Morgan Stanley slashes junk bond allocation

The $2 trillion firm sees recession risks rising and tax-cuts boost as short-lived

Jan 4, 2018 @ 2:40 pm

By Bloomberg News

It's too late in this market cycle to bet on high-yield bonds, according to Morgan Stanley Wealth Management.

So, the $2 trillion money management arm is completely slashing junk bond allocation. True, tax cuts are expected to inject fresh momentum into high-flying stocks, but the boost may be short-lived and mask balance-sheet weaknesses, Mike Wilson, chief investment officer, wrote in a note distributed Wednesday.

"While the tax cuts just enacted in the U.S. may lead to better growth in the short term, they may also bring forth the excesses we typically see before a recession — which is something credit markets figure out before equities," according to the note. "We recently took our remaining high yield positions to zero as we prepare for deterioration in lower-quality earnings in the U.S. led by lower operating margins."

Buoyed by bullish global economic data, global markets took off in the new year. The MSCI All-Country World index has advanced 1.6 percent so far this week while the Bloomberg Barclays Global High Yield index rose 0.4 percent. Both gauges are trading at a record high.

As the cyclical peak approaches, investors should prepare for at least one correction in global stocks this year, Wilson said.

Though Morgan Stanley doesn't expect a recession in 2018, it sees the risks rising. Between tightening monetary policy and fewer positive surprises in earnings and economic data, any remaining upside is likely to be speculative, according to the firm.

"We think it will be much tougher to make money in 2018 and 2019 than in 2016 and 2017 as the risk of a recession and outright bear market comes closer," Wilson wrote. "Late-cycle dynamics have become even more evident."

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