Morgan Stanley predicts new stock market crash

| December 3, 2007 | 0 Comments

Morgan Stanley issued a stark warning at the beginning of June this year, predicting a market correction in the order of 14% in European equities - which could wipe out as much as 1000 points from the FTSE 100.

Bull traders continued on till August. Then the credit bubble finally burst, the credit crunch hit, and the FTSE 100 sank from 6700 points to 6050 within a week.

And now Morgan Stanley have announced that it’s not over yet.

As detailed in The Telegraph, Morgan Stanley are now predicting a strong possibility that a bear market that could see the FTSE 100 fall to around 5350 over 2008.

The overall economic indicators are not good - while August’s crash was triggered by the arrival of the Credit Crunch, this was merely the first salvo in what promises to be a continued and painful economic period that we have now entered.

The Sticking Plaster

The big problem with the Credit Crunch is that we are now faced with a situation very much like that of a sticking plaster.

You know it’ll hurt to deal with it, so you have two options:

1. A quite hard removal, which will hurt quite a bit, but be over quickly
2. A long slow removal, which hurts and continue to hurt as the plaster is slowly removed

And it’s obvious the financial sector has chosen the second method.

To be fair, they haven’t much choice. A sudden deluge of debt write-offs would cause panic in the markets, and adversely affect share prices in a wide range of companies quickly and destructively.

Shareholders, and investors - which will also include the banks themselves - could never accept that.

So the situation now is that while some of the worst of the worthless debt floating around is being declared as losses - with RBS expecting to write off £1.5 billion this week - the rest is being shuttled away into what are called Structured Investment Vehicles (SIV).

To a layman, this could be seen as “cooking the books”. In business, it’s called managing risk.

But the sticking plaster scenario says that the financial institutions of the world are merely drawing out the process, and then slowly but surely, much of the debt restructured in SIVs could be declared worthless.

Credit crunch hits home

The serious problem with this scenario is that overall economic conditions are becoming worse.

The UK has been living in the shadow of a property bubble which has proven resilient so far - but now banks have little money to loan. Mortgages will now be granted on a selective basis, and mortgage lending is already dropping fast as the crisis spreads there.

Even worse, the buy to let market has seen a sudden stall in lending - the subprime market in buy to let has already collapsed.

Larry Elliot at the Guardian identifies this as the soft-belly of the UK property market, which if collapses, could bring the rest of the UK property market down with it.

If that wasn’t bad enough, the number of profit warnings issued to shareholders is rising - as consumers are hit by a double whammy of the higher cost of debt, alongside rising inflation.

This also puts the Bank of England in a very tight spot. They’ve already had to explain to MP’s why they completely failed to keep on top of inflation for 12 months over 2006-2007, and have only just managed to reign it in on target.

And now we have oil prices nudging towards $100 a barrel, and rising food prices on top of debt payments.

The economic pressures are pushing downwards on consumer spending, the key engine of the economy.

Some analysts are calling on the Bank of England to reduce interest rates to help UK companies free up cash for lending and help rebuild the inter-banking lending system.

Certainly they have a point - after all, it is widely believed that companies with a European presence have already been borrowing heavily from the European Central Bank at their lower rates.

Yet cut rates, and you could lose control of inflation, while rewarding banks for sharp lending practices. And still draw out the continuing economic correction so that it is painful for longer.

The future isn’t so bright

Whether or not Morgan Stanley’s bear market prediction comes true isn’t really the issue - the problem is that there are so many negative indicators now live in the world economy, and especially the UK economy.

What is worse is that the only expectation for these to balance would be to force us all through a period of escalating repossessions, bad debt problems, lower consumer spending, and falling share prices.

Alan Greenspan, who some blame for setting up weakness in the US Treasury’s monetary policy isn’t so concerned, though. Taking a long-term view, he regards a harsh correction as a necessity to an overly long economic boom.

Whatever the actual outcome, few people are optimistic about the financial situation over 2008 and even 2009.

It simply remains to be seen just how harsh that correction will be.

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