- "After nine years of markets outperforming the real economy, we think the opposite now applies," the team of Morgan Stanley strategists wrote Sunday.
- Chief among Morgan Stanley worries are a return of inflation, uncertain political outlook and tightening monetary policy.
- "We are not looking for an economic recession in the next 12 months but we could experience the fear of one," wrote equity strategist Mike Wilson.
The "end of easy" investing is over. At least, according to Morgan Stanley.
The investment bank warned investors that it may be time to swap some equities for cash as a confluence of economic factors hamstring 12-month return forecasts and demand a move into safer asset classes.
"After nine years of markets outperforming the real economy, we think the opposite now applies as policy tightens," the team of Morgan Stanley strategists wrote Sunday. "2018 is seeing multiple tailwinds of the last nine years abate — the end of easy."
Chief among Morgan Stanley worries are a return of inflation, uncertain political outlook and tightening monetary policy, the lack of which helped fuel the unprecedented run in the U.S. stock market over the past nine years.
As such, chief U.S. equity strategist Mike Wilson — currently the most bearish strategist tracked by CNBC — told clients that the two 10 percent corrections in the S&P 500 earlier this year were hardly a shock.
The firm lowered its global equity allocation from overweight to equal weight.
"We think it's pretty obvious that the market had discounted the news on tax cuts, global growth and still supportive financial conditions," Wilson wrote. "In many ways a correction or consolidation was overdue and makes perfect sense. The question is whether or not this turns into something more sinister."
"We are not looking for an economic recession in the next 12 months but we could experience the fear of one if financial conditions deteriorate further and investors begin to worry about an earnings deceleration turning into an outright decline," he added.
Both the Dow Jones industrial average and fell into correction territory earlier this year amid a spike in market volatility, a rude awakening after a year of historic calm and successive all-time highs.
The indexes have since pared their losses amid a rally in technology stocks and rising crude prices, with the Dow up roughly 2.5 percent and the S&P 500 up 3 percent over the past month.
Still, the bank advised curbing equity exposure overall, with Wilson recommending energy, financials and industrials across all regions on a sector-by-sector basis. Energy, in particular, could prove a smart move as crude prices climb, he explained, while also providing some defensive characteristics such as yield and capital return.
Among safer options, the strategists increased their exposure to cash by 2 percent and said that among global government debt, long-term U.S. Treasurys are likely the best bet.
"We forecast 10-year Treasury yields to end the year below 3 percent (year-end forecast at 2.85 percent) and eventually fall below 2.75 percent towards mid-2019," strategist Matthew Hornbach wrote.
"We expect debate over the size of the Fed's balance sheet to increase meaningfully into and out of end-2018," he added. "The primary risk to its size is larger than the consensus expects — meaning that the Fed would stop normalization earlier than expected."
The technically important yield curve should continue to flatten throughout 2018, the Morgan Stanley strategists said, as short-term yields outpace long-term rates.
And while the strategists aren't expecting a recession anytime soon, they do foresee a curve inversion in early 2019, typically a bellwether of economic troubles.