Investors should start to “scale back” their holdings of emerging-market stocks after a rally lifted valuations and as economic data points to a rising risk of a return to recession, Morgan Stanley said.
The brokerage lowered its recommended “overweight” in developing-nation stocks to 4 percent from 6 percent and added to holdings of cash, Jonathan Garner wrote in a report today. Still, investors should reduce their holdings “gradually, rather than precipitately,” in part because of the outlook for liquidity and earnings, he said.
The MSCI Emerging Markets Index has surged more than 30 percent since the strategist raised the weighting of emerging-market equities in May, then his first asset allocation change since June 2009. Technical indicators including the number of stocks near their 52-week high and the MSCI index’s annual volatility level have deteriorated, he wrote.
“We are starting to dial back the major overweight we have had in place on Asia and emerging-market equities since our May 26 upgrade,” Garner wrote.
He has a yearend target of 1,200 for MSCI’s gauge of 21 developing nations, which retreated 0.4 percent to 1,117.35 as of 9:29 a.m. in Singapore. Garner’s forecast for the MSCI Asia-Pacific excluding Japan Index is 486. The measure slid 0.5 percent to 463.67 in recent trading.
The rally in emerging markets means that valuations are now back to “long-run average levels” on metrics such as the 12-month price-to-estimated earnings ratio and are slightly above average levels based on companies’ historical book value, according to Garner.
Developing-nation equities have also attracted 20 straight weeks of inflows amounting to about $47 billion, with strong fund flows having previously served as a “useful contrarian indicator,” the brokerage said.
While recent economic data suggests an increasing risk of a so-called double dip, Morgan Stanley continues to forecast “robust” global growth next year with inflation likely to remain “contained,” according to the report.
Indications from the U.S. Federal Reserve and the Bank of Japan that further measures to support the economic recovery are in store also suggests that equity valuations may “overshoot” their average levels over the long run, the strategist said.
“We are starting to walk to the door rather than running,” Garner said. “We recommend focusing on quality and dividends as themes.”
The brokerage reduced so-called beta, a measure of risk, by removing Belle International Holdings Ltd., China’s largest retailer of women’s shoes, and Centennial Coal Co., an Australian producer of thermal and coking coal, from its Asia-Pacific portfolio. It added CFS Retail Property Trust, a Sydney-based real-estate trust, and KT&G Corp., South Korea’s biggest tobacco company.
Within global emerging markets, Morgan Stanley removed OAO Mobile TeleSystems, Russia’s largest mobile-phone company, and Etihad Etisalat Co., Saudi Arabia’s second-largest mobile-phone company.