Given the size of the October rally in equity markets one might be tempted to think that the events of August and September simply were the latest example of these waves of collective madness that happen to plague financial markets from time to time. Yet, as bears point out, the US economy is vulnerable. Investment could be in for a sharp slowdown given the low capacity utilisation rate whereas consumption could slow markedly given the sharp fall in consumer confidence since July (-14.5%).

To make matters even worse, the growth in the US economy should also be adversely affected by a fall in net exports as a consequence of the Asian crisis. What's more, the drag on the economy by a fall in net exports could be a lot worse if at the same time Latin America were to succumb to a series of disastrous devaluations.

It is thus easy to paint a bleak outlook for the US (and world) economy and to forecast renewed doom and gloom for equity markets. However, the logic of the above bear case may be partially flawed.

Firstly, since 1969, a fall in consumer confidence by 15% or more has just as often been followed by a rise in retail sales than by a fall. Secondly, the relationship between capacity utilisation and investment appears to have broken down since the early 1990s. Thirdly, some signs of stabilisation have recently appeared in Asia where-as in Japan at last some progress has been made on the handling of a number of structural problems. Bears also may have overstated the importance of Brazil which only accounts for 2.3% of US exports.

Moreover, falling unemployment in Europe coupled to the end of government spending cuts could lead to a sustained increase in European dom-estic spending. Finally, central bank-ers seem to have realised the depth of the emerging markets crisis and have started a process of generalised monetary easing, the end of which we probably still have not seen.

We therefore do not subscribe to the bear scenario and have adopted a neutral equity weighting in our portfolios. We also believe an environment of slowing economies and monetary easing should be rather favourable to bonds and therefore we still overweight them.

As far as country equity allocation is concerned, we clearly favour Europe over the US. The old continent is less advanced in the cycle, is characterised by a better earnings evolution and its valuation looks -apart from a few exceptions- more attractive than that of the US. We particularly like the Netherlands and Switzerland (having been beaten down to more attractive valuations), the UK (more easing in the offing and attractive valuations) and Italy (which seems to be less affected by earning downgrades than most of its European counterparts). After the huge declines since the start of this year we no longer underweight Japan and emerging markets where we believe risk still to be quite high but current prices have discounted the major part of it.

Jan Deroost is head of research & strategy at Fimagen in Belgium