Investors need to prepare further for downshifting in a year when picking winners is proving tricky, Morgan Stanley says.
The multiple tailwinds of the last nine years are abating for markets, and policy tightening means the opposite now applies. Global equities now have limited 12-month upside so should be reduced to equal-weight (to 2 percent from 4 percent), while exposure should be raised to emerging-market hard currency debt and cash, strategists led by Andrew Sheets wrote in a midyear outlook Sunday titled “the End of Easy.”
“Growth momentum, inflation, balance sheet size, earnings revisions, stock-bond correlations and U.S. policy rates are all transitioning,” the strategists said. “For markets, we think this means 2018 will see a series of rolling tops in credit (January), yields (summer) and equities (3Q).”
Investing may have seemed uncertain and even scary at times over the past eight years, the report noted, though in retrospect it looks easier because just about everything outperformed cash. Even in the past 18 months, growth surprised to the upside and inflation to the downside, with U.S. political risk to the positive. But with those factors in the rear-view mirror, the outlook is less favorable.
The reduction of equities to equal weight means Morgan Stanley now differs from peers like JPMorgan Chase & Co. and Goldman Sachs Group Inc., which still have stocks as overweight in their allocations.
Morgan Stanley is remaining cautious on credit, recommending up-in-quality trades. U.S. and Asia corporate debt is least attractive, while emerging-market hard currency debt is most attractive. The strategists prefer oil over metals, predicting that slowing demand growth in China will be a downside risk for iron ore and copper. They also see limited, tactical opportunities to sell volatility, while expecting “broad-based and strategic” chances to buy volatility across credit, foreign-exchange and equity markets.
The report’s key calls include:
- Overweight European stocks and global energy equities
- Japanese yen to hit 95 by the third quarter of 2019
- U.S. Treasury 10-year yields will end the year lower, with a flatter curve
- Strong 12-month gains for the South African rand and Brazilian real
Still, the strategists don’t see the more difficult environment yielding a dramatic downturn.
“We do not think that this topping process will be followed by declines like those seen after 2000 and 2007,” they wrote. “Those were the largest equity and credit bubbles in modern history (respectively), and today’s excesses aren’t nearly as extreme. Rather, we think that markets would face more modest declines in a choppy range.”
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