Morgan Stanley Says Unloved Stocks Can Beat Global Downturn

(Bloomberg) -- The status of the world’s least favorite asset has its benefits. Morgan Stanley, which just slashed global equities to underweight on growth concerns, believes that European stocks can outperform weaker markets.

Although European equities have over the past 30 years tended to decline more than global markets during corrections, that relationship is changing, strategists led by Graham Secker said in a note to clients.

The reason? Europe doesn’t look so bad in comparison to the other regions in terms of economic data and earnings revisions, according to Morgan Stanley. Expectations that the European Central Bank will restart quantitative easing in the fourth quarter could provide an additional boost to stocks, it said. European funds have suffered the longest outflows in over a decade and low valuations are helping the case for the region.

“While we wouldn’t expect European equities to go up in absolute terms when global stocks are falling, we do think there are a number of reasons why Europe could outperform despite weaker markets,” Morgan Stanley strategists said. “European stocks have a better-than-normal chance of outperforming in a down market given low positioning and valuation and ‘less bad’ macro and earnings trends."

In this context, Morgan Stanley recommends buying euro-zone companies with high domestic exposure, as well as peripheral equities from such countries as Spain and Italy, which should win from further bond spread tightening.

The MSCI EMU Index is up 16% this year, compared to a gain of 17% for the MSCI World, as optimism over the softer stance of global central banks and bets on a U.S.-China trade deal fueled investor appetite. Despite this rally, investors continue to flee European-focused stock funds, turning the asset into the world’s favorite short trade. Messy politics and lackluster earnings growth compared to the U.S. are keeping many traders away.

--With assistance from Lisa Pham.

To contact the reporter on this story: Ksenia Galouchko in London at kgalouchko1@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Jon Menon

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