Morgan Stanley issues triple sell warning on equities

[HenryTo]

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/06/06/cnmorgan106.xml

[rffrydr]

Retracted.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

"Full House" buy signal:

http://ftalphaville.ft.com/blog/2008/11/04/17783/why-draaisma-is-saying-buy-buy-buy-buy/
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Sticking a toe in:

We go overweight equities for the first time in 3 months, reducing our cash weighting by 3% and
increasing our equity weighting by 3%.
BE:
Thus, we are now 3% overweight equities (versus 50% benchmark), 2% overweight cash (10% benchmark), and we stay
5% underweight bonds (versus 40% benchmark). We view this is a first step ahead of a bear market rally on the back of oversold conditions, attractive
valuations, and falling inflation later this year, but we keep some powder dry in case markets fall again in the short-term. SECTORS: We continue to stay OW
defensives, UW cyclicals as the biggest certainty in this market is the earnings recession. But we now neutralize our long-held OW Energy versus UW Financials
bet, as described in Sector Rotation: The Snapback May Not Be Far Away (July 7, 2008). After these moves we are OW Healthcare, Insurance, Telcos,
Consumer Discretionary, UW Industrials, Materials, Tech, Consumer Staples, and Neutral Energy, Utilities. STOCKS: we are buying UBS, Prudential, selling
Veolia, and removing 1% from Energy across existing holdings.

• The strategic outlook remains bad: earnings and capital repair … First, we believe the earnings outlook is grim. In recessions, profit margins and ROE
revert to the mean, or worse. Earnings weakness has only recently started to spread beyond financials, and ROE ex Financials is still close to an all-time high. If
you are optimistic, earnings may trough at some point in 2009 at around the historical average, but not before that, we think. Second, an end is not yet in sight of
the capital repair phase in financials. Financials are in big trouble, and this is before the credit cycle hits. We are looking out for stabilisation in US house prices
or an improvement in the quarterly Fed survey of senior loan officers, and there are no signs of either.

• … but the tactical outlook has improved. When markets fall, one has to turn incrementally more bullish. MSCI Europe has fallen 30% from its peak on June 1
2007 till July 15, 2008, and in the near term we see only limited downside. After rapid downward moves like these, a meaningful rally follows at some point.
Several of our indicators were at or very close to critical buy levels. Later this year, there is a strong possibility of a re-rating of the low P/E multiple. The main
determinant of P/Es is inflation, and headline CPI in the US is set to rise to close to 6% in the next few months, from its current level of 5%. Once it starts to fall,
it should trigger a re-rating of multiples.

We do not exclude renewed weakness in the very short-term … There are a few things missing for us to feel very confident that we have already seen the
low in the near-term. We would like to see more realistic earnings expectations. We would like to see a higher skew and VIX as a further indication that
sentiment based on market action is bearish, as opposed to sentiment based on surveys. We would feel more comfortable buying more if there is more visibility
on inflation easing, with the worst inflation number out of the way in the next few months. We think that a correction may not be complete before a few failed
rallies of 3-5% followed by lower lows. We would also be prepared to buy more once the CVI fully hits minus -2 and/or the CMTI hits -0.5, which both almost
happened last week. We know that patience is key in bear markets: adding risk today is not a patient approach.

• … but with valuations having fallen a lot, the near-term downside is limited… The trailing P/E is close to 10 times. That is quite expensive only if the
stagflation regime persists. However, if you believe, like we do, that inflation fears will ease later this year, then it is cheap. The long-term average P/E is 14.5,
therefore a 40% fall in earnings is fully in the price. That is a larger fall in earnings than we are currently expecting, and implies a trough ROE of just below 11%,
which we believe is quite realistic. Also, last Tuesday our CVI hit minus 1.8, which is close to the -2 ‘must-buy’ level.

• … while our tactical indicators suggest a good risk-reward … The following indicators are suggesting that the risk-reward of buying now is decent.
1. The AAII Survey of net bulls at –33 is below -20, after which markets have been up on average 28% in the next 6 months, up 90% of the time;
2. The EUREX put/call ratio of 1.3 is above 1.2, suggesting markets will be up 10.4% in next 6 months, with an 86% likelihood of up markets;
3. Our capitulation indicator of –2.8 standard deviations, last week, is the lowest ever bar Oct-98. After a reading of below -2, markets have been up on
average 12.4% in next 6 months, with a 90% likelihood of up markets
4. Our combined Market Timing Indicator of -0.2 last week suggests that markets will be up 7.7% in next 6 months, with an 81% likelihood of up markets
5. Our CVI at -1.8 last week indicates that markets are likely to be up 8.3% in the next 6 months with a 82% likelihood of up markets
BE:

• … and there are even some recent positives if you care to look for them. Most importantly, the fall in the oil price is bringing forward the moment that the
market starts to focus on lower inflation. We got within a few percent of ‘must-buy’ levels on our indicators, while our Risk and Fundamentals Indicator do not give
a sell signal anymore. Earnings revisions accelerated further on the downside which we believe is a good tactical sign. Also, corporate activity has picked up
markedly, central banks have turned less hawkish, and authorities are trying to step in, such as with the GSE rescue.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

He's bullish on value...soon:

[HenryTo]

Mr. Draaisma of Morgan Stanley is back again - this time says to go to cash again:

http://www.ft.com/cms/s/0/ddeb0f1c-915a-11dc-9590-0000779fd2ac.html

[rffrydr]

I think it's the Oils/chemicals selling at peak cycle lows (and a few assorted related basic materials e.g. steel). Heavy representation in DAX. Less in the SP but still creates heavy skew.
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Today is the Tomorrow you worried about Yesterday!

[dash]

I'm still having a hard time understanding MS comment about European P/Es being at record highs. Perhaps the Telegraph journalist misquotes him, but even if that's not the case the premise is that valuations have become much less attractive, and the latest market commentary also points out that equities are at their most expensive levels since May 2006.

Nevertheless, if you look at what's happened to P/E ratios since this bull market began (early 2003) then in the majority of cases we've actually seen a decline. Here's a post from Ticker Sense with the data:

http://tickersense.typepad.com/ticker_sense/2007/06/global_returns_.html

[rffrydr]

Citibank like a lotta investors is going down looking for the rabid retail investor--they'll never find him. He's paying his mortgage(s). To add insult to injury the Schwabs of the world are consolidating--out of weakness.

T-bills below funds:

It's not inflation, and not economic slowdown. The dollar isn't rallying and the spreads over treasuries are not coming off. It's that old bugaboo the Current Account as sparked by the China Bull and the disengaging from the dollar by petromoney. The stage was set weeks ago with big chinese buying of T-bills (over bonds); dollar selloff on their sovereign funds; Kuwait and Syria unpegging to the dollar; and PE going bonkers to suck up the bottom of the punchbowl. Then, the pricing of Blackstone as China commits. The new Japanese?

ps The Wed before expiration friday

It's not a bear until Apple and The GOOG join the party.
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Today is the Tomorrow you worried about Yesterday!

[dash]

Yes, those were scary charts in the mid-week commentary, especially for anyone holding a lot of junk debt. This said, the recent rise in yields has hit treasuries just as hard as corporate debt, so, so far at least, interest rate rises don't seem to be happening because of a mass exit from high yield. Similarly, the selloff in late Feb was (supposedly) caused by a reduced appetite for risk. Stable corporate bond spreads aren't an indication that this is now happening, though demand for credit default swaps is on the rise.

Spreads on inflation linked treasuries have also been steady, so it doesn't seem like higher yileds are being driven by inflationary fears either.

Interestingly, the yield curve is now fully upward sloping as yields on medium to longer maturities have risen more than the short-end of the curve. An inverted curve didn't lead to a recession or a bear market (at least not so far), so will an upward sloping curve be an accurate indicator of a period of future economic strength?

[HenryTo]

So my take on all this is: The final top in equities have not come yet, but if we endure a significant correction in the high yield, commodity, or EM security market, then that will no doubt drag stocks down as well. Most probably not to as much as the extent we saw in Fall 1998, but it is probably going to be at least the 10% correction we have been looking for.

[HenryTo]

Dash, you're too kind, as always. I'll correct that in this weekend's commentary as well as list the dates of the prior signals.

Given the proliferation of hedge funds, private equity funds, and the huge weighting of the financial sector within the S&P 500, I would say that there is already some euphoria in the financial markets today, but that is not happening in equities as much as in other asset classes, such as real estate, commodities, EM securities, and high yield bonds.

Note the last chart I showed in the commentary this morning. If that isn't an indicator of euphoria, what is?

I am not sure why there isn't more speculation in equities, but perhaps the coupon payments, interest rates, yield spreads, and default risk is just much easier to model for hedge funds (even for a supercomputer) than equities are. Moreover, retail investors tend to speculate in equities as opposed to other vehicles, and they are still more or less out of the market right now, aside from mutual fund investments in their 401(k) or 403(b) porfolios.

[dash]

Ooops. Just goes to show that MarketThoughts is a much more reliable source of info than Bespoke Thanks for the correction.

I don't follow the European markets closely, but I was a bit surprised to hear MS thinks stocks are expensive relative to bonds. Here in the US, until recently, the relative cheapness of stocks vs bonds has been one of the main arguments underpinning the rise. In fact a dividend yield of 5.90% still looks largely supportive, even with 10yr yields now at 5%. So it seems to me that the sudden rise in yields, rather than their absolute levels is the main concern at the moment.

Here's Citibank with a slightly different take on this:

[HenryTo]

Dash,

I just read the MS commentary - the last "full house" sell signal was April 2002, not early 2000. I will correct that in this weekend's commentary.

Thanks,

Henry

[rffrydr]

MS says indicies masking overvaluation (read oil).
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Nov. thru Feb. High Yield disappeared.
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Today is the Tomorrow you worried about Yesterday!