Morgan Stanley (AMEX: MWD - News) has turned bullish on credit markets for the first time since the start of the bear market, according to Neil McLeish, head of European credit strategy.

"Valuation is extreme, even on a 100-year view, sentiment reflects outright panic and fundamentals for higher-quality credit are improving due to official intervention," he says.

"Investors should overweight investment grade credit, with a focus on the largest European banks and non-cyclicals.

"We continue to believe that 2007 represented not only the peak of a 'vanilla' cycle that started in 2003 but also the peak of a 30-year 'debt supercycle' that started in the early 1980s. The unwind of this supercycle should end with lower private sector leverage across the developed world and a smaller and less complex financial sector.

"However, we believe that credit markets are now pricing too high a likelihood of sustained debt deflation. Although policymakers have fumbled several times, we believe they will react more aggressively over the next few weeks and remind markets that the partial socialisation of credit risk should cushion the supercycle unwind for higher-quality credit.

"Nonetheless, we do not expect the real economy or earnings to trough until 2009. History suggests credit spreads reach their final peak only a couple of months before the final trough in the real economy, some time in the first half of 2009."