Is capitulation on the cards?

By Jeremy Gaunt, European Investment Correspondent

LONDON (Reuters) - Profit warnings, breaches of key index levels, record oil prices, stressed consumers and investors seeking safety provide the background for markets this week, and many people are wondering how long this will all last.

There has been no classic "capitulation" -- a market concept which states that heavy, sometimes panic, selling of stocks heralds the bottom and a beginning of an upturn. But there is enough gloom around to make a contrarian bullish.

"You are beginning to get into capitulation territory now," said David Bowers, joint managing director of Absolute Strategy Research and consultant to Merrill Lynch for its monthly global fund manager sentiment survey.

"Are we going to go from a narrow bear market to a broad bear market?" he said, meaning that investors may start selling not only poorly performing stocks such as financials but also those which have not done too badly this year.

This week may offer some sort of answer if only because of the depths that have been reached recently.

MSCI's main gauge of world stocks .MIWD00000PUS, for example, fell last week to a five-month trough. This was below the key March low it reached during the height of the Bear Stearns crisis when the U.S. Federal Reserve stepped in.

The U.S. S&P 500 index .SPX has joined its European .FTEU3 and Japanese .N225 counterparts in formal bear market territory -- that is, at least 20 percent below a cycle's peak.

Investor sentiment indicators have also been hitting significant levels. Reuters global asset allocation poll last week, for example, showed equity holdings among leading investors to be at the lowest level in the more than four years it has been compiled.

IN THE BALANCE

Some investors, albeit tentatively, are beginning to scent a possible end to the stock slide. Swiss wealth manager Sarasin, for example, has told its clients that it is time gradually to build up their stock holdings again.

"We are seeing that the cycle is showing signs of stabilizing and appears to be bottoming out," said Philipp Baertschi, a strategist in Zurich for the bank, which manages 80 billion Swiss francs ($79 billion) in assets. "We think the markets will take advantage and rally," he told Reuters.

Reflecting a dilemma for investors, however, clients of Barclays' wealth management arm have been told almost the opposite. The firm has cut back its recommended stock weighting.

"Oil prices and inflation are unlikely to fall back sharply, and there are potentially severe problems stemming from wage/price spirals in some of the major developing economies," wrote Michael Dicks, head of research and investment strategy.

Next year is also beginning to look increasingly gloomy, he added.

The dilemma is essentially whether stocks have now fallen so far that they are a bargain buy compared with bonds, cash and other assets, or whether rising inflationary pressures and slowing economies spell serious trouble ahead.