Some might have expected Morgan Stanley’s European strategist - aka the Super Bull - to now row back from his prediction of the coming equity nirvana. What, with the decapitated heads of Wall Street royalty rolling in the gutter - and even the MS banking team predicting contagion from subprime to all things consumer.
But no! Teun Draaisma, the man who said Sell, Sell, Sell in June and then Buy in mid August, is not being knocked off course by a touch of the wobbles:
We remain optimistic on equities. Our thoughts as described in ‘This Rally Is Not Over’ on October 22 have not changed. We see around 10% upside to our 1750 index target for MSCI Europe. In the short-term, markets will undoubtedly remain volatile due to the renewed credit worries and the continues US housing slump, but we see upside on a 6-month view and we do not expect the current correction to exceed 10%. We continue to believe in a mid-cycle slowdown environment, not a recession, expecting 6% EPS growth in 2008. Valuations are attractive and sentiment is nervous. Our tactical valuation indicator, our CVI, is at 0.26, below the first warning level of +1. We are overweight equities, underweight bonds.
Draaisma accepts that credit worries are back on the agenda and that financial risks remain high. As he says in his latest note to clients:
The larger-than-expected Merrill Lynch writedown has been described by some of our credit analysts as a ‘game changer’ as it has provided a yardstick for how to price many of the illiquid fixed income instruments that are still on and off financials’ balance sheets. It has increased the strain in credit markets again, in part leading to the collapse of share prices in the monoline bond insurers in the last few weeks, leading to talks about the potential of forced selling in the $2.5 trillion muni bond market. Our European credit strategist Neil McLeish analyses that the liquidity problem from a few months ago has now changed into a capital problem which is more difficult to solve, and where further rate cuts are less impactful.
So, while higher oil, renewed credit turmoil, more bad US housing news, a bad earnings season, falls in European business sentiment and a weak dollar are all incrementally negative for European stocks, Draaisma also sees some positives:
Equities are a bit cheaper than before, bond yields are lower, ISM new orders was stable above 50, ISM employment edged higher to 52, weekly claims edged lower, challenger job cuts were down, and payrolls were larger than expected, while emerging market growth is still booming.
