Morgan Stanley analysts assume, like we do, that the tightening cycle has begun, and so they’re drawing investor attention to the last two times this was the case:
Start of tightening and growth scare just like 1994 and 2004. Two of the key market themes in 2010 were also prominent in both1994 and 2004 we believe. First, these are ‘start of tightening’ years. The Fed started hiking the Fed funds rate in 1994/2004. That has not happened yet but we
believe the tightening process has clearly begun, given recent events (e.g. Asian tightening and Fed raising the discount rate and beginning liquidity withdrawal). Despite policy rates not moving yet, such moves combined with sovereign concerns mean the cost of capital is rising. Second, a
growth scare is building we believe. Investors are questioning the strength and durability of the recovery and leading indicators are already rolling over. In summary, markets struggle in the face of higher uncertainty, lower growth prospects and tighter monetary conditions.
• In post-credit bubble world shifts in policy and growth prospects are key. Gerard Minack has pointed out that the growth in excess credit (i.e. above GDP growth) lead equity markets in the period from early 1980s to late 2000s. We believe post-credit bubble economies are structurally weaker and therefore more vulnerable to shifts in policy. Moreover, interest rate changes are not the only important lever of policy. Stimulus withdrawal itself (or the prospect of it) contributes to a deterioration in business sentiment and lead indicators. Japan was a good example of such an environment. Policy changes marked most of the main turning points in Japanese stocks e.g. swings in fiscal spending, tax increases, QE, FX intervention etc. Fiscal policy will likely play a key role (as it did in Japan). Fiscal policy was much looser in this cycle than in early 1990s or 2000s and we may be close to an inflection point. The US budget deficit is twice the size it was in 1994 or 2004 and is set to contract from 2010. The standardized budget deficit (i.e. adjusted for cyclical and one-off effects) should widen again in 2010 but at a much slower rate.
• Conclusion today -we think it is too early to buyand expect the current correction phase to last a few months oreven quarters longer. We would like to wait until either fundamentals improve or our valuation and sentiment models give buy signals.
And here are some visuals and numbers to emphasise the point:
Photo: Morgan Stanley
Photo: Morgan Stanley