Best bet in a bloody hard year: Morgan Stanley

Sweden should be your European equity play for 2016, says Morgan Stanley — but don't get overexcited just yet.

"It's the best of a bad bunch," Graham Secker, chief European equity strategist at the bank, said at a media briefing on Monday.

"There are no double-digit returns forecast for any asset class anywhere in the world… It's been bloody hard this year… and it's going to be just as hard next year."

Stockholm, Sweden
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Secker and his team forecast just 1 percent earnings per share (EPS) growth for the MSCI Europe index in 2016, as "commodity sectors see another year of earnings contraction and foreign exchange impact provides little overall impact," according to his 2016 outlook report.

EPS for the U.K.'s benchmark FTSE 100 is seen contracting by a sharp 8 percent, as commodity stocks continue to drag on earnings and subdued emerging market performance weighs.

However, things look a little better for Sweden, which like the U.K. is a member of the European Union (EU), but is not one of the 19 countries that uses the euro.

Secker said that Swedish equities would benefit from the weak krone, a monetary policy aimed boosting the economy and the second-highest growth rate of any country in the EU — including the faster-growing emerging economies in Eastern Europe.

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"It's the best economy with both a low currency and loose monetary policy," Secker said.

Morgan Stanley forecast that Swedish gross domestic product (GDP) growth would reach 2.8 percent in 2016, after peaking this year at around 3.0 percent. That is the bank's highest forecast for any country in the EU next year, bar Ireland, which is seen expanding by 3.9 percent.

Regarding monetary policy, the Swedish central bank is seen by Secker making a further 10 basis point cut to repo — the rate at which central bank lends money to commercial banks — in December, taking it to minus-0.45 percent.

The Riksbank itself, which was an early adopter of negative rates, said in October that it expected to make no increase to repo until the second half of 2017.

Negative rates hurting investment: Swedish CEO
Negative rates hurting investment: Swedish CEO

It also operates a government bond-buying program, which was extended last month by 65 billion Swedish crowns ($7.5 billion), so that total purchases will amount to 200 billion crowns by the end of June 2016.

"Inflation is picking up slowly but should stay well below target, therefore allowing the Riksbank to maintain very accommodative policy," Secker and colleagues said in Morgan Stanley's 2016 outlook report.

The Swedish crown, meanwhile, has slumped by around one-third (34 percent) against the U.S. dollar since the start of 2014 and is seen remaining low.

"The weak SEK should be good for the stock market, given that it has a high degree of oversees exposure, while our preference for cyclicals is also supportive, given their high weighting in the index," said the Morgan Stanley report.

Sweden's economy expanded by a seasonally adjusted 0.8 percent in the third quarter compared to the second quarter in 2015, and 3.9 percent compared to the third quarter of 2014, official statistics from the country showed on Monday.

The 0.8 percent figure was double the 0.4 percent consensus forecast by economists and twice the official flash estimate of EU-wide growth of 0.4 percent.

Sweden's purchasing managers index (PMI) rose to 53.5 in October, up from 53.3 in September, according to Swedbank, indicating that the rate of business activity expansion increased.

In the Morgan Stanley report, Secker was also positive on cyclical stocks, commodity stocks and banks more broadly.

"Equities are still extremely cheap versus other assets classes," Secker said on Monday.

He added that the "next three months seem reasonably good for equities — then it gets tougher."

— By CNBC's Katy Barnato. Follow her on Twitter @KatyBarnato.