Download Back To School Early September is a time for transition, often from

Back To School
Early September is a time for transition, often from leisurely days at the pool or beach
to a pile of “to do” lists. Children face the anxiety of entering the next grade, while mom and
dad contemplate their own challenges at work.
Markets are anxious, too. September historically is the weakest month of the year for
US equities and has consistently delivered negative returns. Perhaps this anomaly is just a
reflection of market participants’ combined “personal” anxieties but – more than likely – it is
the fact that real transitions in the economy and geopolitical events tend to occur at this time
of year.
So far, 2013 has not disappointed, with several important inflection points now
occurring simultaneously. First, the global economy continues to improve at very different
speeds around the world. Surprising many has been the recovery in Europe and, as a result,
European stocks have quickly assumed a leadership role in global equity markets since late
June. Second, throughout the globe, we have seen significant changes in policy. The longawaited tapering of asset purchases by the Federal Reserve is expected to begin this month,
just as Japan tries to implement real structural reform. Finally, the tragic events in Syria
remind us that tensions in the Middle East remain ever present.
All of this is causing investors some uncertainty – and opportunity. In general,
Morgan Stanley & Co.’s economics and strategy teams believe the global economy continues
to heal form the financial crisis of 2008 and 2009. In a switch from the past decade, the
developed economies – not the emerging economies – are the ones with momentum. Hence,
the developed markets should continue to lead equity market performance.
The mid-cycle correction in risk assets that began in May, marked by a jump in longterm interest rates, is likely to persist for at least a few more weeks or months. While there
could be a flight to quality and subsequent decline in interest rates in the near term, we do
not think that would be a trade worth playing. Instead, we continue to favor stocks over
bonds and anticipate divergent performance across all regions and sectors. Stay underweight
benchmark duration within fixed income and look to add equities in Japan, Europe and the
US during the traditionally weak month of September.
The Wilson Group’s Outlook on Rising Interest Rates
Over the upcoming months and years, the Wilson Group expects interest rates to rise
– but the manner in which the expected increases occur will dictate how we react and
position our portfolios. We prefer to see interest rates increase in an orderly fashion unlike
the extreme spike that occurred in the 10-year Treasury from May 2nd to July 5th – 1.63% to
2.72%. This created havoc in the bond market and also affected the stock market during that
timeframe. However, we believe that long-term interest rates will create a “staircase effect”
– a gradual rise followed by a period of acclimation then another minor increase with a
cooling off period, etc. Our thesis is that this orderly ascension will foster a more stable and
positive vibe in both the stock and bond markets.
Rising Rates Need Not Sink Stocks
Many investors believe that financial markets have become too dependent on
monetary stimulus from the Federal Reserve and, therefore, any pullback in the central
bank’s Quantitative Easing, which could result in higher long-term interest rates, could
damage the economy and the equity market. However, history shows that stocks have
generally performed well in rising-rate environments.
Much of the concern about rising interest rates has come in the wake of Fed
Chairman Ben Bernanke’s May 22 comments about tapering asset purchases. Remember,
though, that interest rates have been rising for more than a year; the yield on the benchmark
10-year US Treasury bond hit a closing low of 1.43% on July 25, 2012. From that date until
July 31, 2013, the S&P 500 gained 29% and the MSCI All Country World Index ex US, a
broad measure of global equities, rose 25%. In contrast, the Barclays US Aggregate Bond
Index fell about 2%.
US Equity Strategy – Where’s the Bear?
Morgan Stanley Research North America
Today Morgan Stanley’s global macro team published a joint note looking at all major
asset classes around the world (see “Dealing with Daylight”). As we said in March, the lack of
a credible bear case seems to be driving multiple expansion for equities. Looking 12 months
forward, we are introducing a base case S&P500 price target of 1840, implying roughly 12%
upside from here. Why? For one thing, markets can work while estimates are being
downwardly revised.
The economy / earnings: Our global economics team forecasts an accelerating DM economy
and stabilizing emerging markets, making the bear case in EPS unlikely. Due to better than
expected Q2 financial sector EPS, we are raising our 2013 EPS forecast to $105.50, and our
2014 EPS to $112 (from $103 and $110). Our 12-month S&P500 price target is predicated on
EPS of $118 from the middle of 2014 through the middle of 2015. Key risks are a materially
stronger dollar, Brent outside of the $80 to $120 range, or materially higher rates.
Tapering: We don’t believe bond yields will back up much more in the near term. The
government doesn’t want to slow the economic recovery, demand for income is enormous,
and CEOs are incented to grow their dividends. While some tapering is in the price, the rate
of tapering is open to debate.
Hubris and debt: These two cause every crisis or bubble to burst. Today CEO confidence is
only average, while the market is near record highs. Capital spending is low, M&A isn't
exactly frenzied, hiring is low, and inventory builds in advance of recovery are weak. The
date when debt is due is more important than how much there is, and very few companies
are likely to go bankrupt in the next 2.5 years. By this measure, we’re not at the top of the
cycle. Balance sheets are in great shape, cash balances are at record levels, and financial
obligations have been pushed out. We are buyers of dips and maintain our constructive
stance, even though markets appreciated more than we expected year-to-date.
We have argued in the past that it is extremely difficult to forecast the market multiple. Even
knowing major economic results a year before everyone else would barely aid in this regard.
As such, we are left to guess at what might cause changes to the market multiple. There is
evidence that higher real rates from today’s suppressed levels have been associated with
multiple expansion. Our bear case target is 1352 and our bull case is 2327.
Alternative Investments in Rising Rate Environment
With most fixed income instruments responding negatively to the rising interest rate
environment, a lot of folks are asking for a substitute to traditional bond investing. The
Wilson Group has developed a proprietary model called the Absolute Return strategy which
employs multiple asset classes as our answer to a bond-like alternative. The underlying
investments are actively managed mutual funds in the long-short, arbitrage, floating rate and
commodity areas, just to name a few. Ask us about it today if you’re looking for a bond-like
alternative and click on the link below for a very informative white paper.
http://www.morganstanleyfa.com/public/projectfiles/0c4b0ee3-08a9-40b7-b13483bc53a1b466.pdf
In addition to employing alternatives to mitigate interest rate risk, there are particular types
of fixed income instruments and strategies which can position your fixed income portfolio to
be more protected in a rising-rate environment. The Wilson Group has implemented
floating rate, bank loan and short duration fixed income securities in our clients’ accounts as
a way to be proactive in this market. To learn more about these securities, please click on
the link below.
http://www.morganstanleyfa.com/public/projectfiles/eb4ff54d-6f19-4d49-b80520a4042db4b0.pdf
This material does not provide individually tailored investment advice. It has been prepared without regard to the
individual financial circumstances and objectives of persons who receive it. The strategies and/or investments
discussed in this material may not be suitable for all investors. Morgan Stanley Wealth Management recommends
that investors independently evaluate particular investments and strategies, and encourages investors to seek the
advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s
individual circumstances and objectives.
The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley
Wealth Management or its affiliates. All opinions are subject to change without notice. Neither the information
provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past
performance is no guarantee of future results.
S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad
stock market. An investment cannot be made directly in a market index.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the
equity market performance of developed markets. As of May 30 2011, the MSCI World Index consists of the
following 24 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France,
Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore,
Spain, Sweden, Switzerland, the United Kingdom, and the United States. An investment cannot be made directly in a
market index.
The Barclays Capital U.S. Aggregate Index covers the U.S. Dollar-denominated, investment-grade, fixed-rate, taxable
bond market segment of SEC-registered securities. The index includes bonds from the U.S. Treasury, GovernmentRelated, Corporate, Mortgage-Backed, Asset-Backed, and Commercial Mortgage-Backed Securities sectors. An
investment cannot be made directly in a market index.