Morgan Stanley Smith Barney shuns risk as Europe recession looms

Researchers at Morgan Stanley's $1.6 trillion wealth-management arm are favoring cash and investment- grade bonds even as stocks and junk debt rally, saying a looming recession in Europe keeps markets “far from worry-free.” Morgan Stanley Smith Barney recommends investors be “underweight” riskier assets, maintaining cautious allocations adopted in October, strategists led by Chief Investment Officer Jeff Applegate wrote in a report distributed today. The strategists made the call as the Standard & Poor's 500 Index climbed to the highest level since 2008 last week and speculative-grade debt gained 1.8 percent in February after the best back-to-back months since 2009. “Despite the markets' positive reactions to the news flow, the fundamental backdrop is far from worry-free,” the strategists wrote, citing euro-zone economic growth and a decline in German exports in December. “These data suggest Europe has already entered a recession. So far, knock-on effects to the U.S. economy have not materialized, but, given the substantial trade linkages within the global economy, any European recession is likely to wash up on U.S. shores.” While Morgan Stanley Smith Barney says it's “an opportune time to harvest gains in lower-quality credits,” JPMorgan Chase & Co.'s high-yield strategists raised their estimate this month for 2012 junk bond returns to 13.7 percent from 9.4 percent. Bank of America Merrill Lynch strategists anticipate a 12.3 percent rally for the assets this year. The bonds have gained 4.8 percent this year through Feb. 24, Bank of America Merrill Lynch index data show. ‘Due for a Pause' Relative yields on high-yield, high-risk debt fell to 601 basis points, or 6.01 percentage points above Treasuries, on Feb. 24, the lowest since Aug. 3, according to the index data. “With less-compelling credit valuations, a possibility that domestic economic data may struggle to surprise to the upside and the continuing sovereign-debt drama in Europe, we believe that the credit rally is due for a pause or possibly even a partial reversal in the coming months,” the Morgan Stanley Smith Barney strategists wrote. “Investors should consider harvesting some profits where appropriate.” European services and manufacturing output unexpectedly shrank in February as the euro-area economy struggled to rebound from a contraction in the fourth quarter, and German exports fell in December four times more than economists forecast, reports showed this month. In a moderate balanced strategic portfolio, Applegate's team recommends 30 percent in investment-grade debt, including short-duration, government, corporate and securitized bonds; 4 percent in high-yield debt; 32 percent in global equities and 26 percent in alternative and absolute-return investments, according to the report. --Bloomberg News--