Morgan Stanley red flags will keep investors on their toes

Over the past few months, fundamentals-based analysts from Morgan Stanley have become increasingly bearish on the stock market.

Some of the reasons given are that the market is too optimistic, yield growth is slow, market pessimism has remained steady with no sense of any crisis, and the forward price-to-earnings ratio is too high.

These analysts expect the entire market could see a 10 to 15 percent correction in the next six months.

And it's not just the fundamentals-based analysts at Morgan Stanley who are bearish, as the investment bank's technical analysts are also starting to question the outlook for stocks.

This is only the fifth time in the past 30 years that all five of Morgan Stanley's market indicators have given out 'sell' signals. The previous four were March 1990, May 1992, June 2007 and February this year.

Though all five indicators pointed to 'sell' at the same time in February this year, the stock market continued to rise.

But when all the indicators pointed to 'sell' in June 2007, global stocks began to fall significantly, less than five months later. And following that, the collapse of Lehman Brothers in 2008 triggered the global financial tsunami.

Personally, I am still positive about the performance of the global stock markets since central banks across the world are still dishing out abundant liquidity to financial markets.

Also, based on their experience back in 2015, the US Federal Reserve and other central banks do not seem to be courageous enough to tighten monetary policy because they know that the global economic uptrend and rise in financial asset prices are mainly because of the infusion of liquidity from central banks and governments. So any action they take could cause the global economy and financial markets to lose momentum and trigger a recession and financial crisis.

The market, meanwhile, has realized that central bankers are reluctant to turn off the money taps and become quite fearless, and even though many stock valuations are too high and doubts are creeping in, investors still expect the market to stay bullish.

The latest risk reminder from Morgan Stanley analysts is like a bucket of cold water being poured on an overly optimistic market that's oblivious to warning signs.

History shows us that every financial crisis has been triggered by unexpected market factors.

The actual problem is that people believe that central banks will continue to play a key role in supporting the economy and financial markets, and as long as they do not withdraw liquidity too fast, the stock market has nothing to worry about.

The biggest worry right now is that everyone is grossly underestimating the threat of inflation.

If prices of resources and energy continue to rise, then hyperinflation could take a firm hold across the world and central banks may be forced to act - and this could set the stage for a global financial market crisis.

So if you are aware of the fact that four months after Morgan Stanley put out a "sell" call in June 2007, global stocks peaked and fell, then you should really be on guard that inflation might take off in the next three months and force central banks to change monetary policy, and that could possibly trigger a financial market crisis.

Andrew Wong is chairman and CEO of Anli Securities