UPDATE : US recession fears create bear market for stocks, more pain seen

Venus: sweat after reading this morning note from my broker...

1/22/2008 4:29:00 PM

SINGAPORE (Thomson Financial) - Global stock markets have started 2008 on a sour note amid heightened fears that the US is headed for a recession that will dent export markets around the world and analysts are forecasting more pain to come
"The bear market has started viciously," said Gerard Minack, strategist at Morgan Stanley in Sydney

All major stock market benchmarks have fallen so far in 2008 and are expected to struggle in the first half, or at least until the world's biggest economy shows some signs of recovery. The MSCI all-country indices shows world markets have fallen about 12 percent so far this year. Most benchmarks have fallen even more sharply from the peaks hit in 2007 -- the Hang Seng, for example, is now down 30 percent from its Oct 30 peak of nearly 32,000

Technically, a bear market is considered to have begun when stocks correct more than 20 percent from a recent peak

Investors have clearly given up hopes that the US economy will pick up soon as they opted to continue selling shares even as President Bush unveiled Friday a 145 billion-dollar package to resuscitate the ailing economy. The package, while welcome, is viewed by many as too little to have an impact and too late to help the US economy avoid recession

"The odds are tilting in favor of the US economy experiencing a recession in 2008," said Tony Dolphin, London-based Director of Economics and Asset Allocation at Henderson Global Investors, in a note to clients

"The US is still the world's largest economy. If it goes into a recession in 2008, there will be a substantial slowdown in economic growth in the rest of the world," Dolphin said

While many investors believe that stock valuations look compelling as many markets have declined more than 20 percent from their peak, analysts believe it is misleading to think about valuations at this stage

"Investors need to be careful. Equity markets appear to offer good value, especially in relation to bonds, but profit margins globally are at very elevated levels and valuation measures, such as price-to-earnings ratios may be misleading," Dolphin said

"If the global economy experiences a sharp slowdown in 2008, then we can expect to see margins return to more normal levels. This would involve sizeable downgrades to earnings expectations. It is quite possible that earnings will fall for the first time since 2002," he said

Morgan Stanley's Minack said that while Asian economies may still produce decent growth rates even if the US economy slows down significantly, what investors should be watching is earnings

"If you're an investor - rather than an economist - it's really earnings decoupling, not GDP decoupling, that matters. Earnings could get hit -- say if commodity prices fall -- even if volumes expand, sustaining GDP growth," Minack said

"We have yet to see the impact of slower growth on earnings. That will come

The 'value' that may trigger a rally will, in my view, ultimately prove to be illusory," he added

Betting on Asia Notwithstanding the likelihood of earnings downgrades, Singapore-based Standard & Poor's Asian Equity research head Lorraine Tan believes that Asian companies will continue to offer investors good value

While its difficult to tell how much of the negative news has already been priced in, Tan said she believes Asian stocks are still attractive because Asian companies will continue to outpace earnings growth of their global peers

"Asian companies are in much stronger position than they were before the 1997 Asian financial crisis," Tan said

Still, Tan said she expects a challenging first half for the Asian markets given uncertainties in the US economy

Tan advises investors to avoid cyclical stocks that are susceptible to discretionary spending, particularly property developers, which have enjoyed strong demand for housing and office space in the last few years

Financial stocks are also likely to bear the brunt of selling for the time being as the subprime crisis in the US will take time to resolve

"The market is being driven by fear right now and the current fear is of a major insolvency in the US," said Andrew Pease, an investment strategist at Russell Investment Group

"There's a lot of talk about bond insurers going insolvent --- that could happen if they change the ratings of some of these portfolios that people are holding --- there's a lot issues in there in terms of how much subprime losses are to be written down," Pease said

Already, Fitch Ratings has downgraded US bond insurer Ambac and investors are bracing for further downgrades from credit rating agencies. That would mean banks would have to writedown investments in yet another asset class even as investors fear more subprime-related writedowns

"There is certainly still plenty of downside from here we think. If you think the US is going into a recession there is going to be a lot more earnings downgrades to come across Asia and market multiples can potentially go quite a bit lower from here," said Daniel McCormack, a strategist at Macquarie Securities in Hong Kong

"If the US is going into a recession, the next 3-6 months is going to be very challenging for Asian equities," he added

Morgan Stanley is advising its clients to focus on defensive sectors such as utilities and telecommunications companies

DBS Vickers Securities also believes telecommunications companies in Asia would be a good bet to hedge against the market downturn

"As the US economy navigates in troubled waters, amid the tsunami of (subprime-related) losses, Asian telcos should continue to sail smoothly in the safe domestic waters," said analysts in a note to clients

Among Asian telecom companies, DBS said companies from Singapore are the most defensive, given their strong cashflows and attractive dividend yields of as much as 7 percent. There are three telecommunications companies in Singapore, Singapore Telecommunications Ltd, StarHub Ltd, and MobileOne Ltd

Telecom companies in China and Indonesia also offer strong growth prospects, it added

Companies with high earnings visibility for the next two or three years are also attractive, said McCormack at Macquarie

One example in that category is shipyards, many of whom have full order books until 2010. The shipyard industry has benefitted from the boom in oil exploration activities brought on by the surge in crude oil prices in the past few years as well as strong demand for bigger and newer cargo ships. While demand for oil rigs and cargo ships may deteriorate in tandem with faltering US economic growth, Samsung Securities analyst PJ Yoon believes it is too early to sell shipbuilding stocks

"While we do not expect investor sentiment to improve in the near term, we do not advise taking profit on shipbuilding shares at this time, as we foresee restored order momentum from mid-February," Yoon said in a note to clients

"If economic expansion were to continue even at a snail's pace, ship owners are likely continue placing new orders -- although the order volume would vary depending on the amount and timing of vessels already ordered," Yoon said

There is also need for shipowners to renew their ageing fleet of vessels, particularly bulk carriers that transport raw materials like iron ore and coal

Other investors believe the technology sector, which has underperformed the markets last year, could also be ripe for a rebound. "High-tech stocks been especially oversold, so they have good chance of leading rebounds once sentiment in the broader market turns around," said Tsuyoshi Segawa, strategist at Shinko Securities in Tokyo.