By Genevieve Cua

David Darst, Morgan Stanley's chief investment strategist and managing director, is telling investors to 'keep some powder dry'. There is a more than 50 per cent probability of still more downside risk in markets, he says.

The asset allocation guru was in Singapore yesterday. He has called on investors to be defensive since last year.

'Our message is you need to be patient, cautious, careful, defensive and conservative. We have extra cash in the portfolio. On risk assets, we have a defensive style.'

In bonds, he advocates Treasuries; in stocks, he likes healthcare, consumer stocks, utilities and telecommunications. Treasuries have been one of the best-performing asset classes this year, delivering some 5 per cent in returns, compared with the US market which is down about 15 per cent, and emerging markets which have fallen by more than 30 per cent.

'For some investors, they can have hedging and risk management strategies, with put options, inflation protected securities (TIPS), and inverse ETFs.' The latter are also called 'bear' or 'short' exchange traded funds, which profit from broad market declines.

Mr Darst's GDP forecasts for the US are 1.5 per cent for 2008 and an anaemic 0.7 per cent for 2009. 'It's a very slow recovery. The main reason is there is a housing bust, and the bursting of the credit bubble. Liquidity is plentiful but credit is tight.

'I would give a 25 to 30 per cent probability that we are in the vicinity of a bottom; a 10 to 15 per cent chance that we will trade sideways for a while... But our near-term outlook is a 50-plus per cent chance that we are still going to have considerable downside risk.'

Among the various signposts to watch for signs of a bottom are profits, house prices, and credit spreads. The latter, he says, are 'now to the wide side, but (spreads on risky bonds) are still tighter than some investment-grade bonds'.

Mr Darst, who has studied the long history of investment returns, offers some interesting perspectives based on the past. For equities, based on the S&P 500 since 1901, it seems a Democratic administration is better for annual compounded returns - 6.7 per cent between 1901 and 2000, compared with 4.6 per cent for a Republican administration.

A Republican administration, however, is better for bonds. The annual compounded return from US long-term government bonds was 7.9 per cent with a Republican administration, versus 2.7 per cent for Democrats.

As for small stocks, the outperformance against the S&P500 is an impressive 8.2 per cent with a Republican in the White House, against minus 3.5 per cent for a Democrat.

This article was first published in The Business Times on September 13, 2008.