Investors await signs of 'capitulation'

By Jeremy Gaunt
Sunday, July 6, 2008

LONDON: Profit warnings, breaches of key index levels, record oil prices, stressed consumers and investors seeking safety provide the background for markets this week, and many people are wondering how long this will all last.

There has been no classic "capitulation" - a market concept stating that heavy, sometimes panic, selling of stocks heralds the bottom and a beginning of an upturn. But there is enough gloom around to make a contrarian bullish.

"You are beginning to get into capitulation territory now," said David Bowers, joint managing director of Absolute Strategy Research and consultant to Merrill Lynch for its monthly global fund manager sentiment survey.

"Are we going to go from a narrow bear market to a broad bear market?" he asked - meaning that investors may start selling not only poorly performing stocks like financials but also those that have not done too badly this year.

This week may offer some sort of answer if only because of the depths that have been reached recently.

MSCI's main gauge of world stocks, for example, fell last week to a five-month low. This was below the key March low it reached during the height of the Bear Stearns crisis, when the U.S. Federal Reserve stepped in.

The Standard & Poor's 500 index has joined its European and Japanese counterparts in formal bear market territory - that is, at least 20 percent below a cycle's peak.

Investor sentiment indicators have also been hitting significant levels. Reuters global asset allocation poll last week, for example, showed equity holdings among leading investors to be at the lowest level in the more than four years it has been compiled.

Some investors are beginning to scent a possible end to the stock slide. Sarasin, the Swiss-based wealth manager, has told its clients that it is time gradually to build up their stock holdings again.

"We are seeing that the cycle is showing signs of stabilizing and appears to be bottoming out," said Philipp Baertschi, a strategist in Zurich for the bank, which manages 80 billion Swiss francs, or $79 billion, in assets. "We think the markets will take advantage and rally," he said.

Reflecting a dilemma for investors, however, clients of Barclays' wealth management arm have been told almost the opposite. The firm has cut back its recommended stock weighting.

"Oil prices and inflation are unlikely to fall back sharply, and there are potentially severe problems stemming from wage/price spirals in some of the major developing economies," wrote Michael Dicks, head of research and investment strategy.

Next year is also beginning to look increasingly gloomy, he added.

The dilemma is essentially whether stocks have now fallen so far that they are a bargain buy compared with bonds, cash and other assets, or whether rising inflationary pressures and slowing economies spell serious trouble ahead.

Leaders of the Group of 8 leading economies, meeting in northern Japan at the beginning of this week, are unlikely to do anything to solve this dilemma.

They will almost certainly touch on some of the elements of it - notably the weak dollar, the soaring price of oil and the accompanying rising threat of inflation.

"Oil is the driving variable," said Emanuel Ravano, managing director of Pimco Europe.

But with finance ministers and central bankers absent from the meeting, market reaction could be limited. Some analysts have suggested there is mismatch between the themes of the G-8 summit and who is participating at a time of major economic and financial distress.

A key parameter in any decision to buy stocks is valuation.

Sarasin's Baertschi reckons they are cheap. "The market is oversold," he said, estimating that earnings growth forecasts this year have been revised down by 5 percent to 10 percent, meaning expectations have dropped to a more realistic level.

But a lot of this depends on continued economic growth, and last week's gloom was compounded by a series of profit warnings.

These included the British retailer Marks & Spencer, the French retailer Carrefour and the Swedish-Japanese mobile phone maker Sony Ericsson.

Banks, including most of the U.S. giants, have already been buffeted by losses, so the latest warnings reflect a spread into more consumer-exposed stocks.

With this in mind, investors will be focused this week on the beginning of the latest U.S. earnings season, with a particular eye on Friday on General Electric.

The company is something of a proxy for the global economy.

It is a worldwide business involved in commercial and personal finance, healthcare, industrial production, infrastructure and entertainment.


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