Geoff Cutmore - Morning Thoughts

Stones in Ponds

Geoff Cutmore

What goes wrong for markets from here?

Morgan Stanley created ripples on the pond this morning by issuing its so-called triple-sell warning on equities. The research suggests a 14% correction likely over the next 6 months. Do you buy it? Were they producing warnings like these on the eve of the last significant correction?

If you buy into Chris Locke’s analysis, the clock is ticking for a likely third-quarter event: a correction of the order of 20% from the highs. He says he has never been more certain from his charting work of the likelihood of a drop in equity prices. Having said that, and with the greatest respect to Chris, I think he has been consistently more accurate with his commodity analysis than with his work on equities. The degree of momentum has been a surprise for many market analysts and the bad news (like the higher oil price) just hasn't been bad enough to check the gains.

The markets have also been immune to the rate-tightening cycles in Europe, the U.S. and somewhat in Japan. Many noted market commentators see limited correlation anyhow between the daily market moves and the steady ratcheting up of rates. Ultimately the frog will be slowly boiled … and investors will check out of equities as cash offers better returns and higher borrowing costs stem economic activity and slow corporate earnings growth. That could still be 18 months away, who knows? Pick a time horizon!

So, we have an interest-rate rise on the cards from the ECB (but will they remove the 'accommodative' word)  and tomorrow a BoE meeting that is likely to keep rates on hold -- although some in the market are worried they could be taken by surprise as they were with the hike in January. The BRC data at the start of the week suggests the consumers desire to spend is weakening. A survey from the Nationwide points to U.K. consumer confidence at an 18-month high, so it's a mixed bag then.

Meantime, earnings news flow has slowed down but we continue to get a trickle of positive stories. Yesterday's better-than-expected Ryanair results sweetened the bitter pill of Michael O'Leary's warnings about yields later in the year. Today Bouygues, the French telecom and housing group, posted market-beating numbers. It looks as though Sarkozy may be very lucky with the economic cycle! There is no indication at this point that any slowing in corporate earnings is going to reduce investor appetites.

Do the politics matter? We will enjoy seeing our politicians squirm against a backdrop of a tetchy G8, with friction over climate change and Bush’s missile defense scheme. Do we need a missile defense system in Europe? It would be entertaining if the issues weren't so serious. The market impact so far from any of this seems to be zilch.

Don’t ignore the summer. As volumes begin to slow the market will be more vulnerable to swings on weak liquidity. Not a time to be brave if you are looking for an entry point to the broader market. Even if you see markets well bid by the private equity gorge-fest -- with funds raised for buying companies likely to top $600 billion this year -- it's important to keep the eyes peeled for changes in sentiment.

Useful program with Steen Jakobsen, the most memorable line: "private equity is dead. We are now in the world of governments and central bankers with Sovereign Wealth Fund." That's the new story for the investor to get their head around.

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