Morgan Stanley, in a view on global markets, has advised its clients to cut exposure to equities after their valuation indicators indicated a sell on global equities. It has advised to slash exposure to equities after its three key warning indicators began flashing a "Full House" sell signal. The triple warning has been triggered for the first time since the dotcom bust. It has been triggered just five times since 1980.

The report states that the mid-cycle rally is over. The model forecasts 14% correction over the next six months. MSCI index of 600 European and British equities had dropped by 15% over six months after each "Full House" signal.

Factors affecting Equities
- Interest rates are rising and reaching critical levels
- Fall in bond yields will act as an automatic stabilizer for world economy
- Markets will be back once they shake off the latest excesses

The first of the three signals Morgan Stanley monitors is a "composite valuation indicator" that divides the price/earnings ratio on stocks by bond yields. It measures "median" share prices that capture the froth of the merger boom, rather than relying on a handful of big companies on the major indexes. "If you look at all shares, the p/e ratio is at an all-time high of 20," it says.

The other two gauges measure fundamentals such as growth and inflation, as well as risk appetite. "Investors are taking far too much comfort from global liquidity. Markets always return to fundamental value, so people could be in for a rude awakening. This is the greater fool theory," they say. "The trigger may be rate rises by the Bank of Japan, or a widening of credit spreads. There are lots of little triggers."

Morgan Stanley is not predicting a recession, believing bond yields will fall during a correction and act as an "automatic stabiliser" for the world economy. Once the market shakes off the latest excesses, it's back to the races.