I wanted to post a somewhat disturbing piece of research from Morgan Stanley this morning. Each year, Morgan holds a gathering of portfolio managers in posh Lyford Cay, Bahamas. Morgan's macro analysts do a great job of summarizing the goings-on at the conference which provides us lower-level financial types some idea of what the higher-ups are thinking. Oftentimes, this consensus thinking provides some great counter-trend trades. Even though these are some of the smartest people in the business, if everyone is thinking alike and positioned with the consensus, then there's a good chance the information has already been priced into the market.
The complacency expressed by managers at this year's conference struck me as particularly disturbing. While complacency isn't necessarily a good timing indicator, it does indicate that any negative events aren't being priced into the market and could cause a sudden downturn as everyone heads for the exits.
I might just be biased because I remain cautious on the economic outlook. Therefore, I'll let you decide by reading the summary yourself. The full article can be accessed here. The summary comes from Morgan Stanley's Stephen Roach:
We did a fair amount of interactive polling at this year's conference in order to deepen our understanding of the macro assumptions held by the investors in attendance. Three key conclusions: (1) Inflation was not perceived to be a major risk; fully 45% of the group thought the core CPI would recede from its latest reading of 2.9% in September 2006 into the 2.4% to 2.8% zone over the next 12 months. (2) There was little concern over the interest rate outlook over the next year; the Fed was seen as more inclined to ease, and the inversion of the yield curve was thought to come to an end. (3) US economic growth was thought likely to recede into the 2.5% to 2.75% range over the next year; fully 77% of those in attendance were looking for a modest updrift in US unemployment.
Market implications: The Lyford consensus is banking on a quintessential soft landing. With a persistence of low inflation unlikely to disrupt a still powerful liquidity cycle, this relatively benign macro scenario was generally viewed as a green light for these fully invested fund managers.
Risks: We had ample discussions of the possibilities of a China slowdown, the bursting of the US housing bubble, a derailing of the credit cycle, and a politically-induced demise of globalization. None of these risks seemed to faze the Lyford consensus in November 2006.