Morgan Stanley cuts allocation to global equities, sees limited upside

Lower earnings, slower growth drive decision; other research and broking houses are also raising fears of slowdown in corporate earnings globally

Analysts at Morgan Stanley have turned little less optimistic on global equities and cut their allocation on this asset class from equal-weight to under-weight. Among all asset classes, they are now underweight in both equities and credit, equal-weight in government bonds and overweight in cash. Their most preferred asset class remains emerging market (EM) fixed income.

“Over recent weeks, you’ve heard us discussing why we think investors should fade the optimism from the recent G20. Why we think bad data should be feared rather than cheered because it will bring more central bank easing. Why we think the market is too optimistic on 2019 earnings and is underestimating the pressure from inventories, labour costs and trade uncertainty,” wrote Andrew Sheets, their chief cross-asset strategist in a July 7 report.

Over the next 12 months, Sheets sees mere a one per cent average upside to Morgan Stanley’s price targets for the S&P 500, MSCI Europe, MSCI EM and Topix Japan (including dividends and equally weighted). 

"If we ignore those targets and estimate returns for those same regions based on current valuations, adjusting for whether returns tend to be better or worse given current economic data, the upside is very similar (3 per cent). There comes a point for every analyst where you need to change your forecast or change your view. We’re doing the latter," he wrote.

Morgan Stanley's pessimism on economic growth was also reflected last week when Chetan Ahya, their chief economist and global head of economics cut the global growth forecast to a six-year low of 2.9 per cent by 2019-end from 3.2 per cent in the first quarter of 2019 (1Q19) and the recent peak of 4 per cent in the second quarter of 2018 (2Q18).

On earnings, Sheets believes the market is under-pricing the risk that companies lower full-year guidance.

“Global PMIs have continued to fall. And Morgan Stanley’s Business Conditions Index, a survey of how our equity analysts feel about their companies, suffered its largest one-month decline ever in June. We believe all this signals risk to equities,” Sheets said.

Besides Morgan Stanley, fears of a slowdown in corporate earnings globally are being raised by other research and broking houses as well. Analysts at HSBC, for instance, see consensus earnings per share (EPS) growth in Asia to slow from 7.2 per cent in 2018 to 5.9 per cent in 2019e. Most of the earnings downgrades, according to them, have been in Korea, where they now expect earnings to contract by 25 per cent in 2019e. 

“Outside North Asia, things look better. Pakistan, India and China are now the fastest-growing markets. Indonesia and the Philippines should see 7 per cent and 13 per cent EPS growth in 2019e, respectively. In terms of valuations, based on consensus earnings expectations, Asian 12-month forward PEs are now at 12.8x. Valuations are becoming more attractive for China, the Philippines, Singapore and, borderline, India,” wrote Herald van der Linde, head of equity strategy for Asia Pacific at HSBC in a recent report co-authored with Prerna Garg.

  

Among regions, HSBC remains overweight (OW) India and the Philippines and has upgraded Indonesia and Thailand to OW on their strong macro story. 

“We remain neutral on China. We upgrade Malaysia and interest-sensitive Hong Kong to neutral. We remain underweight (UW) on Korea, Taiwan and Pakistan,” HSBC said.