It’s that time of the year when brokerages have traditionally polished their crystal balls and come up with soothing predictions for the new year.
This time around, the debris from disintegrating banks has clouded the ball quite a bit, but the equity strategists have manfully come forward and done their bit. Never mind that uncertainty is so high even the International Monetary Fund has been reduced to changing its forecasts every month. Never mind that the credibility of investment banks is at an all-time low, rivalled only by that of the rating agencies. It is at times like this that we have most need of soothsayers.
So, what do the experts say?
There are basically two ways of looking at 2009. Everybody agrees that we are in a spectacular bust, the likes of which have not been seen since the Great Depression. The difference between the two camps lies not in recognizing the seriousness of the problem, but in their belief in the efficacy of policy action.
If you’re in the camp that believes that the unprecedented fiscal and monetary stimulus unleashed by central banks and governments across the globe will not work, or will compound the problem, then you probably think we’ll see a repeat of the Great Depression. But the far larger camp believes the stimulus is bound to revive the economy and the markets, most likely in the second half of 2009.
The title of Merrill Lynch’s India strategy report is 2009: A Tale of Two Halves, with a dismal first half and better markets in the second half—although the economic news is likely to continue to be bad, earnings are likely to bottom out and markets turn upward.
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Writes Citigroup’s chief economist Lewis Alexander: “At some point next year… when downside economic risks dissipate and deleveraging pressures ease, current extreme valuations should provide attractive opportunities.” A UBS report says that “Inflection points are likely to occur in H1 2009, but caution is warranted for now: Markets will have to overcome a ‘tsunami’ of bad economic and corporate earnings releases through early next year. Market recoveries are likely to be sporadic and uneven into early 2009.”
And here’s JPMorgan: “Our end-’09 targets are suggesting a 20-30% upside from here, only bringing equity markets back to the levels seen at the end of September.” Goldman Sachs strategist Peter Oppenheimer says there will be a big rally in the second half of next year (30-50%), but markets could fall further (20-30%) before then.
Analysts also underline the importance of the current quarter’s corporate results, which are likely to be truly dismal, given that the world economy fell off a cliff in October, as the credit crunch morphed into a global recession.
Thereafter, according to UBS, “The balance of the year is then likely to be characterized by anticipation of a bottoming in the business and earnings cycles. Equity and credit markets should recover, albeit sporadically and unevenly. Eventually, robust gains are likely as a value-driven rotation back into risk assets takes place.”
Indeed, one of the heartening signs of the current bear market rally is that markets across the world have been going up in spite of really bad news. Market bottoms are often defined as the point at which stocks stop going down on bad news.
On Friday, for example, in spite of the uncovering of a huge scam in the US involving Bernard Madoff, the collapse of a bailout plan for the US auto sector and horrible data from China, US stocks went up. One reason is, as investment bankers have been pointing out, stock valuations have become very cheap. The other reason is that central banks have thrown huge amounts of cash at the problem in an effort to counter the destruction of liquidity that has occurred as a result of the destruction of the “shadow banking system”, the leverage built up by all those fancy derivative products that have now evaporated. Most of that liquidity has taken refuge in the US treasury market, where short-term yields turned negative last week, meaning that investors had to pay to hold treasuries.
How long can such a mad market continue? If a part of that money comes into the equity markets, it could lead to a big rally.
Many analysts also believe that the Asian markets will outperform others next year. Says JPMorgan: “We overweight EM (emerging markets) Asia into 2009 as it benefits from financial surpluses and thus has more policy flexibility.” DBS Research believes that Asia will recover more quickly than during the last downturn because “Asia is bigger and more dynamic today,” and because it “now generates almost as much new demand every year as the US”. Nevertheless, these reports do not include India among the list of star performers, because of its current account and fiscal deficits, its reliance on external fund flows and its political uncertainty.
What’s the caveat to a second-half rally?
One of them is that the current bout of risk aversion may continue for much longer than anticipated. But the real concern lies in another quarter: Emerging markets did well in a world of high leverage and deregulation.
As Citigroup’s global head of emerging markets Don Hanna points out, “For emerging markets, the road ahead will get rockier, even after the global recession has been weathered. Global capital flows and financial intermediation are likely to be more regulated and liquidity more dear, leading to higher intermediation costs and less investment.”
It may be a very long time before Goldilocks comes visiting again.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org.