Steve Schaefer: Exile On Wall Street

The Bulls Are Back In Town At Morgan Stanley Smith Barney


Nov. 10 2010 - 3:47 pm

Feeling glum about America? Have a conversation with Morgan Stanley Smith Barney chief investment strategist David Darst and the rest of the firm’s global investment committee.

At a morning briefing with reporters in Morgan Stanley’s 5th Avenue tower Wednesday, Darst and global investment strategist Charles Reinhard both made the case that even with all the short- and long-term challenges facing the U.S. economy, the stock market is in a multi-year bull market and has been since the March 2009 lows. Neither suggested that the market’s path will be an unabated rally to all-time highs, but Reinhard argues that the common preconditions that have marked nearly every 20% correction over the past 80 years are largely absent.

For one thing, inflation is not a clear and present danger. If it were, you can bet the Federal Reserve wouldn’t be pouring another $600 billion into Treasury purchases. Secondly, there is no irrational exuberance in the market. (Not as many cabbies talking up their stock portfolios as there used to be, right?). Thirdly, the threat of a double-dip recession that would slash corporate profits is in the rear view mirror, and finally the valuation of the S&P 500, about 12.5 times earnings, is at the lower end of the range of the past 20 years.

The absence of the conditions that typically drive significant corrections makes it an appealing time to be invested in stocks. “Bull markets don’t die of old age, they get assassinated,” Reinhard says, “and we don’t see any of the most common assassins Bull markets don’t die of old age, they get assassinated, and we don’t see any of the most common assassins [looming].”

Elaborating on Reinhard’s case for a multi-year bull market in stocks, Darst gave a lively talk that started with an outline of the cardinal principles behind the asset allocation strategy at Morgan Stanley Smith Barney, which is owned 51% by Morgan Stanley and 49% by Citigroup..

Chief among those principles is portfolio protection, akin to Warren Buffett’s “never lose money” credo, but another important consideration is reversion to the mean, or the belief that over the long-term assets tend to move back to their historical averages. Over the last 10 years, large-cap U.S. stocks are among the worst performing asset classes (a pair of burst bubbles will do that to you), and Darst argues that big multinational companies at 11 or 12 times earnings with a dividend yield better than that of a U.S. Treasury are too attractive to ignore. “There are great, big companies sitting out there like Rembrandts in the driveway at a tag sale,” he quipped Wednesday.

Morgan Stanley Smith Barney likes emerging market equities as well, but Darst points out that there are plenty of U.S. companies that are secretly emerging market stocks. Take casino operators for example. Stocks like Las Vegas Sands and MGM Mirage are wildly outperforming the S&P 500 in 2010, largely because their exposure to the rapidly growing gambling scenes in Macau and Sinagpore.

The casino stocks illuminate the lesson that playing emerging markets is not the same as shunning U.S. stocks. There are plenty of companies that sell their goods around the world, but are getting overlooked “because they’re headquartered in Cincinnati or Atlanta,” according to Darst.

Among the host of companies trading at low earnings multiples and offering rich yields that Darst highlights are Dow Jones industrial average components like Procter & Gamble, Johnson & Johnson, Pfizer and Merck. All four offer fatter dividend yields than that of a 10-year Treasury note.

Follow my blog Exile On Wall Street, or Twitter @SchaeferStreet.