The summer’s over – at least in Europe – and so it’s time for a “Back to School” note from Teun Draaisma and his strategy team at Morgan Stanley. Clients received a catch-up brief on Thursday.
But we detect a note of weariness in the House of Teun. Yes, this particular bear market rally might push equities a notch or two higher in the short term, but overall prospects remain grim:
We are in the early stages of a 30% earnings recession…We expect -14% and -17% EPS growth in 2008 and 2009, respectively, with earnings troughing at the end of 2009. We assume that ROE, which peaked at an all-time high of 18% in January 2008, will trough at 11% at the end of 2009. This implies an EPS fall of 30% peak-to-trough. This compares with IBES consensus expectations of 0% growth in 2008 and 13% growth in 2009, making our 2009 EPS growth estimate a full 30% below the consensus growth rate. So far, the earnings recession has been concentrated in Financials, but we expect this to broaden out to non-financials too.
Casting an eye back over the past month or two, Mr Draaisma detects some good news. The Jackson Hole conference, for example, and also Alastair Darling’s blabbing to the Guardian suggest no one – from policy makers to investors to company executives – remains in denial. This is positive since it increases the likelihood of drastic policy action and reduces the risk of either “financial Armageddon” or a Japan-type scenario, where problems are simply ignored.
Meanwhile, inflation has surprised on the downside, the dollar has strengthened and there’s been the odd bit of M&A – even if credit markets have refused to join stock prices in bouncing off their lows.
It might even be the case that July 15, 2008, proves to be the low point of this particular bear market.
We think we have already seen the severe part of this bear market, with a peak-to-trough correction of 30%, and now we are entering the dull part, where markets bump along the bottom for quite some time until fundamentals improve.
When might that be? The second half of 2009, in Draaisma’s view. Maybe.
Patience is key, but a bull market will start at some point, when fundamentals start improving. We are watching three things most closely for signs of improvement. First, we would like to see ROE below average rather than the current close to peak levels. Second, we would like to see signs of stabilisation in US house prices, and we will watch the inventories of unsold homes closely. Third, we would like to see the capital repair phase among financials complete, and we will watch the quarterly Fed survey of senior loan officers closely.
There is no sign of improvement on any of these three points.
Related links:
For the Great Rotate, we must wait – FT Alphaville
(Still) Waiting to rotate – FT Alphaville