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					September 3, 2013

MORGAN STANLEY RESEARCH




                                                                                                              MORGAN STANLEY RESEARCH
Global Strategy Outlook                                                                                       GLOBAL STRATEGY TEAM
                                                                                                              Morgan Stanley & Co. LLC
Dealing With Daylight                                                                                         Jason Draho 
                                                                                                              Matthew Hornbach 
                                                                                                              Sivan Mahadevan 
                                                                                                              Adam S. Parker 
                                                                                                              Rashique Rahman 
Cycle intact and valuations not extreme, hence we maintain our                                                Vishwanath Tirupattur 
strategic preference for equities over credit over government bonds.
                                                                                                              Morgan Stanley & Co. International plc+
We view current volatility as a transition away from the sweet spot that
                                                                                                              Paolo Batori 
characterized 1H13 towards a market focused on fundamental and valuation                                      Neil McLeish 
differentials. However, this is not the end of the cycle, in our view, and we                                 Hans Redeker 
therefore maintain a risk-positive stance over our 6-month strategic horizon.                                 Graham Secker 

Sweet spot behind us, but the mid-cycle correction isn’t. We                                                  Morgan Stanley Asia Limited+

maintained a defensive stance in late June due to our belief that the mid-                                    Jonathan Garner 
                                                                                                              Viktor Hjort 
cycle correction was not yet over. We expect volatility to continue near term,
with a peak likely at some point later in September or October.
                                                                                                              MS Asset Class Views (6 months)
The worst of the 2013 bond sell-off is behind us, in our view, and the                                           Global Asset Allocation             –                  +
near-term risk for core yields is now two-way. We expect a more                                                    Equities
gradual, two-way rise in core yields from here, with the US 10Y eventually                                         Credit
hitting 3.36% over a 12-month horizon. However, near-term bearish investor                                         Government Bonds
sentiment has reached levels normally associated with a counter-trend rally.                                       Cash

Emerging markets require further adjustment, but differentiation is also                                         Equities                            –                  +
important and valuation now more supportive. Fundamentally, we                                                      US
believe more adjustment is required for EM, implying that bouts of market                                           Europe

volatility will continue, but a 1997/98-style unwind is unlikely under our base                                     Japan
                                                                                                                    AxJ
case. The valuation case is now more mixed. In equities, we still favour DM
                                                                                                                    EM
over EM due to better risk/reward. In fixed income, we upgrade EM local
bonds to Neutral from Underweight due to more attractive valuation.                                              Credit                              –                  +
                                                                                                                    US
USD bull market limited to EM axis thus far, and we expect this to                                                  Europe
broaden out. A combination of a stronger economy and rising yields should                                           Asia
transform the US from a funding source to an investment destination,                                                EM
boosting the USD against G10 currencies as well as EM. We note                                                      Securitized
sentiment and positioning towards the greenback are now more balanced.                                           Government Bonds                    –                  +
Alpha remains an underlying theme, despite near-term volatility. In                                                 Treasuries
                                                                                                                    Bunds
equities, we continue to favour DM, but sectoral themes are diverse. In US
                                                                                                                    JGBs
rates, we shift our long-held curve steepening view to a flattening bias. In
                                                                                                                    EM Local
credit, we still prefer securitized credit that is less rate-sensitive and more
levered to the DM recovery. In Europe, the EUR has the least risk premium                                        FX                                  –                  +
priced for a return of Eurozone stress compared with other assets. In FX,                                           USD

EM differentiation should be high, based on fundamentals; we favor MXN                                              EUR
                                                                                                                    JPY
and PLN over the Fragile 5 (INR, IDR, TRY, BRL, ZAR).
                                                                                                                    EM


                                                                                                              Note: The rankings are relative within each asset class


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MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




Table of Contents
Dealing With Daylight ......................................................................................................................................................... 3
Government Bonds: Cheap Enough? ................................................................................................................................ 8
FX: USD Strength Drives FX ............................................................................................................................................ 11
Equities: Stay DM-centric ................................................................................................................................................. 13
Credit: Favor DM, Cautious on EM .................................................................................................................................. 16
Morgan Stanley Key Market Forecasts ............................................................................................................................ 19
Morgan Stanley Key Economic Forecasts ....................................................................................................................... 20



Global Strategy Team
Contributors to this Report


Jason Draho1                                                         +1 (212) 761-7893                              Jason.Draho@morganstanley.com
Matthew Hornbach1                                                    +1 (212) 761-1837                              Matthew.Hornbach@morganstanley.com
Sivan Mahadevan1                                                     +1 (212) 761-1349                              Sivan.Mahadevan@morganstanley.com
Adam S. Parker1                                                      +1 (212) 761-1755                              Adam.Parker@morganstanley.com
Rashique Rahman1                                                     +1 (212) 761-6533                              Rashique.Rahman@morganstanley.com
Vishwanath Tirupattur1                                               +1 (212) 761-1043                              Vishwanath.Tirupattur@morganstanley.com


Paolo Batori2                                                        +44 (0)20 7677-7971                            Paolo.Batori@morganstanley.com
Anton Heese2                                                         +44 (0)20 7677-6951                            Anton.Heese@morganstanley.com
Neil McLeish2                                                        +44 (0)20 7677-7481                            Neil.McLeish@morganstanley.com
Anthony O’Brien2                                                     +44 (0)20 7677-7748                            Anthony.OBrien@morganstanley.com
Hans Redeker2                                                        +44 (0)20 7425-2430                            Hans.Redeker@morganstanley.com
Graham Secker2                                                       +44 (0)20 7425-6188                            Graham.Secker@morganstanley.com
Andrew Sheets2                                                       +44 (0)20 7677-2905                            Andrew.Sheets@morganstanley.com


Jonathan Garner3                                                     +852 2848-7288                                 Jonathan.Garner@morganstanley.com
Viktor Hjort3                                                        +852 2848-7479                                 Viktor.Hjort@morganstanley.com


Le Ngoc Nhan6                                                        +813 5424-7698                                 Le.Ngoc.Nhan@morganstanley.com




1 Morgan Stanley & Co. LLC                                 3 Morgan Stanley Asia Limited+                     5 Morgan Stanley & Co. International plc, Seoul Branch+
2 Morgan Stanley & Co. International plc+                  4 Morgan Stanley Taiwan Limited+                   6 Morgan Stanley MUFG Securities Co., Ltd.+




                                                                                                                                                                             2
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook
                                                                                                                     –           +
                                                                                             Equities
                                                                                             Credit
                                                                                             Government Bonds
Dealing With Daylight                                                                        Cash



Neil McLeish
Jason Draho

We maintain a constructive view of developed market                 Investment Themes, Bull and Bear Scenarios
risk assets over our strategic six-month investment                  Transition out of the sweet spot suggests ongoing
horizon, but near term we expect ongoing volatility and a             volatility near term. US bonds yields will likely work
continuation of the mid-cycle correction that began in                higher over the next 6-12 months, but near-term we
May/June.                                                             think the bulk of the 2013 bond bear market is already
                                                                      behind us. EM volatility should continue, with
The sweet spot combination of improving growth plus GME3              valuations now much better relative to DM but not yet
(Great Monetary Easing, Part 3) plus attractive risk asset            extreme. We differentiate between equities (still prefer
valuations is now behind us. As such, we believe markets              DM over EM) and EM local markets fixed income
are transitioning to a more challenging environment, one              (upgrade to Neutral from UW). We expect USD bull
focused on growth, policy and valuation differentials. Near           market to continue and broaden out to DM axis. Oil
term, this volatile transition has further to run in order to         could temporarily rise further on geopolitical risk, but
complete the mid-cycle correction that kept us somewhat               this would not change our overall base case, and
                                                                      fundamentals leave Brent's risk-reward unappealing
cautious back in June (A Mid-Cycle Correction).
                                                                      going into 4Q13 (Crude Oil: Geopolitical Rally
Transitioning out of the sweet spot is not the same as ending         Reinforces Negative Risk Skew for 4Q13).
the current cycle, an event that we do not believe is                Our bull case revolves around greater focus on EM
imminent, especially in the case of developed markets.                valuations, as more stable US bond yields allow EM
Indeed, our economists called for DM growth to accelerate in          economies to stabilize, encouraging investors to
their Global Macro Outlook published September 2                      emphasize the EM valuation discount. EM equities
(Acceleration, Stabilisation and Accommodation). Better DM            would be the major beneficiary under our bull case
growth is one factor, but also valuations for equities and            given their valuation discount. DM risk assets also
credit are not yet expensive when viewed on a long-term               outperform bonds but lag EM materially over the next
horizon; hence, they should still beat government bonds over          6 months.
the six-month horizon under our base case.                           Our bear case is driven primarily by EM
                                                                      fundamentals, as accumulated problems drive a
The two main risks to this scenario are another sharp move
                                                                      bigger and more volatile unwind, with a negative
higher in core bond yields and a more disorderly unwind in
                                                                      feedback loop between technicals and fundamentals.
EM. Of the two risks, we are more concerned about EM                  Under this scenario, EM valuation discounts widen
because these problems are based not only on rising                   further but the feedback loop via growth and
financial market stress but also on accumulated structural            especially corporate profits also hits DM equities and
problems over the last decade.                                        credit hard. Higher UST yields may initially contribute
                                                                      to this scenario, but yields quickly stabilize and end
We do expect US 10-year Treasury yields to work their way
                                                                      the year materially lower than today. In Europe, the
higher over the next year to peak at around 3.36% in 12               bear case is significant because the OMT (Outright
months time, but near term we note that sentiment towards             Monetary Transactions) is unlikely to be activated,
bonds is already very bearish. Hence, a counter-trend rally           while the fragile recovery can be easily derailed.
for USTs is a real possibility over the balance of 2013.

A stabilization in bond yields would ease, but not eliminate, the
pressure on EM because it is based on structural issues.            We would summarize our asset allocation stance as follows:
However, we also believe that EM fundamentals are more
diverse and better able to adjust than was the case during past          We continue to favour equities over credit over
periods of extreme stress, such as 1997/98. As such, our EM               government bonds on a 3-6 month horizon.
base case is for ongoing valuation adjustment and volatility,             Equities and credit spreads are no longer cheap in a
but not an extreme case of across-the-board contagion driven              long-term context, but neither are they expensive.
by outright ‘sudden stops’. Valuations have improved and we               History suggests they will richen further until the
upgrade EM local currency fixed income to Neutral from UW.                current cycle peaks.



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MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




      Core government bonds are still a strategic                Moreover, the subsequent risk rally since the end of June
       underweight, but more two-way near term. We                pushed DM risk asset sentiment to complacent levels and
       expect the US 10Y to rise further to 3.36% over the        the valuation of US equities relative to Treasuries back to the
       next 12 months. However, near-term bearish investor        rich end of its post-2009 range (Exhibit 1).
       sentiment towards bonds has reached levels normally
       associated with a counter-trend rally.
                                                                  Exhibit 1
      EM has cheapened, justifying less bearishness. In          Equities at Rich End of Recent Range
       equities we continue to prefer DM over EM, but in
                                                                      8.0%                                   Real equity yield minus real bond yield
       fixed income we note better valuations and return
                                                                                                             Long-term average since 1881
       prospects and hence upgrade from UW to Neutral. In             7.0%
       both cases, the difference lies in the risk/reward skew.
                                                                      6.0%
      Less bullish on credit, but should still beat
       government bonds. Securitized credit remains our               5.0%

       favorite sector, but the strong performance YTD is             4.0%
       approaching our strategists’ bull case. We cut Asia
       credit to underweight because of deteriorating                 3.0%                                                                    3.40%

       fundamentals and deleveraging in China. Europe
                                                                      2.0%
       remains our preferred region for corporate credit.                Jan-09           Jan-10        Jan-11        Jan-12         Jan-13

      USD rally to broaden out against DM. We remain             Source: Federal Reserve, Shiller, Bloomberg, DataStream, Morgan Stanley Research
       USD bulls. The USD rally we expected has been
                                                                  Consequently, we believe that the mid-cycle risk correction
       concentrated on the EM axis thus far, and we expect
                                                                  has further to run. At a minimum, higher volatility is likely as
       this picture to broaden out with USD gains against DM
                                                                  global markets complete the transition from the liquidity-
       over the next six months.
                                                                  fueled sweet spot to a world focused on absolute and relative
Sweet spot behind us, mid-cycle correction continues              growth, policy, and valuation, with volatility for all asset
                                                                  classes still off from the June peaks (Exhibit 2).
In March, our spring global strategy outlook suggested that
beta’s dominance would give way to alpha as a bigger driver
of returns (The Return of Alpha). At that time, three factors
                                                                  Exhibit 2
constituted a favourable environment for alpha generation         Volatility to Rebound Near Term
and a broader sweet spot for markets, namely:
                                                                     220             Indexed to 100 as of most
      A prospective move from Twilight to Daylight for global       210                   recent trough
                                                                     200
       growth, plus                                                  190             Equity
                                                                     180             Rates
      A strong call for GME3 from our economics team (in            170             FX
       spite of improving growth), plus                              160             Credit
                                                                     150
      Attractive equity and corporate bond valuations               140
                                                                     130
       relative to real bond yields.                                 120
                                                                     110
QE tapering talk triggered what we characterized as a mid-           100
                                                                      90
cycle correction in our summer global strategy outlook (A                    1   6   11 16 21 26 31 36 41 46 51 56 61 66 71 76 81
Mid-Cycle Correction). The sweet spot had a temporary                                           Days Since Trough
summer reprieve after Fed Chairman Bernanke pushed back           Source: Bloomberg, Morgan Stanley Research
on tapering and rate hike expectations. But with the fading
tailwind of GME3 giving way to a more diverse set of global       Bond yields: A more gradual, two-way rise from here
monetary policies, which exacerbated EM structural                We expect DM bond yields to move higher over the course of
problems, what’s left is a more challenging macro backdrop.       the current cycle, but near-term risk is more two-way. Our US
The mid-cycle correction that played out between May and          interest rate strategist Matt Hornbach forecasts a 2.79% 10Y
the end of June was unusually mild by historical standards, a     by year-end, close to the current level. As such, we believe
result that seemed at odds with this new set of challenges.       markets are already priced for tapering to start in September




                                                                                                                                                       4
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September 3, 2013
Global Strategy Outlook




and end next June; hence, the actual tapering                                                  12-month bear case of 3.85% could result from technical
announcement should have a relatively modest near-term                                         fixed income market imbalances combined with additional
impact on yields.                                                                              upside for US employment data and uncertainty created by
Exhibit 3
                                                                                               the Fed chair transition, but near term we believe yields are
Investors Are Very Bearish on UST Prices                                                       more likely to consolidate before moving higher again over
                                                                                               the course of 2014.
    % of traders bullish                                                      T-Bonds

     100                                                                      20-day MA        Emerging markets: Volatile transition, not a meltdown
      90
      80
                                                                                               A period of adjustment with bouts of disorderly market moves
      70                                                                                       and ultimately extensive differentiation, rather than a crisis
      60                                                                                       reminiscent of 1997/98, is our base case for EM. In the near
      50                                                                                       term, EM growth is likely to stabilize measured on a Q-o-Q
      40
                                                                                               basis. China’s ‘mini-stimulus’ is already creating a growth
      30
      20
                                                                                               bounce in 2H13, and some other countries are trying to
      10                                                                                       counteract the slowdown with fiscal measures.
       0
       Jan-03               Jan-06                Jan-09               Jan-12                  However, a potential cyclical inflection point shouldn’t be
                                                                                               taken as an all-clear for EM, as fundamental challenges
Source: MBH Commodity Advisors, Morgan Stanley Research
                                                                                               remain. The root of these problems is a loss of
In fact, a counter-trend tactical UST rally is possible, led by                                competitiveness reflected in rising real exchange rates for
the long end. The US yield curve is close to its steepest                                      many emerging economies over the last decade. Fiscal
level in the past 40 years and investor sentiment on bonds                                     stimulus can stabilize growth in the short term, but the
was recently as bearish as it has been at any time in the past                                 medium-term problems require structural adjustment through
decade (Exhibit 3). The eight prior instances when sentiment                                   supply-side reforms. The fall in nominal exchange rates over
was this bearish were followed, on average, by a steady                                        the past two years restores some of the lost competitiveness,
decline in the 10Y yield, starting within two months of the                                    but Exhibit 5 highlights that the adjustment process in real
sentiment extreme (Exhibit 4). Since sentiment troughed                                        exchange rates is far from over.
three weeks ago, yields have drifted modestly higher, making
the current move a notable outlier from past trends.
                                                                                               Exhibit 5
                                                                                               EM Competitiveness Declined in the Last Decade
Exhibit 4                                                                                        125            EM REER
Lower Yields Usually Follow Extreme Bearishness                                                                 EM NEER
                                                                                                 120            EMU Periphery REER
                                                                                                                                        REER Appreciation
    Basis point change from bearish sentiment reading
        50                                                                                       115
                                             Average since 2003
        40
                                                                                                 110
        30                                   Bps change in 10-year yield since July 1
        20                                                                                       105
        10
           0                                                                                     100
       -10
                                                                                                   95
       -20                                                                                                                                           NEER Flat
       -30                                                                                         90
       -40                                                                                          Feb-03       Feb-05        Feb-07       Feb-09       Feb-11   Feb-13
       -50                                                                                     Source: Haver Analytics, Morgan Stanley Research
          t+0              t + 30           t + 60          t + 90           t + 120

                                                                                               During this period of adjustment, EM risk assets are likely to
Source: MBH Commodity Advisors, Bloomberg, Morgan Stanley Research
Note: We track the changes in the 10-year yield from the closing yield on the first day of a   remain volatile and markets will be exposed to the 'great EM
bearish sentiment reading, which we define as when the 20-day moving average of the T-
Bond Daily Sentiment Index crosses below 20%
                                                                                               unwind' – unwinding US QE, unwinding China’s leverage,
                                                                                               and unwinding EM domestic excess credit (The Great EM
Ultimately, we do expect core bond yields to work their way                                    Unwind). The positive news is that we believe that EM
higher over our strategic investment horizon, with the US                                      sovereign fundamentals are more diverse today than the
10Y to hit 3.36% by 3Q14 under our base case. And our                                          overly simple ‘EM’ moniker implies. In addition, a majority of




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MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




EM sovereigns have greater financial flexibility, with FX                        Exhibit 7
reserves being a primary source (Exhibit 6). The growth in                       CMTI Highlights Tactical Downside for Risk Assets
EM debt markets has been mostly in local bonds, which                               Index level
means the external position of these countries is stronger.                          1.00


                                                                                     0.50

Exhibit 6
EM FX Reserves Provide Financial Flexibility                                         0.00


    45%                                                                              -0.50
    40%
    35%                                                                              -1.00

    30%                                                                                                                       Combined Market Timing Indicator
    25%                                                                              -1.50
                                                                                         Mar-09           Mar-10        Mar-11         Mar-12            Mar-13
    20%
    15%                                                                          Source: Bloomberg, Morgan Stanley Research

    10%
                                                                                 Long-term valuation metrics indicate that equities and
     5%
                                                                                 credit are not expensive. Exhibit 1 showed that US
     0%
            1980   1984   1988    1992      1996     2000   2004   2008   2012   equities’ earnings yield relative to bond yields are at the rich
              EM External Debt (% of GDP)          EM FX Reserves (% of GDP)     end of the post-crisis range. But over a much longer period
                                                                                 (1881-2013), the relative value of equities is not far from the
Source: IMF, Haver Analytics, Morgan Stanley Research
                                                                                 average (Exhibit 8). A similar case holds for corporate credit.
As such, our base case scenario suggests that while EM
markets and macro policy will be stressed further during the
current transition period, we will not witness a widespread                      Exhibit 8
‘sudden stop’ of the kind experienced in 1998. Instead, we                       Equities Still Reasonable versus Bonds Long Term
expect differentiation, based on structural reform winners                         35%                                               G&D E/Y minus Real 10y BY
and losers and separating the vulnerable from the not-so-                          30%
                                                                                                                                     Long term average
                                                                                                                                     Today (3.40%)
vulnerable (see What If The Tide Goes Out? and The Fragile
                                                                                   25%
Five), with growing support from more attractive valuations.
                                                                                   20%
Asset allocation: tactical weakness, cyclical resiliency                           15%

The mid-cycle correction is not over, in our view, and we                          10%

expect additional volatility to unfold over the next few weeks.                     5%
                                                                                                                                                              3.40%
This may well produce an entry point to become more                                 0%
aggressive on risky assets across the board, a temptation
                                                                                    -5%
that we resisted in June due to our belief that the mid-cycle                          1881        1905        1929        1953        1977          2001
correction had unfinished business. Near term, the CMTI
                                                                                 Source: Federal Reserve, Shiller, Bloomberg, DataStream, Morgan Stanley Research
indicator used by our European equity strategy team is now
above 0, which has been a sell signal for equities during this                   In Europe, equities, credit, and peripheral sovereigns are
cycle (Exhibit 7). We will also monitor our normal sentiment                     attractive, the EUR is not. Our base case is that the
indicators, which have moved away from complacency but                           Eurozone crisis does not re-escalate in the next 3-6 months,
have not yet reached outright risk aversion.                                     but the risks are skewed more to the bear case. Equities,
                                                                                 peripheral sovereigns and credit are pricing in a reasonable
                                                                                 risk premium for the bear case occurring. But the EUR has
                                                                                 the least risk premium priced in, and hence less cushion
                                                                                 against a bear case, and can go lower even in the base case
                                                                                 if the ECB becomes more accommodative as we expect.




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September 3, 2013
Global Strategy Outlook




EM valuations plus our economists’ base case justify                                        In the case of EM equities, absolute valuation is also getting
selectively less bearishness. Across FX, equities and                                       attractive, which supports our overall preference for equities
bonds we note that EM valuations have become materially                                     versus bonds over our 6-month strategic horizon. However,
more attractive relative to DM, but are not yet at extreme                                  our equity strategists’ bull/bear/base scenarios highlight a
levels across-the-board relative to history. However, we add                                better risk/reward in DM equities, and indeed the relative
exposure in EM local currency government bonds (Exhibit 9)                                  valuation of EM equities is not yet close to the extremes seen
and move from UW to Neutral. This shift is based on better                                  in prior EM crises (Exhibit 10). As such, the difference
valuations and our economists’ base case for DM                                             between our equity and fixed income stance on the DM vs.
accommodation and EM stabilization as key themes over                                       EM divide lies in the different risk/reward skew for each asset
their forecast horizon.                                                                     class.
Exhibit 9                                                                                   Exhibit 10
EM Local Currency Government Bonds vs. DM:                                                  EM Equity Valuation Attractive in Absolute Terms,
Better Valuation, Move to Neutral from UW                                                   But DM Offers Better Risk/Reward
                                                                                             TTM P/B                                                     EM / DM relative P/B
                                                                                              4.5                                                                          1.6
                                                                                              4.0                                                                          1.4
                                                                                              3.5                                                                          1.2
                                                                                              3.0
                                                                                                                                                                           1.0
                                                                                              2.5
                                                                                                                                                                           0.8
                                                                                              2.0
                                                                                                                                                                           0.6
                                                                                              1.5
                                                                                              1.0                                                                          0.4
                                                                                              0.5                                                                          0.2
                                                                                              0.0                                                                          0.0
                                                                                                Jan-92   Jan-95    Jan-98     Jan-01   Jan-04   Jan-07   Jan-10   Jan-13
                                                                                                      MSCI EM P/B           MSCI World P/B      Relative valuation (RHS)
Source: Bloomberg, Morgan Stanley Research
Note: EM yields compiled from Turkey, South Africa, Poland, Hungary, Indonesia, Malaysia,
                                                                                            Source: MSCI, DataStream, Morgan Stanley Research
Thailand, South Korea, and Mexico. DM refers to the US and Germany.




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September 3, 2013
Global Strategy Outlook
                                                                                                                                           –                   +
                                                                                                     Treasuries
                                                                                                     Bunds
                                                                                                     JGBs
Government Bonds: Cheap Enough?                                                                      EM Local



Matthew Hornbach United States
Anthony O’Brien, Anton Heese Europe                                Investment Takeaways
Rashique Rahman Emerging Markets                                    Core DM government bond yields should continue to
Le Ngoc Nhan Japan                                                   rise, but negative total returns will be less uniform
                                                                     across markets. Yield curves should remain steep as
Government bonds have cheapened relative to their                    investors demand higher term premiums and central
fundamental fair values but are not cheap enough to                  banks anchor rate expectations, but the risk of flatter
change our defensive stance on the asset class. Yet, not             yields curves is looking more asymmetric now –
all regions should deliver negative total returns over the           especially in the US Treasury market.
next three to six months. We prefer USTs and JGBs over
                                                                    In euro-sovereign spreads, the ECB’s pledge to do
Bunds and gilts; the periphery over semi-core in Europe;
                                                                     “Whatever it takes” has not only reduced the absolute
and Russia, Colombia and Peru within EM.                             level of credit risk but also the level of contagion. This
      In core developed markets, we have raised our yield           implies decent outperformance in the peripheral
       forecasts across all markets except Japan. We see             countries, but substantial downside risk remains if the
                                                                     bear case scenario emerges.
       10-year UST yields at 2.79% at year-end – up slightly
       from 2.70% in our last forecast. We see 10-year              In EM sovereign local markets, higher DM yields
       Bunds at 1.97%, 10-year gilts at 3.05%, and 10-year           should continue to pressure yields higher, but better
       JGBs at 0.90%. Despite the increases, we expect only          valuation means that we move Neutral from UW.
       German Bunds and UK gilts to produce negative total           Local market performance will also depend on
       returns over the next six months. Carry should                idiosyncratic drivers, and we expect Russia, Colombia,
                                                                     and Peru to outperform; India, Indonesia, and Brazil
       insulate Treasuries from negative returns despite
                                                                     should underperform.
       moderately higher yields, and JGBs should remain
       protected by the Bank of Japan.

      Euro-sovereign spreads should continue to benefit           Developed Market Yields
       from a decline in systemic risk and suppressed              An improved growth outlook in the UK, an earlier exit from
       volatility. We anticipate the periphery (SP, IT, IE) will   recession in Europe, continued economic strength in the US
       generate positive carry returns versus the core and         and stability in Japan helped developed market government
       semi-core countries. While semi-core spreads should         bonds move back toward fair value (see Exhibit 1). Cheaper
       grind tighter versus the core into year-end, the            levels last existed in 2010 after the Fed announced QE2, but
       periphery should tighten more meaningfully. We              inflation expectations played a larger role back then.
       forecast the 5-year Spain-Germany spread to reach           Exhibit 1
       2.35% by year-end, the 5-year Italy-Germany spread          Developed Market 10-Year Yields Have Cheapened
       to reach 2.15%, and the 5-year Ireland-Germany              Relative to Fair Value – But Not Yet Cheap
       spread to reach 1.90%.                                          bp
                                                                      200
  
                                                                                                                            Cheap to f air v alue estimate
       For emerging market local bonds, we expect yields to
                                                                      150
       increase gradually in line with those of core markets,
       but we move Neutral from UW given the sell-off that            100

       already occurred. In aggregate we forecast EM yields            50

       to end the year at 6.2%. We see considerable                     0
       divergence within the asset class. In particular, we
                                                                       -50
       expect local bonds in Brazil, Indonesia, India, South
       Africa and Turkey – the so-called ‘Fragile 5’ – to post        -100

       larger capital losses as inflation remains high and risks      -150                                 Rich to f air v alue estimate
       of continued currency weakness keep risk premia                -200
       elevated. Strong ties to US markets suggest Mexican               1996    1998    2000    2002     2004     2006      2008          2010         2012

       yields have scope to stabilize by year-end, but given                    UST              DBR                  UKT                         JGB

       strong ties to the US are poised to rise through 2014.      Source: Morgan Stanley Research




                                                                                                                                                               8
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




Government bond yields could cheapen further against their                     In Europe, with inflationary pressure subdued and the
fundamental fair value estimates if (1) uncertainty over                       recovery fragile, we believe the ECB is likely to cut rates later
tapering and the next Fed Chair rises further, (2) inflation                   this year. This should steepen the Bund curve further, as 10-
expectations rise, or (3) conventional rate policy expectations                year yields follow UST yields higher. In such a yield curve
become unhinged. While the former two would help yield                         steepening, 2-year Bund yields would finish the year at
curves steepen further, an unhinging of rate expectations                      0.10%, whereas 10-year Bund yields would settle at 1.97%.
would help yield curves flatten materially – a risk we see                     Gilts are likely to underperform both UST and Bunds as
impacting the US Treasury market primarily.                                    economic growth returns to trend in 2014 and inflation
                                                                               remains above the 2% target. Forward guidance should keep
In the US, uncertainty over the timing and pace of tapering
                                                                               the MPC on hold until 2015; hence the 5-year sector is likely
during Chairman Bernanke’s last several months as Fed
                                                                               to remain vulnerable. We forecast 2-year gilt yields at 0.65%
Chair coupled with uncertainty over his successor drove term
                                                                               and 10-year gilt yields at 3.05% by year-end.
premiums higher while rate expectations remained anchored.
10-year Treasury yields blew through our previous year-end                     Our bull case for core-rates in Europe sees the fragile
forecast of 2.70% and the yield curve steepened to new                         recovery challenged and the economy performing worse
highs. Because we do not expect term premiums to                               than forecast. 2-year Bund yields would remain well-
compress again so easily in the real growth environment                        anchored – ending the year at 0.00% – and 10-year Bund
forecast by our economists, we raised our Treasury yield                       yields would fall to 1.30% by year-end. The gilt market would
forecasts again. We now see 10-year yields ending the year                     also see a significant rally in the bull case for bonds. Our bull
at 2.79% – slightly higher than our previous 2.70% forecast.                   forecast has 2-year gilts at 0.30% and 10-year gilts at 2.20%
Looking one year ahead, we see 10-year yields ending at                        by year-end. In the bear case, positive surprises on growth
3.36% at the end of 3Q14 and, looking further out at the                       continue and sovereign stresses further abate. In this
eventual tightening cycle our economists see in 2015, we                       scenario, yields would rise across the bund curve, with the 5-
                                                   1
believe 10-year yields will peak out around 4.00%.                             year sector underperforming the most. 2-year yields in
                                                                               Germany and the UK would rise to 0.48% and 0.90%,
However, a preoccupation with higher 10-year yields would
                                                                               respectively; while 10-year yields would bear the brunt of the
mask a trend we think should begin over the coming three to
                                                                               move to higher yields. Our bear case has 10-year Bunds
six months: a flatter yield curve term structure – initially led
                                                                               rising to 2.33% and 10-year gilts rising to 3.35% by year-end.
by the belly of the yield curve between the 3- and 7-year
maturities. As tapering gets underway – either in September                    We remain constructive on Euro-sovereign spreads and
or “later this year” – market focus should turn toward the                     think they should continue to trade within the post-OMT
timing of rate hikes. Just as FOMC participants introduced                     (Outright Monetary Transaction) range with the potential to
the idea of tapering sooner than the market expected                           move lower. We expect yields to rise as Bund yields rise in
previously, the same could be true of rate hikes if the                        the base case, but Spain, Italy and Ireland should generate
economic data outperform their expectations. As a result, the                  positive carry returns versus the core and semi-core
market should demand a premium for taking the risk that rate                   countries. The bull case for sovereign spreads is the bear
hikes arrive sooner than forecast currently.                                   case for Bund yields, which implies rising yields but falling
                                                                               credit spreads. We would anticipate peripheral spreads to
The bear case for Treasuries involves an acceleration of
                                                                               benefit the most and tighten to new post-OMT lows. For core
growth and fall in the unemployment rate that exacerbates
                                                                               and semi-core countries, we also see tightening, but less so
this risk. We would see 10-year yields at 3.39% at year-end,
                                                                               in France and the Netherlands.
but more importantly would see 2-year yields at 0.86%. On
the other hand, economic data could also underperform the                      The risk to European peripheral spreads remains skewed to
expectations of FOMC participants, or tighter financial                        our bear case as spreads are currently close to their tightest
conditions could create a flight-to-quality environment –                      levels since the blow-out in July 2011 and systemic risk is low
leading to our bull case for bonds. Tighter financial                          (see Exhibit 2). The bear case involves an adverse ruling on
conditions would aggravate economic wounds not fully                           the legality of the OMT programme from the German
healed – causing the yield curve to bull-flatten as economic                   Constitutional Court, coupled with a further political crisis and
growth slows again. We forecast 10-year yields back at                         renewed economic weakness. Peripheral spreads would return
2.25% in our bull case with the belly of the yield curve                       to post-OMT wides, but are likely to remain within the post-
outperforming. 5-year yields could approach 1.00% again.                       OMT range. Core and semi-core spreads would also suffer
                                                                               from renewed systemic stress and retrace to 1Q12 levels.
1
    See US Interest Rate Strategist: Shot Through the Heart, August 16, 2013




                                                                                                                                              9
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




Exhibit 2                                                                                        In CEEMEA, we expect yields to increase on average, but
Euro-Sovereign Systemic Risk Indicators                                                          with some important divergence between markets. Yields in
      0.9   Index Level                                                   Index Level     2.5    CEE should gradually increase in line with those of the
      0.8                                                                                 2.0    Eurozone, as these economies stabilise and their easing
      0.7
                                                                                          1.5    cycles end. Yields in Turkey and South Africa should rise
                                                                                          1.0
      0.6                                                                                        further near term, as currency volatility and inflation remain
                                                                                          0.5
      0.5                                                                                        high, only to stabilise in 4Q in line with their currencies.
                                                                                          0.0
      0.4                                                                                        Yields are likely to continue to rise in 2014. Russia should
                                                                                          -0.5
      0.3                                                                                        outperform the region because we expect inflation to decline
                                                                                          -1.0
      0.2                                                                                        significantly and the CBR to embark on an easing cycle.
                                                                                          -1.5

      0.1                                                                                 -2.0
                                                                                                 Hungary has scope to outperform in CEE.
       0
       2008               2009        2010          2011    2012           2013
                                                                                          -2.5
                                                                                                 Similarly in LatAm, our expectation for an ongoing rise in
               ECB Composite Indicator of Systemic Stress   PC1 ( Sovereign Risk) (rhs)          core market yields will adversely impact the likes of the
Source: ECB, Morgan Stanley Research                                                             Mexican and Brazilian local bond markets; both are poised to
                                                                                                 post further capital losses into 2014. Nonetheless, we
In Japan, we revised down our yield forecasts primarily in                                       anticipate near-term recovery in Mexican local markets on
the belly of the curve. We expect various factors to offset the                                  the back of valuations and reform momentum; further, our
modest impact from higher US Treasury yields. The BoJ’s                                          economists expect Banxico to remain on hold, in contrast to
aggressive JGB purchases placed more downward pressure                                           the tightening currently priced into the market. The
on market volatility than we had expected previously. With                                       uncertainty about the inflation trajectory and the policy mix in
the purchase program expected to continue for the                                                Brazil ahead of next fall’s presidential elections does not
foreseeable future, term premiums should remain                                                  bode well for NTNF’s, despite the very large carry.
suppressed – keeping 10-year JGB yields at or below 0.90%
                                                                                                 In Asia, we see marked divergence depending on country
into year-end. In addition, our economists do not see a
                                                                                                 fundamentals. We see further big jumps in yields in India and
different trajectory for the economy than they did earlier in
                                                                                                 Indonesia, both of which should need to tighten policy further
the year. However, concern over the impact of the
                                                                                                 to protect their currencies. The third biggest increase in
consumption tax hikes could drive the realization of our bull
                                                                                                 yields should be in Thailand, where we expect policy
case which sees 10-year JGB yields falling to 0.65%. Our
                                                                                                 tightening to start in 2014. Other markets should see only a
bear case assumes a much more lenient path for the
                                                                                                 gradual increase in yields in line with core-market yields,
consumption tax hikes – which would drive 10-year JGB
                                                                                                 including Korea, Malaysia, and the Philippines, which benefit
yields to 1.20% by year-end.
                                                                                                 from stable macro outlook and inflows. China bonds should
Emerging Sovereign Local Markets                                                                 also outperform as domestic growth slows.

Our scenario-weighted forecast sees EM local bond yields                                         Exhibit 3

increasing further, albeit gradually, to 6.2% at year-end;                                       EM 5-Year Real Yield
hence, we move Neutral from UW given the large adjustment                                            12.0                                                                 4.5
that already occurred. Real EM bond yields should rise and                                           11.0                                                                 4.0

eventually settle at levels prevailing in 2010-2011, leaving                                         10.0                                                                 3.5

nominal yields at 6.8% end-2014. Higher DM rates should                                               9.0                                                                 3.0

put upward pressure on EM rates, but performance of local                                             8.0                                                                 2.5
                                                                                                      7.0                                                                 2.0
markets will diverge and depend increasingly on
                                                                                                      6.0                                                                 1.5
fundamentals and idiosyncratic drivers. Our bear case yield
                                                                                                      5.0                                                                 1.0
forecast envisions an even larger rise in EM yields, to 6.7%
                                                                                                      4.0                                                                 0.5
end-year and 7.3% end-2014 driven by higher core-market                                               3.0                                                                 0.0
yields, but more specifically by further adjustment in the                                            2.0                                                                 -0.5
‘Fragile Five’ markets of Brazil, India, Indonesia, Turkey and                                           2009      2010       2011       2012         2013   2014

South Africa – as markets price in monetary tightening to                                                          Real yield, % (RHS)        5y yield, %    CPI YoY, %

protect currencies. Through mid-2014, we expect Russia,                                          Source: Bloomberg, Morgan Stanley Research
Colombia, and Peru to be the outperformers, while India,
Indonesia, and Brazil should underperform.




                                                                                                                                                                                 10
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook
                                                                                                                              –                   +
                                                                                                 USD
                                                                                                 EUR
                                                                                                 JPY
FX: USD Strength Drives FX                                                                       EM



Hans Redeker G10 FX                                              Abenomics, BoJ Governor Kuroda reaffirmed his
Rashique Rahman Emerging Markets                                 commitment to an unconditional, aggressive anti-deflationary
                                                                 stance. In addition, our analysis suggests that the
Investment themes / drivers of our view                          announcement and implementation of structural reforms
                                                                 expected in coming months should lift growth prospects and
 We stick to our bullish USD story, as rising rates and         profit expectations, fostering JPY capital outflows.
  growth outperformance both support the currency
                                                                 We have kept our bearish EUR call unchanged despite
 We expect autonomous JPY weakness to resume due
                                                                 better than expected data recently. We note that the
  to anti-deflation rhetoric and structural reform
                                                                 improvement in data has not been supported by credit
 Stronger data will be unable to support sustained GBP          growth. As such, our economists do not expect accelerated
  and EUR gains, in our view                                     economic growth to be sustainable, and we expect further
 EM currencies could see some near-term stability but           ECB easing, which will likely weigh on EUR.
  will likely suffer further medium-term adjustment              Moreover, EUR is not pricing in the considerable political
                                                                 risks stemming from the German election, the German
                                                                 constitutional court decision, and peripheral uncertainty.
Accelerating US growth combined with downward revisions          Should the German Constitutional Court place limitations on
to EM growth estimates support our call for a strong USD.        the OMT, this would mean the ECB is no longer able to do
Indeed, market developments have worked in our favor as          ‘whatever it takes’ to support EMU. The ‘lender of last resort’
US data improves and September Fed tapering is likely.           would no longer be in place for the EUR, reducing faith in the
USD strength should continue to dominate markets. Our            common currency. Furthermore, we think that ultimately the
economists now expect US growth to be roughly in line with       German election could end in either a more euroskeptic or a
global growth for the rest of the year. The combination of a     more pro-austerity government – both of which pose risks to
stronger economy and rising yields should transform the US       EUR. Finally, we note that uncertainty in peripheral Europe
from a funding source to an investment destination. US           continues, which will also provide headwinds to EUR.
equities should continue to outperform, lifting equity capital   Similarly, despite better data out of the UK and better growth
flows into the US, which tend to be unhedged, boosting USD.      prospects, we remain bearish on GBP. The central bank’s
Attractive domestic investment opportunities increasingly        introduction of formalized forward guidance suggests they
should lure US investors, cutting long-term capital outflows.    are trying to guide rates and the currency lower. So long as
Higher US rates should also work in favor of USD. Rising         the output gap persists in the UK, we expect monetary policy
yields have sparked an outflow from the US Treasury market       to remain loose and GBP to stay under pressure.
but should boost US fixed-income assets over time. Rising        Exhibit 1
short-term rates in anticipation of Fed tightening will also     US Outflows are Easing
raise the cost of hedging, prompting foreign investors to            Index Level                                                      USD tn
unwind FX hedges on US assets.                                        100                                                                  -0.6

                                                                                                                                           -0.8
Investors are now shifting from funding in USD to funding in           95

JPY, as illustrated by the 11.5% rise in Japanese bank                                                                                     -1.0
                                                                       90
lending overseas. Indeed, the BoJ’s commitment to end                                                                                      -1.2
                                                                       85
deflation should keep the cost of funding in JPY low.                                                                                      -1.4
                                                                       80
Furthermore, rising US front-end rates in time will lead                                                                                   -1.6
Japanese investors to unwind hedges on their considerable              75                                                                  -1.8
USD holdings, boosting USDJPY.                                         70                                                                  -2.0
                                                                        Feb-03      Feb-05      Feb-07      Feb-09   Feb-11       Feb-13
Despite this shift, JPY showed temporary strength this                         USD TWI         US Claims Against Foreign Non Banks (RHS)
summer. However, we expect Japanese economic policies
                                                                 Source: Reuters EcoWin, Morgan Stanley Research
to work in favor of a weaker JPY going forward. In order to
avoid concerns about tighter fiscal policy derailing



                                                                                                                                              11
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




Emerging markets have endured most of the global currency         will cause flows to head to the USD and away from EM, all
adjustments versus the USD in recent months, with a high          else being equal.
degree of volatility. However, this has only turned a spotlight
                                                                  Second, following a period of stability, we expect growth in
on a process of adjustment that has been ongoing for around
                                                                  China to continue to slow in 2014, with the structure of
two years. Indeed, the shift in US monetary policy dynamics
                                                                  growth also changing – away from commodity-intensive
has been just the latest stage in what has been a steady
                                                                  investment and towards consumption. This means that those
erosion of external support for EM currencies.
                                                                  currencies that have benefitted from a large terms-of-trade
While we believe that the medium-term outlook will see            boost associated with rising volumes of commodity exports
further adjustment for EM currencies, we do expect a near-        and rising commodity prices over the years (such as BRL
term period of stabilization, likely following the September      and IDR) could see further adjustment.
FOMC, when we anticipate that the Fed will announce the
                                                                  Third, the structure of US growth is arguably becoming less
start of and provide more clarity on the pace of tapering.
                                                                  advantageous for EM too, with the recovery seen so far not
Importantly, after two years of adjustment, real effective        having resulted in any pickup in export growth in EM. Without
exchange rates for the ‘Fragile 5’ are now below their 10-        this external demand feeding through, EM currencies are
year averages. Although perhaps not enough to foster the          particularly vulnerable. The lack of export growth is also
type of external rebalancing that would support a medium-         partly because many EM economies have lost
term recovery, this at least suggests valuations are more         competitiveness over the years, as reflected in elevated
attractive. It also means that EM is in a better place to take    levels of real exchange rates.
advantage of recovering DM growth, which at some stage
                                                                  In this context, with many EM countries facing high inflation
should at least partially feed through into EM. Finally,
                                                                  (particularly Turkey, Brazil, South Africa, India, Indonesia and
technicals are healthier, with large USD positions built up
                                                                  Russia), nominal exchange rates need to adjust in order to
and carry (based on implied yields) at more elevated levels.
                                                                  prevent a rise in their real exchange rates. This is particularly
However, we think any near-term recovery will be short lived.     important considering many EM countries suffer from large
We still believe that further adjustment is required for EM       current account deficits, which could become increasingly
currencies on a trade-weighted basis over the medium term,        unsustainable if inflation pushes real exchange rates too high.
which – given our bullish views on the USD – portends more
                                                                  Finally, with limited signs of reform efforts underway – apart
USD/EM upside on the whole.
                                                                  from Mexico, where we expect the MXN to rally – the policy
The essence of this view is captured in Exhibit 2, which          response of rate hikes and rising bond yields threatens to
shows the annual change in the level of EM central bank FX        undermine EM growth further, placing added pressure on
reserves (and the percentage point contribution of various        capital flows.
regions within emerging markets), adjusted for exchange           Exhibit 2
rate valuations on the assumption that at the aggregate level,    A Regime Change for EM Currencies
currency weights in reserves reflect those in IMF COFER
                                                                      YoY change in EM Central Bank FX Reserves
data. This clearly shows how the balance of payments
                                                                       35%
situation in EM has changed from prior years, when EM
                                                                       30%
countries did not have to work particularly hard in order to           25%
receive currency inflows. Now, a reversal of fortune is at             20%
hand, and EM has to work harder to become more export                  15%
competitive and attract capital inflows.                               10%
                                                                        5%
Without sufficient reform efforts, we believe that several              0%
forces will keep EM currencies under pressure.                         -5%
                                                                      -10%
First, a further rise in US interest rates over the medium               Jan-05            Jan-07          Jan-09     Jan-11   Jan-13
                                                                                          AXJ (ex China)     CEEMEA   LatAm
term, supported by a sustained recovery in the US economy,
                                                                  Source: Haver Analytics, Morgan Stanley Research
                                                                  Note: Assuming IMF COFER Weights




                                                                                                                                        12
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook
                                                                                                                                                                      –            +
                                                                                                                                  US
                                                                                                                                  Europe
                                                                                                                                  Japan
                                                                                                                                  AxJ

Equities: Stay DM-centric                                                                                                         EM




Jonathan Garner Asia/GEMs                                                                Exhibit 2 provides our new 12-month forward scenario-
Adam S. Parker, Ph.D. United States                                                      weighted bull and bear case targets. Upside to target price is
Graham Secker Europe                                                                     highest for Topix and lowest for Europe. Downside risks to
                                                                                         bear case targets are greatest in EM and APxJ. Upsides to
Equity allocation: We remain DM-centric in our equities
                                                                                         bull case targets are similar for US, Japan, APxJ and EM.
allocation despite the significant de-rating in valuation
                                                                                         Overall on a risk-adjusted basis, this exercise leads us to
multiples which has taken place this year in the emerging
                                                                                         recommend US, Europe and Japan over APxJ and EM,
markets. We raise Europe from neutral to join the US and
                                                                                         particularly over the next 3 months.
Japan as our preferred regions versus APxJ and EM.
                                                                                         Exhibit 2
Economic backdrop: Morgan Stanley’s Global Economics                                     MS Major Equity Indices Scenario-weighted Target
team just further upgraded its view on developed market                                  Prices & Bull and Bear Cases
(DM) economic growth, now projecting accelerating G10
                                                                                                                      12-month        12-month          12-month          12-month
GDP growth of 2% in 2014, up from 1% this year. In contrast,                                                           Forward        Forward         Forward Bull     Forward Bear
                                                                                           New                        Scenario        Scenario         Case Price        Case Price
our team lowered its view of emerging market (EM)                                         Ranks   Equity Market     Weighted Price Weighted Upside    Target Upside   Target Downside

economic growth by a further 30 bps for 2013 to 4.8% and by                                  1    Japan (Topix)*        1,357           20%               40%              -23%
                                                                                             2    US (S&P 500)          1,840           13%               43%              -17%
80 bps for 2014 to 4.9%, albeit seeing some sequential                                       3    Europe (MSCI)*        1,350            8%               32%              -22%
                                                                                             4    MSCI APxJ              493            15%               47%              -36%
growth stabilisation in the next couple of quarters. Overall the                             5    EM (MSCI)             1,037           13%               46%              -37%
global economy is expected to accelerate in growth from
                                                                                         Source: RIMES, Morgan Stanley Research. Data as of Aug 27, 2013.
2.9% in 2013 to 3.5% in 2014.                                                            *Topix and MSCI Europe in Local Currency terms.

Our revised 12 month ahead Target Prices and
2014 earnings forecasts                                                                  DM opportunities: An acceleration in global growth is
                                                                                         typically good for DM corporate earnings and equities. An
We are moving as of this publication to producing regular 12-                            “endogenous” move higher in core bond yields does not
month ahead target prices for all 5 major regions in global                              necessarily pose a threat to DM equities performance at this
equities (instead of solely year-end targets in some regions).                           stage of the cycle. From a valuation perspective, the MSCI
As part of this exercise, Exhibit 1 takes a fresh look at our                            World price-to-book at 1.95x is still only in the 73rd percentile
earnings forecasts using our economists’ views as inputs as                              of its 20-year range and well below the levels at which it
well as incoming corporate data and our top-down models.                                 traded in the mid- to late-cycle environment of 2003-07
We are above bottom-up consensus for Japan (by 600 bps)                                  (Exhibit 3).
and below consensus by 600 bps for the US and 500 bps for
                                                                                         Exhibit 3
EM and to a lesser extent for Europe and APxJ.                                           MSCI World (DM) Trailing Price to Book Value
Exhibit 1                                                                                Ratio – Still Scope for Re-rating
MS Major Equity Índices Top-down Base Case EPS
Expectations and Valuations versus Consensus                                             7.0x                                                 MSCI World
                                                                                                                                              MSCI World ex Financials
                                                                                         6.0x
                            MS Top         Consensus
                         Down 2014E 2014E EPS                                            5.0x

                         EPS Growth          Growth            MS        Consensus       4.0x
Regions                       (yoy)            (yoy)       2014E PE 2014E PE                                                                                              3.05x
                                                                                         3.0x
*Japan (Topix)                25%              19%            12.6           13.2
                                                                                                                                                                          1.95x
US (S&P 500)                   6%              12%            15.6           13.7        2.0x

*Europe (MSCI)                 9%              12%            12.0           11.9        1.0x
APxJ (MSCI)                   12%              14%            10.9           10.7
                                                                                         0.0x
EM (MSCI)                     10%              15%             9.6            9.2           Jan-92         Jan-96       Jan-00       Jan-04          Jan-08       Jan-12
Source: RIMES, IBES, Morgan Stanley Research
*Japan Earnings growth is based on calendar year (Jan-Dec) and in local currency. MSCI   Source: MSCI, RIMES, Morgan Stanley Research, data as of August 27, 2013
Europe EPS is also based on local currency.




                                                                                                                                                                                  13
MORGAN STANLEY RESEARCH

September 3, 2013
Global Strategy Outlook




While the financials sector faces the likelihood of structurally            Exhibit 5

low price-to-book multiples, valuation does not appear to be                2013 YTD Performance Decomposition – More of
an obvious impediment even on an ex-Financials basis.                       the Same Likely Near Term

EM risks: However, for EM, external funding needs are                          35%                                                Earnings Growth
                                                                               30%                                                Multiple Expansion
critical and a rise in the global cost of capital can be an                                                                       Dividend
                                                                               25%
impediment. Our FX team’s forecast of USD strength can                                                                            Total Return
                                                                               20%
create a significant challenge that can weigh on both                          15%
earnings power and multiples. We are already seeing this                       10%
play out in a pattern of currency weakness, rising domestic                     5%
rates, banking sector pressures and equity multiple                             0%
contraction. The last time that EM’s P/B relative was at a                     -5%

discount of more than 25% and falling was in late 1995 /                      -10%
                                                                              -15%
early 1996 during the hiatus between the Mexican Tequila
                                                                              -20%
crisis and the Asian crisis. This was also a period of                                   TOPIX*        S&P 500     MSCI Europe MSCI APxJ          MSCI EM
decelerating EM growth and rising funding risks. Meanwhile,
                                                                            Source: MSCI, Factset, Morgan Stanley Research, Data as of August 27, 2013.
EM’s ROE relative to DM has fallen steadily from a peak of                  *Topix and MSCI Europe in Local Currency terms.

1.87x in early 2010 to 1.10x currently. This is on par with the
ROE relative recorded both in early 2004 – after which it                   Regional backdrops
stabilized and valuations recovered – and 1995/6, after
                                                                            US: For the SPX we are continuing with the bullish tone
which it fell further and valuations plummeted to a trough of
                                                                            established in our March coordinated note. Our new 12-
0.42x P/B relative.
                                                                            month forward price target now implies double-digit upside
Exhibit 4                                                                   for the market between now and the end of next summer.
MSCI EM Performance Relative to MSCI World (DM)                             Why? Our view is that the market movement has not been
versus Price to Book Relative                                               and won’t be for the next 6 months about the base case. It
                                                                            will be about the bear case – or lack of one. Please see our
  60%            6M Price Performance            Trailing PB (RHS)   1.6x
                                                                            accompanying note today that walks through details of the
  50%
                                                                     1.4x
  40%                                                                       US forecast (US Equity Strategy: Where’s the Bear?).
  30%                                                                1.2x
                                                                            To be clear, we think the consensus bottom-up estimates are
  20%                                                                1.0x
  10%                                                                       too high. But that's been true 29 of the 37 years since 1976
                                                                     0.8x
   0%                                                                       when the consensus forward EPS estimates were created.
 -10%                                                                0.6x   Obviously markets can work while these base case
 -20%                                                                0.4x   estimates are being downwardly revised. So, the question is
 -30%
 -40%
                                                                     0.2x   what drives a rising probability of the bear case for the US,
 -50%                                                       0.0x            not whether the consensus outlook for the base case is too
    Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13                 optimistic.
Source: RIMES, Morgan Stanley Research. Data as of August 27, 2013          We find it hard to see the bear case probability rising.
                                                                            Our global economics team is forecasting growth
For the time being we look for further EM de-rating vs. DM,                 acceleration in the US and globally and expects EM to
not least as 73% of market cap in EM by sectors (particularly               stabilise at least near term. We forecast earnings for months
consumer discretionary, materials and industrials) is                       13-24 in the future with a model that uses a number of macro
experiencing relative ROE contraction versus DM while only                  factors. Higher consumer confidence (wealth creation
27% (healthcare, IT and Utilities) is experiencing expansion.               through equities and housing), among other things, is driving
Exhibit 5 decomposes year-to-date returns for the five major                our outlook for modest mid-single-digit earnings growth. Key
regions in global equities. Market multiple expansion has                   factors to watch to get more negative on EPS would be a big
been the most pronounced driver of DM performance, except                   dollar strengthening, Brent crude climbing out of the 85 to
for Japan where earnings growth has dominated. In EM                        115 band, and much higher interest rates. In that regard, key
multiple contraction and to a lesser extent earnings declines               issues remain Bernanke’s replacement and the pace and
have generated poor performance.                                            size of tapering. However, our economics team expects US
                                                                            monetary policy to remain accommodative next year.



                                                                                                                                                            14
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We also note that the hubris which typically marks a market        forecast of ¥90 for calendar year-end 2014, or 25% above
top is conspicuously lacking. CEO confidence surveys show          2013, compared with consensus at ¥86. Central to this
only average confidence levels while the market is near            above-consensus outcome is our below-consensus view on
record highs. Capital spending remains at the lower end of         the yen discussed in the FX strategy section. In our view, the
the range, M&A isn't exactly frenzied, hiring is low, inventory    next catalysts for Japan are a) the decision on whether to
builds in advance of a recovery are weak. Balance sheets           delay or phase in the consumption tax hikes due in April
are in great shape, cash balances are at record levels, and        2014 and October 2015, b) the recently mooted corporate
corporates have been extending the maturity of their financial     tax reduction and c) the general progress of the supply-side
obligations.                                                       components of Abenomics.

What is the “right” S&P500 earnings multiple? Well, it is          For APxJ / EM, we cut base case earnings once more:
unknowable, or at least unforecastable, in our view. But we        For EM 2013e EPS is reduced from US$93 to US$87. We
know that higher real rates from today's low levels have           last cut in June when consensus was US$95. It is now
historically been coincident with higher multiples. Therefore,     US$89. We introduce a forecast for 2014 of US$95, or 10%
if nominal yields slowly back up but CPI does not materially       above 2013. Consensus is US$99 or 15% above 2013. Our
expand, that’s consistent with multiple expansion. Our view        APxJ forecasts are also shown in Exhibit 1. We believe that
is that the lack of a bear case – i.e., a lower probability of a   the key factors for performance in EM are: a) whether the
bear case and less severity of a bear case if one surfaces –       recent pickup in China’s economic activity extends through
is important and will likely drive our base case of higher         2H, and b) the interaction of external funding pressure on
multiples. Bottom line: We like US equities and would              more vulnerable economies with domestic reform agendas.
buy dips as they appear this quarter.                              This is particularly important to stabilise the FX, rates and
                                                                   growth mix in the “Fragile 5” of Brazil, India, Indonesia,
Europe: With MSCI Europe trading at close to a 20-year
                                                                   Turkey and South Africa.
valuation high on trailing P/E relative to MSCI World and
close to a 20-year low on trailing P/BV, the key to European       Our most and least preferred sectors in global equities
outperformance revolves around improving ROE, which also           and key themes are given in Exhibit 6. For further details,
stands close to a 20-year relative low. The recent                 see the separate regional equity strategy pieces also being
improvement in Europe's economic lead indicators                   published today. The heterogeneity in sector preferences
suggests that European EPS and ROE will start rising               reflects the divergent macro environment regionally. We are
again over the next quarter, and our margin lead indicator         most inclined to own cyclicals in Europe (European
also suggests margins will expand in 2014 for the first time in    exposure) and Japan (both exporters and domestic reflation
three years. However, with our economists forecasting only a       beneficiaries) and more inclined to own quality stocks in US
modest uptick in European GDP, the prospect of a strong            and APxJ / EM.
profit recovery as witnessed after previous recessions is          Exhibit 6
unlikely and we forecast EPS growth of 9% for 2014 and             Most Preferred and Least Preferred sectors with
2015. Moreover, a bear case outcome in EM would be                 key themes
negative for Europe’s earnings given that EM plus the rest of      Region      Most Preferred Sectors Least Preferred Sectors   Most Preferred Themes
                                                                   EM/APxJ Energy                     Food Beverage & Tobacco   - Quality Stocks in the form of Best
the world ex DM accounted for 33% of EU company sales                          Banks                  Capital Goods              Business Models
and 65-90% of top-line growth in the last three years.                                                                          - Prefer Reliable growth with MS
                                                                               Automobiles            Diversified Financials    conviction over value stocks
At this time we make no changes to our valuation                               Software & Services                              -
                                                                                                      Consumer Durables & Apparel Exporters with DM Exposure
                                                                               Insurance              Transportation            - Avoid stocks with High leverage/
assumptions and continue to assume 'fair value' is equivalent                  Consumer Services      Retailing                 High Proportion of US$ Debt
to a 12m P/E of around 12.5x. This decision reflects some          Japan       Consumer Discretionary Healthcare                - Exporters with market share gain
                                                                               Industrials            Utilities                  potential on Yen weakness
near-term tactical concerns about the tapering of QE and                       Financials                                       - Asset Reflation Beneficiaries
higher bond yields against some more positive medium-term                                                                       Micro Reforms Beneficiaries
                                                                   USA         Healthcare             Consumer Staples          - Quality
dynamics such as the prospect of equity inflows and the                        Technology             Consumer Discretionary    - Mega caps
likelihood that inflation remains very modest.                                 Industrials                                      - Dividend is not dead
                                                                   Europe      Banks                  Consumer Staples          - Value and cyclical stocks with
Japan: For Topix, we raise base case calendar year-end                         Healthcare             Industrials               high European exposure
                                                                               Insurance              Materials
2013 EPS to ¥72 from ¥70. We last raised it in February, and
consensus is currently ¥73. We also introduce a new                Source: Morgan Stanley Research




                                                                                                                                                                   15
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Global Strategy Outlook                                                                                               –             +
                                                                                              US
                                                                                              Europe
                                                                                              Asia
                                                                                              EM
Credit: Favor DM, Cautious on EM                                                              Securitized



Paolo Batori Emerging Markets                                     reduced US rates pressure, and supportive technicals.
Viktor Hjort Asia                                                 However, as we move into 2014, deteriorating fundamentals,
Sivan Mahadevan United States                                     higher US rates, and a stronger USD may lead to further
Andrew Sheets Europe                                              weakness. In addition, China rebalancing presents a further
Vishwanath Tirupattur Securitized Products                        challenge to EM fundamentals. As such, we see the need for
                                                                  increased differentiation in EM credit, favouring sovereigns
The credit outlook differs by geography as we remain
                                                                  and corporate sectors that are set to lead and/or benefit from
sanguine on DM markets and cautious on EM and Asia.
                                                                  the broad structural reforms much needed by the major EM
We are most bullish on securitized products where we
                                                                  economies to enable sustained growth and competitiveness.
see multiple opportunities centered on the notion that
when collateral fundamentals are improving (US housing            Within DM, we are overweight investment grade credit and
and European CRE) or stable (US leveraged loans),                 equal weight high yield, and generally favor Europe over the
structural leverage is a source of alpha. Within corporate        US (except for cash IG) as Europe’s quicker than expected exit
credit, we favor European credit over US in CDS, HY B’s,          from recession leaves more room for upside. Bank
and GBP credit, but not in cash IG. Meanwhile, we are             deleveraging and periphery-related risks remain concerns in
cautious on EM and least bullish on Asia, recognizing             Europe, but cash spreads have rallied this year and technicals
relatively slower growth and rising funding costs in both.        remain marginally positive. In the US, the economy is forecast
                                                                  to maintain >2.5% growth in the second half of 2013 and 2014,
We think the bifurcation in EM versus DM performance can
                                                                  leading to Fed tapering and higher rates. In addition, the
persist due to diverging economic growth and rising US
                                                                  housing sector should continue to improve and defaults to
rates, leading us to prefer DM credit to EM. So what has
                                                                  remain low.
changed? Previously EM had accounted for the majority of
global growth, but now this dynamic is shifting as US growth
accelerates, Europe continues its modest recovery, and EM         Investment Takeaways
growth has fallen but may stabilize from here.                     We are still constructive on global credit overall.
Exhibit 1
                                                                    We see excess returns dominated by carry if we have
Projected Incremental GDP Growth by Region                          rates stability and look to alpha opportunities as issuer-
                                                                    specific stories increase dispersion.
 1.60%
                          2014E less 2013E GDP Growth
 1.40%
 1.20%                                                             We remain most constructive on securitized
 1.00%                                                              products. Their structural leverage amplifies returns
 0.80%
 0.60%
                                                                    driven by stable or improving collateral fundamentals –
 0.40%                                                              the ongoing US housing recovery being a case in point.
 0.20%
 0.00%                                                             In the US and Europe, we prefer IG to HY given
-0.20%
-0.40%                                                              stickier institutional flows and less call constraint. In IG
            Asia ex-     EM        Global   G10     US   Europe     Financials, our strongest call is senior over sub debt in
             Japan                                                  the US, and LT2 over senior in Europe.
Source: Morgan Stanley Research estimates
                                                                   We see pockets of value for crossover US IG bond
In light of slowing growth, tighter funding conditions and          investors in the muni market, especially in mid- to
significant supply pressures, here we downgrade our view on         high-grade muni credits and longer dated maturities
Asia and recommend that investors reduce exposure,
                                                                   We prefer Europe to the US for IG and HY bonds,
particularly in high yield. Tighter funding conditions along
                                                                    but US loans to European loans.
with weaker fundamentals present headwinds, and other
markets are at more favorable investor entry points in the         China growth and funding conditions are
credit cycle. Within Asia credit, we are particularly wary of       paramount to the Asia (ex Japan) and EM story.
lower-quality issuers as a growing number of stressed credits       Tighter Asia bank credit and an appreciating USD
                                                                    driving real rates higher, even against a sluggish
may hurt returns substantially.
                                                                    growth outlook, are key risk factors.
In EM, we maintain our equal weight view near term, as we
think markets should stabilize given improved valuations,



                                                                                                                                   16
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Global Strategy Outlook




What is the impact of the EM story on DM and vice                 Investors should also look to alpha. In a rising growth and
versa? In the US, EM IG Yankees’ impact may continue to           rate environment, spreads typically tighten, but this is not
be significant despite the fact that they are a small sector.     always true. If we look back, we see that credit spreads (for
Index year-to-date excess returns are modestly positive, hurt     certain assets) have widened as UST yields rose at different
by the EM sector’s underperformance, and this does not            points in time, which may be of heightened importance now
include non-Yankee issuers with earnings linked to EM or the      that US rates are expected to rise marginally into next year.
broader commodity story that have suffered as well. Going         Therefore, we advise caution particularly for investors in
forward, we think excess returns may remain low but               asset classes whose performance is more sensitive to rates
positive, enhancing the EM IG Yankee sector’s importance.         volatility (have greater negative convexity, like US HY and
Meanwhile, European bond issuers have low exposure to             parts of the muni market) and whose inflows may have been
EM due to smaller mining and staples sectors.                     more reliant on the QE technical (such as EM).

The reaction of EM risk assets to the Fed’s announcements         Given growth prospects and market dispersion, we think
regarding tapering highlighted the extent to which EM             investors should look for alpha opportunities. One way to do
economies benefited from Fed easing. For EM credit                this is through curve positioning. In US and Europe, we still
specifically, a stronger USD and rising US rates naturally        like the front-end, while in EM and Asia we prefer longer
increase the cost of borrowing. The most exposed                  dated sectors. Another opportunity is through structural
corporates are those with a higher portion of hard-currency       leverage on a stable or improving collateral, as we have in
denominated debt versus revenues. At the same time, a             securitized products. Below we outline our views on ratings
number of EM corporates have capitalised on the flow of           and sectors and expand on them in the asset commentaries.
funding into EM over the past few years and undertaken            Exhibit 3
liability management exercises that reduced the short-term        Summary of Forecast 12-month Returns
refinancing risk, locking in term funding at historically low     Region Asset       12m Return     Best Sector          Best   Best     Supply         View
rates. For sovereigns, the cost and availability of external             Class        Forecast                           Rating Maturity Risk
                                                                  US           IG       (bps)
                                                                                         140        Snr Fins, Energy,     NA    3-7y         Medium     OW
funding becomes more prohibitive for those countries with                                           Basics
the largest external funding requirements (current account                  HY           540        Media, HC, Loans      BB    4-5y         High       EW
                                                                           Munis         -31        Transp, Ess. Srvs,    >A+   4-9y +       Low         NA
deficit + short-term debt + medium-term amortisation) and                                           Tax Sec., High Ed           25-30y
limited FX reserves.                                                                                                            (Barbell)
                                                                            CLO       1000-1200             NA            NA      Min 2y     Low        OW
Increasing risk premiums and deteriorating risk/reward in EM               Equity                                                (non-call
                                                                                                                                  period)
economies would not only make it difficult to attract capital,           Alt-A         325-350      Senior Tranches       NA        NA       High       OW
but may also result in capital outflows. The resulting currency          RMBS
                                                                  Europe  IG              67        Sub Fins,             BBB   3-5y,        Very Low OW
pressures and potential loss in reserves would only                                                 Utils,                      5-7y
exacerbate the external funding requirements of already                                             Spain Corps
                                                                              HY          76        TMT, Autos,            B   3-5y,         Medium     EW
vulnerable economies.                                                                               Gaming                     5-7y
                                                                           CMBS        300-400      Senior Tranches       NA      NA         Low       OW
Exhibit 2                                                         Asia      IG           30         Fins                 BBB > 6-10y         Very High EW
EM and DM Credit Risk Diverging                                                                                           BB
                                                                  EM          Sovs       -43                NA           BBB / 7-10y         Medium     EW
                                                                                                                          BB
                                                                           Corps          22        IG Quasi Sovs,       BBB / 5-7y          Medium /   EW
                                                                                                    Oil & Gas, Telecom    BB                 High
                                                                  Source: Morgan Stanley Research
                                                                  Notes: US CLO Equity (2.0) return forecast is the yield. US Alt-A RMBS and Eur CMBS
                                                                  excess return forecast is the discount margin with the benchmark as LIBOR. US IG, US
                                                                  HY, Munis, Asia IG, and EM excess return benchmarks are the duration matched UST.
                                                                  Eur IG and HY excess return forecast benchmark is the duration matched swap. Supply
                                                                  risk is a subjective measure of weak technical dynamics increasing credit risk over the
                                                                  near term.

                                                                  Securitized Products: As noted before, structural leverage
                                                                  embedded in different forms and by varying degrees is the
                                                                  source of alpha in securitized credit. Structural leverage helps
                                                                  to amplify returns when the underlying collateral performance
                                                                  is improving or stable. This thesis is applicable broadly across
Source: Bloomberg, Morgan Stanley Research
                                                                  securitized credit. We highlight three such opportunities with
                                                                  significant positive convexity potential. First, senior tranches



                                                                                                                                                         17
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Global Strategy Outlook




of legacy Alt-A non-agency RMBS stand to benefit from the         Asia Credit: We are downgrading Asian high yield credit to
ongoing US housing recovery in terms of higher voluntary          underweight as the asset class faces several headwinds.
prepays, improving transition rates resulting in fewer defaults   Growth in Asia is slowing at a time when corporate leverage is
on the margin, and lower loss severities. Second, senior          at multi-year highs and borrowing conditions are deteriorating.
bonds in European CMBS benefit from the quality barbell in        This will put upward pressure on corporate default rates and
underlying pools. As stronger loans refinance and the             banks’ NPLs and also increase the USD bond supply.
weakest loans get worked out, seniors benefit from upside
                                                                  This environment strongly favors high- over low-credit quality,
convexity in cash flow timing. Third, US CLO 2.0 equity
                                                                  and we prefer financials over non-financial corporates, and
tranches benefit from the continued benign default
                                                                  investment grade over high yield. Asian financials enjoy better
environment in leveraged loans, resulting in front-loaded cash
                                                                  supply technicals, strong funding models, and spreads that
flows and convexity potential from the embedded long
                                                                  are wider or in line with corporates. Within Asia investment
callability option.
                                                                  grade, we are cautious on Chinese SOEs due to the potential
European Credit: Slow growth and corporate caution puts           supply risk and instead prefer Hong Kong corporates, as
Europe in a fundamentally earlier and more credit-friendly        better standalone fundamentals and a stronger banking
stage of the credit cycle. We think this extends through year-    system provide support. While we are cautious on Asian high
end, causing Europe to post better balance sheet trends and       yield in general and expect an unfavorable fundamental
lower net supply, which means investors should focus on           environment, we prefer China property over industrials.
sectors that embrace this theme: subordinated financials and
                                                                  EM Credit: In the sovereign space, we prefer credits in CEE
Spanish corporates. Although a revival of sovereign stress
                                                                  (Hungary, Poland) that we believe will be more protected from
would be a clear negative for performance (and our
                                                                  both a rise in UST yields and a China slowdown while also
positioning), we think EU credit can prove quite robust against
                                                                  offering better carry. With commodities remaining broadly
the two risk factors Morgan Stanley sees as more likely:
                                                                  stable, we remain positioned in low-beta LatAm, with the
faster-than-expect Fed tapering and a major EM growth
                                                                  notable exception of Brazil where we expect further
disappointment.
                                                                  weakness. The main near-term risk to our view is an overshot
US Credit: In the US, rising growth expectations and tapering     on the US Treasury yield leading to material outflows and a
fears have dominated the headlines this year. But despite         broad sell-off within the asset class. Idiosyncratic factors
headwinds from rising rates, the credit story remains a mildly    make the risk-reward unattractive in the very high-yield sector
good one relative to other fixed income asset classes. As the     (Ukraine, Venezuela).
yield curve has bear steepened, total returns have fallen into
                                                                  We see little scope for EM corporates to outperform sovereign
negative territory and have driven outflows in munis and HY,
                                                                  credit into year-end, particularly as valuations (versus
while technicals in IG remain somewhat supportive.
                                                                  sovereigns) still look rich on a historical basis. In addition, we
Company fundamentals are weakening in IG and HY, but
                                                                  expect the primary market to weigh negatively on spreads as
firms are still able to issue and refinance at low coupons,
                                                                  investors become increasingly selective in adding risk and
keeping interest coverage elevated. Meanwhile, the muni
                                                                  likely to demand new-issue concessions in the primary
market offers improved valuations and pockets of relative
                                                                  markets. We look to add risk in the low-beta quasi-sovereigns
value versus corporates for income-driven investors.
                                                                  and favour IG oil and gas and telecoms; both sectors are
As such, we remain overweight investment grade credit and         supported by strong balance sheets, low cost bases, and
are more cautious on high yield (preferring loans to bonds)       limited external funding requirements. In financials, we see
and munis. Given higher rates, wider spreads, and somewhat        the banking sectors in Russia and Mexico as better placed
less ‘frothiness’ in HY today compared to a few months ago,       than in Brazil and Turkey to adjust to the headwinds facing
we think we are getting closer to an entry point. In munis,       EM economies and the required policy adjustments. We
opportunities still exist but total-return-driven investors are   maintain our underweight recommendation on the EM metals
likely to be dissatisfied as risks like bond extension make the   and mining sector, although we do see scope for Russian
market more rates sensitive if broader US government yields       steel to outperform on the back of strong domestic demand.
continue to rise.




                                                                                                                               18
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Global Strategy Outlook




Morgan Stanley Key Market Forecasts


                                                                 Current           MS 12m Forecasts (3Q 14)
                                                                8/28/2013       Base        Bull         Bear
                    Interest Rates
                           UST 10y                                  2.77        3.36        2.61         3.86
                           Bund 10y                                 1.88        2.47        1.40         3.02
                           Gilt 10y                                 2.80        3.70        2.20         4.20
                           JGB 10y                                  0.72        1.10        0.85         1.35
                    FX
                           EUR/USD                                  1.33        1.24        1.37         1.17
                           USD/JPY                                   98         117         121           98
                           GBP/USD                                  1.55        1.46        1.60         1.36
                           AUD/USD                                  0.89        0.79        0.95         0.71
                    Equities
                           S&P 500                                  1635        1840        2327        1352
                           MSCI Europe                              1244        1380        1654        971
                           Topix                                    1114        1432        1592        871
                           MSCI EM                                  910         1089        1340        574
                           MSCI APxJ                                426         521         633         274
                           MSCI EM Latam                            3033        3600        4400        2400
                    Credit
                           US IG Corp                                139        130           89         175
                           US HY Corp                                496        455          360         750
                           EU IG Corp                                103         99           89         180
                           Asia IG Corp                              226        250          200         400
                           CDX IG                                     83         77           64          97

                   Source: The Yield Book, Bloomberg, Morgan Stanley Research




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Global Strategy Outlook




Morgan Stanley Key Economic Forecasts

                                                Annual                                        Quarterly
                                  2012          2013E           2014E          2013E                        2014E
Real GDP (%Q, SAAR)                      Bear   Base     Bull   Base    3QE            4QE   1QE     2QE            3QE   4QE
Global                            3.2    2.6     2.9     3.2     3.5    3.8            3.7   3.4      3.2           3.7   3.9
G10                               1.5    0.8     1.0     1.2     2.0    1.7            2.1   2.3      1.5           1.9   2.1
  US                              2.8    1.6     1.6     1.7     2.7    2.1            2.7   2.8      2.9           2.8   2.8
  Euro Area                       -0.5   -0.7    -0.5    -0.3    0.9    0.4            0.9   0.9      1.0           1.2   1.2
  Japan                           2.0    1.1     1.6     1.8     1.3    2.2            2.9   3.3     -3.5           0.3   1.3
  UK                              0.2    1.3     1.4     1.5     2.4    3.6            2.0   2.4      2.0           2.0   2.0
EM (%Y)                           4.9    4.2     4.8     5.1     4.9    5.0            4.5   4.7      4.9           4.8   5.1
  China (%Y)                      7.7    7.0     7.6     7.7     7.1    7.7            7.4   7.4      7.3           6.8   7.0
  India (%Y)                      5.1    4.1     4.4     4.6     4.6    4.5            3.9   3.8      4.2           5.0   5.1
  Brazil (%Y)                     0.9    1.5     2.1     2.4     1.7    1.8            1.5   1.9      0.6           2.3   2.0
  Russia (%Y)                     3.4    1.5     2.2     2.9     3.1    2.4            2.9   3.4      3.9           3.0   2.8


Consumer Price Inflation (%Y)
Global                            3.3    2.9     3.3     3.4     3.0    3.2            3.3   3.2      3.5           3.3   3.3
G10                               1.9    1.4     1.5     1.6     1.7    1.8            1.5   1.3      1.5           1.5   1.4
  US                              2.1    1.5     1.6     1.6     1.4    1.6            1.5   1.3      1.7           1.4   1.3
  Euro Area                       2.5    1.5     1.5     1.6     1.6    1.4            1.5   1.6      1.8           1.5   1.4
  Japan                           -0.1   -0.1    0.2     0.4     2.3    0.5            0.7   0.8      2.8           2.7   2.7
  UK                              2.8    2.7     2.7     2.7     2.7    2.8            2.6   2.6      2.8           2.8   2.6
EM                                4.8    4.4     5.1     5.2     4.3    4.6            5.0   5.0      5.4           5.0   5.0
  China                           2.6    1.5     2.6     2.6     1.8    3.0            2.6   1.5      2.2           1.9   1.5
  India                           9.3    10.2    10.8    11.6    7.4    10.9           9.9   8.3      8.0           6.7   6.5
  Brazil                          5.4    6.0     6.2     6.5     6.1    6.1            5.8   5.8      5.8           6.2   6.5
  Russia                          5.1    6.0     6.5     7.0     4.9    6.1            5.5   5.2      4.8           4.7   5.0


Monetary Policy Rate (% p.a.)
Global                            3.3            2.9             2.9    3.0            2.9   2.8      2.9           2.8   2.9
G10                               0.6            0.5             0.3    0.5            0.5   0.4      0.4           0.3   0.3
  US                              0.2            0.2             0.2    0.2            0.2   0.2      0.2           0.2   0.2
  Euro Area                       0.8            0.3             0.3    0.5            0.3   0.3      0.3           0.3   0.3
  Japan                           0.1            0.1             0.1    0.1            0.1   0.1      0.1           0.1   0.1
  UK                              0.5            0.5             0.5    0.5            0.5   0.5      0.5           0.5   0.5
EM                                6.2            5.4             5.5    5.7            5.4   5.4      5.5           5.5   5.5
  China                           6.0            6.0             5.5    6.0            6.0   6.0      5.8           5.8   5.5
  India                           8.0            7.3             7.3    7.3            7.3   7.3      7.3           7.3   7.3
  Brazil                          7.3            9.8             9.8    9.0            9.8   9.8      9.8           9.8   9.8
  Russia                          5.5            5.0             4.8    5.3            5.0   4.8      4.8           4.8   4.8




Source: Morgan Stanley Research




                                                                                                                                20
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Collateralized mortgage obligations and other mortgage-related securities are not suitable for every investor and are subject to certain risks. The
value and price of these securities is sensitive to conditions affecting the real estate market and the assets underlying these securities. Accordingly,
changes in economic conditions, the value of underlying assets, credit conditions, interest rates, or other factors can cause these securities to
diminish in value. In addition, residential mortgage-backed securities are subject to risks related to prepayment and clean-up call risk. When the
obligations underlying these securities are prepaid at a faster pace than expected and the securities are called, an investor may have to reinvest in
securities with a lower yield and/or fail to recover additional amounts (premiums) paid for securities with higher interest rates, resulting in an
unexpected capital loss. The structure of these securities may be complex and less information may be available about them than other types of
debt securities.

                                                       Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley & Co. LLC and/or Morgan Stanley
C.T.V.M. S.A. and/or Morgan Stanley Mexico, Casa de Bolsa, S.A. de C.V. and/or Morgan Stanley & Co. International plc and/or RMB Morgan
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(Singapore) Securities Pte Ltd (Registration number 200008434H), regulated by the Monetary Authority of Singapore (which accepts legal
responsibility for its contents and should be contacted with respect to any matters arising from, or in connection with, Morgan Stanley Research)
and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N.
67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley
Wealth Management Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813, which accepts
responsibility for its contents), and/or Morgan Stanley India Company Private Limited, and/or PT Morgan Stanley Asia Indonesia and their affiliates
(collectively, "Morgan Stanley").
For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the
Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or
Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.
For valuation methodology and risks associated with any price targets referenced in this research report, please email
morganstanley.research@morganstanley.com with a request for valuation methodology and risks on a particular stock or contact your investment
representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY 10036 USA.
Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and
that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in
this report: Jason Draho, Matthew Hornbach, Sivan Mahadevan, Adam S. Parker, Rashique Rahman, Vishwanath Tirupattur, Paolo Batori, Anton
Heese, Neil McLeish, Anthony O’Brien, Graham Secker, Andrew Sheets, Jonathan Garner, Viktor Hjort, Le Ngoc Nhan.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.
Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at
www.morganstanley.com/institutional/research/conflictpolicies.
Important US Regulatory Disclosures on Subject Companies
Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of Federative Republic Of
Brazil, Government Of Japan, Government Of South Korea, People's Republic Of China, Republic Of France, Republic Of The Philippines, Ukraine,
United Kingdom Of Great Britain And Northern Ireland, United States Of America.
Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Federative Republic Of Brazil,
Government Of Malaysia, Government Of South Korea, People's Republic Of China, Republic Of Colombia, Republic Of France, Republic Of India,
Republic Of Turkey, Russian Federation, Ukraine, United Kingdom Of Great Britain And Northern Ireland.
In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Federal Republic Of
Germany, Federative Republic Of Brazil, Government Of Japan, Government Of Malaysia, Government Of South Korea, Hungary, Ireland, Italian
Republic, Kingdom Of Spain, People's Republic Of China, Republic Of Colombia, Republic Of France, Republic Of Indonesia, Republic Of Peru,
Republic Of Poland, Republic Of South Africa, Republic Of Turkey, Russian Federation, Ukraine, United Kingdom Of Great Britain And Northern
Ireland, United Mexican States.
Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from
Federative Republic Of Brazil, Government Of Japan, Government Of Malaysia, Government Of South Korea, Ireland, People's Republic Of China,
Republic Of France, Republic Of Indonesia, Republic Of Poland, Russian Federation, United Kingdom Of Great Britain And Northern Ireland.
Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client
relationship with, the following company: Federal Republic Of Germany, Federative Republic Of Brazil, Government Of Japan, Government Of
Malaysia, Government Of South Korea, Hungary, Ireland, Italian Republic, Kingdom Of Spain, People's Republic Of China, Republic Of Colombia,
Republic Of France, Republic Of India, Republic Of Indonesia, Republic Of Peru, Republic Of Poland, Republic Of South Africa, Republic Of The
Philippines, Republic Of Turkey, Russian Federation, Ukraine, United Kingdom Of Great Britain And Northern Ireland, United Mexican States,
United States Of America.
Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the
past has entered into an agreement to provide services or has a client relationship with the following company: Federal Republic Of Germany,
Federative Republic Of Brazil, Government Of Japan, Government Of Malaysia, Government Of South Korea, Hungary, Ireland, Italian Republic,
Kingdom Of Spain, Kingdom Of The Netherlands, People's Republic Of China, Republic Of France, Republic Of Indonesia, Republic Of Poland,
Republic Of South Africa, Russian Federation, United Kingdom Of Great Britain And Northern Ireland, United Mexican States.
Morgan Stanley & Co. LLC makes a market in the securities of Federative Republic Of Brazil, People's Republic Of China, United Kingdom Of Great
Britain And Northern Ireland.
The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation
based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall
investment banking revenues.
Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making,
providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit,
investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in
Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this
report.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.
STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below).
Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not




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the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since
Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley
Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as
investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings)
and other considerations.
Global Stock Ratings Distribution
(as of August 31, 2013)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell
alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the
stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended
relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy
recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

                             Coverage Universe    Investment Banking Clients (IBC)
                                            % of                   % of % of Rating
    Stock Rating Category       Count       Total     Count Total IBC Category
Overweight/Buy                   978          34%           400          38%          41%
Equal-weight/Hold               1280          44%           491          46%          38%
Not-Rated/Hold                   114           4%            28           3%          25%
Underweight/Sell                 510          18%           137          13%          27%
Total                          2,882                       1056
Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual
circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan
Stanley received investment banking compensation in the last 12 months.
Analyst Stock Ratings
Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index or the average total return
of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis over the next 12-18 months.
Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index or the average
total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis over the next 12-18 months.
Not-Rated (NR) - Currently the analyst does not have adequate conviction about the stock's total return relative to the relevant country MSCI Index
or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.
Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index or the average total
return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.
Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the
relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant
broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant
broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index;
Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.
Important Disclosures for Morgan Stanley Smith Barney LLC Customers
Citi Research publications may be available about the companies or topics that are the subject of Morgan Stanley Research. Ask your Financial Advisor or use
Research Center to view any available Citi Research publications in addition to Morgan Stanley research reports.
Important disclosures regarding the relationship between the companies that are the subject of Morgan Stanley Research and Morgan Stanley Smith Barney LLC or
Morgan Stanley or any of their affiliates, are available on the Morgan Stanley Wealth Management disclosure website at
www.morganstanley.com/online/researchdisclosures.
For Morgan Stanley specific disclosures, you may refer to www.morganstanley.com/researchdisclosures.
Each Morgan Stanley Equity Research report is reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval is conducted by the
same person who reviews the Equity Research report on behalf of Morgan Stanley. This could create a conflict of interest.
Other Important Disclosures
Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Bolivarian Republic Of Venezuela, Federal Republic
Of Germany, Federative Republic Of Brazil, Government Of Japan, Government Of Malaysia, Hungary, Ireland, Italian Republic, Kingdom Of Spain, Kingdom Of The
Netherlands, People's Republic Of China, Republic Of Colombia, Republic Of France, Republic Of India, Republic Of Indonesia, Republic Of Peru, Republic Of Poland,
Republic Of South Africa, Republic Of The Philippines, Republic Of Turkey, Russian Federation, Thailand, Ukraine, United Kingdom Of Great Britain And Northern
Ireland, United Mexican States, United States Of America.
Morgan Stanley Hong Kong Securities Limited is the liquidity provider/market maker for securities of People's Republic Of China listed on the Stock Exchange of Hong
Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk.
Morgan Stanley is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning
of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the
recommendations or views expressed in research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors.
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The fixed income research analysts, strategists or economists principally responsible for the preparation of Morgan Stanley Research have received compensation
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The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1%
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                                                                                                                                                                             23
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not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and,
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Additional information on recommended securities/instruments is available on request.




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