Morgan Stanley’s European equity strategy team, led by Teun Draaisma, issued a new call on Friday: it’s time to get (back) into European equities.
In April, Draaisma advised clients to be underweight European equities and then to ‘test the waters’ in July. In September, he said he would “buy a bit more” but only if the MSCI Europe fell 5 t0 10 per cent from its August 28 high. On the other hand, if the index rallied 15 per cent or more – sell.
Following a wild ride in September, and as of the close on Thursday, the MSCI Europe was about a hair’s breadth higher than the August 28 benchmark.
In any event, it appears the team’s attention has shifted away from that index and over to the debt-equity clock, which was first wheeled out in 2003:
From the note (emphasis theirs):
As the debt-equity clock ticks from ‘repair’ to ‘recovery’… 2009 has been a record year for credit performance by almost every measure, with European investment grade bonds up 14% YTD. Risk-adjusted, this is far superior to the 22% total return for MSCI Europe, given that volatility of IG credit is 3-4x lower. A focus by corporate Europe on cash generation and balance sheet repairs, as well as record-low starting valuations, have been the key drivers of this move. In other words, we were in the ‘repair’ phase of the debt-equity clock where credit tends to outperform…We believe this phase is probably over now, as a new growth cycle is about to start. Our economists expect 3.7% global GDP growth in 2010 and 2011, with the recovery becoming more self-sustained and balanced in 2011.
…it’s time to prefer equities over high-quality credit. While it is too early make a wholesale rotation from credit to equities, as credit can also perform well in the ‘recovery’ phase, and still Andrew Sheets Edmund Ng, CFA offers reasonable value overall, the highest-quality portion of credit markets presents an increasing number of instances where credit risk looks relatively less appealing.
According to MOST analysts Andrew Sheets and Edmund Ng, while both high-quality credit and equities will continue to deliver positive returns, equities will outperform for the following reasons:
a) Fundamentals — earnings rebound more favourable for equities, as it leads to ‘shareholder-friendly’ corporate actions
b) Valuations – equities look cheap versus high-quality credit
c) The ‘quality’ disconnect — better to own high-quality equities than credit
Full note in the usual place.
Related links:
Sell bonds, buy stocks says Credit Suisse – FT Alphaville
Great, great, under-expectations: What the pundits say – FT Alphaville