Picks from Morgan Stanley's David Darst

Many of our strategists think the market will be largely range-bound and move sideways as it did from 1966 to 1982, when it gained only 15 percent. We see the recent volatility as a correction, not the beginning of another downturn. The stock market is in pause mode midway through a two-to-three-year bull market in risk assets—meaning junk bonds, corporate credit, real estate investment trusts (REITs), commodities, emerging-market stocks, Canada, and Australia. We are overweight risk asset classes and underweight cash, Treasury inflation-protected securities, and U.S. government securities. This was a brilliant call until the market selloff.

We're aware of the headwinds in the U.S., such as home prices and joblessness. There's also China as it tightens monetary policy and the European sovereign debt crisis. U.S. taxes will go up at the end of the year if no one does anything, and that's another headwind. Completing financial services legislation, according to Barney Frank, will take the month of June. These unresolved things have the potential to rattle the market.

At the same time, though, there's growth in corporate profits in the U.S., Europe, Japan, and emerging markets. Interest rates and inflation are low. Monetary policy is still stimulative, although there is some tightening around the world. In the U.S. there is good corporate liquidity, and we're seeing mergers and acquisitions, dividend increases, and stock buybacks.

Investors need to recognize they have superstar companies sitting here in the U.S. Just look around you: Giants like IBM (IBM), Johnson & Johnson (JNJ), Procter & Gamble (PG), Medtronics (MDT), and Schlumberger (SLB) are selling at the same price multiples as small-cap and mid-cap stocks.

Outside of the blue chip universe, we like junk bonds. In the latest market selloff, the spread between average junk bond yields and Treasuries opened up by 150 basis points. [A basis point is one one-hundredth of a percent.] Junk bonds are attractive because spreads are wider—you're getting paid more for taking some risk—and the economy is improving. It's tough for a small investor to get a good price buying individual junk bonds, so they should invest through an exchange-traded fund, a closed-end fund, or an open-end mutual fund. For instance, there's the SPDR Barclays Capital High Yield Bond ETF.

We like U.S. stocks, but our European strategist went overweight in European stocks on May 21. Europe is so cheap, selling at 11 times earnings. We expect earnings on the MSCI Europe Index to go up 59 percent over the next 12 months. In Europe, we're focusing on pharma, energy, and materials. We like companies like Roche, Glaxo SmithKline (GSK), AstraZeneca (AZN) and Total (TOT), the French energy company. In Canada, we like companies like Toronto-Dominion Bank (TD), Suncor Energy (SU), and Canadian Natural Resources (CNQ).

The Stats: David Darst is managing director and chief investment strategist of Morgan Stanley Smith Barney Global Wealth Management Group. He is the author of The Little Book that Saves Your Assets (Wiley).

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