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Morgan Stanley: Rally Over, Stocks Headed Down 11 Percent

Morgan Stanley analyst Teun Draaisma recommends that investors use “tactical caution” for the next three to six months.

The European equity analyst called for investors to sell stocks in June 2007 when the markets were flashing a “full house sell” signal. He then flipped bullish in November of 2008 as the markets were pricing in a much more severe situation than Draaisma saw unfolding.

“We recommend selling into strength, and we think MSCI Europe will reach 1,030 at some point later in 2010, down 11 percent from here,” Draaisma writes in a note to investors.

"The last 12 months have been characterized by record stimulus and rising economic leading indicators,” Draaisma says, adding that Morgan Stanley reduced its equity exposure two months ago.

Fresh signs that the economy continues to recover sent the Dow Jones industrial average briefly above 11,000 Friday for the first time in 18 months.

Draaisma’s thesis is that good growth will lead to tightening measures and struggling equity markets this year, just like in 1994 and 2004.

He believes the next six months will be characterized by some stimulus withdrawal as a reaction to good growth in Asia and the United States, and softening leading indicators.

The recent rally was larger than Morgan Stanley expected, and Draaisma believes it was due in part to the Fed’s refusal to tighten the money supply.

”Sentiment had turned quite cautious in early February,” he says. Nevertheless, we do think the market peak associated with the start of tightening is near, and expect 2010 to show a volatile whipsaw pattern in equities.”

The Dow hadn't crossed that level since Sept. 29, 2008, just as the worst phase of the financial crisis was beginning.

The Dow very briefly traded over 11,000 in the final five minutes of trading before settling slightly lower. The Dow had come within 12 points on both Monday and Tuesday.

The Dow rose 70.28, or 0.6 percent, to close at 10,997.35. The Standard & Poor's 500 index climbed 7.93, or 0.7 percent, to 1,194.37. The Nasdaq composite index rose 17.24, or 0.7 percent, to 2,454.05.

The Dow is now up 68 percent from a 12-year low of 6,547.05 on March 9, 2009. It's still down 22 percent from its October 2007 peak of 14,164.53.

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Morgan Stanley analyst Teun Draaisma recommends that investors use tactical caution for the next three to six months. The European equity analyst called for investors to sell stocks in June 2007 when the markets were flashing a full house sell signal. He then flipped...
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