Thursday, August 16, 2007


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.

9 comments:

xatomic said...

Before we all turn all bearish on the local scene..here's the latest update on AP 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 early
1990s. 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 recordcapital 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 are
decelerating, we believe we are beginning to see Fed support
for markets.

xatomic said...

FYI

The man himself, Teun Draaisma, the MS Strategist who foresee this coming, has just turned bullish on European equities in his latest MS update...citing "first change in asset allocation since Jan 22 2007..) and going from neutral cash to overweight equities and underweight bonds..

Dali maybe you will like to give us your views on complex economics on whether this subprime mess is really just contained in US or will fundamentally spread to Asia

Salvatore_Dali said...

xatomic,

lol, i was wrong n MS was right... to me the subprime thing is a small thing ... but these were packaged into CDOs and sold to funds and other investors ... then some hedge funds leveraged up by borrowing yen to play some Asian mkts and also having some CDO exposure ... CDOs collapsing, cannot get out or sell there... redemptions coming, can only sell asian holdings ... a client wanting to withdraw 1m usd would see this hedge fund needing to sell 5m worth of stocks etc... it does not really affect asia per se but indirectly we get bashed.. owing to the leveraging effect

kam said...

If market were to rebound next week, these two worth a punt : KPS 5843, BHIC 8133

hellthy correction said...

im surprise that local governments have been relatively quiet about the jitters in equity markets. perhaps a good move i.e. to allow markets to find its own eventually. Equally gone are the eras of the state imposing eccentric measures trying to stop a stampede. Let market forces dictates its own direction and let the parties continue....

hellthy correction said...

How to survive a market correction
The Dow's plunge has been plenty scary, but this is no time to panic. Here are things to do, and not to do, with your investment dollars.
By Tim Middleton
The continued decline of the Dow Jones Industrial Average ($INDU, news, msgs) leaves investors with a big question: What to do next?
But this is no time to panic. Market corrections are an opportunity to upgrade the quality of a portfolio on the cheap. In panics, everything gets whacked. Only later, as they sift through the carnage, do investors discover that plenty of good stuff has been thrown out with the bad. The truly bad, meanwhile, gets worse.
If you've been prudent, you've built up some cash to take advantage of a correction that has been widely predicted. If not, the time to act is now. You don't need to take drastic action: A correction is short-lived by its nature, and stocks remain the likeliest assets to perform well in the next few years.
Contrarian Chronicles: A 300-point drop? This is just the beginning
Here are some simple do's and don'ts.
Do:
Lower your risk profile. In a correction, "you want to sell the assets you're least comfortable with," notes David Ellison, the chief investment officer of FBR Funds. "If you think they're risky, get rid of them." Among domestic stocks, the likeliest candidates are real-estate investment trusts, which have trebled in recent years. Other vulnerable groups could include microcap stocks, which are hypersensitive to the economy, and communications funds, which have been buoyant after being crushed at the end of the 1990s, the last time there was a panic. Overseas, the target is even more obvious. Emerging markets get pneumonia when the global economy sneezes. Fixed-income investors will shun mortgage bonds, high-yield bonds and the debt of developing countries.
If you do sell assets, hold on to the proceeds in a money-market account or Treasury bills. You are going to want this money pretty quickly, depending on events, because stocks are the best place to be, even when they're correcting.
Watch for bargains to develop among the kind of blue-chip companies that have proved resilient in past market tempests. Health-care mutual funds are a great place to start looking. So are technology funds, because a market panic isn't a capital-spending panic; blue-chip stock funds in general; and foreign-stock funds, particularly those with plenty of exposure to long-suffering Japan.
Stick with high-growth companies, like the midcaps I recommended in my column of Feb. 27. Post-correction buyers are going to be looking for winners, and this is a winning bunch. Ditto blue-chip growth.
Don't:
Rush into bonds. What's the profit? Corporate bonds and high-quality municipal bonds are already delivering misery yields. As one of Pimco's bond gurus, Paul McCulley, pointed out in my book "The Bond King," "The upside of a bond is that you get your money back." Investors own bond funds to cut risk; you own them always, not selectively. If bond yields were 8%, they would look interesting; below 5%, they aren't worth a second look.
Waste time on traditional havens such as gold, real estate or commodities. Those markets have enjoyed massive multiyear rallies that have already filled them with risks of their own.
Be scared into bear-market funds. Despite benefiting from the worst bear market in a generation from 2000 through 2002, the average bear-market mutual fund declined an average of 7.1% in the 10 years that ended Jan. 31.
Longer term, you might decide this long-in-the-tooth stock rally could use a few buttresses in your portfolio. Here are some to consider:
Long/short funds. As I described in a column in January, these funds play down markets as well as those with the usual upward tilt.
Market neutral funds. Some funds hedge away from stock risk. One group I described last August are merger funds, which scalp some of the premium in corporate acquisitions.
Permanent Portfolio Fund (PRPFX). As I noted in November, it has almost no exposure to stocks.
Other than that, take advantage of the correction to exchange some of your lowest-quality assets for some of the highest quality. When normal times return, you'll be sitting pretty.
At the time of publication, Tim Middleton didn't own any securities mentioned in this article.

ikanair said...

Arrr.. first cupboard(subprime) fall over and scatter a whole bunch of roaches. Wait a little longer and the second cupboard(US consumer spending) will fall soon pulling with it the third cupboard(Shanghai bubble), then, and only then, will we hit the bottom.

Liquidate,sit tight and watch the show.

SAMMY MU said...

Props to Dali and Xatomic on keeping everyone up to date on what you're seeing. As a firm believer that nobody is bigger than the market -not even those who believe they are the market -I continue to be cautious for the big picture. But that doesn't mean we can't (or won't) see sharp rallies and other opportunities. The key will be not to get swept up in the euphoria or or drowned in the negativity.

You know what's great for accumulation? Perisai. And yes, I have a position in the name. Like the insider news.

solomon said...

The old story again, sentiment vs fundamental. The one believe in the first will sell, the latter will shop around for value stocks.

Notwithstanding this, my opinion is that stay away from equity for the time being. Enjoy the school holidays with the kids. Until when? My best answer is when the remisiers receive no buy order for couple of days or months, depends on yr risk appetite.

Our mkt will only start to stabilize if the general election is called for or perhaps the start of a war in the Middle East.

This round, I think the mkt is going for sharp correction (at least 20%-30% from the high of 1400 level translate into 1000-1100).

Take a step back, I personally think there is an agenda behind this fall. I don't think subprime is, neither is the YEN carry trade, but the war in the Gulf. I might be wrong but it will soon be revealed.

Human character never change.....greedy. Dali, what say you?