Morgan Stanley Smith Barney (MS) said Monday that it was boosting its exposure to risk assets. This is based on the view that, although there is a challenging global economic outlook, major central banks are providing liquidity, which should support risk-asset markets and the broader global economy.
The broker-dealer’s investment policy committee believes that “the impact of committed monetary policy is palpable,” MSSB Chief Investment Officer Jeff Applegate and others wrote in its late-August commentary on global market and economic developments.
“The MSCI All Country World Index, our proxy for the global equity market, is less than 5% below its mid-March peak, as downbeat economic news is no longer providing as much of a negative surprise as was the case earlier in the year,” the group explained. “Moreover, with yields on many traditional safe-haven investments at or near their historic lows, the higher dividend yields available on equities are attractive and provide some degree of valuation support.”
As a result, MSSB has adjusted its tactical allocations: It broadly eliminated an overweight position in safe havens and an underweight in risk assets.
To neutralize its general tactical position, it made several shifts at the asset-class level. In addition, the group reclassified inflation-linked securities as fixed income instead of an alternative asset “to encourage more clients to consider the beneficial diversification properties of inflation-linked securities.”
Read on for the asset-allocation models that Morgan Stanley has outlined for fixed income, equities and alternatives to reflect this overall outlook.
In MSSB’s view, high yield is more at risk than investment grade. “With the price of the Barclays Capital High Yield Index around 102, investors have very limited upside price potential, as roughly 70% of the high yield market is callable at either par or 101,” the group said in its report. “While investors may be attracted to the coupon income the high-yield market offers relative to other fixed income assets, we believe the upside potential is limited to coupon income while downside potential exists.”
MSSB is staying focused on Ba1-rated credits with shorter maturities, as “the higher quality and lower duration should provide some price protection, as well as the ability to clip a relatively attractive coupon.”
Investment grade is apt to remain more stable than high yield in a risk-off environment, it argues, and thus the group thinks investors will continue to seek the yield pickup of investment-grade corporates over risk-free assets.
“During the next 12 to 18 months, we see investment-grade credit as one of the most attractive investment opportunities, on a risk-adjusted basis, across asset classes,” according to Kevin Flanagan, chief fixed-income strategist, and other team members. “In a low-growth, low-yield world, we believe investors will be attracted to the additional income of investment grade credit versus Treasuries and the lower volatility of returns versus equities and high yield.”
The firm notes that spreads have tightened on emerging-market bonds. But it still sees the chance of a sell-off in EM bonds as being very low, given the central banks' inclination to boost liquidity in the presence of any renewed market weakness
Here are Morgan Stanley's exact outlooks for different classes:
1. Short Duration: Market Weight
With yields extremely low in many markets, MSSB's investment team expects relative performance to lag over any reasonable holding period, except in an environment of negative returns on risk assets.
2. Government: Underweight
With interest rates low, "the price of safety is very expensive in perceived safe-haven markets," the group says. "We see better value elsewhere."
3. Investment-Grade Corporates & Securitized: Overweight
These securities offer investors an attractive combination of high credit quality and yields that are above those on government bonds, notes MSSB.
4. Emerging Markets: Overweight
The yield spread is above its long-term trend line, according to the investment team.
5. High Yield: Market Weight
MSSB reports that the yield spread is close to the long-term average.
Despite the world’s dire economic conditions, MSSB views central banks’ efforts to ease financial conditions as “a lift to a global equity market that is already attractively valued relative to cash and bonds,” it said in its latest report. Plus, “the gaps between the equity dividend yield and those on cash and government bonds are at least two standard deviations from their long-term averages. Amid this tug-of-war, we believe that a neutral allocation to equities is appropriate.”
Within equities, European stock valuations seem particularly attractive, says MSSB. Even so, it maintains a tactical underweight position. “After all, with the continued emphasis on fiscal austerity and the distinct possibility that Greece may exit the monetary union, potential pitfalls remain,” the report says. “So we continue to prefer emerging markets and the U.S. at the regional level.”
As for emerging markets, it is overweight thanks to the region’s “latitude to make adjustments that support economic growth than those in developed economies.” And within U.S. stocks, it favors large caps.
6. U.S. Equities: Overweight
MSSB suggests that a defensive stance favors large-cap stocks at the capitalization level; at the style level, it favors growth stocks against a backdrop of decelerating earnings growth, and relative-valuation readings support this positioning.
7. Developed Markets, Excluding U.S.: Underweight
The firm has increased its exposure to Europe but remains underweight overall. It is market weight in Canada and the Asia Pacific ex-Japan region (predominantly Australia) and underweight Japan, where challenges to economic growth appear to be structural as well as cyclical.
8. Emerging Markets: Overweight
"Policymakers’ focus has generally shifted away from containing inflation and toward supporting growth, and there is more scope for policy support than in the developed economies," MSSB wrote.
9. Inflation-Linked Securities: Underweight
With break-even rates close to their long-term averages, the investment team says there is better value elsewhere.
Global Alternative/Absolute-Return Investments
While there’s been a recent weather-induced spike within the agricultural sector, prices for many commodities have dropped due to slowing global economic growth, which has made commodities one of the worst-performing asset classes during the past year, notes MSSB. Still, the worst of the declines probably are behind us for this phase of the cycle, it adds, and hence the firm has shifted its tactical allocation position in commodities from slightly underweight to neutral.
Hussein Allidina—head of commodity strategy at Morgan Stanley and a member of the Global Investment Committee—continues to rank gold among his favorite tactical commodity picks. He predicts an average price of $1,727 per ounce for the rest of this year, and $1,816 for 2013 vs. the current price of about $1,615.
10. REITs: Underweight
Given a backdrop of slowing global economic growth, and lacking a relative-valuation advantage, MSSB experts say they are inclined to limit exposure to this asset class. For U.S. real estate investment trusts, the dividend yield spread versus the S&P 500 dividend yield is well below its long-term average.
11. Commodities: Market Weight
Although non-agricultural price declines are possible if the global economy continues to slow, the worst of the declines appears "to be behind us for this phase of the cycle," according to the investment team.
12. Managed Futures: Overweight
This asset class often performs well as a hedge against adverse equity market conditions, notes MSSB.
Read 12 Key Investment Strategies for Rest of 2012 on AdvisorOne.
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