Mumbai: The global macro strategist at Morgan Stanley, Gerard Minack, speaks about where the markets have reached after the rally started in March. Edited excerpts.
Is the global bear market over?
I don’t think bulls and bears is the right way to look at it anymore. I think, in the Western markets, the most likely outcome is that we see extended range trading for three-four years. These will be big tradable ranges, but there is enormous potential to destroy values if people get sucked into the upmove too late and then end up selling too low. The parallel I am thinking of is more like Japan in the 1990s or in the US from the mid-1960s to the early-1980s, when we saw 16 years where in real terms equity markets did nothing. So it’s certainly not a bull market, but we may not make new lows in the bear market. In that sense, the worst for the market is over in my view.
So you’re saying the early March low of 666 we saw for the S&P (500) will not get violated?
That’s probably the case. I still think there is probably a one in five chance that we will go to new lows. What we need to see, to break to new lows, is the return to systemic risk. I can’t rule it out. In fact, the systemic risk these days doesn’t just revolve around the commercial banks in the US or commercial banks in Europe. The new potential systemic risk is sovereign risk, and we’re starting to see a hint of that coming into the markets. This is something we need to watch very closely. If we see capital markets withdraw support for the government’s effort to stimulate activity then we could go back and make new lows. So it’s wrong to assume that we’ve started a new bull market. We haven’t.
Recovery expectations: Morgan Stanley’s Gerard Minack says the markets will be disappointed if the US economy continues to contract
Are you saying that with the S&P having hit a bottom at 666, as far as you can see, most of the work with the rally has been done from a tactical perspective, or could there be juice left yet from where we are to around 950?
I have been saying to people that 950-1,000 is most likely the point when a rally loses steam. I’ve got a stretched target at 1,100. The significance of 1,100 is that at that level the equities will be at 14 times, two-year ahead earnings.
I’ve focused on two-year ahead earnings because investors know 2009 is going to be a very tough year. I think the reason people are buying equities is because of the recovery profile for earnings. The significance of 14 times is that it is the average P-E (price to earnings ratio) that the markets saw through the 2003-2007 bull markets. So I’d be surprised if the markets go to a higher P-E ratio than what we saw through that extended bull move. So 1,100 is the stretched target. By the time we get to a stretched target of 1,100...at those levels, the markets are pricing in a V-shaped earnings recovery. And at those levels you start to need to see macro data that supports that kind of V-shaped outlook. And my view is that we simply won’t see a V-shaped earnings recovery or a V-shaped macro recovery in the West.
By when do you think the first signs of trouble, economically speaking or from an economic data point of view, would start surfacing once again?
I think the hurdle that the data has to jump gets higher as the markets go up. Three weeks ago, I got to use an example: we saw non-farm payrolls fall by 550,000.
Now, the way markets were at that stage, they could cope with the relatively poor number. If we get the S&P, however, to 1,000, or a little above that, then in two or three months the declining payrolls of 550,000 would be damaging to the markets.
The worry period is actually as we move through the third quarter because the second quarter is going to get a lot of inventory rebuild. We’d like to see GDP (gross domestic product) growth from -6(%) in Q1 (first quarter) to something around -2(%) in the June quarter, which is quite a substantial, sequential improvement. The risk is that investors extrapolate the trajectory and they look for a possible positive September quarter in terms of GDP data, and we think that’s quite unlikely. And as a result, if we see the high frequency indicators like the jobless claims, payrolls, and new orders, then I think that would be sufficient for people to get concerned and the markets starting to get off the highs at that stage.
If you get, say, -2% in the second quarter and then in the third and fourth quarter, you still get negative numbers of (around) -1(%), -2(%), -1.5(%), would the market be disappointed that the recovery is stalling, or would it remain hopeful saying this is still (better) than -6% and eventually, as we go into the next fiscal, these numbers will turn positive?
I think the market would be disappointed if we continue to get negative GDP in the second half of the year. It’s all about what’s been priced in. At 700, markets have priced in no growth. At 1,000, it is starting to expect a V-shaped recovery, and you need to justify those earnings forecasts. You need to see clear signs of some sort of positive growth numbers in 2010, you need to get sense that the economy is picking up sufficient momentum; to generate what is quite a spectacular earnings recovery over the next 18-24 months. When I talk to clients, my sense is that a lot of them are quite sceptical. A lot of investors have been sucked into this rally, not because they are true believers in a V-shaped recovery, but simply because of the pain of being short and caught in a rising market.
Is it conceivable that the US goes into a multi-year range, if not in a vicious bear market, which is constantly plunging and making new lows while this part of the world—India and China—actually strike out modest bull markets of their own, if not the roaring variety of 2007?
I think that’s completely plausible for the next couple of years. There are differences here: firstly, the financial system is not broken. We’re seeing, therefore, policy getting better traction unlike in the US or Europe, where we are seeing the credit growth contract; we’re seeing credit expand in Asia...
My own view is that unlike the second half of last year when Asian markets dramatically underperformed when Western markets fell, I think Asian markets can outperform, in the relative sense—and I stress relative—if we did see another slide in Wall Street. In other words, Asian markets could face a setback, but it wouldn’t be as severe as we’re likely to see in the US.