Last week Morgan Stanley explained why it thought we could be in for one of the longest market expansions on record, pushing the S&P 500 to 3000 in the next few years. That thesis was largely based on the idea that we are undergoing a long, slow upswing that has only recently finished recovering from 2008 and begun properly expanding. But global markets are out of sync, with Japan in danger of sliding back into deflation, Europe trying to avoid its own lost decade, and the jury still out on how well China will manage its transition to slower growth.
Morgan Stanley retains a strategic preference for equities
“The current global expansion, already one of the longest on record, has further to run, helped by a lack of ‘animal spirits’ and the unsynchronized nature of global growth. We retain a strategic preference for Equities, over Credit, over Government Bonds,” write Morgan Stanley analysts Andrew Sheets, Phanikiran Naraparaju, and Serena Tang.
Bund, BoJ yields close to all-data lows
Compared to the last thirty years, US equity valuations as measured by trailing PE, CAPE, and P/B are above the median, but only just. Eurozone, Japanese, and EM equities all have lower valuations compared to the US and to their own 30-year histories, while DM 10-year yields are pushing the bottom of their historical ranges across the board. Bunds and Japanese government bonds are actually a couple of basis points above their all-data lows, and Morgan Stanley analysts expect more accommodative monetary policy from both the ECB and the BoJ in the future.
Morgan Stanley recommends keeping some cash on hand
Against that backdrop it’s easy to see why Sheets, Naraparaju, and Tang recommend being overweight equities (with an emphasis on Europe and Japan), overweight credit, and strongly underweight government bonds. They also recommend allocating 3% of your portfolio to cash to take advantage of a possible temporary dip if US growth should come in stronger than expected. The argument is that if US GDP growth picks up stocks might dip in the short term in anticipation of the Federal Reserve hiking rates even sooner, but US growth should spur international growth in the long run, so the dip would likely be temporary. If you assume that the cash allocation comes from what would normally be government bonds, you aren’t giving up much yield over the next quarter or two to have dry powder ready for such a dip.