Downunder Daily : Rhythm of Cruelty
It's trite but true: markets never move in a straight line. More
to the point, extended bear markets always have tradable counter-trend rallies.
Colleague Bill Smith has noted the current market rhyming with the extended
2000-02 sell-down (Exhibit 1).
Short-term calls are not my forte, but the pre-conditions for some recovery seemed to come into place over the past 2-3 weeks: 1) sentiment indicators were bleak; 2) investor earnings expectations were being slashed; 3) volatility had increased (although the VIX index had not returned to the extremes seen over the prior 18 months); and 4) short interest had sharply increased.
The rise in short interest is particularly noteworthy. It reached record levels for the S&P 500 (Exhibit 2). It was off the chart for financials: according to Bill, short interest in banks stood at 11.2% of shares outstanding at end June. By way of comparison, short interest peaked at around 3% of the IT sector in the midst of the 2000-02 bear market.
Some, but not all, of our strategists are now recommending that investors trade the bounce. Our emerging market equity team has gone overweight equities (see Jonathan Garner, Buy Back: Raising Equities Weighting To 6% OW, 10 July). Likewise, our investment-grade credit team expects a bounce in credit (see Gregory Peters, Tactical Turn, 18 July).
Amidst this tactical finessing, remember the bigger picture point: this is not the end of the bear market, in my view. I continue to think that we are at the early stage of what is effectively the second of two bear markets. The first bear market was centered on western world financials; the second will be driven by a cyclical decline in global growth and earnings.
It is too early in the global growth slowdown cycle to think that markets can look through the bad news to come. In many economies, only the first signs of slowdown are appearing. (For the latest summary of our forecasts, see Richard Berner, Global Forecast Snapshots, 18 July). For the US, the recession isn't expected until later this year. (Our US economics team expects GDP to fall in Q4 2008/Q1 2009).
For markets, there remains a critical difference between now and the conditions that signaled an end to the TMT bear market: the trough in equities in the prior cycle occurred almost 3 years into what proved to be a four-year cycle of monetary policy easing. Now, however, we remain in a tightening cycle. Exhibit 3 shows an unweighted average of policy rates of 47 (non-G7) central banks. A net balance of 20 banks have tightened over the past 13 weeks.
Against that backdrop, I continue to insist that the biggest risk for investors now is value traps. Equities may appear cheap, but earnings can fall a lot further. Even in the US, the market furthest into the earnings decline, profits look high on a long-term view (Exhibit 4). The earnings bubble has a lot more air to release.
What is likely to change in the second bear market is relative sector performance (Exhibit 5). As growth becomes a greater concern than inflation, the sector outperformers of the past year will start to suffer. Our US strategy team has turned cautious on energy and materials, a shift that fits with the prospective global growth slowdown (see Abhijit Chakrabortti, Fracture: Materials Breaking, 15 July).
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END OF RESEARCH ABSTRACT
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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 June 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.
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.
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Short-term calls are not my forte, but the pre-conditions for some recovery seemed to come into place over the past 2-3 weeks: 1) sentiment indicators were bleak; 2) investor earnings expectations were being slashed; 3) volatility had increased (although the VIX index had not returned to the extremes seen over the prior 18 months); and 4) short interest had sharply increased.
The rise in short interest is particularly noteworthy. It reached record levels for the S&P 500 (Exhibit 2). It was off the chart for financials: according to Bill, short interest in banks stood at 11.2% of shares outstanding at end June. By way of comparison, short interest peaked at around 3% of the IT sector in the midst of the 2000-02 bear market.
Some, but not all, of our strategists are now recommending that investors trade the bounce. Our emerging market equity team has gone overweight equities (see Jonathan Garner, Buy Back: Raising Equities Weighting To 6% OW, 10 July). Likewise, our investment-grade credit team expects a bounce in credit (see Gregory Peters, Tactical Turn, 18 July).
Amidst this tactical finessing, remember the bigger picture point: this is not the end of the bear market, in my view. I continue to think that we are at the early stage of what is effectively the second of two bear markets. The first bear market was centered on western world financials; the second will be driven by a cyclical decline in global growth and earnings.
It is too early in the global growth slowdown cycle to think that markets can look through the bad news to come. In many economies, only the first signs of slowdown are appearing. (For the latest summary of our forecasts, see Richard Berner, Global Forecast Snapshots, 18 July). For the US, the recession isn't expected until later this year. (Our US economics team expects GDP to fall in Q4 2008/Q1 2009).
For markets, there remains a critical difference between now and the conditions that signaled an end to the TMT bear market: the trough in equities in the prior cycle occurred almost 3 years into what proved to be a four-year cycle of monetary policy easing. Now, however, we remain in a tightening cycle. Exhibit 3 shows an unweighted average of policy rates of 47 (non-G7) central banks. A net balance of 20 banks have tightened over the past 13 weeks.
Against that backdrop, I continue to insist that the biggest risk for investors now is value traps. Equities may appear cheap, but earnings can fall a lot further. Even in the US, the market furthest into the earnings decline, profits look high on a long-term view (Exhibit 4). The earnings bubble has a lot more air to release.
What is likely to change in the second bear market is relative sector performance (Exhibit 5). As growth becomes a greater concern than inflation, the sector outperformers of the past year will start to suffer. Our US strategy team has turned cautious on energy and materials, a shift that fits with the prospective global growth slowdown (see Abhijit Chakrabortti, Fracture: Materials Breaking, 15 July).
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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 June 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 | 910 | 42% | 278 | 44% | 31% |
| Equal-weight/Hold | 898 | 42% | 265 | 42% |
30% |
| Underweight/Sell | 353 | 16% | 86 | 14% | 24% |
| Total | 2,161 |
| 629 | ||
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.
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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
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