Stocks make up lost ground

"If you'd nodded off over the Christmas break Rip Van Winkle-style, and just woken up again, you'd be forgiven for thinking nothing much had happened in the first quarter," says Fidelity's Tom Stevenson. After a nasty slide that saw some indices, including the FTSE 100, fall into bear-market territory defined as a 20% drop markets have recovered over the past few weeks.

US stocks climbed for five weeks in a row, offsetting January and early February's losses. Like the FTSE 100, the S&P 500 is back at the level at which it started the year. Global stocks, defined by the FTSE All-World index, have done the same. The mood has vastly improved too. The US Vix index, a measure of stockmarket volatility known as Wall Street's "fear gauge", is at a seven-month low. In March alone, it fell by a third.

So what went right? "In short, the world had a scare about a US recession and deflation, and then recovered from it, all in less than three months," says John Authers in the Financial Times. Poor US and Chinese data, along with a falling yuan and sinking commodity prices, fuelled fears of a downward lurch in global growth and a possible currency war sparked by a yuan devaluation.

But as the outlook for America improved and China made clear it would apply more stimulus, investors also appeared to decide that the commodity slump had run ahead of the fundamentals. A weaker dollar also calmed people's shattered nerves, as it had reinforced the commodity slide, which was viewed both as a symptom and a harbinger of slowing global growth.

"It's always recessions that kill bull markets," notes James Breech, head of Cougar Global Investments, in the Financial Times. So unless a recession occurs, which seems unlikely for now, the US-led market rally can continue. But don't expect markets to rocket. Indeed, the earnings picture is uninspiring. Half of eurozone company earnings come from overseas, and the euro hasstrengthened in the past year. Throw in a lacklustre global backdrop, and it's no wonder earnings-per-share forecasts for the region have been slashed. In America, where margins are historically high, S&P 500 first-quarter earnings are expected to fall by almost 9% year-on-year.

With the fundamentals inauspicious, stockmarkets are relying on supportive central banks and on stocks' appeal relative to overpriced bonds. That means Europe and Japan remain the most promising markets. But keep an eye on American inflation. As we noted here last week, the next event to rattle markets is likely to be an inflation, not a deflation, scare.