Third Quarter's Market Storm May Ease

This was a special summer, when the words "summer lull" were not pronounced in connection with stock markets.

In Europe, investors were able to enjoy a bit of sunny weather only at the beginning of July, and it has all been stormy since then - with sunny patches here and there.

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But the fourth quarter is likely to be calmer - that is, if no other major bad news comes from the banking sector.

On the face of it, it looks like the U.S. sneeze did cause an European flu. The FTSE 100 lost over 2% over the third quarter, the CAC 40 fell over 5.6% and the DAX lost over 1.6% in the third quarter.

However, economists say it's not more than an ordinary cold.

"For European stock markets to be down only 3% for the quarter is the seventh wonder of the world," David Buik, partner at BGC Partners, told CNBC.com.

Poisonous Cocktail

The financial sector, heavily represented in the main European indexes, has been in the spotlight for much of the quarter, mergers & acquisitions activity fell, signs of weaker consumer confidence surfaced in the U.K., France and Germany, and the credit markets all but dried up.

"That is a very intoxicating cocktail, I should think," Buik said, adding that the markets' health improved in September from August.

In July, news that U.S. home foreclosures soared over 90% from a year ago sent shockwaves through the financial system, with investors taking a deeper look into the extent of the subprime mortgages crisis.

At the beginning of August, French bank BNP Paribas barred investors from redeeming cash in funds worth $2.2 billion, saying it was unable to calculate their value due to turmoil in the subprime market.

A day later, central banks started pumping billions of dollars into the banking systems in a concerted effort to beat the credit crisis.

But on August 16, in a sign the panic had spread beyond the banking sector, European shares took their largest one-day fall in over four years.

Fed Offers Relief

The next day the U.S. Federal Reserve cut the rate at which it lends to commercial banks in a surprise move, providing the markets with some relief.

The bad news for the European financial sector was not over. Towards the end of August, reports that Barclays was forced to borrow money from the Bank of England's emergency facility at its penalty rate knocked banking again.

This, together with speculation on the losses that German banks Deutsche Bank and Commerzbank may suffer from the exposure to the U.S. subprime crisis, prompted calls for greater transparency and disclosure.

The Northern Rock crisis in September, an old-fashioned run on a bank reminiscent of the last century, was just the latest nail in the coffin for a sector which lost nearly 10% of its share value in the quarter.

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The Fed's rate cut on Sept. 18 was followed by a relief rally both in the U.S. and Europe, a sign that the world's biggest economy is still setting the trend for the globe.

Economists think the worst moments of the stock markets are behind us - provided the Fed keeps prescribing the same medicine.

"The Fed rate cuts will overcome any slowdown in the U.S.," Kevin Sullivan, from Clariden Leu, told "Worldwide Exchange," stressing the psychological importance of the cuts as they keep the consumers spending.

"With caveats, as long as the FTSE doesn't break the 6100s and a similar drop in percentage points in the Dow and the S&P (doesn't happen), I think we will go higher by the end of the year," he added.

Opportunities Emerge

Investors have emerged wiser from the turmoil and are much more likely to scrutinise their portfolios.

"The financials, in particular, have been sold with little discrimination between companies which might have exposure to dubious loans and those which are unlikely to have," Andrew Bell from Rensburg Sheppards said in a market note.

"The baby has been thrown out with the bathwater, so to speak, and it is usually correct to buy when other people's panic has created valuation anomalies," he added.

Analysts say shares in the food sector are likely to perform strongly due to the recent rises in prices for staples such as wheat, corn or soybeans while precious metals seem to be another winning bet.

Technology stocks and the commodities sector, with demand in Asia still running high, seem to be other areas where shares may ensure good returns, although in the case of commodities economists have warned they have been used as safe havens for a long time and may not come cheap.

Central banks will be in the hot seat again in October, with the European Central Bank and the Bank of England meeting next week to take decisions on rates.

"I see no change coming from the BOE and the ECB next week, but I wouldn't be surprised if it comes in the next month," BGC Partners' Buik said.

© 2008 CNBC.com