Morgan Stanley's Late-Cycle Playbook Says Buy U.S. Stocks, Euro

  • ‘Strategically constructive’ on euro first time since crisis
  • Among picks are Japan equities, but risks to mount in 2018

UBS's Emanuel Sees Disconnect in Markets and Data

The second half of this year may be a golden opportunity for investors to enjoy handsome returns from the most benign global economic backdrop since the financial crisis, before the story changes in 2018.

“Synchronous self-sustaining growth, contained inflation and well-telegraphed, gradual withdrawal of policy should drive more animal spirits” in the latter half of 2017 among both investors and companies, Morgan Stanley strategists including London-based Andrew Sheets wrote in a June 4 report. “2018 will be tougher,” they wrote, reprising the old adage to “make hay while the sun shines.”

Continued solid growth in both developed and emerging markets this year, along with high levels of confidence and low inflation and borrowing costs, should push companies into boosting capital spending and investors further into equities, Morgan Stanley says. This is “typical late-cycle behavior.”

Among the investment bank’s strategic picks for the second half of this year are the following:

  • U.S. and Japanese equities, which are preferred to Europe in part because of expectations for a stronger euro. The analysts target 2,700 for the S&P 500 Index by the second quarter of 2018 and 1,730 for Japan’s Topix.
  • The euro, thanks to improving growth and subsiding political uncertainty. It’s forecast to rise to $1.18 by year-end. Also buy the euro against the yen, the bank says.
  • Chinese equities (the MSCI China index), along with Indian stocks, given that China’s gradual monetary tightening “should be manageable” and India could be “at the start of a new growth cycle.”
  • Emerging-market currencies including Mexico’s peso, the Malaysian ringgit and Polish zloty. In credit markets, Argentina, Indonesia and Russia are worth a look.
  • Treasuries should outperform German bunds.
  • U.S. credit “seems very late-cycle,” so investment grade should do better than high-yield. “Europe remains our favored region” for corporate debt given the cycle concerns are less pronounced there.

One key area for investors to monitor is corporate bond spreads, which analysis indicates tend to turn around before stocks.

Here’s why 2018 looks bleaker, according to Morgan Stanley:

  • With the Federal Reserve shrinking its balance sheet and raising rates, the European Central Bank tapering stimulus and the Bank of Japan exiting yield-curve-control, net issuance in bond markets will climb, hurting fixed income.
  • Valuations in stocks will be richer as investors carry more exposure into the new year.
  • Corporate earnings growth is set to slow.
  • “Downside risks to nominal GDP growth remain the predominant risk in 2018” for the bank’s economists.

For now, the Morgan Stanley strategists put it this way: “how long will CEOs be able to resist the siren song of cheap funding, low volatility and good macro data?” They anticipate both business investment and merger-and-acquisition activity to increase. 

“We think there remains scope for investor greed to increase, as the ‘fear of missing out’ becomes more powerful,” the strategists wrote. “It would be typical late-cycle behavior.”

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