Great rotation move over!

Once markets get comfortable with near-term risks of oil, U.S. earnings, and currency volatility, equities should continue to do well in 2015, according to Morgan Stanley.

In its February 13, 2015 research report titled: “Our 2015 Thesis: The Great Rebalancing Act”, Morgan Stanley notes active managers will likely continue to perform well this year.

2015 – The year of great rebalancing

The Morgan Stanley report notes flattening of the yield curve, valuation compression, rotation to late-cycle stocks, underperformance of EM and small caps and a strengthening U.S. dollar all suggest that the markets are in a rebalancing mode.

It also highlights that the strength of U.S. dollar should help rebalance global growth:

USD strength to aid global growth Equities   Great Rebalancing
Great Rebalancing

 

Turning its focus to oil prices, the MS report highlights that the decline in the crude oil prices is similar to the 1986 episode:

Drop in crude oil price Equities

However, as can be deduced from the following graph, oil prices lead the leading indicator of growth:

Oil Prices - lead indicator of growth Equities

The Morgan Stanley team prefers oil importing Southeast Asia over oil exporting Latin America and also likes China and India.

The MS team terms 2015 as the year of the “Great Rebalancing” led by the currency and commodity market moves in 2014: US to EAFE, oil producers to consumers, EM investment to consumption, rich to the middle class.

Great Rebalancing – European equities to outperform

The Morgan Stanley report points out that though Europe hasn’t begun to expand, this is the period when “early cycle” stocks have worked best.

MS on Euro Area Equities

Citing Forbes’ last month article titled: “ECB’s €1 Trillion QE Will Not Solve Eurozone’s Growth And Inflation Problems”, the report highlights that: “To a large extent the ECB’s QE program will do little to boost growth in the Eurozone and may not help those countries most in need of it.”. However, it also notes ECB QE is getting a vote of confidence from markets:

ECB QE Equities

Moreover, thanks to Europe finally getting support from the ECB with QE, this will pave the way for the end of fiscal austerity:

End of austerity Equities

The Morgan Stanley research team anticipates European equities will continue to outperform in 2015.

Focusing on Japan, the report notes Japan’s recovery appears to be at risk of rolling over.

MS Cycle Indicator-Japan Equities

That said, the report also points out that Japan has been outperforming the US for almost a year:

Topix Vs S&P500 Equities

The MS analysts argue that Japan is still in the early stage of new bull market with high skepticism and low valuations.

The Morgan Stanley research team continues to recommend equities over fixed income. Moreover, in the U.S., the research team prefers Healthcare, Technology, Financials, select Consumer Discretionary and Energy. The team believes small- and mid-capitalization stocks are set for a rebound with enhanced margin upside and less USD exposure.