There is a triple threat overhanging the market, and unhappily, it is not in the form of Jennifer Lopez, the singer, dancer, and actor.
Morgan Stanley has advised clients to slash exposure to the stock market after its three key warning indicators began flashing a “Full House” sell signal for the first time since the dotcom bust.
Teun Draaisma, chief of European equities strategist for the US investment bank, said the triple warning was a “very powerful” signal that had been triggered just five times since 1980.
“Interest rates are rising and reaching critical levels. This matters more than growth for equities, so we think the mid-cycle rally is over. Our model is forecasting a 14pc correction over the next six months, but it could be more serious,” he said. Mr Draaisma said the MSCI index of 600 European and British equities had dropped by an average of 15.2pc over six months after each “Full House” signal, with falls of 25.2pc after September 1987 and 26.2pc after April 2002. “We prefer to be on the right side of these odds,” he said.
The first of the three signals Morgan Stanley monitors is a “composite valuation indicator” that divides the price/earnings ratio on stocks by bond yields. It measures “median” share prices that capture the froth of the merger boom, rather than relying on a handful of big companies on the major indexes.
“If you look at all shares, the p/e ratio is at an all-time high of 20,” he said.
The other two gauges measure fundamentals such as growth and inflation, as well as risk appetite. “Investors are taking far too much comfort from global liquidity. Markets always return to fundamental value, so people could be in for a rude awakening. This is the greater fool theory,” he said. “The trigger may be rate rises by the Bank of Japan, or a widening of credit spreads. There are lots of little triggers.”
Morgan Stanley is not predicting a recession, believing bond yields will fall during a correction and act as an “automatic stabiliser” for the world economy. Once the market shakes off the latest excesses, it’s back to the races. — DailyTelegraph
It is interesting to note that a dire warning of this magnitude is somehow delivered with the de rigueur “no recession, back to business quickly” assurance. Not very creative. Anyway, there is more at the MS Global Strategy Bulletin.
Bloomberg had a better story last week, one that appeals to my market philosophy: When given lemons, make lemonade.
Looming Crash Prompts Jump in Distressed Debt Hiring
By Kabir Chibber and John Glover
May 30 (Bloomberg) — The biggest winners from the global buyout boom are hiring distressed-debt bankers in Europe at the fastest pace in five years.
Goldman Sachs Group Inc., the world’s most profitable securities firm, hired Andrew Wilkinson, the lawyer who advised creditors in the bankruptcies of Eurotunnel Plc and Parmalat Finanziaria SpA, to help lead its restructuring business in London. Morgan Stanley, the third most-active merger adviser this year behind Citigroup Inc. and Goldman, added seven bankers in the past year, boosting its group to 61. Blackstone Group LP, poised to become the world’s largest publicly traded buyout firm, is starting a corporate restructuring group in Europe.
“When the turn does come, it will be unlike anything we have ever seen before,” said Iain Burnett, 43, managing director of Morgan Stanley’s special situations unit in London. “The scale of it could be considerable because of the size of some of these leveraged deals,” said Burnett, who began his career in London a month before the October 1987 stock market crash.
Firms are paying as much as $3 million a year for bankers who advise bankrupt companies and for traders who specialize in defaulted debt, according to Heidrick & Struggles International Inc., the world’s third-largest recruiting firm. That’s on par with derivatives and commodities traders.
Restructuring groups are growing faster in Europe than in the U.S. as companies in the U.K., France and Germany pile on record amounts of debt, according to Standard & Poor’s. European companies borrowed a record $252.6 billion in loans and bonds rated below investment grade, according to data compiled by Bloomberg.
European companies acquired by buyout firms had debt equal to 6.2 times earnings before interest, tax, depreciation and amortization in the first quarter of this year, according to Fitch Ratings. That’s up from 5.1 times in 2004 and 4.8 in 2003.
Heidrick & Struggles, based in Chicago, says it’s placing more distressed-debt bankers in London than at any time since 2002, after Internet-related companies crashed. So far, there isn’t much work to do. Near-record-low defaults have reduced Europe’s market for distressed debt to 150 billion euros ($202 billion), a quarter of the size five years ago, according to data compiled by Deutsche Bank AG.
Little to Do
Only one European company — Teksid SpA, an auto-parts maker based in Turin, Italy — has defaulted this year, and only four companies worldwide have missed interest payments, according to Moody’s Investors Service.
“Banks have to pay market rates to attract quality employees, but the problem is the employee may be sitting on his or her hands for six to 12 months,” said Lee Thacker, capital markets partner at Heidrick & Struggles in London.