Morgan Stanley’s 5 high conviction calls for the next 6 months

Beyond our hometown bias, you can almost guarantee that Australian investors’ allocations to equities will be US dominated. While you could argue there’s good reason for this, after all the US economy and stock markets are the largest in the world, this ignores the wealth of high calibre opportunities in other regions. It also sets up investors for a dangerous reliance on the US. And we all know what has happened in the past courtesy of that reliance…

In light of this, investors who might want to take a broader global approach to their portfolios might be interested in learning that the Morgan Stanley equities team is currently overweight European and Japanese equities while being more neutral on US equities.

The team also holds a “cautiously constructive” view on markets as a whole—that is, there are many uncertainties, but there’s a sense that a soft landing has been delivered.

Perhaps best encapsulating what this means for investors, Serena Tang, Global Head of Cross-Asset Strategy Research, suggested investors, “lean in, but really look for assets which still give you some cheap optionality should growth surprise on the upside, good convexity should growth or other negative shocks affect us over the next 12 months.”

This was merely the starting point for an insightful panel on the global economic outlook at the Morgan Stanley Australia Summit, featuring:

• Seth Carpenter, Chief Economist and Global Head of Economics
• Serena Tang, Global Head of Cross-Asset Strategy Research
• Robert Feldman, Senior Adviser at Morgan Stanley MUFG Securities
• Laura Wang, China Equity Strategist
• Chris Read, Australia economist

Read on to find out what the experts at Morgan Stanley are seeing in Europe and Japan, and their highest conviction calls for the next six months.

The timing of a recession and why the US continues to outperform

As Carpenter reminds us, the global outlook is heavily driven by the US and the activities of the US Federal Reserve.

“Our view is very strongly that there’s still more of that fairly low-cost disinflation to happen in the US, in Europe and other developed markets. That’s a big part of what’s going to allow the Fed, in our view, to cut later this year – maybe even more than what the market has priced in for the ECB,” says Carpenter.

He argues that the continued strength in the US comes down to the long tail of fiscal policy and, at present, the patient approach of the Fed in its attempts to bring down inflation would suggest a soft landing rather than a hard landing. That’s not to say the US will get off scot-free.

“At some point, there will be a recession. I don’t know exactly when that will be, but the further we go out, those risks will mount,” Carpenter says.

The US election and what that means for markets

The Biden vs Trump election race is a dominant theme for the US, but the impact on markets varies.

As Carpenter notes, you need one party controlling all three houses to enact significant policy changes. For example, if the Republicans took all, he would expect this to result in fiscal expansion.

While some investors may be concerned about trade implications, given the famous standoff and tariffs set under Trump’s presidency as he attempted to reduce the trade gap with China, Carpenter said this actually had minimal impact on either country. He also noted that the Biden presidency instituted tariffs on EVs from China by virtue of offering subsidies to locally built EVs.

#1 - High conviction call for the US

Carpenter predicts US inflation will decrease in the second half of the year to the extent that it will surprise markets.

Why Morgan Stanley is overweight Europe

Tang is clear to differentiate between Europe and European assets when explaining why she is overweight European equities. She sees better valuations there compared to the US, and likes the exposures such companies offer in a portfolio.

“About 25% of revenue exposure (for European assets) is actually to the US. You’re getting that exposure at much cheaper multiples than owning US examples. 

You’re getting 8% exposure to China, 30% overall to EM and you’re getting the potential upside of cheap optionality there should EM growth or China recovery surprise to the upside, but at much lower volatility,” says Tang.

Carpenter adds that this is not as bullish a call as it might appear. Morgan Stanley believes that growth will pick up slowly in Europe in the coming year, while inflation will come down.

“European businesses have held onto a lot of workers, and job security is pretty solid as the economic growth comes back into the labour reports,” Carpenter says.

#2 - High conviction call for Europe

Tang is bullish on Europe and Japanese equities for the next six months, viewing the valuations as favourable.

The best conditions we’ve seen in Japan for years

After years of negative rates and stagnant inflation, Japan is in its best position in years. Technology is critical to its future and embedded in all aspects.

Feldman explains that the labour shortage in Japan means that Japan will lose about 1% of its workforce every year for the next 30 years, meaning productivity has to offset that. Further to that is a skills shortage, with not enough AI experts – Feldman looked at the progress of AI adoption across 309 Japanese companies and found they had the second largest number of adopters and enablers after the US.

Finally, he points to the geopolitical situation, with concerns over North Korea prompting a greater focus on Japan's economy.

“We have to defend ourselves and part of that is making our economy stronger,” Feldman says.

As part of this, the Japanese government has focused on increasing the use of equities for returns, initially through reforming the Japanese Government Pension Investment Fund. The Japanese government now intends to extend reforms across the industry to corporate pensions and establish an “asset management nation” that would encourage these pensions to switch to higher equity allocations from their current focus on bonds.

This is also a benefit of encouraging institutions to raise capital through equities rather than bonds, and is supportive of Japanese equity markets.

#3 - High conviction call for Japan

The acceleration of technology adoption by Japanese companies is a major theme for the next six months, and underappreciated by the market.

The mixed outlook for China

The recent rally in Chinese equities may have seen investors hoping this was the great return for China, but Wang says it is “not a comeback story yet”, pointing to the different angles across the economy.

On a positive note, there have been upward revisions in China’s GDP, which appears to be stabilising. On the flip side, Wang expects deflationary pressures to continue and GDP to deflate next year.

The Chinese government has stepped up to support the economy—though not in the large-scale ways we’ve seen in the past. Select measures have been taken to curb excess housing and boost export markets while also seeking to manage overcapacity in the industrial and manufacturing sectors.

“Taking these steps into account across the board, and considering the lack of actions in the consumption category, I think around 20-25% of what can be done has been done to reflate the economy. There’s more to come,” says Wang.

She points out that Chinese valuations have recovered to around 10 times the level they were in 2019.

“I would argue, either from a macro perspective or from a geopolitical set up perspective, China today is not particularly superior compared to China back in 2019. We don’t see valuations as offering particularly attractive earnings growth,” says Wang.

This is not to say investors should steer clear of China. Wang believes investors who focus on fundamentals will do best.

“It’s about identifying the best positioned company in every single sector, with the right strategy, with the right public governance reform initiative, with the right action to improve shareholder returns and with superior returns coming from these companies versus the rest of the industry,” Wang says.

#4 - High conviction call for China

Wang is backing companies in the SOE (state-owned enterprises) sector.

“On a broad basis, these are extremely undervalued versus their global peers, whereas they are actually achieving a higher profit margin compared to their global peers,” Wang says.

The Chinese government has also been pushing these companies to pay out more dividends, and better manage investor relationships. Wang also expects SOE reform to be a key reform agenda for the Chinese government.

Finally, the story in Australia

Read notes that the RBA actually tightened less than comparable peers—not necessarily comforting to Australians, but it was a deliberate policy of the RBA to move slower.

The Morgan Stanley view is that Australia will hold rates this year, with cuts to start in early 2025, pending upside risks.

“The labour market is softening. Unemployment is starting to tick up. There’s definitely some weakness there. We’re seeing the powers working on more cyclical industries, hospitality, retail. Most forward indicators are pointing to a relatively gradual headline softening,” says Read.

He reminds investors that policy has a lagged effect on the economy and that there may be some risks in the August result season.

#5 - High conviction call for Australia

Read believes that the combination of the macro backdrop, along with the prospect of three cuts from the US Federal Reserve will result in a strong Australian dollar.

Livewire was a guest at the Morgan Stanley Australia Summit.

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