The key question for investors these days is whether the recent market setback spells the end of the global recovery in economic activity and financial markets that began more than a year ago. Our answer to this question is no. The drop in risky asset prices - strikingly similar across all regions and products - looks to us like a healthy correction to markets that had run up extremely rapidly.

The events of the past couple of months should pose little risk to the global economic recovery, and we have made few changes to our economic forecasts. Fiscal sustainability issues in peripheral European countries are not likely to have a significant effect on demand in the US and Asia: Lower oil prices and interest rates should provide enough of a boost to offset any negative impact from weaker import demand from Europe. Indeed, the recent market instability seems to be delaying monetary tightening: we have moved back our forecast for the first rate hike by the Fed from September to next April (and edged up our near-term US GDP forecast). Even within Europe, the boost from a weaker euro - as well as from lower interest rates and oil prices - should offset fiscal drag over the next year or so.

If the economic recovery remains intact, we see this market setback as having created a near-term buying opportunity, especially in equities. Stocks have sold off far more than corporate bonds - much of the increase in corporate spreads has been caused by the rally in government bonds - so that relative valuation has shifted decisively in favor of equities. Valuations in the US and Europe look particularly attractive, as some of the early recovery countries such as China and Brazil are tightening monetary policy in an effort to avoid overheating. Moreover, the easy money/tight fiscal policy mix that we expect in developed markets has tended to be associated with strong equity market performance.

But while we are optimistic that markets will bounce back in the near term, we believe there are constraints on how far the rally can go. Equity market performance is not as uniformly positive at the beginning of the monetary tightening process as it is in the early stage of economic recovery. Moreover, the fiscal challenges facing many developed markets are significant (US, UK and Japanese fiscal positions are all worse than for Europe as a whole), and it is not yet clear that the adjustment process can be delivered while maintaining solid economic growth. Finally, the difficulties policymakers have had in re-establishing financial market stability in the wake of the Greek crisis has undermined investor confidence, which was just beginning to recover following the most severe financial crisis since the Great Depression. Until some of these issues are resolved, investors will likely remain cautious and asset values are unlikely to reach anywhere near the peaks of recent business cycles.

David Fuller's view Some short-term caution is still warranted while Wall Street remains on the defensive and most other stock markets continue to consolidate last year's exceptional gains.