October 23, 2008

Trading Diary: Solvency Issues & PE Ratios

Solvency Issues & PE Ratios

By Colin Twiggs
October 23, 2008 8:00 a.m. ET (11:00 p.m. AET)

These extracts from my trading diary are for educational purposes and should not be interpreted as investment or trading advice. Full terms and conditions can be found at Terms of Use.

I will be away on the weekend; so this is my last newsletter for the week.

Economy

The ICAP 1-month New York Funding Rate (an alternative to LIBOR that is less open to manipulation) spread over the overnight index swap rate eased by more than 100 basis points (1.0%), but remains alarmingly high. A spread of 2.50 percent is unsustainable in the long term.

The Fed may be able to provide liquidity but cannot allay fears regarding bank solvency. An underlying cause is the failure of accounting standards to accurately reflect bank solvency. And many banks are hiding behind current standards because marking assets to market value would reveal that they are insolvent.

The only way to restore stability is to either sell toxic assets to an independent buyer, such as the US taxpayer, or write them down to zero. If liabilities then exceed assets, the taxpayer will again be needed. This time to restore solvency through preferred share funding. Pricing of the rescue is critical to its success. Price the funding too cheap and it will be abused. Some banks have already made noises about funding acquisitions. Pricing of preferred shares should also include participation or conversion options to reward the taxpayer for the risks being assumed. This is not a hand-out and any banks that are not viable should be merged with their stronger compatriots or broken up and sold off piece-meal. With creditors picking up the tab. Not the taxpayer.

Credit Default Swaps

Another reason for current hesitation is the shadow cast by the $65 trillion credit default swaps market. This requires regulation and creation of a formal exchange that can trade a standardised product. Not something that is likely to occur until after the election.

Election 2008

The coming election adds further uncertainty. Expect a post-election rally, but this is unlikely to signal the end of the bear market. The real task at hand is to restore the world's biggest debtor to solvency. Raising taxes in order to balance the books appears the only short-term solution. And cutting back on spending programs in the medium term.

The long-term solution is to stimulate investment. Lowering interest rates is a blunt instrument that actually does more harm than good. The accompanying rise in inflation channels funds away from real investment to speculation in rising asset prices, that inevitably lead to higher interest rates. The consequent slow-down heralds the downfall of any corporations deceived into poor long-term investment decisions by artificially low interest rates and the temporary inflationary spike in consumption. Increased tax incentives for new investment lead to similar distortion, with many investments bound to fail when the artificial stimulus is removed.

What business really needs is stability. Stable demand, sustained by limiting intervention in interest rate markets and tight control over credit expansion. And stable low interest rates, brought about by stimulating savings rather than consumption. Consumption spending may produce a short-term "sugar rush" but only investment in productive assets delivers long-term gains.

Shipping and China

The Baltic Dry Index had a spectacular fall in recent weeks. The index is dominated by large bulk carriers of coal and iron ore, reflecting the fall-off in shipments between major producers, particularly Australia and Brazil, and China, the largest global consumer. This warns of substantial falls in revenue for both producers and consumers.

China's export-led economy looks increasingly likely to join the global recession. And Australia would inevitably follow. A fall below 1900 on the Shanghai Composite Index would offer a target of 1500, calculated as 1900 - ( 2300 - 1900 ).

Gold & Oil

Gold is headed for a test of the band of support around $700 after a bearish failed swing in a long-term descending broadening wedge formation. Failure would offer a target of $560, calculated as 740 - ( 920 - 740 ), the June 2006 low.

Spot Gold IAU chart (1/10th of an ounce)

Brent crude broke through the band of support at $70. OPEC production cuts would increase support, but presently appear unlikely to prevent a test of the 2007 low of $50.

Stocks

The S&P 500 is approaching the 50% retracement level of 800 and there is talk that stocks now represent exceptional value. Price Earnings (PE) ratios are relatively low at 16.5, based on 2008 forward estimates of 54.5 cents/share. Estimates for 2009 are 48.5 cents — a 40 percent fall from the 2006 peak of 81 cents. Index earnings fell roughly 50% in the 2001 recession.

This raises two questions. First, is 48.5 cents the bottom of the current earnings cycle? The chart below shows how the earnings volatility has increased in recent business cycles. An earnings fall to 40 cents/share would not be unreasonable. Expect further shocks as employment falls, consumption slows and the economy slides into recession. That includes more bank write-downs.

Second, what are future PEs likely to be? Expect an extended period of stagflation, with low growth accompanied by high inflation. In the last such period, from the late 1960s to the early 1980s, PE ratios declined to as low as 7. While I am not suggesting a repeat, history shows that when inflation is high PE ratios fall.

If earnings had to fall to 40 cents/share and PE ratios to a fairly optimistic 15, that would offer a projected target of 600 — 33 percent below the current level of 900.

Long term support at 800 appears vulnerable.

The S&P 500 index is again testing support at 900. The ban on short selling had an unexpected side effect. With no short sellers jumping to cover their positions, the market failed to rally, exhibiting a dead cat bounce. The short-term pennant warns of continuation of the down-trend. Failure of support would offer a short-term target of 800, from the 2002/2003 lows.

The FTSE 100 formed a similar pennant above 3900. Breakout would test the 2003 low of 3300.

The German DAX is similarly testing 4500. Downward breakout would offer a target of 3600, the August 2004 low.

The Australian All Ordinaries is likewise testing short-term support at 3950. Failure will offer a target of 3400: the 2001 to 2002 high (and 50 percent retracement level from 6800).

Treasury Yields

Ten-year treasury yields are headed for another test of support at 3.40 percent, anticipating further rate cuts. Yield differentials are high, reflecting healthy bank margins.

The Shadow Banking System

The $10 trillion shadow banking system continues to unravel. Total commercial paper in issue is falling rapidly despite the Fed purchasing commercial paper to maintain liquidity. Contracting credit in the shadow banking system is likely to affect the global economy for at least two to three years.

Declining commercial paper yields reflect Fed intervention. Short-term treasury yields are also expected to stabilize, due to the introduction of interest payments on bank reserves deposited with the Fed. The effective fed funds rate has declined well below its 1.50 percent target — warning of further rate cuts.

commercial paper rates compared to federal funds rate and treasury bills

Corporate Bonds

Corporate (Baa/Aaa) bond spreads have spiked upwards in anticipation of record defaults.

Housing

Treasury yields may be falling but this is more than offset by the upward spike in mortgage spreads. An up-trend in fixed mortgage rates would warn of further weakness in the housing market.

30 Year Fixed Mortgage Rates Compared to Treasuries

Banks

The Fed and Treasury are pouring massive amounts of money into the financial system in order to avoid a complete melt-down. Unfortunately this is not just a liquidity crisis. It is firstly a solvency crisis, with lenders wary of defaults in the interbank market. Too many toxic assets remain undisclosed, leading to uncertainty, and a reluctance to lend. Tough measures are needed to restore confidence. And if there are a few more casualties, so be it.

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else.

~ John Maynard Keynes

To change your email address click here

To stop receiving Trading Diary newsletters click here.

Comments [0]

October 21, 2008

Commodities are still the go

Thursday, October 16: There has always been a necessity to characterise calamitous world events with the
word "great". The horrific loss of life in the First World War resulted in historians calling it the Great War.
Similarly, the worst global financial crisis in modern history back in the 1930s has been called the Great
Depression. More recently, US Federal Reserve chairman Ben Bernanke labelled the uncharacteristically long
period of low global bond yields and inflation in the early part of this decade as the Great Moderation.

The Great Deleveraging
However, the recent events in 2008 will inevitably been described by historians as the Great Deleveraging.
Maybe I could register it as a domain name and receive royalties every time the phrase is used on the internet,
or when comedian Vince Sorrenti is forced to include the phrase in his send-up of the significant usage of
"great" in Australian history, with the Great Barrier Reef, Great White Shark, and the Great Dividing Range, etc.
In reality, the Great Deleveraging of 2008 is really the "greatest" global margin call of all time. In some cases,
assets and trading positions of major US investment banks and hedge funds were leveraged by up to 20 times.
It is little wonder that the world financial system has ground to a halt under the threat of systemic meltdown
through counterparty risk.
Considering the absolute carnage in the global foreign exchange markets, it appears that the extent, and the
leverage of the currency-related "carry" trades has been significantly underestimated. The extraordinary 35.5%
fall in the Australian dollar in just over 10 weeks, to the recent intra-day low of US63.2¢ last week is clear proof.
(It is now around US60¢.)
In addition, it has now become very clear that the 30%-plus fall in the US dollar index over the past six years
has spawned massive global US dollar hedge trades. In this regard, with the global deleveraging and
unwinding of risk positions I have been simply amazed by the extent of the short US dollar and long commodity
trade. The stunning short covering rally in the US dollar, and the corresponding fall in the Australian dollar, has
only been exceeded by the spectacular fall in commodity prices.

You must have flash to see this embedded document.

(download)

Comments [0]

October 13, 2008

Downunder Daily : Playing a Bounce

A few thoughts on playing a bounce in risk assets:

First, after the broad-based bear market, a reversal is likely to involve broad-based gains. But to maximize the short-term upside may conflict with some longer-term considerations. Put simply, it may be that the bullish reversal will see what's fallen fastest bounce the hardest. Buying bombed-out assets may be fine for tactically adept investors. But buying (positive) beta in the bounce risks getting left with (negative) beta in a renewed down-leg if you miss the turning point.

Second, comparing valuation metrics across asset classes is tricky, but it seems that the most supportive (cheap) valuations are in credit, rather than equity. Indeed, our credit strategists were slightly ahead of our equity strategists in turning upbeat, particularly on investment-grade credit (see, for example, Gregory Peters, Insanity Now, Serenity Later, 3 October). Greg notes that for investment grade, the spread per leverage (that is, basis points spread per unit of balance sheet leverage) has never been higher.

Neil McLeish, from our European credit team, notes that many credit spreads have not been this wide since the Great Depression. There are very few equity metrics that are at their cheapest level since the Great Depression. (For reference, the Graham-Dodd P/E, which is based on a 10-year inflation-adjusted earnings series, is now around 15; it has been as low as 5.)

Third, while the proximate cause of any bear-market rally may be policy-makers' actions to stem serious systemic problems, solving systemic problems will not avoid a sharp economic slowdown. Our economists acknowledge that the policy response reduces the downside risk - most melodramatically, reduces the risk of another Great Depression - but our team continues to expect a global recession next year. The prospect of a difficult economic cycle colours the way most of our strategists want to play any revival in markets.

Fourth, financials should do well in a bounce, in part because they have fallen the farthest (in both equity and credit terms) in the sell-off, and in part because policy-makers are specifically targeting their rescue efforts at this sector. Neil McLeish is strongly recommending that clients buy financial sector debt, both in Europe (Exhibit 1, from Supercycle Unwind: Taking a Bullish Stance, 6 October) and in the UK. Conversely, our US investment-grade credit team remains cautious on cyclical sectors (Exhibit 2, which is taken from Greg Peters, Some Earnings Guidance, 10 October).

Fifth, our equity strategists see reasonable tactical upside. Exhibit 3 is a summary of their forecasts (the returns are based on the market close on 8 October). Both our European and Emerging Markets teams have increased their equity exposure (Teun Draaisma, Time to Buy a Little Bit More, 13 October; Jonathan Garner, Upgrading EM Equities to Maximum 10% Overweight, 13 October).

Finally, as has been the case in credit, equity investors have punished cyclicality and leverage in the bear market. Exhibit 4, from our Emerging Markets team, shows the performance of high- and low-leveraged stocks in their universe.

This highlights the trade-off in playing the bear-market rally for equity investors. It may be that the most beaten-down stocks and sectors will perform best in the counter-trend rally. But the medium-term outlook remains difficult for both cyclical and leveraged stocks (the latter on the basis that credit conditions will remain tight). It remains difficult to ascertain whether the cyclical downturn is in the price.

Our US team have lifted some of their cyclical shorts, but maintained others (see Abhijit Chakrabortti, Get Shorty: Final Short Ideas, 7 October). Our European team remains cautious on the cycle, and focuses on value-based and financial-based long-short ideas (see Teun Draaisma, Capital Preservation Rules, 6 October). In Asia, Mal Wood is looking to play beneficiaries of lower material costs and easier domestic policy (see Falling Commodities = Margin Support + Easier Policy, 6 October).

I'm heading to the Middle East and Europe for marketing. Next DuD is to be published on 3 November. GM

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of September 30, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	40%	292	44%	33%
Equal-weight/Hold	937	42%	278	42%	30%
Underweight/Sell	387	17%	90	14%	23%
Total	2,216		660

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

Comments [0]

October 9, 2008

Downunder Daily : Now What?

A few thoughts:

Investors have now seen the most likely catalyst for (at least) a counter-trend rally in risk assets. Coordinated rate cuts have capped a panoply of policy responses to the unfolding crisis. This should, in normal circumstances, lead to a tradeable bounce in markets. In equity terms, that would be a 2-3 month, 10-20%, rally.

If a bounce doesn't happen, we will have to ask why. Several factors, not mutual exclusively, could stymie a rally:

1. The recent absence of bear market rallies could be due to some of the unusual features of current markets. Restrictions on short-sales have reduced the number of investors that are natural buyers (ie. profit-takers) after sharp sell-offs. Where shorts are thin, short-squeezes don't happen.

2. There is broad-based pressure to reduce leverage, and the focus now is on the financial sector generally and the investor community specifically. (Later in the cycle, I think it will switch to the household sector). This pressure may be forcing enough selling to counteract buyers attracted by apparent mis-pricing of assets.

3. The market has seen the policy response and is taking the view that it won't work. In other words, markets are betting on a deep global recession.

4. This is capitulation. Colleague David Darst uses a market-cycle framework where one of the defining features of a market bottom is "improving fundamentals are ignored" (Exhibit 1). If this is the key factor, then the bounce may be delayed, but ultimately to see capitulation would be a major positive.

The initial response to the rate cuts has not been promising. One day is too soon to judge whether the bounce will appear or not. However, the extreme volatility underscores the difficulty in playing a tactical rally in these fast markets: even if the bounce appears in a week or two, prices could be significantly lower than they are now.

Tactical calls are never my forte. But my view now is that the risk-reward has tipped against maintaining short positions. Several of my colleagues, such as Teun Draaisma, who has a much better track record than me at these things, is calling for a tactical rally.

Taking a step back, the key strategic issue remains whether markets are now too pessimistic on the cycle. We have to decide what sort of recession is priced, and what sort of recession is likely.

The first point is to note the discrepancy between credit and equity pricing. Credit pricing is at extremes. Our European credit team is now outright bullish on investment grade credit, and has cut its underweight in high yield (see Neil McLeish, Into The Breach: Why We're Bullish, 8 October). High yield credit markets in Europe are now pricing in 40-50% default rates. Neil has been a longstanding bear, but has now changed his view given that pricing. Exhibit 2 shows the pay-off on high yield debt under various scenarios. There is a small positive return under even the worst-case scenario (47% cumulative default rate, and 20% recovery rate). As an aside, Neil is more bullish on investment grade credit than high yield, but Exhibit 2 illustrates the point about what is now priced.

While credit pricing is at extremes, I don't think equities are. Yes, they are quickly getting cheaper, and now pricing in a major recession. But while credit is pricing in something worst than anything but GD2, the same isn't true for equities, in my view. As a generalization, my view is that equities would have to fall around another 20% to be at a comparable level of pessimism. At those lower levels, the risk-reward would favour medium-term buyers, barring any outcome except something of near-depression severity.

How has the policy response changed the economic outlook? Our global economics team is now expecting global recession. But it had also expected broad-based rate cuts, so the initial reaction is that the overnight policy moves do not change the base case, even if the tail risk is reduced (see Joachim Fels, The Great Monetary Easing, 8 October).

Remember, that the problem in a credit crunch is not the price of credit, it's the supply of credit. Rate cuts don't hurt, and they send a signal that policy makers recognize the seriousness of the situation. But the key has to be fixing credit flows. In that context, arguably the more important moves this week has been the Fed stepping into the commercial paper market, and UK authorities recapitalizing banks. As I've argued before, recapitalization is a critical stage.

This remains early days for rate cuts and recapitalization. The IMF estimates that the global banking system will require capital injections of US$675 billion. Further rate cuts will likewise be required, because my view is that policy remains restrictive in many economies.

This suggests that investors continue to face a very tough 2009. More to the point, it's not clear that equity markets have priced in what may eventuate, even if they have come closer over the past month.

Consequently, I'm not convinced that we've passed the strategic low point for equities in this cycle. I have to be less bearish now than I was even a month ago, but the headwind for earnings, the prospect of investor deleveraging (and what that may mean for trough valuations), and the fact that tail risks are non-zero, suggest that any near-term rally will ultimately fail and markets will at least revisit their lows.

We are in uncharted waters. Long-term readers may remember that I was far too late in calling the bottom of the last bear market. I may be too late again. But my hunch is that the risk-reward remains to err on the side of strategic caution: I doubt that the rebound from the lows will be particularly sharp, while the risk of another big leg down can't be ruled out.

Barring another round of policy cuts tonight, I won't write a DuD tomorrow. GM

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of September 30, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	40%	292	44%	33%
Equal-weight/Hold	937	42%	278	42%	30%
Underweight/Sell	387	17%	90	14%	23%
Total	2,216		660

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

Comments [0]

October 7, 2008

Downunder Daily : Exceptional for Some

The most obvious catalyst for a bounce in risk assets is aggressive central bank easing. Time will tell whether yesterday's unexpected 100bp cut by the Reserve Bank of Australia sets a pattern. Our global team expects several central banks to ease in coming months. The prospect now, however, may be for unexpectedly large moves. Morgan Stanley US economists Dick Berner and Dave Greenlaw, for example, expect the Federal Reserve to cut the funds target to 1% by year-end.

The big question is this: Would this mark the bottom for markets? A few comments:

We are at the stage where investors have to judge what sort of recession the world faces. But I'm not sure this call is binary; that is, I'm not sure that risk assets are now attractively priced (on a medium-term view), except on a worst-case outcome. I do agree that if this is a mild downturn, then many markets probably are below fair value. But you don't have to fret about GD2 to remain strategically bearish, in my view.

Having said that, there are differences among markets. In particular, it is true that this has been an exceptional cycle for credit markets. Neil McLeish, our head of European credit, notes that credit spreads in the US are at levels not seen since the Great Depression (Exhibit 1). In other words, it may be for credit that you do have to expect depression-like conditions to remain strategically bearish. Neil has turned bullish on European credit (see Supercycle Unwind: Taking a Bullish Stance, 6 October).

However, it is not true to say that this cycle has been exceptionally severe for equity markets. Exhibit 2 shows how far the S&P 500 index is from all-time highs. It is now (at 1010) around 36% from its peak. This is a significant bear market, but it's not exceptional.

Exhibit 3 is another way to gauge the severity of a bear market. It shows how far the market has fallen in terms of 'time' - that is, how many years' gain has been erased by the bear market. The current bear market has pushed the S&P back to 1997 levels, erasing 11 years' gain. This is not exceptional by historical standards. In fact, what stands out as exceptional is the 20-year period that followed 1980, when set-backs were brief and shallow. This - not coincidently - coincides with the debt super cycle that, I think, has now peaked.

I'm not denying the obvious point that the decline in equities reflects a significant re-assessment of the outlook for earnings and the economy. But in many respects, this is a severe bear market for equities only by the benign standards of the past 25 years.

Whether the bear market has factored in enough, or too much, downside for equities will depend on the depth of the cycle and how far the earnings bubble deflates. Earnings remain high as a share of GDP, and the capitalization of equities likewise remains well above long-term averages (Exhibit 4).

There are, however, now some tactical measures suggesting that this has been an unusual bear market. Colleague Bill Smith notes that over half of the S&P 500 is now more than 40% below its 52-week high (Exhibit 5). This has been a remarkably broad-based bear market (which I think is because the preceding earnings bubble was likewise broad-based). This is one tactical indicator suggesting that we may see a bounce. But a bounce wouldn't mean the end of the bear market.

I'm interstate for the next couple of days, so the next DuD is to be published on Monday, 13 October. GM

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of September 30, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	40%	292	44%	33%
Equal-weight/Hold	937	42%	278	42%	30%
Underweight/Sell	387	17%	90	14%	23%
Total	2,216		660

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

You must have flash to see this embedded document.

(download)

Comments [0]

October 6, 2008

Downunder Daily : Stress Fracture

Don't expect a 'normal' recession when the banking system is under stress. That's the key takeaway from the IMF's latest World Economic Outlook, which includes a detailed survey of 'Financial Stress and Economic Downturns'. Our global economics team agrees: We expect close to global recession in 2009 (typically taken as 2 1/2% global growth). Our global GDP forecast is now 2.7% for 2009. For details, see Richard Berner and David Greenlaw, A Deeper US Recession Goes Global, 6 October.

The IMF collates data from developed economies and investigates 113 episodes of financial stress. The first point to note is that we are now experiencing the broadest period of financial stress since at least 1980. Exhibit 1 shows the percentage of countries experiencing financial stress. This is a global credit bubble that is deflating, so the fall-out will be global.

The second point is that slowdowns or recessions that are accompanied by financial stress - particularly if that stress involves the banking system - are longer and deeper than average (Exhibit 2).

Exhibit 3 provides the important summary data. This is the key comparison: The typical recession that is not preceded by financial stress lasts for 3.1 quarters and is associated with a cumulative output loss of 5.4% (output lost relative to trend). The typical recession that is accompanied by banking-related financial stress lasts for 7.6 quarters and is associated with a cumulative output loss of 19.8%. (There are 17 cycles that fit into that latter category.)

Banking-driven recessions involve larger cumulative output losses in part because they are deeper. Exhibit 2 shows the typical four-quarter GDP change profile for the various types of cycles - the typical nadir of a banking-related recession is around -1 1/2% GDP growth. As importantly, banking-related downturns produce a larger output loss because they last longer.

One factor that tends to exacerbate banking-related downturns is that banks are an important transmitter of monetary policy changes. If the banks are under stress, the policy response to weaker growth becomes less effective.

The IMF also discusses the pro-cyclical behaviour of bank leverage, which, in turn, explains why banking-related stress seems to be more important than other types of financial stress. Banks changing their behaviour can extend the downturn. As Exhibit 4 shows, the subsequent growth in bank assets is significantly slower after a recession, and the cost of capital is higher. This fits with my view that the financial system will not quickly return to its old way of operating, even after the current recession is completed.

Following on from my note last Friday (Now It's a Recession...), if the key issue facing investors is to decide how long the recession may last, the IMF's work suggests that the recession will last longer than usual. This is now also the view of the Morgan Stanley economics team. The tumble in equity markets suggests that investors are now likewise moving to price in a longer and deeper downturn.

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of September 30, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	40%	292	44%	33%
Equal-weight/Hold	937	42%	278	42%	30%
Underweight/Sell	387	17%	90	14%	23%
Total	2,216		660

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

Comments [0]

October 2, 2008

Downunder Daily : Now It's a Recession...

...well, not officially yet - but the ISM has fallen below the traditional recession threshold (44), and our US team thinks that GDP contracted in the September quarter. What does it mean?

First, the Fed will likely ease in a recession. It always does. This cycle has been unusual, of course, because the Fed has already eased by 325 basis points. Nonetheless, in a recession, policy makers do what they can, and for the Fed that means easing. Our US team expects a rate cut before year-end. (As an aside, the same point applies elsewhere: an OECD recession points to OECD-wide rate cuts.)

Second, inflation will likely fall. It always does, although with a lag (Exhibit 1). Even in the 1970s, inflation fell in recessions. Unless you want to go against a lot of history - and I don't think the Fed will - then the prospect of falling inflation clears the way for rate cuts.

Third, earnings will very likely fall. They always do in a recession. That, in turn, means downgrades to forecasts. Downgrades could be particularly large now because current forecasts are ludicrously high, in my view. Excluding financials, the consensus forecast is for around 13% earnings growth in 2009 and 2010.

Exhibit 2 shows the correlation between the ISM index and the one-month change to 12-month-ahead consensus EPS forecasts for the S&P 500. The 12-month-ahead earnings estimate was scaled back by 0.9% last month; the ISM at current levels is usually associated with 2%-per-month downgrades.

Fourth, recessions aren't good for equities. Recessions always trigger a fall in equities. But there's a caveat on this point: Markets are forward-looking, and occasionally by the time it's clear that a recession is under way, the market may have already priced it in.

Now, for example, we're acknowledging a recession that is already three months old. More to the point, while the Fed may keep cutting late in a recession, and inflation certainly keeps falling, and analysts continue to downgrade, equities usually rally late in a recession.

Our US strategy team highlights the performance of equities in recessions in its latest monthly (see Abhijit Chakrabortti, In the Flow, 1 October). Exhibit 3 shows the key table.

The S&P 500 has fallen by 9.5% on average prior to the start of a recession. It falls an additional 18% from the start of the recession to the trough. From the trough to the end of the recession, the S&P has, on average, rallied by 25.0%. While there is significant variability among recessions, the pattern of pre-emption (falling into the start of a recession, rallying prior to the end) is consistent.

Two follow-on points: First, I think that this cycle has been unusual because we have seen two bear markets run together. The first bear market was almost exclusively a finance-centered affair. Because of that, I do not think that the 'acknowledgement' phase (as described in Exhibit 3) started when the market peaked last October. I think that the second, recession-related bear market started when the economically sensitive sectors peaked, which was in mid-May. Put another way, the clock started ticking on the recession-driven bear market in May, not last October.

Second, the key question for investors now is not 'whether there will be a recession' but 'what sort of recession'. Equities rally from the recession trough. Looking ahead, the most important issue to decide will be when the recession is at its most severe. If it's a run-of-the-mill affair, then the equity market may be a buy before year-end. That's because the average recession runs 11 months, so if an 'average' recession started in May, there's a good chance that the worst point in the cycle will be in the December quarter. Once past the nadir, equities could start to rally.

I think the risks in this cycle are skewed unusually to the downside, and I see a 20-25% risk that this could be the worst recession in 60 years. That is the debate we'll have to have in the next few months. For now, however, even the vanilla recession view suggests further downside to equities.

No DuD on Monday (holiday in Sydney). GM

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of September 30, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	40%	292	44%	33%
Equal-weight/Hold	937	42%	278	42%	30%
Underweight/Sell	387	17%	90	14%	23%
Total	2,216		660

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

Comments [0]

October 1, 2008

Downunder Daily : 1-2-3

I think we're in the second stage of a three-stage financial sector adjustment. Liquidity was the focus in the first stage. Solvency is now the main issue in the second phase, and that will require capital provision. Deleveraging has already started, but I think it will be the most important feature of the third phase, and will continue even after lenders have been recapitalized.

Through the early stages of this crisis, the policy response was largely concerned with improving liquidity. A range of new lending facilities was introduced to enhance financial system liquidity. There were also rate cuts in the US. Liquidity measures provided only temporary relief. The problems went deeper than liquidity; they reflected solvency.

Solvency concerns increased in line with losses. Losses mounted, but capital raising lagged (Exhibit 1) - a worrisome mix for leveraged institutions. Moreover, there are more losses to come. Exhibit 2 shows our credit team's forecast of mark-to-market losses for a selection of US and European banks. These estimates don't include higher provisions as the deteriorating macro environment hits banks' loan books.

It has become clear that the private sector was unwilling, or unable, to contribute enough capital to maintain some institutions' solvency. Consequently, it's become necessary for the public sector to step in. Public sector balance sheets have been put to greater use over the past two months. Sometimes this has been implicit (conservatorship of the GSEs) or explicit (effective nationalization of some European lenders). A few comments on this loss/recapitalization process:

First, the size of the losses suggests that public participation is inevitable. This may be politically unpalatable, but is necessary. That public participation may be dressed up different ways, but the point is that capital is required, and the private sector now seems unwilling or unable to provide it.

Second, I had thought that recapitalization would be more difficult to engineer in Europe than in the US, given the regional patchwork of regulatory and political authority (and, dare one say, 'bailing out bankers' may be even less popular than in the US). As it's turned out - at least on the form of the past week - this has not been true. Authorities in a number of European countries have taken quick and effective measures to support a number of at-risk institutions.

The action in Europe has been piecemeal, but the more important point is that there has been little compunction about putting the public balance sheet behind failing private sector institutions. That contrasts with the stumble this week in the US Congress.

Third, to state the obvious: To solve a solvency problem, there has to be an injection of capital. Changing accounting standards won't do it. Nor, for that matter, will asset-swapping if the transaction occurs at fair value. Such a transaction may improve liquidity (selling a structured product for a Treasury bond means the seller has a more liquid security), but the failure of the intense liquidity provision measures shows that the issue was more than one of just liquidity.

Clearly, selling an asset for less than its 'true' value hurts the seller. It's the reverse of capital injection. The trade may do good if the immediate effect of the transaction is to improve sentiment enough so that capital raising is easier. Put another way, this is a zero-sum game: If authorities buy assets and make a profit, that will come at the long-term expense of the banks that sell the asset at a loss. In the current crucible, there may be no choice, but the fact remains that such a transaction is not going to recapitalize the lender.

The details of the latest US bail-out plan are not completely clear. But what the plan may involve is an upside-down version of what happened in the last banking crisis. This is not a reference to the Resolution Trust Corporation, set up to help the Saving & Loan sector. It's a reference to the very steep yield curve in the early 1990s which helped the banks recapitalize in the wake of the losses on Latin American loans. Banks were able to pick up juicy, low-risk carry by funding at the short end (cheap deposits and a Fed funds rate at 3%) and invest in long-end Treasuries (which peaked at 9% in 1990). Banks restricted lending to the private sector, and bought lots of quality long-end paper (pushing the 10-year Treasury yield to almost 5% by 1993). It worked (helped by some nudge-and-wink accounting on the Latam loans which saw the write-downs delayed).

The problem now for the banks is that 'safe' carry is difficult to achieve. Long-end yields are under 4%, and the curve is relatively flat. The TARP proposal may see lenders sell high-yield (but problematic) assets in return for low-yielding cash. That is, it's a negative carry trade. The government, not lenders, looks set to enjoy positive carry: Buy high-yield assets, funded by low-yielding Treasuries, generating substantial positive carry (enough, so the view goes, to compensate for the low asset quality).

If the package buys time, it will achieve something. But to the extent that the bail-out does work as a recapitalization scheme, it means more capital ultimately will have to be found elsewhere. In other words, the bail-out will not mark the end of the recapitalization phase.

It's worth noting that a recent IMF survey of financial crises found that the average gross cost to government of bank recapitalization in 32 banking crises was 7.8% of GDP, and the ultimate net cost was 6.0% of GDP. (This is taken from an IMF working paper: Systemic Banking Crises: A New Database, WP 08/224.) This, however, is likely to be an above-average crisis.

The third phase of the process will be deleveraging. Even if the financial institutions' capital base can be replenished, the simple point is that current leverage rates (20 times for commercial banks - see Exhibit 3) are unlikely to be sustained. If, as an example, commercial banks aim to reduce their leverage from 20 times to 18 times, then - in the absence of new capital - the balance sheet will have to be reduced. The aggregate balance sheet is now around US$8 trillion. In other words, even after recapitalization, there is likely to be a period of tight credit.

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of September 30, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	40%	292	44%	33%
Equal-weight/Hold	937	42%	278	42%	30%
Underweight/Sell	387	17%	90	14%	23%
Total	2,216		660

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

Comments [0]

October 1, 2008

Capital research --2020 Climate,Energy & Investment

You must have flash to see this embedded document.

(download)

Comments [0]

September 30, 2008

Downunder Daily : Tactics vs. Strategy

There is tension (again) between tactical indicators and the bigger picture. After a rugged month, culminating in Monday's sell-off, tactical indicators are positive. However, it's not clear to me that conditions are in place for a major bottom for risk assets.

The tactical case is that sentiment is horrible, valuations ostensibly attractive, markets are oversold, and a range of catalysts could sustain a positive reversal. Those catalysts include:

·European authorities' aggressive response to financial problems: bailing out institutions, injecting capital, or, in Ireland, guaranteeing bank liabilities.

Arguably, this is more than simply a tactical point. Neil McLeish, our head of European credit, notes that the actions by European policy makers explicitly or implicitly support bank depositors, senior creditors, and, in some cases, subordinated creditors of their major banks. In short, Europe is socializing credit risk. This is a bold and, we believe, appropriate move to head off the real and growing risk of widespread debt deflation.

·A revamped rescue package being approved by Congress. This plan may approve an FDIC request to lift the limit on deposit insurance to $250,000.

·A prospective turn to easier policy by central banks. It is, in my view, becoming increasingly difficult for any central banker to argue that the most important risk remains inflation.

Measures seen to help growth would be particularly important. While financial stress is front of mind, we are now seeing equity investors worry as much about recession as financial collapse, in my view. The relative sector performance over the past month has been a textbook move into economically defensive sectors (Exhibit 1). This is different from what went before, when the financial sector led declines.

Cycle fears are reflected in an expected earnings miss. Exhibit 2 shows the global MSCI index, and the 12-month forward consensus EPS forecast. If the appropriate P/E is 15 (to be fair, a big 'if'), then the market is now braced for a 30%-plus earnings decline.

Given this mix of factors, our US, European, and EM equity strategists are tactically bullish on their sectors, while our European and US credit teams are upbeat on investment-grade credit.

Strategically, I still have concerns, although I have to be less bearish than I have been. I have argued that this cycle would pop an earnings bubble. We are some way to achieving that. In the US, trailing earnings are now below the long-term trend (Exhibit 3 ). Although, to be fair, this is headline, or GAAP, earnings, so include all the write-downs; arguably, the bubble in 'core' earnings has substantially more deflation ahead.

Likewise, some of the valuation measures I watch are less stretched. For example, the Graham-Dodd P/E (which is based on a trailing inflation-adjusted 10-year EPS series) is now well off its highs. However, the current level remains above the long-term average (Exhibit 4). Likewise, in most other markets, measures such as ROE, or margins, or profit share to GDP remain above long-term averages - but are now off their peaks. In short, while valuations aren't as stretched as they have been, they're not so cheap that they provide a buffer against further bad cyclical news.

The cyclical headwinds are likely to remain powerful for some time, and the sector-specific deleveraging amongst financials - which will impinge on leveraged investors - may continue to depress risk assets. Moreover, there is the risk that the deleveraging occurs in a disorderly fashion that leads to a deeper than expected economic cycle. I put the risk of severe recession - not quite GD2, but something nasty - at around 20%. Given cycle headwinds, the (fat) tail risk, and the lack of deep value, I think the risk-reward still favors strategic caution.

Back to Top

END OF RESEARCH ABSTRACT

Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley Asia Limited (which accepts the responsibility for its contents) and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H, regulated by the Monetary Authority of Singapore, which accepts the responsibility for its contents), and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").
For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA.

Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gerard Minack.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies
The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight and Underweight are not the equivalent of Buy, Hold and Sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of August 31, 2008)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight to hold and Underweight to sell recommendations, respectively.

	Coverage Universe		Investment Banking Clients (IBC)
Stock Rating Category	Count	% of Total	Count	% of Total IBC	% of Rating Category
Overweight/Buy	892	41%	299	45%	34%
Equal-weight/Hold	936	43%	277	42%	30%
Underweight/Sell	367	17%	87	13%	24%
Total	2,195		663

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index, on a risk-adjusted basis over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V) - We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still perform in that manner.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.
For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them.
Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons
Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits.
The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments.
To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments.
To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives.
Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia by Morgan Stanley Australia Limited A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. In Australia, Morgan Stanley Research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions.
Morgan Stanley Research, or any portion hereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities/instruments is available on request.

IMPORTANT LEGAL NOTICE
This document is copyrighted by Morgan Stanley and is intended solely for the use of the Morgan Stanley client, individual, or entity to which it is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person outside of the recipient's organization without the express consent of Morgan Stanley. By accepting this document you agree to be bound by the foregoing limitations.

This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. Morgan Stanley may advise the issuers mentioned herein or deal as a principal in or own or act as a market maker for securities/instruments mentioned herein. The research and other information provided herein speaks only as of its date. We have not undertaken, and will not undertake, any duty to update the research or information or otherwise advise you of changes in the research or information. This email message and any attachments are being sent by Morgan Stanley and may be confidential. If you are not the intended recipient, please notify the sender immediately by email an delete all copies of this message and any attachments.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned. Morgan Stanley may deal as principal in or own or act as market maker to securities/instruments mentioned or may advise the issuers. This may refer to a research analyst/research report. For additional information, research reports and important disclosures, contact me or see https://secure.ms.com. We do not represent this is accurate or complete and we may not update this. Past performance is not indicative of future returns. This communication is solely for the addressee(s) and may contain confidential information. We do not waive confidentiality by mistransmission. Contact me if you do not wish to receive these communications. This communication is directed in the UK to those persons who are professional and eligible counterparties (as defined in the UK Financial Services Authority's rules).

Comments [0]