Chances of a deeper correction are rising: Chris Wood

Published on Tue, Nov 03, 2009 at 10:57 | Updated at Wed, Nov 04, 2009 at 10:04 | Source : CNBC-TV18

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Global equities have surged about 70% in six months on hopes of a rebound in the US economy. However, with valuations getting stretched, central banks raising the drumbeat on policy tightening, and fear that governments may withdraw their stimulus measures, the road ahead looks bleak for global equities.

Chris Wood, Equity Strategist, CLSA, says the chances of a deeper correction in global equities are rising.

Jim Walker, MD, Asianomics, too doesn't see a V-shaped recovery in global equities. "If you look at the level of activity across the world from Europe to America to Japan to Asia, it is weak. It's a very weak recovery so far and as governments withdraw stimulus over the course of the next year, it is going to get weaker still."

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On US markets:

After Friday's sell-off, US markets ended Monday in the green zone on positive manufacturing data. The US economy grew at a better-than-expected annualised rate of 3.5% in the third quarter. The return comes after four successive quarters of shrinking economic activity. Experts hail this as the end of the recession which was worse than the Great Depression of 1930s.

The ISM manufacturing index rose to 55.7 from 52.6 in September. This is the third straight month of growth and highest reading since April 2006. Pending home sales rose to their highest level in nearly three years in September. Also, construction spending rose 0.8% in September.

But Wood is still cautious. He says there is some initial indication of a technical breakdown in the US. "The US market will be vulnerable early next year the US market. If it becomes clear, after this inventory cycle, that consumption, employment is not really recovering, then the market will go down. You will then get renewed stimulus in the US and measures trying to generate growth. The key variable in the West is government policy." CLSA's best case scenario is 1,200 on the S&P 500 by year-end, he added.

However, Richard Bernstein of Richard Bernstein Capital Management is a lot more bullish. "Right now, there is a blurring between the secular issues and the cyclical ones. There are people, including me, who are concerned about the secular issues, but we can't ignore the fact that the economy is getting better, employment is improving. When that happens you will see a cyclical rebound."

Also see: Obama warns on US job losses, urges export boost

Michael Darda of MKM Partners too sees the markets headed higher. "We have moved a very long way in a very short period of time, so we are building in recovery expectations. A period of consolidation and correction will not be out of line. I believe that the recovery process is underway. Even if the big gains are behind us in percentage terms, I still think that in the next 6-8 months the markets will move higher, correction and pullbacks notwithstanding."

On Asia:

Today, Asian markets ended weak ahead of the two-day monetary policy meeting of the Federal Reserve. Wood feels an easy monetary policy in Asia can create asset bubbles. (Read: Easy monetary policy in Asia may create asset bubbles: CLSA) "The worst case correction in Asia is at one-third of highs." Wood advises investors to use significant corrections in Asia to buy stocks. “We have reduced our weight on India, and increased our weight on China."

On India:

In last week's credit policy, the Reserve Bank had stated that it would be looking to raise rates going forward on the back of positive August IIP numbers. This didn't go down well with the market which sees a further rise in borrowing cost. The street sees the recovery in India Inc on the back of lower expenses, rather than a pick-up in business.

According to Wood, India is most likely to see the first rate hike in Asia. But was quick to add that the Reserve Bank won't be aggressive in monetary tightening. "Going into Q1 of next calendar year, the Indian stock market will have to deal with a likelihood of monetary tightening. That is not a disaster. It just creates some negative noise in the short-term."