If investors are bearish on stocks, the adage goes, that's a good sign because sentiment isn't bubble-like — and some of that money might even flow in from other assets, sending equities higher yet.
Morgan Stanley Investment Management, however, does not see it that way now, even as Bank of America Merrill Lynch's October fund manager survey left the firm's Bull & Bear indicator at an "extreme bear" level, with cash levels rising to 5% from 4.7%.
As macro data like manufacturing readings and auto sales deteriorate, the current bearish sentiment and defensive positioning seem "justified," according to Andrew Harmstone, a managing director at Morgan Stanley IM, which had $497 billion under management as of June 30.
"Normally somewhat bearish sentiment is a good sign for stocks, but actually it isn't here because of the risks," Mr. Harmstone said in an interview in Singapore. "There is still this negative momentum which we think has not been fully priced in."
That view isn't shared by everyone. Credit Suisse Group AG's Mandy Xu said earlier this month that "the pain trade is to the upside" given investors' defensive posture, while J.P. Morgan Chase's John Normand predicted that the market drawdown a couple weeks ago wouldn't be as bad as the one last December, partially because of neutral-to-defensive positioning.
However, Mr. Harmstone doesn't see stocks running into catastrophe, either. "Defensive positioning reduces the risk of a broad-based decline in equities from panic selling," he said.
