Morgan Stanley's Credit Team Joins The Bearish Call, Looks To Reduce Risk In Counter-Trend Rallies

Over the weekend, we presented the suddenly very pessimistic outlook by Morgan Stanley's equity strategist team which stated in no uncertain terms that it "assigns a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic" adding that it "continues to assign a higher probability to the bear case than the bull case, and believe the recent price action increases the probability of the bear case." Yesterday, the firm's Credit Strategy team joined the call for a bearish outcome, when in a conference call it stated its case for why its "bearish strategic view is based on long-term structural and valuation issues." Two key metrics watched by MS: i) The unsustainable DM credit super-cycle may be approaching a difficult dénouement, and ii) based on long-term P/E valuation measures, US and UK equities are still expensive. MS warns that "a larger correction in risk assets is likely if a recession occurs, more so for equities" a topic discussed by the equity strategy team over the weekend which believes that the probability of a recession has surged (and continues to be confirmed by leading indicators such as yesterday's Empire State Fed survey). Morgan Stanley's concluding advice to clients: "look to reduce risk in Developed Markets  in Counter-Trend rallies." Luckily, any time volume trickles to a halt, the counter-trend rally should present itself providing ample opportunities for selling into it.

The take home:

Prefer EM assets over DM
· Better cyclical, secular, valuation, and fund flow factors
· Within EM, credit has become rich relative to equities
· Potential rate cuts positive for local bonds, negative for currencies


Continue to reduce beta in DM
· UW European equities on sovereign concerns


Maintain neutral position on government bonds
· 10Y Treasury to stay range bound while Fed on hold
· Bunds face incremental risk from sovereign stress contagion


EUR weakness, JPY strength
· Expect continued EUR weakness from sovereign risk concerns
· JPY remains supported as only G4 currency not in debt spotlight


Commodities stay resilient if growth does
· Expansionary monetary policy bullish for gold
· If growth holds up, commodity balances will tighten

A chart readers saw over the weekend showing the potential downside once the recession stretches its wings:

Yet what is amusing is that Morgan Stanley as usual hedges to the hilt, saying that both IG and HY credit is cheap on some metric they follow. So... credit is rich, but its two components are cheap? Brilliant.

More in the full presentation below:



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