Beware Morgan Stanley's red-hot rally

The stock has gone nearly vertical, so a sell-off could be steep, too.

By InvestorPlace Sep 11, 2012 10:57AM

ImageSource PictureQuestBy Dan Burrows

iplogoThe return of the risk-on trade in late July did wonders for financial stocks, none more so than beleaguered investment bank Morgan Stanley (MS). Now, thanks to a couple of prominent analyst upgrades, shares have gone positively vertical in September.

All of which makes MS more susceptible to a steeper slide when the risk-off trade comes roaring back.

Sure, if you're bullish on the prospects for the risk-on trade for a good while longer, buy the financials, by all means. They're as sensitive a pro-cyclical sector as there is. That's why financials have been the best performing sector of the S&P 500 over the last month, rising 3.6%.

Indeed, ever since European Central Bank President Mario Draghi unleashed the risk-on trade with his late July commitment to do "whatever it takes" to save the euro, the benchmark Financial Select Sector SPDR ETF (XLF) has rallied more than 10%, outpacing the broader market by about 3 percentage points.

Just don't be surprised when the trade reverses, especially if you've been stock-picking with any equity that's gone this far, this fast.

Morgan Stanley managed rocket-like liftoff a couple months after its botched handling of the Facebook (FB) IPO. MS is up 33% since the late-July risk-on rally began in earnest. In September alone, the stock is up about 13%.

Here are some company-specific things that have helped:

  • The Facebook IPO and subsequent share-price swoon might be an open wound, but the company went public back in May. As the Street's thinking goes, that's so yesterday.
  • Morgan Stanley caught a break mid-summer when Moody's took a much smaller axe to the bank's credit rating than the market feared.
  • Cost cuts: MS is on track to shed 4,000 jobs this year. Yes, it makes my skin crawl, but when a company fires people, its stock often goes up because it means more revenue will flow to the bottom line.

But what really got Morgan Stanley shares moving this month were a couple of influential upgrades. Mike Mayo, an iconoclastic and widely respected bank analyst at CLSA, last week lifted MS to outperform (buy, essentially), and hiked his price target to $23 from $16.

JPMorgan Chase (JPM) analyst Kian Abouhossein likewise upgraded MS last week, to overweight (again, buy, essentially).

Too bad the easy money looks to have been made. MS dropped as much as 2% Monday while the XLF slipped factionally.

Market timing is folly in the best of times. The risk-on trade will eventually stumble on something, whether it's selling the news of more quantitative easing from the Federal Reserve later this week or a current-quarter earnings recession.

If you're an active trader, ride the broader financial sector, if you must, but it's probably already too late to pounce on Morgan Stanley. Monday's sell-off looks more like a warning than a buying opportunity.

As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.

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