Europe: A "Full House" Alert

09/15/2015 10:00 am EST

Focus: GLOBAL

Jon Markman

Editor, Trader's Advantage

Morgan Stanley has issued a "full house" buy alert on international stock markets for the first time since early 2009, effectively calling the bottom of this summer's equity slump, notes Jon Markman in Money and Markets.

The investment bank reportedly told customers that all five of its market-timing signals are flashing a buy signal in sync with recent panic selling that reached capitulation levels.

This occurs very rarely, the bank said, and is a condition that typically leads to a V-shaped recovery, which delivers a 23% average gain in stock prices over the following 12 months.

It's interesting that the signal has emerged in sync with my own Tech Trend Trader market assessment model, which has just gone long for the first time this year.

Graham Secker, Morgan Stanley's chief European equity strategist, said the sell-off over recent weeks is largely driven by emotion and has little to do with the underlying outlook for the world economy.

The trailing dividend yield on stocks—measured by the MSCI Europe index—is currently 2.4 percentage points above the yield on a mix of European government bonds, near its all-time highs of the past century, the bank reported. Such levels usually precede powerful equity rallies, it said.

Morgan Stanley's bold call has raised eyebrows since the bank caught the exact top of the European equity market in June 2007 using the same timing indicators, on that occasion issuing a "full house" sell alert.

Secker added that the bank senses the current mood has echoes of 1998 during the East Asia crisis and the Russian default, when there was a nasty squall in the markets but it proved to be a false alarm.

The five timing tools in the MS algorithm are valuation, fundamentals, risk, capitulation, and a combined market indicator.

Between them they capture mutual fund flows, market breadth, and technical momentum measures such as the rate of change, as well as price-to-earnings ratios, dividend yields, and their relationship to bonds.

Morgan Stanley said the best way to invest in the rebound would be through EuroZone bank stocks because they will benefit from quantitative easing and loose-money policies by the European Central Bank.

You can do this through a single fund, the iShares MSCI Europe Financial Sector (EUFN).

The bank also predicted Italy would be the star country over the next two years as it benefits from dramatic reforms. The fund for that potential trend is iShares Italy (EWI). Buona fortuna.

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