How much upside is left for global stocks which have marched higher this year despite trade worries and cooling economic growth? Two of Wall Street's biggest banks have different opinions.
JPMorgan expects equities to advance as much as 15 per cent higher over the next 12 months, but Morgan Stanley has issued a warning on the prospects for stock markets this year.
Morgan Stanley said earnings estimates are too high amid a weak economic environment, while investors are overly optimistic that central banks will come to their rescue.
The bank's cross-asset strategists are consequently cutting their investment recommendations to 'underweight' equities, their lowest weighting towards stocks in five years, via a reduction in US and emerging markets. In a note published late on Sunday they said they prefer emerging market sovereign debt and Japanese government bonds.
JPMorgan's equity strategists are more optimistic: "We expect equities to advance further before the next US recession strikes, perhaps of the order of 15 per cent over the next 12 months, which hands-down should beat the returns of bonds and cash."
Markets have largely brushed off signs of weakening economic growth and worries over persistent trade tensions as investors have instead zeroed in on a dovish tilt from some of the world's leading central banks in the hope that interest rate cuts and even new stimulus could prolong the current economic cycle.
The MSCI All World equity index, a broad measure of developed and emerging market stocks, has risen more than 16 per cent this year, while sovereign bond prices have also rallied.
Morgan Stanley said: "Poor estimates for risk-adjusted return is a central part of our argument. But around this, we see a market too sanguine about what lower bond yields may be suggesting — a worsening growth outlook."
Valuations lie at the heart of the differing views.
JPMorgan argues that analysts estimates for earnings over the next 12 months are still trailing previous market peaks. "While the consensus view is that multiples can only go lower, we think there is a potential for the market to start to price in that the Fed will end up too dovish for the remainder of the current cycle," the bank said.
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In contrast, Morgan Stanley sees valuations as stretched, with the bank's expected 12-month returns for global equities near their lowest levels in six years. "We think earnings estimates are generally too high, and second-quarter earnings season could drive adjustments."
The S&P 500 posted its best first half of the year since 1997, up 17 per cent, but FactSet data has showed that analysts have been slashing their US earnings' forecasts.
In addition, Morgan Stanley pointed to continued weakness in global PMIs and commodity prices as pointing to genuine economic risks, and is unconvinced that the expected central bank response will prove a panacea: "Neither the yield curve nor inflation expectations reflect much bond market confidence that central bank easing will 'work', reviving growth and realised inflation."
Morgan Stanley did confess there are "plenty of risks" to its downgrade, chief among them the lack of other options as investors hunt for yield. "For all the challenges facing equities, the lack of other investment options could mean that these concerns simply don't matter," the bank said.
Written by: Philip Georgiadis
© Financial Times