The good news that shook investors

THIS IS, it seems, fast becoming the crash that never was. A month ago, with the FTSE 100 down more than 25 per cent from its 20 July peak of 6,179 and New York's Dow Jones falling like a stone, the talk on the dealing floors was of 1929, market meltdown and worldwide economic depression.

Now, with the Dow hovering around 9,000 again and the FTSE having regained nearly four-fifths of its losses from the trough of 4,648.7 on 5 October, it all seems like a bad dream.

"Suddenly, the skies have cleared," says Omar Sheikh, head of research at brokers Charles Stanley. "Fears of global recession, bank failures and distressed sales by hedge funds have been allayed by concerted action by the Group of Seven to reduce interest rates. Investors have been switching funds of bonds into equities, and the powerful rally in world stock markets this has caused has left the bears running for cover."

Investors dropped the banking sector like a hot brick as, one after the other, shocks ranging from the Russian bond crisis to the near-collapse of Long-Term Capital Management, the hedge fund, hit home. But the sector has rebounded as quickly as it fell.

Meanwhile the "safe haven" sectors such as utilities and retailing, which saw some share prices rise in September when all about them were falling, have performed abysmally since.

At the same time, 10-year gilts yields have fallen back to 4.5 per cent from a peak of 5 per cent as the panic flight to these supposedly recession- proof instruments has been dramatically reversed. Even sectors such as engineering and chemicals, which had been underperforming all year, are up sharply on the month.

Trevor Greetham, UK market strategist at Merrill Lynch, the US investment bank, says: "There has been a ferocious unwinding of safe-haven bets. All the sectors that are outperforming now are the sectors that were underperforming in September. We really are back where we started."

This phenomenon can be seen at its most graphic from a look at the behaviour of individual stocks. Barclays, the FTSE's second-worst faller, plunged 54.8 per cent to a low of 867p on 5 October. Since then it has seen its share price jump 42.45 per cent to 1,235p. Money manager Amvescap, the worst performer, tumbled 62.3 per cent from peak to trough. Having bottomed out at 263p, it has since rebounded by 73 per cent to 476p.

Beneficiaries from the flight from risk, such as electricity producer PowerGen whose shares rose by 5.5 per cent to 886.5p in September, have reversed thrust just as smartly. PowerGen's stock fell by 5.8 per cent in October to trade at 835p, 5p off where it was in July. Rival National Power rose by nearly 2 per cent in September, but since the market recovery began it has slipped by 5.4 per cent to 536.5p.

The rebound is, of course, no more a purely British phenomenon than the collapse that preceded it. Germany and France, the two largest continental European markets, have bounced back by 23 per cent. On Wall Street, the Dow is up by 15 per cent from its lows.

Similarly, in other markets it has been banks and cyclical stocks such as automotive and engineering companies that fell fastest in the collapse and have recovered most sharply in the rally of recent weeks.

The big difference between Wall Street and the European markets is that, whereas the Dow began falling in July, hit bottom on 31 August and has since rallied close to its peak, Europe - including the UK - bottomed on 5 October. There has been a steady rise since, but there is little bit further to go.

Surprisingly, however, the relief has been far from universal. Spare a thought for the UK pension fund manager who, in October when shares were rebounding strongly, was holding 7 per cent cash. The five-year average levels are 4.5 per cent. Now, according to yesterday's Merrill/Gallup survey, UK pension-fund managers are itching to plunge back in to the market - just when the big broking houses are telling investors that this rally may not last.

Mr Greetham at Merrill Lynch thinks the rebound has been much too speedy for comfort, and that there may be more trouble ahead.

He points out that globally equities have bounced back by around 18 per cent in the past month, the fastest rise in any month since February 1991 when the Gulf War ended with the rout of Saddam Hussein's troops and the oil price, which had rocketed during the conflict, went into free fall.

This time there is no similar positive factor at work for the economy at large. True, the fears of a major banking failure and a global credit crunch have receded, but the threat of worldwide recession to which the investment world suddenly awoke in September has not eased entirely.

The US Federal Reserve, warns Mr Greetham, may cut interest rates to save the world from wholesale collapse, but it is not going to cut again just to keep an irrational share boom aloft. "People are saying that the Fed cuts have given enough of a shove to be able to see across the short- term ravine of earnings slumps to the recovery on the other side. Personally, I still think the world economy is going to slow sharply. At these levels the market is overbought."

Richard Davison, European strategist at Morgan Stanley Dean Witter, is also far from convinced that the current market rally is built to last. In 1987 the market went through six months of stabilisation, during which shares zigzagged nervously before resuming their rise. Eleven years on, the economic backdrop is much bleaker and profits forecasts still have a long way to come down.

Mr Davison warns that December, normally one of the stock market's better months, could be painful. "There is still fear about the economic future no matter how much easing there is. Growth is going to be sluggish next year. The UK economy will be weaker than many competitors, and that means weaker profits growth and a weaker stock market."