1. 10 Investment Ideas for 2010
gloBal invEStmEnt CommittEE
The Morgan Stanley Smith Barney Global Investment Committee (GIC)
JanuarY 2010 believes the global recovery that began in the second half of 2009 will
transition into a global economic expansion in 2010. In the broadest sense,
By Jeff Applegate the GIC recommends that investors position their portfolios for this
Chief Investment Officer
scenario by overweighting investment-grade and high yield bonds, equities
By David M. Darst, CFA
Chief Investment Strategist
and alternative/absolute return investments such as commodities and real
estate investment trusts (REIT). The GIC also advises underweighting
By Barbara Reinhard, CFA
Emerging Markets Strategist developed-market sovereign bonds, short-duration bonds and cash.
By Charles Reinhard
Global Investment Strategist In line with that guidance, the GIC has tapped the global resources of
By Douglas Cohen Morgan Stanley Smith Barney to formulate what it believes to be the 10
Senior Equity Strategist best investment ideas for 2010. These ideas cut across global equities, fixed
Morgan Stanley & Co.
income, currency and alternative/absolute return investments—and all are
By John M. Dillon
Senior Fixed Income Strategist
consistent with the GIC view of the global economy. The order in which
By Kevin Flanagan
the ideas are presented is not indicative of preference.
Senior Fixed Income Strategist
1. EmErging markEtS EquitiES: BriC One of our most significant equity
By Marshall Kaplan
Senior Equity Strategist
themes for the year ahead is that emerging markets equities should again outpace
Private Client Investment Strategy developed-market equities. Our expectation is that, during 2010, the developing
Citi economies will grow at about three times the rate of the developed economies. More-
By Edward M. Kerschner, CFA over, valuations are reasonable—at 13 times the 2010 consensus earnings forecast.
Senior Strategy Consultant
By Dan Nelson The economic outlook favors the emerging markets, too. In the 19 of 22 years since
Head of Portfolio Strategy & Research Group 1988 that the US economy was recovering from a recession or was expanding, emerg-
By Nicolas Richard ing markets equities outperformed the developed markets by an average of 9% (see
Director of Strategic Asset Allocation Chart 1). This analysis includes the challenging 1994 through 1998 period, when the
By Douglas Schindewolf emerging markets were racked by crises in Mexico, Asia and Russia.
Director of Tactical Asset Allocation
morgan StanlEY Smith BarnEY llC
2. gloBal invEStmEnt CommittEE 10 Investment Ideas for 2010
Chart 1 MSCI Emerging Markets Index Minus MSCI World Index (Developed Markets) Returns by Year
60%
48 Emerging Market Equity Outperforms Developed Market Equity
42 43
40 37 38
27
18 20
20 14
11 12 12
7 9
3
0
-10
7.5%
-14 -14
-20
-19
-28 -29 Developed Market Equity Outperforms Emerging Market Equity
-40
-52
-60
'88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 YTD '09
Source: MSCI as of Dec. 21, 2009
Within the emerging markets, the Morgan Stanley strategy 3. ForEign EXChangE In our opinion, one of the key
team favors Brazil, Russia, India and China—the so-called developments in the currency markets this year will be a
BRICs. Though investors often see them as a block, we have rebound in the US dollar versus the major developed cur-
specific reasons for recommending each country: Brazil’s rencies, especially versus the euro and the yen. We believe
economic recovery is strengthening and the outlook for pri- the dollar’s strength will be a result of the diverging GDP
vate consumption is bright; Russia features a valuation dis- growth rates in the developed-market economies—with
count of more than 40% from the MSCI Emerging Markets the US growing the fastest at 2.8%, followed by Europe at
Index, based on its forward P/E ratio, and is a beneficiary 1.2% and Japan at 0.4%, according to the Morgan Stanley
of higher oil prices; India gets a nod for its forecasted 2010 economics team. By the same measure of relative economic
GDP growth rate of 8% combined with improved political growth driving currency appreciation, we expect that the
stability; and China—the largest of the emerging markets— US dollar will weaken against the majority of emerging
carries the best growth expectations, up 10% in 2010. markets currencies. For example, Mexico, Brazil and Korea
are forecast to grow at 3.8%, 4.8% and 5.0%, respectively,
2. EmErging markEtS DEBt Expectations for global which will tend to favor their currencies vis-à-vis the dollar.
economic growth and an even more favorable outlook in
the developing economies will be a positive for emerging 4. muniCipal BonDS The opportunity for municipal
markets debt, in our view. We note that, in the wake of the bonds appears compelling, especially with the prospect of
recession, many developing countries have stronger current- higher US Treasury yields later this year. On the positive
account positions and better fiscal policies than many of the side, some formidable offsets may enable municipal bonds
developed markets. As that view becomes more wide- to outperform Treasuries, thus mitigating rising yields. These
spread among investors, we believe emerging markets debt include: the impact of the federally taxable Build America
spreads—the extra yield over Treasuries—will continue to Bonds program, which diverts what would otherwise be tax-
tighten. In addition, there is potential for upgrades from the exempt issuance into taxable securities; a very strong history
debt ratings agencies, which leads us to favor this asset class of debt repayment and low default rates among investment-
for 2010. grade bonds; and unusual yield differentials in moderate
investment-grade debt. For example, spreads for both A- and
2/ January 2010
3. gloBal invEStmEnt CommittEE 10 Investment Ideas for 2010
Chart 2 Municipal Bonds: Incremental Yield by Credit Rating
400
BBB-Rated General-Obligation 10-Year Municipal-Bond Spread Over Comparable-Maturity AAA-Rated Municipal Bonds
350
A-Rated General-Obligation 10-Year Municipal-Bond Spread Over Comparable-Maturity AAA-Rated Municipal Bonds
300
250
Basis Points
200
150
100
50
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Municipal Market Data Co. as of Dec. 22, 2009
BBB-rated bonds over comparable maturity AAA-rated Key drivers of investment opportunity within the global
municipal bonds stand at almost 2.5 times their respective water market include: significant capital-expenditure re-
long-term averages, according to Municipal Market Data quirements; increased recognition of the value of water, wa-
Co. (see Chart 2). As the economy continues to recover and ter quality, water sanitation and the security of supply and
market sentiment improves, we expect these relationships to sanitation; political willingness to price water according to
gradually tighten. economic principles, thereby charging users accordingly;
political willingness to include environmental protections
We enter 2010 favoring general-obligation and essential- in water pricing; and the potential for consolidation within
service revenue bonds from larger issuers holding investment- a fragmented global industry.
grade ratings in the upper-BBB-and-higher tiers. We also
view the new-issue market as an efficient way to access the 6. YiElD StoCkS The current low interest rate environ-
municipal-bond market. Given their defensive nature, we ment places renewed focus on investors’ “thirst for yield.”
also advocate the purchase of premium-priced securities With money-market returns in single-digit basis points and
over bonds trading at par or at a discount to par. While we Treasury yields low, we believe the case for high-quality
view prerefunded securities as fairly priced in the current dividend-paying stocks is compelling as a solution to unmet
market, they represent a reasonable consideration for those investor-income needs.
interested in ultra-high credit quality.
Many global equity opportunities provide levels of current
5. WatEr There is an immense need to build and upgrade income comparable to those of bonds, with the potential for
the water infrastructure in both the developed and de- both capital appreciation and growth in the income stream
veloping economies. The coming growth around delivery over time. Indeed, our work suggests that the relationship
and disposal of this essential commodity leads us to have a between global equities and relevant benchmark govern-
positive view on water-related investments. Areas of focus ment yields currently stands at historically attractive levels.
include the production of drinking water in the face of
population growth where resources are scarce or of low These stocks are more than a substitute for bonds. Divi-
quality, water distribution networks and the collection and dends have played an important role in equity returns for
treatment of wastewater. most multiyear periods during the past 100 years. Dividend-
3/ January 2010
4. gloBal invEStmEnt CommittEE 10 Investment Ideas for 2010
Chart 3 US & China Contributions to Commodity Demand Growth, 2003-2008
120%
107
China 104
99 101
100
US
80
60 55
40 37 37
22
20 19
11
5
0
-5
-10
-20 -16
-23
-29
-40
Cotton
Corn
Copper
Zinc
Crude
Aluminum
Sugar
Soybeans
Source: Morgan Stanley Research, IEA, USDA as of Dec. 17, 2009
paying stocks have other advantages as well, including Moreover, the chronic lack of investment needed to boost
the potential for lower volatility and better returns. Our production could also lead to tighter supplies and higher
analysis indicates that dividends—one of the few financial prices. The crude oil market is one example. The Morgan
metrics that cannot be restated—often have proven to be a Stanley commodities team points out that as demand
better use of corporations’ excess cash than many of the ill- picks up, the market’s attention is apt to turn to long-term
conceived investments and acquisitions of that have taken structural-supply issues. The team is forecasting that global
place over time. What’s more, the aging of the baby-boomer spare capacity in crude oil production will start declining in
generation creates a constituency for yield stocks since, un- 2011; by 2012, supply levels could be as tight as they were
like fixed income securities, they have the ability to increase in 2007 and 2008, when such constraints led to record-high
their payouts over time. prices. The Morgan Stanley forecast is for oil to average $85
per barrel in 2010, $95 in 2011 and $105 in 2012.
7. CommoDitiES Extremely easy monetary policy
undoubtedly helped lead commodity prices higher in 2009, 8. CrEDit-rElatED FiXED inComE Within the
but monetary policy may become less accommodative as we credit-related fixed income markets, 2009 was a blockbuster
move further into 2010. Still, we believe commodities will year. Investment-grade bonds, as measured by the Barclays
continue their uptrend, as global economic expansion acts Capital Credit Index, gained 16% and high yield securi-
as a propellant for prices—more than making up for liquid- ties, as measured by the Barclays Capital High Yield Index,
ity losses. In particular, rising demand from the developing gained 58% (through Dec. 29, 2009). We think 2010 can
economies is likely to have a positive impact. For example, be another good year for these assets, seeing improved
in the 2003 to 2008 period, China’s growth in demand for economic and default-risk outlooks in an economy moving
most commodities outpaced US growth in demand (see from recovery to expansion. Thus, we think credit spreads
Chart 3). On the supply side, inventories accumulated dur- will likely tighten further in 2010, offering investors a cush-
ing the recession will likely be drawn down over the next ion against potentially rising interest rates.
year, thereby tightening supply/demand balances.
4/ January 2010
5. gloBal invEStmEnt CommittEE 10 Investment Ideas for 2010
In the investment-grade universe, we favor bonds within keep pace with global equity markets in the year ahead. We
sectors that should benefit from the economic recovery and note that substantial improvements in credit-market condi-
a rising rate environment, such as paper and forest products, tions are positive for the sector. There are also noticeable im-
cable television, consumer goods and metals and mining. provements under way in property fundamentals. US REITs
For investors willing to accept higher volatility, there are alone raised over $24 billion in new capital in 2009, which
high-quality opportunities in bank and insurance senior will likely help the financial conditions of many firms—and
and subordinate debt, as yields are still attractive compared perhaps fuel acquisitions and real estate transactions in 2010.
to nonfinancials. Under a moderately rising rate scenario,
we think it is timely to start to extend maturities in credit- 10. auStralian anD CanaDian EquitiES We have
related fixed income. On a risk-reward basis, we believe a positive view of Australian and Canadian equities and believe
the most attractive opportunity in the high-grade market these two markets are well positioned to benefit as the economic
resides in the seven-year maturity range. recovery leads to an expansion. Their enviable position comes
from their heavy index weightings in materials and—especially
For high yield investors, we recommend higher-quality issu- in the case of Canada—energy companies. These two nations are
ers. Our preference is for B- and BB-rated issuers within the leveraged to global commodity consumption and should benefit
cable, industrial, energy and consumer-goods sectors with from commodity prices, which we expect to move higher this
maturities between two and five years. year. From a valuation perspective, Australia and Canada have
solid returns on equity of 8.1% and 7.1%, respectively, versus
9. rEal EStatE invEStmEnt truStS We have a favor- 6.8% for the MSCI World Index. Dividend yields are relatively
able outlook for the global REIT asset class in 2010. While attractive as well, at 4.0% for Australia and 2.6% for Canada
they may be unlikely to repeat the 37% total return generated versus 2.5% for the MSCI World Index.
in 2009 (through Dec. 29), we do think global REITs can
5/ January 2010