Corporate Europe Feels Blue
Jul 06, 2006
Eric Chaney (London)
Unimpressed by the strong business surveys recently released, Morgan Stanley’s equity and credit analysts covering European listed companies reckon that market and business conditions have deteriorated over the last three months. The synthetic index derived from our quarterly European Analyst Survey dropped from its all-time peak, 61.5 in March, to 49.0 in late June, below its three-year average, conventionally calibrated at 50. Pessimism was widespread across sectors, but most of the bad news came from Telecoms and Financials. More generally, our analysts expressed concern about financing conditions, which we attribute to higher interest rates and lower stock prices.
A contingent divergence? Three months ago, our synthetic index rose in sync with the manufacturing surveys we use to gauge the euro area business cycle (such as Ifo, Insee, Isae). This time, the latter surprised on the upside whereas our own tally turned negative: business conditions are worse, capex plans are softer, financial conditions are as bad as in June 2003, and pricing power failed to improve. We see two main reasons behind the divergence, one contingent, the other more structural. The contingent factor is the equity market correction: when analysts completed the survey, the broad Euro-stoxx index had lost 10% from its May peak. Since then, markets have recouped a part of their earlier losses. Yet the jury is still out regarding the medium-term trend, and this may have weighed on the business outlook. A tug-of-war between capex cycle and monetary policy More fundamentally, the dramatic worsening of financing conditions suggests that large companies are more sensitive than others to monetary normalisation. Also, traditional surveys are reflecting manufacturers’ views, driven largely by the global and European capex cycles, while our survey encompasses all sectors, including the most leveraged and sensitive to interest rates such as Telecoms and Financials. At the risk of over-simplifying the picture, we may see the first signs of a tug-of-war between the capex cycle, still in its infancy in our view, and the impact of rising interest rates. Capex plans slightly and unevenly trimmed Breaking an upward trend almost uninterrupted since the start of the survey (June 2003), capex plans were downgraded, although still pointing to positive developments. The largest downward revisions came from Energy, Industrials and Telecoms but did not go so far as to indicate capex cuts. Only two sectors, Healthcare and Technology, reported stable capex plans, with all the others continuing to plan capex expansion. Financial and Consumer Staples even upgraded their own capex plans. On balance, the correction was relatively mild and still consistent with a continuation of the capex cycle. Slower demand was probably not the trigger, but rather worsening financing conditions: if demand had disappointed, companies would also have planned more redundancies. This was not the case: the headcount index was unchanged compared with March, despite a significant downturn in Industrials. What if the US economy experienced a hard landing? The main fear that makes markets nervous is a possible policy mistake by the Fed, precipitating a recession, instead of the expected soft landing. How would European companies’ profits be affected? Because of huge overseas acquisitions since 1999, the answer is not trivial. We asked our analysts to quantify this scenario: interestingly, 52% answered that it would not matter. Among the 48% anticipating lower profits, Technology, Materials, Industrials and Consumers would be the worst hit. A message for policymakers We think it would be a mistake to dismiss the message from this survey on the pretext that analysts might have overreacted to stock market gyrations. At this early stage of the European recovery, a combination of tighter money, fiscal stabilisation and stronger currencies could harm companies’ profits excessively. In turn, this could choke off the capex cycle and thus result in slower productivity growth and higher inflation. Since pricing power is weakening again, according to our survey, the ECB should take good notice.
Important Disclosure Information at the end of this Forum
The Mysterious Hunger Strike of Vegetarians
Jul 06, 2006
Serhan Cevik (from Istanbul)
The first inflation figure after the global volatility shock is rather encouraging. Global risk reduction has led to a sharp depreciation of the Turkish lira and consequently an increase in import prices and production costs. According to the Central Bank of Turkey, the pass-through effect contributed 68% of the 2.2% increase in the consumer price index in the past two months. Although structural changes in the economy and financial de-dollarisation have reduced the pass-through effect on consumer prices, pricing behaviour is not fully immune to a weaker currency. Of course, this is a serious challenge for an inflation-targeting central bank, especially when exogenous shocks, such as higher commodity prices and risk aversion, cause abrupt fluctuations in expectations. However, we should not focus excessively on financial volatility and ignore economic fundamentals. Ultimately, it is the state and structural features of an economy that determine inflation dynamics. And the first inflation figure in Turkey after the global volatility shock is rather encouraging, although we have yet to see the full extent of the damage. The large drop in unprocessed food prices curbed the rise in headline inflation. After suffering from high and variable inflation for three decades, the Turkish economy has experienced rapid disinflation towards single-digit rates in recent years. Unfortunately, consumer price inflation has stuck in a narrow range around 8% in the last year-and-a-half because of inflationary supply shocks and a combination of inertia and strong demand in the housing sector. Today the country faces a new challenge — the effect of currency depreciation on production costs and consumer prices. Although the pass-through effect contributed 0.9 percentage points to the headline reading, the CPI posted a monthly rise of 0.3% in June — much lower than our and consensus expectations, thanks to the 5.9% drop in unprocessed food prices. As a result, annual inflation increased marginally from 9.9% in May to 10.1%, albeit remaining above the upper bound of the uncertainty band. Considering the lira’s fall and extreme noise in the markets, this is an encouraging result. Of course, it is too early to declare the end of troubling times, since higher commodity prices, lagged pass-through and the inertia in non-tradables still present significant risks. The lira’s weakness has taken its toll on producer prices and currency-linked sectors. Turkey’s import-dependent economy has long suffered from soaring oil and other commodity prices. Now the lira’s weakness is exacerbating these exogenous pressures, especially on production costs. The producer price index posted a month-on-month increase of 4.0% last month, pushing the year-on-year inflation rate to 12.5%. This is a significant but unsurprising development. We observed the same behaviour two years ago when the start of monetary tightening in the US weakened the lira and resulted in a 4.5% surge in the PPI, but a mere 0.4% increase in the CPI. In other words, inflation pressures are still a result of supply-side shocks, not driven by the so-called ‘demand bubble’ in the domestic economy. The normalisation of food prices confirms that there is no ‘demand bubble’ in Turkey. Similar to the PPI’s reaction, currency-linked categories of the CPI basket have shown an immediate pass-through from the exchange rate’s weakness. For example, transportation items recorded a 5.4% increase in the last two months, pushing annual inflation from 7.9% in April to 12.6% in June. However, this is again a reflection of higher fuel prices and the lira’s sharp depreciation, not an excessive demand growth. Indeed, apart from the special case of the housing sector, the key components, such as food and clothing, show no sign of overheating. While clothing prices remain unchanged year on year, the most significant shift has started taking place in the food category (which accounts for 27.7% of the CPI basket). After posting a cumulative increase of 6.5% in the first five months, food prices declined by 2.7% in June. But this aggregate figure does not reveal the whole picture. As we argued in a recent report, there has been a curious divergence between processed and unprocessed food prices (see The Mysterious Vegetarian Demand Bubble, June 19). Supply constraints resulted in an 11.4% increase in unprocessed food prices in the first five months, compared with a 2.3% rise in processed food prices, but we are now seeing the beginning of normalisation in fruit and vegetable prices that has already led to a 5.9% drop in unprocessed food prices last month. Fundamentals give no reason to lose our faith in macroeconomic normalisation. Inflation is likely to remain above the central bank’s target at the end of the year, but we believe that this will be a temporary phenomenon and disinflation will remain on track over the medium term. Although our assessment is based on structural factors such as a productivity-driven shift of the supply curve and drop in unit labour costs, and greater integration with the global economy, we are also mindful of the effect of volatility on consumer spending. Despite higher production costs, the state of the economy — output gap, unemployment, disposable income growth, etc. — and restrictive financial conditions should mitigate the pass-through to consumer prices. Turkey is not out of the global storm yet, but fundamentals give no reason to lose our faith in macroeconomic normalisation.
Important Disclosure Information at the end of this Forum
Central Bank Unlikely to Turn Hawkish in Near Term
Jul 06, 2006
Sharon Lam (Hong Kong) and Andy Xie (Hong Kong)
Central bank likely to keep rate unchanged tomorrow. Although the market has turned more cautious on the Korean economy, we have been stressing for a while that fundamentals remain solid. Indeed, recent macro data has continued to come in better than expectations, namely with exports outperforming, the trade surplus widening and domestic demand holding up. The strong macro data have sparked fears that the Bank of Korea (BoK) might turn more hawkish. We, however, do not believe that the BoK will need to be aggressive and raise the rate two months in a row, as June’s consumer inflation came in below expectations while the central bank itself has revised down its inflation forecast for this year. Meanwhile, the won has again shown slight appreciative pressure recently due to the strong trade surplus and US$ decline. Most importantly, the big uncertainty from North Korea means it is not favorable for the central bank to add further pressure to the market now. Macro data released today further reinforce our view that BoK will freeze rates at 4.25% tomorrow. Nevertheless, we hold onto our view that the BoK is not yet done with this rate hike cycle due to inflationary pressure in the pipeline, and we believe that a 25bp rate hike next month is likely, unless the North Korea situation worsens. Further mild rate hikes should not cause concern as Korea’s interest rate is still below neutral. Consumer sentiment little changed in June, but North Korea a big swing factor. As expected, Korea’s consumer sentiment remained soft in June and therefore reduces the chance of a rate hike tomorrow. Yet, the slowdown in sentiment from May was smaller than market’s expectations. Indeed, despite a weak stock market and tougher property tightening stance from the government, overall consumer sentiment was little changed in June, with a reading at 97.4 from 98 in May. With recent macro data coming in much better than market’s expectations, we believe that sentiment is bottoming out. Nevertheless, North Korea’s nuclear tests will be a big swing factor. If North Korea refrains from further action, we believe the market will focus on fundamentals again, and fundamentals in Korea have proven to be solid. We believe that data to be released next month will show improvement in consumer sentiment, and this will continue over the next three months, supporting domestic demand again. Government property tightening starting to work, so no need for aggressive rate hikes. The government’s administrative measures to cool the property market have begun to show some impact and therefore reduce the need for aggressive monetary policies. After the government ordered domestic banks to curb mortgage lending last month, Korea’s household debt growth did slow in June. Total lending to households eased to W4.3 trillion in June from W4.6 trillion in May. In particular, mortgage loan growth slowed to W2.2 trillion in June from W3.1 trillion in May. We expect property prices to begin to stabilize going forward. Yet, we do not expect a crash as Korea does not have a nationwide, nor even a Seoul-wide, property bubble to begin with. Property price increases are concentrated in very limited areas within Seoul where demand was not merely speculation-driven, but also driven by the baby boomers’ urge to move their children to better education neighborhoods. At the same time, downside to the property market is also limited by ample liquidity in economy, while household debt growth has not shown any sign of overheating. Producer inflation surged in June, but not by enough to prompt immediate rate hikes. High oil prices have caused production prices in Korea to continue to rise. Producer inflation jumped to a 15-month high at +3.2% in June from +2.6% in May. The increase in producer prices will eventually be passed onto consumers. We expect consumer inflation to tick up further in the coming months and, as a result, we have been sticking to our view that the BoK will need to raise interest rates further this year. Yet again, Korea’s inflation remains relatively well-contained due to a strong currency and therefore we believe that the BoK will not turn hawkish. We look for another 25-50bp rate hike this year, which will put Korea’s interest rate just at a neutral level and therefore not dampen the economy.
Important Disclosure Information at the end of this Forum
25bp Rate Cut after June Pause
Jul 06, 2006
Deyi Tan (Singapore)
Quick comment. Bank Indonesia cut the benchmark rate by 25bp to 12.25% today. The move was in line with market expectations. Currency stability remains the focus for Bank Indonesia. We maintain our belief that Bank Indonesia’s primary concern is still currency stability, followed by inflation, then growth. After all, interest rates are at current levels to shore up support in the face of currency depreciation late last year and, to a lesser extent and perhaps incorrectly, to counter inflationary pressures that are largely due to changes in administered prices. Given the recent IDR rally, especially in the aftermath of the fed funds rate hike on June 28 and with the latest June number showing inflation stabilizing at a 15.5% YoY pace (relatively unchanged from May’s 15.6% YoY), the window of opportunity was opened to lower rates on growth concerns, in our view. Nonetheless, the meeting on August 8 will be interesting, coming right before the fed funds rate meeting. The July inflation number will be out on August 1 and, on that count, the data will likely favor a rate cut. We look for July inflation to be slower than May-June, though not lower than 15%. However, the risks would be how the market reacts to a likely fed funds rate tightening then, and how the market reads the move. Nonetheless, if risks are skewed to the upside in the Fed’s tightening cycle, this would cap the ability of the central bank to cut rates, in our view. We expect rate cuts to be gradual, with three more 25bp cuts, and the BI rate reaching 11.50% by year-end.
Important Disclosure Information at the end of this Forum
Disclosure Statement
The information and opinions in this report were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley & Co. International Limited and/or Morgan Stanley Japan Securities Co., Ltd. and/or Morgan Stanley Dean Witter Asia Limited and/or Morgan Stanley Dean Witter Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley & Co. International Limited, Taipei Branch and/or Morgan Stanley & Co International Limited, Seoul Branch, and/or Morgan Stanley Dean Witter Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents), and/or JM Morgan Stanley Securities Private Limited and their affiliates (collectively, "Morgan Stanley").
Global Research
Conflict Management Policy
This research observes our conflict management policy, available at www.morganstanley.com/institutional/research/conflictpolicies.
Important Disclosures
This report does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages them to seek a financial adviser's advice. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. This report is not an offer to buy or sell any security or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.
With the exception of information regarding Morgan Stanley, reports prepared by Morgan Stanley research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we do not represent that it is accurate or complete. We have no obligation to tell you when opinions or information in this report change apart from when we intend to discontinue research coverage of a company. Facts and views in this report have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
To our readers in Taiwan: This publication is distributed by Morgan Stanley & Co. International Limited, Taipei Branch; it may not be distributed to or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Dean Witter Asia Limited as part of its regulated activities in Hong Kong; if you have any queries concerning it, contact our Hong Kong sales representatives.
This publication is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of this publication in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that this document has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., which accept responsibility for its contents. Morgan Stanley & Co. International Limited, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International Limited representative about the investments concerned. In Australia, this report, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act.
Trademarks and service marks herein are their owners' property. Third-party data providers make no warranties or representations of the accuracy, completeness, or timeliness of their data and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. This report or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request.
|
