12 Key Investment Strategies for Rest of 2012: Morgan Stanley

Morgan Stanley Smith Barney (MS) said Monday that it is maintaining a cautious asset-allocation strategy.

The broker-dealer’s global investment-policy committee, in its latest round of commentary on global market and economic developments, says that its outlook has been heavily influenced by the “still inadequate” policy response to both slower U.S. growth and the recession in Europe.

“As economic data have largely continued to disappoint, it is increasingly clear that the direction of financial markets for the remainder of the year depends upon both the actions and rhetoric of policymakers across the globe,” the committee said in its commentary, written by MSSB Chief Investment Officer Jeff Applegate and others.

“The potential for and vulnerability to shocks remains high, with the eurozone debt crisis and the U.S. fiscal cliff looming large,” the committee added. “This does not create an attractive backdrop for bold changes in investment strategy. Accordingly, our broad strategy must remain cautious and mindful of the elevated nature of fat-tail risks.”

The group’s analysis suggests that many safe havens would have “less vulnerability” in the likely challenging economic period ahead. It has outlined asset-allocation models for fixed income, equities and alternatives that reflect this overall outlook.

Global Bonds/Fixed Income

While it is tough to make a compelling valuation case for cash and short-duration bonds when their yields generally fall short of inflation and appear expensive relative to equities and other risk assets, given the cyclical risks at hand, the defensive properties of these asset classes should provide ballast to a diversified portfolio, MSSB says.

Its investment-policy group is cautious of developed-market sovereign debt, as real yields on U.S., U.K. and German government bonds are negative and those on French bonds are barely positive.

In prioritizing safety and quality over wide spreads, MSSB is limiting its exposure to high-yield corporate bonds and emerging-market debt, while favoring exposure to investment-grade corporate bonds. (See its exact outlook for different fixed-income classes, below.)

1. Short Duration: Overweight

Given the heightened risk of recession in many developed economies, we favor this safe-haven asset class.

2. Investment-Grade Corporates: Overweight

These bonds offer relative safety and quality. In the US, yield spreads versus Treasuries are above average.

3. Emerging Markets: Market Weight

Attractive yield spreads are offset by a desire to limit exposure to risker asset classes.

4. Government: Underweight

With yields near historical lows in perceived safe havens and an unusual degree of uncertainty about additional credit downgrades and default risk in some countries, we see better value elsewhere within the bond market.

5. High Yield: Underweight

If the “growth scare” continues, yield spreads are likely to widen.

Global Equities

MSSB says it is maintaining a modest tactical underweight position in global equities and continues to prefer the emerging markets and United States. The reason? Liquidity.

“Despite a challenging macroeconomic backdrop, one of the primary reasons we have not cut back to an even larger underweight position in stocks is that central banks have significantly expanded their balance sheets in recent years,” the group explained. “That ample liquidity must find a home and, with yields on many safe-haven investments at historic lows, the search for yield seems likely to lead many investors to the stock market.”

Equity-dividend yields, the Morgan Stanley Smith Barney experts say, are higher than yields on U.S. and German government 10-year notes in some countries/regions.