Morgan Stanley downgrades global equities to underweight, says upside limited

As fears of slowdown grow, Morgan Stanley in a recent report downgraded global equities from equal-weight to underweight as the upside remains fairly limited from current levels.

Over the next 12 months, there is now just 1 percent average upside to Morgan Stanley’s price targets for the S&P 500, MSCI Europe, MSCI EM, and Topix Japan.

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 – about 3 percent, said the note.

In light to a slowdown in global growth, economists are calling for the Federal Reserve to lower rates later this month and the ECB to embark on a new round of quantitative easing. But, will it help to prop growth? Morgan Stanley thinks otherwise.

“We think a repeated lesson for stocks over the last 30 years has been that when easier policy collides with weaker growth, the latter usually matters more for returns. Easing has worked best when accompanied by improving data,” the global investment bank said in a note.

As markets have rallied over the last month, global trade and PMI data have continued to worsen. Global inflation expectations, commodity prices, and long-end yields suggest little optimism about a growth recovery.

Economists at Morgan Stanley also downgraded their global growth forecasts. We forecast an aggressive Fed and ECB action because we think growth concerns are material, it said.

On the earnings front, Morgan Stanley thinks that the market is underpricing the risk that companies presented lower full-year guidance.

A US-China trade tension that was widely expected to be resolved led instead to a new round of tariffs. Global PMIs have continued to fall, and Morgan Stanley’s Business Conditions Index, a survey of how its equity analysts feel about their companies, suffered its largest one-month decline ever in June.

“We believe all these signals are a risk to equities. Meanwhile, we’re mindful of the drop in both liquidity and average returns starting in late July. And, given high expectations of central bank easing, and a number of geopolitical uncertainties, the risk that poor liquidity magnifies bad news seem credible,” said the note.

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