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Is the Tide Turning for Global Equity Markets?

Global equity markets ignored negative headlines on Europe’s economy and nagging concerns about a slowdown in China to end in the black for the second straight month in July, signaling a return of risk appetite among investors.

Caroline Purser | Photographer's Choice | Getty Images

Stock markets worldwide have already priced in too much negative news and are poised for much sharper gains in the months ahead amid signs of more supportive policies from global central banks, said Nomura in a recent report.

“Worldwide market volatility in May essentially ‘pre-priced’ a high likelihood of an imminent synchronized global recession, presumably stemming from disorderly deterioration in the euro area,” Nomura said. “Yet with every week the global catastrophe fails to materialize.”

The MSCI World Index hit a three-month high on Monday at 319.44, lifted by stronger-than-expected U.S. jobs dataon Friday and optimism that Europe will take action to end a debt crisis in the euro zone.

Nomura forecasts the MSCI World index could rally 19 percent from current levels by the end of the year.

It has risen about 10 percent since early June when concerns about a possible break-up of the euro zone, a slowing Chinese economy and weak U.S. economic data sent the index to its lowest level in more than five months as investors dumped equities and snapped up safe-haven U.S. Treasuries and Japanese bonds.

A move from equities into safe-haven bonds should continue to unwind, Nomura says, amid positive signsthat the European Central Bank will take decisive action to end the debt crisis in the 17-member single-currency zone.

That’s a view that Mun Hon Tham, Regional Strategist at Maybank Kim Eng shares.

“The ECB has outlined clearly plans for further quantitative easing and suppressing bond yields, so this will be a positive sign for investors. The money is there, what investors want to see is firm action and I think that is coming,” Mun Hon told CNBC Asia’s “Cash Flow.”

ECB President Mario Draghi last Thursday suggested the ECB could start buying government bonds to lower crippling borrowings costs in Spain and Italy once governments activated euro zone bail-out funds to join the ECB in buying bonds.

Hon said that within Asia he would favor cyclical stocks over defensive plays as risk appetite returns.

“These (cyclical stocks) have been pretty much bashed up. If you look at relative value, defensive stocks are pretty expensive and with the change in the macro picture – we are probably seeing a soft landing in China, more affirmative action from the ECB and the Fed in the weeks ahead – it is a good time to re-look at these names,” he said.

The U.S. Federal Reserve, which left monetary policy unchanged at a meeting last week, is expected to ease monetary policy via bond purchases or alternative stimulus measures in September.

“Policy support should continue to be forthcoming in the U.S…Emerging market central banks also got on the easing bandwagon, with rate cuts in China, Brazil, Korea, South Africa, Argentina, Colombia, Philippines and Hungary,” Nomura added.

Food Inflation Could Be the Spoiler

The brokerage said one potential risk to a rally in equity prices was high food prices, which could constrain central banks from easing monetary policy.

Prices for crops such as wheat, corn and soy beans, have shot up in the past three months – wheat prices, for instance, have gained about 40 percent – threatening the outlook for inflation and causing a headache for policy makers keen to use monetary policy to stimulate their economies.

- By CNBC's Dhara Ranasinghe