Morgan Stanley Says Buy European Stocks After Slump

By Alexis Xydias

Nov. 4 (Bloomberg) -- European stocks are showing a ``full house buy signal'' because they are already pricing in an ``earnings recession'' after a slump in the past 17 months, according to strategists at Morgan Stanley.

The MSCI Europe Local Index, which tumbled 41 percent through yesterday since reaching a record in June 2007, may gain 15 percent in the next twelve months, the brokerage said.

Other than low valuations, the buy signals include ``a capitulation among retail investors, purchasing managers and sell-side analysts,'' a team of strategists led by London-based Teun Draaisma wrote in a note dated Nov. 3. ``The idea is that when these three groups know about the bad news, equity prices are probably already reflecting it.''

European indexes have slumped with stocks elsewhere this year amid mounting credit losses and an economic slowdown. The Dow Jones Stoxx 600 Index, another benchmark for equities in the region, is trading at 9.5 times its members' trailing earnings, the lowest reading since at least 2002. The measure has dropped 37 percent in 2008, on course for its worst year on record.

Analysts have reduced their estimates for profits this year at Stoxx 600 companies. They now expect a 6.8 percent drop, compared with an 11 increase forecast at the start of the year, according to Bloomberg data.

Economic Slowdown

European finance ministers said yesterday the region's economy is facing a ``difficult'' year as they struggled to put together a coordinated plan to limit the fallout from a recession caused by the global financial crisis.


In the U.S., manufacturing contracted in October at the fastest pace in 26 years as a record share of banks made it tougher to get loans and faltering economies abroad eroded prospects for American exports. The Institute for Supply Management's factory index fell to 38.9 from 43.5 in September, the Commerce Department said Nov. 3. A reading of 50 is the dividing line between expansion and contraction.

Draaisma warned that while ``sell signals'' have had a perfect track record in predicting declines since 1987, ``buy signals'' have not been as well-timed. ``Buy'' alerts in July 1984, August 1998 and September 2002 appeared earlier than they should have, according to the note.

The strategist upgraded European stocks to ``overweight'' on July 21, citing prospects for a ``bear-market rally.'' Instead, the MSCI Europe Local dropped 22 percent in the following three months as banks collapsed, money markets seized up and hedge funds unwound equity investments.

`There Is Value'

While timing indicators don't always work, current valuations are compelling, Draaisma said.

``This is consistent with our idea that the severe part of the bear market is over, that there is value, but probably no hurry, as there are many short-term risks related to emerging markets, foreign exchange and deleveraging,'' according to the note. ``The more prudent investor may wish to stay in cash and not be overweight equities, but our advise is not to be short or underweight equities.''

To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net.