Paul Mazzilli doesn't describe himself as overly bullish these days.

Still, the veteran Morgan Stanley exchange-traded funds analyst clearly isn't as bearish as many other market observers right now.

"Calling an absolute bottom isn't easy at this point," said Mazzilli. "But stocks are so oversold and there's so much cash on the sidelines, markets are due for a bounce at some point. This sure doesn't look like an ideal time to bail out of equities."

Morgan Stanley's team of ETF analysts and market strategists just put out its latest assessment of the industry. It's intended to drill down into specific ETFs as well as provide investors and advisors a forecast of prospects in the next three to nine months.  

A sidebar of sorts is that the 293-page report (not counting disclosures) will likely prove to be the final in-depth research coming from the investment firm with Mazzilli as lead analyst. He has confirmed plans to move on, signaling the end of an era as one of the industry's pioneering analysts. (See story here.)

Over the years, Mazzilli often took controversial views of the industry's growth. But his commentary was made on the basis of facts and detailed research. In other words, he was hardly an analyst who shot from the hip to create headlines and bring attention to himself.  

That tendency to take strong views runs through this latest Morgan Stanley report. In a recent interview about the research piece, Mazzilli made it clear that he believes now is the best period he has seen in more than a year to invest in stock ETFs.

How long it'll take for markets to recover is anyone's guess, he emphasizes. But here are a few trends Mazzilli says investors face in coming quarters:

• Large-caps have trailed smaller-cap names for most of the year. That makes wading into large-cap ETFs even more appealing going forward.

"A lot of the selling has been in blue chips, which leaves them with very attractive valuations," said Mazzilli. "And mega-caps, in particular, represent some of the most oversold stocks in the market."

The ETFs he favors in large-caps are: Diamonds Trust (NYSEArca: DIA) and iShares S&P 100 Index (NYSEArca: OEF).

• In large-cap sectors, he notes that Telecom has held up fairly well. Mazzilli brings up AT&T and compares its performance to the banking segment as a case in point.

"Telecoms aren't highly leveraged and people don't stop using phones when the economy sours. They might actually use them more," said Mazzilli.  

The nature of Telecom has changed, he added. "It's not just business communications anymore. It's about wireless and interpersonal communications," Mazzilli added.

He also favors Consumer Staples and Health Care going forward. The report's picks among sector-specific ETFs are: Consumer Staples Select Sector SPDR (NYSEArca: XLP); iShares Dow Jones U.S. Telecommunications (NYSEArca: IYZ) and Health Care Select Sector SPDR (NYSEArca: XLV).

• In terms of broad-based industries, Mazzilli and company believe Energy will rebound at some point. Mazzilli says long-term demand for oil production and services should continue to grow worldwide.

Sector ETFs in the energy space that he favors include: SPDR S&P Biotech ETF (NYSEArca: XBI); iShares DJ Oil Equipment & Services (NYSEArca: IEZ); Claymore S&P Global Water Index ETF (NYSEArca: CGW) and PowerShares WilderHill Clean Energy Portfolio (NYSEArca: PBW).

• His team decided to downgrade ETFs related to defense and aerospace stocks.

"During an election year, that space typically does well. But then after a new president comes in, it usually doesn't do too well," said Mazzilli. "In this case, the new administration will likely have more important spending priorities than defense-related projects."

• International ETFs are particularly due for a bounce, according to short-term technical indicators. But when that could come or how long it'll last is anyone's guess, says Mazzilli. As such, risks with single-country-focused ETFs will be more pronounced than ever.

"As you peel the onion of more-diversified ETFs, you're taking on more varied exposures to different types of risk," said Mazzilli. "Russia, for instance, is severely oversold. But Hong Kong is more of a defensive play, because we see it as a lower-risk way of playing the growth in Asia rather than going into China. Hong Kong also has less currency risk than most countries in general."

In developed international markets, the Morgan Stanley team favors iShares MSCI EAFE Index Fund (NYSEArca: EFA) and Vanguard Europe Pacific ETF (NYSEArca: VEA).

For emerging markets, its top choices are Vanguard Emerging Markets ETF (NYSEArca: VWO) and WisdomTree Emerging Markets High-Yielding Equity Fund (NYSEArca: DEM). 

Murray Coleman is managing editor at IndexUniverse.com. He welcomes comments and suggestions via email at: This e-mail address is being protected from spambots. You need JavaScript enabled to view it .