gerard minack joins inside business, page-2

ALAN KOHLER, PRESENTER: This is supposed to be the Great Recession; everyone's saying so, including the Prime Minister and Reserve Bank. But then this week we get a surge in employment and retail sales and an acceleration of the two-month old share market rally. Even the US Government's testing of American banks showed they won't need as much capital as feared. So what is going on? Let's ask a bear! Gerard Minack of Morgan Stanley.

(To Gerard Minack) Well Gerard, do you believe this week's employment data that shows that unemployment has actually fallen?

GERARD MINACK, MORGAN STANLEY: No I don't. It is a survey and it's quite a noisy survey, in part because of budget cutbacks it's reduced the sample size. So the most you can probably draw from the data is that they didn't really hire that many additional workers last month, they may not have fired so many the month before. The point I emphasise to people is all the leading indicators are saying things are getting worse, and despite this week's very strong numbers I still think that's the underlying situation.

ALAN KOHLER: And what about retail sales, which also was much stronger than expected?

GERARD MINACK: Retail sales - better calibre survey. It's probably just the sugar hit that we've seen from all the policy response to the downturn. And it is worth remembering - and this number illustrates it - that so far for the average Australian it's been a magnificent recession: costs them less to fill up their car, costs them less to pay off their mortgage, Kevin Rudd keeps on mailing them cheques. So what we've seen for the latest available data...

ALAN KOHLER: Not many people have lost their jobs.

GERARD MINACK: That's right - if you believe the data.

ALAN KOHLER: If you believe the data.

GERARD MINACK: That's right. But what we saw last year, which is the latest available numbers, household disposable income was up 13 per cent. So you can imagine the man on the street saying, "If that's the recession, bring it on!"

ALAN KOHLER: The other big thing that's happened this week is the bank stress test in the US. The results have come out: $US75 billion ($98.6 billion) in new capital for 10 banks. Do you believe that?

GERARD MINACK: We do. What we think it is a garbage in, garbage out model. Given the macro assumptions they made we think that's roughly the right number. Our worry is the macro number may be worse and the losses would be bigger. The other point we make about the stress test is the banks they really need to stress test is actually now European banks. In other words, we think there are still risks in the global financial system, but increasingly swinging to Europe, where you've got banks that are more leveraged than in America, they have been less aggressive or less honest, in a sense, on their marking to marker their books, and they've got exposure to some real economic basket cases in their own region.

So yes the US, we find it's a plausible set of numbers given the assumptions they made. We think the risks are even bigger in Europe than in the US now.

ALAN KOHLER: And the other thing is that the market's been rallying very, very strongly - particularly in the US - on the basis of optimism about earnings rebounding. Do you believe that?

GERARD MINACK: No, I think people are far too optimistic. I'm not even sure they know how far they're going to drop in the near term. But a reflection of that optimism is we now have the S and P 500, which is their benchmark, on the highest trailing price earnings ratio we have ever seen.

ALAN KOHLER: What is it?

GERARD MINACK: It's at 56 times and we've got data all the way back to 1880, so the market on that one measure has never been more expensive.

ALAN KOHLER: So what does that tell you?

GERARD MINACK: That's telling you that people go yes, earnings are dropping, but there's a huge piece of elastic and it's going to snap very quickly so we can look over that valley to the next hill.

And I also think that hill that they are looking to, the upgrades, the up pick in earnings is far too high, if you exclude financials because there is a big cloud over those. The current consensus view that is earnings from this year to 2011 will jump about 45 per cent, which will take them to a new all time high and...

ALAN KOHLER: This is in the United States?

GERARD MINACK: This is in the US, that's right. I think that's very unlikely. It's not going to be a V-shaped recovery. And in addition, a lot of the special factors that really created what I've called an earnings bubble over the last 10 years have disappeared.

And so we're going have to get used to a lower level for earnings, and that makes me think equities are not as cheap as they look. However, the market may keep on going up because it's hard to see a catalyst in the very near term for why people will move down their 2010 and 2011 numbers.

The classic market behaviour, markets never move in a straight line. One thing always goes hand-in-hand with bear markets - that's bear market rallies. We are seeing a very big one at the moment, it may keep on going, but then the market's going to get to a level where it goes "Oh gosh, now we really need good news to justify where we are." It's not coming, and we start to move back down again.

ALAN KOHLER: Someone said the other day, "Gerard Minack's turning bullish, it's time to sell!"

GERARD MINACK: (laughs) Well..

ALAN KOHLER: You're not exactly bullish but you were, you are sort of embracing the rally in a way, aren't you?

GERARD MINACK: I'm embracing it in that it's for some clients, some investors who are capable of trading. There's a tradeable bounce here. The low for the S and P was the magic 666. We might get to 1,000, let's say we get to 999. That's a 50 per cent move; I mean people can make decent money.

The bigger picture story however is to be aware of the downside risks, and what we may end up seeing is we range trade for the next three or four years, much like Japan did for a decade, much like the US did once you adjust for inflation from 66 to 1980 - it was 14 years of a range bound market, where the only way investors could really add value was to trade the ranges. And they were big ranges - 40, 50 per cent moves up and down.

ALAN KOHLER: But do you think it will see 666 again?

GERARD MINACK: I don't think we will necessarily go back to the lows, certainly not as my most likely outcome. I think there is a chance, I put it at say, 20 per cent, that we do go to new lows and it goes back to those risks in the financial system which I think have diminished but have not been eradicated.

But my base case is we probably get back down towards say 750; that's why you don't want to be buying equities at 1,000, because you could face a 25 per cent drop. You will have to be nimble and be aware that the framework is telling you that people are too optimistic at the moment. If they get too pessimistic again you can buy again. You've got to fade the consensus.

ALAN KOHLER: Thanks Gerard.

GERARD MINACK: You're welcome.