with investors than disappointing May readings on UShouse prices, regional manufacturing and consumer confidence, this seemed hardly a fair trade-offand suggested that the rises were likely to be a one-day wonder.

This proved to be the case the very next day, 1 June, when the combination of a well below forecastdrop in the ISM manufacturing index for May, a shockingly weak private sector jobs report and astring of downbeat outlook statements from Americas leading retailers, saw the Dow slump 279points to 12,290. And if this was not enough to depress investors, further evidence that the recoverywas stalling was provided by the non-farm jobs number for May showing only one-third of the widelyexpected gain and a reversal of the downtrend in the unemployment rate with an uptick to 9.1%.

As a result markets continued to slide and were given a further downward nudge by the Fedchairmans acknowledgement that the recovery was uneven and frustratingly slow, but with nomention of a further round of QE. Eurozone sovereign debt problems also weighted on sentiment afteryet another downgrade for Greece and a warning that the ECB itself was at risk of collapse given itshighly-levered exposure to struggling Eurozone economies. This second point was widely reported tobe alarmist but it still raised the question of the source of the ECBs apparently unlimited funding.The answer was that it was backed by all the central banks in Europe and taxpayers. So, no problemthen.

IMF backs ChancellorThe London market followed Wall Street down, its course unchecked by the IMFs endorsement ofthe governments austerity plans. However, the endorsement was complicated by a recommendationof emergency measures in the form of more QE and tax cuts if weaker growth and higher inflationpersisted, developments which Moodys warned could lead to a loss of the countrys triple-A ratingin the event of any excessive relaxation of the original plans.

One writer thought that Moodys was concerned about the stability and unity of the coalition giventhat many of its Liberal Democrat members, cabinet ministers included, appeared to have no stomachfor implementing tough choices and were too unaccustomed to office and the responsibility anddiscipline that it required. The intervention of a troublesome priest in the form of the Archbishop ofCanterbury was not considered to be an influential factor.

As the month progressed the downtrend in markets continued, interrupted only briefly by theoccasional half-hearted rally which was almost immediately expunged after another item ofdepressing news. Retail sales on both side of the Atlantic in the first quarter came in well belowexpectations and accompanied by gloomy forecasts for the rest of the year, and slower growth in

Chinas exports and a fall in Germanys industrial production in April, appeared to confirmsuspicions that the global economic recovery was faltering.

The failure of OPEC to reach agreement over Saudi Arabias proposal to raise oil production quotasto meet rising demand did not suggest any likely softening of the price and benchmark Brent crudemoved up $1 to $119 a barrel. But the most influential downward pressure on stock markets was theongoing disagreement among Eurozone leaders over how to deal with Greeces sovereign debt crisis,resulting in the cost of insuring against default soaring to record levels, not just for Greek governmentdebt but for that of the rest of the PIIGS.

The principal concern appeared to be that Germanys insistence that bondholders must share in thepain involved in any restructuring of Greek debt would alienate holders of the debt of the otherperipheral Eurozone countries who would be tempted to liquidate their positions while they stillcould. And since so much of that debt is a core holding of banks, pension funds and insurancecompanies across Continental Europe, such an event would precipitate another and much moredamaging financial crisis. Greek ten-year bond yields topping 17% did not augur well for asatisfactory outcome and official protestations of Eurozone solidarity over the issue were widelyseen as falling into the they would say that, wouldnt they? category.

Six down in a rowBy the end of the second week of June and after an unusual six consecutive weeks of losses, the Dowhad slid below 12,000 to 11,951, the S&P500 to 1271 and the NASDAQ Composite to 2643. InLondon the FTSE100 had crashed significantly below 5800 to 5766 with mines and banks leading theway, unsupported by no change bank rate decisions by both the Bank of England and the ECB.Another unsettling factor for investors as a reminder, in case they had forgotten in times of buoyantmarkets, that being a shareholder necessarily involves being a victim of the fallout when things gowrong at the top. Care home provider, Southern Cross, had come to grief after a business planimplemented by its private equity owners in preparation for flotation in 2006 with an equity marketvaluation of 425 million at an offer price of 225p, turned out to be based on faulty premises. Withthe company making huge losses and drowning in debt and the share price below 5p, its survival wasnow in doubt.

Another reminder for investors that buying into companies in far away countries with strange-sounding names can also carry dangers was provided by Kazakhstan-based Eurasian NaturalResources (ENRC). Floated in 2007 in accordance with the rules of the London Stock Exchange, thecompanys founding and majority shareholders had fired their UK name directors, former Glaxochairman and CEO Sir Richard Sykes included, and were running it like a private company again andin a way more Soviet than City, to quote one of the ex-directors.

On the generous assumption that the Citys code of governance provides some degree of protectionfor investors, the lesson from ENRC is that buying shares in any company based in a countrypossessed of an alien business culture means signing up to a caveat emptor deal. The Americans werelearning that lesson too after finding serious defects in the accounts of many of the Chinese companies

that had obtained their US listing via reverse takeovers and thus avoided the more rigorous testingthat an IPO would have demanded.

Greece rolls overAs June progressed, Greeces problems came to the fore and moved from the financial pages of thenational press to become the subject of leading articles and main features. The fear was widelyexpressed that the ramifications of the Greek default would be so far reaching that it would constituteanother Lehman moment and produce a similar dramatic fallout. Lex in the FT disagreed, pointing outthat this time around markets were not going to be taken by surprise and that exposure to losses waslimited to 25 or so mainly European banks, making it possible to negotiate a much more orderlydefault than in the case of Lehman where the products had been so complex and the counterparties sonumerous that the administrators are still working out today who owes what to whom.

At the same time, Lex conceded that the risk of a Lehman moment in the Eurozone remained if Spainor Italy were in the frame; a possibility, even probability, in the view of many other commentators.Germanys reluctant agreement that the rejigging of Greeces debt should take the form of a voluntaryrollover, rather than a debt exchange with extended maturities, triggered another rally in US marketsbut London and other European markets, with the Greek crisis nearer to home thanks to theinvolvement of their 25 or so banks, were less enthusiastic.

In the final week of the second quarter, stock markets sprang into life led by an exuberant Wall Streetas a run of strong earnings reports accompanied by unexpectedly upbeat regional PMI manufacturingnumbers revived hopes that the recovery was gaining traction. Data on housing and employmentremained inconclusive, but while acknowledging a disconnect between the economy and CorporateAmerica, investors seemed happy to give the economy the benefit of the doubt. Even the downwardrevision of the growth forecast for the current year from 3.2% to 2.8%, and no mention of QE3 tofollow the conclusion of the Feds bond buying spree, failed to dampen buyers enthusiasm and theS&P500 registered a gain of 5.6% over the week taking it to 1339, while the Dow added 647 pointsto 12,582. The FTSE100 just failed to top 6000 again but still managed to rise by 5.1% to 5989,apparently undisturbed by growing evidence of blood on the high street as retailer after retailerannounced sharply falling profits and embarked upon a programme of store closures.

A reprieve for GreeceIf such items of news seemed to provide little justification for a one-week rise of over 5% in marketsacross the board, there was some further encouragement to be taken from the International EnergyAuthoritys (IEA) decision to release an initial 60 million barrels of oil from its stockpile, and fromthe Greek governments success in getting parliamentary approval for its five-year austerity plan, thusensuring the 12 billion loan tranche would arrive on schedule and head off the threat of default.

However, more sceptical commentators pointed out that after an immediate fall in the oil price tobelow $90 on the IEAs announcement, it had rebounded to $95 by the end of the week and, in anycase, the stockpile would have to be replenished. As for the Greek situation, 12 billion was no more

than a sticking plaster; default, however it was structured, was inevitable further down the line. Theyalso saw the sharp rise in bond yields the US 10-year Treasury had risen over the week from 2.86%to 3.22% as an overreaction to the ending of the Feds bond buying programme and the Greek bail-out. The sovereign debt crisis was still with us, they argued, and a short-term fix for Greece didnothing to solve it.

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Quarter three, July to September

Recovery, what recovery?The first week of the third quarter raised hopes that the end-June rally was going to develop into ameaningful advance under the influence of an uptick in US economic data and a solution, if only atemporary one, to Greeces debt problems. The Dow had topped 12,700 with the S&P500 over 1350,while the FTSE100 seemed to be keeping its head comfortably above the 6000 level. Even Japanbegan to enthuse its ever-patient fans on signs of rising production as the recovery from theearthquake gained momentum and the Nikkei 225 managed to move above the 10,000 mark again, tothe benefit of the other Asian markets.

Unfortunately for the bulls, this wave of renewed optimism over the prospects for global recoverywas soon to be snuffed out. Shockingly disappointing US jobs gains in June of 18,000 againstconfident expectations of around 120,000 and soaring bond yields and spreads among theperipheral Eurozone countries, as contagion now threatened Italy and Spain, took away the two propsof the June rally.

The disagreements among the Eurozone leaders over how to sort out Greece, coupled with the factthat even after their bailouts, Ireland and Portugal were clearly still in trouble, suddenly spookedbond investors. If all the European Central Banks (ECBs) costly efforts had been unable to improvethe lot of these three countries, how could it possibly cope if contagion spread to Italy or Spain? Theanswer was that it could not and bond investors started to sell.

Suddenly ten-year bond yields in both Italy and Spain were topping 6% before falling back to 5.5%for Italy and 5.8% for Spain on talk that the ECB was buying in the market. If Greece, Ireland andPortugal were the Northern Rock and Bear Stearns of 2011, there was no question that Italy or Spaincould be the Lehman Brothers. Stock markets reacted accordingly and within the space of three daysthe FTSE100 lost 300 points and the Dow lost 250 as investors fled to the supposed safe havens ofUS Treasuries, German bunds, UK gilts and, of course, to gold.

The sovereign debt crises in the Eurozone had also taken the spotlight off two other situations, neitherof which was doing anything for investor sentiment. One was the Obama administrations battle witha Republican-dominated House over establishing a mutually agreed deficit reduction plan to allowthe raising of the national debt ceiling and avoid a technical default. Since a spending programmewhich would breach that ceiling had already been passed by both houses, the dispute was widelyseen as a party political one inimical to the national interest.

Nevertheless, most observers believed an accord would be reached before the August deadline, afterstriking a balance between Democratic tax rises and Republican spending cuts, especially now thatMoodys and Standard & Poors had raised the temperature by threatening to downgrade US debt removing their triple-A rating if the House failed to reach an agreement. One commentator wasmoved to quote Winston Churchills wartime assessment of the Americans, After exhausting every

alternative they always end up doing the right thing, and was confident that what President Obamahad referred to as Armageddon would be averted.

Its The Sun wot won it!In the UK, the phone hacking scandal at the News of the World had put Rupert Murdochs NewsInternational media empire in the dock and raised questions over the degree of political influence hehad exercised in the country in recent years. The fallout in stock markets was dramatic with $5 billionwiped off News Internationals capitalisation on Wall Street. In London the shares of satellitebroadcaster BSkyB collapsed from 850p to below 700p after the government effectively vetoed MrMurdochs proposed bid for the company and forced its withdrawal.

But just when things were looking grim for the markets on all fronts, Ben Bernanke threw them alifeline by telling a Congressional hearing that the Fed stood ready to respond should economicdevelopments indicate that an adjustment in the stance of monetary policy was appropriate. In otherwords, more stimulus could be on its way and markets responded appropriately enough, led by theDow which on 13 July plussed 170 points at the opening before settling at 12,491 to finish up 44.

In London, the FTSE100 added 37 to 5906 although, just like the Dow, it finished well below its highfor the day. The positive statement from Bernanke that had given markets positive impetus wastempered by an announcement by the Office for Budget Responsibility (OBR) stating that theChancellor would have to do a lot more in terms of tax rises and spending cuts if public sector debtwas to avoid continuing along an unsustainable path. Second quarter GDP growing at 0.2% and adowngrade for the years performance by the Independent Treasury Economic Model (ITEM) to 1.2%did not suggest the economy was treading the recovery path and of course demand in the countrysbiggest export market was bound to suffer as country after country in the Eurozone embarked uponausterity measures.

Markets were on the slide again as the second half of July began, disappointed by no sign of the Fedchairman following through with the idea of further stimulus and by the failure of governments on bothsides of the Atlantic to come up with credible plans to deal with their debt problems. The resultsfrom the new round of stress tests for European banks did nothing for public confidence. Only eight ofthe 91 banks tested failed by falling below the 5% core tier one capital ratio (under Basel II) butsince no measure of the banks ability to withstand a sovereign default was incorporated in the tests,they were widely regarded as a whitewash.

Banks led the markets down on Wall Street, London and the Eurozone capitals with falls in the 5% to7% range, reflecting their varying degrees of exposure to the crisis. Safe havens took centre stageagain as gold topped $1600, a nominal high, and silver shot ahead to $40. Yields on US Treasuriesand German bunds and UK gilts fell to new lows for the year. On the other side of the coin, peripheralbond yields soared with those of Italy and Spain moving above 6% again, but this time staying thereand making 7% the next stop a figure judged to be the point of no return in the science of bondyields. Any country that has to pay that much to find buyers for its bonds is regarded as being stuck ina permanent debt trap out of which it is impossible to grow.

No way outThe failure of the politicians to come up with a solution to the debt problems that were now havingsuch a damaging impact upon the daily lives of every citizen in the developed world did nothing fortheir standing in the eyes of those who elected them. The political system, in particular the Americanone which made it so difficult to agree a vital deficit reduction plan, was seen as dysfunctional evencompared with those of the PIIGS (Portugal, Italy, Ireland, Greece and Spain), all of which hadquickly passed onerous austerity packages through their parliamentary systems. However, since it isdemocratic systems which are being discussed, enacting measures in a parliament is one thing butgetting the people to accept them is quite another.

Strangely, despite the frightening backdrop the stock markets, perverse as ever, were ready torespond to a run of excellent earnings reported by Americas leading companies and to strongindications from the White House that the Democrats and the Republicans were at last getting togetherto do the right thing. The news gave Wall Street its best day of the year as the Dow rose 202 pointswith 27 out of its 30 constituents gaining, the NASDAQ Composite added 61 to 2826, with Applemaking a new high, and the S&P500 was up 21 to 1326. Raised hopes for a deal on the deficitreduction plan calmed nerves considerably and gold went into sharp reverse, falling $20 to $1585.Significantly though, US Treasury bonds actually rose slightly, pushing the yield down to practicallythe lowest point of the year at 2.88%, reflecting diminished default expectations (the yield on the 30-year bond fell much more sharply) as opposed to haven considerations.

A stitch in timeWall Streets performance enthused markets elsewhere; Japans Nikkei 225 topped 10,000 again andthe Hang Seng edged over 22,000, but gains in Europe were much more restrained given that asolution to sovereign debt problems there seemed as far away as ever. Everything depended on themeeting of the heads of the 17 member states on 21 July and their decision on whether or not to adopta one for all, and all for one approach. Since the very nature of the Eurozone meant that the problemwas not going to be confined to the PIIGS if they made the wrong choice, the pressure on them to dothe right thing was enormous.

In the event, the meeting resulted in a deal that was as good as anyone could have expected. Greecewould get its money with the benefit of a lower interest rate of 3.5% and an extended repaymentschedule from 7.5 years to 15 years, revised terms which were also to apply to the loans made toIreland and Portugal. In addition, new powers were to be accorded to the European FinancialStability Facility (EFSF) to provide precautionary lines of credit to help countries running intodifficulty and to recapitalise any bank in trouble. It was also permitted to buy bonds in the secondarymarket in exceptional circumstances and with the agreement of the ECB. One-third of the 159billion aid package for Greece was to be provided by private sector bondholders i.e. mainly banks on a voluntary basis and would involve debt swaps, rollovers and the acceptance of a 20%discount on capital values.

Since this last point was likely to trigger a selective default rating for Greece it was much more

controversial. To allay market fears it was to apply only to Greece as a special case and not to beextended to any other country finding itself in a similar situation in the future. According to the EUpresident the net result of the bailout agreement was to improve Greek debt sustainability, to stop therisk of contagion and to improve the Eurozones crisis management ability.

One for all and all for one?The immediate reaction in financial markets was a rebound in the euro and a sharp rise in stockmarkets across the Eurozone and in London. This was led by the banks rising between 7% and 10%;they were relieved by the shelving of the 50 billion tax on them that had been proposed by theFrench. Bond yields among the PIIGS fell back to their lowest level in two weeks but still remaineduncomfortably high and the initial favourable reaction was quickly countered by a more soberappraisal. The consensus was that the deal had contained the crisis, not resolved it, and in theabsence of a credible growth strategy and its implementation, the next crisis was just around thecorner.

With Greeces debt trading at around 50 cents in the euro, a 20% haircut was not going to be veryeffective or realistic in reducing its burden. It was also widely noted that there had been no proposedincrease of the 440 billion EFSFs rescue fund which meant that there would be nowhere nearenough in the pot if Italy or Spain got into trouble. And, in any case, the whole deal was still subjectto ratification by all 17 of the parliaments of the Eurozone member states. The conclusion of almostevery commentator was that the Eurozone remained a house divided, and that the Euro as a commoncurrency could not continue to work without fiscal union and the creation of Eurozone bonds wherebythe debt of every member state was guaranteed. To achieve such a goal would involve a long anddifficult political process and more crises along the way were considered inevitable.

Running for coverStock markets took the hint and retreated again, receiving no encouragement from Wall Street, nowdepressed by the fading of initial hopes that agreement on a deficit reduction plan had been reachedbetween the Democrats and Republicans. As a result, the final week of July witnessed a steadyerosion of share prices as investors directed their attention to the supposed safe havens of governmentbonds, gold, the Swiss franc and the Yen. Their bearish mood was accentuated by disappointingsecond quarter GDP figures of just 0.2% in the UK (and from the US at 1.3%) against expectations of1.8%. This was accompanied by a downward revision of the first quarters growth figure from 1.9%to a shock figure of 0.4%. By the last day of the month, the Dow had lost 550 to 12,143, the S&P500had lost 52 to 1292, while the FTSE100, at 5815, was down 135.

The striking of a deal between the Obama administration and the Republicans over the weekend of 30and 31 July sparked an initial relief rally of 139 points in the Dow on the first day of August but itwas soon dissipated as a run of below expectations manufacturing data brought the economy sharplyinto focus. An austerity package long on spending cuts, even though it was below the Bowles Simpson$4 trillion plan, would be hitting the economy when it was down, putting the US in the same dilemmaas the one facing the weaker countries of the Eurozone. Namely, how can a realistic deficit reduction

programme be compatible with any sort of growth strategy?

The dawning realisation that overspending and now over-indebted governments in the developedworld had painted themselves into a corner was to give markets their worst week since the depths ofthe financial crisis in November 2008. Both the FTSE100 and the Eurofirst 300 plunged 10% to5247 and 975 respectively. The Dow was down 5.8% at 11,444 and the S&P500 fare even worse asit fell by 8.7% to 1199. The declines were paralleled in markets everywhere, leaving the FTSE All-World index off 7.6% on the week with most indexes recording drops of more than 10% from theircyclical peaks.

It was now all too clear that the second Greek bail-out two weeks earlier had done nothing to assuagefears of default in the Eurozone periphery and now Italy and Spain were in the spotlight. SeorBarroso, the president of the European Commission, did not help the situation when he stated that theEFSF should be enlarged to boost systematic capacity to respond to an evolving crisis. TheGermans were not happy with the idea and expressed their concern that in embarking upon a bondbuying spree, the ECB was exceeding its authority by doing what the fiscal authorities in individualcountries should be doing. This collectivisation of risk, they believed, posed a threat to monetarystability and augured a slippery slope towards debt monetisation. Germany had reluctantly agreed tothe ECB buying Irish and Portuguese bonds and the offer of unlimited funds to banks to prevent themoney markets freezing, but Italy and Spain were in a totally different league.

US debt downgradedMeanwhile on the other side of the Atlantic, Wall Street was in freefall; a downgrade in Americastriple-A bond rating was anticipated despite the last minute bipartisan agreement over the deficitreduction plan. Panic took hold on 4 August as the Dow dived 512 points, the S&P500 dropped 60points and the NASDAQ Composite fell by 136. These performances contrasted with new lows foryields on Treasuries, UK gilts and German bunds, and gold hitting a new high.

That made the jobs report for July, due the following day, a make or break news item. The 117,000jobs created in July were comfortably above the estimates of 75,000 to 85,000, but an initial reliefrally of 170 points in the Dow was quickly replaced by a 244 point fall before the index rebounded toend the day with a 61 point gain, said to be in response to the ECBs decision to extend its bondbuying programme to include Italian and Spanish debt.

The actual downgrade by Standard & Poors by one notch to AA+ came after the close of the US andEuropean markets but was greeted by sharp falls across Asia in the order of between 2% and 3%;these performances were thought likely to be mirrored in London and New York on Monday morning.They were, but in spades. The Dow plunged a near record 634 points to breach the 11,000 level andend the day at 10,809 while the S&P500 lost 80 to 1119 and the NASDAQ Composite dropped 174to 2347. In London, the FTSE100 saw its fourth triple digit drop in a row, taking it perilously close tothe 5000 level to close at 5068. The percentage decline of the FTSE250 was greater still it fell 451points to 9861.

Double jeopardyWith two major crises running in parallel, the level of uncertainty confronting investors was dauntingbut some market commentators, albeit a minority, were not downhearted and saw a buyingopportunity. Their argument was that the rating downgrade was inevitable in the circumstances andtherefore had already been priced in by the markets. Likewise for the ECBs decision to start buyingItalian and Spanish bonds. The argument ran that both of these were solutions of a sort and themarkets should see them as such. Furthermore, with bond yields falling, equities were becoming evercheaper relative to bonds and earnings were continuing to exceed expectations.

The contrary view held that the rating downgrade was a warning shot across the administrationsbows and that henceforth it would be compelled to implement a credible deficit reduction plan in anear-Chapter Eleven style restructuring, without too much regard for the adverse impact it wouldhave on growth. Companies would have no choice but to retrench and adapt to a less benign tradingenvironment in which earnings would be hard to come by.

As for the ECBs bond buying programme, over 300 billion had already been dispensed buyingsome 20% of the bond capital of Portugal, Ireland and Greece, and the bank simply lacked thefirepower to prop up Italy and Spain given the quantity of bonds likely to come on to the market. Thismeant that it was no time for taking risks in equities, a view apparently confirmed when, within hoursof the downgrade, the yield on the now officially slightly less trustworthy US Treasury ten-year bondsdived to a new low for the year of 2.34% (after a short-lived flash rise to 2.56%). This affirmed theirpole position in the world of bonds; the best of a bad lot.

The next couple of days 8 August through 10 August seemed to settle the argument in favour of thebears as equity markets plunged, led by banks recording double digit percentage losses. Record one-day falls taking the Dow down to 10,719, the S&P500 to 1120 and the FTSE100 to an intraday low of4791 looked like a re-run of the aftermath of the Lehman collapse until they were succeeded byrecord one-day rises as the Federal Reserve pledged to keep interest rates exceptionally low into2013 in response to slower than expected growth and the deterioration of the labour market. By theend of the week the markets appeared to have survived everything thrown at them, including the threatof a downgrade to Frances debt and a run of second quarter growth figures from the US, the UK andFrance that made a double dip recession almost a certainty. The Dow was up to 11,269, the S&P500to 1178 and the FTSE100 had recovered to 5320, apparently heartened by the perpetuation of theFeds cheap monetary policies and perhaps by the hope of the launch of QE3 hinted at by the use ofthe term as appropriate with regard to the employment of additional policy tools.

The other supposedly ameliorating factor in the Eurozone crisis in the form a ban on short selling offinancial stocks was widely seen as not very helpful and even counterproductive in light of theineffectual record of this strategy in 2008. As for the full percentage point fall in Italian and Spanishten-year bond yields in reaction to ECB buying, reputed to be in the order of 22 billion, there was nogood reason to believe that yields would stabilise around 5% in the absence of a continued buyingprogramme since the attendant austerity measures were all too subject to technical and politicalexecution risk.

Though the Spanish and Italian ten-year bonds had reacted from their peak levels earlier in the week,the attendant rise in the price of gold to $1800 and the ten-year US Treasury bond yield touching anintraday low of 2.03% did not suggest that all investors were placing their bets on a happy outcome.Indeed, the rioting and looting in London and the UKs provincial cities which coincided with thechaotic conditions in the stock markets were seen by some commentators as a rehearsal for thedemonstrations certain to break out across Europe as the authorities tried to implement the harshausterity programmes necessary to restore financial balance to their economies.

Germany slows downAfter three straight sessions of substantial gains, taking the FTSE100 to 5350 and the Dow to 11,482,the rally came to an abrupt halt as the hopes that had sustained it were dashed by a disappointingoutcome from the Franco-German summit on 15 August. Political opposition in Germany had alreadyeffectively vetoed the idea of the country playing a solo supportive role, via the medium ofEurobonds, or any form of fiscal union, in propping up southern Europe and now the news that growthin the powerhouse of the Eurozone had stood still in the second quarter cast doubt on its ability to doso.

That left Chancellor Merkel and President Sarkozy with little to talk about, but their conclusion thatthe 440 billion stability fund was big enough to deal with the crisis was not what the markets wantedto hear when it was clear that funding of well over 2 trillion would be required if the situation inItaly or Spain deteriorated. Neither was the proposal for a financial transaction tax seen as market-friendly and shares of exchange operators fell sharply. In the Eurozone, political expediency clearlyoverruled economic necessity just as it had in America over the matter of the debt ceiling and thedeficit reduction plan.

In America, company reports continued to present a mixed picture with above expectation earningsand outlook from one industrial giant countered the next day by a depressing result from another,leading to share price moves in the order of 5% to 10% in either direction. Similarly, data onproduction, housing and employment remained inconclusive but now with a clear negative bias, and arally sparked by one mildly encouraging report was soon snuffed out by a disappointing one.

Markets paused for breath in mid-August after their dramatic three-day surge but while the leadindices were going nowhere, it was significant that bank shares continued to fall, reflecting fearsabout their vulnerability if recession returned and the sovereign debt crisis remained unresolved.These fears were soon seen to be justified by the report that one unnamed European bank had gonecap in hand to the ECB to tap its emergency lending facility for 500 million. Coupled withexpressions of concern by the New York Federal Reserve about European banks drawing down theircash balances held there, this raised the prospect of a repeat of the funding crisis of 2008 wheninterbank lending virtually collapsed and money market funds were reluctant to lend.

Markets now began another downward lurch, helped on their way by Morgan Stanley cutting itsforecasts for global growth and stating its belief that America and Europe were dangerously close torecession, a belief apparently substantiated by a raft of depressing data on manufacturing, housing,

employment and consumer spending released on the same day. The Dow plunged 420 points to10,990 while the FTSE100 had its worst day since March 2009, losing 239 points to 5092. Asianmarkets also suffered with Japans Nikkei 225 falling 224 to 8719 and the Hang Seng in Hong Konglosing 530 to 19,486. By contrast bond yields sank to record lows with that on the Treasury ten-yeardipping below 2% intraday before closing at 2.08%, gold rose to a new peak of $1865, and demandsoared for the Japanese yen and the Swiss franc.

Cul de SacThe stock market now became front page news once more. The VIX index, a cocktail of option tradesdesigned to measure the degree of anxiety present in the markets, shot up to record levels, promptingmore than one commentator to quote from FDRs 1933 inauguration speech We have nothing to fearbut fear itself. However, investors clearly knew exactly what they were afraid of. The hoped-forrecovery hadnt happened despite being dearly bought and paid for, and the debt crisis had simplybeen kicked upstairs to sovereign states now seen to be unable to manage it any better than their bankshad done.

This left a huge question mark over the future and since the authorities seemed to have run out ofoptions, it was better to play safe. Hence the record outflow of money from equity and bond fundsinto money market funds. Investors might earn almost nothing from these funds but they would not beat risk of losing 20% of their capital as they would have done by holding some of the worlds biggestbanks in the first three weeks of August. Volatility of this degree is a traders dream but an investorsnightmare.

Practically zero interest rates for the next two years might be good for business but they also smackedof desperation in that they seemed to be the last policy option open to the authorities. Manycommentators saw them as the first step on the road towards Japanisation as the economies of thedeveloped world adjusted to living with high debt to GDP ratios, deflation, depressed property andstock markets, ageing populations and political stalemate. In the case of the stock market, it wassuggested that Japanisation had already arrived given that the period from 2000 to 2010 was the firstdecade since 1950 in which the leading stock indices had failed to show a rise.

Nevertheless, this end of an era moment was not recognised as such and the supposed superiorattractions of equities over bonds in the long-term, i.e. over a ten-year timescale, continued to betrumpeted. This lack of acceptance of what was looking like the new normal presented anopportunity for major rallies as investors seized upon new policy action as promising a return toyesterday. Thus if the idea of another round of QE to try to kick-start the recovery appeared to beruled out by signs of incipient inflation, it was likely to be seen as worth the risk. Already withinflation at 4.4% in July, the Bank of Englands Monetary Policy Committee (MPC) votedunanimously in August to keep interest rates unchanged at 0.5%. The latest growth figures from theEurozone seemed certain to cause the ECB to rethink its tightening bias and possibly reverse the Julyrate rise to 1.5%.

Ace in the Hole?The final week of August opened on a brighter note with markets supposedly responding to theprospect of an end to the fighting in Libya and the restoration of the countrys oil exports. The Londonmarket also took heart from the substantial premium attached to Autonomy by Hewlett Packard, whichindicated that the whole UK software sector was underappreciated and undervalued. Share pricesacross the sector rose by 2% and more with chip designer ARM particularly in favour and now seenas a possible target for Apple, one of its biggest customers.

Hopes were also high that Ben Bernanke would come up with some new ideas, short of QE3, at theFederal Reserves annual meeting in Jackson Hole at the end of the week. With bids and rumours ofbids further aiding sentiment, markets embarked upon a dramatic thee-day climb. The Dow plussed500 points to 11,320, the S&P500 was up 54 to1177, the NASDAQ Composite climbed 123 to 2467.In Europe the FTSE100 gained 164 to 5205 and the Eurofirst 300 added 27 to 936. It looked as if riskwas on again as the US Treasury ten-year bond yield rose in those three days to 2.26% and the goldprice, which had touched $1900, crashed by more than $150.

Unfortunately for the bulls, market strength was compromised by the fact that once again banks failedto join in the rise, hinting at serious problems in the sector yet to be revealed. In the US, Bank ofAmerica, an institution seen as representative of the country, was the most prominent loser, its shareprice already having more than halved over the year while in Europe the share price of almost everybank seemed to be heading back towards its low point of March 2009. The capital position of all ofthem might have looked a lot better than it did at that time, but recession and regulation had been badfor business and this time around their respective states were in no position to mount another bailoutoperation.

Warren Buffet now lifted bank shares off the bottom with a reprise of his move on Goldman Sachs inOctober 2008, demonstrating his confidence in the future of Bank of America with a $5 billioninvestment. However, it should be noted that it was the same sort of copper bottomed, belt and bracesdeal he had done with Goldman Sachs, zeroing-in on preferred stock with a 6% coupon together withan option to buy 700 million of common stock at $7.14 until 2021. Thus, apart from the confidence-building factor, it was a better deal for the shareholders of Berkshire Hathaway than for those of theBank of America.

Passing the buckThere were no surprises coming out of Jackson Hole beyond expressions of confidence in the USeconomy and just a hint that something might be done to promote a stronger recovery after fullerdiscussion at the September monetary policy meeting. That hint was enough to overcome initialdisappointment with Bernankes speech and a 200 point fall in the Dow was transformed by the endof the day into a 134 gain.

The NASDAQ Composite continued its spectacular recovery, gaining another 60 to 2479 thanks tobuyers returning in force for the big names in technology. The fact that the Fed chairman also stated

that growth policies were outside the province of the central bank served to focus attention on whatthe President might say in his keynote speech on Labor Day a week hence. With the news that thealready disappointing 1.3% second quarter growth figure was being revised down to just 1%, theodds on the deployment of some of the Feds range of tools capable of providing additionalmonetary stimulus seemed to be shortening.

Such hopes kept markets on a roll in the concluding three days of August with further encouragementprovided by Hurricane Irene doing less damage than feared, a slightly better than expected USconsumer spending report for July and a Greek bank merger seen as taking some of the heat out of theEurozone crisis. All this was enough to send the Dow up to 11,612, the S&P500 to 1218 and theNASDAQ Composite to 2579, providing an example for London to follow when it reopened afterBank Holiday Monday.

The FTSE100 plussed 264 points over the next two days to 5394, the FTSE250 topped 10,000 againwith a rise of 246 to 10,243, and the Eurofirst 300 added 24 to 964. However, the fact that safehaven bond yields had reversed their recent rise and the gold price was on its way up again suggestedto many observers that markets were demonstrating their overoptimistic bias. This view gainedcredibility as far as the Eurozone debt situation was concerned; worrying events were all around asthere were signs of a political crisis brewing in Germany as Chancellor Merkels partners sided withthe opposition to brand the ECBs bail-outs and bond buying as unconstitutional, the Italiangovernment backtracked on its austerity package and collateral agreements were demanded asconditions for EU states to participate in the Greek bail-out.

As for hopes of economic recovery in the US, the Eurozone and the world in general, they weredashed in the first two days of September as PMI data for manufacturing and services everywhereneared or actually fell below the critical 50 level which marks the borderline between expansion andcontraction. Against such a backdrop, the US non-farm payroll number for jobs created in August wasgoing to be accorded even greater significance than usual. The fact that it came in at zero sent marketsinto a tailspin and US and German ten-year bond yields plunged to new lows of close to 2% as goldclimbed back towards the $1900 level.

Nevertheless, market strategists at HSBC, Citigroup and UBS were not dismayed and reaffirmed theirend-year targets for the FTSE100 at 6300, 6200 and 6100 respectively, basing their optimism on thebelief that companies were in good shape but that the problems lay with the high debt levels ofgovernments and consumers. Thus their forecasts were subject to the caveat that it was difficult tosee sustainability of earnings if theres another recession and that it could all go wrong!

Another Black MondayWith Wall Street closed for Labor Day on 5 September, it was left to European and Asian markets toreact to the Dows 253 point fall on the dismal jobs figure and the latest round of disappointingeconomic data, all against the background of a growing Eurozone debt crisis. Banks led the marketsdown, helped on their way by the pronouncement of Deutsche Bank CEO, Josef Ackermann, that anumber of European banks would collapse if their holdings of sovereign debt were marked tomarket. The banks of the weaker Eurozone countries were regarded as especially vulnerable sincetheir fate was inextricably linked with their governments, a point driven home by bond yields in Italyand Spain rising again despite substantial purchases over the week by the ECB.

UK banks were also prominent fallers with investors worries over regulation and restructuring and alooming recession. This was compounded by multi-million dollar lawsuits over the allegedmisrepresentation of the status of securitised mortgage debt sold to US institutions. These fears werereflected in the cost of insuring the banks bonds against default rising to record levels as shares ofthose named on the lawsuits RBS, HSBC and Barclays all recorded significant losses.

The UKs High Street retailers were also sold down in the wake of gloomy August sales figures asconsumer confidence waned in the face of high inflation and low wage growth. Dixons Retail Group(Currys and PC World) continued to suffer from increasing competition from the major supermarketsin its core consumer electronics business and the share price at 10p was now back to its low point ofMarch 2009. Mining and oil shares also lost ground on growing fears of a global slowdown; thecontinuing problems of BP, a major holding in every pension fund in the country, served as areminder to investors that buy and hold is not guaranteed to be the best investment policy.

The FTSE100 ended the day down 189 at 5102, a loss of 3.6%, but Germanys DAX fell 5.6% andFrances CAC40 fell 4.7%, as investors ran for cover. Government bonds were in demand, pushingthe yield on ten-year Treasuries to below 2% and that on German Bunds to a record low of 1.87%,while gold recovered the whole of the previous weeks dramatic loss to top $1900 again. The flightto the Swiss franc had reached such a level that the Swiss National Bank was prompted to interveneto protect its export-oriented economy and it pegged the euro exchange rate to SFr1.20.

But just two days later the merry-go-round saw the bulls back in charge. Apparently they had takeninspiration from the German courts rejecting the contention that the bail-outs and bond buyingoperations of the ECB were outside the law and from the prospect of another round of stimulus, albeitshort of QE3, to be revealed by the US president in his Labor Day speech on 8 September. The Dowtopped 11,400 again and the NASDAQ Composite reached 2500. But, significantly perhaps, theS&P500 just failed to make it back to the 1200 mark, while in London the FTSE100 added almost250 in three days to reach 5340.

Unfortunately for the bulls, a more considered appraisal of the judgement of the German courtscoupled with doubts that the Obama administrations $450 billion Jobs Act would make it throughCongress, made the rally look more like a swan song. The first did provide a positive in that thecourts did not judge the actions of the ECB to be in violation of the Eurozones constitution but at the

same time it stipulated that major decisions should be subject to parliamentary approval of memberstates. This meant that important EU initiatives would become political footballs in every parliamentin the region, making the quantum leap towards fiscal and political unity, so desired by theEurophiles, a forlorn hope. As for the Jobs Act, while the size was much greater than expected andthe halving of payroll taxes and the plans for infrastructure spending met with broad approval, it waswidely believed that Republicans would see it as a pre-election pitch and oppose it on principal.

To buy or not to buy?If such considerations were enough to call a halt to the rally, signs of a split within the ECB over howto deal with the regions debt crisis were to send the markets into sharp reverse. The catalyst was theresignation of Jrgen Stark, the banks chief economist and executive board member, who was knownto be opposed to the banks buying of Italian and Spanish bonds. The cost of insuring sovereign debtsoared and the yield on Greek debt topped 25%, a level interpreted as providing a 98% chance ofdefault. Bank shares across the region fell by 10% or more with those of France in the lead giventheir exceptionally large holdings of Greek sovereign debt, now seen as greatly overvalued.

In the UK, banks had their own problem to deal with in the shape of the Independent Commission onBanking which recommended that banks retail arms should be the ring fenced and share pricestumbled in response. Fears about exposure to the problems of European banks and to stallingeconomies both at home and abroad led to falls in the 5% to 10% range among US national banks andthe Dow dipped below 11,000, unimpressed by a lacklustre speech on the economy by the Fedchairman in which he made no mention of deploying the tools at his disposal.

However, a further 168 point dip to 10,824 was turned into a 69 point gain to 11,062 on a rallysupposedly triggered by expectations that China would step in as a buyer of Italian bonds after areport that China Investment Corporation (CIC) officials had visited Italys Ministry of Finance. Mostcommentators thought that this would be an unlikely event since the CICs premature foray intoPortuguese bonds had incurred losses and in any case the ECB was already a buyer. At the same time,the incident stressed that the Eurozone debt crisis was now the main focus of market attention, a pointmade all too clear as the Euro fell out of the $140 - $145 box that had contained it for the precedingsix months, helped on its way by signs of the ECB relaxing its hawkish monetary policy stance and theprospect of a rate cut.

Holding the lineA joint statement by Germany and France on 15 September that Greeces future remained in theEurozone seemed to reassure investors, raising hopes that Greece would continue to receive fundingand avoid default, and markets continued to rise. Fears about the stability of Eurozone banks werealso allayed by the agreement of the developed worlds five leading central banks to provide short-term dollar funding to those banks shut out of US money markets, and Senor Barroso delivered hisown boost to sentiment by pledging to come up with proposals for the creation of Eurobonds. Lesswelcome in Europe were the urgings of the US Treasury Secretary, Timothy Geithner, for the regionsleaders to get their act together, given that the Obama administration was not seen a much of a modelfor integrated policy action.

By the end of the third week in September, the rally appeared to have run its course but after a 5.2%gain over five straight sessions, the S&P500 had managed to regain the technically significant 1200level, the Dow had topped 11,500 and the NASDAQ Composite was above 2600. In London, theFTSE100 plussed 3% to 5368 and the Eurofirst 300 had firmed 2.3% to 937. In the context of thisrenewed wave of optimism, bond yields were rising again and gold fell back to below the $1800mark. The breaking news of a $2.3 billion loss racked up by a rogue trader at UBS failed to spoil theparty, save that of the bankers who had seen the ICB report as not too bad but now heard calls for thetimescale for its implementation to be accelerated.

Markets marked time awaiting the outcome of continuing high level talks between the troika of theIMF, the European Commission and the Greek premier, but by now practically every financialcommentator saw default as inevitable. It was no longer a case of if by when. They also expressedsurprise that the markets could entertain any hope that the dreaded event could be avoided by grantinga second instalment of the bail-out package in return for the passing of even harsher austeritymeasures than the original ones that had led to massive civil unrest.

By the same token, the rise in European markets on the day that Italian debt was downgraded onenotch and given a negative outlook by Standard & Poors was regarded as illogical and clearly hadmore to do with expectations that the Feds two-day meeting later in the week would see anotherrabbit pulled out of the hat in some form of stimulus. The betting was on the Fed selling shorter-termTreasuries to buy long-term ones in their place, thus holding its balance sheet level while keepinginterest rates low in a strategy called Operation Twist.

Most commentators saw little merit in the manoeuvre since long-term rates were already at historiclows and because supposedly much more stimulative measures had obviously failed in the last twoand a half years, indicating that the Fed was flogging a dead horse. Using a gaming analogy, onewriter, Simon Black of GB Capital, suggested that Ben Bernanke, when faced with the simple choiceof Stick, twist or bust, was going for the only choice that gave him any sort of chance. Similarly, theLondon market remained firm on indications that the Bank of Englands MPC was ready to downplayinflation expectations and vote for a further round of QE.

Against the oddsUnfortunately for the bulls, the markets were to demonstrate that it is better to travel hopefully than toarrive. The unveiling by the Fed of the $400 billion Operation Twist had the misfortune to occur onthe same day the IMF chose to downgrade growth forecasts both for the US and the world and whenthe European Commission revealed that growth across the European Union had slowed to a virtualstandstill.

Thus with the sovereign debt crisis still in full swing and European banks seen to be struggling withcapital and asset quality shortfall, this growing evidence of a slowdown in global growth gaveinvestors nothing to hang on to and nothing to look forward to. It seemed that all their disappointedhopes had coalesced at one point and markets everywhere reacted violently, wiping out the whole ofthe preceding weeks gains and then some.

Commodities suffered along with equities on the prospect of falling demand and to the surpr