A synopsis of the major reports issued globally by Morgan Stanley strategists in the past week. Please see full versions of these articles on our Client Link Website. Please contact your Morgan Stanley representative for access if needed.
US Equity Strategy: The Long Hot Summer
Abhijit Chakrabortti, Jason Todd
We are more comfortable with the valuation of the equity market than the outlook for earnings. In a world of 4%-plus headline inflation, low single-digit earnings growth, and a return to trend volatility, a P/E around 14.7x is warranted, which suggests that downside is limited provided our assumptions are correct. The biggest downside driver for the S&P 500 will likely be any move up in headline inflation and a growing belief that such a move is more than transitory.
Europe Equity Strategy: Sector Rotation - A Turning Point May Not Be Far Away
Teun Draaisma
At some point the pendulum will swing back to value from momentum plays, we believe. The possible triggers for this are interrelated: when the oil price falls, or when inflation peaks, or when emerging markets slow down meaningfully. All may well happen in the next few months, but it won't pay to be early on this call. Recently, we have moved towards value by upping Consumer Discretionary/Financials, while lowering our stance on Energy/Materials.
Europe Credit Strategy: Remembering Six Months to Forget
Andrew Sheets, Neil McLeish et al.
Attractive risk premium for investment-grade credit, both absolutely and relatively. We believe that asset allocators will continue to move money (gradually) into high-grade credit against the current valuation backdrop — part of the reason we have not seen March wides retested, while equities have hit new lows. European banks have entered the “repair” phase of the credit cycle, in our view, which clearly favours creditors at the expense of shareholders.
Japan Equity Strategy: Hitting the Bottom
Naoki Kamiyama
Japanese stocks should outperform until the global situation normalizes. Even in a bear market, we expect Japan to continue outperforming Europe and US. We anticipate support from the low possibility of earnings forecasts being reduced, ongoing expectations of higher dividends, and a relatively stable yen. Late July may see the bottom for share prices, as it becomes clear that there are no strong grounds for concern about earnings at Japanese firms.
Asia/Pacific Equity Strategy: The Inflation Hurdle
M. Wood, R. Tsai, C. Ng
Greater China best-placed, South Asia worst-placed, in our view, given four inflation hurdles we see for Asia — oil, food, weak currencies, and overheating. High oil prices have led to a third oil shock. Whilst fuel subsidies have been reduced, India and Indonesia remain vulnerable. Food inflation has peaked in China as the hog cycle rolls over. Weak currencies are likely to be focused on India and Korea. And overheating is most extreme in Indonesia.
Commodity Strategy: Livestock Update - Bearish Bulls
H. Allidina, J. Friesen, M. Pape
Currently elevated live cattle prices are at risk, in our view, given the level of marketed animals and slaughter rates that are still high assuming waning consumer demand. On the demand side, we are not optimistic that the newly reopened Korean market will increase demand enough to offset the loss in US consumption that is likely to occur as retail prices begin to reflect the increase in live cattle prices seen of late.
India Equity Strategy: Some Good Franchises at Decent Valuations for Long-term Investors
Ridham Desai, Sheela Rathi
Genuinely long-term investors can now find stocks worth buying, despite continued headwinds that include high crude oil prices, political uncertainty, fragile global financial markets, slowing growth and prospects of earnings downgrades. Sensex fair value will likely keep falling as the market lowers earnings estimates and bond prices fall. But at current bond yields and earnings estimates, the Sensex is not far from our fair-value estimate.
Australia Equity Strategy: Death by a Thousand Cuts? Unlikely
T. Walker, A. Conte, G. Minack
Dividend cuts are a buying opportunity. With capital structures and debt levels under intense scrutiny, we think dividend cuts could be another emerging theme during reporting season. We conclude that a company that has just cut its dividend is likely at a point of capitulation. The median outperformance over 12 months following a dividend cut has been 14.4%. This is classic contrarian investing, i.e., buy the stock when things are at their worst.
A synopsis of the major reports issued globally by Morgan Stanley economists in the past week. Please see full versions of these articles on our Client Link Website. Please contact your Morgan Stanley representative for access if needed.
Global Economics: Emerging Inflation?
Manoj Pradhan
Emerging market growth is in danger as inflation threatens to undermine consumer spending. Higher inflation usually means more variability of inflation, and the resulting uncertainty can lower investment and growth. Our EM colleagues see considerable variation in how their respective central banks are likely to respond to the inflation challenge. The commitment of central banks to fight inflation seems to vary according to the growth outlook.
US Economics: The Perfect Storm Returns
Richard Berner, David Greenlaw
The US economy's durability won't last, in our view. The combination of tight financial conditions, higher energy quotes, higher global inflation and weaker global growth may soon promote a mild downturn. Specifically, we think the economy will contract by a 1% average annual rate in 4Q08 and 1Q09, and the economy will be flat over the four quarters ending in 2Q09. This should keep the Fed on hold at least into early next year.
Euroland Economics: Actions Speak Louder Than Words
Elga Bartsch
Job done after one? We don't think so. Despite the dovish rhetoric from the ECB and the noticeable slowdown in the Euroland economy, we don't believe the ECB has done enough tightening yet. We don't think the recent rate hike is sufficient to restore price stability over the medium term. Therefore, we continue to look for another rate hike in the remainder of this year. This would bring the refi rate to 4.5% by year-end.
Currencies: USD Smiling Against EM, Still Frowning Against EUR
Stephen Jen
We still expect the dollar's ascent to be hesitant and asynchronous. We believe that 2H08 could mark some important inflection points for various macro variables that matter for currencies. The dollar has begun to reassert itself against most EM currencies. While the dollar may remain somewhat vulnerable against the EUR near term, we still believe that the USD is grossly undervalued and should perform better over the longer term against the majors.
China Economics: Dissecting Policy Uncertainty
Qing Wang
We do not expect any major shift in China's exchange-rate policy, and we maintain our call for no interest rate hikes this year, even if inflation were to stay high due to energy price deregulation. A GID scheme — government-financed inflation-proof deposits — should achieve the same effect as asymmetric rate hikes but without as much negative impact on banks' net interest margins. We view a GID scheme as the policy option of least resistance.
Japan Economics: Recession Still Primitive
Takehiro Sato
Prospects for deepening recession towards year-end. Japan now seems to have been in a mild recession for more than half a year, but as Asia slows more clearly (having exhausted the policy limits of energy subsidies), we expect the recession to deepen towards the year-end. The average recession in Japan has typically lasted 16 months, implying more of the same at least until January–March 2009.
Currencies: The Energy Shock to Asia
Stephen Jen, Luca Bindelli
The energy shock poses a significant challenge for Asia and many other EM economies. The outsized energy price increases will be a 'game-changer' for Asia, in our view. While there is some scope for remedial policy action to 'amortise' this shock, AXJ currencies will likely weaken against the dollar, and assets should underperform in the period ahead. Even if oil/energy prices stabilise now, this will be a significant shock to Asia, especially China.
Israel Economics: Bank of Israel Minutes Signal Higher Rates
Tevfik Aksoy
We maintain our call for a 25 bp rate hike on July 28, but see upside risk of an additional 25 bp rise in following months. The overall tone of the recent monetary policy minutes was generally cautious, which suggests to us that our policy rate expectation of 4% (another hike of 25 bp) in late July is likely. Depending on upcoming monthly inflation prints and inflation expectations for the next 12 months (now running at 3.3%Y), the BoI may opt to raise rates a little further.
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