And so it begins – strategists at the big investment banks are starting to publish their 2010 forecasts.

Morgan Stanley duo Graham Secker and Teun Draaisma were quick on the draw with a pretty bearish set of predictions for the year ahead.

Secker, the bank’s UK strategist, thinks the UK is in for a GRIM 2010 and reckons the FTSE 100 will finish the year at 4 per cent below its current level:

From NICE to GRIM
Two years ago the Bank of England described the macro environment since its independence in 1997 as NICE, meaning ‘Non-Inflationary Constant Expansion’. As we look out at prospects for the domestic economy over the next five to 10 years, we think GRIM is a much better acronym, meaning ‘Growth Really Is Mediocre’. In addition, we think grim is likely to be a fairly apt description of consumer sentiment as living standards are likely to fall, reflecting factors such as a weak jobs market; low real wage growth; higher taxes; higher inflation (weak GBP means higher import prices); and less credit availability (which means lower spending power on the demand side and less consumer choice on the supply side).

Base case – FTSE100 at 5000 (40% probability)
Our base case reflects a modest economic growth recovery in the West combined with a stronger growth recovery in Asia and Emerging markets. Policy stimulus should remain supportive overall and profit growth should be very good, however, this is countered by valuations that are not overly attractive in absolute terms and nervousness about the durability of economic growth as and when policy support is withdrawn. Markets are likely to get increasingly volatile as we get closer to the heart of the tightening cycle. From a valuation perspective our normalised fair value model points to 5% downside to stocks to hit fair value at the end of 2010 assuming 3% BVPS growth, ROE of 14% and a P/E ratio of 13. A similar outcome is supported by our DVI framework if we assume 3% dividend growth in 2010 and 4.25% bond yields (both of which sound reasonable).

Draaisma, Secker’s European counterpart, expects the MSCI Europe index to end 2010 at 1,030, a drop of around 5 per cent from its current level.

He thinks the strong growth at the start of 2010 will prompt the start of stimulus withdrawal, and markets will start to consolidate their recent gains:

The tightening phase means tougher times for equities.
We are concerned about deleveraging and the poor state of government finances. We expect that the withdrawal of stimulus will be a very dangerous period for the economy and markets; that when the tightening starts in earnest, markets will consolidate at best. Traditionally, as tightening starts equities consolidate for two quarters or more, commodities & defensives do best, tech & financials suffer.

But the tightening phase will start in earnest only after employment creation has started. Authorities will only dare to take some stimulus away when it becomes clear that the economy has fully turned the corner; when employment is being created; when some top-line growth is coming through; and when credit is more freely available, not just in the corporate bond market for sound large caps. Therefore we believe this tightening phase will start at some point in 2010 but only after we have had some more good news. At some point after employment creation has started, good economic news will become bad market news, as its implication will be higher rates and some tightening measures.

 Our best guess is that MSCI Europe (latest value 1085) could go as high as 1200 near-term, as low as 950 during the tightening phase, and will end the year at 1030. The market can continue to rise towards normalized valuations of 1200 as long as the tightening phase has not started yet. We believe it will end 2010 at 1030. It may go as low as 950, consistent with our finding that in the aftermath of secular bear markets the tightening phase leads to an average 25% correction to equity markets.

Further forecasts (for Europe, the US and elsewhere) to follow as they trickle through to FT Alphaville.

Related link:
How to survive The Tightening – FT Alphaville

This entry was posted by Neil Hume on Monday, November 30th, 2009 at 15:14 and is filed under Capital markets, People. Tagged with FTSE 100, Grahan secker, morgan stanley, MSCI, Teun Draaisma. Edit this entry.