Morgan Stanley is a renowned uber-bear when it comes to the Australian
economy and while Gerard Minack and his colleagues admit to making a
few errors of judgement in terms of how long it may take the bear to
come out of hibernation, they are convinced it won’t be too long before
he begins to stir and that once awake, it may take him several years to
crawl back into his cave.

On one hand the economists have revised up their 2006 GDP forecasts to
2.5% and 2007 to 1.1%, from 2.2% and 0.9% due to recent economic data
surprising on the upside, but on the other hand they say this just
serves to reinforce their view that 2007 domestic growth risks are
“skewed to the downside”.

Significantly, the economists have cut their domestic demand forecasts
to just 0.2% from 0.5% in 2007 as it is expected to be slowed down by
ongoing residential construction weakness, a peak in the business
investment cycle, a softer labour market, household financial
pressures and disappearing terms of trade assistance.

OK, so Minack et al underestimated exactly how much cash has been
flowing into Canberra’s coffers and the resultant budget that followed,
and if consumers decide to spend this extra cash then clearly domestic
demand will be higher, the analysts concede, but on the flip side of
this, their forecasts assume that global growth holds, which it may not.

As a result of these expectations, the economists predict looser fiscal
policy and lower rates, which will in turn point to a lower Australian
dollar. The first interest rate cut is expected some time during the March
quarter with a possible 150-200 basis points being cut over the
downswing, the economists say.

This is expected to push the AUD down to around the mid-60c range. If
all this wasn’t depressing enough, Minack points out that the most
important implication of all this is the impact on corporate earnings.
On a top down measure, he expects a double digit decline, which he says
would be “poison to an equity market that is now, in our view, riding
an earnings bubble”.

Presumably this is why Morgan Stanley is forecasting an ASX200 at 3,000 in 2010, down from today’s 4,762.