FT Alphaville recently posted an excellent note by Morgan Stanley describing the skew between the market and reality. MS is one of the few big banks that isn’t buying into the utopian environment for equities. In fact, they believe equity investors are ignoring several risks here – primarily the global tightening that is occurring. They were one of the few banks that actually issued a bearish fiscal 2010 outlook (see here) and have remained skeptical of the rally thus far.
Morgan’s analysts believe the equity market is pricing in a permanent utopia for risk assets – a period of high growth with permanently low rates, but in reality, they say the Fed is ready to start altering their accommodative approach:
“Clearly the markets are in a utopia-type environment; with the Fed seemingly on perma-hold and upside in growth… We are on the other side of those views. As we see it, strong growth will ultimately be met with withdrawal of liquidity, and the risk markets will not like that medicine.”
MS says equities could be at risk of substantial declines should the tide shift from the “rates on hold” camp to the “rate hikes” camp. With the VIX falling to its lowest level since Summer 2007 it certainly appears like investors are complacent and pricing in a utopian environment. Unhedged investors might find themselves in their own personal hell if an unforeseen risk should creep into the equity markets.