Market Crash Ahead! Morgan Stanley Warns A Possible Triple Policy Disappointment; Sees No Policy Boost From US, Europe, Or China

Despite high-flying equity indices, there is some underlying concern that all is not rosy in the global economy (and that Fed/ECB/PBoC might not save the day this time). As Morgan Stanley notes, the overcrowded trades are overweight US and within US overweight defensives – implying cyclicals are starting to reflect the current global macro weakness and that there are further downgrades to global growth forecasts to come. Expectations for a repeat of H2 2011?s surge in positive surprises are misplaced as several unique factors were at play last year – and are very much lacking this year; moreover global growth indicators are significantly weaker than a year ago. With this background, MS also does not expect imminent QE in the US; the Chinese policy response continues to lag expectations; and there are several hurdles to executing ECB action – all of which leave them expecting further substantial downgrades to 2013 consensus earning forecasts in the US.

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The short story is that our US team does not expect imminent QE in the US; there are several hurdles to executing major ECB action; and the Chinese policy response continues to lag expectations.

However, it may be that cyclical sectors have factored in a lot of bad news. We’re not sure. The downgrades to earning forecasts so far have been concentrated in resource sectors (materials – which includes mining – and energy). Forecastearnings for other cyclical sectors – technology, consumer discretionary, industrials – have held up well through this year. Exhibit 5 shows consensus 2013 EPS forecasts by sector (MSCI All Country index) from the start of this year. Forecasts for technology and consumer discretionary have increased through this year; industrials have seen trivial downgrades. There has not been broad-based cyclical downgrades.

The concentration of sector-level downgrades matches a similar regional concentration: big downgrades have been concentrated in Europe and China (Exhibit 6).

The downside risk for cyclical sectors is that earning downgrades spread beyond Europe, China and China-driven global sectors. Adam Parker, for example, continues to expect further substantial downgrades to 2013 consensus earning forecasts in the US. The global team remains cautious on equities overall. More to the point, it’s very unusual for cyclical sectors to outperform in a weak equity market.

Bernanke speech at Jackson Hole signaled a delay on QE3

Bernanke:

As I have discussed today, it is also true that nontraditional policies are relatively more difficult to apply, at least given the present state of our knowledge. Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies. In addition, in the present context, nontraditional policies share the limitations of monetary policy more generally: Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly cannot fine-tune economic outcomes.

** Former Federal Reserve Governor Robert Heller: “The Fed will not act before the Fiscal Cliff is resolved”

** Fed Won’t Ease Now or in September: Feldstein – CNBC (30 AUG 12)

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