When, as a commentator on financial markets, you are subject to the criticism of being too pessimistic, where do you turn? A possible answer is to Stephen Roach of MS, who bravely sticks to his guns when all around him are saying that all is now well. "While Japan has a sense of the urgency to reform", writes he, "America remains the land of denial". The question facing all investors is whether the recent stock market rally of some 15% since early October is just another manifestation of denial, or is it a harbinger of economic recovery? Accordingly, we have searched extra diligently this week for positive economic data. We have found two examples:

• US housing starts, which reached a 16-year high in September.
• An increase in the S&P500 average rolling EPS of about 4%.

Unfortunately these two observations are subject to dampeners, in that:

• Combined new and existing home sales are on a downward trend, as are new mortgages
• PEs have gone up again, to 33.3 on the S&P500 (see "Bigcharts"), a figure so far above historical levels of 14-16, that only the expectation of a massive increase in future profitability could justify it.

The game plan of the US authorities has been and still is to keep the consumer spending until industrial demand picks up. However, all the indicators confirm slower industrial activity, and a poor outlook for the recovery. One index, called "The Risk of Recession" rose dramatically in September to it highest point in over a year. If the knight in shining armour of industrial expansion is coming to the rescue, he is dallying somewhere en route!

American consumers are still consuming: witness the housing starts and the increasing trade deficit. Every time we thought that they had had enough, we have been proven wrong. Nonetheless, data on retail sales are again poor, and, in the words of a car dealer commenting on his sales, "It's as if the tap were turned off on 1^st October". It requires massive incentives (basically free financing) to sell cars in the USA today.

In Europe, the economic situation is scarcely better. A little encouragement may be drawn from the 0.6% increase in euro zone production in August, but overall there is little growth in Euroland. We admire Romano Prodi for his outspoken criticism of what The Economist calls the "Instability and Depression Pact". The sooner the euro zone has its straitjacket removed to allow Governments to compensate for private sector recession, and the earlier the ECB replaces its fixation on a low ceiling for inflation with a slightly higher target, the better. Ironically, the Pact, designed to give strength to the euro, is now a major cause of its weakness.

A recent analysis by Bridgewater of relative market capitalisation in the developed world vs. earnings leads to the conclusion that Japan is very overvalued, the USA significantly overvalued, Canada and Australia about right, while the whole of Europe is highly undervalued. Justification of low European valuations would require European company earnings growing at a much slower rate in $ terms than the rest of the developed world. Either that, or European shares are "incredibly attractive". It makes you want to shout "Get out of the way, ECB and Maastricht fans, we've got a chance to get somewhere in Europe!"

The Norwegian Krone has done very well, but even the Norwegians are warning that investors may have gone over the top. The exit will be very crowded and difficult if all flee at once.

The UK continues to navigate well in turbulent waters. The firemen's strike could, however, be very damaging, especially if other sectors withdraw labour on safety grounds.

If the stock market rally in the USA continues, and if it re-ignites consumer confidence, it will not imply that the USA is out of the woods. It will however mean that the Fed will not dare lower rates, as this would signal that they too have noticed the poor data issued by the Government's own statistical department. That in turn would suggest that the prime reason for remaining in long maturities in US bonds had disappeared and we would have to recommend shortening. We cannot yet, however, make such a recommendation, and will return to this subject next week. In the meantime, we still expect the ECB to lower rates, so we are not even considering shortening for bonds in euros.

Recommended average maturity for bonds in each currency.
Remain long across the board, except in Sterling.

Is the rally in equities over the last ten days a short-term correction in a still bearish trend, and have US interest rates seen their lows? The majority of market participants remain negative towards equities but are starting to think that no more rate cuts are going to take place in the US. On Iraq, an imminent attack looks still unlikely. In Europe, there was big relief after the Irish vote, but Mr. Prodi's outspoken comments that the stability pact is "stupid" speaks for further easing of the rules in an already very "shaky" environment. In Japan, it has to be seen if Mr. Takenaka has enough support to go ahead with radical reforms to the banking system. The most likely outcome is that some range trading is going to continue.

EUR/USD: The euro continues to develop "sideways", range bound between 0.9950 and 0.9650. Only a weekly close outside this range should announce new targets (0.9600 and 1.0150). We incline to the bearish scenario.

USD/CHF: As for the euro, even if some daily moves are interesting, the medium-term pattern is not very exciting. The exchange rate remains between 1.5150 and 1.4750. It still looks like there is buying interest below 1.4800 and that sellers are coming in above 1.5150.

USD/JPY: The first resistance at 124.80 has been triggered and 125.50 nearly tested. It seems that 125.30/50 might be difficult to break short term. Good supports are at 123.80 and 123.30. A move below 123.10 would abort the JPY bearish scenario.

EUR/JPY: Consolidation is in a 120.50 to 122.50 trading range. Major support is at 119.50. The trend remains towards the upside.

USD/CAD: We unfortunately missed establishing a short USD/CAD position around 1.5900, and major support subsequently broke at 1.5780. Most probable consolidation is now between 1.5580 and 1.5780.

AUD/USD: Despite the fact that 0.5550 has again been tested, it might be difficult to see any further sharp gains in the Aussie. It is nevertheless well supported, with first support coming in at 0.5480 and 0.5430.