Morgan Stanley Was Right, I Was Not
A few weeks back I posted the bearish piece by MS on the subprime mess. Going through it again magnifies how prescient the article was. Here's a rerun PLUS AN UPDATED OPINION BY MS:
Morgan Stanley has warned that current jitters on the global credit markets could spread to equity markets. Stock market corrections - after an increase in the cost of debt - historically follow six months later, suggesting that the current rally on Wall Street and European bourses may be more fragile than it looks
The current rally on Wall Street and European bourses may be more fragile than it looks. A rise in the interest rate spread between risky debt and benchmark treasuries knocks away a key support for share prices by raising the cost of money for leveraged buyouts, but there is often a long delay before investors react. A study by MS found that credit spreads began to widen on average six months before every stock market correction of 10pc or more over the past 20 years. The current widening began in February, picking up speed over the past three weeks. If history is any guide, this could point to a global stock market slide as soon as August. Morgan Stanley's model suggests a 14pc fall, or 2,000 points off the Dow. (a 14% correction will take the Dow to 12,000).
"This is not the first time that equity markets take their time to react to bad news," said the bank's chief Europe strategist, Teun Draaisma. "The fundamentals have deteriorated. Equities have reached all-time highs despite higher rates, wider spreads, higher oil, Chinese tightening, and a stronger euro. There is a widespread belief in continuation of good global growth without inflation. While we are not expecting a recession for another two to three years, we believe chances are high that this belief will be seriously tested soon." Mr Draaisma added that ever clearer signs of "stagflation" would soon start weighing on confidence. The current pattern looks similar to the relentless rise in spreads from February to September 2000 when the stock markets finally tipped over.
Morgan Stanley said the trigger for a stock market fall could be a sudden unwinding of yen "carry trade" from Japan, a major source of global liquidity. The worst stock market falls have been -58.4pc after the dotcom bust, -34.3pc in October 1987 and -30.8pc in a two-month shake-out after Russia defaulted in 1998, as measured on the MSCI Europe index.
Well, somebody deserves a big bonus this year.
Thanks to xatomic, here is the latest opinion by Morgan Stanley:
Equity Strategy from Morgan Stanley: Credit market turmoil in the US is likely to extend the period of sluggish US growth well into 2008. It may also slow Europe and the commodity producers. The fallout in Asia, however, should be limited, given Asia’s strong momentum, liquidity boom and potential for stimulus. We foresee Asia outperforming the US like it did in the early1990s. On our indicator checklist, we believe we are close to the trough in this correction. The implications of the US credit squeeze: The housing downturn will deepen, declines in housing related employment will accelerate, household debt burdens will rise, and wealth effects unwind, in our view. Whilst the US is vulnerable to downside risks, Federal Reserve support should be quickly forthcoming if the outlook deteriorates.
Four offsets for Asia: Export diversion to commodity producers and the EU has proven effective, though this is likely to slow. More significant, strong momentum, the liquidity boom, and potential stimulus, particularly from positive political change, should limit the fallout on Asia.
The Analogy Is the Early 90s, Not 1998: In the early 90s, the US was held back by the workout from the S&L crisis. Sluggish US growth versus strong Asian growth led to record capital inflows and substantial Asian equity outperformance. Today’s US home mortgage crisis is more akin to this, rather than the EM crisis of 1998. Where is Asia-Pac in this Correction? We conclude that we are close to the trough. While valuation is still relatively high in Asia, in the US it is just above 11-year lows. Whilst sentiment still appears too high, and US indicators a redecelerating, we believe we are beginning to see Fed supportf or markets.