By Ambrose Evans-Pritchard
06/06/2007
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.
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