(This post previously appeared at the author’s blog)
Morgan Stanley isn’t jumping on the bull market bandwagon as investors ignore issues in Europe and snatch up risk assets (see their bearish 2010 outlook here). In fact, MS says investors are missing the bigger picture here. They recommend selling the near-term strength as problems in Greece are likely to persist and possibly spread and result in a double dip recession:
“We recommend selling risky assets into strength over the near term. The road to repair will be a long, painful journey buffeted by tremendous uncertainty—not typically a great environment for risk-taking. While the announcement details will garner the headlines, the real medium/longer term issue for the markets is not whether troubled sovereigns get the needed aid/liquidity, but rather, whether the aid and the accompanying necessary fiscal retrenchment leads to an unexpectedly soft mid-cycle economic slowdown—or, worse, a double dip—for the developed world.”
More specifically, they say the markets are getting the outlook all wrong with regards to Greece. They say the contagion effects could be severe due to several reasons:
“What the markets are missing. CDS spreads on Greek sovereign debt, yield-curve steepness, and earnings expectations implicit in equities are all too sanguine given the severity of the crisis. The market is underestimating the tough domestic fiscal reform needed, without which ECB liquidity support is unlikely to be forthcoming. And because of the close interrelationships between the European banking system and sovereign credit, the contagion effects are much greater than the market perceives.”
Based on this outlook MS continues to avoid the high risk trade. They currently view the Euro as a sell, developed markets as more risky than emerging markets, and prefer high quality stocks over Treasuries as the problem of debt weighs on the markets:
- The euro will continue to weaken regardless of how the Greece situation evolves.
- The significant economic growth differential of the emerging world (6.9% vs. 2.3%) will reassert itself, and thus its outperformance relative to developed markets.
- Treasuries will underperform as investors adjust yields for increased debt risks.
- The trade in global equities is still high-quality stocks that can handle uncertainty-induced swings.
Source: Morgan Stanley
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