Seeking signs of life

Morgan Stanley reckons equities are headed nowhere but Goldman Sachs is optimistic and some experts are even predicting a stock market rally. So who is right? Nick Clark reports


The Bull Case


Green shoots have been tentatively sprouting around the globe in the past couple of months. Markets are up off their lows and economic data has strengthened, and some believe this marks the first step to a recovery and possibly even a "bull run".

Peter Oppenheimer and his research team at Goldman Sachs are positive about the indicators. Yesterday the bank published a note that declared: "Our economists believe that we are past the low point in the economic cycle."

Goldman predicted that the decline of annualised growth in major economies hit its nadir in the first three months of 2009. "Recently released global activity data has been mixed, but they are showing signs of stabilisation, albeit at a low level," Mr Oppenheimer said.

There have certainly been positive signs in the UK. There was good news for the housing sector as mortgage approvals hit the highest levels since May 2008, and the Nationwide house price index rose for the first time in 17 months. There was a pick up in activity in the manufacturing, construction and services sectors, according to CIPS/Markit's surveys. The Bank of England's Credit Conditions Survey, published earlier this month, also made for more positive reading

Fidelity International fund manager Anthony Bolton is a cheerleader for the growth case, saying that a bull phase had started. Mr Bolton, who has called the bottom of the market several times, said investors shouldn't "give up at the last fence". The change from bear to bull was subtle, he said, adding that "there are the first signs of things changing for the better".

The markets have rallied heavily off their lows, with European indices up 17 per cent off their lows, while the S&P 500 is up 25 per cent.

The global rises have been helped by rising commodity and oil prices and a strengthening in economic data worldwide. American retail sales have improved, while its ISM Manufacturing Index, as well as China's Purchasing Managers' Index, strengthened. The Centre for European Economic Research has also released positive numbers for economic expectations in the region.

Barclays Capital's head of technical strategy, Jordan Kotick, said: "We believe it is a bull market in the second quarter. We perhaps think it will be a bull market in the third quarter as well." He cautioned, however: "If you are a very long-term trader, you will probably still assume it is a bear market and we think rightfully so."

The case for the bulls was lifted by the positive reaction to the G20 conference, and the decision to increase the resources of the International Monetary Fund by $1 trillion to help tackle the economic downturn. Goldman backed the "aggressive and unconventional policy measures" in its note yesterday.

Mr Oppenheimer said that while the recent bounce was similar to other bear market rallies, "this feels more substantive given some support from improving fundamentals and more aggressive policy".

Even the bears admit they could be wrong. Morgan Stanley, which led the rearguard against talk of a recovery, said: "If policy action is successful in repairing banks' balance sheets and putting a floor under house prices, the next bull market may have already started."

That said, the bulls felt they should temper their enthusiasm. While Goldman said: "It is unlikely the market re-tests the February lows," it added that there was still risk on the downside and the upswing in the cycle "does not mean it is the start of a new bull market".

The Bear Case

Despite signs of stabilisation, many observers remain unconvinced that the rises represent anything more than just another bear market rally. Morgan Stanley this week sent the London markets into a tailspin after giving a big thumbs down to talk of a recovery.

The investment bank's analysts, overseen by Teun Draaisma, acknowledged signs of economic strength on Monday asking if it was "even a new bull market". The conclusion was emphatic: "The bear market is not over."

Mr Draaisma said: "The fundamentals are not turning. Our three signposts to identify the end of the bear market do not flash green. Our mantra continues to be patience."

The fundamentals that interest Morgan Stanley comprise earnings, US housing numbers and banks' balance sheets. While mortgage rates have lowered, and house prices are down, it cites the Case-Shiller index in the US, which believes domestic house prices will not bottom out until the middle of next year.

So why the recent rises in the stock market? Just normal bear market activity, according to Mr Draaisma. "We are currently in one of those classical 20 per cent plus bear market rallies on the hope of successful policy action," he said, pointing to five such rallies from 1930 to 1932.

Morgan Stanley also points to worrying signs in the credit markets, which have lagged the rally, and cautioned against expecting inflation anytime soon.

Reporting season is fast approaching and investors fear the numbers, especially at the banks, could disappoint. Gordon Grender, fund manager at GAM, said corporate earnings were likely to disappoint, adding it would be "some time" before the markets were in the bull phase again.

Morgan Stanley also fears "the greater fool theory". The theory is of an investor buying into a questionable investment thinking they can sell to a bigger fool at a higher price, as sentiment improves.

"We do not wish to invest on that basis. We could be wrong on fundamentals, that is quite possible, but we would not like to be rightly bearish on fundamentals and yet be a buyer because of this kind of thinking," he said.

Market onlookers are also worried about risks of deflation. Roger Bootle, economic adviser to Deloitte, said: "It is far too early to talk about a recovery. Indeed, the fact that pay is already falling on some measures means that a deflationary spiral remains a significant risk.

"The worst of the falls in output may be behind us. But it will be a long time – quite possibly not until the end of next year – before the economy is expanding again," he added. Others pointed to ongoing fears over increased unemployment and risks over housing.

Some fear further potential downside as the current market cycle is dominated by the credit crunch, and as banks are forced to deleverage further. "This is a global story, and it is still to be played out," one expert said.

Khuram Chaudhry, quantitative strategist at Merrill Lynch, pointed out that while the data is getting "less bad", it is still contracting. "The difference between the bulls and the bears is how they focus on the 'less bad'. Our feeling is the data has been so bad it is likely to form a base. It might well stabilise, but some investors will confuse this with a recovery."

He continued: "If you are a long-term investor you are not going to find that being aggressively bullish is rewarding in the next 12 months. If you are a trader, there is plenty of scope for rotation in the short term."

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