Breakout

Market’s Next Double-Digit Move Is Down Says Parker

Breakout

A rally in the face of weak economic data picked up steam all day on Thursday as stocks to snapped a five-day losing streak. In many ways Thursday would have been the perfect way to close the 3rd quarter of 2012; a year characterized by markets all but impervious to an economy that is stagnant, at best. With stocks up double-digits going into the start of Q4 on Monday the tension is high on the Street. This morning's latest reading on Chicago PMI confirms that sentiment.

"Fundamentals in terms of the economy remain weak," says Adam Parker, chief U.S. equities strategist at Morgan Stanley. "What helped people feel more optimistic [this year] was removal of some of the real tail risk events that began to surface last year."

He believes investors have had a false sense of optimism that Europe will work itself out, the economy will improve, and fiscal policy gridlock will break. This complacency is ready to snap and the stability of Europe could be that breaking point. To Parker and the Morgan Stanley team, the first signs of market stress will be seen in currencies.

"A key debate will be the Dollar/Euro relationship," says Parker. "For every 1% the Dollar strengthens against the Euro, it's 60 basis points out of U.S. S&P earnings —so a 10% move Dollar/Euro is going to hurt earnings 6%. It's a big deal."

Right now, Parker says nobody is paying attention to currency risk. He calls it the "goldilocks scenario" —everything will work out just right if the Euro and Dollar can be devalued in unison.

Reality tells a different story.

"We think earnings are at risk," he warns. "Nobody's asking about recession scenarios for earnings, which I find surprising given you have a big fiscal cliff, a European recession, and decelerating GDP in most major emerging market economies, in addition to soft U.S. economic news now."

Parker says the low end of analyst estimates for S&P earnings is $116 for the year, while his outlook is $99.

"Normally when growth disappoints and decelerates you get the multiple contracting also, so we see the next double-digit move in the equity market as down, not up from here," he says.

Parker, whose 2011 market call was the best among Wall Street strategists, came into 2012 with a bearish target of 1,167 for the S&P 500 based on this belief that earnings would decline and the multiple would contract. Parker was right on the soft EPS growth, what surprised him was investors willingness to pay more for per dollar earned by S&P500 companies.

"Yet the multiples expanded a lot this year because of policy, the Fed positioning," he admits. "We think the fundamentals have really disconnected from the multiple, and that will reverse over the next few months."

Parker's year-end target for the S&P is a bit higher than where he started the year, currently at 1,214. He doesn't necessarily think we'll plunge to those levels, but it's more about the trend not being your friend right now. Weak earnings, multiples contracting, and a downward shift in sentiment will pave the way for a rough fourth-quarter in his view.

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