Morgan Stanley’s $4.8 million notes on MSCI Emerging Markets are too short, contrarian says

By Emma Trincal

New York, Nov. 4 – Morgan Stanley Finance LLC’s $4.8 million of 0% buffered PLUS due May 2, 2025 linked to the MSCI Emerging Markets index show some strengths in the structure and underlying asset pick, but the length of the investment in the midst of a bear market created too much risk, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the index return is positive, the payout at maturity will be par plus 300% of the index return, subject to a maximum return of par plus 41%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 20% or less and will lose 1% for every 1% that it declines beyond 20%.

“The leverage can expand your gains and the cap is reasonable. It’s not too low. I also like the fact that you have a real buffer, not a barrier. These are the positive characteristics,” he said.

“The main negative is the 2.5-year tenor, which may not be long enough to give you time to recover from the bear market.”

Long gain, long pain

If bear markets are shorter than bull markets, they also last much longer than average when they emerge from a long-lasting bull cycle as it is the case today, he said.

“We had the longest bull market in U.S. history. It’s been going on from March 2009 to January 2022.

“In the roaring 1920’s, the bull market lasted more than eight years from August 1921 to September 1929. Then you had a 34-month bear market, which is almost three years. It’s always possible.”

The average length of a bear market for the S&P 500 index is 18.6 months, according to S&P Dow Jones Indices, which tracks bear and bull markets since September 1929 up until February-March 2020.

Earlier start

The bear market for emerging markets began in February of last year, he noted.

“It peaked almost a year ahead of the United States. Here, we reached a high on Jan. 4, which marks the start of the current downtrend, he said.

“Intuitively you would think the pullback for emerging markets could stop a year earlier than in the United States. But historically, it may not be the case. Just because the bear market got off to an earlier start doesn’t mean much, really,” he said.

What Kaplan found particularly attractive about emerging markets was their value.

“They’re the cheapest they’ve been in a long time. One has to go back to March 2020 or January 2016 to find lower prices, he noted.

“So, we have an undervalued situation with emerging markets, which should create some kind of regression to the mean. That’s a real good thing. Over the next several years, you’re likely to do better in emerging markets than in the United States”

Pros and cons

Judging the notes was not easy, however.

“You have to weigh those positive factors – the protection with a buffer, the leverage, the fact that the index is undervalued, all those positive things against what I see as the main negative – time,” he added.

“Two-and-a-half years is really too short,” he said.

Investors need to decide if the strengths associated with the investment can offset the shortcomings.

“It’s hard to tell. There’s always a real danger when a bear market follows a very long bull market. Prices are likely to drop more and for a longer period of time than average,” he said.

“I like the asset and the structure. I don’t like the length of the notes.”

At least the buffer offers some real protection, he said, pointing as an example to a 25% price drop limiting noteholders’ losses to a modest 5% loss.

Bond bull

“Your losses may not be huge. But if your objective is to make money, there are better choices out there,” he said.

Kaplan said he is very bullish on bonds. With interest rates rising, most investors expect more of the same and have turned increasingly bearish on bonds.

As a contrarian, Kaplan anticipates the opposite.

“Most bonds are likely to gain over the next two-and-a-half years. Government bonds are very cheap...not just in the United States but also around the world. Emerging markets debt for instance is a bargain. Bonds right now offer better opportunities for capital appreciation than stocks.”

With interest rates in the United States “the highest in a long time,” investors can use Treasury yields to secure income in excess of 4% while investing in undervalued assets likely to rise in price in the future.

As the yield curve is inverted, one-year Treasuries offer the highest yield at 4.75%, he noted.

“You’re getting one of the safest investments at extremely high yields and at extremely low prices while remaining pretty liquid,” he said.

On the longer end of the yield curve, Treasury buyers could achieve substantial capital gains if interest rates go down, which, according to Kaplan is inevitable given how much and how fast yields have increased.

He pointed to the iShares 20-year Treasury bond ETF listed under the ticker “TLT.”

“In March 2020, at the bottom of the bear market, TLT was at 190. Today, it’s at 94. If it was to go back to its 190 level, you would gain over 100%.”

Big bubble

The idea of buying emerging markets was judicious but the timeframe of the notes was not, he said.

“U.S. markets are dropping; real estate prices are coming down; and the economy is slowing. Too much money has been flowing into mega-cap stocks like Apple, Amazon or Tesla for too long, making those names dangerously overpriced and ready to collapse. We’ve seen a little bit of this bloodbath recently when some big tech companies reported their earnings.

On Oct. 27, Meta Platforms suffered a 25% loss following its disappointing earnings.

“More money flowed into global equity markets last year than in the previous 20 years combined. That’s the definition of a major bubble. And when a major bubble bursts, the damage is severe.”

Kaplan would greatly prefer to see the note structured around a maturity of four or five years.

“It would give you enough time to recover from any bear market.”

Meanwhile investors are not lacking better alternatives to make money.

“Bonds are cheap...U.S. Treasuries, sovereign debt in emerging markets...precious metals, gold miners, silver are also very attractive. This note is based on a cheap asset class. But the price could drop much further. The time horizon is just not right.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Nov. 1.

The fee is 1%.

The Cusip number is 61774Q124.

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