Why this stock-market rally can last

Optimism seems to have returned as mysteriously as it had vanished. With no clear catalyst, riskier assets have enjoyed one of the fastest revivals since the collapse of Lehman in 2008. After a punishing summer, the main question for investors is whether this revival can last. With a few caveats, we believe it can.

Predicting shorter-term moves is harder in a market that has become detached from fundamentals. The MSCI All Country World index, the broadest gauge of global equities, has jumped 7 percent since sentiment suddenly improved on Sept. 29. The VIX measure of equity market volatility declined for 10 consecutive days, the most consistent fall since 2009 and only the third such stretch over the past decade.

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Markets gave up some of the recent gains on Monday – even before the release of disappointing import figures from China that might have justified a more sober mood. This is in keeping with recent months. Neither the sharp slide in risk assets in August nor the October revival has been driven by economic data surprises.

That said, economic and earnings data for the third quarter from the U.S., the euro zone and Japan should be relatively positive. This should promote the market rebound and refocus attention on the fundamentals. Purchasing managers' indices in all three regions indicate an expansion of activity.

We also believe the Chinese economy has the willingness and the tools to avert a dramatic slowdown in growth. Its budget is in surplus, it still has reserves of well over $3 trillion, and its one-year interest rates are at 4.6 percent, leaving room for the country to ease monetary policy.

Lastly, all major central banks are aggressively promoting growth. We see little danger that inflation will force them to remove the punch bowl. And equity valuations are nowhere near bubble territory. The MSCI World index is valued at less than 16 times predicted earnings versus an 18-year average of 17 times.

However, the anatomy of the rebound is likely to change from here. The biggest gainers so far have been emerging markets and commodities. Brazil's benchmark equity index, the Bovespa, has been close to the top of the rankings with a gain of 13 percent in dollar terms, along with Hong Kong's Hang Seng, which has added 11 percent. Among raw materials, industrial metals are up, explaining a 7 percent rally in the basic resources sector in the European Stoxx 600, which has climbed 24 percent.

We attribute this mostly to normalization from an extreme level of negativity. We would not expect the pace of improvement to be maintained. The outlook for emerging markets continues to be clouded by weak corporate earnings growth along with slow economic growth for many. Earnings growth for the MSCI Emerging Markets index, we believe, is likely to be just 4-6 percent over the coming 12 months, with even worse prospects for commodity-reliant nations like Brazil and Malaysia.

While euro-zone and Japanese equities have both rebounded by 7 percent since September 29th, they have lagged emerging markets. That pecking order should reverse if the rally matures. The economies of both the euro zone and Japan are backed by highly supportive monetary policy and we are expecting corporate earnings growth of 12-15 percent and 18 percent respectively – far faster than for emerging markets. We are overweight both euro-zone and Japanese equities over our tactical six-month investment horizon.

Overall, the drop in riskier assets reflected excessive pessimism over the global outlook. The rebound suggests that markets may be returning to a more realistic assessment of fundamentals. But investors should still expect volatility and temporary setbacks.

Commentary by Christopher Swann, cross-asset strategist at UBS Wealth Management, which oversees $1 trillion in invested assets. Follow UBS onTwitter @UBS.