Is Europe's Rally in Its Final Stage?

These words from Morgan Stanley's chief European equity analyst, Teun Draaisma are particularly interesting as we (the collective) sit awash in a world of government intervention and central bank liquidity, while ignoring the fact it is not endless. Fascinating chart below as well.

If you are not familiar with Draaisma, he made a well known call in summer 2007 to avoid equities. While he did get investors back in too early after the September/October 2008 crash - I would assume someone who followed his advice between summer 07 and November 08 would have saved themselves a lot of pain; and losses suffered in Jan/Feb 09 would have been made up by now.

His thoughts are below - please note: I think the U.S. economy is so structurally damaged that I'll stick to my call for no rate increases until early 2011, but Draaisma believes it will happen mid 2010. Whatever the case, the market will start to price in tightening sometimes between "now" and "summer 2010"... which has the potential for destroying this simplistic "dollar sucks" trade.

That doesn't mean the dollar is not in a long term secular decline but this is a decades-long situation based on the debt spiral the country is in; and as with any instrument, nothing goes straight up - or down. What I found interesting is in previous tightening periods, materials and oil based stocks still were relative outpeformers... hmm... that seems a bit contrarian to me, but then again in the "old days" all commodities on Earth were not just an inverse trade to the U.S. dollar.

First via Clusterstock

• Enjoy the bull while you can. According to Morgan Stanley euro analyst Teun Draaisma, we've got a little more rally left, and then a long, low multi-year grind as moneys starts to get tight.

1. The tightening phase may start in the next quarter
   or two. We believe investors need increasingly to
   consider the implications of monetary and fiscal stimulus
   withdrawal. We expect the first Fed rate hike in
   mid-2010, but the tightening turning point could come
   sooner, for instance through higher oil. Our portfolio is
   already quite well positioned for this next phase, and we
   provide a ‘tightening checklist’ to decide when to
   position fully for it. The Fed language change ahead of
   the first hike, or a market timing sell signal, would
   indicate the start of that next phase, for us.
2. Lessons from past tightening cycles. The start of
   tightening phases tends to lead to some indigestion and
   a defensive rotation in equity markets, for two quarters
   or more. The 1994 and 2004 episodes led to a 16% and
   8% fall in MSCI Europe over eight and five months.
   Sector performance was defensive, but Oil and
   Materials outperformed, too. In the aftermath of secular
   bear markets tightening phases have been more severe,
   with equities falling on average 25% over 13 months.

Does history have to repeat? No. But it generally rhymes - a great chart below (click to enlarge)

To repeat what we (and many others) have said before, the rally is not remarkable in terms of percentage gains... it is simply the velocity of said rally - we've compressed time like never before.

*************************

Also, via FT Alphaville:

• The most oft repeated argument for why the current rally is built on sand is that money cannot remain loose forever. Yes, liquidity-drunk investors may be partying now, but they will suffer for this over indulgence when ultra-loose monetary policy is reversed. Mass panic will ensue in the markets. Squealing fund managers will be crushed like so many fat men simultaneously piling through a revolving hotel door, and cackling bears will revel in their own rightness.
• Analysts, clearly smelling the fear, have begun to look backwards for previous market reactions to sudden and sustained rate hikes. They need tips on how to survive THE TIGHTENING. So, do you keep skin in the game, or run screaming for the hills?
• Teun Draaisma and Morgan Stanley’s European strategy team have the following advice:

Is it worth trying to capture the upcoming last ~10% of a ~70% rally? We feel we are in the latter stages of this cyclical bull market, before the period of indigestion that typically occurs when the tightening phase starts. We recommend investors use significant further market strength to position for the next phase. In the aftermath of secular bear markets these tightening phases could last for four quarters, while markets fall by 25%; 2004 was a benign version of such a tightening period, and even then it lasted for two or three quarters while markets fell 8%.

Our best guess is that this tightening period will start before summer 2010. We keep in mind what Jonathan Bell Lovelace, founder of Capital, is quoted as saying: “When everyone wants to sell, you accommodate them and buy. When everyone wants to buy, you accommodate them and sell. Don’t try to get the last 5 percent. Don’t be greedy”.

Do you know anyone who wants to currently sell? People (i.e. myself) are smirked at when they sell positions... because stocks "can only go up"...

Greed and fear... how quickly things change. We said in late 2008, 2009 would be a year of ping-pong between extremes. While accurate, we did not have a clue it would be to this degree.

Comments

[TradingHelpDesk]

Considering purely economic data we shouldn't raise rates for many months yet, but from an asset price inflation point of view we already should have.

Oil is a prime example. It's already way above fundamental fair value but there is a wall of liquidity coming into markets which is desperate to find a home. Thus the S&P rally as well.

The Fed and Bank of England are digging us all a very big hole.

www.dukascopy.com/iben...

2009 Oct 27 09:00 AM

[enigmaman]

We already have tightening bias the last month, Australia has made its first move, England is talking about their move, China is taking action requiring higher bank reserves, Bernanke has said get US deficits and spending under control, Geithner said they will be ending some programs thus quietly withdrawing liquidity, the signals are out there, the warning bells have begun to ring and I think the market is starting to listen. I would not expect the market to wait for a knock at its front door from the Fed before it starts packing, I mean these WS guys always have one foot in and one foot out the door all the time, ready to pivot as needed. The key to their success will be to leave the building without being noticed because what they dont want is to be fighting a crowd at the exit door.

2009 Oct 27 09:41 AM

[cayman]

this rally will continue until we all are xpecting the next leg up...rather than the next leg down

2009 Oct 27 10:47 AM

[TraderMark]

England is in as bad shape as the US - they are still debating how much QE to do. No way they raise rates soon

India did not raise rates overnight - surprised me actually

Canada talking about QE to try to fight Ben bernanke's destruction of the dollar campaign

not clear at all when this tightening occurs but yes, asset inflation is alive and well as speculators get to play with the people's money. On the other hand we have a lot of deflation in the real economy.

Oh a conundrum indeed.


On Oct 27 09:41 AM enigmaman wrote:

> We already have tightening bias the last month, Australia has made
> its first move, England is talking about their move, China is taking
> action requiring higher bank reserves, Bernanke has said get US deficits
> and spending under control, Geithner said they will be ending some
> programs thus quietly withdrawing liquidity, the signals are out
> there, the warning bells have begun to ring and I think the market
> is starting to listen. I would not expect the market to wait for
> a knock at its front door from the Fed before it starts packing,
> I mean these WS guys always have one foot in and one foot out the
> door all the time, ready to pivot as needed. The key to their success
> will be to leave the building without being noticed because what
> they dont want is to be fighting a crowd at the exit door.

2009 Oct 27 11:12 AM

[untrusting investor]

Very well stated. Would certainly agree with your comments and analysis. Dangerous times to be going long almost anything now.


On Oct 27 09:41 AM enigmaman wrote:

> We already have tightening bias the last month, Australia has made
> its first move, England is talking about their move, China is taking
> action requiring higher bank reserves, Bernanke has said get US deficits
> and spending under control, Geithner said they will be ending some
> programs thus quietly withdrawing liquidity, the signals are out
> there, the warning bells have begun to ring and I think the market
> is starting to listen. I would not expect the market to wait for
> a knock at its front door from the Fed before it starts packing,
> I mean these WS guys always have one foot in and one foot out the
> door all the time, ready to pivot as needed. The key to their success
> will be to leave the building without being noticed because what
> they dont want is to be fighting a crowd at the exit door.

2009 Oct 28 01:55 AM

[untrusting investor]

Yes, but it is not just a Fed mandated interest rate hike that matters. What about the dollar devaluation? It appears that enough other countries are getting fed up with the dollar decline and "will enforce" some rise in the dollar, even if only temporay. What about the ongoing massive issue of Treasury debt? The bond market and the bond vigilantes will not keep absorbing large government debt issues at low rates. What about defacto inflation via commodities, especially oil, and the dollar decline? What about rising import prices, particularily food, because of the dollar decline? What about the continuing credit deleveraging and it's negating effect on the velocity of money and even the massive Fed liquidity?

In short, there are many other factors to consider other than just a Fed decision to tighten interest rates, and they have to be feeling the pressure from many of these other factors as well.


On Oct 27 11:12 AM TraderMark wrote:

> England is in as bad shape as the US - they are still debating how
> much QE to do. No way they raise rates soon
>
> India did not raise rates overnight - surprised me actually
>
> Canada talking about QE to try to fight Ben bernanke's destruction
> of the dollar campaign
>
> not clear at all when this tightening occurs but yes, asset inflation
> is alive and well as speculators get to play with the people's money.
> On the other hand we have a lot of deflation in the real economy.
>
>
> Oh a conundrum indeed.

2009 Oct 28 02:09 AM