Morgan Stanley says stocks could fall 10%

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Morgan Stanley says stocks could fall 10 percent

OSLO (Reuters) - European stocks are overvalued and could fall by at least 10 percent within three to six months, a Morgan Stanley equity strategist said on Thursday.

"Tactically, we are neutral equities and overweight cash, seeing a correction of at least 10 percent," Vice President for European Equity Strategy Ronan Carr told an investor conference in Oslo.

"We are not calling for the end of the bull market, which typically runs from one recession to the next," Carr said. "We are cautious short term."

Morgan Stanley have preferred cash over equities and have been underweight in bonds since January 22 this year, he added.

"Our biggest concern is valuation," Carr said, adding that the investment bank preferred stocks with large capitalisations because of their relatively cheaper valuation and stronger balance sheets compared with small-caps.

Morgan Stanley was overweight in banks, pharmaceuticals, oil, materials and technology sectors, and underweight in autos, investment banks, real estate and consumer staples, he said.

Market timing models were also giving Morgan Stanley short-term "sell" signals.

"It's a bit mixed at the moment, but the sentiment is increasingly too bullish," Carr said. "The most worrying is the ratio between 'put' and 'call' options. People have given up buying protection on their portfolios."

Carr also pointed to an element of froth in credit markets, as shown by the emergence of "covenant light" bonds with less investor protection.

A market pullback could be triggered by wobbles in the credit markets or an inflation scare, Carr said.

"Bond yields have risen in the U.S. up to a level where you often see market pullbacks. You could also have an inflation scare, although were not worried on a structural basis."

A spill-over from troubled parts of the U.S. housing market and an overheating Chinese economy, were other possible triggers, he said.

"The property markets are looking stretched globally. Nobody talks about the U.S. subprimes anymore, but the full repercussions have not played out yet," Carr said. "If the U.S. has a hard landing, the rest of the world is unlikely to survive unscathed."