October 11, 2011

Morgan Stanley Shifts to Bearish Allocation

Morgan Stanley is embracing more cash, bonds and managed futures and moving away from equities, commodities and REITs as the risk of a recession increases

Morgan Stanley building in New York. (Photo: AP) Morgan Stanley building in New York. (Photo: AP)

The global investment committee of Morgan Stanley Smith Barney said Monday that the risk of recession in the United States and the rest of the developed world had “grown significantly in recent weeks, so we are adopting an overweight position in safe havens and an underweight position in risk assets.”

Chief Investment Officer Jeff Applegate and his colleagues explained in an asset-allocation report, “This is the most significant change to our tactical asset allocation in more than two years, as we are decisively moving to bearish from bullish.”

In general, Morgan Stanley is embracing more cash, bonds and managed futures and moving away from equities, commodities and REITs. In its moderate-balanced model portfolio, for instance, the percent of cash has increased two percentage points to 5%, and allocation in global equities has fallen by two percentage points to 32%.

“The primary source of the recent financial market distress—with, we think, more to come—has been a combination of policy inaction and ineptness in the U.S. and Europe,” Applegate and the other committee members said in the report. In August, the October report says, the Morgan Stanley Global Economics team explained that the developed economies were moving “dangerously close” to a recession.

Morgan Stanley’s report also draws attention to the Economic Cycle Research Institute’s recent warning that that the U.S. economy is on track for a recession. According to the investment bank, the ECRI has successfully called each of the last four U.S. recessions “with no false alarms.”

Historically, the average decline during recession-related bear markets is about 30%, the investment experts point out. As of Wednesday, the S&P 500 was 16% below its three-year closing price high of April 29.

“With further fiscal-policy tightening in the offing and policy missteps by the European Central Bank, we expect Europe will soon be in recession,” Applegate and his team wrote.

But while Morgan Stanley is bearish, particularly on Japanese and European equities, it expects growth to continue in the emerging-market economies due to monetary tightening. “At the global level, we still would expect GDP growth to be positive,” it said.

“Within U.S. equities, we continue to favor large-cap stocks. Large-cap stocks typically outperform during adverse market conditions and still have a relative valuation advantage as compared with history,” the report’s authors explained.

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