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Morgan Stanley Sees S&P Hitting 2,014 in 2014

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It’s a month away, but Morgan Stanley’s (MS) equity team is already celebrating the New Year.

With an outlook of 11.5% upside in the S&P 500 next year, the group says that market index should hit 2,014 by the end of 2014.

These results should be driven by a “forecast of 6% operating earnings growth, a net 3% share repurchase and modest further multiple expansion,” explain Adam Parker and colleagues in their latest outlook report, released Friday.

They share four main reasons for their upbeat take on 2014.

First, Morgan Stanley raised its fourth-quarter earnings numbers for 2013: “The Q3 numbers were better than we expected … primarily driven by the financial sector,” the report noted.

The group now estimates $109 for 2013 earnings per share. “This is well above our initial forecast from two years ago of closer to $100, but well below the initial consensus bottom-up estimate of nearly $123,” it said.

Second, Morgan Stanley rolled forward its 12-month forward target from the end of Q3 to year-end 2014. This effectively adds its Q4 2015 EPS estimate of $2.90 to the outlook.

Thus, its 2015 EPS full-year forecast stands at $122.90 in earnings.

Third, the equity group sees price-to-earnings multiple expansion.

“For our base case we have raised our PE assumption by about three-fourths of a turn,” it said in its outlook. “Our fundamental view is that a steeper curve and the lack of a bear case forming will cause multiple expansion, consistent with what we have written about in several recent notes.”

Finally, when it comes to net earnings, Morgan Stanley says investors need to be aware of the 3%-per-year net share count reduction, which likely means a 5-6% total share reduction between now and year-end 2015.

“My sense is some investors may not realize that net earnings growth will be closer to 9% per year,” Parker stated, while operating earnings show 6% growth. “All individual stocks are typically evaluated by analysts (with targets) on net earnings, not operating earnings, and in this environment of huge repurchases this is an important distinction.”

‘Tapering Is Good’

Morgan Stanley is not convinced that Fed tapering and rising interest rates will be bad for equity markets. In fact, a rising 10-year yield that isn’t accompanied by a jump in the CPI “could be good for the price-to-earnings ratio for the U.S. market from these levels.”

The equity group stresses that “higher real yields will likely be associated with a slightly better U.S. economic growth outlook and not just less Fed demand for Treasuries.”

Of course, a “Pavlovian reaction” could spark a short-term market sell-off. But then, Morgan Stanley may “want to buy a market dip in the spring around the potential beginning of tapering, if one forms, unless our outlook for corporate earnings markedly deteriorates.”

When it comes to investment sectors, Morgan Stanley’s equity team prefers health care to consumer staples, technology to consumer discretionary, and chemicals to industrials and energy.

Within financials, which represent about 18% of its portfolio of 54 holdings, it likes capital-market sensitive banks and asset managers to insurers and regional banks. (About 6% of its portfolio is in JPMorgan; other financial holdings include BlackRock, Bank of America and American Express.)

The group is not recommending utilities, telecommunications or staples. It prefers drugmakers and “idiosyncratic dividend growers over just a high yield level.”

So far this year, its portfolio is up 31.3% vs. 29% for the S&P 500.

Check out Buffett’s Bank Bets Are on the Money: Report on ThinkAdvisor.