More on Europe’s biggest stock market fallers.
The price action just before the close of business on Monday.
UK:
As we noted earlier, the laggards are largely miners or industrials.
The reason, according to Morgan Stanley strategist Graham Secker, is that the market is experiencing a ‘growth scare’ where attractive valuations could count for nothing.
There has been a material deterioration in the fundamental backdrop for stocks. We believe the market is in the midst of a significant growth scare and that equity valuations and sentiment can overshoot on the downside. We downgrade European equities to neutral and remain overweight defensive
The question is by how much?
Here’s a couple of ways to look at that question.
Over the last 20-30 years there are few ‘panic’ periods that we can use to benchmark the current situation; however 1987 and 1998 are probably most relevant for our purposes. Both suggest that equity prices and sentiment levels can drop further, as we illustrate in the following statistics:
In both 1987 and 1998 European, UK and US equities fell by between 25% and 35%. Currently MSCI Europe is down 18%. S&P is down 12% and the FTSE All-Share is down 14%.
However, the macro backdrop is worse than in either 1987 or 1998, when the Fed cut rates to help stabilise the correction (something that’s off the table now, of course).
Indeed, a double-dip recession is now a real probability. So how might stocks fare under that scenario?
Scenario #3 – Renewed recession
Our third scenario assumes that DM economies fall back into recession as the structural headwinds overwhelm any further policy initiatives that the authorities come up with. Under this scenario, sentiment metrics are likely to become increasingly unimportant as they could be trumped by a deteriorating fundamental outlook for profits.
From a valuation perspective, a contraction in profits could prompt investors to focus increasingly on Shiller or Graham and Dodd type valuations as occurred most recently in the last recession. On this basis the outlook for stocks is bleak, in our opinion, as equity bear markets only tend to end when such valuation multiples fall into single-digit territory. Today, MSCI Europe is on a Shiller PE of 11.6 and the FTSE All-Share is on a Shiller PE of 13.3 – implying a stock market decline of c. 14% and 25% respectively until we reach a single-digit multiple. Note that US stocks are currently on a Shiller PE of 20.8
Perhaps this dip isn’t a dip to buy.
More to follow in the usual place.
Related link:
The QE3 pain threshold – FT Alphaville