Tuesday, 15 November 2005

Investors bullish but complacent?

Morgan Stanley's chief economist Stephen Roach thinks investors are complacent about the investment outlook.

There was a decidedly bullish tone to our 21st annual Global Investment Roundtable in Lyford Cay...

Fully three-fourths of the assembled investors thought US equities would rise through mid-2006. The group was also optimistic on Japanese equities, but the bullish margin was considerably thinner. And by a factor of two-to-one, the Lyford consensus was bearish on European stocks. The group was relatively bullish on the interest rate outlook: Fully two-thirds of the assembled investors thought the federal funds rate would remain below 4.75% by mid-2006, and only a couple of lonely souls took the bearish side of a 5.5% call on 10-year Treasuries over the same period. The bulk of the crowd thought oil prices would remain below $60 through mid-2006. Finally, the currency view was overwhelming populated by euro-bashers, although the group was more evenly divided over the yen outlook...

The elastic world can certainly take some tough body blows. But...[t]he elasticity of globalization hardly provides a guaranty of immunity from macro shocks. The final word from Lyford Cay came from another veteran who noted, "We all know these imbalances you speak of are unsustainable -- we just can’t afford to focus on the endgame." Elasticity or complacency? To me, it sounds more like the latter -- and even more like denial.

His colleague Andy Xie is similarly bearish for 2006.

The current round of growth optimism may last six months. Two factors could cause growth expectations to turn down by mid-2006: (1) the tightening by major central banks could start to bite by that time; and (2) the property bubble has already begun to deflate in China and the US, which could become a major headwind for growth by the middle of next year...

There has been a close correlation between the increase in risk appetite and decline in interest rates, making monetary policy more potent than usual in this cycle. This has been the principal reason for the numerous bubbles that have elevated global growth. As monetary conditions reverse, the risk appetite may reverse also. Many financial bubbles could deflate in 2006, bringing down the global growth rate.

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