GLOBAL INVESTMENT COMMITTEE

OCT. 26, 2015

The GIC Weekly

What We Are Talking About
Quest for Quality. Broad market index retracement of
the August correction obscures major shifts in performance drivers and challenges ahead; outperformance of
growth over value unlikely to persist; third-quarter
earnings, while solid, emphasize need for stock-specific
discrimination; barbell portfolios between secular growth
leaders and cheap dividend growers, with an emphasis on
LISA SHALETT
high-quality companies; stockpicking should benefit from
Head of Investment & Portfolio Strategies
higher performance dispersion and falling correlations.
Morgan Stanley Wealth Management
Lisa.Shalett@morganstanley.com
Consider balancing US equity exposure between high+1 212 296-0335
growth secular winners in tech, consumer discretionary
and health care and cheap high-quality cyclicals with solid
For additional insight into market
performance, sentiment, macrodividend growth potential such as financials and
economic trends and the GICs latest
diversified industrials.
thinking, please see the new GIC
ChartBook Weekly Digest. Clients:
Ask your Financial Advisor for a
copy. Advisors: Follow this link.
Upcoming Catalysts
Oct. 26 US new home sales
Oct. 26 Dallas Fed Manufacturing Survey
Oct. 27 US durable goods orders
Oct. 27 S&P/Case-Shiller Home Price Index
Oct. 27 Conference Board Consumer Confidence
Oct. 27 Richmond Fed Manufacturing Survey
Oct. 27 & 28 FOMC meeting
Oct. 29 US third-quarter GDP
Oct. 29 US pending home sales
Oct. 29 Japan Consumer Price Index
Oct. 30 US personal income and spending
Oct. 30 Chicago Purchasing Managers Index
Oct. 30 Euro Zone Consumer Price Index

Quest for Quality

During the past four weeks, the US stock market has retraced nearly all of Augusts
11% sell-off. On one level, that might suggest some kind of all clear signal. Indeed,
many technical indicators are now constructive: the VIX is below 20, the yield curve has
steepened, oil prices have stabilized, the dollar has eased, high yield credit spreads have
tightened and the S&P 500 is back above its 200-day moving average.
Even so, we remain cautious as the markets snapback is not quite what it seems.
Heading into October, sentiment was extremely negative and so aggressive short and
defensive positioning was bound to reverse if macro data stabilized and third-quarter
earnings came in without massive disappointments. Still, lingering concerns around
earnings resilience are legitimate, especially if global growth remains tepid, capital
investment continues to be lackluster, rising credit costs reduce the efficacy of share
repurchases and mergers-and-acquisitions (M&A) strategies and wage pressures weigh on
profit margins. While investors who held tight through the turmoil have likely recouped
some of their losses, underlying trends have been less benign. Indeed, we have seen
powerful sector rotation and reversals in price momentum.
One of the most painful of these has been the sharp pullback in biotechnology and other

Please refer to important information, disclosures and qualifications at the end of this material.

THE GIC WEEKLY

health care stocks. Although health care has been the sectorlevel poster child for this cycles growth-style bias
understandable when GDP growth, inflation and interest rates
are lowthe reversal raises questions about whether market
leadership is about to shift. Whats more, financials that should
have benefitted from the steepening yield curve are lagging
while consumer staples and services, widely expected to be
victims of the strong dollar, are rallying. In such circumstances,
portfolio construction is challenging and not easily summarized
with the usual banners of cyclical versus defensive, growth
versus value, large cap versus small cap or multinational versus
domestic. For the first time in this cycle, winners and losers are
being determined at the company level.
For US equity investors, the Global Investment Committee is
navigating this environment by focusing stock selection on
idiosyncratic risk and taking a barbelled approach between
secular growth leaders and cheap dividend growers, with an
emphasis on high-quality companies. This elevates the
importance of sustained high free cash flow as a driver of
success in this next phase of the market cycle in which gains
should largely rest on skillful capital deployment instead of
margin expansion or higher price/earnings (P/E) multiples.
Third-quarter earnings reports illustrate the relevance of
quality as a theme. As of Oct. 23, roughly half of the S&P 500
companies have reported. As anticipated by Adam Parker,
Morgan Stanley & Co.s chief US equity strategist, earnings
estimates coming into the quarter were too pessimistic and thus,
about 73% of those reporting have surprised to the upside,
beating forecasts by an average 3.2%. Revenue growth has been
more challenged, with only 44% beating lackluster expectations
and the aggregate missing the consensus mark by roughly half a
percentage point. While these results may seem in line with
prior quarters, what is different is how sectoral dispersion has
shifted; the differences in earnings surprises from high to low
across sectors have been relatively narrow while the differences
within sectors have been quite wide. With limited pricing power
and tepid top-line growth, the quarters best profit reports have
resulted from expense discipline, cost cutting and the balance
sheet and cash flow capacity that allows for share repurchases
and M&A. In addition, companies that are holding and gaining
market share through innovation, product differentiation and
competitive distribution models are distancing themselves from
those stumbling under the weight of the macroeconomic cycle.
Credit costs play a role, too. With nearly 80% of corporate
financing getting done in public markets, the widening of credit
spreads has had a more variable impact on companies,
depending on balance sheet leverage. While high-quality

companies have had limited constraints on their ability to

execute accretive share repurchases and M&A, others are
increasingly experiencing credit downgrades, which have
doubled this year from 2014s low. But where companies fall on
the credit-cost spectrum is not easily classified; some are among
the fastest in secular growth and others reside among the more
value-oriented cyclicals.
While earnings performance of companies with high cash
flow has begun to diverge from the broader market, importantly,
valuations have not; intrasector P/E multiple dispersion remains
at extremes. This creates opportunities, according to Parker. He
noted that while high-quality stocks outperformed low-quality
stocks on a risk-adjusted basis in September and the 11.8%
performance differential is the widest performance spread since
December 2008, there is still plenty of room for high quality to
make relative gains. On a free-cash-flow basis, high quality
versus low quality stocks are at a 350 basis point spread, the
most extreme since 2000. He notes that high-quality stocks have
typically traded at a 10% discount to low-quality stocks, but that
discount is now 23%. What also makes this compelling, he adds,
is that earnings expectations for the high-quality cohort are
much more modest and thus suggest higher future achievability.
Furthering the valuation argument, he goes on to say that US
high-quality stocks are also much cheaper relative to their highquality counterparts in Europe.
A final point around our quality preference relates to market
positioning and active managers tendency to own quality stocks
and our view that active management will be increasingly
effective. One of the most important success factors for active
managers is falling correlations between and among, companies,
sectors and geographies (see Active and Passive Strategies: An
Opportunistic Approach, March 2015). Our Chart of the Week
(see page 3) shows correlations have begun to fall. Interestingly,
according to Parkers research, hedge fund managers are
currently upside down on quality factor positioning; their
ownership of low-quality stocks is near the highs of the cycle.
Bottom Line: We believe company-specific factors will
increasingly drive divergence in performance. Our approach is
to focus on quality as defined by free cash flow as a unifying
theme. Watch for continued dispersion of earnings results and
valuation to separate winners from losers. Consider neutralizing
style biases in portfolios and balancing US equity exposure
between high-growth secular winners in tech, consumer
discretionary and health care and cheap high-quality cyclicals
with solid dividend growth potential, specifically in financials
and diversified industrials.

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

Chart of the Week: Moving Toward a Stockpickers Market

Fridays 2,075 close for the S&P 500 suggests a full
retracement of the August correction. While the rebound
has been corroborated by stabilization in China,
constructive global central bank policy, decent earnings
reports and a reduction in volatility, the Global Investment
Committee believes that going forward, performance will
be driven more by stock specifics than broad style,
geographic or capitalization classifications. Evidence of
this can be seen by the fact that the average stock in the
S&P has retraced just 75% of its August loss. Intrastock
and geographic correlations have plummeted, which
suggests good opportunities for active stock selection.

0.8
0.7

Trailing Six-Month Equity Return Correlation

US Large Cap
US Sectors
Major Countries
0.61

0.6
0.5

October 2015

0.4
0.33
0.33

0.3
0.2
0.1
0.0
1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

Source: FactSet as of Oct. 19, 2015

Asset Class Performance and Heat Map (as of Oct. 23, 2015)
Asset Class
Cash
90-Day US Treasury Bills

Annualized Returns (%)

Yield

YTD

1-Yr.

0.0

0.0

0.0

0.0

0.1

10Yr.*
1.3

6.2
-0.3
0.7
-0.9
-0.4
-2.4
2.5
9.4
-6.6
-7.0

14.8
5.9
8.8
6.0
8.8
4.9
3.0
11.9
-10.2
-9.5

15.0
12.2
11.9
13.2
5.5
9.7
-5.7
-3.7
-0.3
-1.8

14.4
11.9
14.5
14.9
14.3
12.8
7.7
10.1
-0.6
-3.1

17.4
13.3
16.3
15.1
16.5
14.4
7.1
6.1
3.5
-1.2

8.2
5.7
7.7
7.3
9.0
7.5
4.2
2.3
6.1
5.5

1.6
1.5
-4.0
-4.6
0.9
-10.7

1.3
1.9
-7.5
-6.3
-1.9
-17.3

1.4
6.0
-2.2
3.5
0.0
-5.7

1.2
1.8
-2.8
-1.5
4.0
-7.9

1.7
3.1
0.3
2.0
6.6
-2.5

3.4
4.5
3.0
4.0
7.4
4.5

1.0
-26.3
-18.9
-1.7
-2.5
-2.7
2.5
-2.2
2.8
1.0

5.2
-32.0
-28.1
-7.7
-2.1
0.4
9.9
7.7
3.2
4.4

14.7
4.8
-18.7
-6.7
-0.6
5.2
13.7
4.9
-4.5
4.7

6.6
-3.0
-15.7
-16.0
1.3
0.4
13.4
12.2
7.1
8.6

8.9
5.1
-8.5
-3.5
0.4
-0.9
15.3
14.4
6.4
9.4

5.4
8.1
-6.9
8.7
0.4
0.6
6.9
6.6
3.9
5.5

2014 3-Yr.* 5-Yr.*

Global Equities
US Large-Cap Growth
US Large-Cap Value
US Mid-Cap Growth
US Mid-Cap Value
US Small-Cap Growth
US Small-Cap Value
Europe Equity
Japan Equity
Asia Pacific ex Japan Equity
Emerging Markets*****
Global Fixed Income
Short-Term Fixed Income
US Fixed Income
International Fixed Income
Inflation-Linked Securities
High Yield
Emerging Markets Fixed. Inc.
Alternative Investments
REITs
Master Limited Partnerships***
Commodities ex Prec. Metals
Precious Metals
Hedged Strategies******
Managed Futures****
S&P 500
Russell 2000
MSCI EAFE
MSCI AC World

20Yr.*
2.5

Current
YTM
0.01
Current
Div. Yld.
7.8
1.35
8.0
3.27
7.9
0.97
10.2
2.89
9.4
0.72
10.3
2.85
7.0
3.43
0.4
2.01
6.0
4.53
5.3
2.91
Current
YTM
4.6
1.25
5.6
2.30
4.2
1.24
6.7
8.5
7.42
8.8
6.77
Current
Div. Yld.
8.6
3.46
7.55
1.2
5.5
8.4
2.02
8.0
1.53
4.9
3.32
6.5
2.71

*September 30, 2015. **20-year average as of September 30, 2015. ***Volatility and Correlation: June
30, 2006 - Present. ****Volatility and Correlation: February 28, 1998 - Present. ******Volatility and
Correlation: January 31, 1998 - Present. Hedged strategies consist of hedge funds and managed
futures. *****Values calculated using USD.
Source: FactSet, Bloomberg

Valuation

Volatility (%)

Correlation to
Global Equities

Current
Avg.
30 Days 20 Yrs.* 30 Days 20 Yrs.*
YTM
YTM
0.01
1.40
0.00
0.64
-0.26
0.00
Current
Avg.
P/E*
P/E**
20.0
17.9
18.3
17.9
0.91
0.88
16.1
12.9
15.6
14.5
0.90
0.88
23.3
20.3
19.3
23.5
0.92
0.80
16.4
14.1
16.3
16.4
0.88
0.87
26.5
22.2
21.6
22.6
0.92
0.82
19.6
17.4
16.9
17.2
0.88
0.84
15.2
13.3
16.6
18.1
0.88
0.94
14.3
17.2
26.5
17.8
0.52
0.67
14.8
14.2
19.9
21.5
0.62
0.85
11.5
10.6
17.4
23.6
0.84
0.85
Current
Avg.
Spread Spread**
33.0
30.0
1.4
2.1
-0.47
-0.07
55.0
54.0
2.8
3.5
-0.54
0.00
51.0
52.0
7.4
8.0
-0.36
0.28
6.6
7.5
-0.02
0.43
582.0
493.0
5.3
10.2
0.56
0.76
375.0
307.0
12.7
13.1
0.76
0.69

16.4
22.3
14.9
15.4

14.9
20.8
13.9
14.1

10.8
50.1
13.5
17.1
4.5
4.4
16.44
21.07
16.34
15.02

18.3
18.4
16.8
18.9
6.2
8.2
15.2
19.9
16.6
15.6

0.86
0.78
0.31
0.25
0.92
-0.29
0.93
0.88
0.87
1.00

0.79
0.55
0.43
0.20
0.63
0.18
0.95
0.82
0.96
1.00

Cheap

Low

Low

Moderate

High

High

Expensive

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

Morgan Stanley & Co. Forecasts (as of Oct. 23, 2015)

10-Yr. Govt.
Headline Inflation (%)
Bond Yield (%)
2017E Q4 15E Q2 16E 2015E 2016E 2017E
3.7
3.1
3.5
4.0
1.8
2.3
2.6
0.1
1.5
2.2
1.8
0.1
1.3
1.7
2.1
2.1
2.4
0.1
1.2
1.5
0.8
0.6
0.9
0.6
1.3
2.6
5.1
5.3
5.1
5.3
6.7
3.3
2.8
1.5
1.5
1.5

Real GDP Growth (%)

2015E 2016E
3.1
3.4
2.4
1.9
1.3
1.9
2.7
1.9
0.5
1.6
4.1
4.6
7.0
6.8

Global
US
Euro Zone
UK
Japan
Emerging Markets
China

Currency Versus US Dollar

Q4 15E

Q1 16E Q2 16E

1.13
1.54
121

1.11
1.53
122

1.08
1.52
123

6.60

6.69

6.77

Source: Morgan Stanley & Co. Research

Macro Factor Heat Map (as of Oct. 23, 2015)

Economic
Growth

Rates

Inflation /
Deflation

Liquidity

Sentiment and
Risk

Valuation

Earnings

GIC Conclusion

US

-1

Waiting on the
0
Fed

Japan

-1

Encouraging
1
Momentum

Europe

-1

-1

Earnings
1
Growth
Dependent

China

-1

-1

Growth
0
Trends
Stabilizing

Brazil

-1

-1

-1

-1

Stagflation;
-1
Avoid

Risk Asset
Positive

Neutral

Risk Asset
Negative

Note: Text in a factor box denotes a color change; For a further explanation of the chart, see page 8.
Source: Morgan Stanley Wealth Management GIC

Market Factor Data Points (for the week ending Oct. 23, 2015)
Positives

Global Growth

Rates

Negatives

US housing starts surged to 1.2 million in September

September US home sales beat estimates

Four-week average US jobless claims at 42-year low

Kansas City Fed Manufacturing Survey improved
Europe flash PMI for October steady at 54
Japan flash PMI for October well ahead of expectations
China GDP up 6.9% year over year, beating forecasts
ECB keeps rates unchanged, further easing possible
China cut bank rates and reserve requirements by 25
basis points and 50 basis points, respectively

US dollar hits 10-week high

Brazilian impeachment threat adds to economic turmoil

Inflation
S&P 500 surges to positive territory, breaking though
Sentiment and Flows
200-day moving average
Source: Morgan Stanley Wealth Management GIC

Conference Board Leading Economic Index fell 0.2% in

September, worse than expected
Japan exports weak in September

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

S&P 500 Earnings Estimates

MS & Co. S&P 500 12-Month Price Target

Consensus
Morgan Stanley
$129 $129

EPS Landscape

Scenario
Probability

2015E

2016E

P/E
Ratio

Scenario
Target

Upside /
Downside

Bull Case

20%

126.1

133.7

17.4

2,425

16.9%

6%

6%

124.0

128.5

16.6

2,200

6.0%

4%

4%

116.6

110.8

14.0

1,500

-27.7%

-2%

-5%

$124
$119

Growth

$118

Base Case

60%

Growth
Bear Case

20%

Growth
2014

2015E

2016E

Current S&P 500 Price

2,075

Source: FactSet, Thomson Reuters, Morgan Stanley & Source: Thomson Reuters, Morgan Stanley & Co. Research as of Oct. 23, 2015
Co. Research as of Oct. 23, 2015

S&P 500 Sector Performance and Valuation (as of Oct. 23, 2015)
Index Name

Total Return
WTD (%) YTD (%) 1-Year (%) Dividend Yield (%)

Beta

Forward 12-Mo. P/E*

S&P 500
2.09
2.47
8.60
2.02
Energy
-0.99
-11.87
-17.46
3.33
1.17
Materials
2.05
-5.87
-4.39
2.23
1.08
Industrials
3.87
-0.74
5.85
2.17
1.00
Consumer Discretionary
1.66
11.61
21.83
1.42
0.96
Consumer Staples
2.23
6.53
14.10
2.49
0.77
Health Care
-0.69
2.33
9.26
1.57
1.01
Financials
2.51
-1.00
7.45
1.91
1.03
Information Technology
4.61
7.96
16.35
1.45
1.12
Telecommunication Services
1.58
2.47
1.09
4.72
0.72
Utilities
-0.47
-2.98
4.78
3.69
0.66
*Dark blue/light blue/gray fill denotes whether current relative forward 12-month P/E is low/neutral/high relative to history.
Source: Morgan Stanley & Co.

16.4
29.0
15.7
15.8
18.7
20.0
15.6
12.9
16.4
12.3
15.9

Performance of Style and Cap Pairs (as of Oct. 23, 2015)

1.03
Small Cap vs. Large Cap
1.01
0.99
0.97
0.95
0.93
0.91
0.89
0.87
0.85
0.83
Oct '13
Feb '14
Jun '14
1.15
1.10 Cyclicals vs. Defensives
1.05
1.00
0.95
0.90
0.85
0.80
0.75
0.70
0.65
Oct '13
Feb '14
Jun '14

Oct '14

Feb '15

Jun '15

Oct '15

1.12
Growth vs. Value
1.11
1.09
1.08
1.06
1.05
1.03
1.02
1.00
0.99
0.97
Oct '13
Feb '14
1.12
1.10

Jun '14

Oct '14

Feb '15

Jun '15

Oct '15

Jun '14

Oct '14

Feb '15

Jun '15

Oct '15

Quality vs. Junk

1.08
1.06
1.04
1.02
1.00
0.98
0.96
Oct '14

Feb '15

Jun '15

Oct '15

0.94
Oct '13

Feb '14

Source: Morgan Stanley & Co. Small Cap is represented by the Russell 2000 Index; Large Cap represented by the Russell 1000 Index; Growth
represented by the Russell 1000 Growth Index; Value represented by the Russell 1000 Value Index.Cyclicals, Defensives. Quality and Junk are
based on Morgan Stanley & Co. Research analysis.

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

Fixed Income Weekly Insight: Spreads Remain Wide for Homebuilder Bonds
Throughout the recent global market volatility, the US
housing sector has remained strong. We have
consistently seen solid numbers this year in housing
starts, new-home sales and mortgage applications.
Whats more, this trend could continue as affordability
remains well above its historic levels and household
formations continue to increase. Still, spreads on the
high yield bonds of homebuilders remain wide relative
to the past two years as the broader high yield market
has sold off. As shown in the chart (right), spreads
have begun to tighten, and we believe this trend will
continue. Given the housing sectors strong
fundamentals, we see this as a high yield opportunity.

430 Basis Points

Option Adjusted Spread,
High Yield Homebuilder Bonds
400

370

340

310

280

250
Oct '13

Apr '14

Oct '14

Apr '15

Oct '15

Source: The Yield Book Software and Services. 2015 Citigroup Index LLC. All rights reserved. Data as of Oct. 22, 2015

Government Debt Monitor (as of Oct. 23, 2015)

US
Yield (%)
Current WTD

Treasury Benchmark

Global
Yield (%)

Total Return (%)

Total Return (%)*

YTD

YTD

10-Year Govt. Bond Current WTD

YTD

YTD

France
Germany
Japan
Spain
UK

0.03
-0.03
-0.02
0.03
0.11

1.66
1.60
1.25
1.78
0.64

3-Month
2-Year
5-Year
10-Year
30-Year

0.00
0.64
1.42
2.09
2.90

0.00
0.03
0.06
0.05
0.02

-0.04
-0.02
-0.24
-0.08
0.15

0.02
0.96
2.66
2.28
-1.31

2-Yr./10-Yr. Spread (bp)

10-Yr. TIPS Breakeven (bp)

145
152

2.07
3.87

-6.14
-15.70

0.85
0.51
0.30
1.63
1.86

-0.07
-0.04
-0.02
-0.14
0.06

0.32
0.01
0.07
US Tax Exempt
10-Year AAA Muni
2.04
0.02
2.04
2.02
Interest Rate Volatility** (bp) 71
-3.89
1.87
10-Yr. Muni/UST Ratio 98.20
-1.75
98.20
*Global total returns reflect Citigroup 7- to 10-year bond indexes and Muni total returns reflect Barclays Municipal Bond Index Total Return
**Interest Rate Volatility measured by Merrill Lynch Option Volatility Estimate (MOVE) Index
Source: Bloomberg, Thomson Reuters Municipal Market Data (MMD)

Fixed Income Spread Dashboard

High Yield Investment Grade

Duration Yield-to- OAS

(Yrs.) Worst (%) (bp)

3-Month LIBOR

Benchmark Returns

OAS Range**
Past Two Years (bp)
Rich
Cheap

Total Returns (%)

Index

YTD

MTD

2014

MBS*

3.84

2.33

16

-3

40

Barclays US Aggregate

1.47

0.34

5.97

AAA

4.11

1.41

26

37

Barclays US MBS

1.91

0.29

6.08

AA

4.96

1.78

12

20

Barclays US IG Corporates

0.76

0.86

7.46

6.79

2.83

121

79

132

Barclays Municipal

2.02

0.25

9.05

BBB

7.37

3.99

220

134

249

Barclays US High Yield

0.32

2.84

2.46

BB

4.52

5.84

446

253

541

Barclays Global Aggregate

-2.00

0.25

0.59

JPMorgan Emerging Market

3.05

3.38

5.53

3.99

8.04

697

367

775

CCC

3.60

11.88

1,201

664

1,255

Unless stated, indexes utilized are Citi Broad Investment Grade, Citi High Yield, and Citi Global Indexes.
*MBS distills high grade agency-rated mortgage-backed securities, a substantial subsector of investment grade indexes
**OAS stands for Option-Adjusted Spread or spread over the Treasury. Grey diamond denotes current OAS; blue circle denotes two-year average.
Source: Bloomberg, The Yield Book Software and Services. 2015 Citigroup Index LLC. All rights reserved. Data as of Oct. 23, 2015

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

Tactical Asset Allocation Reasoning

Global Equities

Relative Weight
Within Equities

US

Overweight

While US equities have done exceptionally well since the global financial crisis, they are now in the midst of their first
10% correction in four years. We believe the US and global economies continue to heal, making recession neither
imminent nor likely in 2015 or 2016. US equities are still the highest quality in the world and provide a lower-risk way of
participating in the rebound.

International Equities
(Developed Markets)

Overweight

We maintain a positive bias for Japanese and European equity markets given the political and structural changes taking
place in Japan and our expectation for an improving economic outlook in Europe. European and Japanese central
banks are now engaged in much more aggressive monetary policy than the US, while also moving away from fiscal
austerity. Both of these markets are more highly leveraged to the global economy and represent a higher risk/higher
reward way to participate in a rebound.

Emerging Markets

Overweight

Emerging market (EM) equities have been a mixed bag for the past few years and we expect that to continue. While the
broad EM equities asset class remains vulnerable to Fed tightening and US dollar strength, the market is pricing in
much of this risk. We expect a rebound to commence in the next 12 months as weak EM currencies lead to better
relative growth. We recommend selectivity: India, China H-shares, Taiwan and Korea.

Global Fixed
Income
US Investment Grade

Relative Weight
Within Fixed
Income
Overweight

We have recommended shorter-duration* (maturities) since March 2013 given the extremely low yields and potential
capital losses associated with rising interest rates from such low levels. We have subsequently reduced the size of our
overweight in short duration with short-term interest rates now expected to move higher with the Feds tightening cycle
later this year or in early 2016. Within investment grade, we prefer BBB-rated corporates and A-rated municipals to US
Treasuries.

International
Investment Grade

Underweight

Yields are extremely low globally, leaving very little value in international fixed income, particularly as the global
economy begins to recover more broadly. While interest rates are likely to stay low, the offsetting diversification benefits
do not warrant much, if any, position, in our view.

Inflation-Protected
Securities

Overweight

With deflationary fears having become extreme in the first quarter of 2015, we believe these securities now offer relative
value in the context of our forecasted acceleration in global growth and expectations for oil prices and US dollar yearover-year rate of change to revert back toward 0%.

High Yield

Overweight

The sharp decline in oil prices has created some dislocations in the US high yield market. Broadly speaking, we believe
default rates are likely to remain muted as the economy recovers, while corporate and consumer behavior continue to
be conservative. We prefer higher-quality (B to BB) issues and vigilance on security selection at this stage of the credit
cycle. With energy-related issues, investors should remain selective.

Underweight

We remain underweight as the Feds rate-hike cycle will likely be a disproportionate headwind for emerging market
(EM) debt. Much like EM equities, EM debt exposure should be selective. For investors who want to own EM debt, the
GIC recommends US-dollar-denominated debt with a focus on China, India and Mexico.

Emerging Market
Bonds

Alternative
Investments
REITs

Commodities

Relative Weight
Within Alternative
Investments
Underweight

Overweight

With our expectation for rising interest rates, we believe REITs are now fairly to slightly overvalued, especially relative to
other high-yielding asset categories. Therefore, we recently reduced our tactical asset allocation. Non-US REITs should
be favored relative to domestic REITs at this point.
Most commodities have underperformed in the past few years, with energy leading the charge lower. We believe
commodities are likely to perform better for the remainder of 2015 as global growth reaccelerates and the oil market
comes into better supply/demand balance.

Master Limited
Partnerships*

Equal Weight

Master limited partnerships (MLPs) have been devastated during 2015 due to collapsing oil prices and a less hospitable
financing market. We expect tax-loss selling to weigh on MLPs into the fourth quarter but think MLPs should rally as oil
prices and financing markets stabilize. That will likely be a rally to sell.

Hedged Strategies
(Hedge Funds and
Managed Futures)

Equal Weight

This asset category can provide uncorrelated exposure to traditional risk-asset markets. It tends to outperform when
traditional asset categories are challenged by growth scares and/or interest rate volatility spikes. Within this asset
category, we favor event-driven strategies, given our expectation for increased mergers-and-acquisitions activity.

*For more about the risks to Master Limited Partnerships (MLPs) and Duration, please see the Risk Considerations section beginning on
page 10 of this report.
Source: Morgan Stanley Wealth Management Global Investment Committee as of Oct. 23, 2015

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

Macro Factor Heat Map Key (see page 4)

Economic
Growth

Rates

Inflation /
Deflation

Liquidity

Sentiment and Risk

Valuation

Earnings Conclusion

Dark Blue Economic growth

robust

Steep yield curve

Low-moderate and Liquidity robust Shorter-term sentiment and

rising inflation
in economy / technicals bearish
banking
system

Risk assets
attractively
valued

Earnings
outlook
robust

Confluence of factors
supports a risk-on
investment approach

Light Blue Economic growth

neutral

Normal yield curve

Low-moderate and
declining inflation;
moderate inflation;
higher and falling
inflation

Liquidity
neutral in the
economy /
banking
system

Risk assets
neutral

Earnings
outlook
neutral

Confluence of factors
supports a neutral
investment approach

Gray

Economic growth
anemic

Flat/inverted yield
curve

Very high/low
inflation/deflation;
high and rising
inflation

Liquidity low in Shorter-term sentiment and

economy /
technicals bullish
banking
system

Risk assets are Earnings

richly valued
outlook
anemic

Confluence of factors
supports a risk-off
investment approach

Up

Growth accelerating Yield curve

steepening

Inflation rising

Liquidity
increasing

Sentiment becoming more

bullish

Valuations rising Earnings

outlook
improving

Down

Growth declining

Yield curve flattening Inflation falling

Liquidity
decreasing

Sentiment becoming more

bearish

Valuations falling Earnings

outlook
worsening

Signal
Hor
izon

One to three years

One to three years

One to three months

Six months to
two years

Inputs

Industrial prod 10-year vs. 2-year Consumer Price

uction
government bond
Index
Unemployment
yield spread
Total return
Earnings revisions
Home prices
OECD LEI (China
and Brazil)
MS & Co. ARIA
(US)

One to three years One to three

years
M1 growth
Private credit
growth
Libor-OIS
spread

Shorter-term sentiment and

technicals neutral

MS US Equity Risk Indicator Forward

(US)
price/earnings
MS Combined Market
ratio
Timing Indicator (Europe)
Price/book
MS Global Risk Demand
ratio
Index
Equity risk
Relative strength index
premium
Members above / below
High yield
moving average.
option-adjusted
Index above / below moving spread
average
Consumer confidence

Please refer to important information, disclosures and qualifications at the end of this material.

Six months
to two
years
Earnings Weighted average
revisions z-score of all factors
breadth
Earnings
surprise
Return
on equity

Oct. 26, 2015

THE GIC WEEKLY

Index and Survey Definitions

BARCLAYS MUNICIPAL BOND INDEX This is
a rules-based, market-value-weighted index
engineered for the long-term tax-exempt
bond market.
BARCLAYS US AGGREGATE BOND INDEX

This index tracks US-dollar-denominated

investment grade fixed rate bonds. These
include US Treasuries, US-governmentrelated, securitized and corporate securities.
BARCLAYS US CORPORATE HIGH-YIELD
INDEX This index measures the market of

US-dollar-denominated, noninvestment
grade, fixed-rate, taxable corporate bonds.
BARCLAYS US MORTGAGE-BACKED
SECURITIES INDEX This is an index which

covers the mortgage-backed securities

component of the Barclays US Aggregate
Bond Index.
CITI EMERGING MARKET SOVEREIGN BOND
INDEX This index includes Brady bonds and

US-dollar-denominated emerging markets

sovereign debt issued in the global, Yankee
and Eurodollar markets, excluding loans. It
comprises debt in Africa, Asia, Europe and
Latin America.
CITI EURO BROAD INVESTMENT GRADE
BOND (EUROBIG) INDEX This is a

comprehensive representation of the

European investment grade corporate bond
market.
CITI HIGH YIELD MARKET INDEX This

index
tracks performance of below-investment grade debt issued by corporations domiciled
in the US and Canada.

CITI SPAIN GBI CURRENCY HEDGED 7 TO 10

YEAR USD This index measures the

performance of Spain sovereign bonds in

the seven-to-10-year maturity range and is
denominated in US dollars.

PURCHASING MANAGERS INDEXES (PMI)

is a comprehensive representation of the US

investment grade corporate bond market.
CONFERENCE BOARD LEADING ECONOMIC
INDEX This index includes economic

variables that tend to move before changes

in the overall economy.

index measures
the performance of the 1,000 largest US
companies based on total market
capitalization.

examines the weighted average of prices of

a basket of consumer goods and services.
KANSAS CITY FED MANUFACTURING
SURVEY This is a survey of 300

RUSSELL 1000 GROWTH INDEX This

index
measures the performance of those Russell
1000 companies with higher price-to-book
ratios and higher forecasted growth.

manufacturers located in the 10th Federal

Reserve District that provides data on
manufacturing trends. The district includes
Colorado, Kansas, Nebraska, Oklahoma,
Wyoming, western Missouri and northern
New Mexico.

RUSSELL 1000 VALUE INDEX This

index
measures the performance of those Russell
1000 companies with lower price-to-book
ratios and lower forecasted growth.

MERRILL LYNCH OPTION VOLATILITY

ESTIMATE (MOVE) INDEX This is a yield-

RUSSELL 2000 INDEX This index measures

the performance of the 2,000 smallest
companies in the Russell 3000 Index.

curve-weighted index of the normalized

implied volatility on one-month US
Treasury options.

RUSSELL 3000 INDEX This

index measures
the performance of the 3,000 largest US
companies based on total market
capitalization.

S&P 500 INDEX This capitalization-weighted

index includes a representative sample of
500 leading companies in leading industries
in the US economy.

MORGAN STANLEY EQUITY RISK

INDICATOR This is a proprietary sentiment

and risk indicator for US equities.

MORGAN STANLEY GLOBAL RISK DEMAND
INDEX This index tracks risk sentiment as

reflected in the relative price movements of

seven risky assets versus their safer
counterparts; plus, three volatility indicators.
MSCI ALL COUNTRY WORLD INDEX This is

These economic indicators are derived

mostly from monthly surveys of privatesector companies. The principal producers
of PMIs are Markit Group, which conducts
PMIs for more than 30 countries, and the
Institute for Supply Management, which
conducts PMIs for the US.
RUSSELL 1000 INDEX This

CONSUMER PRICE INDEX This index

average across the Risk, Fundamentals and

Composite Valuation Indicators.

performance of Japan sovereign bonds in

the seven-to-10-year maturity range and is
denominated in US dollars.

measures wholesale price levels in the

economy.

CITI US BIG CORPORATE BOND INDEX This

performance of France sovereign bonds in

the seven-to-10-year maturity range and is
denominated in US dollars.

CITI JAPAN GBI CURRENCY HEDGED 7 TO

10 YEAR USD This index measures the

PRODUCER PRICE INDEX This index

performance of UK sovereign bonds in the

seven- to-10-year maturity range and is
denominated in US dollars.

MORGAN STANLEY COMBINED MARKET

TIMING INDICATOR (CMTI) The CMTI is an

performance of Germany sovereign bonds

in the seven-to-10-year maturity range and
is denominated in US dollars.

MSCI EAFE INDEX This capitalizationweighted index tracks the total return of
stocks in 21 developed-market countries in
Europe, Australia and the Far East.

CITI UK GBI CURRENCY HEDGED 7 TO 10

YEAR USD This index measures the

CITI FRANCE GBI CURRENCY HEDGED 7 TO

10 YEAR USD This index measures the

CITI GERMANY GBI CURRENCY HEDGED 7

TO 10 YEAR USD This index measures the

market performance in the global developed

and emerging markets.

VIX This

is a trademarked symbol for the

Chicago Board Options Exchange Market
Volatility Index, a measure of the implied
volatility of the S&P 500 index options.

free-float-adjusted market capitalization

index that is designed to measure equity

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015

THE GIC WEEKLY

Risk Considerations
MLPs
Master Limited Partnerships (MLPs) are limited partnerships or limited liability companies that are taxed as partnerships and whose interests (limited
partnership units or limited liability company units) are traded on securities exchanges like shares of common stock. Currently, most MLPs operate in
the energy, natural resources or real estate sectors. Investments in MLP interests are subject to the risks generally applicable to companies in the
energy and natural resources sectors, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk.
Individual MLPs are publicly traded partnerships that have unique risks related to their structure. These include, but are not limited to, their reliance
on the capital markets to fund growth, adverse ruling on the current tax treatment of distributions (typically mostly tax deferred), and commodity
volume risk.
The potential tax benefits from investing in MLPs depend on their being treated as partnerships for federal income tax purposes and, if the MLP is
deemed to be a corporation, then its income would be subject to federal taxation at the entity level, reducing the amount of cash available for
distribution to the fund which could result in a reduction of the funds value.
MLPs carry interest rate risk and may underperform in a rising interest rate environment. MLP funds accrue deferred income taxes for future tax
liabilities associated with the portion of MLP distributions considered to be a tax-deferred return of capital and for any net operating gains as well as
capital appreciation of its investments; this deferred tax liability is reflected in the daily NAV; and, as a result, the MLP funds after-tax performance
could differ significantly from the underlying assets even if the pre-tax performance is closely tracked.

Duration
Duration, the most commonly used measure of bond risk, quantifies the effect of changes in interest rates on the price of a bond or bond portfolio.
The longer the duration, the more sensitive the bond or portfolio would be to changes in interest rates. Generally, if interest rates rise, bond prices
fall and vice versa. Longer-term bonds carry a longer or higher duration than shorter-term bonds; as such, they would be affected by changing
interest rates for a greater period of time if interest rates were to increase. Consequently, the price of a long-term bond would drop significantly as
compared to the price of a short-term bond.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and
economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets,
since these countries may have relatively unstable governments and less established markets and economies.
Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures
funds, and funds of hedge funds, private equity, and managed futures funds, are speculative and entail significant risks that can include losses due to
leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack
of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less
regulation and higher fees than mutual funds and risks associated with the operations, personnel and processes of the advisor.
Managed futures investments are speculative, involve a high degree of risk, use significant leverage, have limited liquidity and/or may be generally
illiquid, may incur substantial charges, may subject investors to conflicts of interest, and are usually suitable only for the risk capital portion of an
investors portfolio. Before investing in any partnership and in order to make an informed decision, investors should read the applicable prospectus
and/or offering documents carefully for additional information, including charges, expenses, and risks. Managed futures investments are not intended
to replace equities or fixed income securities but rather may act as a complement to these asset categories in a diversified portfolio.
Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to,
(i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events,
war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence,
technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary
distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.
Physical precious metals are non-regulated products. Precious metals are speculative investments, which may experience short-term and long
term price volatility. The value of precious metals investments may fluctuate and may appreciate or decline, depending on market conditions. If sold
in a declining market, the price you receive may be less than your original investment. Unlike bonds and stocks, precious metals do not make interest
or dividend payments. Therefore, precious metals may not be suitable for investors who require current income. Precious metals are commodities
that should be safely stored, which may impose additional costs on the investor. The Securities Investor Protection Corporation (SIPC) provides
certain protection for customers cash and securities in the event of a brokerage firms bankruptcy, other financial difficulties, or if customers assets
are missing. SIPC insurance does not apply to precious metals or other commodities.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk.
Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date.
The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the
maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the
risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk
that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015 10

THE GIC WEEKLY

Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater
credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives
and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.
Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax
(AMT). Typically, state tax-exemption applies if securities are issued within one's state of residence and, if applicable, local tax-exemption applies if
securities are issued within one's city of residence.
Treasury Inflation Protection Securities (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation
by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is
linked to inflation, TIPS may significantly underperform versus conventional U.S. Treasuries in times of low inflation.
Principal is returned on a monthly basis over the life of a mortgage-backed security. Principal prepayment can significantly affect the monthly
income stream and the maturity of any type of MBS, including standard MBS, CMOs and Lottery Bonds. Yields and average lives are estimated
based on prepayment assumptions and are subject to change based on actual prepayment of the mortgages in the underlying pools. The level of
predictability of an MBS/CMOs average life, and its market price, depends on the type of MBS/CMO class purchased and interest rate movements.
In general, as interest rates fall, prepayment speeds are likely to increase, thus shortening the MBS/CMOs average life and likely causing its market
price to rise. Conversely, as interest rates rise, prepayment speeds are likely to decrease, thus lengthening average life and likely causing the
MBS/CMOs market price to fall. Some MBS/CMOs may have original issue discount (OID). OID occurs if the MBS/CMOs original issue price is
below its stated redemption price at maturity, and results in imputed interest that must be reported annually for tax purposes, resulting in a tax
liability even though interest was not received. Investors are urged to consult their tax advisors for more information.
Asset-backed securities generally decrease in value as a result of interest rate increases, but may benefit less than other fixed-income securities
from declining interest rates, principally because of prepayments.
Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Companies paying dividends can reduce or cut payouts at any time.
Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk,
significant stock price fluctuations and illiquidity.
Stocks of medium-sized companies entail special risks, such as limited product lines, markets, and financial resources, and greater market
volatility than securities of larger, more-established companies.
Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their
business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these
high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the
performance of any specific investment.
The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes. Morgan
Stanley Smith Barney LLC retains the right to change representative indices at any time.
Credit ratings are subject to change.
REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited
diversification and sensitivity to economic factors such as interest rate changes and market recessions.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy.
Investors should consult with their tax advisor before implementing such a strategy.
Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency,
economic and market risks.
Investing in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and
market risks. Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and
domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied
economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These
risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in
countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not
be offered or sold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase,
holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015 11

THE GIC WEEKLY

Disclosures
Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This
material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or
other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance.
The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors,
including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.
Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this
material.
This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any
security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own
independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision,
including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain
material information not contained herein and to which prospective participants are referred. This material is based on public information as of the
specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or
warranty with respect to the accuracy or completeness of this material. Morgan Stanley Wealth Management has no obligation to provide updated
information on the securities/instruments mentioned herein.
The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy
will depend on an investors individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors
independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and
income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates,
securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. Estimates of future
performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions
may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the
projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any
projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.
Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not
materially differ from those estimated herein.
This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is
not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not
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Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice. Each client
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2015 Morgan Stanley Smith Barney LLC. Member SIPC.

Please refer to important information, disclosures and qualifications at the end of this material.

Oct. 26, 2015 12