Thoughts on the Market

How Young People Think About Money Nov 01, 2024

Our US Fintech and Payments analyst reviews a recent survey that reveals key trends on how Gen Z and Millennials handle their personal finances.

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Welcome to Thoughts on the Market. I’m James Faucette, Morgan Stanley’s Head of US Fintech and Payments. Today I’ll dig into the way young people in the US approach their finances and why it matters.

It’s Friday, November 1st, at 10am in New York.

You’d think that Millennials – also commonly known as Gen Y – and Gen Z would come up with new ways to think about money.After all, they live most of their lives online, and don’t always rely on their parents for advice – financial or otherwise. But a survey we conducted suggests the opposite may be true.

To understand how 16 to 43 year-olds – who make up nearly 40 per cent of the US population – view money, we ran an AlphaWise survey of more than 4,000 US consumers.

In general, our work suggests that both Millennials and Gen Z’s financial goals, banking preferences, and medium-term aspirations are not much different from the priorities of previous generations. Young consumers still believe family is the most important aspect in life, similar to what we found in our 2018 survey. They have a positive outlook on home ownership, college education, employment, and their personal financial situation. 28-to-43-year-olds have the second highest average annual income among all age cohorts, earning more than $100,000. They spend an average of $86,000 per year, of which more than a third goes toward housing.

Gen Y and Z largely expect to live in owned homes at a greater rate in five to 10 years, and younger Gen Y cohorts' highest priority is starting a family and raising children in the medium term. This should be a tailwind for many consumer-facing real estate property sectors including retail, residential, lodging and self-storage. However, Gen Y and Z are less mobile today than they were pre-pandemic. Compared to their peers in 2018, they intend to keep living in the same area they're currently living in for the next five to 10 years.

Gen Y and Z consumers reported higher propensity for saving each month relative to older generations, which could be a potential tailwind for discretionary spending. And travel remains a top priority across age cohorts, which sets the stage for ongoing travel strength and favorable cross-border trends for the major credit card providers.

In addition to all these findings, our analysis suggests several surprising facts. For example, our survey results contradict the widely accepted notion that younger generations are "credit averse." The vast majority of Gen Z consumers have one or more traditional credit cards – at a similar rate to Gen X and Millennials. Although traditional credit card usage is higher among Millennials and Gen Z than it was in 2018, data suggests this is driven by convenience, not financing needs. Younger people’s borrowing is primarily related to auto and home loans from traditional lenders rather than fintechs.

Another unexpected finding is that while Gen Y and Z are more drawn to online banking than their predecessors, about 75 per cent acknowledge the importance of physical branch locations – and still prefer to bank with their traditional national, regional, and community banks over online-only providers. What’s more, they also believe physical bank branches will be important long-term.

Overall, our analysis suggests that generations tend to maintain their key priorities as they age. Whether this pattern holds in the future is something we will continue to watch.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

A Global Credit Tour Oct 31, 2024

With the US election as a backdrop, our Head of Corporate Credit Research Andrew Sheets tells three stories that help encapsulate the state of global credit markets.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll go around the credit world in three short stories.

It's Thursday, October 31st at 2pm in London.

The US election next Tuesday continues to be a top issue on investor minds, and indeed is a top issue for us here at Thoughts on the Market, where it’s dominating your feed over this week.

For credit, our positive view this year has been closely tied to the idea that the asset class likes moderation. For example, in data released yesterday the US economy grew a solid 2.8 per cent in the third quarter, while core inflation moderated to just 2.2 per cent, close to the Fed’s target. And Morgan Stanley’s forecasts for the rest of this year and next see that pattern continuing: Solid US Growth, falling inflation, driving steady further rate cuts from the Federal Reserve and all creating a better-than-expected backdrop for credit that should support tighter than average spreads.

That idea that credit likes moderation is core to how we view the election. Outcomes that could drive larger changes in economic policy, domestic policy or foreign policy, are all larger risks. And outcomes that could drive more moderate outcomes across all of these factors are likely going to be better for credit, in our view.

But you may also be tired of hearing about the election. And so for you, here is a quick tour of the credit world in three non-election stories.

In Asia, Korea will be added to the FTSE World Government Bond Index, an important benchmark for global bond investors. This has significant implications across Korean assets, but for Credit, it may be most important for sparking more interest in Corporate Bonds denominated in local Korean Won.

This is a larger market than investors may initially realize, totaling roughly $1 trillion US equivalent in size. And meanwhile, the exposure of foreign investors to this market is historically low. A large market with little global exposure is a potential opportunity.

Moving to Europe, you could be forgiven for thinking the mood is pretty dour. Growth has been weaker than in the United States, while the US Election is raising questions around everything from disruptions to trans-Atlantic trade, to the future of NATO, to the war in Ukraine.

But over the last month, flows into European credit have been extremely good. Per work by my colleagues, inflows into European credit have reached record levels over the last several months. The start of rate cuts leading investors to lock in still-attractive all-in yields in Europe is a big part of this story.

Finally, in the US, we continue to see remarkable shifts in the ease with which investors can trade large volumes of corporate bonds. So-called portfolio trading, where investors buy or sell bonds as a group, continues to grow, with September seeing a new all-time high in activity. Year-to-date, through September, we estimate that roughly $760 billion – with a ‘b’ – has been traded this way. It’s never been easier to trade very large volumes of corporate bonds.

The US election on November 5th will continue to dominate investor focus over the coming days. As it should. Credit has been an enormous beneficiary of the recent backdrop that’s seen solid growth, moderating inflation, and moderating policy rates. The vote will have an important bearing on whether that moderation continues, or if something new takes its place.

But away from the election there are other important things happening. Korea’s Local Currency Corporate bond market is a large, underinvested market that may get more attention after index inclusion. European Credit is seeing record flows despite its macro uncertainties, an indicator of underlying investor demand. And in the US, the continued rise of portfolio trading is re-shaping market structure and improving the ability to trade ever larger volumes of corporate bonds.

Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Oh, and Happy Halloween.

US Election: Waiting Out a Close Race Oct 30, 2024

Our Global Head of Fixed Income and Thematic Research, Michael Zezas, outlines how investors should navigate the closing days of the presidential campaign -- including a vote-counting period that could extend past Election Day.

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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income and Thematic Research. Today is going to be a little bit different. We’re exactly six days away from the US election. The race is neck-and-neck, and I want to sketch out what investors should expect in the next couple of weeks.

It’s Wednesday, October 30, at 10 AM in New York.

This is an historic election, and the outcome remains highly uncertain. What’s more, there’s a good chance we won’t know the winner on election night due to close vote counts. My colleagues and I have spent a lot of time on this show trying to give our listeners a sense of how the election might impact different economies around the word as well as markets, sectors, and specific industries. But today I want to take a step back and highlight a few things that investors should keep in mind right now.

To sum up what we’ve covered so far: The key policies at stake are taxes, tariffs, and immigration. Congressional composition will be critical in determining the extent of tax cut extensions in either win outcome. Domestic, consumer-oriented sectors are most exposed to tax changes, while clean-tech is the most exposed to potential efforts at a repeal of the Inflation Reduction Act. Macro impacts vary depending on the scope of policies and their sequencing, but we see downside risks to growth in a Republican win outcome.

As our listeners know, a candidate needs 270 Electoral College votes to win. Former President Trump’s most likely path to victory is through the Sun Belt – Arizona, North Carolina and Georgia; while Vice President Harris’ most likely path to victory is through the so-called Blue Wall – Michigan, Wisconsin and Pennsylvania.

In terms of the Senate, polling and prediction markets have consistently implied higher likelihood of Republicans winning control. Democrats are defending more seats in states that Trump won in 2020, as well as more seats in states Biden won by a small margin. As far as the House of Representatives, Republicans need 11 of the 25 toss-up seats to maintain control of the House, and Democrats need 15. The generic ballot is the most reliable House indicator, in our view. It’s a political poll which asks not which candidate you plan to vote for to represent you in Congress, but rather which political party – Democrat, Republican or Independent – that you would support. The generic ballot historically correlates with the House winner, and it currently favors Democrats.

All this leaves us with two key takeaways:

First, don’t expect conclusive results on election night. Early vote data from key states reflects our view that vote-by-mail levels are lower than in 2020 but still elevated versus historical levels. And it may take days to get all the mail-in votes counted.

Second, full election results may differ from early returns. Why is that? A candidate may have a deficit in election night vote counts but still come back to win the race once all ballots are counted. This depends on two key variables: The share of the electorate who vote by mail; and the skew among those ballots toward Democrats – a blue shift – or Republicans – a red shift.

So again, we need to be patient and wait for the final results. And when that happens, we will start digging deep into the post-election outlook for the economy and markets.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

The U.S. Election and Tax Policy Oct 29, 2024

Our U.S. Public Policy and Valuation, Accounting & Tax strategists assess the possible scenarios in the upcoming elections, and what they could mean for both taxpayers and the market.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US public policy strategist.

Todd Castagno: And I'm Todd Costagno, Head of Global Valuation, Accounting, and Tax Research at Morgan Stanley.

Ariana Salvatore: With less than a week to go until the US election, the race is still neck and neck. Today, we dig into a key issue voters care about: Taxes.

Todd Castagno: It's Tuesday, October 29th at 10am in New York.

So, Ariana. Taxes are an issue that impact both businesses and individuals. It's a key component of both candidates plans and proposals. How have they evolved over the campaign?

Ariana Salvatore: I'd say in general we do tend to see a lot of overlap between Harris' proposals and the ones that the Democrats were campaigning on before she took over the mantle from President Biden in July. That being said, in some instances, her plans go beyond what was requested in the president's fiscal year [20]25 budget request.

For example, that $6,000 credit for newborns and the $25,000 homebuyer tax credit. These are areas where we've seen her campaign go beyond the scope of what Biden was campaigning on while he was still in the race. Of course, it's important to remember that any of these proposals would have to pass muster in a Democrat controlled or a split Congress – meaning that there will be some tempering of these plans at the margin.

Todd Castagno: So former President Trump campaigned in his first election on tax policy. He's campaigning on tax policy in his current campaign. What are his plans and views?

Ariana Salvatore: We've been talking about the Republican sweep outcome as the most deficit expansionary from tax policy changes because Republicans understandably have more fealty to the 2017 Tax Cuts and Jobs Act.

That law is set to expire by the end of next year. So, in a Trump win scenario plus Republican Congress, we think you can get most of that 2017 law extended. While in a Trump win scenario with divided government, it's probably a little bit narrower. In general, as I said, deficits skew larger in Republican win outcomes for that reason, with an asymmetry across the other election scenarios. That being said, we do still expect to see deficit expansion in 2026, regardless of who's in power, because these tax cuts will be extended one way or another.

But Todd, you've done a lot of work in this area and there are some substantial impacts from a potential corporate rate increase to think through. Can you give us a little bit of detail on what that kind of increase would mean for stocks and bonds?

Todd Castagno: Yeah. So, investors have been very focused on the rate and where it matters and where it does not matter. So, if you really think about it, most companies that are exposed to a rate increase or decrease are domestic oriented, consumer companies, retail companies, you know, hospital facilities, industrials; those are the most exposed to a rate increase.

Multinationals this time around are less exposed. So, if we go back to 2017, we think about it; that was a different story. We had $2 trillion of trapped cash on the sidelines that did come back – buybacks, dividends, corporate hiring. You know, this time around, that's a different story. So there is exposure but it's mainly consumer-oriented companies.

Ariana Salvatore: That makes sense. And you mentioned the 2017 almost as a blueprint for what we saw last time. You mentioned dividends and buybacks.

Do you have any sense of how this time around could be different? What do we think companies would likely spend these tax cuts on?

Todd Castagno: Well, there are tax cuts. I do think it's going to be different. I do think the $2 trillion does not exist. That's not going to happen. So, you're going to have fewer buybacks, fewer dividends. But you could see some changes in employment. You could see some changes in investment. Things like upfront expensing could help boost the economy, higher jobs, et cetera.

One thing, Ariana. You know, tax cuts are expensive. I think that's what we've all contemplated for almost 10 years now. How are we going to pay for these in this new world?

Ariana Salvatore: Well Republicans have proposed a few different pay forwards. But to your point, we're not in the same environment as 2017, and we don't expect to see the same ones that were part of the original Tax Cuts and Jobs Act negotiations this time around. Specifically, former President Trump has talked about not extending the SALT cap, which was a revenue raiser that capped the amount of deductions some individuals could take between state and federal taxes. That provision raised about $900 billion over 10 years.

Republicans in general are mainly focused on peeling back some parts of the IRA – or the Inflation Reduction Act – as a cost saving measure, as well as letting some of the tax cuts from the 2017 law roll off.

We contrast that with the Democrat sweep outcome, where we could see a corporate rate increase to 25 per cent in our view, in spite of Harris’ pledge to bring it up to 28 per cent from the current 21 per cent.

Todd Castagno: So, we could talk about the Inflation Reduction Act for a second. You know, that was a bill that was designed to bring energy, clean energy manufacturing back to the United States.

It was a very large bill; it was partisan. But what do we think about in this next election outcome of actually repealing some of those items?

Ariana Salvatore: It's a great question. And Republicans on the campaign trail have been talking a lot about peeling back the IRA. Importantly, in our view, we don't think a full-scale repeal is likely even in a Republican sweep outcome. There are a few reasons for that, but mainly because if you look at where these projects are being located, it's in Republican held states and districts. And Republicans in the house currently have said that they're not interested in rolling back the law. That being said, there are ways to potentially cap the amount of outstanding money that has not yet been allocated.

And the president could work with the treasury or other federal agencies to tighten up some of the criteria or the guidance around accessing some of the tax credits that will limit the overall deployment.

Todd Castagno: I think the recent Supreme Court decision also plays into that.

With candidates’ tax plans – I’ve run a lot of numbers from a company perspective. You've run a lot of numbers top down from a deficit perspective. What did you come to view?

Ariana Salvatore: We do see deficits expanding in 2026 and beyond. That's because, in our view, it's not really in lawmakers’ interest to allow all of the tax cuts – both individual and corporate – from 2017 to expire. We think the largest extension, as I mentioned before, comes in a Republican sweep. But in general, in some form or another, we think that at least a portion of these lower tax rates are going to stay around.

That adds $2.8 trillion to the deficit over 10 years on the high end per our estimates; and $700 billion over 10 years in our smallest expansion scenario, a Democrat sweep.

So finally, Todd, in either win outcome, what's the timeline of key tax-related events that investors should be paying attention to?

Todd Castagno: So, this is the trillion-dollar question. So, most of the individual side of the tax cuts and jobs act expires at the end of 2025. There are certain business provisions that have already started to phase out. There are certain provisions that are permanent, like the corporate rate.

When will Congress get to this? They will get to it at some point, but we just don't know when that is. Could it be early 2025? Could it be 2026? And I think investors should pay attention to that because Congress doesn't always act on time; and we also don't know what the extensions will look like. Some things could be extended three years, five years, 10 years. Some things could be permanent.

So that's the jigsaw puzzle that we'll have to put together after the election.

Ariana Salvatore: Great. Well, I guess three things in life are certain – death, taxes, and the fact that we will be following this issue very closely.

Todd, thanks so much for taking the time to talk.

Todd Castagno: Great to speak with you.

Ariana Salvatore: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share the podcast with a friend or colleague today.

Markets Uncertain Ahead of U.S. Election Oct 28, 2024

As the U.S. presidential race continues to be neck and neck according to opinion polls, our Chief Fixed Income Strategist considers the possible market implications if some policies proposed during this campaign are implemented.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about understanding market dynamics against the backdrop of U.S. elections.

It's Monday, Oct 28th at 1 pm in New York.

The outcome of the U.S. elections, now just over a week away, has been at the center of every discussion I have had in the last several days. There have been significant moves, not so much in the opinion polls – but in prediction markets. In the opinion polls, the presidential race remains tight and neck-to-neck in key swing states with poll numbers well within the margin of error. But some prediction markets have shifted meaningfully toward Republicans in the contests for both the presidency and control of Congress.

Financial markets have also moved a lot. Stocks exposed to a Republican win outcome have risen a fair bit.

To understand the potential policy changes that can have an impact on markets, I think it is crucial to understand the sequencing of those policy changes.

Given the moves in the prediction markets, let us first frame a Trump win scenario.It seems reasonable to bucket the possible shifts into three categories – fiscal policy, immigration controls, and tariffs.

Meaningful changes in fiscal policy require control of both houses of Congress; and even in a Republican sweep, scenario legislation would still be time-consuming and likely come last. We don’t really have many details on how changes to immigration policy would be implemented and so their timing remains very unclear. On the other hand, given broad presidential discretion on trade policy, Trump’s expressed intentions in his campaign messaging, and the precedent of his first term, tariff changes would likely come first.

Our economists have looked at the potential impact of tariffs on the economy. They concluded that broad tariffs imply downside risks to growth through declines in consumption, investment spending, payrolls, and labor income, and upside risks to inflation. Their estimates suggest that imposing all the tariffs currently under discussion could result in a delayed drag of -1.4 per cent on real GDP growth and a more rapid boost of 0.9 per cent to inflation.

How do we reconcile the equity market’s reaction to the increasing odds of a Trump win in some prediction markets with the idea that there will be a drag on GDP growth and boost to inflation that our economists assess?

Two explanations. Markets could be counting on the prospect that all tariffs would not be imposed. Or at least would be sequenced over an extended period, with some coming much later than others. Also, markets could be putting greater emphasis on the revival of “animal spirits” driven by expectations of regulatory easing, which is hard to define or quantify.

Let us look at other markets.

In the bond markets, treasury yields have risen notably in the last month. Many investors see the Republican sweep outcome as most bearish for US Treasuries, based on the experience of the 2016 election. As Matt Hornbach, our global head of macro strategy has noted, there are meaningful differences between the Fed’s monetary policy today and the pre-election period in 2016, suggesting that any rise in Treasury yields would be more contained this time, even in a Republican sweep outcome.

In 2016, markets were pricing in about 30 basis points of rate hikes over the next 12 months. Contrast that to the current market expectation of about 135 basis points in rate cuts over the next 12 months. Also, in the year after the 2016 election, expectations for the Fed Funds Rate rose nearly 125 basis points. A similar rise in expectations for Fed policy now would require market participants to expect the Fed to stop cutting immediately; and refrain from further cuts through 2025. This seems like a remote possibility – even under a Republican sweep elections scenario.

Given the recent moves across markets and the expectations they are pricing in, markets may now be somewhat offside should Harris win, as they would have to reverse the course.

Elections are a known unknown. Based on opinion polls, this race remains extremely tight, and multiple combinations of presidential and congressional outcomes are very much in play. We must also contend with the prospect that determining the outcome may take much longer this time.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

A $10 Trillion Opportunity in US Reshoring Oct 25, 2024

After decades of offshoring, the pendulum for US manufacturing is swinging back toward domestic production. Our US Multi-Industry Analyst Chris Snyder looks at what’s behind this trend.

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Welcome to Thoughts on the Market. I’m Chris Snyder, Morgan Stanley’s US Multi-Industry Analyst. Today I’ll discuss the far-reaching implications of shifting industrial production back to the United States.

It’s Friday, October 25th, at 10am in New York.

Global manufacturing is undergoing a seismic shift, and the United States is at the epicenter of this transformation. After decades of offshoring and relying on international supply chains, the pendulum is swinging back toward domestic production. This movement – known as reshoring – is not just a fleeting trend but a strategic realignment of manufacturing capabilities that is indicative of the “multipolar” theme playing out globally.

In fact, we believe the US is entering the early innings of re-Industrialization – a multi-decade opportunity that we size at $10 trillion and think has the potential to restore growth to the US industrial economy following more than 20 years of stagnation.

The reshoring of manufacturing to the US is fueled by a combination of factors that are making domestic production both viable and lucrative. While the initial sparks were ignited by policy changes, including tariffs and trade agreements, the COVID-19 pandemic laid bare the risks of elongated supply chains and over-dependence on foreign manufacturing.

Meanwhile, the diffusion of cutting-edge technologies, such as automation, artificial intelligence, and advanced robotics, has diminished the cost advantages of low-wage countries. The US -- with its robust tech sector and innovation ecosystem -- is uniquely positioned to leverage technology to revitalize its manufacturing base.

Who are the direct beneficiaries? High-tech sectors, such as semiconductors, pharmaceuticals, and advanced manufacturing systems, are likely to be the biggest winners. Traditional industrial sectors, such as automotive and aerospace, are also seeing a resurgence. Finally, companies that invest in more sustainable manufacturing processes stand to gain from both policy-driven incentives and a growing market demand. All told, these businesses should see shorter supply chains, reduced legal and tariff costs, and a more resilient operational structure.

As for the broader US economy? We think the implications are pretty profound. In altering the US industrial landscape, reshoring promises not only to boost GDP growth, but it could also stabilize and potentially reverse the trade deficits that have plagued the US economy for years.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Retirement in the Age of Higher Life Expectancy Oct 24, 2024

Morgan Stanley’s European Head of Research Product Paul Walsh speaks to Betsy Graseck, Global Head of Banks and Diversified Finance, and Bruce Hamilton, European Asset Managers Diversified Financials Analyst, about the implications of increasing life expectancy for the financial industry.

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Paul Walsh: Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's European Head of Research Product, and today we dig into a topic that really affects us all. Retirement.

Life cycles are extending as people are living longer, healthier lives. Coupled with government pension funds that are increasingly under pressure, this means that consumers will need to build much more robust investment plans to substitute for salaries to carry them through a longer retirement.

And to understand more about the changing financial needs and challenges of an aging population, I'm delighted to be joined by my colleagues, Betsy Graseck, Global Head of Banks and Diversified Finance, and Bruce Hamilton, our European Asset Managers Diversified Financials Analyst.

It's Thursday, October the 24th at 3pm in London.

Betsy Graseck: And it's 10 am in New York.

Paul Walsh: Now Bruce, let's start with you. As people live longer, they will likely spend more time in retirement. Managing and ensuring retirement income over a longer duration could have a significant impact on asset management. What are the broad trends you're seeing in the industry right now?

Bruce Hamilton: So, the asset management industry in large part has focused on the accumulation phase of investors journey. Whilst this remains critical as people build assets for retirement – and we see growing allocations from affluent investors to private markets as a trend which is likely to be reinforced by the aging theme – there's a significant need for decumulation products and solutions that can offer returns and income over a prolonged retirement.

We see a lot of innovation as asset managers look to develop products to meet this need.

Paul Walsh: So Betsy, people are living longer. How ready are consumers for retirement? Are most retirement plans or similar financial services ready to handle this challenge?

Betsy Graseck: Some are ready. But given how rapidly the global population is aging, there is an increasing need to provide solutions to individuals. Just to put a number on it, the global population that is 65 years old or older in the year 2000 was only 7 per cent. This is set to hit 10 per cent next year in 2025 and 16 per cent in 2050. All groups need service and advice – with the affluent group needing the most increase in services especially if government pension funds come under more pressure.

Paul Walsh: So, I think you set the scene really well there, Betsy, and I guess the obvious question is, how can wealth and financial planners best respond, do you think? Is it by creating new products? Or do we need a much deeper transformation?

Betsy Graseck: We see individuals today having a wide range of retirement choices. What we feel they really need here is personalized, customized advice, delivering solutions that can address their unique needs. These span from affluent individuals needing salary replacement strategies to high-net-worth individuals looking for philanthropic and wealth transfer strategies. A focus on integrated, personalized advice, innovative products, and high-quality service that meets clients as they wish to connect effectively will be critical.

Paul Walsh: It seems to me that it is – but is this a positive for the financial services sector? And if so, what do you think is the size of this revenue opportunity and over what time period do you think?

Betsy Graseck: Well, the way we've looked at this is across the global asset manager and global wealth manager industry, as they will be the ones called upon to address these needs. And we do see a roughly 30 per cent uplift in global revenues by 2028, which equates to [$]400 billion in incremental revenues across the global industry.

And that is driven by the expansion of individuals looking for advice, in particular from the affluent group, as well as an increase in fee-based products to address the income needs.

Paul Walsh: And there's some big numbers that you've quoted there, Betsy. So let's dig into the financial subsector and industries. What are the biggest untapped opportunities there?

Betsy Graseck: Well, the number one is the affluent customer base that we do see having the biggest need for advice, relative to advice seeking today. And as that group, reaches out and receives advice from wealth channels, that is one major driver here. The second driver is the increase in fee-based products to service the income replacement needs.

Paul Walsh: And what are the biggest challenges do you think? Obviously, we've talked about the opportunity there, but the biggest challenges to financial services that you see along the way.

Betsy Graseck: Well, the way I think about this is what is required to be a winner, and the winners need to be able to integrate their entire organizations to deliver for clients. And also leverage technology efficiently and effectively to be able not only to deliver the highest quality service in the way the client wants to be serviced; but also to optimize cost structures, which then can get reinvested – you know, higher pretext getting reinvested into the business.

The challenges are the opposite of institutions that remain siloed and institutions that have, you know, maybe a tech strategy that is not set to respond to the needs of this client set.

Paul Walsh: Thanks for that, Betsy; and Bruce, I just want to pivot back to you. Some asset managers are partnering with insurance companies to offer guaranteed income streams and wealth transfer solutions. What are some of the successful models that you've seen so far?

Bruce Hamilton: So, asset managers are adopting a range of approaches. Some have acquired insurance subsidiaries, some have taken significant minority stakes, while others have looked to deepen partnerships with insurance. Trade offs include the degree of control versus the capital intensity that ownership of insurance brings. So, we see more than one route, but a continued push towards greater collaboration between asset managers and insurers.

Given the potential for the asset managers to access stable, permanent capital, that can then be deployed in a range of investment strategies to offer diversified sources of income via private or structured credit to support returns for the end insurance clients.

Theoretically, the best place models to deliver retirement solutions will have elements of wealth advice, plus a hybrid asset management insurance product approach. Given the importance of providing investors with regular and variable income, a guaranteed minimum level of income, plus an ability to generate a return to offer potential for legacy to pass to heirs.

Paul Walsh: And of course, Bruce, it's very difficult to talk about product innovation, without bringing in the topic of AI. As asset managers are working to create ever more personalized retirement solutions as we've heard, how and to what extent do you think they are leveraging AI?

Bruce Hamilton: So, our interviews with a range of management players confirmed that many of the potential use cases being worked on 12 months ago have now been put into production. It's still early days, and so far, most use cases are focused on areas that can drive efficiencies.

So, for example, in RFP report writing, synthesis of research, and some of the middle and back-office processes for asset managers. But over time, AI can clearly feed more bespoke client service by wealth and asset managers with areas such as customized investment proposals and financial planning offering potential.

Paul Walsh: Fascinating topic. Betsy and Bruce, thank you so much for taking the time to talk.

It's clear that increasing lifespans are reshaping the financials sector by driving product innovation, influencing asset allocation strategies, and, of course, creating new market opportunities.

And to our listeners, thanks as always for taking the time to listen in. If you enjoy Thoughts on the Market, please do leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

Europe’s Demographic Dilemma Oct 23, 2024

Our Chief Europe Economist Jens Eisenschmidt and Europe Equity Strategist Regiane Yamanari discuss the strain of an aging population on the future of Europe’s economy and markets.

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Jens Eisenschmidt: Welcome to Thoughts on the Market. I'm Jens Eisenschmidt, Morgan Stanley's Chief Europe Economist.

Regiane Yamanari: And I’m Regiane Yamanari from the European Equity Strategy Team.

Jens Eisenschmidt: Today we are discussing one of the most urgent challenges Europe is facing right now, a declining working age population – and its implication for Europe's economy and potential solutions.

It’s Wednesday, October 23rd, at 3 pm in Frankfurt.

Regiane Yamanari: And 2 pm in London.

So Jens, people are getting older around the world, living longer. Although the rate of change is different from country to country, can you tell us what's the situation in Europe right now?

Jens Eisenschmidt: Yes, Europe faces a declining working age population, so much is sure. We have just put out a big report, where we come up with numbers around this issue. We think for the large four Euro area countries – Germany, France, Italy, and Spain – we see a decline in Euro area working population by 2040 by 6.4 per cent. People also get older, so that doesn't necessarily mean the overall population is declining by as much. It simply means that working age population, as a sort of most direct, relevant measure for the economy, is declining.

Regiane Yamanari: Why does an aging population hamper economic growth?

Jens Eisenschmidt: So, think about the economy producing, in a very stylized sense, with two factors. One is capital and the other one is labor. And typically, these two factors are connected. So, you can't really produce just with one factor. Typically, you need at least some labor to produce something or at least some machinery to produce something with labor.

So we just; I mean, it's a very simple way of looking at the economy, but typically very powerful in explaining what's going on. So, if we take this approach and look at our economy through the lens of these two factors and we have one factor declining significantly, this will affect the amount the economy can produce.

So, we are talking here about so-called potential growth or potential output. And we think the declining working age population will lead to a decline in potential output. For the Euro area economies I was just mentioning, we think it could be around 4 per cent over the period 2000, from now to 2040. And that amounts to on an annual basis around 25 basis points lower growth potential.

Regiane Yamanari: Suppose policy makers want to boost Europe's working age population, which they do. What options do they have? Which European countries most benefit from these policies or options?

Jens Eisenschmidt: Yeah, the oldest policy measure, or if you want the most discussed one, typically has been birth rates.

Now, many of the policies being implemented here – and they have been implemented for decades already – have been found to be not really changing [the] situation in a profound way. So, birth rates have either stopped increasing again or actually continued dropping. So, policy makers’ attention probably for this reason has turned to other measures.

Other measures we think of here mostly in the current debate is increasing net migration, so you're basically getting your working age population replenished to some extent from the outside. Changing participation pattern in your own domestic labor market – typically, it's framed around the question, how much or how high is the share of one cohort versus the other.

For instance, males versus females. We have countries where there is a large gap between these two groups, just to name an example here. And you know, closing that gap could help you increasing or offset; some of the projected decline in working age population.

Another measure that's often discussed is increasing, retirement age. So essentially working age population is defined by those age between 15 and 64. And of course, if you work for longer, so you increase retirement age, that will also help, to stem against some of the projected decline in working age population.

Now, if you look around for the countries that we are discussing in the report, um, then there are different ways these policies affect these countries.

So, for instance, in Italy, closing the gap between male and female labor force participation would offset a large part of the projected fall in its working age population because that gap is so large. In France, in terms of our numbers, the most effective measure would be increasing the retirement age. And again, in Germany and Spain, it would probably be migration policies that are most effective.

Okay now let's consider the alternative, Regiane. Suppose nothing changes. There are fewer and fewer working age people in Europe. How would this affect companies earning growth?

Regiane Yamanari: So, if there are no policy action, and here assuming all else equal, I mean, no change in productivity, for example. Due to a lower GDP growth, we estimate the headwinds of European demographics could lower companies long term earnings growth by 90 basis points. So, from 5.1 to 4.2 per cent by the end of the decade. And this compares to an average growth of 6.4 per cent that we had in the past 10 years.

Jens Eisenschmidt: And how would this be reflected in the stock market?

Regiane Yamanari: Yeah, so potential lower earnings growth is negative for European equities, right? But it's worth highlighting two points here. First, is that European companies have been diversifying their activities and revenues across the globe in the recent decades. And the revenue exposureof European companies to develop Europe, including the UK has reached a 30-year low. So, we estimate that just 38 per cent of European companies’ revenues are generated in develop Europe, on a free flow market cap weightedbasis.

And second, I think we see this impact being more idiosyncratic at sector at stock level. Just to give an example, so we have this factor analysis that we have done. We found that companies reducing headcount in Europe have been outperforming companies increasing. So in our view, this impact, it will be idiosyncratic, and it will depend by sector and the the stock.

Jens Eisenschmidt: What sectors and industries then do you expect to be most affected by an aging population and the declining labor force?

Regiane Yamanari: Yeah, so first of all, I think one thing to mention is that it's very clear that the theme of, aging population is gaining traction in European C-suite commentary. So we found using AlphaSense Large Language Model, when we analyze companies transcripts, a notable rise in mentions of aging population – and in particular, if we compare to the US, to the US companies, we know that labor intensive industries like kept goods, construction and materials, business services are among those at the top of thelist.

And those mentions have been increasing in most cases when we compare to the average of the last fiveyears.

Jens Eisenschmidt: So how are companies adjusting their business models to account for these challenging demographic trends?

Regiane Yamanari: So we see, for example, industrial automation, robotics, and software adoption accelerating in the face of declining working age population across Europe, which might surprise some people as some people is relatively under-penetrated by technology.

Regiane Yamanari: For example, if we look at industrial robot density in Germany, that is less than half of South Korea. And there are some sectors, for example, like hospitality that our analyst has flagged that the companies have been changing and adopting initiatives related to recruitment, technology adoption, portfolio rationalization – just a few examples here – and adjusting their business models as well to navigate a scenario of reduced labor availability and higher costs. And well, not to mention AI, which we have seen a rapid development and pace of adoption as well.

Jens Eisenschmidt: I'm glad you mentioned AI. It was on my mind. I was about to ask you. So, what do you think, uh, the role of AI could be in helping with the demographic challenge?

Regiane Yamanari: Our view is mainly on productivity gains. So, we them to start materializing, but they are likely to be small and grow consistently over time. An important portion of AI adopter companies cost base are related to R&D, marketing, distribution costs – and these areas we still are to see broad based application of AI, if this is really to be meaningful at the corporate level or even a national level.

So the way we see is that the productivity gains being reflected on margins, but still to be small at this level.

Jens Eisenschmidt: So, this one remains to be seen. We will surely be watching closely whether AI can deliver what it seems to be promising to generate productivity gains to offset the demographic challenge.

Regiane, thanks a lot for taking the time to talk.

Regiane Yamanari: Great speaking with you, Jens.

Jens Eisenschmidt: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Mind Meets Machine in Brain-Computer Interfaces Oct 22, 2024

Our Medical Technology expert analyzes the medical potential and market opportunity in technology that allows direct communication between the human brain and an external device.

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Welcome to Thoughts on the Market. I’m Kallum Titchmarsh, from Morgan Stanley’s U.S. Medical Technology Team. On today’s episode – a dive into a topic that sounds like it’s straight out of science fiction. Brain Computer Interfaces, or BCIs.

It’s Tuesday, October 22, at 10 AM in New York.

The latest version of Tony Stark – better known as his alter ego Iron Man – is a good example of a brain computer interface. When the billionaire businessman-inventor is critically wounded, he builds an armor suit that gives him superhuman abilities. Flying through air. Clearing out obstacles with repulsor blasts. Shooting enemies with guided missiles. All controlled by his brain.

This, of course, is the stuff of science fiction. Real world examples of brain computer interfaces – or BCIs – aren’t fantastical. But they are fascinating. Translating thoughts into actions like generating text on a screen or moving a robotic limb.

BCIs have been in development for more than a century, but recent advances have brought them much closer to becoming a reality. We expect to see BCIs in commercial medical use in about five years, at which point they can help treat a wide range of health disorders, from motor neuron disease – such as ALS – to depression.

The market opportunity for BCIs looks enormous – $400 billion of total addressable market – or TAM – in the US alone. This figure includes two types of BCIs: enabling BCIs, which facilitate behaviors like moving a cursor on a screen, and preventive BCIs, which can prevent adverse events like depressive states or epileptic seizures.

We divide the BCI healthcare opportunity into two segments: early TAM and intermediate TAM. The early TAM includes individuals with critical upper limb impairment and select variants of neurological conditions like epilepsy and depression. These patients will likely be the first to receive a BCI. The intermediate TAM includes patients with moderate upper limb impairment and severe lower limb impairment. As BCI technology develops, these patients will eventually become eligible for treatment.

There are at least 2.8 million patients in the US forming the early TAM and an additional 6.8 million within the intermediate TAM. Together, these groups represent the $400 billion of potential revenue I already mentioned based on a single implant procedure.

The opportunity may be significantly larger when factoring for potential replacement cycles and recurring revenues from software upgrades. But while the estimated TAM is indeed vast, we think penetration will remain limited through the first 20 years of launch. By 2035, we expect just under $1.5 billion of revenue to be generated from BCI implant procedures, hitting north of a $500 million annual run rate in 2036, and reaching the $1 billion annual run rate by 2041.

It’s exciting to think BCIs will begin their healthcare application in the coming years, but we anticipate a number of regulatory hurdles on the way to widespread adoption in healthcare and beyond. Will BCIs push into fields like neurogaming, warfare, and even biological optimization of humans?

The potential is certainly there, and with it the burden of the safe and responsible use of this cutting-edge technology.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

What’s Boosting Cyclical Stocks? Oct 22, 2024

Our CIO and Chief U.S. Equity Strategist explains his preference for cyclical stocks amid a rise in global money supply and current US election dynamics.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about our recent upgrade of quality cyclicals and how it will be affected by the US election and liquidity.

It's Monday, Oct 21st at 11:30am in New York.

So let’s get after it.

We continue to have conviction in our recent cyclical shift and Financials upgrade. Indeed, cyclicals traded well last week as most economic data came in stronger than expected. It’s worth noting we recommend investors stay up the quality curve within the cyclical space, however. While Financials have been the best performing sector in the S&P 500 since our upgrade, institutional investors remain under-exposed to Financials based on our data suggesting the sector can run further.

In addition to better economic data, there are other factors affecting pro-cyclical stocks. We are focused on two, in particular. The election and global liquidity.

We believe a Trump win with a split Congress would provide a pro-cyclical bias with small caps keeping pace with large caps. The markets seem to agree, with the recent cyclicals outperformance led by financials. Meanwhile, consumer stocks negatively exposed to tariff risks under a Trump win have underperformed. Interestingly, there is some overlap between this recent leadership and the post Biden debate period in early July as well as the months surrounding the 2016 election. Finally, we've also witnessed higher interest rates and a stronger US Dollar more recently, which is something to watch closely as a possible headwind for liquidity post election and into 2025.

While some argue a Trump win would be a headwind for growth and equity markets, due to tariff risks and slower immigration, we think there's an additional element from the 2016 experience that’s worth considering—rising animal spirits. More specifically, in 2016 Trump's pro-business approach led to the largest three-month positive impact on small business confidence in the past 40 years. It also translated into a spike in individual investor sentiment. It appears to me that markets may be trying to front-run a repeat of this outcome as Trump's win in 2016 came as a surprise to pundits and markets alike.

This also means a Harris win could lead to some reversion in terms of overall equity market performance and leadership. Most notably, bonds could potentially rally with defensive and quality growth stocks doing better like earlier this year. Secondarily, even with a Trump win, certain areas of the market may be vulnerable to a ‘sell the news’ phenomena if the upside is already priced amid bullish positioning.

On this front, we would also point out that the economic set-up today is very different than the 2016 period when the economy had much more slack and could absorb additional pro-cyclical policies like tax cuts or other forms of fiscal stimulus.

Turning to liquidity, we note that global money supply in US dollars has surged at an 18 per cent annualized rate since the end of June. I believe this has also had a positive effect on equity prices, not to mention credit spreads, precious metals, cryptocurrencies and real estate.

Bottom line, in the absence of a major swing in election probabilities or global liquidity between now and the election, equity markets are likely to trade with a bullish tilt both at the index level and from a style, sector, factor standpoint.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

How the US Election Could Upset Credit Markets Oct 18, 2024

Our Head of Corporate Credit Research Andrew Sheets discusses why uncertainty around the election’s outcome could be detrimental for credit investors.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss the US Election, and how it might matter for Credit.

It's Friday, October 18th, at 4pm in London.

Morgan Stanley’s positive view on credit this year has been anchored on a simplistic thesis. Credit is an asset class that hates extremes, as it faces losses if a company fails, but doesn’t earn extra if that company’s profits double or even triple. Credit, to an unusual degree, is an asset class that loves moderation.

And here at Morgan Stanley, we’ve been forecasting … a lot of moderation. Moderate growth for the U.S. and Europe. Moderating inflation, that continues to fall into next year. And a moderation of central bank interest rates, rather than the type of sharp declines that you tend to see around recessions; as we think Fed funds will settle in a little bit below three-and-a-half per cent by the middle of next year. This moderate economy, coupled with moderate levels of corporate aggressiveness should be music to a credit investor’s ears, and support richer-than-average valuations, in our view.

So how does the upcoming U.S. election on November 5th fit into this otherwise benign picture?

Who runs a government matters, especially when it’s the government of the world’s largest and strongest economy. This election is also notable for the differences between the two candidates, who are presenting sharply contrasting visions of economic, domestic and foreign policy. Against this backdrop, we suggest credit investors try to keep a few things top of mind.

First, and most broadly, the idea that “credit likes moderation” remains our north star. Outcomes that could drive larger changes of economic policy, or larger uncertainty in policy in general, are probably going to be a larger risk for credit.

Second, of all the various policies under discussion, tariffs feel especially important as they can be largely implemented without congressional approval, and are thus far easier to see go into effect. Tariff proposals could create significant dispersion at the single-name level in credit, and pose significant risks for sectors like retail, which import a large share of their ultimate goods. For time-limited investors, tariffs are the policy area where we’d spend the most time – and where much of our Credit Research around the election has been focused.

Third, it’s notable that as we head into this election, expected volatility, in equities or credit, is elevated even as the stock market sits near all time highs, and credit spreads are historically low. So this begs the question. Do these options markets know something that the rest of the market does not? We’re skeptical. Historically, when you’ve seen high volatility alongside all-time-highs in the market – and it’s not all that common – it’s tended to be a positive short-term indicator, rather than a negative one. And one way we could perhaps explain this is that it suggests that investors are still a little bit nervous, and not as positive as they otherwise could be.

The U.S. election is close in time, uncertain in outcome, and has stakes for future policy. That high implied volatility we see at the moment, in our view, could reflect known unknowns, rather than some hidden factor. Tariff policy, being largely independent of congress and thus easier to implement, is probably the most relevant for single-name credit exposures. And most broadly, credit likes moderation, and should do best in outcomes that are more likely to achieve that.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Could the US Election Reshape the Energy Sector? Oct 17, 2024

Our expert panel explains whether the US election will impact energy policy, including how the Inflation Reduction Act’s possible fate and increased tariffs could transform the sector.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.

David Arcaro: I'm Dave Arcaro, Morgan Stanley's US Power and Utilities Analyst.

Andrew Percoco: And I'm Andrew Percoco, the North American Clean Tech Analyst here at Morgan Stanley.

Michael Zezas: And today we're discussing another key election related topic that generates a lot of political and market debate: Energy policy.

It's Thursday, October 17th at 10am in New York.

The outcome of the 2024 election will likely determine the direction of U.S. climate policy for years to come. David, what are the key focus areas for investors as they evaluate the various election outcomes on the utilities and clean energy industries?

David Arcaro: Yeah, Mike, investors are highly focused on the Inflation Reduction Act, the IRA, especially as it pertains to the election and the clean energy space. This was a law that was passed in 2022, and it really has supportive policies across the entire clean energy spectrum. It's got tax credits and incentives for solar, wind, offshore wind, green, hydrogen, nuclear, you name it. Battery storage. And some of those tax credits go all the way to 2032 and beyond in some cases.

So, it's a very supportive policy when it comes to the clean energy industry and the growth outlook. So, the big question is what's going to happen to the Inflation Reduction Act – depending on which administration is in place following the election.

Our core view is that the IRA stays in place; that the core wind, solar storage and nuclear tax credits all remain, regardless of the outcome of the election. And then separately, investors are focused on tariff policy as it pertains to clean energy. It is a global industry. A lot of the equipment and materials are imported around the world. And so, any changes to the tariff approach could have an impact on the space as well.

Michael Zezas: Got it. And so how does the outlook for renewables change under different election outcomes?

David Arcaro: Yeah, really, the outlook for renewables growth is not very different in our view, regardless of the outcome of the election.

We think it's a strong growth outlook either way. And part of that is because we've got policies that we expect to stay in place that will be supportive regardless of the outcome, as I mentioned with the Inflation Reduction Act. And then we've also got demand. It's a very strong demand backdrop for the renewable space – and that's because in the electric industry, we're seeing an inflection in electricity usage across the US.

It's been stagnant for years and years, but now with data center growth, with industrial production accelerating, and manufacturing and onshoring, we're seeing a big change in the growth outlook for electricity usage. And that means we need more power plants. We need more to be built, and renewables are going to be the predominant new resource for producing electricity in the US.

Some of these companies like data centers, they want renewables to power their operations. And most utilities, electric companies that are building power plants, they're going to be using renewables more than anything else. There are impediments to building fossil plants, it's challenging to permit and there's supply chain delays and issues.

So, we think there's a very strong growth outlook for renewables based on that demand and the policy support going forward, regardless of the outcome.

Michael Zezas: And Andrew, how about corporate tax policy, including renewable energy tax credits?

Andrew Percoco: I mean, as Dave mentioned, we think IRA repeal risk is very low, and I think the only scenario where IRA repeal is a relevant conversation is in a Republican sweep scenario. But even under this scenario, we would expect any repeal measures to be targeted in nature and not a wholesale repeal of the bill. So, the question then becomes, you know, what is safe and what's at risk of getting cut.

So, to start off with what's safe; maybe three items that I'll highlight. One would be domestic manufacturing tax credits. There's been a lot of bipartisan support for the onshoring of manufacturing. So, the clean energy manufacturing tax credits within the IRA look like they are on solid footing, regardless of the election outcome.

Now, why do domestic manufacturing tax credits have bipartisan support? One, there's a general view that we need to reduce our reliance on China for our energy infrastructure and, two, the job creation angle. The IRA has created over 150, 000 new jobs, and a lot of those jobs are in states where there is a large representation of Republican voters. So, the local pushback would be pretty severe if IRA was repealed in full.

Number two, area of IRA that we think is safe would be nuclear tax credits. There's a general understanding across both sides of the aisle that nuclear is an important and reliable form of clean energy, and that we need to support the existing fleet of assets.

And then third again, as Dave mentioned, solar storage and wind investment tax credits. These have been around for a while, well before the IRA was in place and they've had bipartisan support. They've been extended multiple times, even under past Republican administrations. So, we would not expect any changes to those core tax credits in a Republican sweep.

On the flip side, you know what's potentially at risk in a Republican sweep? Number one would be consumer facing tax credits like the EV tax credits. This is something that the Republicans have definitely taken aim at on the campaign trail.

Number two would be offshore wind. Former President Trump has definitely had [a] very candid view of offshore wind, and the issues that it poses on local communities. So, this could be another area where, they look for some targeted repeal. And then the third would just be delayed implementation of any unfinalized rules, by the time they take office.

Michael Zezas: Makes sense. And finally, what other key election implications should investors focus on at this point when it comes to clean energy?

Andrew Percoco: Yeah, I think the biggest would be around tariffs. It's frankly the hardest to predict but could have some pretty meaningful near-term implications for clean energy.

Just to zoom out for a second, the clean energy supply chain is global with a heavy concentration in China and Southeast Asia. So, if there is higher tariffs put in place against these regions, it could create some disruption in supply chains and impact the pace at which we deploy renewables in the US. But frankly, at the same time, it should just accelerate a trend that we're already seeing in the US, which is the onshoring of manufacturing, thanks in part due to the IRA.

So ultimately could create some near-term disruption but doesn't change the secular growth for the renewable space since developers in the US have already started to make the shift towards domestic supply.

Michael Zezas: Yeah, that makes sense, Andrew. And obviously tariffs have been top of mind for investors as we've talked about here. Well, David, Andrew, thanks for taking the time to talk.

And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share Thoughts on the Market with a friend or colleague today.

What Does The Fed Rate Cut Mean For Mortgages? Oct 16, 2024

Mortgage rates aren’t directly influenced by Federal Reserve policy. However, the Fed’s recent cut likely will have a domino effect on the US housing market, say our Co-Heads of Securitized Products Research Jay Bacow and James Egan.

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Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of Securitized Products Research at Morgan Stanley.

James Egan: And I'm Jim Egan, the other Co-Head of Securitized Products Research at Morgan Stanley. And on this episode of the podcast, we're going to discuss the impacts of a 50-basis point cut from the Fed on the US housing and mortgage markets.

It's Wednesday, October 16th at 1 pm in New York.

Now, Jay, the Fed cut 50 basis points at its last meeting. What are your views on the mortgage market in the aftermath of that cut?

Jay Bacow: We think that is constructive for mortgages and we recommended a long mortgage basis versus rates. The healthy economy and a Fed that doesn't want to fall behind the curve should be good for risk assets in general. We think there's a likelihood of vol possibly falling and that is constructive for agency mortgages in particular.

Now it's a positive narrative. But, the valuations matter, and we have to admit that the valuations are not that compelling with spreads on agency mortgages trading near the tights since the regional bank crisis. However, if you look further back, mortgages start to look attractive, particularly relative to other high quality fixed-income assets.

For instance, agency mortgages are basically trading at the average spread they've traded at since the GFC. Corporate credit, on the other hand, is trading within a few basis points of the tights since the GFC. If risk assets are going to do well, and we're certainly seeing that in corporate credit and in the stock market, we think mortgages are particularly priced attractively relative to most of them.

James Egan: Alright, so relative value for mortgages makes sense, but can you talk a little bit about the technicals here?

Jay Bacow: The technicals are where we feel more confident. One of the reasons why mortgage spreads have been wide for the past two years – it's an environment where the Fed and the domestic banks, the two largest holders of mortgages, have been reducing their holdings.

Now, we still expect the Fed to reduce their holdings of mortgages, but we think the bank demand is going to turn positive. That's due to not just clarity around the Basel III Endgame that should be coming soon, but more directly related to this conversation – as the Fed cuts rates that directly impacts the amount of yield that banks earn of the cash sitting at the Fed.

Now, that is projected to continue to go down as the Fed cuts rates. What's not projected to continually go down very much is the yield on the securities that they can be buying in mortgages. So, the incentive for them to move out of cash and into securities, and those securities likely to be mortgages, is picking up as the Fed cuts rates. And it's not just the banks that are going to be more active. It's also overseas investors. As the Fed cuts rates and the Bank of Japan hikes, the FX (foreign exchange) hedging costs, which is basically a function of the interest rate differential between the two banks is likely to decrease, which means that overseas investors will be more active.

A steeper curve is going to be positive for REIT demand. And then over time, as the Fed cuts rates and money market yields go down, those retail investors are likely to be incentivized to move out of money market funds into core funds with higher yields, which will be supportive of money manager demand – although that's likely a 2025 story.

James Egan: All right, Jay, thank you for that. But one of the questions that you and I have received a lot since the Fed's cut is: Okay, the Fed cut 50 basis points. Why haven't mortgage rates come down by 50 basis points on the follow?

Jay Bacow: Well, so, mortgage rates, obviously in the US, the vast majority of them are 30-year fixed rate mortgages. And so, if you have one, the Fed actions don't impact that. If you have an adjustable-rate mortgage, it will reset – but typically those resets happen every six months. Although you're probably getting asked about the prevailing mortgage rate; and the prevailing mortgage rate – because it's the 30-year fixed rate, it's not a function of Fed funds – but it's more of a function of the yields further out the curve. Although maybe Jim, you can do a better job explaining this.

James Egan: So, when it comes to interest rates and mortgages, Jay, as you mentioned, we're going to be more focused on the five- and 10-year part of the curve than we are on Fed funds.

To provide a little bit of an example there, from the fourth quarter of 2023 until the Wednesday morning that the Fed cut, 30-year mortgage rates had decreased by 180 basis points. The Fed had yet to cut a single basis point. But, just taking a step back from that cut specifically, mortgage rates have come down significantly from the fourth quarter of 2023.

Jay Bacow: Right, and those mortgage rates coming down significantly has improved affordability. But what's maybe a little surprising is that hasn't really led to a pickup in sales volumes. How should we think about that moving forward?

James Egan: So as mortgage rates have come down, we have seen an increase in mortgage applications, but that's been driven almost entirely by refinance applications.

Purchase applications, and that's going to be what's behind home sales, those have been more or less treading water for the past 12 months. This relationship makes sense, in our view. As mortgage rates have come down, housing remains unaffordable. It's just more affordable than it was in the second half of 2023.

But, if you were one of the people who bought a home over the past 24 months, and, to put that into context, that was the lowest number of home sales over a 24-month period since the second quarter of 2013. But if you were one of those people, there's a good chance that you're in the money to refinance right now.

Jay Bacow: And that's something that we're seeing in the data. We've talked about the truly refinance indicators on this podcast in the past, and it measures the share of mortgages that have at least 25 basis points of incentive to refinance after accounting for closing costs.

Right now, only about one in six of the outstanding borrowers have incentive to refinance. Now, that's up from pretty close to zero at the end of 2023, but if you just look at borrowers that have taken out their mortgage in the past two years, almost two-thirds of them have incentive to refinance.

Now, Jim, does that mean that purchase volumes are doomed to languish around these levels?

James Egan: No, but the reaction might not be as strong as some people are hoping for. While affordability has improved, it remains challenged. And the lock in effect has become a very popular phrase in the US housing and mortgage markets. And that's still in play. 75 per cent of the conventional mortgage universe still has a mortgage rate below 5 per cent.

Even with the prevailing rate at 6 per cent today, the effective mortgage rate on the outstanding universe is 200 basis points out of the money. That's better than 350 [basis points] out of the money like we saw last year. But that would still be the worst that it's been in 40 years.

Jay Bacow: And presumably, that is why we have this continually tight inventory.

James Egan: Exactly. Now, as rates come down, we are starting to see listings increase, but it's barely made a dent in the historically low nature of the existing housing supply. The existing home sales typically grow in the 12 to 24 months following affordability improvement, but not necessarily in that initial period while affordability is improving.

So relative to history, we're actually not underperforming that much from a sales perspective. And we should be beginning that 12 to 24 months sweet spot in the fourth quarter of [20]24. We just started that two to three weeks ago. While we expect existing home sales to increase, we think the growth is going to be modest relative to history and we're calling for 5 per cent growth in the coming 12 months.

On the home price side, a lot of this is in line with our current view. So, we think you're going to continue to see the pace of growth slow. It's already started to slow. We think we get from about 5 per cent today to 2 percent by the end.

Jay Bacow: All right, so the Fed cutting rates is not likely to cause mortgage rates to drop materially. We expect a modest pickup in housing activity. We expect home price growth to slow, but still end the year positive; and it should be supportive for mortgage spreads versus treasuries.

Jim, always a pleasure talking to you.

James Egan: Pleasure talking to you too, Jay.

Jay Bacow: Thanks for listening. And if you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

South Korea’s ‘Super-Aging’ Challenge Oct 15, 2024

Our Chief Korea and Taiwan Economist discusses the reforms needed to overcome Korea’s urgent demographic crisis.

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Welcome to Thoughts on the Market. I’m Kathleen Oh, Morgan Stanley’s Chief Korea and Taiwan Economist. Today I’ll discuss what’s needed to overcome Korea’s aging population crisis.

It’s Tuesday, Oct 15th, at 4 PM in Hong Kong.

South Korea faces some of the world's most challenging demographics and will officially become a super-aged society next year – that’s more than 20 percent of the population 65 or older. The implications of this are so significant that the Korean government recently declared a national emergency, and we don’t think this is overstating the case.

Korea’s low fertility rate is the primary culprit. In 2023 it plummeted to the lowest level globally and currently sits at 0.72. For reference, the total fertility rate of 2.1 children per woman is what’s necessary to maintain a stable population in general. By next year, Korea’s population will start declining and is projected to shrink by a third over the next 40 years as the working population halves. At this pace, the Bank of Korea forecasts that Korea’s potential growth could enter negative territory by 2040, down from 2 per cent in [20]24-25.

So why does Korea have such a record-low fertility rate? In the short term, there are two key drivers: First, the declining number of marriages during the pandemic drove a rapid drop in births; having children out of wedlock is taboo in Korea. Once weddings resumed in 2022, Korea saw a slight but insufficient rebound in births.

Second, housing prices have gone up 80 per cent in the past decade, which has discouraged young couples from having families. Families with first children feeling extra financial burdens to have [a] second child. Beyond the short term, structural factors have also played a role. After a compressed period of rapid economic growth, Koreans feel uncertain about the employment conditions and housing outlook.

Tackling the low fertility rate has been on Korean policymakers’ agenda for the past 20 years. The government has invested more than $320 billion into solving the demographic challenge. And while these efforts have certainly raised awareness, they have yet to overcome the crisis. And why? Because Korea has not addressed the root causes of the problem -- income uncertainty, high childcare and education costs.

It’s clear what’s needed here are structural reforms and Korea is clearly taking important steps towards overcoming the issue by tackling the fundamental problems now. Policymakers are working to reshape the pension system for the first time in 15 years. They are focusing on measures around improving work-life balance, reducing the gender wage gap, and increasing support for working parents. They are also considering lowering barriers to immigration, which could help alleviate talent shortages. They are also working on reducing the cost of private education. And finally, the government is also focused on improving the country’s capital market infrastructure. They are aiming to attract foreign investment, as well as to help households secure [a] source of asset accumulation, and lower borrowing costs for domestic players.

Of course, it’s impossible to quickly reverse the downtrend and positive change will require multiple years - even decades. Korea’s government has set a medium-term goal of returning the fertility rate to 1.0 by 2030, which would delay working population decline by five years. And if the fertility rate reaches 2.1, that would delay the decline in the workforce by 20 years. Conversely, if Korea’s fertility rate remains at the current rate of 0.72, the population will halve by 2065 and the economy will start contracting in 2040, a worst-case scenario that the government is determined to avoid.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Markets Spin Toward Cyclicals Oct 14, 2024

A slump in tech stocks may explain the market rotation – but it’s the earnings season that investors need to watch, says CIO and Chief US Equity Strategist Mike Wilson.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the recent rotation toward more cyclical parts of the equity market.

It's Monday, Oct 14th at 11:30am in New York.

So let’s get after it.

Last Monday, we upgraded cyclicals relative to defensives after taking profits in our defensive overweight two weeks prior. These calls come on the back of September's strong jobs report and our economists' expectation for the Fed to still cut interest rates into next year. The resilient labor report effectively reverses the softness we saw in labor markets over the summer which had re-introduced hard landing risks into the markets, driving big outperformance in bonds and defensive stocks. In short, it was a good time to lock in profits after an historically good run.

Indeed, cyclical stocks have delivered better performance with these improved macro data. Importantly, the rates market is confirming this move. Oftentimes, the rates market tends to hold onto growth risks longer than the equity market. Thus, the recent move higher in yields following resilient data suggests the bond market pricing is shedding some of its growth concerns, and giving us more confidence in our cyclicals upgrade.

Furthermore, our cyclical overweights at the sector level in Industrials, Financials and Energy are all exhibiting a positive correlation to rates. Conversely, defensives are exhibiting a negative correlation to yields. In other words, good macro data is still good for many large cap cyclical stocks, while it's bad for defensives. Thus, further stabilization in the economic surprise index should continue to support quality cyclicals' relative performance even if it comes amid higher yields.

Meanwhile, positioningin cyclicals remains light amongst our institutional client base. This is particularly true for Financials. In our view, this creates opportunity in a sector that we upgraded to overweight last week. This upgrade was based on rebounding capital markets activity, a better loan growth environment in 2025, an acceleration in buybacks post Basel Endgame re-proposal, and attractive relative valuation. Finally, we also factored in the notion that several large cap bank stocks had de-risked in mid-September with lowered guidance ahead of earnings season. Initial results from earnings season last week indicate that large cap banks are clearing that lowered hurdle. On the other side of the coin, positioning in defensives and quality growth remains extended. This is consistent with our conversations with clients who generally remain positioned for a soft macro growth regime.

Given the significant influence of the Magnificent 7 stocks on the overall direction of the S&P 500, investors remain focused on how this group of stocks will trade into year-end. It's notable this cohort has underperformed since the second quarter earnings season, and relative performance just took another leg lower. The breadth among this group has been somewhat narrow with only one of the seven making new highs since the summer in both absolute and relative terms. In our view, this may be one of the reasons for the better performance in other areas of the market and is a potential driver of further broadening into cyclicals. Of course, if the market reverts back to these stocks, it’s a risk to our cyclical upgrade.

Earnings season will be an important factor in terms of these rotations. The fundamental reason for the underperformance of the Magnificent 7 could simply be the deceleration in earnings growth from the very strong pace last year. If this underperformance continues, it could provide further fuel for the quality cyclicals to continue to do better as we expect. Conversely, if earnings revisions show relative strength for the Mag 7, these stocks will likely outperform once again and market leadership may narrow—like it did during [the] second quarter and all of 2023.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

US Economy: What Could Go Wrong Oct 11, 2024

Our Head of Corporate Credit Research and Global Chief Economist explain why they’re watching the consumer savings rate, tariffs and capital expenditures.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Andrew Sheets: And today on this special episode of the podcast, we'll be discussing what could cause our optimistic view on the economy and credit to go wrong.

Andrew Sheets: It’s Friday, Oct 11th at 4pm in London.

Seth Carpenter: And as it turns out, I'm in London with Andrew.

Andrew Sheets: So, Seth you and your global economics team have been pretty optimistic on the economy this year. And have been firmly in the soft-landing camp. And I think we’ve seen some oscillation in the market's view around the economy over the course of the year, but more recently, we've started to see some better data and increasing confidence in that view.

So, this is actually maybe the perfect opportunity to talk about – well, what could go wrong? And so, what are some of the factors that worry you most that could derail the story?

Seth Carpenter: We have been pretty constructive all along the whole hiking cycle. In fact, we've been calling for a soft- landing. And if anything, where we were wrong with our forecast so far is that things have turned out even better than we dare hoped. But it's worth remembering part of the soft-landing call for us, especially for the US is that coming out of COVID; the economy rebounded employment rebounded, but not proportionally. And so, for a long time, up until basically now, US firms had been operating shorthanded. And so, we were pretty optimistic that even if there was something that caused a slowdown, you were not going to see a wave of layoffs. And that's usually what contributes to a recession. A slowdown, then people get laid off, laid off people spend less, the economy slows down more, and it snowballs.

So, I have to say, there is gotta be just a little bit more risk because businesses basically backfilled most of their vacancies. And so, if we do get a big slowdown for some reason, maybe there's more risk than there was, say, a year ago. So, what could that something be is a real question. I think the first one is just -- there's just uncertainty.

And maybe, just maybe, the restraint that monetary policy has imparted -- takes a little bit longer than we realized. It's a little bit bigger than we realized, and things are slowing down. We just haven't seen the full force of it, and we just slowed down a lot more.

Not a whole lot I can do about that. I feel pretty good. Spending data is good. The last jobs report was good. So, I see that as a risk that just hangs over my head, like the sword of Damocles, at all times.

Andrew Sheets: And, Seth, another thing I want to talk to you about is this analysis of the economy that we do with the data that's available. And yet we recently got some pretty major revisions to the US economic picture that have changed, you know, kind of our basic understanding of what the savings rate was, you know, what some of these indicators are.

How have those revisions changed what you think the picture is?

Seth Carpenter: So those benchmark revisions were important. But I will say it's not as though it was just a wholesale change in what we thought we understood. Instead, the key change that happened is we had information on GDP -- gross domestic product -- which comes from a lot of spending data. There's another bit of data that's gross domestic income that in some idealized economic model version of the world, those two things are the same -- but they had been really different. And the measured income had been much lower than the measured gross domestic product, the spending data. And so, it looked like the saving rate was very, very low.

But it also raised a bit of a red flag, because if the savings rate is, is really low, and all of a sudden households go back to saving the normal amount, that necessarily means they'd slow their spending a lot, and that's what causes a downturn.

So, it didn't change our view, baseline view, about where the economy was, but it helped resolve a sniggling, intellectual tension in the back of the head, and it did take away at least one of the downside risks, i.e. that the savings rate was overdone, and consumers might have to pull back.

But I have to say, Andrew, another thing that could go wrong, could come from policy decisions that we don't know the answer to just yet. Let you in on a little secret. Don't tell anybody I told you this; but later this year, in fact, next month, there's an election in the United States.

Andrew Sheets: Oh my goodness.

Seth Carpenter: One of the policies that we have tried to model is tariffs. Tariffs are a tax. And so, the normal way I think a lot of people think about what tariffs might do is if you put a tax on consumer goods coming into the country, it could make them more expensive, could make people buy less, and so you'd get a little bit less activity, a little bit higher prices.

In addition to consumer goods, though, we also import a lot of intermediate goods for production, so physical goods that are used in manufacturing in the United States to produce a final output. And so, if you're putting a tax on that, you'll get less manufacturing in the United States.

We also import capital goods. So, things that go into business CapEx spending in the United States. And if you put a tax on that, well, businesses will do less investment spending. So, there's a disruption to actual US production, not just US consumption that goes on. And we actually think that could be material. And we've tried to model some of the policy proposals that are out there. 60 per cent tariff on China, 10 per cent tariff on the rest of the world.

None of these answers are going to be exact, none of these are going to be precise, but you get something on the order of an extra nine-tenths of a percentage point of inflation, so a pretty big reversion in inflation. But maybe closing in on one and a half percentage points of a drag on GDP – if they were all implemented at the same time in full force.

So that's another place where I think we could be wrong. It could be a big hit to the economy; but that's one place where there's just lots of uncertainty, so we have to flag it as a risk to our clients. But it's not in our baseline view.

Seth Carpenter: But I have to say, you've been forcing me to question my optimism, which is entirely unfair. You, sir, have been pretty bullish on the credit market. Credit spreads are, dare I say it, really tight by historical standards.

And yet, that doesn't cause you to want to call for mortgage spreads to widen appreciably. It doesn't call for you to want to go really short on credit. Why are you so optimistic? Isn't there really only one direction to go?

Andrew Sheets: So, there are kind of a few factors the way that we're thinking about that. So, one is we do think that the fundamental backdrop, the economic forecast that you and your team have laid out are better than average for credit -- are almost kind of ideal for what a credit investor would like.

Credit likes moderation. We're forecasting a lot of moderation. And, also kind of the supply and demand dynamics of the market. What we call the technicals are better than average. There's a lot of demand for bonds. And companies, while they're getting a little bit more optimistic, and a little bit more aggressive, they're not borrowing in the kind of hand over fist type of way that usually causes more problems. And so, you should have richer than average valuations.

Now, in terms of, I think, what disrupts that story, it could be, well, what if the technicals or the fundamentals are no longer good? And, you know, I think you've highlighted some scenarios where the economic forecasts could change. And if those forecasts do change, we're probably going to need to think about changing our view. And that's also true bottom up. I think if we started to see Corporates get a lot more optimistic, a lot more aggressive. You know, hubris is often the enemy of the bond investor, the credit investor.

I don't think we're there yet, but I think if we started to see that, that could present a larger problem. And both, you know, fundamentally it causes companies to take on more debt, but also kind of technically, because it means a lot more supply relative to demand.

Seth Carpenter: I see. I see. But I wonder, you said, if our outlook, sort of, doesn't materialize, that's a clear path to a worse outcome for your market. And I think that makes sense.

But the market hasn't always agreed with us. If we think back not that long ago to August, the market had real turmoil going on because we got a very weak Non Farm Payrolls print in the United States. And people started asking again. ‘Are you sure, Seth? Doesn't this mean we're heading for a recession?’ And asset markets responded.

What happened to credit markets then, and what does it tell you about how credit markets might evolve going forward, even if, at the end of the day, we're still right?

Andrew Sheets: Well, so I think there have been some good indications that there were parts of the market where maybe investors were pretty vulnerably positioned. Where there was more leverage, more kind of aggressiveness in how investors were leaning, and the fact that credit, yes, credit weakened, but it didn't weaken nearly as much -- I think does suggest that investors are going to this market eyes wide open. They're aware that spreads are tight. So, I think that's important.

The other I think really fundamental tension that I think credit investors are dealing with -- but also I think equity investors are -- is there are certain indicators that suggest a recession is more likely than normal. Things like the yield curve being inverted or purchasing manager indices, these PMIs being below 50.

But that also doesn't mean that a recession is assured by any means. And so, I do think what can challenge the market is a starting point where people see indicators that they think mean a recession is more likely, some set of weak data that would seem to confirm that thesis, and a feeling that, well, the writing's on the wall.

But I think it's also meant, and I think we've seen this since September, that this is a real, in very simple terms, kind of good is good market. You know, I got asked a lot in the aftermath of some of the September numbers, internally at Morgan Stanley, 'Is it, is it too good? Was the jobs number too good for credit?'

And, and my view is, because I think the market is so firmly shifted to ‘we're worried about growth,’ that it's going to take a lot more good data for that fear to really recede in the market to worry about something else.

Seth Carpenter: Yeah, it's funny. Some people just won't take yes for an answer. Alright, let me, let me end up with one more question for you.

So when we think about the cycle, I hear as I'm sure you do from lots of clients -- aren't we, late cycle, aren't things coming to an end? Have we ever seen a cycle before where the Fed hiked this much and it didn't end in tears? And the answer is actually yes. And so, I have often been pointing people to the 1990s.

1994, there was a pretty substantial rate hiking cycle that doesn't look that different from what we just lived through. The Fed stopped hiking, held out at the peak for a while, and then the economy wobbled a little bit. It did slow down, and they cut rates. And some of the wobbles, for a while at least, looked pretty serious. The Fed, as it turns out, only cut 75 basis points and then held rates steady. The economy stabilized and we had another half decade of expansion.

So, I'm not saying history is going to repeat itself exactly. But I think it should be, at least from my perspective, a good example for people to have another cycle to look at where things might turn out well with the soft landing.

Looking back to that period, what happened in credit markets?

Andrew Sheets: So, that mid-90s soft-landing was in the modern history of credit -- call it the last 40 years -- the tightest credit spreads have ever been. That was in 1997. And they were still kind of materially tighter from today's levels.

So we do have historical evidence that it can mean the market can trade tighter than here. It's also really fascinating because the 1990s were kind of two bull markets. There was a first stage that, that stage you were suggesting where, you know, the Fed started cutting; but the market wasn't really sure if it was going to stick that landing, if the economy was going to be okay. And so, you saw this period where, as the data did turn out to be okay, credit went tighter, equities went up, the two markets moved in the same direction.

But then it shifted. Then, as the cycle had been extending for a while, kind of optimism returned, and even too much optimism maybe returned, and so from '97, mid-97 onwards, equities kept going up, the stock market kept rallying, credit spreads went wider, expected volatility went higher. And so, you saw that relationship diverge.

And so, I do think that if we do get the '90s, if we're that lucky, and hopefully we do get that sort of scenario, it was good in a lot of ways. But I think we need to be on the watch for those two stages. We still think we're in stage one. We still think they're that stage that's more benign, but eventually benign conditions can lead to more aggressiveness.

Seth Carpenter: I think that's really fair. So, we started off talking about optimism and I would like to keep it that you pointed out that the '90s required a bit of good luck and I would wholeheartedly agree with that.

So, I still remain constructive, but I don't remain naive. I think there are ways for things to go wrong. And there is a ton of uncertainty ahead, so it might be a rocky ride. It's always great to get to talk to you, Andrew.

Andrew Sheets: Great to talk to you as well, Seth.

And thanks for listening. If you enjoy the show, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

How Safe is AI? Oct 10, 2024

Mike Canfield, Morgan Stanley’s Head of Europe Sustainability Research, discusses why ensuring safe and responsible artificial intelligence is essential to the AI revolution.

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Mike Canfield: Welcome to Thoughts on the Market. I'm Mike Canfield, Morgan Stanley's Europe, Middle East and Africa Head of Sustainability Research.

Today I'll discuss a critical issue on a hot topic: How safe is AI?

It's Thursday 10th of October at 2pm in London.

AI is transforming the way that we live, work, and connect. It's really got the potential at every level and aspect of society, from personal decisions to global security. But as these systems become ever more integrated into our critical functions – whether that's healthcare, transportation, finance, or even defense – we do need to develop and deploy safe AI that keeps pace with the velocity of technological advances.

Market leaders, academic think tanks, NGOs, industry bodies, intergovernmental organizations have all attempted to codify what safe or responsible AI should look like. But at the most fundamental level, the guidelines and standards we've seen so far share a number of clear similarities. Typically, they focus on fostering innovation in practical terms, as well as supporting economic prosperity – but also asserting the need for AI systems to respect fundamental human rights and values and to demonstrate trustworthiness.

So where are we now in terms of regulations around the world?

The EU's AI Act leads the way with its detailed risk-based approach. It really focuses on transparency as well as risks to people and fundamental rights. In the USA, while there's no comprehensive federal regulation or legislation, there are some federal laws that offer some sector specific guidance on AI applications. Things like the National Defense Authorization Act of 2019 and the National AI Initiative Act of 2020. Alongside those, President Biden's published an executive order on AI, promoting safety, responsible innovation, and supporting Americans and their rights, including things like privacy. In Asia Pacific, meanwhile, countries are working to establish their own guidelines on consumer protection, privacy, and transparency and accountability.

In general, it’s very clear that policymakers and regulators increasingly expect AI systems developers to adopt what we'd call the socio-technical approach, focused on the interaction between people and technology. Having examined numerous existing regulations and foundational standards from around the world, we think a successful policymaking approach requires the combination of four core conceptual pillars.

We've called them STEP. That's Safety, Transparency, and Ethics and Privacy. With these core considerations, AI can take a step – pun intended – in the right direction. Within safety, the focus is on reliability of systems, avoiding harm to people and society, and preventing misuse or subversion. Transparency includes a component of explainability and accountability; so, systems allowing for future feedback and audits of outcomes. Ethically, the avoidance of bias, preventing discrimination, inclusion, and the respect for the rule of law are key components. Then finally, privacy considerations include elements like data protection, safeguards during operation, and allowing users consent in data used for training.

Of course, policymakers contend with a variety of challenges in developing AI regulations. Issues like bias, like discrimination, implementing guardrails without stifling innovation, the sheer speed at which AI is evolving, legal responsibility, and much more beyond. At its most basic, though, arguably the most critical challenge of regulating AI systems is that the logic behind outcomes is often unknown, even to the creators of AI models, because these systems are intrinsically designed to learn.

Ultimately, ensuring safety and responsibility in the use of AI is an essential step before we can really tap into ways AI could positively impact society. Some of these exciting opportunities include things like improving education outcomes, smart electric grid management, enhanced medical diagnostics, precision agriculture, and biodiversity monitoring and protection efforts. AI clearly has enormous potential to accelerate drug development, to advance material science research, to boost manufacturing efficiency, improve weather forecasting, and even deliver better natural disaster predictions.

In many ways, we need guardrails around AI to maximize its potential growth.

Thanks for listening. If you enjoy the show, please do leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

US Elections: The Outlook For Asia Oct 09, 2024

Our Global Head of Fixed Income and Thematic Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss how the upcoming US elections might impact economic policies in Asia.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.

Chetan Ahya: And I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.

Michael Zezas: Today, we'll talk about what the US election means for Asia's economy.

It's Wednesday, October 9th at 10am in New York.

Chetan, we're less than a month now from the US election, and when I think about what it means for Asia, perhaps the most immediate and direct impact would be via tariffs.

Now, our colleagues have already addressed some of this on the podcast, but I'm eager to hear your thoughts. And in the case of a Trump win and a significant tariff increase on China, how big of an impact do you think this policy would have on China's economy, and what particular areas of the economy might be most affected?

Chetan Ahya: Well, Mike, I think firstly the tariff numbers being floated, i.e. that if it is 60 per cent, it would mean an increase in tariff of about 35 percentage points over an existing number, which is at 25 per cent. So, the amount of tariffs that we're talking about this time are larger than what we saw in 2018-19. And in terms of implications, of course, it will depend upon exactly what is the magnitude of tariff that is being imposed, but we definitely think there will be a significant downside to China's growth; and we expect an increase in deflationary pressures.

Just to give you a bit of perspective of what happened in 2018-19, tariff resulted into China's growth slowing by a full percentage point from 6.9 per cent to 5.9 per cent; and at the same time, we saw that there was downward pressure on China's inflation dynamic. And the timing of tariffs this time does not seem to be great. China is going through an existing challenge of debt deflation loop. And we've seen that China's GDP deflator, which is a broader measure of prices, has been in deflation already for about seven quarters now. And so, in this context, tariffs will further add to its deflationary pressures and make that macro situation much more complicated.

Michael Zezas: Got it. And so, how do you think China might respond if it becomes the target of higher tariffs?

Chetan Ahya: So, we think China's policy makers could take up three sets of measures to mitigate the impact of tariffs.

Number one, there will be, of course, depreciation in its exchange rate, which will be offsetting some part of the tariff increase effect. And so, for example, the weighted average tariff increase was about 18 percentage points during 2018-19, and the RMB depreciation was about 11 per cent. So, there was a significant offset of that tariff increase by currency depreciation.

Number two, China could continue to take its effort to rewire trade flows and supply chain. So, for example, in 2018-19, we've seen a significant rewiring of exports from China to the US via Vietnam and Mexico, and we think this time that could be expanded to some more economies.

And number three, China also resorted to focusing on new markets, i.e. some of the other emerging markets other than US. And at the same time, they focused on introducing new export products; like in the last cycle, they focused on solar panels, lithium batteries, EVs, and old generation chips. So, in effect, they will try to expand their market base from US into other emerging markets. And at the same time, they will be focusing on new products to ensure that their market share in global goods exports is maintained.

So, Mike, we've been discussing the potential impact of a Trump win. But how would a Harris White House shape trade policy, vis-à-vis China and rest of Asia?

Michael Zezas: Yeah, I think a Harris White House would represent a lot of continuity with the Biden White House's approach toward Asia and China, specifically when it comes to trade. That is to say, there's a lot of support for continued use and expansion of non-tariff barriers – things like export controls, and inbound and outbound investment restrictions. And there's less interest in using higher tariffs than what we already have as a tool.

So, you can expect that. And I think you could also expect there to be kind of a broader reach out to develop economic relationships with Pan Asia as a means of enabling some of the transition that multinational companies would need to rewire their supply chains.

But if we take as a given that that might be Harris's approach to trade policy, Chetan, what's your outlook for Asia if she wins in November?

Chetan Ahya: Well, if Harris wins, that would eliminate the key risk to region's outlook in form of significant tariff implementation. And in this case, we expect status quo to our Asia forecast. And we would maintain our constructive outlook for the large economies in the region. And within the group, we think India and Japan are best positioned from a structural standpoint. While China, we were concerned about the debt deflation loop, but with the recent set of policy measures, we think that the risks are now more balanced as far as China macro-outlook is concerned.

Michael Zezas: Got it. Well, Chetan, thanks for taking the time to talk. This is obviously a very important topic as we get closer to the US election.

Chetan Ahya: Great speaking with you, Mike.

Michael Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen; and share Thoughts on the Market with a friend or colleague today.

Economics Roundtable: US Election And Tariffs Oct 08, 2024

The rhetoric around the US elections is heating up, and tariffs have become a central theme – to rally for or against. In Part II of our roundtable discussion, our chief economists break down national and global implications of this policy lever.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

On this special episode of the podcast, we're going to continue our third roundtable discussion with Morgan Stanley's economists from around the world as we enter the fourth quarter of 2024.

It's Tuesday, October 8th at 10am in New York.

Jens Eisenschmidt: And 3pm in London.

Seth Carpenter: All right, so yesterday we covered topics about central banks, inflation, reflation, deflation, China's stimulus policies – a whole set of things. But today I really want to focus on the upcoming US elections and some of the possible implications around the world.

As of this recording, the race between Vice President Harris and former President Trump is essentially in a dead heat and it has left policymakers and market participants with few clear signals about what policy is going to be going forward.

One key policy lever is tariffs; and so Diego, I’m going to come to you. What has the US team said about tariffs and what it might mean for the economy?

Diego Anzoategui: Yes, I think the three key policy levers to consider are tariffs, as you mentioned Seth, immigration policy, and fiscal policy. Tariffs, in particular, are basically a presidential authority, so the outcome of the election is going to be very important there.

Fiscal policy will depend not only on the White House, but also on the Congress, which most polls suggest that it will be split between the two parties. So, we don't expect much there. And immigration policy is tricky because if you take a look at the data, immigration flows have been decreasing. And the key question here is whether the new policy is going to affect that already decreasing path

Seth Carpenter: For tariffs, I know that we've published -- that there's both a boost to inflation that can come, but also a hit to economic growth. And that boost to inflation likely comes first.

The logic is tariffs are taxes, and so they should be seen as a tax on consumption spending -- but also, on domestic CapEx spending and domestic manufacturing because a lot of the imports that are under tariff are either capital goods or intermediate goods that go into manufacturing here in the US.

Diego Anzoategui: Yeah, that's right. Of course, the details will matter a lot. So, suffice it to say, there's a lot of uncertainty.

Seth Carpenter: Okay, that's fair. Chetan, let me come back to you on this. This topic is particularly important for China's economy since the Trump campaign has pledged tariffs of up to 60 per cent on China, and then 10 per cent globally -- something that our public policy team believes could be a driver of a broader decoupling.

You've written a lot about tariffs, tariff structure, what it means for China, the deflationary path. Could you just elaborate a little bit for us?

Chetan Ahya: Yeah, absolutely. I think the timing of this tariff, if they do come up in November or sometime in 2025, couldn't have been coming at a worse time for China. As we've been discussing, China has already been going through this challenge of deflation, and tariffs essentially will mean additional deflationary pressures on China.

So that is one source of impact that we would be watching. The other would be what is the impact on global corporate confidence and China's corporate confidence. That can have additional negative impact in form of slowdown in investment. And one other thing to keep in mind is that in 2018-2019, China could respond, in terms of fiscal and monetary easing and offset some of the downside that came from tariffs. But in this cycle, considering the state of the property market, it would be very difficult for China to reflate that property market demand and offset the downside from tariff.

So essentially, we think the tariffs, if they come in this time, could be far more challenging for China, particularly for deflation management.

Seth Carpenter: Of course, tariffs are global and the Trump campaign has talked about not just tariffs on China. So, Jens, let me come to you. Maybe there are some implications here for Europe as well.

During former President Trump's administration, there were targeted tariffs that, met challenges of the WTO and retaliatory tariffs on American exports to Europe. Looking back on what happened in 2018 and 2019, what do you think could be ahead in the event that former President Trump wins the election again?

Jens Eisenschmidt: So, the episode in 2018 could be actually a template, even though it's probably limited in scopes because tariffs were much more limited that were applied back then. We've talked about around 1 per cent of total American-EU imports that back then were targeted; while now we are really talking about, at least in terms of proposals, everything.

So first to notice that when back then the impact was limited, it will be a little bit bigger now simply because more is targeted. And we think it could be around 30 basis points, shaping around 30 basis points, of European GDP.

Again, that's a very crude measure that depends on many things in particular on also the retaliation. And here for instance, we think EU would, of course, like last time, file a complaint with the World Trade Organization, you know, as a basis for then following negotiations around these tariffs.

Then, the EU would, of course, be looking into what type of tariffs it could put in terms of retaliation on US products entering the EU. And here we would observe first that a lot of that is actually oil, and it's unlikely that you would want to put tariffs on oil -- or more broadly energy goods. So also, natural gas.

Then that means we would look for the next product categories. But here, I think it's not so clear; no single product category stands out. But what stands out is that the US has a surplus in services exports to the EU. And here the EU could, in theory at least, come up with a strategy to retaliate through services regulation. Again, that would need to be seen, once we see these tariffs being implemented. But that certainly would be a road for the EU to take.

Seth Carpenter: Thanks Jens. It makes a lot of sense. And gentlemen, I want to thank you all for a terrific discussion today.

And thanks to our listeners. If you like Thoughts on the Market, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or a colleague today.

Economics Roundtable: Central Banks Turn the Corner Oct 07, 2024

Morgan Stanley’s chief economists take stock of a resilient global economy that has weathered a recent period of market volatility, in Part I of our two-part roundtable.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. And on this special episode of the podcast, we'll hold our third roundtable discussion focusing on Morgan Stanley's global economic outlook as we enter the final quarter of 2024.

I am joined today by our economics team from three regions.

Chetan Ahya: I’m Chetan Ahya, Chief Asia Economist.

Jens Eisenschmidt: I’m Jens Eisenschmidt, Chief Europe Economist.

Diego Anzoategui: I’m Diego Anzoategui from the US Economics team.

It's Monday, October 7th at 10 am in New York.

Jens Eisenschmidt: And 3 pm in London.

Seth Carpenter: I have to say, a lot has happened since the last time we held this roundtable. To say the very least, we've had volatility in financial markets. But on balance, I kind of have to say the global economy has more or less performed the way we expected.

The US economy is cruising towards a soft landing. The labor market maybe is a touch softer than we expected, but consumer spending has remained resilient. In Asia, Japan's reflation story is largely intact, while China is still confronting that debt deflation cycle that we've talked about. And in Europe, the tepid growth we had envisioned -- well, it's continuing. Inflation is falling, but the ECB seems to be accelerating its rate cuts. So, let's get into the details.

Diego, I'm going to start with you and the US. The Fed cut interest rates in September for the first time this cycle, and they cut by 50 basis points instead of the 25 basis points that some people -- including us -- were expecting. So, the big question for you is, where does the Fed go from here?

Diego Anzoategui: So, we are looking for a string of 25 basis point cuts from the Fed as long as labor markets hold up. Inflation has come down notably and we expect a normalization of interest rates ahead. But, of course, we might be wrong again. Labor markets might cool too much, and in that case, one or two additional 50 basis point cuts might happen again.

Seth Carpenter: So, either the Fed glides into the soft landing or they pick up the pace and they cut faster.

So, Jens, let me turn to you and pivot to Europe. You recently changed your forecast for the ECB, and you're now looking for a rate cut in October. And that's following two cuts already that the ECB has done. So, what prompted your change? Is it like what Diego said about a softer outcome prompting a faster pace of cuts. What's likely to happen next for the ECB?

Jens Eisenschmidt: That's right. We changed our ECB call. And to understand why we have to go back to September. So already at the September meeting the ECB president, Lagarde, made clear in the press conference that the bank was a little bit less concerned about structurally high services inflation that is forecast to be persistently high still for some time to come -- mainly because there was more conviction that wages would come down eventually.

And so, they could really focus a little bit more, give a bit more attention to the growth side of things. Just as a reminder, the Fed has a dual mandate. So, it's growth and inflation. The ECB only has inflation. So basically, if the ECB wants to act on growth, it needs to be sure that inflation is under control. And then since September what happened is that literally every single indicator, leading indicator, for inflation was negative. We had lower oil prices, we had a stronger euro, and of course, also weaker activity in terms of the PMIs pointing to a cooling of the ongoing recovery.

So, all of that led us to revise our inflation forecast, and that means that ECB will very likely already be a target mid next year. That should lead to an acceleration of the rate cut cycle. And then it's only a question, will it be already in October or in December? And here comes the September inflation print in, which was softer in particular on the core or on the services component than expected. And we think that has tilted the balance; or will tilt the balance in favor of an October rate cut.

So, what we see now is October, December, January, March -- 25 basis points rate cuts by the ECB leading to a rate of 250. Then this being close to neutral, they will slow down again, quarterly rate cut pace. So, June, September, December, 25 basis points each -- leading to a final rate end of next year at 175.

Seth Carpenter: Okay, got it. So, inflation has come down in most developed market economies. Central banks are starting to cut. For the Fed, there's an open question about how much strength the labor market still has and whether or not they need to do 50 basis points or 25.

But I have to say, Chetan -- and I'm going to come to you because -- in Asia, we saw a lot of market turmoil in August, and that was partly prompted by the rate hike of the BoJ. So, here's a developed market economy central bank that's not cutting. In fact, they're starting to raise interest rates. So, what happened there? And what do you think happens with the BoJ going forward?

Chetan Ahya: Well, Seth, in our base case, we do expect BoJ to hike by another 25 basis points in January next year. And as regards to your question on what happened in terms of the volatility that we saw in the month of August? Essentially, as the BoJ took up its first rate hike, there was a lot of concern that BoJ will go in a consecutive manner, taking up successive rate hikes. But at the end of the day, what we saw was, BoJ realizing that there is a clear endogeneity between financial conditions and their reaction function. And as that communication was clearly laid out, we saw markets calming down. And now going forward, what we think BoJ will be watching will be the data on inflation and wages.

We think they would be waiting to see what happens to the inflation data in the month of November and October, i.e., whether there is a clear, rise in services inflation, which has been running at around 1.3 per cent. And they would want to see that wage pass through to services inflation is continuing.

And then secondly, they will want to see what ishappening to the wage expectations from the workers in the next round of spring wage negotiations. The demand from workers will be clear by the end of this year, so sometime in December. And therefore, we think BoJ will look at that information and then take up a rate hike in the month of January next year.

Seth Carpenter: Okay, so if I step back for a second, even if there are a few parts of the puzzle that still need to fall into place, it sounds to me like you're saying the Japan reflation story is still intact. Is that fair?

Chetan Ahya: That's right. We think that, you know, the comment from the prime minister that came out a few days back; he's very clear that he wants to see a situation where Japan gets rid of deflation. So, we think that the policymakers are fully lined up to ensure that the reflation story remains intact.

Seth Carpenter: That's super helpful and it just absolutely contrasts with what we've been saying about China, where they have sort of the opposite story. There's been a debt deflation cycle that you and the Chinese team have really been highlighting for a long time now, talking about the challenges for policy.

We did get some news out of Beijing in terms of policy stimulus. Could you and break down for us what happened there and whether or not you think that's enough to really shift China's trajectory away from this debt deflation cycle?

Chetan Ahya: Yes, Seth, so essentially, we got three things from Chinese policy makers. Number one, they took up big monetary policy easing. Number two, they announced a package to support the equity markets. And number three, they announced some measures to support the property market.

Now we think that these measures are a positive and particularly the property market measures will be helpful. But in terms of real impediment for China's reflation story, we think that the key need of the hour is to take up aggressive fiscal easing to boost consumption. Monetary policy easing is helpful, but it's not really the key impediment to the reflation path.

Seth Carpenter: All right, so if I wanted to see the glass as half full, I would say, look at this! Beijing policymakers have turned the corners. They're acknowledging that there's some policy impetus that needs to be put into place. But if I wanted to see the glass as half empty, I could take away from what you just said, that there just needs to be more, maybe fiscal stimulus to directly promote household spending.

Is that that fair?

Chetan Ahya: That's absolutely right. What's happening in China is that there has been a big structural adjustment in the property sector because now the total population is declining. And so therefore there is a big demand hole that is being left by the weakness in housing sector.

Ideally, what they should be doing, as I was mentioning earlier, [is] that they should be taking a big fiscal easing to support consumption spending. But so far what we've been seeing is that they've been trying to fill that demand hole with more supply in form of investment in manufacturing and infrastructure sector.

And unfortunately, that's been actually making the deflation challenge more complex. So going forward, we think that, you know, we should be watching out what they do in terms of fiscal stimulus. There was a comment in the Politburo statement that they will take up fiscal easing. We suspect that the timing of that fiscal policy announcement could be by end of this month alongside National People's Congress meeting. And so, what will be the size of fiscal stimulus will be important to watch as well.

Currently, we think it could be one to two trillion RMB. But in our work that we did in terms of what is the scale of fiscal stimulus that is needed to boost consumption, we estimate that it should be somewhere around a 10 trillion RMB spread over two years.

Seth Carpenter: Got it. Thanks, Chetan. Super helpful.

Gentlemen, I have to say, we might have to stop here for the day. But tomorrow, I want to get [to] another topic, which is to say, the upcoming US election. It's got huge implications for the macroeconomy in the US and around the world. And I think we’re going to have to touch on it. But for now, we'll end the conversation here.

And thank you, the listeners, for listening. If you enjoy this show, please leave us a review wherever you listen to the podcast and share Thoughts on the Market with a friend or colleague today.

Why the Fed’s Next Move May Matter Less Oct 04, 2024

Following the US Federal Reserve’s September rate cut, labor data may have more impact on markets than further cuts. Andrew Sheets, Head of Corporate Credit Research, explains why.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss why what the Fed does next might not matter all that much.

It’s Friday, October 4th, at 2 pm in London.

Over recent months the Federal Reserve has been at the center of the global market debate. After keeping policy rates unchanged at the end of July, a decision the markets initially cheered, a string of weak data in early August drove concerns that Fed policy was behind schedule. The Fed then responded with a larger-than-expected half-percent interest rate cut in September. And so, given these swings, a common question for investors is, understandably: What will the Fed do next?

But what if the Fed’s next move doesn’t matter all that much?

Monetary policy is both powerful and weak. Powerful, because interest rates impact so many decisions across the economy, from buying a home, to financing equipment, to acquiring a competitor. And it’s also weak, because how interest rates impact these decisions can have a long and variable lag. It can be six to twelve months before the full impact of an interest rate cut is felt in the economy. And so that half percentage point cut by the Fed last month might not be fully felt in the US economy until June of 2025.

That lag is one reason why the Fed’s next move may matter less. The second reason is what we think the market is worried about. We think a lot of the market’s volatility over the last two months has been driven by concerns that the US economy, particularly the labor market, is weakening right now.

If interest rates are too high and the labor market is weakening, then cutting more rapidly in the coming months might not make a difference. Because of that lag, the help from lower rates simply wouldn’t arrive in time.

Meanwhile, there’s also a view that interest rates might need to fall quite a long ways to have the sort of impact that would be needed if the economy is really slowing down rapidly: by the Fed’s own Summary of Economic Projections (SEP), the policy rate that neither helps or hinders the economy could still be about 2 per cent lower than the current rate – even after that half a percentage point cut in September. Interest rates are well above what could be neutral.

In short, if the data weaken materially over the coming months, more Fed cuts may not necessarily help in time. And if the data remain solid, Fed policy will have lots of time to adjust. It’s the data, not the Fed’s next action, that are most important at the moment.

We also see support for this idea in history. It’s notable that some of the most aggressive US interest rate-cutting cycles – 2001, 2008, February of 2020 – overlapped with weak equity and credit markets. And it was smaller rate cutting cycles – in 1995-96, 1998 or 2019 – that overlapped with much better markets. And that makes sense; if one assumes that it’s the data rather than exactly how much the Fed is cutting rates that matter most to the market.

All of this especially feels topical today. Today’s better than expected report on the US jobs market should support the case that Fed policy is on schedule, and larger adjustments aren’t needed. It’s good news.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Can China’s Stimulus Shift Its Economy? Oct 03, 2024

Our Chief China Economist Robin Xing and Chief China Equity Strategist Laura Wang discuss how markets have responded to rate cuts and commitments to government spending, and what they could mean over the long term.

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Laura Wang: Welcome to Thoughts on the Market. I'm Laura Wang, Morgan Stanley's Chief China Equity Strategist.

Robin Xing: And I'm Robin Xing, Morgan Stanley's Chief China Economist.

Laura Wang: All eyes have been on China this past week, and today we'll discuss why recent news from China's policymakers have commanded the attention of global markets.

It's Thursday, October the 3rd, at 4pm in Hong Kong.

So, Robin, China has been wrestling with the triple macro challenge of debt deflation and demographics -- what we call the three Ds -- for some time now. Last week, China's central bank, PBOC, announced a stimulus package that exceeded market expectations. And then later in the week, top China Communist Party officials, known as the Politburo, focused their monthly meeting on economics, which is not their usual practice.

This meeting was a positive surprise to both us and the market. Let's start with the PBOCs easing package. For listeners who haven't been following China's economy closely, what's our current view on China's economy and can you walk us through the policy measures that the central bank introduced?

Robin Xing: China's economy has been struggling lately and that's pushed the Beijing to pivot approach. Over the last 18 months, they have tried smaller, reactive measures. But now, they are doing something much bigger. On September 24, the People's Bank of China, PBOC, made a bold move, cutting interest rates and introducing new tools to support the stock market.

Now, these cuts might sound small, just 20 basis points, but they are pretty rare in China. They also cut the reserve requirement ratio, which is a fancy way of saying banks can lend more money by 50 basis points. And for the first time, the central bank gave forward guidance, signaling even more cuts could come by year end.

On top of that, the PBOC launched two big programs, a 500 billion yuan fund to help investors buy stocks, and a 300 billion yuan program to help companies buy back their own shares. These moves gave a much-needed boost to both the markets and consumer confidence.

Laura Wang: And how about the Politburo meeting that came on the heels of the PBOC announcement? What exactly did it focus on?

Robin Xing: The Politburo meeting was a rather critical moment. Normally, they don't even talk about the economy in September. But this year was different. It really signaled how urgent things have become.

They made it clear they are ready to spend more. The government is pledging to increase public spending because other parts of the economy, like corporates and consumers, are holding back. There is also a big focus on the housing market, which has been in decline since 2021. They are promising to stop that slide, and it's the strongest commitment we have seen so far.

Laura Wang: So, given everything we've seen from the PBOC and the Politburo, do you think this is a ‘whatever it takes moment’ to address the macro challenges facing China's economy?

Robin Xing: Not quite, but it's close. We are seeing the start of what's going to be a bumpy recovery. The deflation problem, where prices are falling and people are not spending, is complicated.

Beijing seems open to trying different approaches, but fixing the deeper issues -- like the struggling housing market and the local government debt -- it’s going to take a lot. In fact, we think China might need to spend about 1-1.5 trillion dollars over the next two years to really turn things around.

Right now, the measures they have announced are smaller than that. That's because these are new policies. And they still need to build consensus and work out the details. So, while this isn't a ‘whatever it takes moment’ yet the mindset has definitely shifted in that direction.

Laura Wang: In this case, what are the next steps you are monitoring for China's policymaker and how long will the various measures take to implement?

Robin Xing: We expect to see a supplementary budget of 1-2 trillion yuan announced at the upcoming NPC Standing Committee meeting in late October. This budget should focus on boosting consumer spending, increasing social welfare, and helping local governments managing their debt. We will likely see more monetary easing too.

As well as tweaks to the Housing Inventory Buy Back program. These steps should help the economy grow slightly faster, possibly hitting a 5 per cent quarter on quarter growth over the next two quarters, compared to the 3 per cent we have seen recently.

Looking ahead, we will get more clues at the December Central Economic Work Conference. That's when we might see the first signs of plans to use central government funds to tackle housing and local government debt issues. The full details could come in March 2025. If things don't improve quickly, and especially if social unrest starts to rise, Beijing may have to act even more aggressively.

We are keeping an eye on our social dynamics indicator, which tracks how people feel about jobs, welfare and income. If that dips further, it could push the government to ramp up stimulus measures.

Laura, turning it over to you. How are stock markets reacting to all this policy signaling from China?

Laura Wang: I would say to say that the market has responded very enthusiastically is an understatement. I'll give you some numbers.

On the first day of the PBOC announcement, the Shanghai Composite Index, as well as the Hong Kong Market Hang Seng Index, were both up by more than 4 per cent in one single day. Then with the further boost from the surprise Politburo meeting -- by now, both the Shanghai Composite Index and the Hang Seng Index have already been up by more than 21 per cent in just one week's time.

Robin Xing: Within the China stock market, which sectors and industries do you think will most benefit from the shift in policy?

Laura Wang: There are a few ways to position to benefit from this major market condition change. We have a list of companies that we believe will directly benefit from the PBOC market stabilization funding, given the funding's low cost compared to these companies implied re-rating opportunity, just by tapping into the funding and enhancing their shareholder returns.

For the potential reflationary fiscal efforts suggested by the Politburo meeting, as more details come out, I think sectors with good exposure to reflation, particularly the private consumption, will benefit the most -- given their still relatively low valuation, large market cap and high liquidity.

Robin Xing: Finally, Laura, what are your expectations for the markets in China and outside of China for the next few weeks and months?

Laura Wang: Clearly this rally so far is reflecting significant sentiment improvement and capitals that are willing to take a leap of faith and preposition for physical reflationary efforts ramp up. If the government can deliver these measures in a timely fashion, and more importantly, on top of that, communicate their commitment to winning this uphill battle against deflation, I think further valuation re-rating is quite possible for both the Asia market and the Hong Kong market by another 10 to 20 per cent.

To go beyond that level, we need to see clear signs of a corporate earnings growth reacceleration, which would require incrementally more easing to come along in the next few months. We should also monitor the housing market inventory level very closely because any earlier completion of this inventory digestion could suggest less drag on demand investment.

Obviously, there are still a lot of moving parts and it's still a very much evolving story from here. Robin, thanks for taking the time to talk.

Robin Xing: Great speaking with you, Laura.

Laura Wang: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

What Could the Dockworkers’ Strike Mean for Growth and Inflation? Oct 02, 2024

Thousands of U.S. dockworkers have gone on strike along the East Coast and Gulf Coast. Our Global Head of Fixed Income and Thematic Research Michael Zezas joins U.S. economist Diego Anzoategui to discuss the potential consequences of a drawn-out work stoppage.

----- Transcript -----

Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley.

Diego Anzoategui: And I'm Diego Anzoategui from the US Economics team.

Michael Zezas: And today, we'll be talking about the implications of this week's US dockworker strike on the US economy.

It's Wednesday, October 2nd, at 11am in New York.

Diego, as most of our listeners likely know, yesterday roughly 45,000 US dockworkers went on strike for the first time in perhaps decades at 36 US ports from Maine to Texas. And so, I wanted to get your initial read on the situation because we're obviously getting a lot of questions from clients concerned about what this could mean for growth and inflation.

Diego Anzoategui: Yeah, of course, there's a lot of uncertainty about this situation because we don't know how long the strike is going to last. But the strike can in principle hit economic growth and boost inflation -- but only if it is long lasting, right. Local producers and retailers, they typically have inventories of final and intermediate goods, so the disruption needs to be long enough so that those inventories go down to critical levels in order to see a meaningful macroeconomic impact.

But if the strike is long enough, we might see an important impact on economic activity and inflation. If we look at trade flows data, roughly 30 per cent of all goods imports and exports are handled by the East and Gulf ports.

Michael Zezas: So then let's drill down on that a bit. If the strike continues long enough and inventories decline, what are the shocks to economic growth that you're considering?

Diego Anzoategui: Yeah, I would think that there are two main channels through which the strike might hit economic activity. The first one is a hit to local production because of disruptions in the supply of capital goods and intermediate goods used for domestic production. We not only use the ports to bring final goods, but also intermediate and capital goods like machinery, basic metals, plastic, to name a few.

And the second channel is directly through exports. The East Coast and Gulf ports channel 84 per cent of exports by water. Industries producing energy, chemicals, machinery, cars, might be affected by these bottlenecks.

Michael Zezas: Right, so fewer potential imports of goods, and fewer potential productive capacity as a consequence. Does that have an impact on inflation from your perspective?

Diego Anzoategui: Yes, it can have an impact on inflation. Again, assuming that the strike is long lasting, right? I would expect acceleration in goods prices, in particular key inputs coming from the Eastern Gulf ports. And these are cars, electronics, clothes, furniture and apparel. All these categories roughly represent 13 per cent of the core PCE basket, the price index.

Also, you know, a meaningful share of food and beverages imports come through water. So, I would also expect an impact there in those prices. And in terms of what prices might react faster, I think the main candidate is food and beverages -- and especially perishable food that typically have lower inventory to sales ratios.

And if we start seeing an increase in those prices, I think that would be a good early signal that the disruptions are starting to bite.

Michael Zezas: That makes sense. And last question, what about the impact to the US workforce? What would be the impact, if any, on payroll data and unemployment data, reflecting workforce impact -- the types of data that investors really pay close attention to.

Diego Anzoategui: Yeah. So, we will likely see an impact on nonfarm payrolls, NFP, and the unemployment rate if the strike is long lasting. But even if there are not important disruptions, the strike itself can mechanically affect October's nonfarm payrolls print. They want to be released in November. Remember that strikers don't get paid, and they are not on the payroll; so they are not be[ing] counted by the establishment survey.

But a necessary condition to see this downward bias in the NFP reading is that the strike needs to continue next week, that is the second week of October, right. But know that The Fed tends to look through these short run fluctuations in NFP due to strikes -- because any drag we see in the October sprint will likely be followed by payback in November if the strike is short lived.

Michael Zezas: Got it. That makes a lot of sense. Diego, thanks for making the time to talk with us as this unfolds. Let's hope for a quick resolution here.

Diego Anzoategui: Thanks, Michael. Great speaking with you.

Michael Zezas: And thanks for listening. If you enjoy Thoughts on the Market, please be sure to rate and review us on the Apple Podcasts app. It helps more people find the show.

The Potential Domino Effect of US Tariffs Oct 01, 2024

Our US public policy and global economics experts discuss how an escalation of US tariffs could have major domestic and international economic implications.

----- Transcript -----

Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US Public Policy Strategist.

Arunima Sinha: And I’m Arunima Sinha, from the Global Economics team.

Ariana Salvatore: Today we're talking tariffs, a major policy issue at stake in the US presidential election. We'll dig into the domestic and international implications of these proposed policies.

It's Tuesday, October 1st at 10am in New York.

In a little over four weeks, Americans will be going to the polls. And as we've noted on this podcast, it's still a close race between the two presidential candidates. Former president Donald Trump's main pitch to voters has to do with the economy. And tariffs and tax cuts are central to many of his campaign speeches.

Arunima Sinha: You're right, Ariana. In fact, I would say that tariffs have been the key theme he keeps on coming back to. You've recently written a note about why we should take the Republicans proposed policies on tariffs seriously. What's your broad outlook in a Trump win scenario?

Ariana Salvatore: Well, first and foremost, I think it's important to note that the President has quite a bit of discretion when it comes to trade policy. That's why we recommend that investors should take seriously a number of these proposals. Many of the authorities are already in place and could be easily leveraged if Trump were to win in November and follow through on those campaign promises. He did it with China in 2018 to 2019, leveraging Section 301 Authority, and many of that could be done easily if he were to win again.

Arunima Sinha: And could you just walk us through some of the specifics of Trump's tariff proposals? What are the options at the President's disposal?

Ariana Salvatore: Sure. So, he's floated a number of tariff proposals -- whether it be 10 per cent tariffs across the board on all of our imports, 60 per cent specifically on China or targeted tariffs on certain goods coming from partners like Mexico, for example. Targeted tariffs are likely the easiest place to start, especially if we see an incrementalist approach like we saw during the first Trump term over the course of 2018 to 2019.

Arunima Sinha: And how quickly would these tariffs be implemented if Trump were to win?

Ariana Salvatore: The answer to that really depends on the type of authorities being leveraged here. There are a few different procedures associated with each of the tariffs that I mentioned just now. For example, if the president is using Section 301 authorities, that usually requires a period of investigation by the USTR -- or the US Trade Representative --before the formal recommendation for tariffs.

However, given that many of these authorities are already in place, to the extent that the former president wants to levy tariffs on China, for example, it can be done pretty seamlessly. Conversely, if you were to ask his cabinet to initiate a new tariff investigation, depending on the authority used, that could take anywhere from weeks to months. Section 232 investigations have a maximum timeline of 270 days.

There's also a chance that he uses something called IEEPA, the International Emergency Economic Powers Act, to justify quicker tariff imposition, though the legality of that authority hasn't been fully tested yet. Back in 2019, when Trump said he would use IEEPA to impose 5 per cent tariffs on all Mexican imports, he called off those plans before the tariffs actually came into effect.

Arunima Sinha: And could you give us a little more specific[s] about which countries would be impacted in this potential next round of tariffs -- and to what extent?

Ariana Salvatore: Yeah, in our analysis, which you'll get into in a moment, we focus on the potential for a 10 per cent across the board tariff that I mentioned, in conjunction with the 60 per cent tariff on Chinese goods. Obviously, when you map that to who our largest trading partners are, it's clear that Mexico and China would be impacted most directly, followed by Canada and the EU.

Specifically on the EU, we have those section 232 steel and aluminum tariffs coming up for review in early 2025, and the US-MCA or the agreement that replaced NAFTA is set for review later in 2026. So, we see plenty of trade catalysts on the horizon. We also see an underappreciated risk of tariffs on Mexico using precedent from Trump's first term, especially if immigration continues to be such a politically salient issue for voters.

Given all of this, it seems that tariffs will create a lot of friction in global trade. What's your outlook, Arunima?

Arunima Sinha: Well, Arianna, we do expect a hit to growth, and a near term rise in inflation in the US. In the EU, our economists also expect a negative impact on growth. And in other economies, there are several considerations. How would tariffs impact the ongoing supply chain diversification? The extent of foreign exchange moves? Are bilateral negotiations being pursued by the other countries? And so on.

Ariana Salvatore: So, a natural follow up question here is not only the impact to the countries that would be affected by US tariffs, but how they might respond. What do you see happening there?

Arunima Sinha: In the note, we talked with our China economists, and they expect that if the US were to impose 60 per cent tariffs on Chinese goods, Beijing may impose retaliatory tariffs and some non-tariff measures like it did back in 2018-19. But they don't expect meaningful sanctions or restrictions on US enterprises that are already well embedded in China's supply chain.

On the policy side, Beijing would likely resort less to Chinese currency depreciation but focus more on supply chain diversifications to mitigate the tariff shock this time round. Our economists think that the risk of more entrenched deflationary pressures from potential tariff disruptions may increase the urgency for Beijing to shift its policy framework towards economic rebalancing to consumption.

In Europe, our economists expect that targeted tariffs will be met with challenges at the WTO and retaliatory tariffs on American exports to Europe, following the pattern from 2018-19, along with bilateral trade negotiations. In Mexico, our economists think that there could be a response with tariffs on agricultural products, mainly corn and soybeans.

Ariana Salvatore: So, bringing it back to the US, what do you see the macro impact from tariffs being in terms of economic growth or inflation?

Arunima Sinha: We did a fairly extensive analysis where we both looked at the aggregate impacts on the US as well as sectoral impacts that we'll get into. We think that a pretty reasonable estimate of the effect of both a 60 per cent tariff on China and a 10 per cent blanket tariff on the rest of the world is an increase of 0.9 per cent in the headline PCE prices that takes into effect over 2025, and a decline of 1.4 percentage points in real GDP growth that plays out over a longer period going into 2026.

Ariana Salvatore: So, your team is expecting two more Fed cuts this year and four by the first half of 2025. Thinking about how tariffs might play into that dynamic, do you see them influencing Fed policy at all?

Arunima Sinha: Well, under the tariff scenario, we think that it's possible that the Fed decides to delay cuts first and then speed up the pace of easing. So, in theory, the effect of a tariff shock is really just a level shift in prices. And in other words, it's a transitory boost to inflation that should fade over time.

Because it's a temporary shock. The Fed can, in principle look through it as long as inflation expectations remain anchored. And this is what we saw in the FOMC minutes from the 2018 meetings. In a scenario of increased tariffs, we think that the uncertainty about the length of the inflationary push may slow down the pace of cuts in the first half of 2025. And then once GDP deceleration becomes more pronounced, the Fed might then cut faster in the second half of [20]25 to avoid that big, outsized deceleration and economic activity.

Ariana Salvatore: And what about second order effects on things like business investment or employment? We talked about agriculture as a potential target for retaliatory tariffs, but what other US sectors and industries would be most affected by these type of plans?

Arunima Sinha: That's something that we have leaned in on, and we do expect some important second round effects. So, if you have lower economic activity, that would lower employment, that lowers income, that lowers consumption further -- so that standard multiplier effect.

So overall, in that scenario, with the 60 per cent tariffs on China, 10 per cent on the rest of the world that are imposed fully and swiftly, we model that real consumption would decline by 3 per cent, business investment would fall by 3.1 per cent, and monthly job gains would fall by between 50- and 70, 000.

At the sectoral level, this combination of tariffs have potential to increase average tariffs to the 25 to 35 per cent range for almost 50 per cent of the NAICS industries in the United States when first put into place. And we expect the biggest impacts on computers and electronics, apparel, and the furniture sectors; but this does not take into account any potential exclusion lists that might be put into place.

Ariana Salvatore: Finally, what does all this boil down to in terms of a direct impact to the US consumer wallet?

Arunima Sinha: So, the impact of higher tariffs on consumer spending would depend on many factors, and one of the most important ones is the price elasticity of demand. So how willing would consumers be to take on those higher prices from tariffs, or do we see a pullback in real demand? What we think will happen is that higher prices could reduce real consumption by as much as 2. 5 per cent. The impact on goods consumption is much more meaningful because imported goods are directly affected by tariffs, and we would expect to see a drag on real goods consumption of 5 per cent. But then you have lower labor income and higher production costs and services prices that is also going to bring down services consumption by 1.3 per cent.

Ariana Salvatore: So, it's important to keep in mind here that US tariff policy would undoubtedly have far reaching consequences. That means it's something that we're going to continue to follow very closely. Arunima, thanks so much for taking the time to talk.

Arunima Sinha: Great speaking with you, Ariana. Thank you,

Ariana Salvatore: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

The Impact of Central Bank Pivots Sep 30, 2024

Our CIO and Chief US Equity Strategist Mike Wilson takes a closer look at the potential ramifications of the sharp central bank policy shifts in the U.S., Japan and China.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about what to expect from the sharp pivot in global monetary and fiscal policy.

It's Monday, Sept 30th at 11:30am in New York.

So let’s get after it.

Over the past few months, Fed policy has taken on a more dovish turn. To be fair, bond markets have been telling the Fed that they are too tight and in many respects this pivot was simply the Fed getting more in line with market pricing. However, in addition to the 50 basis point cut from the Fed, budget deficits are providing heavy support; with August’s deficit nearly $90b higher than expected. Meanwhile, financial conditions continue to loosen and are now at some of the most stimulative levels seen over the past 25 years.

Other central banks are also cutting interest rates and even the Bank of Japan, which recently raised rates for the first time in years, has backed off that stance – and indicated they are in no hurry to raise rates again. Finally, this past week the People’s Bank of China announced new programs specifically targeting equity and housing prices. After a muted response from markets and commentators, the Chinese government then followed up with an aggressive fiscal policy stimulus. Why now?

Like the US, China is highly indebted but it has entered full blown deflation with both credit and equity markets trading terribly for the past several years. There is an old adage that markets stop panicking when policy makers start panicking. On that score, it makes perfect sense why China equity and credit markets have responded the most favorably to the changes made last week. European equity markets were also stronger than the US given European economies and companies have greater exposure to China demand. On the other hand, Japan and India traded poorly which also makes sense in my view since they were the two largest beneficiaries of investor outflows from China over the past several years. Such trends are likely to continue in the near term.

For US equity investors, the real question is whether China’s pivot on policy will have a material impact on US growth. We think it’s fairly limited to areas like Industrial spending and Materials pricing and it’s unlikely to have any impact on US consumers or corporate investment demand. In fact, if commodities rally due to greater China demand, it may hurtUS consumer spending.

As usual, oil prices will be the most important commodity to watch in this regard. The good news is that oil prices were down last week due to an unrelated move by Saudi Arabia to no longer cap production in its efforts to get oil prices back to its $100 target. If prices reverse higher again and move toward $80/bbl due to either China stimulus or the escalation of tensions in the Middle East, it would be viewed as a net negative in my view for US equities.

As discussed last week the most important variables for the direction of US equities is the upcoming labor market data and third quarter earnings season. Weaker than expected data is likely to be viewed negatively by stocks at this point and good news will be taken positively. In other words, investors should not be hoping for worse news so the Fed can cut more aggressively.

At this point, steady 25 basis point cuts for the next several quarters in the context of growth holding up is the best outcome for stocks broadly. Meanwhile individual stocks will likely trade as much on idiosyncratic earnings and company news rather than macro data in the absence of either a hard landing or a large growth acceleration; both of which look unlikely in the near term. In such a scenario, we think large cap quality growth is likely to perform the best while there could be some pockets of cyclical strength in companies that can benefit from greater China demand. The best areas for cyclical outperformance in that regard remain in the Industrial and materials sectors.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Keeping the Faith For A Soft Landing Sep 27, 2024

Credit likes moderation, and the Fed’s rate cut indicates its belief that the economy is heading for a soft landing. Our Chief Fixed Income Strategist warns that markets still need to keep an eye on incoming data.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the implications of the Fed’s 50 basis points interest rate cut for corporate credit markets.

It's Friday, Sep 27th at 10 am in New York.

For credit markets, understanding why the Fed is cutting is actually very critical. Unlike typical rate cutting cycles, these cuts are coming when the economic growth is still decelerating but not falling off the cliff. Typically, rate cuts have come in when the economy is already in a recession or approaching recession. Neither is the case this time. So the US expanded by 3 per cent in the second quarter; and the third quarter, it is tracking well over 2 per cent.

So, these cuts do not aim to stimulate the economy but really to acknowledge that there’s been significant progress on inflation, and move the policy towards a much more normalized policy stance. In some way, this really reflects the Fed’s confidence in the inflation path. So that means, not cutting now would mean restraining the economy further through high real interest rates. So, this cut really reflects a growing faith by the Fed in achieving a soft landing. Also, the size of the cut, the 50 basis point cut as opposed to 25 basis points, shows the Fed’s willingness to go big in response to weaker data, especially in labor markets.

So since the beginning of the year, we have been pretty constructive on spread products across the board, particularly corporate credit and securitized credit, even though valuations have been tightening. Our stance is based on the idea that credit fundamentals will stay reasonably healthy even if economic growth decelerates, as long as it doesn’t fall off the cliff. Further, we also believe that credit fundamentals will improve with rate cuts because stress in this cycle has mainly come from higher interest expenses weighing on both corporations and households. This is in stark contrast to other recent periods of stress in credit markets – such as 2008/09 when we had the financial crisis, 2015/16 we had the challenges in the energy sector and then 2020, of course, we faced COVID.

So the best point of illustrating this would be through leveraged loans, which are floating-rate instruments. As the Fed started tightening in 2022, we saw increasing pressures on interest coverage ratios for leveraged loan borrowers. That led to a pick-up in downgrades and defaults in loans. As rate hikes ended, we started seeing stabilization of these coverage ratios, and the pace of downgrades and defaults slowed. And now, with rate cutting ahead of us and the dot plot implying 150 basis points more of cuts for the rest of this year and the next year to come, the pressure on interest coverage ratios are going to be easing, especially if the economy stays in soft landing mode.

This suggests that while spreads are today tight, the fundamentals could even improve with rate cuts – that means the spreads could remain around these levels, or even tighten a bit further. After all, if you remember the mid-1990s, which was the the last time that the Fed achieved a soft landing, investment grade corporate credit spreads were about 30 basis points tighter relative to where we are today.

That 'if' is a big if. If we are wrong on the soft landing thesis, our conviction about the spread products being valuable will prove to have been misplaced. Really the challenge with any landing is that we can’t be certain of the prospect until we actually land. Till then, we are really looking at incoming data and hypothesizing: are we heading into a soft or hard landing?

So this means incoming data pose two-sided risks to the path ahead for credit spreads. If incoming data are weak – particularly employment data are weak – it is likely that faith in this soft landing construct will dim and spreads could widen. But if they are robust, we can see spreads tightening even further from the current tight levels.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

How Long Until Consumers Feel Rate Cut Benefits? Sep 26, 2024

Our US Consumer Economist Sarah Wolfe lays out the impact of the Federal Reserve’s rate cut on labor market and consumers, including which goods could see a rise in spending over the next year.

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Welcome to Thoughts on the Market. I’m Sarah Wolfe, from the Morgan Stanley US Economics Team.

Today, a look at what the Fed cut means for US consumers.

It’s Thursday, September 26, at 2 PM in Slovenia.

Earlier this week, you heard Mike Wilson and Seth Carpenter talk about the Fed cut and its impact on markets and central banks around the world. But what does it actually mean for US consumers and their wallets? Will it make it easier to pay off credit card debt and secure mortgages? We explore these questions in this episode.

Looking back to last week, the FOMC cut rates by a larger chunk than many anticipated as risks from inflation have come down significantly while labor market risks have risen. Now, with inflation wrangled in, it’s time to start reducing the restrictiveness of policy to prevent a rise in the unemployment rate and a slump in economic growth. In fact, my colleague Mike Wilson believes the US labor data will be the most important factor driving US equities for the next three to six months.

Despite potential risks, the current state of the U.S. labor market is still solid and that’s where the Fed wants it to stay. The health of the labor market, in my opinion, is best reflected in the health of consumer spending. If we look at this quarter, we’re tracking over 3 per cent growth in real consumption, which is a strong run rate for consumption by all measures. And if we look at how the whole year has been tracking, we’ve only seen a very modest slowdown in real consumer spending from 2.7 per cent last year to 2.5 per cent today.

For a bit of perspective, if we go back to 2018 and 2019, when rates were much lower than they are today, and we had a tight labor market, consumption was running closer to 2 to 2.3 per cent. So we can definitively say, consumption is pretty solid today.

What is most notable, however, is the slowdown in nominal consumption which takes into account unit growth and pricing. This has slowed much more notably this year from 5.6 per cent last year to 4.9 per cent today. It’s reflected by the significant progress we’ve seen in inflation this year across goods and services, despite solid unit growth – as reflected by stronger real consumer spending.

Our US Economics team has been stressing that the fundamentals that drive consumption – which are labor income, wealth, and credit – would be cooler this year but still support healthy spending. When it comes to consumption, in my opinion, I think what matters most is labor income. A slowdown in job growth has stoked fears of slower consumer spending, but if you look at aggregate labor income growth and household wealth, across both equities and real estate, those factors remain solid. So, then we ask ourselves, what has driven more of the slowdown in consumer spending this past year?

And with that, let’s go back to interest rates.

Rates have been high, and credit conditions have been tight – undeniably restraining consumer spending. Elevated interest rates have pushed banks to pull back on lending and have curbed household demand for credit. As a result, if you look at consumer loan growth from banks, it’s fallen from about 12 per cent in 2022 to 7 per cent last year, and just 3 per cent in the first half of this year.

Tight credit is dampening consumption. When interest rates are high, people buy less -- especially on credit. And this is a key principle of monetary policy and it's used to lower inflation. But it can have adverse effects. The brunt of the pain has been borne by the lowest-income households which rely heavily on revolving credit for basic spending needs and more easily max out on their credit limits and fall delinquent.

As such, as the Fed begins to lower interest rates, the rates charged on consumer loan products have started to moderate. And with a lag, we expect credit conditions to ease up as well, allowing households across the income distribution to begin to access more credit. We should first see a rebound in durable goods spending – like home furnishing, electronics, appliances, and autos. And then that should all be further supported by more activity in the housing market.

While interest rates are on their way down, they are still relatively elevated, which means the rebound in consumption will take time. The good news, however, is that we do think we are moving through the bottom for durable goods consumption – with pricing for goods likely to stabilize next year and unit growth to pick back up.

Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

US Elections: The Wait for Clarity Sep 25, 2024

With the US presidential race being as closely contested as it is, Michael Zezas explains why patience may be a virtue for investors following Election Day.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.

Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why investors should prepare to wait to get clarity on the US election result.

It's Wednesday, September 25th at 10:30am in New York.

As we all know, markets dislike uncertainty; and one of the biggest potential catalysts between now and the end of the year is the results of the US presidential election. So it’s important for investors to know that the timing of knowing the outcome may not be what you expect.

On most U.S. presidential election days, the outcome is known within hours of polls closing in the evening. That’s because while all votes may not yet have been counted, enough have to make a reasonable projection about the winner.

But that’s not what happened in 2020. Vote counts were tight across many states. A condition that was compounded by the slowness of counting mail in ballots, which was a style of voting more widely adopted during the pandemic. As a result, news networks didn’t make a formal outcome projection until about four days after election day.

Rather than a reversion to the norm of quickly knowing the result for the 2024 election, we expect an outcome similar to 2020. It could be days before we reliably know a result.

The same dynamics as 2020 are in play. Polls show a very close race. And while more voters are likely to show up in person this year, voting by mail is still expected to represent a substantial chunk of ballots cast this cycle. That’s because many states' rules automatically send mail-in ballots to those who voted by that method in the last election. And some recent news out of Georgia underscores the potential for a slower result. The state just adopted a rule requiring all its votes to be hand-counted.

Now, this may not matter if either candidate has enough votes without Georgia to win the electoral college. But if Georgia is the deciding or tipping point state then a longer wait becomes possible. Per the 538 election forecast model, there’s about an 11 per cent chance that Georgia plays this role.

So, bottom line, investors may have to be patient this November. It could take days, or weeks, to reliably project an election outcome, and therefore start seeing its market effects.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

One Rate Cut, Many Effects Sep 24, 2024

From stock price fluctuations to concerns about deflation, the reactions to the Fed rate cut have been varied. But we still need to keep an eye on labor data, says Mike Wilson, our CIO and Chief US Equity Strategist.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the Fed’s 50 basis point rate cut last week, and the impact on markets.

It's Tuesday, Sept 24th at 11:30am in New York.

So let’s get after it.

As discussed last week, I thought that the best short-term case for equities was that the Fed could deliver a 50 basis point cut without prompting growth concerns. Chair Powell was able to thread the needle in this respect, and equities ultimately responded favorably.

However, I also believe the labor data will be the most important factor in terms of how equities trade over the next three to six months.

On that score, the next round of data will be forthcoming at the end of next week. In my view, that data will need to surprise on the upside to keep equity valuations at their currently elevated level. More specifically, the unemployment rate will need to decline and the payrolls above 140,000 with no negative revisions to prior months.

Meanwhile, I am also watching several other variables closely to determine the trajectory of growth. Earnings revision breadth, the best proxy for company guidance, continues to trend sideways for the overall S&P 500 and negatively for the Russell 2000 small cap index. Due to seasonal patterns, this variable is likely to face negative headwinds over the next month.

Second, the ISM Purchasing Managers Index has yet to reaccelerate after almost two years of languishing. And finally, the Conference Board Leading Economic Indicator and Employment Trends remain in downward trends; this is typical of a later cycle environment.

Bottom line, the Fed's larger than expected rate cut can buy more time for high quality stocks to remain expensive and even help lower quality cyclical stocks to find some support. The labor and other data now need to improve in order to justify these conditions though, through year end.

It's also important to point out that the August budget deficit came in nearly $90 billion above forecasts, bringing the year-to-date deficit above $1.8 trillion. We think this fiscal policy has been positive for growth but has resulted in a crowding out within the private economy and financial markets.

This is another reason why a recession is the worst-case scenario even though some argue a recession is better than high price levels or inflation for 80-90 per cent of Americans. A recession will undoubtedly bring debt deflation concerns to light, and once those begin, they are hard to reverse. The Fed understands this dynamic better than anyone as first illustrated in Ben Bernanke's famous speech in 2002 entitled “Deflation, Making Sure It Doesn’t Happen Here.” In that speech, he highlighted the tools the Fed could use to avoid deflation including coordinated monetary and fiscal policy.

We note that gold continues to outperform most stocks including the high-quality S&P 500. Specifically, gold has rallied from just $300 at the time of Bernanke’s speech in 2002 to $2600 today. The purchasing power of US dollars has fallen much more than what conventional measures of inflation would suggest.

As a result, gold, high-quality real estate, stocks and other inflation hedges have done very well. In fact, the newest fiat currency hedge, crypto, has done the best over the past decade. Meanwhile, lower quality cyclical assets like commodities, small cap stocks and commercial real estate have done poorly in both absolute and relative terms; and are losing serious value when adjusted for purchasing power.

The bottom line, we expect this to continue in the short term until something happens to change investors' view about the sustainability of these policies. In order to reverse these trends, either organic growth in the private economy needs to reaccelerate and we’ll see a rotation back to the lower quality cyclical assets; or recession arrives, and we finish the cycle and reset all asset prices to levels from which a true broadening out can occur.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

As the Fed Recalibrates, What’s Ahead for Central Banks? Sep 23, 2024

Our Global Chief Economist, Seth Carpenter, explains why, despite last week’s big Fed move, there’s still plenty of uncertainty in global markets and questions about how other central banks will respond.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Today, I'll be talking about the Fed meeting, where they cut rates for the first time in this cycle, and what it means for the economy around the world.

It's Monday, September 23rd at 10am in New York.

The Fed cut rates by 50 basis points; but we did not see a huge shift in its reaction function. Rather, the 50 basis points was to show a commitment to not falling behind the curve -- to use Chair Powell's words. From here, the most likely path, from my perspective, is a string of 25 basis point cuts. Powell has again demonstrated that the Fed can move gradually, or quickly, depending on perceptions of risk.

But for now, judging from Powell, or other policy makers comments, the Fed still sees the economy as healthy in the labor market; as solid. But another payroll print of 100, 000 or softening in consumer spending, well, that would tip the balance. So, the market debate will continue to focus on the pace of rate cuts and the ultimate landing zone.

Our baseline is a touch more front loaded than the dot plot would imply; with us expecting the funds rate to reach just below 3.5 per cent in the middle of next year, rather than the end of next year. The Fed's projections have declines in the target rate into 2026 and beyond, but I have to say the dispersion in the dots that they put up shows just how much consensus is yet to be built within the committee. And, as a result, the phrase data dependency, well, that's not a term that we want to drop from the lexicon anytime soon.

The magnitudes of the changes differ, but a comparison that we have made often here is to the 1990s, and that cutting cycle eventually it paused as the economy stabilized and continued to grow. So, there are lots of options for where we go next.

Globally, central banks will be adapting and reacting both to global financial conditions like this Fed rate cut, as well as their domestic outlook. Among emerging market economies, Brazil and Indonesia make for useful case studies. With an eye on defending its policy credibility and on market expectations, the central bank in Brazil hiked rates to 10-and-three-quarters per cent this week after a cutting cycle and then a long pause. A weaker currency is the external push, but strong domestic growth is the internal consideration and both of those imply some inflation risks.

The Bank of Indonesia cut rates after a strong appreciation in the currency, which lowered the risk from inflations, and it really enabled them to change their footing.

Now, for DM central banks, the 50 basis point cut really doesn't materially shift our expectations for what's going to happen. If we are right, and ultimately we get a string of 25 basis point cuts, there's little reason for other developed market central banks to really adjust what they're doing. In Europe, we're waiting for inflation data to confirm the slowdown after the softening of wages that we've seen. So, we have high conviction that there's a cut in September, and we expect another cut in December.

Now, more cutting by the Fed might lead to a stronger Euro, which would reinforce that inflation trend, but I don't think it would be enough to really change the path and prompt more aggressive cutting from the ECB. After skipping a rate move in September, given all the question marks they still see about inflation in the UK, we think the Bank of England restarts their cuts in November.

The split decision at this most recent meeting shows that the MPC is not making frequent adjustments to its plan based on small tweaks to the incoming data. And finally, for the Bank of Japan, we expect them to stay on hold until January. The meeting for the Bank of Japan was primarily about communication, and indeed, Governor Ueda's comments did not prompt the type of reaction that we saw at the July meeting. So, if we're right, and the Fed's path is mostly, like we think it will be, these other developed market central banks don't have to make big changes.

So, the Fed didn't really fully recalibrate its outlook. Instead, what it did was signal a willingness, but just a willingness, to make large shifts; with no clear indication that the fundamental strategy has changed.

The market implications seem like they could be clear. With the Fed easing, amid economic conditions that remain resilient, that should be positive for risk assets. But the Fed is also trying to prevent complacency, and I have to say, uncertainty is plentiful. If for no other reason, we've got an election coming up, and that makes forecasting what happens in 2025 very difficult.

Thanks for listening. And if you enjoy this show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Mexico Judicial Reforms Spark Investor Concern Sep 20, 2024

Our Chief Latin American Equity Strategist explains how potential changes in Mexico’s regulatory approach could have implications for the country’s equity markets.

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Welcome to Thoughts on the Market. I’m Nikolaj Lippmann, Morgan Stanley’s Chief Latin American Equity Strategist. Today I’ll talk about Mexico’s recent judicial reform and its potential impact on equities market.

It’s Friday, September 20, at 10am in Mexico City.

Mexico has made significant changes to its judicial system. After winning two-thirds majority in both houses – enough to allow for constitutional changes – Mexico policymakers have embarked on a robust reform agenda. Their first stop is a comprehensive reform of the judicial branch, which aims at replacing roughly 2,000 senior judges including the entire Supreme Court.

New judges will no longer be appointed but will now be elected by popular vote. This is practically unprecedented in a global context, and while the executive branch might still try to filter future candidates, this new system will likely create a real risk to checks and balances on the judicial branch as well as to expertise and procedure. Additional reforms, including the elimination of independent regulatory bodies, would likely compound these risks.

The judicial reform could have a material impact on Mexican equities. So much so, that we think Mexico goes from being an investor favorite to a ‘show me’ story where investors are less likely to give the market the benefit of the doubt. This is likely to result in a derailing or lower set of multiples being paid by investors in Mexican equities or higher risk premium required to invest.

Essentially, the judicial reforms could add fiscal, labor and concession/regulatory risk for Mexican companies, even though Mexico has deep manufacturing ecosystems, and has been well-positioned from the transition to [a] multipolar world. Just to give you a sense. Mexico has already sailed past China in terms of manufacturing exports to the United States, and are now approaching the levels of the entire European Union in terms of manufacturing export to the US.

These new reforms will raise significant investor concerns, so much so that we’ve downgraded Mexican equities to underweight, a second downgrade since June. Mexican equities have sold off roughly 20 per cent in the past three months, in dollar terms. And we think the judicial reform may contribute to further decline. All in, we see significantly greater potential for negative outcomes than positive outcomes going forward.

Looking ahead, we see three key challenges for Mexico:

First, the new judicial structure would raise concerns about the independence of the judicial branch.

Second, the United States-Mexico-Canada Agreement, the USMCA, is up for review in 2026, and Mexico's judicial reform could mean a much deeper revision. Mexico has committed to maintaining independent regulatory bodies for a number of areas, such as telecom, electricity, in competition. The judicial reform could complicate this commitment.

Electricity is a key challenge for Mexico, and it requires immediate investments. Our nearshoring investment thesis stands, but the electricity-related challenges are becoming more pronounced, and they won’t be helped by investor concerns around the judicial reform.

So all in, some businesses will be at greater risk from these developments. We expect technology, digitalization, real estate companies to be at the least level of risk, or the lowest level of risk. Domestic concessions could be at more risk.

We will continue to bring you relevant updates as Mexico reforms unfold.

Thank you for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. It helps more people find the show.

Industrials Outlook ‘Better Than Feared’ Sep 19, 2024

Investors came away from Morgan Stanley’s recent Industrials Conference with a more optimistic outlook than they expected, based on perspectives including freight transportation’s momentum and AI’s impact on the growth of data centers.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley Research's U.S. Thematic Strategist.

Ravi Shanker: I'm Ravi Shanker, Morgan Stanley's Freight Transportation and Airlines Analyst.

Chris Snyder: And I'm Chris Snyder, the U.S. Industrial Analyst.

Michelle Weaver: Today, we'll talk about key themes for Morgan Stanley's recently concluded industrials conference in Laguna Beach.

It's Thursday, September 19th at 10am in New York.

Last week, we were all out in Laguna Beach at the industrials conference. There were about 500 different industrials investors, along with 156 corporates, which gave us a pretty comprehensive read on what's going on in the industrial sector.Investor sentiment around industrials was pretty poor heading into the conference, and the overall tone of management, though, seemed better than feared in presentations.

Chris, your coverage includes companies with exposure to a wide range of end markets. What did you learn about the cycle from your discussions with company management?

Chris Snyder: Yeah, I think you categorized it well: consistent, largely unchanged, but better than feared. Morgan Stanley did a poll ahead of the conference. And only 5 percent of investors thought that the conference would be bullish for industrial risk sentiment. Coming out of the conference, 60 percent of industrial investors are bullish on risk sentiment into the end of the year. So, I think it kind of shows that sentiment was in a very bad place and ‘better than feared’ is the right way to categorize it.

We've generally been surprised at the lack of optimism around the industrial cycle in the market. The industrial economy has been in contraction for almost two years now, and it seems like we're on the verge of a rate cut cycle, which has historically been a tailwind for the cycle.

You know, in our coverage, business is driven by a combination of investments and then production of goods; and the companies we’re seeing real bifurcation on that. On the investment side -- and that's things like data center, new manufacturing facilities with all the US reshoring momentum -- that business remains strong. And on the production side of the house, that business remains soft. And that's generally in line with our call. We prefer CapEx exposure, particularly those that are tied into energy efficiency.

Michelle Weaver: Great. That's really positive to hear that the investment side is still doing well. Ravi, your freight coverage is very macro as well -- in that the freight companies move all the stuff that other companies are making. How does demand from shippers look? And what are freight companies saying about the cycle?

Ravi Shanker: Yeah, from a freight transportation perspective, I guess, no news was good news out in Laguna; largely because we have already started to see an improvement in the freight cycle, at the end of 1Q going into 2Q. And I think the market was just waiting to see if that would sustain through 3Q. The data has been supportive so far, and the good news was most of the trucking companies did validate the fact that we have seen a continuation of seasonality from 2Q into 3Q.

And looking forward, they're also anticipating a fairly decent peak season, probably the most robust peak season we have had in two or three years. And I use the word robust on a relative basis because it's not going to be the greatest peak season ever. But certainly, better than we've had the last couple of years. But that momentum should continue into 2025.

So, nobody really was high fiving out there. But certainly, noted the fact that we are seeing a continued improvement in the cycle; and that momentum should continue into next year.

Michelle Weaver: One of Morgan Stanley Research's three key themes for the year is technology, diffusion and AI; and this theme came up repeatedly throughout the conference.

Chris, some of your companies have significant exposure to data centers, which have seen a huge boost in demand from AI. What does the growth opportunity look like for Multi's names with exposure to data centers?

Chris Snyder: Yeah, data center is a growth opportunity for my industrials’ coverage. And they primarily are driven by the investment side. How much data centers are we building? And they sell a lot of the equipment that goes into the data centers. And what we're seeing now is that there's a huge focus on energy efficiency within the data center. You know, obviously it helps improve their cost profile, but also as there's growing concerns around load growth and electricity allotment.

And what that's doing is it's driving demand towards the high end of the spectrum, which is where our big public companies compete. You know, they're the ones that are always spending R&D and innovating and driving energy efficiency for the customer. So, we think there's a mix up opportunity behind it.

In terms of growth rates, you know, most of the companies are talking to about 15 percent kind of plus as the growth rate going forward or where they are exposed. And the conference brought, you know, really positive updates. There was no talk of slowdown. And generally, it sounds like momentum remains firm and growth will continue.

Michelle, what were some of the other ways companies discussed AI or how they're leveraging the technology?

Michelle Weaver: Yeah. So, when I think about how companies have been adopting AI so far, not just within industrials, but within the broader market, it's largely been about things that are plug and play solutions; something like taking a chat bot, putting that on your website, and then you don't need as many customer service representatives.

So, when I'm at these kind of events, I always like to listen for more unique or differentiated ways of adopting AI. And I heard about a really interesting case from a company that holds about half of the global market for luxury seating. Processing leather is a super important part of manufacturing seats and has typically been really labor intensive and skilled labor at that. But this company is using AI to scan cow hides to determine what the optimal use for them is, and then inventory them.

Before that, a worker had to individually mark the leather for imperfections and then determine how to cut around that. So, I thought that was a pretty interesting use of AI.

But now I want to turn over to the consumer exposed pockets of industrials. Discretionary spending has been slowing as multiple years of high prices have been weighing on consumers. But overall, I thought the commentary around the consumer at the conference seemed pretty mixed, and we saw a big divide between the high-end and low-end consumers.

Ravi, what did you hear from the airlines around travel demand?

Ravi Shanker: Unlike the transportation side where what we heard was fairly consistent with expectations, I think things were much better than expected on the airline side largely because the airlines came out and validated the fact that demand continues to remain very robust -- pretty much across the board. But as you mentioned, definitely at the high end, the premium traveler continues to travel.

International is rebounding post Olympics. Corporate is normalizing as well, and some of the low-cost carriers did mention that they were seeing some weakness on the low-end consumer side. Although it was unclear to them if that was actual demand weakness or a function of too much capacity in the marketplace.

But they did come out and validate that demand continues to remain very robust; and with capacity continuing to come out of the marketplace and be more balanced with demand, you have seen pricing inflect positive for all the airlines for the first time in several quarters. So definitely, a pretty supportive backdrop for airline demand. And that is going to show up in airline numbers in the third and fourth quarters as well, we think.

Michelle Weaver: As someone who's been in the airports a lot recently, I can definitely feel that demand has held up well. Chris, some of your companies also sell consumer products. What does consumer demand look like in your space?

Chris Snyder: I would say stable, but at soft levels. And I think a lot of the tailwinds that Ravi is seeing on the service side of the house in airlines is actually coming at the expense of my companies who sell consumer goods. You know, if you look at the consumer wallet share, service mix has not gotten back to the levels that we saw in 2019 and we think that will remain a headwind for goods purchasing going forward.

Michelle Weaver: Ravi, Chris, thank you for taking the time to talk.

Ravi Shanker: Thanks so much for having me.

Chris Snyder: Thank you.

Michelle Weaver: And to our listeners, thanks for tuning in. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Presidential Debate Targets Perceptions Over Policy Sep 18, 2024

While the electoral impact of last week’s US presidential debate is unclear, our Global Head of Fixed Income and Thematic Research offers two guiding principles to navigate the markets during the election cycle.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about takeaways from the US presidential campaign debate.

It's Wednesday, September 18th at 10:30am in New York.

Last week, Vice President Harris and Former President Trump met in Philadelphia for debate. Investor interest was high, and understandably so. As our Chief Economist Seth Carpenter has previously highlighted in his research, visibility remains low when it comes to the outlook for the US in 2025.

That’s because the election could put the country on policy paths that take economic growth in different directions. And of course, the last presidential debate in June led to President Biden’s withdrawal, changing the race dramatically. So, any election-related event that could provide new information about the probability of different outcomes and the resulting policies is worth watching.

But, as investors well know from tracking data releases, earnings, Fedspeak, and more, potential catalysts often remain just that – potential. For the moment, we’re putting last week’s debate in that category.

Take its impact on outcome probabilities. It could move polls, but perhaps not enough for investors to view one candidate as the clear favorite. For weeks, the polls have been signaling an extremely tight race, with only a small pool of undecided voters. While debates in past campaigns have modestly strengthened a candidate’s standing in the polls, in this race any lead would likely remain within the margin of error.

On policy, again we don’t think the debate taught us anything new. Candidates typically use these widely watched events to influence voters’ perceptions. The details of policies and their impact tend to take a back seat to assertions of principles and critiques of their opponents. This is what we saw last week.

So if the debate provided little new information about the impact of the election on markets, what guidance can we offer? Here again we repeat two of our guiding principles for this election cycle.

First, between now and Election Day, expect the economic cycle to drive markets. The high level of uncertainty and the lack of precedent for market behavior in the run-up to past elections suggest sticking to the cross-asset playbook in our mid-year outlook. In general, we prefer bonds to equities. While our economists continue to expect the US to avoid a recession, growth is slowing. That bodes better for bonds, where yields may track lower as the Fed eases, as opposed to equities, where earnings may be challenged as growth slows.

Second, lean into market moves that election outcomes could accelerate. For several months, Matt Hornbach and our interest rate strategy team have been calling for a steeper yield curve, driven by lower yields in shorter-maturity bonds. They have been guided by our economists’ steadfast view that the Fed would start cutting rates this year as inflation eases. We doubt that policies in Democratic win scenarios would change this trend, and a Republican win could accelerate it in the near term, as higher tariffs would imply pressure on growth and possibly further Fed dovishness. Pricing that path could steepen the yield curve further.

And of course, there’s still several weeks before the election to get smart on the economic and market impacts of a range of election outcomes. We’ll keep you updated here.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

US Elections: The Politics of Healthcare Sep 17, 2024

Our US Public Policy Strategist explains the potential impact of the upcoming presidential election on the healthcare sector, including whether the outcome is likely to drive a major policy shift.

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Welcome to Thoughts on the Market. I’m Ariana Salvatore, Morgan Stanley’s US Public Policy Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll focus on what the US election means for healthcare.

It’s Tuesday, September 17th at 10am in New York.

Around elections what we tend to see is voters rank healthcare pretty high among their priority list. And for that reason it’s not surprising that it generates significant debate as well as investor concern – about everything from drug pricing to potential sweeping reforms. We think that the 2024 election is unlikely to transform the US healthcare system. But there are still policies to watch that could change depending on the outcome. We outlined these in a recent note led by our equity research colleagues Erin Wright and Terence Flynn.

To start, we think bipartisan policies should continue uninterrupted, regardless of the election outcome. Certain regulations requiring drug price and procedural transparency, for example, which affect hospitals and health plans, are unlikely to change if there is a shift of power next year. We’ve seen some regulations from the Trump era kept in place by the Biden administration; and similarly during the former president’s term there were attempts at bipartisan legislation to modify the Pharmacy Benefit Management model.

There are some healthcare policies that could be changed through the tax code, including the extension of the COVID-era ACA subsidies. In President Biden’s fiscal year [20]25 budget request, he called for an extension of those enhanced subsidies; and Vice President Kamala Harris has proposed a similar measure. As we’ve said before on this podcast, we think tax policy will feature heavily in the next Congress as lawmakers contend with the expiring Tax Cuts and Jobs Act. So many of these policies could come into the fold in negotiations.

Aside from these smaller potential policy changes, we think material differences to the healthcare system as we know it right now are a lower probability outcome. That’s because the creation of a new system - like Medicare for All or a Public Option - would require unified Democratic control of Congress, as well as party unanimity on these topics. Right now we see a dispersion among Democrats in terms of their views on this topic, and the presence of other more motivating issues for voters; mean[ing] that an overhaul of the current system is probably less likely. Similarly, in a Republican sweep scenario, we don't expect a successful repeal of the Affordable Care Act as was attempted in Trump’s first administration.

The makeup of Congress certainly is important, but there are some actions that the President can leverage unilaterally to affect policy here. For example, former President Trump issued several executive orders addressing transparency and the PBM model.

If we look at some key industries within Healthcare, our equity colleagues think Managed Care is well positioned heading into this relatively more benign election cycle. Businesses and investors are focusing on candidates' approaches to the Medicare Advantage program and the ACA Exchange, which has subsidies set to expire at the end of 2025.

Relative to prior elections, Biopharma should see a lower level of uncertainty from a policy perspective given that the Inflation Reduction Act, or the IRA, in 2022 included meaningful drug pricing provisions. We also think a full-scale repeal of the IRA is unlikely, even in a Republican sweep scenario. So, expect some policy continuity there.

Within Biotech, the path to rate cuts is likely a more significant driver of near-term Small and Mid-Cap sentiment rather than the 2024 election cycle. Our colleagues think that investors should keep an eye on two election-related factors that could possibly impact Biotech including potential changes to the IRA that may impact the sector and changes at the FTC, or the Federal Trade Commission, that could make the M&A environment more challenging.

As always, we will continue to keep you abreast of new developments as the election gets closer.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Markets Readying for a Rate Cut Sep 16, 2024

With the Federal Reserve poised to make its long-awaited rate cut this week, our CIO and Chief US Equity Strategist tells us why investors have pivoted their concerns from high inflation to slowing growth.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about what to expect as the Fed likely begins its long-awaited rate cutting cycle this week.

It's Monday, Sept 16th at 10:30am in New York.

So let’s get after it.

After nearly 12 months of great anticipation, the Fed is very likely to start its rate cutting cycle this week. The old adage that it is often easier to travel than arrive may apply as markets appear to have priced an aggressive Fed cutting cycle into the middle of next year while assuming a soft-landing outcome for the economy.

More specifically, the two-year US Treasury yield is now 180 basis points below the Fed Funds Rate which is in line with the widest spread in 40 years, a level associated with a hard landing. This is the bond market's way of messaging to the Fed that they are late in getting started with rate cuts. This doesn't mean the Fed can't get ahead of it, but they may need to move faster to keep investors' hopes alive.

As a result, the odds of a 50 basis point cut have increased over the past week but it’s still well below a certainty. This is unusual going into an FOMC meeting and is setting markets up for a greater surprise either way. How the markets react to what the Fed does this week will have an even greater influence on investor sentiment than usual, in my view. Ideally, rates should rise at both the front and back end if the bond market likes the Fed’s actions because it signals they aren’t as far behind in trying to orchestrate a soft landing. Conversely, a fall in rates will be a vote of lower confidence.

On the other side of the ledger, we have the equity market which appears to be highly convicted that the Fed has already secured the soft landing, at least at the index level. Today, the S&P 500 trades at 21x forward earnings, which also assumes a healthy path of 10 percent earnings growth in 2024 and 15 percent growth in 2025.

Under the surface, the market hasskewed much more defensively as it worries more about growth and less about high inflation. I have commented extensively in this podcast about this shift that started in April and why we have been persistently recommending defensive quality for months. With the significant outperformance of defensive sectors since April, the internals of the equity market may not be betting on a soft landing and reacceleration in growth as the S&P 500 index suggests.

Keep in mind that the S&P 500 is a defensive, high-quality index of stocks and so it typically holds up better than most stocks as growth slows in a late cycle environment like today. These growth concerns will likely persist unless the data turn around, irrespective of what the Fed does this week.

In the 11 Fed rate cutting cycles since 1973, eight were associated with recessions while only three were not. The performance over the following year was very mixed with half negative and half positive with a very wide but equal skew. Specifically, the average performance over the 12 months following the start of a Fed rate cutting cycle is 3.5 percent – or about half of the longer-term average returns. The best 12-month returns were 33 percent, while the worst was a negative 31 percent.

Bottom line, it’s generally a toss-up at the index level. The analysis around style and sectors is clearer. Value tends to outperform growth into the first cut and underperform growth thereafter. Defensives tend to outperform cyclicals both before and after the cut. Large caps also tend to outperform small caps both before and after the first rate cut. These last two factor dynamics are supportive of our defensive and large cap bias as Fed cuts often come in a later cycle environment. It’s also why we are sticking with it.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Bank of Japan’s Role in Market Volatility Sep 13, 2024

After sending global markets in a brief tailspin in early August, the Bank of Japan is once again the center of attention. Our Global Chief Economist and Chief Asia Economist discuss the central bank’s next steps to help ease volatility and inflation.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Chetan Ahya: And I'm Chetan Ahya, Chief Asia Economist.

Seth Carpenter: And on today's episode, Chetan and I are going to be discussing the Bank of Japan and the role it has been playing in recent market turmoil.

It's Friday, September 13th at 12.30pm in New York.

Chetan Ahya: And it's 5.30pm in London.

Seth Carpenter: Financial markets have been going back and forth for the past month or so, and a lot of what's been driving the market movements have been evolving expectations of what's going on at central banks. And right at the center of it has been the Bank of Japan, especially going back to their meeting at the very end of July.

So, Chetan, maybe you can just level set us about where things stand with the Bank of Japan right now? And how they've been communicating with markets?

Chetan Ahya: Well, I think what happened, Seth, is that Bank of Japan (BoJ) saw that there was a significant progress in inflation and wage growth dynamic. And with that they went out and told the markets that they wanted to start now increasing rate hikes. And at the same time, the end was weakening.

And to ensure that they kind of convey to the markets that they want to be now taking rates higher, the governor of the central bank came out and indicated that they are far away from neutral.

Now while that was having the desired effect of bringing the yen down, i.e. appreciated. But at the same time, it caused a significant volatility in the equity markets and make it more challenging for the BoJ.

Seth Carpenter: Okay, so I get that. But I would say the market knew for a long time that the Bank of Japan would be hiking. We've had that in our forecast for a while. So, do you think that Governor Ueda really meant to be quite so aggressive? That meeting and his comments subsequently really were part of the contribution to all of this market turmoil that we saw in August. So, do you think he meant to be so aggressive?

Chetan Ahya: Well, not really. I think that's the reason why what we saw is that a few days later, when the deputy governor Uchida was supposed to speak, he tried to walk back that hawkishness of the governor. And what was very interesting is that the deputy governor came out and indicated that they do care for financial conditions. And if the financial conditions move a lot, it will have an impact on growth and inflation; and therefore, conduct of monetary policy.

In that sense, they conveyed the endogeneity of financial conditions and their reaction function. So, I think since that point of time, the markets have had a little bit of reprieve that BoJ will not take up successive rate hikes, ignoring what happens to the financial conditions.

Seth Carpenter: But this does feel a little bit like some back and forth, and we've seen in the market that the yen is getting a little bit whipsawed; so the Bank of Japan wants to hike, and markets react strongly. And then the Bank of Japan comes out and says, ‘No, no, no, we're not going to hike that much,’ and markets relax a little bit. But maybe that relaxation allows them to hike more.

It kind of reminds me, I have to say, of the 2014 to 2015 period when the Federal Reserve was getting ready to raise interest rates for the first time off of the zero lower bound after the financial crisis. And, you know, markets reacted strongly -- when then chair Yellen started talking about hiking and because of the tightening of financial conditions, the Fed backed down.

But then because markets relaxed, the Fed started talking about hiking again. Do you think that's an apt comparison for what's going on now?

Chetan Ahya: Absolutely, Seth. I think it is exactly something similar that is going on with Bank of Japan.

Seth Carpenter: So, I guess the question then becomes, what happens next? We know with the Fed, they eventually did hike rates at the end of 2015. What do you think we're in line for with the Bank of Japan, and is it likely to be a bumpy ride in the future like it has been over the past couple months?

Chetan Ahya: Well, so I think as far as the market’s volatility is concerned, we do think that the fact that the BoJ has come out and indicated that their reaction function is such that they do care about financial conditions. Hopefully we should not see the same kind of volatility that we saw at the start of the month of August.

But as far as the next steps are concerned, we do see BoJ taking up one more rate hike in January 2025. And there is a risk that they might take up that rate hike in December.

But the reason why we think that they will be able to take up one more rate hike is the fact that there is continued progress on wage growth and inflation; and wage growth is the most important variable that BoJ is tracking.

We just got the last month's wage growth number. It has risen up to 3 percent. And going forward, we think that as the BoJ gets comfort that next year's wage negotiations are also heading in the right direction, they will be able to take one more rate hike in January 2025.

Well, Seth, I think, you know, when we are talking about this volatility that we saw in the financial markets and particularly yen, the other side of this story is what the Fed has to do, and what is Fed indicating in terms of its policy path. And we saw that, after the nonfarm payrolls data, Governor Waller was indicating that the Fed could consider front-loading its rate cuts. What are your thoughts on that?

Seth Carpenter: So, we do think the Fed's getting ready to start cutting rates. Our baseline is that they move at 25 increments per meeting, from now through the middle of next year. I would take Governor Waller's comments though about front-loading cuts -- which I took to mean, you know, the possibility of 50 basis point rate moves -- very much in context, and with a grain of salt.

When he gave that speech, I think what he was trying to do, and I think the last paragraph of that speech really bears it out. He was saying there's a lot of uncertainty here. He said, if the data suggests that they need to front load rates, then he would advocate for it. But he also said that, if the data implied that they need to cut at consecutive meetings, he'd be in favor of that as well. So, he was saying that the data are going to be the thing that drives the policy decisions.

But thanks for asking that question. And thanks to the listeners. If you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.

Corporate Credit at a Crossroads? Sep 12, 2024

Our Head of Corporate Credit Research looks at the Fed’s approach to rate cuts, seasonal trends and the US election to explain why the next month represents a crucial window for credit’s future.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss why the next month is a critical window for credit.

It's Thursday, September 12th at 9am in New York.

We’ve liked corporate credit as an asset class this year and think the outlook over the next 6-12 months remains promising. At a high level, credit likes moderation, and that continues to be exactly what Morgan Stanley’s economists are forecasting; with moderate growth, moderate inflation, and moderating policy in the US and Europe. Meanwhile, at the ground level, corporate balance sheets are in good shape, and demand for fixed income remains strong, dynamics that we think are unlikely to shift quickly.

But this good credit story is now facing a critical window. As we’ve discussed recently on this program, the Fed has taken a risk with monetary policy, continuing to keep interest rates elevated despite increasing indications that they should be lower. U.S. inflation has been coming down rapidly, to the point where the market now thinks the rate of inflation over the next two years will be below what the Fed is targeting. The labor market is slowing, and government bond markets are now assuming that the Fed will have to make much more significant adjustments to policy.

And so, this becomes a race. If the economic data can hold up for the next few months, while the Fed does make those first gradual rate cuts, it will help reassure markets that monetary policy is reasonable and in-line with the underlying economy. But if the data weakens more now, the market is vulnerable. Monetary policy works with a lag, meaning rate cuts are not going to help anytime soon. And so, it becomes easier for the market to worry that growth is slowing too much, and that the cavalry of rate cuts will be too late to arrive.

The second immediate challenge is so-called seasonality. Over almost a century, September has seen significantly weaker performance relative to any other month. Seasonality always has an element of mysticism to it, but in terms of specific reasons why markets tend to struggle around this time of year, we’d point to two factors. First, after a summer lull, you tend to see a lot of issuance, including corporate bonds issuance. And for Equities, September often sees more negative earnings revisions, as companies aim to bring full-year estimates in line with reality. Lots of supply and weaker earnings revisions are often a tough combination.

A final element of this critical window is the approaching US election.This appears to be an extremely close race between candidates with very different policy priorities. If investors get more nervous that monetary policy is mis-calibrated, or seasonality is unhelpful, the approaching election provides yet another reason for investors to hold back.

All of this is why we think the next month is a critical window for credit, and why we’d exercise a little bit more caution than we have so far this year. But we also think any weakness is going to be temporary. By early November, the US election will be over, and we think growth will be holding up, inflation will keep coming down, and interest rate cuts will be well underway. And while September is historically a bad month for stocks and credit, late-October onward is a different and much better story. Any near-term softness could still give way to a stronger finish to the year.

Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Uneven Recovery in Commercial Real Estate Sep 11, 2024

Office buildings continue to struggle in the post-pandemic era, but our Chief Fixed Income Strategist notes that other properties have turned a corner.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about how the challenges facing the US commercial real estate markets have evolved and talk about where they are headed next.

It's Wednesday, Sep 11th at 10 am in New York.

Over the last year and half, the challenges of commercial real estate, or CRE in short, have been periodically in the spotlight. The last time we discussed this issue here was in the first quarter of this year. That was in the aftermath of loan losses announced by a regional bank that primarily focused on rent-stabilized multifamily and CRE lending in the New York metropolitan area. At the same time, lenders and investors in Japan, Germany and Canada also reported sizable credit losses and write-down related to US commercial real estate.

At that time, we had said that CRE issues should be scrutinized through the lenses of lenders and property types; and that saw meaningful challenges in both – in particular, regional banks as lenders and office as a property type.

Rolling the calendar forward, where do things stand now?

Focusing on the lenders first, there is some good news. While regional bank challenges from their CRE exposures have not gone away, they are not getting any worse. That means incremental reserves for CRE losses have been below what we had feared. Our economists’ expectations of Fed’s rate cuts on the back of their soft-landing thesis, gives us the conviction that lower rates should be an incremental benefit from a credit quality perspective for banks because it alleviates pressure on debt service coverage ratios for borrowers. Lower rates also give banks more room to work with their borrowers for longer by providing extensions. For banks, this means while CRE net charge-offs could rise in the near term, they are likely to stabilize in 2025.

In other words, even though the fundamental deterioration in terms of the level of delinquencies and losses may be ahead, the rate of change seems to have clearly turned. In that sense, as long as the rate cuts that we anticipate materialize, the worst of the CRE issues for regional banks may now be behind us.

From the lens of property types, it is important not to paint all property types with the same brushstroke of negativity. Office lots remain the pain point. Looking at the payoff rates in CMBS pools gives us a granular look at the performance across different property types.

Overall, 76 per cent of the CRE loans that matured over the past 12 months paid off, which is a pretty healthy rate. However, in office loans, the payoff rate was just 43 per cent. Other property types were clearly much better. For example, 100 per cent of industrial property loans, 96 per cent of multi-family loans, 89 per cent of hotel loans that matured in the last 12 months paid off. The payoff rates in retail property loans were a bit lower but still pretty healthy at 76 per cent, in clear contrast to office properties. Delinquency rates across property types also show a similar trend with office loans driving the lion’s share of the overall increase in delinquencies.

In short, the secular headwinds facing the office market have not dissipated. Office property valuations, leasing arrangements and financing structures must adjust to the post-pandemic realities of office work. While this shift has begun, more is needed. So, there is really no quick resolution for these challenges which we think are likely to persist. This is especially true in central business district offices that require significant capex for upgrades or repurposing for use as residential housing.

Overall, we stick to our contention that commercial real estate risks present a persistent challenge but are unlikely to become systemic for the economy.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen to this and share Thoughts on the Market with a friend or colleague today.

Trading Spaces: Millennials vs. Boomers Sep 10, 2024

With the generational shift in the US housing market underway, our analysts discuss the impact this trend will have on residential real estate investing.

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Ron Kamdem: Welcome to Thoughts on the Market. I'm Ron Kamdem, head of Commercial Real Estate Research and the US Real Estate Investment Trust team within Morgan Stanley Research.

Lauren Hochfelder: And I'm Lauren Hochfelder, Co-Chief Executive Officer of Morgan Stanley Real Estate Investing, the global private real estate investment arm of the firm.

Ron Kamdem: And on this special episode of Thoughts on the Market, we’ll discuss the tangible impact of shifting demographics on the residential real estate investing space.

It's Tuesday, September 10th at 10 am in New York.

So, Lauren, for several years now, we've been hearing about millennials overtaking the baby boomers. As a reminder, millennials are people between the age of 28 and 43. So someone like me. And there’s about 72 million millennials right now. Baby boomers are around 59 to 78; and there's about 69 million at the moment. This demographic shift will have a profound impact on all sectors of the economy, including residential housing. So, let's lay the foundation first. What are the current needs of baby boomers and millennials when it comes to their homes?

Lauren Hochfelder: Yeah, this is such an interesting moment, Ron, because as you say, their needs are shifting. Over the last 15 years, what have millennials wanted? They have wanted multifamily. They have wanted rental apartment units. And by the way, they've wanted, generally speaking, small ones in cities.

Ron Kamdem: Yup.

Boomers? They have been disproportionately residing in single family homes that they own, and that they've owned for a long time. But here we are, as millennials reach peak household formation years and boomers approach their 80-year-old mark. There's a real shift.

We have millennials growing up and growing out, and boomers growing older. And that means millennials need more space; boomers need more services. Housing with increased care options. And that really leads to three things.

One, pockets of oversupply of multifamily. Developers develop to the rearview mirror; and we have way too much of what they wanted yesterday and too little of what they wanted to what they want tomorrow. The second is increased demand for single family rental in more suburban locations to meet the needs of those millennials. And the third is increased demand for senior housing for the boomers.

Ron Kamdem: Excellent. So, when we look at the next five to ten years, let's consider each of these generations. Demand for senior housing is increasing significantly. Where are we in this process, and what's your expectation for the next decade?

Lauren Hochfelder: Look, we think this is the golden age for senior housing. The demand wave is upon us, supply is way down. And by the way, labor costs, which have been a real headwind, are finally abating. New construction of senior housing has basically fallen off a cliff. It is down 75 per cent from its peak; if you look at the first quarter of this year, it's basically at GFC levels. And third, the senior wealth effect. Not only do seniors need this product, they can afford it.

They have been in those homes, they've owned those homes for a very long time, and over that period, home prices have appreciated. So, seniors are in a position where they can really afford to move into these senior living facilities.

Ron Kamdem: And what about millennials? As they get older, how are their housing needs evolving?

Lauren Hochfelder: I'd say three things. It's they need more space. So single family rental versus multifamily. The second is migratory shifts, right? It's no longer -- I have to live in San Francisco or New York. You're seeing real growth in the southeast and Texas. And the third is this preference to rent. Now, a lot of that's affordability driven.

Ron Kamdem: Right.

Lauren Hochfelder: But I think there's also mobility. There's just general preference. I mean, this is a generation that doesn't own a landline, right? So, they want to rent. They don't want to buy.

Ron Kamdem: So, given these trends as an actual real estate investor, how do you view the supply and demand dynamics within residential investing? And where do you see the biggest opportunities?

Lauren Hochfelder: Look, I think housing in general is attractive to invest in. There's simply too little of it. But you really can't paint a broad brush. You need to invest in the type of housing with the best outlook. And you and I can sit here and debate what's going to happen with interest rates. But what is not debatable is that these two large age groups are going to drive demand disproportionately.

And so rather than speculating on interest rates, let's calculate the number of people in these generations. And so that means that we want to invest in single family. We want to invest in seniors housing, and we want to invest in the markets where these groups want to live.

So, let's turn it around. We've been talking about this growing senior population and, you know, we and my side of the business. We've been investing in a lot of senior housing communities. But how does this affect your world? You cover the entire US public real estate investment trust universe. How are you thinking about these things?

Ron Kamdem: So, our investors are really focused on secular trends that they can invest over a long period of time. And there's really two that I would like to call out. So, the first is the rise of senior housing communities.

As you mentioned earlier, if you think about the US population, the population that's 65 and over is really the addressable market. And we do expect that number to rise to about 21 per cent of the population or 71 million people.

Lauren Hochfelder: So, think about one in four people being eligible or appropriate for senior housing. It's amazing.

Ron Kamdem: That’s an incredible demand function.

Now, the second pieceof it is historically these seniors have actually shied away from senior housing. So, the first sort of trend and inflection point that I want to call out is we do think there's an opportunity for penetration race -- not only to flatten out, but to start increasing. And that's driven exactly by your earlier comment, which is affordability. Remember, about 75 per cent of seniors actually own their own homes, and they've seen a significant amount of price appreciation. Since 2010, their home prices have gone up 80 per cent, which is about two times the rate of inflation.

Second investable trend is the move of outpatient services outside of the hospital setting. So, if you go back to the eighties, only about 16 per cent of services were being done outside of the hospital. In 2020, that number was close to 68 per cent and we think that's going to keep rising. The reason being because of surgical advances, there's a lot of projects that can be done outside of the hospital. Whether it's, you know, knee replacements, trigger finger surgery, cataract surgeries, and so forth. In addition to that, the expansion of Medicare coverage has allowed for reimbursement of these services, again, outside of the hospital.

So, we think these are trends that are in place that should continue over the next sort of decade and drive more demand to the healthcare real estate space.

Lauren Hochfelder: So, what should we be nervous about? What concerns you?

Ron Kamdem: Look, I think on the senior housing side, there's always two factors that we focus on. So, the first is labor. This remains a very labor-intensive industry. But in the US, historically, people coming out of college, they're not necessarily going into the health care space. So, there's been moments of labor shortages. This happened exactly after the pandemic. Luckily, today, the labor situation has abated and you're seeing sort of labor costs back to inflationary type levels.

The second piece of it is just the age of the facilities. Now, keep in mind, there's still a lot of facilities with the average age of about 41, right. And everybody has in the back of their mind, these older facilities with older carpets and so forth. So, when we're thinking about investing in the space, we're always focused on the newer assets, the better quality that are going to provide a better experience for the tenant.

Lauren Hochfelder: So, given these shifts, what segments of your world are poised to benefit the most?

Ron Kamdem: The real estate public market, there's about 160 REITs across 16 different subsectors; and the senior housing subsector is by far the most compelling in our minds. If you think about the REIT market, the average sort of earnings growth is 3 to 4 per cent. However, the senior housing sector, we think you can get 10 per cent or more growth over the next three to five years. The reason being when the pandemic hit, this was an industry that saw occupancy go from 90 per cent to 75 per cent.

There was a moment in time where people thought you'd never put any seniors in the facility again. Well, the exact opposite has happened, and now we're seeing occupancy gains of about 300 basis points of about 3 per cent every year. On top of some pricing power, call it 5, 6 or 7 per cent. So, we're looking at a sector where we think organically you can grow sort of high single digits. With a little bit of operating leverage, you can get to a total earning growth of double digits, which is very compelling relative to the rest of the REIT market.

Lauren Hochfelder: Let's go back to your generation, as you said. Let's go back to the millennials. How do those shifting needs affect which part of the universe you would invest in?

Ron Kamdem: One of the things that I think every real estate owner’s thinking about is how to integrate their platform so that they're more millennial friendly. They're going online. They're using their phones, and I think we're seeing a much bigger investment in marketing dollars on a web presence, on a web platform, and on a mobile friendly app, certainly to be able to interface with that millennial and help with customer acquisitions.

So, I would say that's probably the biggest difference -- is how you target that population in a different way than you did historically.

Lauren Hochfelder: Yeah, I mean we all shop online, shouldn't we get our homes online, right?

Ron Kamdem: That's right. All right, Lauren. Well, thanks for taking the time to talk.

Lauren Hochfelder: Yeah, this been great, Ron. I always enjoy us catching up.

Ron Kamdem: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. It helps more people to find the show.

*****

Lauren Hochfelder is not a member of Morgan Stanley’s Research department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research department and from the views of others within Morgan Stanley.

Shaky Labor Data Pressures Equity Markets Sep 09, 2024

Followingweaker-than-expected August jobs data, our CIO and Chief U.S Equity Strategist lays out how the Federal Reserve can ease concerns about a possible hard landing.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking aboutthe labor market’s impact on equity markets.

It's Monday, Sept 9th at 11:30am in New York. So let’s get after it.

Last week, I wrote a detailed note discussing the importance of the labor data for equity markets. Importantly, I pointed out that since the materially weaker than expected July labor report, the S&P 500 has bounced more than other "macro" markets like rates, currencies and commodities. In the absence of a reacceleration in the labor data, we concluded the S&P 500 was trading out of sync with the fundamentals.

Over the past week, we received several labor market data points, which were weaker than expected. First, the Job Openings data for July was softer than expected coming in at 7.7mm versus the consensus expectation of 8.1mm. In addition, June's initial result was revised lower by 274k. This essentially supported the view that the weak payrolls data in July may, in fact, not be related to weather or other temporary issues.

Second, the job openings rate fell to 4.6%, which is very close to the 4.5% level Fed Governor Waller has cited as a threshold below which the unemployment rate could rise much faster. Third, the Fed's Beige Book came out last week. It indicated that activity remains sluggish with 9 of the 12 Federal Reserve districts reporting flat or declining activity in August, though commentary on labor markets was more neutral, rather than negative. These data sync nicely with the Conference Board’s Employment Trends Index, which I find to be a very objective aggregate measure of the labor market's direction. This morning, we received the latest release for August Conference Board labor market trends and the trend remains down, but not necessarily recessionary.

Of course, the main event last week was Friday's monthly jobs and unemployment reports, where the payroll survey number came in below consensus at 142k. In addition, last month's result was revised lower from 114k to 89k. Meanwhile, the unemployment rate fell by only a couple of basis points leaving investors unconvinced that July’s labor weakness was overstated.

Given much of these labor and other growth data have continued to skew to the downside, the macro markets (like rates, currencies, and Commodities) have been trading with more concern about potential hard landing risks. Perhaps nowhere is this more obvious than with 2-year US Treasuries. As of Friday, the spread between the 2-year Treasury yields and the Fed Funds Rate matched the widest levels in the past 40 years. This pricing suggests the bond market believes the Fed is behind the curve from an easing standpoint. On Friday, the equity market started to get in sync with this view and questioned whether a 25bp cut in September would be an adequate policy response to the labor data. In the context of an equity market that is still quite rich and based on well above average earnings growth assumptions, the correction on Friday seems quite appropriate.

In my view, until the bond market starts to believe the Fed is no longer behind the curve, labor data reverses course and improves materially or additional policy stimulus is introduced, it will be difficult for equity markets to trade with a more risk on tone. This means valuations are likely to remain challenged for the overall index, while the leadership remains more defensive and in line with our sector and stock recommendations. We see two ways in which the Fed can get ahead of the curve—either faster cutting than expected which is unlikely in the absence of recessionary data; or the labor data starts to improve in a convincing manner and 2-year yields rise. Given the Fed is in the blackout period until next week’s FOMC meeting, and there are not any major labor data reports due for almost a month, volatility will likely remain elevated and valuations under pressure overall. This all brings our previously discussed fair value range for the S&P 500 of 5000-5400 back into view.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Balance Sheets Remain Resilient Despite Slowing US Growth Sep 06, 2024

Our Head of Corporate Credit Research, Andrew Sheets, expects a sticky but shallow cycle for defaults on loans, with solid quality overall in high-grade credit.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss some longer-term thoughts on the credit market and the economic cycle.

It's Friday, September 6th at 2pm in London.

Concerns around US growth have risen, an issue that will probably persist even after today’s US Payrolls report came roughly inline with expectations. At Morgan Stanley, we continue to expect moderate slowing in growth, not a slump. By the middle of next year, our economists see growth slowing to a still respectable 2% growth rate, and a total of seven rate cuts.

While growth is set to slow, we think corporate balance sheet metrics are unusually good in the face of this slowing. Indeed, the credit quality of the US investment grade and BB credit markets, which represent the vast majority of corporate credit outstanding, have actually improved since the Fed started hiking rates.

Now, looking ahead, there's understandable concern that these currently good credit metrics won't be sustainable as companies will have to refinance the very cheap borrowing that they received immediately after COVID, with the more expensive costs of today's currently higher yields. But we actually think balance sheets will be reasonably robust in light of this reset, and so their ultimate rate sensitivity could be relatively low.

One reason is that a wave of refinancing means companies have already tackled a significant portion of their upcoming debt, reducing the so-called rollover or refinancing risk. Interest coverage for floating rate borrowers has stabilized and should actually improve as the Fed starts to lower rates.

The debt service costs for higher rated companies will increase as cheaper debt matures and has to be replaced with more expensive borrowing; but we stressed this is a pretty slow process given the long-term nature of a lot of this borrowing. And so, overall, we think the headwinds from higher debt costs are going to be manageable, with the problems largely confined to a smaller cohort of the lowest quality issuers.

We think all of that will drive a so-called sticky but shallow default cycle, with defaults driven by higher borrowing costs at select issuers rather than a single problem sector or particularly poor corporate earnings. And there are also some important offsets. Morgan Stanley's forecast suggests that the Fed will be cutting rates, which will reduce overall borrowing costs over the medium term. And another notable theme over the last two years is that more defaults have been becoming so-called restructurings rather than bankruptcies. These restructurings are more likely to leave a company operating -- just under new ownership -- and create less negative feedback into the real economy.

Now, against all this, we're mindful that credit spreads are tight, i.e. lower than average. But importantly, we don't think this reflects some sort of euphoria from either the lenders or the borrowers.

All-in borrowing costs for corporates remain high, and that's made corporates less likely to be aggressive or increase their leverage. Indeed, since COVID, the overall high yield bond and loan markets have actually shrunk. Leverage buyout activity has been muted and corporate leverage has gone sideways.

These are not the types of things you see when corporates are being particularly aggressive and credit unfriendly. Credit markets love moderation and that's very much what Morgan Stanley's economic forecasts over the medium term expect. Spreads may be tight. But we think they're currently supported by strong fundamentals, modest supply, and improving technicals.

Today's roughly inline payroll number won’t resolve the uncertainty around growth, but longer term, we think the picture remains encouraging.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Global Energy Markets and the US Election Sep 05, 2024

Our US Public Policy and Global Commodities strategists discuss how the outcome of the election could affect energy markets in the US and around the world.

----- Transcript -----

Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US public policy strategist.

Martijn Rats: And I'm Martijn Rats, Global Commodity Strategist.

Ariana Salvatore: Today we'll be talking about a topic that's coming into sharper focus this fall. How will the US presidential election shape energy policy and global energy markets?

It's Thursday, September 5th at 10am in New York.

Martijn Rats: And 3pm in London.

Ariana Salvatore: As we enter the final leg of the US presidential campaign, Harris and Trump are getting ready to go head-to-head on a number of key topics. Healthcare, housing, the state of the economy, foreign policy; and also high on the agenda -- energy policy.

So, Martijn, let's set the stage here. Prices at the gas pump in the US have been falling over recent weeks, which is atypical in the summer. What's happening in energy markets right now? And what's your expectation for the rest of the year?

Martijn Rats: Yeah, it's a relevant question. Oil prices have been quite volatile recently. I would say that objectively, if you look at the market for crude oil, the crude oil market is tight right now. We can see that in inventories, for example, they are buying large drawing, which tell[s] you, the demand is outstripping supply.

But there are two things to say about the tightness in the crude oil market. First of all, we're not quite seeing that tightness merit in the markets for refined products. So, get the market for gasoline, the market for diesel, et cetera. At the moment, the global refining system is running quite hard.

But they're also producing a lot of refined product. A lot of gasoline, a lot of diesel. They're pushing that to their customers. Demand is absorbing that, but not quite in a convincing manner. And you can see that in refining margins. They have been steadily trending down all summer.

The second thing to say about the tightness and crude is that it's largely driven by a set of factors that will likely to be somewhat temporary. Seasonally demand is at its strongest -- that helps. The OPEC deal is still in place. And as far as we can see in high frequency data, OPEC is still constraining production.

And then thirdly, production has been growing in a number of non-OPEC countries. But that absent flows and the last couple of months have seen somewhat of a flat spot in non-OPEC supply growth.

Now, those factors have created the tightness that we're seeing currently in the third quarter. But if you start to think about the oil market rolling into the fourth quarter and eventually 2025, a lot of these things going to reverse. The seasonal demand tailwinds that we are currently enjoying; they turn into seasonal demand headwinds in four q[uarter]and one q[uarter] -- seasonally weaker quarters of the year. Non-OPEC production will likely resume its upward trajectory based on the modeling of projects that we've done. That seems likely. And then OPEC has also said that they will start growing production again with the start of the fourth quarter.

Now, when you put that all together, the market is in deficit now. It will return to a broadly balanced state in the fourth quarter, but then into a surplus in 2025. Prices look a little into the future. They discount the future a little bit

Now, as the US election approaches, investors are increasingly concerned how a Trump versus Harris win would affect energy policy and markets going forward. Ariana, how much and what kind of authority does the US president actually have in terms of energy policy? Can you run us through that?

Ariana Salvatore: Presidential authorities with respect to energy policy are actually relatively limited. But they can be impactful at the margin over time. What we tend to see actually is that production and investment levels are reasonably insulated from federal politics.

Only about 25 per cent of oil and 10 per cent of natural gas is produced on federal land and waters in the US. You also have this timing factor. So, a lot of these changes are really only incremental; and while they can affect levels at the margin, there's a lag between when that policy is announced and when it could actually flow through in terms of actual changes to supply levels. For example, when we think of things like permitting reform, deregulation and environmental review periods and leasing of federal lands, these are all policy options that do not have immediate impacts; and many times will span across different presidential administrations.

So, you might expect that if a new president comes into office, he or she could reverse many of the executive actions taken by his or her predecessor with respect to this policy area.

Martijn Rats: And what have Trump and Harris each said so far about energy policy?

Ariana Salvatore: So, I would say this topic has been less prevalent in Harris's campaign, unless we're talking about it in the context of the energy transition overall. She hasn't laid out yet specific policy plans when it comes to energy; but we think it's safe to assume that you could see her maintain a lot of the Biden administration's clean energy goals and the continued rollout of bills like the Inflation Reduction Act, which contained a whole host of energy tax credits toward those ends.

Now, conversely, Trump has focused on this a lot because he's been tying energy supply to inflation, making the case that we can lower inflation and everyday costs by drilling more. His policy platform, and that of the GOP has been to increase energy production across the board. Mainly done by streamlining, permitting and loosening restrictions on oil, natural gas, and coal.

Now, to what I said before, some of that can be accomplished unilaterally through the executive branch. But other times it might require the consent of Congress, and consent from states -- because sometimes these permitting lines cross state borders.

So, Martijn, from your side, how quickly can US policy, whether it's driven by Trump or Harris, affect energy markets and change production levels and therefore supply?

Martijn Rats: Yeah, like you just outlined, the answer to that question is only gradually. Regulation is important, but economics are more important. If you roll the clock back to, say, early 2021, when President Biden has just took office; on day one, he famously canceled the permit for the Keystone XL pipeline.

But if you now look back, at the last four years, start to finish; American oil production, grew more under Biden, than any other president in the history of the United States. With the exception of Obama, who, of course, enjoyed the start of the shale revolution.

Production is close, to record levels, which were set just before COVID, of course. So, in the end, the measures that President Biden put in place, have had only a very limited impact on oil production. The impact that the American president can have is only -- it's only gradual.

Ariana Salvatore: So, as we've mentioned, expanding energy development has been a massive plank of Trump's campaign platform. And listeners will also remember that during his term in office, he supported energy development on federal land. If Trump wins in November, what would it mean for oil supply and demand both in the US and globally?

Martijn Rats: Admittedly, it's somewhat of a confusing picture. So, if you look at oil supply, you have to split it in perhaps a domestic impact and an international impact. Domestically, Donald Trump has famously said recently that he would return the oil industry to “Drill baby drill,” which is this, this shorthand metaphor for, abundant drilling in an effort to significantly accelerate oil production.

But as just mentioned, there is little to be unleashed because during President Biden, the American oil industry hasn't really been constrained in the first place.

A lot of American EMP companies are focused on capital discipline. They're focused on returns on free cashflow on shareholder distributions. With that come constraints to capital expenditure budgets that probably were not in place several years ago with those CapEx constraints, production can only grow so fast.

That is a matter of shareholder preference. That is a matter of returns. And regulation can change that a little bit, but not so much.

If you look at the perspective outside the United States, it is also worth mentioning that in the first Trump presidency, President Trump famously put secondary sanctions on the export of crude oil from Iran. At the time that significantly constrained crude oil supply from Iran, which in 2018 played a key role in driving oil prices higher.

Now, it's an open question, whether that policy can be repeated. The flow of oil around the world has changed since then. Iranian oil isn't quite going to the same customers as it did back then. So, whether that policy can be replicated, remains to be seen. But whilst the domestic perspective -- i.e. an attempt to grow production -- could be interpreted as a potential bearish factor for the price of oil, the risk of sanctions outside the United States could be interpreted as a potential bullish risk for oil.

And this is, I think, also why the oil market struggles to incorporate the risks around the presidential election so much. At the moment, we're simply confronted with a set of factors. Some of them bearish, some of them bullish, but it remains hard to see exactly which one of them played out. And, at the moment they don't have a particular skew in one direction.

So, we're just confronted with options, but little direction.

Ariana Salvatore: Makes sense. So, I think that makes this definitely a policy area that we'll be paying very close attention to this fall. I suppose we'll also both be tuning into the upcoming debate, where we might get a better sense of both sides policy plans. If we do learn anything that changes our views, we'll be sure to let you know.

Martijn, thanks for taking the time to talk

Martijn Rats: Great speaking with you, Ariana.

Ariana Salvatore: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

US Election: A Game Of Inches Sep 04, 2024

Despite a flurry of election news, little may have changed for investors weighing the possible outcomes. Our Head of Fixed Income and Thematic Research, Michael Zezas, explains why this is the case as we move closer to Election Day.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about recent developments in the US election.

It's Wednesday, September 4th at 10:30am in New York.

While news headlines might make it seem a lot has changed in recent weeks around the US election, in our view not much has changed at all. And that’s important for investors to understand as they navigate markets between now and Election Day on November 5th. Let me explain.

In recent weeks, we've had the Democratic convention, fresh polls, and a third party candidate withdraw from the race and endorse former President Trump. But all appear to reflect only marginal impacts on the probabilities of different electoral outcomes.

Take the withdrawal of independent candidate Robert F Kennedy Junior, which does not appear to be a game changer. Historical precedent is that third party candidates rarely have a path to even winning one state's electoral votes. Further, in polls voters tend to overstate their willingness to support third parties ahead of election day. And it's also not clear that Kennedy withdrawing clearly benefits Democrats or Republicans.

Kennedy originally ran for President as a Democrat, and so was thought to be pulling from likely Democratic voters. However, polls suggest his supporter’s next most likely choice was nearly split between Trump and Harris.

So while it’s possible that Kennedy’s decision to endorse Trump upon dropping out could be meaningful, given how close the race is, we’re unlikely to be able to observe that potentially marginal but meaningful effect until after the election has passed. And such effects could easily be offset by small shifts favoring Democrats, who are showing some polling resiliency in states where just a couple months ago the election was not assumed by experts to be close.

For example, Cook Political Report, a site providing non-partisan election analysis, shifted its assessment of the Presidential election outcome in North Carolina from “lean Republican” to a “toss-up.” Similarly, in recent weeks the site has shifted states like Arizona, Nevada, and Georgia into that same category from “lean Republican.” These shifts are mirrored in several other polls released last week showing a close race in the battleground states.

So, for all the changes and developments in the last week, we think we’re left with a Presidential race that’s difficult to view as anything other than a tossup. To borrow a term from the world of sport – it’s a game of inches. Small improvements for either side can be decisive, but as observers we may not be able to see them ahead of time.

And so that brings us back to our guidance for investors navigating the run up to the election. Let the democratic process unfold and don’t make any major portfolio shifts until more is known about the outcome. That means the economic cycle will drive markets more than the election cycle in the next couple months.

In our view, that favors bonds over stocks. Lower inflation enables easier monetary policy and lower interest rates, good for bond prices; but growth concerns should weigh on equities.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Wallets Wide Open For GenAI Sep 03, 2024

While venture capital is taking a more cautionary approach with crypto startups, the buzz around GenAI is only increasing.

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Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley’s Head of Thematic Research in Europe. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what private markets can tell us about the viability and investability of disruptive technologies.

It’s Tuesday, the 3rd of September, at 2pm in London.

For the past three years we have been tracking venture capital funding to help stay one step ahead of emerging technologies and the companies that are aiming to disrupt incumbent public leaders. Private growth equity markets are -- by their very definition – long-duration, and therefore highly susceptible to interest rate cycles.

The easy-money bubble of 2021 and [20]22 saw venture funding reach nearly $1.2trillion dollars – more than the previous decade of funding combined. However, what goes up often comes down; and since their peak, venture growth equity capital deployment has fallen by over 60 percent, as interest rates have ratcheted ever higher beyond 5 percent.

So as interest rates fall back towards 3.5 percent, which our economists expect to happen over the coming 12 months, we expect M&A and IPO exit bottlenecks to ease. And so too the capital deployment and fundraising environment to improve.

However, the current funding market and its recovery over the coming months and years looks more imbalanced, in our view, than at any point since the Internet era. Having seen tens- and hundreds of billions of dollars poured into CleanTech and health innovations and battery start-ups when capital was free; that has all but turned to a trickle now. On the other end of the spectrum, AI start-ups are now receiving nearly half of all venture capital funding in 2024 year-to-date.

Nowhere is that shift in investment priorities more pronounced than in the divergence between AI and crypto startups. Over the last decade, $79billion has been spent by venture capitalists trying to find the killer app in crypto – from NFTs to gaming; decentralized finance. As little as three years ago, start-ups building blockchain applications could depend on a near 1-for-1 correlation of funding for their projects with crypto prices. Now though, despite leading crypto prices only around 10 percent below their 2021 peak, funding for blockchain start-ups has fallen by 75 percent.

Blockchain has a product-market-fit and a repeat-user problem. GenerativeAI, on the other hand, does not. Both consumer and enterprise adoption levels are high and rising. Generative AI has leap-frogged crypto in all user metrics we track and in a fraction of the time. And capital providers are responding accordingly. Investors have pivoted en-masse towards funding AI start-ups – and we see no reason why that would stop.

The same effect is also happening in physical assets and in the publicly traded space. Our colleague Stephen Byrd, for example, has been advocating for some time that it makes increasing financial sense for crypto miners to repurpose their infrastructure into AI training facilities. Many of the publicly listed crypto miners are doing similar maths and coming to the same outcome.

For now though, just as questions are being asked of the listed companies, and what the return on invested capital is for all this AI infrastructure spend; so too in private markets, one must ask the difficult question of whether this unprecedented concentration around finding and funding AI killer apps will be money well spent or simply a replay of recent crypto euphoria. It is still not clear where most value is likely to accrue to – across the 3000 odd GenerativeAI start-ups vying for funding.

But history tells us the application layer should be the winner. For now though, from our work, we see three likely power-law candidates. The first is breakthroughs in semiconductors and data centre efficiency technologies. The second is in funding foundational model builders. And the third, specifically in that application layer, we think the greatest chance is in the healthcare application space.

Thanks for listening. If you enjoy the show, please leave us a review and share Thoughts on the Market with a friend or colleague today.

*****

Digital assets, sometimes known as cryptocurrency, are a digital representation of a value that function as a medium of exchange, a unit of account, or a store of value, but generally do not have legal tender status. Digital assets have no intrinsic value and there is no investment underlying digital assets. The value of digital assets is derived by market forces of supply and demand, and is therefore more volatile than traditional currencies’ value. Investing in digital assets is risky, and transacting in digital assets carries various risks, including but not limited to fraud, theft, market volatility, market manipulation, and cybersecurity failures—such as the risk of hacking, theft, programming bugs, and accidental loss. Additionally, there is no guarantee that any entity that currently accepts digital assets as payment will do so in the future. The volatility and unpredictability of the price of digital assets may lead to significant and immediate losses. It may not be possible to liquidate a digital assets position in a timely manner at a reasonable price.

Regulation of digital assets continues to develop globally and, as such, federal, state, or foreign governments may restrict the use and exchange of any or all digital assets, further contributing to their volatility. Digital assets stored online are not insured and do not have the same protections or safeguards of bank deposits in the US or other jurisdictions. Digital assets can be exchanged for US dollars or other currencies, but are not generally backed nor supported by any government or central bank.

Before purchasing, investors should note that risks applicable to one digital asset may not be the same risks applicable to other forms of digital assets. Markets and exchanges for digital assets are not currently regulated in the same manner and do not provide the customer protections available in equities, fixed income, options, futures, commodities or foreign exchange markets.

Morgan Stanley and its affiliates do business that may relate to some of the digital assets or other related products discussed in Morgan Stanley Research. These could include market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking.

Special Encore: Health Care for Longer, Healthier Lives Aug 30, 2024

Original Release Date August 8, 2024: Our Head of Europe Sustainability Research discusses how rising longevity is revolutionizing our fundamental approach from reactive to proactive treatment.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Mike Canfield, Morgan Stanley’s European Head of Sustainability Research. Along with my colleagues, we’re bringing you a variety of perspectives; and today we’re focusing on a topic that affects everyone – how much does poor health cost us? And how are ageing populations and longer life expectancy driving a fundamental shift in healthcare?

It’s Thursday, August the 8th, at 4pm in London.

As populations age across the developed world, health systems need to help people live both longer and healthier. The current system is typically built around to focus on acute conditions and it’s more reactive; so it introduces clinical care or drugs to respond to a condition after it’s already arisen, rather than keeping people healthy in the first instance. So increasingly, with the burden of chronic disease becoming by far the greatest health and economic challenge we face, we need to change the structure of the healthcare system.

Essentially, the key question is how much is poor health amongst the ageing population really costing society? To get a true sense of that, we need to keep in mind that workers over 50 already earn one out of every three dollars across the G20 regions. By 2035, they're projected to generate nearly 40 per cent of all household income. So with that in mind, preventable conditions amongst those people aged 50-64 at the moment, are already costing G20 economies over $1 trillion annually in productivity loss. And there’s one more key number: 19 per cent. That's how much age-diverse workforces can raise GDP per capita over the next thirty years,according to estimates from the Organization for Economic Co-operation and Development, or OECD. So clearly, keeping workers healthier for longer underpins a more productive, more efficient, and a profitable global economy. So it’s clear that [if] the current healthcare system were to shift from sick from care to prevention, the global gains would be substantial.

The BioPharma sector is already contributing some targeted novel treatments in areas like smart chemotherapy and in CRISPR – which is a technology that allows for selective DNA modification. While we can credit BioPharma and MedTech for really powerful innovations in diagnostics, in AI deployment for areas like data science and material science, and in sophisticated telemedicine – all these breakthroughs together give a more personalized, targeted health system; which is a big step in the right direction, but honestly they alone can’t solve this much broader longevity challenge we face.

Focus on health and prevention, ultimately, could address those underlying causes of ill-health, so that problems don’t arise even in the first instance. Governments around the world are obviously realizing the value of preventive care over sick care. And as a strategy, disease prevention fundamentally aims to promote wellness across the board, whether that’s in things like mental state, nutrition or even in things like sleep and stress. While it might be easy to kind of conflate that with wellness trends – things like green smoothies or meditation – the underlying benefits of boosting health at the cellular level have much broader and deeper implications. Things like Type 2 diabetes and heart disease, supporting better health across populations can significantly reduce the incidence of a wide range of chronic conditions. It can lower the burden on health systems overall, and actually increase healthy lifespan at the end of the day.

BioPharma advances are significant, but addressing longevity will require a much broader alignment across a myriad of elements; everything really from the food system to sanitation to training healthcare professionals. And of course, all of that will require consistent policy support. Regulators and policymakers are paying very close attention to their ageing population – and so are we. We’ll continue to bring you updates on this topic, which is so important to all of us.

Thanks for listening. If you enjoy the show, please do leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Is the Fed Behind the Curve? Aug 29, 2024

As the US Federal Reserve mulls a forthcoming interest rate cut, our Head of Corporate Credit Research and Global Chief Economist discuss how it is balancing inflationary risks with risks to growth.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley’s Global Chief Economist.

Andrew Sheets: And today on the podcast, we'll be discussing the Federal Reserve, whether its policy is behind the curve and what's next.

It's Thursday, August 29th at 2pm in London.

Seth Carpenter: And it's 9am in New York.

Andrew Sheets: Seth, it's always great to talk to you. But that's especially true right now. The Federal Reserve has been front and center in the markets debate over the last month; and I think investors have honestly really gone back and forth about whether interest rates are in line or out of line with the economy. And I was hoping to cover a few big questions about Fed policy that have been coming up with our clients and how you think the Fed thinks about them.

And I think this timing is also great because the Federal Reserve has recently had a major policy conference in Jackson Hole, Wyoming where you often see the Fed talking about some of its longer-term views and we can get your latest takeaways from that.

Seth Carpenter: Yeah, that sounds great, Andrew. Clearly these are some of the key topics in markets right now.

Andrew Sheets: Perfect. So, let's dive right into it. I think one of the debates investors have been having -- one of the uncertainties -- is that the Fed has been describing the risk to their outlook as balanced between the risk to growth and risk to inflation. And yet, I think for investors, the view over the last month or two is these risks aren't balanced; that inflation seems well under control and is coming down rapidly. And yet growth looks kind of weak and might be more of a risk going forward.

So why do you think the Fed has had this framing? And do you think this framing is still correct in the aftermath of Jackson Hole?

Seth Carpenter: My personal view is that what we got out of Jackson hole was not a watershed moment. It was not a change in view. It was an evolution, a continuation in how the Fed's been thinking about things. But let me unpack a few things here.

First, markets tend to look at recent data and try to look forward, try to look around the corner, try to extrapolate what's going on. You know as well as I do that just a couple weeks ago, everyone in markets was wondering are we already in recession or not -- and now that view has come back. The Fed, in contrast, tends to be a bit more inertial in their thinking. Their thoughts evolve more slowly, they wait to collect more data before they have a view. So, part of the difference in mindset between the Fed and markets is that difference in frequency with which updates are made.

I'd say the other point that's critical here is the starting point. So, the two risks: risks to inflation, risks to growth. We remember the inflation data we're getting in Q1. That surprised us, surprised the market, and it surprised the Fed to the upside. And the question really did have to come into the Fed's mind -- have we hit a patch where inflation is just stubbornly sticky to the upside, and it's going to take a lot more cost to bring that inflation down. So those risks were clearly much bigger in the Fed’s mind than what was going on with growth.

Because coming out of last year and for the first half of this year, not only would the Fed have said that the US economy is doing just fine; they would have said growth is actually too fast to be consistent with the long run, potential growth of the US economy. Or reaching their 2 per cent inflation target on a sustained basis. So, as we got through this year, inflation data got better and better and better, and that risk diminished.

Now, as you pointed out, the risk on growth started to rise a little bit. We went from clearly growing too fast by some metrics to now some questions -- are we softened so much that we're now in the sweet spot? Or is there a risk that we're slowing too much and going into recession?

But that's the sense in which there's balance. We went from far higher risks on inflation. Those have come down to, you know, much more nuanced risks on inflation and some rising risk from a really strong starting point on growth.

Andrew Sheets: So, Seth, that kind of leads to my second question that we've been getting from investors, which is, you know, some form of the following. Even if these risks between inflation and growth are balanced, isn't Fed policy very restrictive? The Fed funds rate is still relatively high, relative to where the Fed thinks the rate will average over the long run. How do you think the Fed thinks about the restrictiveness of current policy? And how does that relate to what you expect going forward?

Seth Carpenter: So first, and we've heard this from some of the Fed speakers, there's a range of views on how restrictive policy is. But I think all of them would say policy is at least to some degree restrictive right now. Some thinking it's very restrictive. Some thinking only modestly.

But when they talk about the restrictiveness of policy in the context of the balance of these risks, they're thinking about the risks -- not just where we are right now and where policy is right now; but given how they're thinking about the evolution of policy over the next year or two. And remember, they all think they're going to be cutting rates this year and all through next year.

Then the question is, over that time horizon with policy easing, do we think the risks are still balanced? And I think that's the sense in which they're using the balance of risks. And so, they do think policy is restrictive.

They would also say that if policy weren't restrictive, [there would] probably be higher risks to inflation because that's part of what's bringing inflation out of the system is the restrictive stance of policy. But as they ease policy over time, that is part of what is balancing the risks between the two.

Andrew Sheets: And that actually leads nicely to the third question that we've been getting a lot of, which is again related to investor concerns -- that maybe policy is moving out of line with the economy. And that's some form of the following: that by even just staying on hold, by not doing anything, keeping the Fed funds rate constant, as inflation comes down, that rate becomes higher relative to inflation. The real policy rate rises. And so that represents more restrictive monetary policy at the very moment, when some of the growth data seems to be decelerating, which would seem to be suboptimal.

So, do you think that's the Fed's intention? Do you think that's a fair framing of kind of the real policy rate and that it's getting more restrictive? And again, how do you think the Fed is thinking about those dynamics as they unfold?

Seth Carpenter: I do think that's an important framing to think -- not just about the nominal level of interest rates; you know where the policy rate is itself, but that inflation adjusted rate. As you said, the real rate matters a lot. And inside the Fed as an institution there, that's basically how most of the people there think about it as well. And further, I would say that very framing you put out about -- as inflation falls, will policy become more restrictive if no adjustment is made? We've heard over the past couple of years, Federal Reserve policymakers make exactly that same framing.

So, it's clearly a relevant question. It's clearly on point right now. My view though, as an economist, is that what's more important than realized inflation, what prices have done over the past 12 months. What really matters is inflation expectations, right? Because if what we're trying to think about is -- how are businesses thinking about their cost of capital relative to the revenues are going to get in the future; it's not about what policy, it's not about what inflation did in the past. It's what they expect in the future.

And I have to say, from my perspective, inflation expectations have already fallen. So, all of this passive tightening that you're describing, it's already baked in. It's already part of why, in my view, you know, the economy is starting to slow down. So, it's a relevant question; but I'm personally less convinced that the fall in inflation we've seen over the past couple of months is really doing that much to tighten the stance of policy.

Andrew Sheets: So, Seth, you know, bringing this all together, both your answers to these questions that are at the forefront of investors' minds, what we heard at the Jackson Hole Policy Conference and what we've heard from the latest FOMC minutes -- what does Morgan Stanley Economics think the Fed's policy path going forward is going to be?

Seth Carpenter: Yeah. So, you know, it's funny. I always have to separate in my brain what I think should happen with policy -- and that used to be my job. But now we're talking about what I think will happen with policy. And our view is the Fed's about to start cutting interest rates.

The market believes that now. The Fed seems from their communication to believe that. We've got written down a path of 25 basis point reduction in the policy rate in September, in November, in December. So, a string of these going all the way through to the middle of next year to really ease the stance of policy, to get away from being extremely restrictive, to being at best only moderately restrictive -- to try to extend this cycle.

I will say though, that if we're wrong, and if the economy is a bit slower than we think, a 50 basis point cut has to be possible.

And so let me turn the tables on you, Andrew, because we're expecting that string of 25 basis point cuts, but the market is pricing in about 100 basis points of cuts this year with only three meetings left. So that has to imply at least one of those meetings having a 50 basis point cut somewhere.

So, is that a good thing? Would the market see a 50 basis point cut as the Fed catching up from being behind the curve? Or would the market worry that a bigger cut implies a greater recession risk that could spook risk assets?

Andrew Sheets: Yeah, Seth, I think that's a great question because it's also one where I think views across investors in the market genuinely diverge. So, you know, I'll give you our view and others might have a different take.

But I think what you have is a really interesting dynamic where kind of two things can be true. You know, on the one hand, I think if you talk to 50 investors and ask them, you know, would they rather for equities or credit have lower rates or higher rates, all else equal -- I think probably 50 would tell you they would rather have lower rates.

And yet I think if you look back at history, and you look at the periods where the Federal Reserve has been cutting rates the most and cutting most aggressively, those have been some of the worst environments for credit and equities in the modern era. Things like 2001, 2008, you know, kind of February of 2020. And I think the reason for that is that the economic backdrop -- while the Fed is cutting -- matters enormously for how the market interprets it.

And so, conditions where growth is weakening rapidly, and the Fed is cutting a lot to respond to that, are generally periods that the market does not like. Because they see the weaker data right now. They see the weakness that could affect earnings and credit quality immediately. And the help from those lower rates because policy works with lag may not arrive for six or nine or twelve months. It's a long time to wait for the cavalry.

And so, you know, the way that we think about that is that it's really, I think the growth environment that’s going to determine how markets view this rate cutting balance. And I think if we see better growth and somewhat fewer rate cuts, the base case that you and your team at Morgan Stanley Economics have -- which is a bit fewer cuts than the market, but growth holding up -- which we think is a very good combination for credit. A scenario where growth is weaker than expected and the Fed cuts more aggressively, I think history would suggest, that's more unfriendly and something we should be more worried about.

So, I do think the growth data remains extremely important here. I think that's what the market will focus most on and I think it's a very much good is good regime that I think is going to determine how the market views cuts. And fewer is fine as long as the data holds up.

Seth Carpenter: That make a lot of sense, and thanks for letting me turn the tables on you and ask questions. And for the listeners, thank you for listening. If you enjoy this show, leave us a review wherever you listen to podcast. And share Thoughts on the Market with a friend or a colleague today.

Bumpy Road Back For US Housing Market Aug 28, 2024

While mortgage rates have come down, our Co-heads of Securitized Products Research say the US housing market still must solve its supply problem.

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Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.

Jay Bacow: And I’m Jay Bacow, the other co-head of Securitize Products Research.

Jim Egan: Along with my colleagues bringing you a variety of perspectives, today Jay and I are here to talk about the US housing and mortgage markets.

It's Wednesday, August 28th, at 10 am in New York.

Now, Jay, mortgage rates declined pretty sharply in the beginning of August. And if I take a little bit of a step back here; while rates have been volatile, to say the least, we're about 50 basis points lower than we were at the beginning of July, 80 basis points lower than the 2024 peak in April, and 135 basis points below cycle peaks back in October of 2023.

Big picture. Declining mortgage rates -- what does that mean for mortgages?

Jay Bacow: It means that more people are going to have the ability to refinance given the rally in mortgage rates that you described. But we have to be careful when we think about how many more people. We track the percentage of homeowners that have at least 25 basis points of incentive to refinance after accounting for things like low level pricing adjustments. That number is still less than 10 percent of the outstanding homeowners. So broadly speaking, most people are not going to refinance.

Now, however, because of the rally that we've seen from the highs, if we look at the percentage of borrowers that took out a mortgage between six and 24 months ago -- which is really where the peak refinance activity happens -- over 30 percent of those borrowers have incentive to refinance.

So recent homeowners, if you took your mortgage out not that long ago, you should take a look. You might have an opportunity to refinance. But, for most of the universe of homeowners in America that have much lower mortgage rates, they're not going to be refinancing.

Jim Egan: Okay, what about convexity hedging? That's a term that tends to get thrown around a lot in periods of quick and sizable rate moves. What is convexity hedging and should we be concerned?

Jay Bacow: Sure. So, because the homeowner in America has the option to refinance their mortgage whenever they want, the investor that owns that security is effectively short that option to the homeowner. And so, as rates rally, the homeowner is more likely to refinance. And what that means is that the duration -- the average life of that mortgage is outstanding -- is going to shorten up. And so, what that means is that if the investor wants to have the same amount of duration, as rates rally, they're going to need to add duration -- which isn't necessarily a good thing because they're going to be buying duration at lower yields and higher prices. And often when rates rally a lot, you will get the explanation that this is happening because of mortgage convexity hedging.

Now, convexity hedging will happen more into a rally. But because so much of the universe has mortgages that were taken out in 2020 and 2021, we think realistically the real convexity risks are likely 150 basis points or so lower in rates.

But Jim, we have had this rally in rates. We do have lower mortgage rates than we saw over the summer. What does that mean for affordability?

Jim Egan: So, affordability is improving. Let's put numbers around what we're talking about. Mortgage rates are at approximately 6.5 percent today at the peak in the fourth quarter of last year, they were closer to 8 percent.

Now, over the past few years, we've gotten to use the word unprecedented in the housing market, what feels like an unprecedented number of times. Well, the improvement in affordability that we'd experience if mortgage rates were to hold at these current levels has only happened a handful of times over the past 35 to 40 years. This part of it is by no means unprecedented.

Jay Bacow: Alright, now we talked about mortgage rates coming down and that means more refi[nance] activity. But what does the improvement in mortgage rates do to purchase activity?

Jim Egan: So that's a question that's coming up a lot in our investor discussions recently. And to begin to answer that question, we looked at those past handful of episodes. In the past, existing home sales almost always climb in the subsequent year and the subsequent two years following an improvement in affordability at the scale that we're witnessing right now.

Jay Bacow: So, there's precedent for this unprecedented experience

Jim Egan: There is. But there are also a number of differences between our current predicament and these historical examples that I'd say warrant examination. The first is inventory. We simply have never had so few homes for sale as we do right now. Especially when we're looking at those other periods of affordability improvement.

And on the affordability front itself, despite the improvement that we've seen, affordability remains significantly more challenged than almost every other historical episode of the past 40 years, with the exception of 1985. Both of these facts are apparent in the lock in effect that you and I have discussed several times on this podcast in the past.

Jay Bacow: All right. So just like we think we are a 150 basis points away from convexity hedging being an issue, we're still pretty far away from rates unlocking significant inventory. What does that mean for home sales?

Jim Egan: So, the US housing market has a supply problem, not a demand problem. I want to caveat that. Everything is related in the US housing market. For instance, high mortgage rates that put pressure on affordability -- but they've also contributed to this lock-in effect that has led to historically low inventory.

This lack of supply has kept home prices climbing, despite high mortgage rates, which is keeping affordability under pressure. So, when we say that housing has a supply problem, we're not dismissing the demand side of the equation; just acknowledging that the binding constraint in the current environment is supply.

Jay Bacow: Alright, so if supply is the binding constraint, then what does that mean for sales?

Jim Egan: As rates come down, inventory has been increasing. When combined with improvements in affordability, this should catalyze increased sales volumes in the coming year. But the confluence of inputs in the housing market today render the current environment unique from anything that we've experienced over the past few decades.

Sales volumes should climb, but the path is unlikely to be linear and the total increase should be limited to call it the mid-single digit percentage point of over the coming year.

Jay Bacow: Alright, and now lastly, Jim, home prices continue to set an all time high but there's the absolute level of prices and the pace of home price appreciation. What do you think is going to happen?

Jim Egan: We're on the record that this increased supply, even if it's only at the margins, and even if we're close to historic lows, should slow down the pace of home price appreciation. We've begun to see that year-over-year home price growth has come down from 6.5 percent to 5.9 percent over the past three months. We think it will continue to come down, finishing the year at +2 percent.

Jay Bacow: Alright, Jim, thanks for those thoughts. And to our listeners, thank you for listening.

If you enjoy the podcast, please leave a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

All Eyes on Jobs Data Aug 27, 2024

Our CIO and Chief US Equity Strategist explains why there’s pressure for the August jobs report to come in strong -- and what may happen to the market if it doesn’t.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the importance of economic data on asset prices in the near term.

It's Tuesday, Aug 27th at 11:30am in New York.

So let’s get after it.

The stock rally off the August 5th lows has coincided with some better-than-expected economic data led by jobless claims and the ISM services purchasing manager survey. This price action supports the idea that risk assets should continue to trade with the high frequency growth data in the near term. Should the growth data continue to improve, the market can stay above the fair value range we had previously identified of 5,000-5,400 on the S&P 500.

In my view, the true test for the market though will be the August jobs report on September 6th.

A stronger than expected payroll number and lower unemployment rate will provide confidence to the market that growth risks have subsided for now. Another weak report that leads to a further rise in the unemployment rate would likely lead to growth concerns quickly resurfacing and another correction like last month. On a concerning note, last week we got a larger than expected negative revision to the payroll data for the 12 months ended in March of this year. These revisions put even more pressure on the jobs report to come in stronger.

Meanwhile, the Bloomberg Economic Surprise Index has yet to reverse its downturn that began in April and cyclical stocks versus defensive ones remain in a downtrend. We think this supports the idea that until there is more evidence that growth is actually improving, it makes sense to favor defensive sectors in one's portfolio. Finally, while inflation data came in softer last week, we don't view that as a clear positive for lower quality cyclical stocks as it means pricing power is falling.

However, the good news on inflation did effectively confirm the Fed is going to begin cutting interest rates in September. At this point, the only debate is how much?

Over the last year, market expectations around the Fed's rate path have been volatile. At the beginning of the year, there were seven 25 basis points cuts priced into the curve for 2024 which were then almost completely priced out of the market by April. Currently, we have close to four cuts priced into the curve for the rest of this year followed by another five in 2025. There has been quite a bit of movement in bond market pricing this month as to whether it will be a 25 or 50 basis points cut when the Fed begins. More recently, the rates market has sided with a 25 basis points cut post the better-than-expected growth and inflation data points last week.

As we learned a couple of weeks ago, a 50 basis points cut may not be viewed favorably by the equity market if it comes alongside labor market weakness.Under such a scenario, cuts may no longer be viewed as insurance, but necessary to stave off hard landing risks. As a result, a series of 25 basis points cuts from here may be the sweet spot for equity multiples if it comes alongside stable growth.

The challenge is that at 21x earnings and consensus already expecting 10 percent earnings growth this year and 15 percent growth next year, a soft-landing outcome with very healthy earnings growth is priced. Furthermore, longer term rates have already been coming down since April in anticipation of this cutting cycle. Yet economic surprises have fallen and interest rate sensitive cyclical equities have underperformed. In my view this calls into question if rate cuts will change anything fundamentally.

The other side of the coin is that defensive equities remain in an uptrend on a relative basis, a dynamic that has coincided with normalization in the equity risk premium. In our view, we continue to see more opportunities under the surface of the market. As such, we continue to favor quality and defensive equities until we get more evidence that growth is clearly reaccelerating in a way that earnings forecasts can once again rise and surpass the lofty expectations already priced into valuations.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

What’s Boosting Consumer Confidence? Aug 26, 2024

Our US Thematic Strategist discusses surging confidence as the political landscape evolves, back-to-school spending starts strong and travel providers enjoy post-COVID demand.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's US thematic strategist. Along with my colleagues bringing you a variety of perspectives, today I'll give you an update on how recent market volatility and the upcoming US election are affecting the US consumer.

It's Monday, August 26th at 10am in New York.

A few weeks ago, we saw really sharp volatility. It was partially sparked by the unwind of the yen carry trade. But there are also renewed fears about a growth slowdown for the US or a possible US recession. Our economists do not think we are going into a recession though, and they have reaffirmed their longstanding view of a soft landing for the economy as a base case. And they think there's a slowdown, but not a slump.

From the more company side, this earning season showed that the US consumer is softening incrementally; but they're not falling off a cliff. Spending is slowing this year, but it's on the heels of what was really high spending over the last couple of years.

We did see some softness during second quarter results around the consumer. Consumer confidence is still intact, and our most recent survey in July showed a pretty strong improvement in sentiment. We think that this is partially a function of the political environment. We ran the survey from July 25th to 29th, shortly after President Joe Biden dropped out of the race and endorsed Vice President Kamala Harris. And we saw the biggest improvement in sentiment was for those who consider themselves middle of the road politically.

Their net sentiment toward the economy improved from negative -23 percent to -1 percent. Net expectations are also really positive for those who identify as liberal. Net sentiment for very liberal respondents is +34 percent, while it's +20 percent for more somewhat liberal ones. Expectations for conservatives are still negative though, but they have improved since the prior wave of our survey.

So, we do think that some of this increase in excitement and increase in confidence has been around the renewed political environment, renewed interest in the race.

As we get close to the end of summer, we note two other key trends. Back to school shopping and travel. So, for back-to-school shopping, we're seeing pretty positive results from our survey. Consumers are reporting they're planning to spend more this back-to-school season versus last year. We saw an increase of 35 percent in spending intentions. And then when we think about the different back to school categories people are spending on, apparel saw the biggest net increase in spending plans versus last year. But we also saw an increase for school supplies and electronics. So, all things very important as the kids go back to school or people go off to college.

Travel's been one part of the market that's held up super well post pandemic. People were very excited to get out there and go on vacations. And we saw, frankly, an unexpected positive level of demand for the past few years, and we didn't see that faster catch up in demand that a lot of people were expecting post pandemic. I know myself; I've been very excited to travel the last few summers. But this earning season we're starting to see more of a mixed bag within the travel space.

Hotels across the board flag softening demand for leisure stays, but business travel has held up well. We saw a different story among the airlines though; several management teams were really emphasizing continued strong demands for air travel. And our survey is supportive of these comments and show that travel intentions remain stable and strong, and plans to follow through on travel that involve a flight also remain robust.

The next three months leading up to the US election will certainly be interesting though, and we'll continue to bring you updates.

Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Market Rebounds but Growth Is Uncertain Aug 23, 2024

Although markets have recovered over the last few weeks after a sudden drop, our Head of Corporate Credit Research warns that investors are still skeptical about the growth outlook.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today we’ll discuss the big round trip for markets and why we’re not out of the woods.

It's Friday, August 23rd at 2pm in London.

The last few weeks have been a rollercoaster. July ended on a high with markets rallying as the Federal Reserve kept interest rates unchanged. Things turned almost immediately thereafter as weak data releases fanned fears that maybe the Fed was being just a little too nonchalant on the economy, making its patience withholding rates high look like a vice, rather than a virtue. A late summer period where many investors were out probably amplified the moves that followed. And so at the morning lows on August 5th, the S&P 500 had fallen more than 8 percent in just 3 trading days, and expected volatility had jumped to one of its highest readings in a decade.

But since those volatile lows, markets have come back. Really come back. Stock prices, credit spreads, and those levels of expected volatility are all now more or less where they ended July. It was an almost complete round-trip. We have a colleague who got back from a two-week vacation on Monday. The prices on their screen had barely changed.

The reason for that snapback was the data. Just as weak data in the aftermath of the Fed’s meeting drove fears of a policy mistake, better data in the days since have improved confidence. This has been especially true for data related to the US consumer, as both retail sales and the number of new jobless claims have been better than expected.

This round-trip in markets has been welcome, especially for those, like ourselves, who are optimistic on credit, and see it well-positioned for the economic soft-landing that Morgan Stanley expects.

But it is also a reminder that we’re not out of the woods. The last few weeks couldn’t be clearer about the importance of growth for the market outlook. This is a crucial moment for the economy, where U.S. growth is slowing, the Fed’s rates are still highly restrictive, and any help from cutting those rates may not be felt for several quarters.

At Morgan Stanley we think that growth won’t slow too much, and so this will ultimately be fine for the credit market. But incoming data will remain important, and recent events show that the market’s confidence can be quickly shaken. Even with the sharp snapback, for example, cyclical stocks, which tend to be more economically sensitive, have badly lagged more defensive shares – a sign that healthy skepticism around growth from investors still remains.

The quick recovery is welcome, but we’re not out of the woods, and investors should continue to hope for solid data. Good is good.

Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

What’s Next for Japan After Rate Hike? Aug 22, 2024

The Bank of Japan jolted global markets after its recent decision to raise interest rates. Our experts break down the effects the move could have on the country’s economy, currency and stock market.

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Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.

Daniel Blake: And I'm Daniel Blake, from the Asia Pacific and Emerging Market Equity Strategy Team.

Chetan Ahya: On this episode of the podcast, we will cover a topic that has been a big concern for global investors: Japan's rate hike and its effect on markets.

It's Thursday, August 22nd at 6pm in Hong Kong.

On July 31st, Japan's central bank made a bold move. For only the second time in 17 years, it raised interest rates. It lifted its benchmark rates to around 0.25 percent from its previous range of 0 to 0.1 percent. And at the press conference, BOJ Governor Ueda struck a more hawkish tone on the BOJ rate path than markets anticipated. Compounded with investors concern about US growth, this move jolted global equity markets and bond markets. The Japan equity market entered the quickest bear market in history. It lost 20 percent over three days.

Well, a lot has happened since early August. So, I'm here with Daniel to give you an update.

Daniel Blake: Chetan, before I can give you an update on what the market implications are of all this, let's make sense of what the macro-outlook is for Japan and what the Bank of Japan is really looking to achieve.

I know that following that July monetary policy meeting, we heard from Deputy Governor Uchida san, who said that the bank would not raise its policy rates while financial and capital markets remain unstable.

What is your view on the Bank of Japan policy outlook and the key macro-outlook for Japan more broadly?

Chetan Ahya: Well, firstly, I think the governor's comments in the July policy meeting were more hawkish than expected and after the market's volatility, deputy governor did come out and explain the BOJ's thought process more clearly. The most important point explained there was that they will not hike policy rates in an environment where markets are volatile -- and that has given the comfort to market that BOJ will not be taking up successive rate hikes in an early manner.

But ultimately when you're thinking about the outlook of BOJ's policy path, it will be determined by what happens to underlying wage growth and inflation trend. And on that front, wage growth has been accelerating. And we also think that inflation will be remaining at a moderate level and that will keep BOJ on the rate hike path, but those rate hikes will be taken up in a measured manner.

In our base case, we are expecting the BOJ to hike by 25 basis points in January policy meeting next year, with a risk that they could possibly hike early in December of this year.

Daniel Blake: And after an extended period of weakness, the Japanese yen appreciated sharply after the remarks. What drove this and what are the macro repercussions for the broader outlook?

Chetan Ahya: We think that the US growth scare from the weaker July nonfarm payroll data, alongside a hawkish BOJ Governor Ueda's comments, led markets to begin pricing in more policy rate convergence between the US and Japan. This resulted in unwinding of the yen carry trade and a rapid appreciation of yen against the dollar.

For now, our strategists believe that the near-term risk of further yen carry trade unwinding has lessened. We will closely watch the incoming US growth and labor market data for signs of the US slowdown and its impact on the yen. In the base case, our US Economics team continues to see a soft landing in the US and for the Fed to cut rates by three times this year from September, reaching a terminal of 3.625 by June 2025.

Based on our US and BOJ rate path, our macro strategists see USD/JPY at 146 by year end. As it stands, our Japan inflation forecast already incorporates these yen forecasts, but if yen does appreciate beyond these levels on a sustainable basis, this would impart some further downside to our inflation forecast.

Daniel Blake: And there's another key event to consider. Prime Minister Kishida san announced on August 14th that he will not seek re-election as President of The Liberal Democratic Party (LDP) in late September, and hence will have a new leader of Japan. Will this development have any impact on economic policy or the markets in your view?

Chetan Ahya: The number of potential candidates means it's too early to tell. We think a major reversal in macro policies will be unlikely, though the timing of elections will likely have a bearing on BOJ.

For example, after the September party leadership election, the new premier could then call for an early election in October; and in this scenario, we think likelihood of a BOJ move at its September and October policy meeting would be further diminished.

So, Daniel, keeping in mind the macro backdrop that we just discussed, how are you interpreting the recent equity market volatility? And what do you expect for the rest of 2024 and into 2025?

Daniel Blake: We do see that volatility in Japan, as extreme as it was, being primarily technically driven. It does reflect some crowding of various investor types into pockets of the equity market and levered strategies, as we see come through with high frequency trading, as well as carry trades that were exacerbated by dollar yen positions being unwound very quickly.

But with the market resetting, and as we look into the rest of 2024 and 2025, we see the two key engines of nominal GDP reflation in Japan and corporate reform still firing. As you lay out, the BOJ is trying to find its way back towards neutral; it's not trying to end the cycle. And corporate governance is driving better capital allocation from the corporate sector.

As a result, we see almost 10 percent earnings growth this year and next year, and the market stands cheap versus its historical valuation ranges.

So, as we look ahead, we think into 2025, we should see the Japanese equity benchmark, the TOPIX index, setting fresh all-time highs. As a result, we continue to prefer Japan equities versus emerging markets. And we recommend that US dollar-based investors leave their foreign exchange exposure unhedged, which will position them to benefit from further strengthening in the Japanese yen.

Chetan Ahya: So, which parts of the market look most attractive following the BOJ's rate hike and market disruptions to you?

Daniel Blake: Yes, we do prefer domestic exposures relative to exporters. They'll be better protected from any further strengthening in the Japanese yen, and we also see a broad-based corporate governance reform agenda supporting shareholder returns coming out of these domestic sectors. They'll benefit from that stronger, price and wage outlook with an improved margin outlook.

And we also see that capex beneficiaries with a corporate reform angle are likely to do well in this overall agenda of pursuing greater economic security and digitalization. So that includes key sectors like defense, real estate, and construction.

And Chetan, what would you say are the key risks to your view?

Chetan Ahya: We think the key risk would be if the US faces a deeper slowdown or an outright recession. While Japan is better placed today than in the past cycles, it would nonetheless be a setback for Japan's economy. In this scenario, Japan’s export growth would face downward pressures given weakening external demand.

The Japanese corporate sector has also around 17 percent of its revenue coming from North America. Besides a deeper Fed rate cut cycle, will mean that the policy rate differentials between the US and Japan will narrow significantly. This will pose further appreciation pressures on the yen, which will weigh on inflation, corporate profits, and the growth outlook.

And from your perspective, Daniel, what should investors watch closely?

Daniel Blake: We would agree that the first order risk for Japan equities is if the US slips into a hard landing, and we do see that the dollar yen in that outlook is likely to fall even further. Now we shouldn't see any FX (foreign exchange) driven downgrades until we start bringing the yen down below 140, but we would also see the operating environment turning negative for Japan in that outlook.

So, putting that aside, given our house view of the soft landing in the US economy, we think the second thing investors should watch is certainly the LDP leadership election contest, and the reform agenda of the incoming cabinet.

Prime Minister Kishida san's tenure has been focused on economic security and has fostered further corporate governance reform alongside the Japan Stock Exchange. And this emphasis on getting household savings into investment has been another key pillar of the new capitalism strategy. So, these focus areas have been very positive for Japan equities, and we should trust -- but verify -- the commitment of a new leadership team to these policy initiatives.

Chetan Ahya: Daniel, it was great to hear your perspective. This is an evolving story. We'll keep our eye on it. Thanks for taking the time to talk.

Daniel Blake: Great speaking with you, Chetan.

Chetan Ahya: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or a colleague today.

At Political Conventions, Policy Waits in the Wings Aug 21, 2024

This week’s Democratic National Convention in the US may be light on policy details, but our Global Head of Fixed Income and Thematic Research explains that the party’s economic agenda is fairly clear as the elections draw closer.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about what investors need to know about U.S. political party conventions.

It's Wednesday, Aug 21st at 10:30am in New York.

This week, the Democratic Party is meeting in Chicago for its National Convention. Conventions for major political parties typically feature speeches from key policymakers, both past and present. So it would seem to be a forum where someone could learn what policies the party plans to implement if it takes control of the government following the November election. But you should expect more political messaging than policy signal.

That’s because the focus of these conventions tends to be more about persuading voters – and that means key policy details typically take a back seat to statements of political values widely shared by the party in order to send a consistent public message. In that sense, an observer may not learn much new about where there’s party consensus on key policy details that markets care about, including specific new taxes that might be implemented, which tax breaks might be extended, how these choices might affect the deficit, and more. That in turn means we may not learn much about what policies could plausibly be implemented if Democrats win the White House and Congress in the November election.

The good news is that we don’t think a convention is required to have a good sense about this. We’ve previously done the work on the plausible policy path resulting from a Democratic victory by examining statements of elected officials and filtering for areas of consensus among Democratic lawmakers. And we’ve also looked at expected legislative catalysts in 2025 and 2026, such as the expiry of key provisions of the Tax Cuts and Jobs Act. In short, we think the plausible policy path resulting from Democrats sweeping the election would mean relative stability on trade and energy policy; and some deficit expansion driven by tax cut extensions only partially offset by new taxes on corporations and high income earners.

Net-net, our economists think this outcome would create less uncertainty for the U.S. growth outlook than a Republican sweep, where potential for substantial new tariffs would interact with greater tax cut extensions and deficit expansion. And while we don’t expect the convention will challenge our thinking here, we’ll of course be tracking it and report back if it does.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Special Encore: Almost Human: Robots in Our Near Future Aug 20, 2024

Original release date July 23, 2024:Our Head of Global Autos & Shared Mobility discusses what makes humanoid robots a pivotal trend with implications for the global economy.

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Welcome to Thoughts on the Market. I’m Adam Jonas, Morgan Stanley’s Head of Global Autos & Shared Mobility. Today I’ll be talking about an unusual but hotly debated topic: humanoid robots.

It’s Tuesday, July 23rd, at 10am in New York.

We've seen robots on factory floors, in displays at airports and at trade shows – doing work, performing tasks, even smiling. But over the last eighteen months, we seem to have hit a major inflection point.

What's changed? Large Language Models and Generative AI. The current AI movement is drawing comparisons to the dawn of the Internet. It’s begging big, existential questions about the future of the human species and consciousness itself. But let’s look at this in more practical terms and consider why robots are taking on a human shape.

The simplest answer is that we live in a world built for humans. And we’re getting to the point where – thanks to GenAI – robots are learning through observation. Not just through rudimentary instruction and rules based heuristic models. GenAI means robots can observe humans in action doing boring, dangerous and repetitive tasks in warehouses, in restaurants or in factories. And in order for these robots to learn and function most effectively, their design needs to be anthropomorphic.

Another reason we're bullish on humanoid robots is because developers can have these robots experiment and learn from both simulation and physically in areas where they’re not a serious threat to other humans. You see, many of the enabling technologies driving humanoid robots have come from developments in autonomous cars. The problem with autonomous cars is that you can't train them on public roads without directly involving innocent civilians – pedestrians, children and cyclists -- into that experiment.

Add to all of this the issue of critical labor shortages and challenging demographic trends. The global labor total addressable market is around $30 trillion (USD) or about one-third of global GDP. We’ve built a proprietary US total addressable market model examining labor dynamics and humanoid optionality across 831 job classifications, working with our economics team; and built a comprehensive survey across 40 sectors to understand labor intensity and humanoid ability of the workforce over time.

In the United States, we forecast 40,000 humanoid units by 2030, 8 million by 2040 and 63 million by 2050 – equivalent to around $3 trillion (USD) of salary equivalent. But as early as 2028 we think you're going to see significant adoption beginning in industries like manufacturing, production, warehousing, and logistics, installation, healthcare and food prep.

Then in the 2030s, you’re going to start adding more in healthcare, recreational and transportation. And then after 2040, you may see the adoption of humanoid robots go vertical. Now you might say – that’s 15 years from now. But just like autonomous car – the end state might be 20 years away, but the capital formation is happening right now. And investors should pay close attention because we think the technological advances will only accelerate from here.

Thanks for listening. And if you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Why Immigration Matters for Global Economies Aug 19, 2024

Our Global Chief Economist explains what stricter immigration policy in key markets around the world could mean for economic growth and inflation.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter Morgan Stanley's Global Chief Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss a key driver of the global economy, migration.

It's Monday, August 19th at 10am in New York.

Migration has always been an important feature of the global economy.

Not surprisingly, migrants typically move from lower income countries to higher income countries and for more than 50 years, it has added something like three-tenths of a percent per year to the growth of high-income economies. But in recent years, migration trends have been hit by a couple of major events.

One was COVID. International travel restrictions during the pandemic slowed, or stopped, migration for a while. Despite a strong rebound over the past two years, many economies still have not fully recovered to pre-COVID migration trends. Another is geopolitical unrest. The Ukrainian refugee crisis, for example, is the largest population displacement in Europe since WWII with increasingly global repercussions.

But how does immigration affect economies? One way that I frame the discussion is that immigration can boost both aggregate supply and aggregate demand. It's likely some of each -- and the relative importance of those two affects how inflationary or disinflationary the phenomenon is.

In 2023, with a very large influx of immigrants into the US labor market, the economy was able to grow rapidly while still seeing inflation fall. The supply effect dominated the demand effect. In Australia, by contrast, with more of the immigrants in school or otherwise not in the labor market, prices -- especially for housing -- have gone up because demand was relatively more important.

But some of the effects will only play out over time. Across many developed market economies, economic activity has risen less than population, meaning that measured productivity is lower. But we think that is just a lagged effect of the response of capital investment to the rise in labor. Over a longer time horizon, immigration can also offset demographic declines. Since 2021 population growth in many high-income economies has turned negative, if you exclude immigrants. Sustaining economic growth and managing government debt loads are made much more difficult with an aging, and then declining population, as a baseline.

We assume that immigration will revert to pre-COVID trends in 2024 and [20]25 for most economies. This delta is largest for the economies with the highest immigration rates, like Canada or Australia; but for other economies, policies, cultural norms, those will determine the path for immigration.

The key, however, is that immigration can be a critical component of demographic trends. In the US, the best estimate of net immigration was about 3.3 million people in 2023, and we assume it will taper from there to something closer to 2.5 million in 2025. That addition to the labor market created what Fed Chair Powell called “a bigger, but not tighter economy.”

For people following the economy in real time, the extra availability of labor is also why we have argued that the rise in the unemployment rate over the past year or so is not the harbinger of recession that it has been in past cycles.

Now, looking ahead, one key risk to our forecasts -- well everywhere around the world -- would be an abrupt tightening in immigration policy that causes the flow of workers to fall quickly or even end. Such a scenario would imply a much sharper economic slowdown and possibly higher inflation in the economies where the supply boost has dominated. That's yet another reason why elections and government policy remain key to the economic outlook.

Well, thanks for listening. And if you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or a colleague today.

Strong Balance Sheets, Cautious Boardrooms Aug 16, 2024

Our Head of Corporate Credit Research explains how corporate balance sheets have remained resilient post-COVID, and why that could continue in the face of a potential economic slowdown.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss how corporate balance sheets are in a better place to handle a potential growth slowdown.

It's Friday, August 16th at 2pm in London.

Much of the volatility over the last several weeks has been centered around fears that excessively high interest rates from the Federal Reserve will now cause the US economy to slow too quickly. Morgan Stanley’s economists are more optimistic and believe that the data will hold up, leading the Fed to start a gradual rate cutting cycle in September, rather than a more radical course-correction. Against this backdrop, good economic data is good for markets and vice versa.

But even though we remain optimistic at Morgan Stanley about a soft landing in the US economy, our economists still expect growth to slow. How prepared are corporate balance sheets for that slowing, and how worried should we be that this could lead to higher rates of default?

A good place to start is thinking about how optimistic companies were heading into any slowdown of the economy. Overconfidence is often the enemy of credit investors, as rose-tinted glasses can lead companies to make too many unwise acquisitions or investments, funded with too much debt.

Yet across a variety of metrics, this isn’t what we see. Despite some of the lowest interest rates in human history, the level of debt to cash-flow for US and European companies has been pretty stable over the last five years. Excess capital held by banks remains historically high. And Merger and Acquisition activity, another key measure of corporate confidence, remains well below the long run trend – even after a pick up this year, as my colleague Ariana Salvatore discussed on this program earlier in the week.

So, despite the strong recovery in the US economy and the stock market over the last four years, many corporate boardrooms have remained cautious, a good thing when considering their financial risk.

Where Corporate debt did increase, it was often in places that we think could withstand it. Large-cap Technology and Pharmaceuticals issuers have taken out more debt over the last several years, relative to history, but it's been a pretty modest amount from a pretty low historical starting point. The Utility sector has also taken on more debt recently, but the stable nature of its business may make this easier to handle.

While companies across the ratings spectrum generally didn’t increase their leverage over the last several years, they did take advantage of refinancing the debt they already had at historically low rates. And this is important for thinking about the stress that higher interest rates could eventually produce.

The average maturity in the US Investment Grade index is about 11 years, and that means that, for many companies, potentially less than one-tenth of their overall debt resets to the current interest rate every year. That means companies may still have many years of enjoying the low interest rates of the past, and that helps smooth the adjustment to higher interest rates in the future.

The lack of corporate confidence since COVID means that corporate balance sheets are generally in a better place if the economy potentially slows. But while this is helpful overall, it’s important to note that it doesn’t apply in all cases. We still see plenty of dispersion between winners and losers, driving divergence under the hood of the credit market. Even if balance sheets are stronger overall, there is plenty of opportunity to pick your spots.

Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Will the US Dollar Remain Strong Post-Election? Aug 15, 2024

Our US Public Policy and Currency experts discuss how different outcomes in the upcoming U.S. elections could have varying effects on the strength of the dollar.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore from Morgan Stanley's U.S. Public Policy Research Team. And I'm

Andrew Watrous: And I'm Andrew Watrous, G10 Currency Strategist.

Ariana Salvatore: On this episode of the podcast, we'll discuss an issue that's drawing increasing attention from investors leading up to the U.S. election -- and that is the U.S. dollar and how a Harris or Trump administration could impact it.

It's Thursday, August 15th at 10am in New York.

Earlier this year, Morgan Stanley experts came on this show to discuss the current strength of the US dollar, which has had quite a historic run.

Now we all know there are numerous ways in which politics could affect the currency. But before we get into the details there, Andrew, can you just set the stage here a little bit and give some context to listeners on where the dollar is right now and what's been driving that performance?

Andrew Watrous: Yeah, the dollar's been rising this year. So, if you look at a trade weighted gauge of the US dollar, it's up about 3 percent, so far. And part of that US dollar strength is because growth expectations for the US have risen since January. There's a survey of Wall Street economists, and if you look at their median forecast for the US growth, it's moved up about one percentage point since January.

And as a result of that strong US growth, we've seen Fed policy expectations move higher. We started this year with the market pricing the Fed to be below 4 percent by December. And that expectation for where the Fed is going to be in December has moved up about 1 percentage point since January.

So, robust US growth and a higher near-term Fed policy rate expectation have made the US more attractive as an investment destination. And that's boosted the US dollar broadly as capital flows to the US.

Ariana Salvatore: That makes sense. Now, thinking about the balance of the year, it's impossible to look ahead and not consider how the US election could impact or change this trend that you've been talking about. As we get closer to November, investors are also starting to question just what will happen to the dollar in a Republican or Democratic win. What's been our approach to thinking through that question?

Andrew Watrous: So, if you look at policies proposed by the Republican presidential campaign, a number of those policies, if implemented, would probably boost the US dollar.

First, higher tariffs on goods imported from our trading partners could weigh on expectations for growth abroad. That would make the US more attractive in comparison, maybe send capital to the US as a safe haven due to policy uncertainty. And of all the scenarios we look at, we think that one where the Republicans control both Congress and the White House would be the scenario in which the federal government spends the most and issues the most debt.

More spending would likely make US growth expectations and bond yields higher in comparison to what we'd see in the rest of the world. So, a Republican presidential administration could attempt to offset some of that US dollar strength; but in the near term we think that the US dollar should go up if a Republican White House looks increasingly likely. And on the other side, the dollar could go down if the likelihood of a Democratic White House looks increasingly likely -- as some positive risk premium around trade and fiscal policy is reduced.

Ariana Salvatore: Okay, so you mentioned quite a few policy variables there. Let's take those issue areas one by one. On trade policy and geopolitical risk, it wouldn't surprise us from the policy side to see a potential Trump administration introduce tariffs, just given the rhetoric we've seen on the campaign trail. We've talked about the potential impact from 10 per cent universal -- targeted or one-for-one tariffs -- which all come with varying degrees of economic impacts.

On the currency side, Andrew, walk us through your thought process on how the risks to growth expectations from tariffs could factor into dollar positive or negative outcomes.

Andrew Watrous: So, a lot of our thinking on this is shaped by what we saw in 2018 and 2019, when there were trade tensions. During that period, the dollar moved higher, starting in spring 2018 until the end of 2019, and a big part of that dollar strength was probably due to trade tensions between the US and China. Those tensions meant that investors were probably more hesitant to take on risk outside the US than they otherwise may have been. That's why the US dollar kept rising during that period, despite the Fed cutting rates three times in 2019. And in 2018 and 2019, we saw expectations for growth in countries outside the US moving lower -- in part because of trade tensions during that period.

So, from speaking to my colleagues in the economics department here at Morgan Stanley, it seems pretty plausible that something similar happens to expectations for growth outside the US, again, if another trade war looks increasingly likely. And that drop in what people expect for growth outside the US would probably boost the US dollar as the US looks more attractive in comparison.

Ariana Salvatore: Got it. Now, shifting gears slightly to the fiscal policy outlook. We've said that the Republican sweep outcome is the most likely to lead to the greatest degree of fiscal expansion, and that's because we think lawmakers are going to have to contend with the expiring Tax Cuts and Jobs Act. We think that in a divided government outcome, or a Democratic sweep, some of those tax measures are still on the table, but it'll probably be a narrower extension from a deficit standpoint.

So, Andrew, what would a fiscally expansionary regime mean for the dollar?

Andrew Watrous: So, as you mentioned, the most fiscally expansionary scenario would be a Republican sweep scenario. And we did some research into capital flows; and the Treasury data show that historically, higher US spending is associated with net inflows of private capital into the US. And if you look at the pace of US spending versus the pace of spending in Europe, if you look at that differential -- that differential is positively correlated to movements in Euro. So faster US spending means lower Euro relative to spending in Europe.

Ariana Salvatore: So, we expect that a Republican administration's policies might strengthen the dollar in summary. But it's possible that they don't like that dollar strength. We've heard Trump talk about the benefits of a weaker currency for exports, for example. So, what might a Republican presidential administration try to do to maybe offset some of the strength?

Andrew Watrous: Yeah, so if we’re right and the Republican policies do strengthen the dollar, that Republican administration could try to offset that dollar strength with a number of policy tools. And those might be effective in weakening the US dollar against one or more of our trading partners. But we don't think that the market expectation of those dollar negative policy options would fully offset the effect of other Republican policies, which would boost the dollar.

There are legal, logistical, and political challenges associated with a lot of those dollar negative policy options. So, for example, former US Trade Representative Lighthizer has reportedly expressed doubt about the viability of broad international coordinated intervention against the US dollar. He said that no policy advisor that he knows of is working on a plan to weaken the dollar. And former President Trump reportedly rejected a 2019 proposal to intervene against the dollar from former White House Trade Advisor Peter Navarro.

Ariana Salvatore: Got it. So, sounds like we have a lot of moving pieces here and we will keep refining our views as we get some more policy clarity in the coming months. Andrew, thanks for taking the time to talk.

Andrew Watrous: Great speaking with you Ariana.

Ariana Salvatore: And thanks for listening. If you enjoy thoughts on the market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Can Vacant Offices Help Solve the US Housing Crisis? Aug 14, 2024

The rise in unused office space has triggered suggestions about converting commercial real estate into residential buildings.But our US Real Estate Research analyst lists three major challenges.

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Welcome to Thoughts on the Market. I’m Adam Kramer, from the Morgan Stanley U.S. Real Estate Research team. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss a hot real estate topic. Whether the surplus of vacant office space offers a logical solution to the national housing shortage.

It’s Wednesday, August 14, at 10am in New York.

Sitting here in Morgan Stanley’s office at 1585 Broadway, Times Square is bustling and New York seems to have recovered from COVID and then some. But the reality inside buildings is a little bit different.

On the one hand, 14 percent of U.S. office space is sitting unused. Our analysis shows a permanent impairment in office demand of roughly 25 percent compared to pre-COVID. And on the other hand, we have a national housing shortage of up to 6 million units. So why not simply remove obsolete lower-quality office stock and replace it with much-needed housing? On the surface, the idea of office-to-residential conversion sounds compelling. It could revitalize struggling downtown areas, creating a virtuous cycle that can lead to increased local tax revenues, foot traffic, retail demand and tourism.

But is it feasible?

We think conversions face at least three significant challenges. First, are the economics of conversion. In order for conversions to make sense, we would need to see office rents decline or apartment rents rise materially – which is unlikely in the next 1-2 years given the supply dynamics — and office values and conversion costs would need to decline materially.

Investors can acquire or develop a multifamily property at roughly $600 per square foot. Alternatively, they can acquire and convert an existing office building for a total cost of nearly $700 per square foot, on average. The bottom line is that total conversion costs are higher than acquisition or ground-up development, with more complexity involved as well.

The second big challenge is the quality of the buildings themselves. Numerous elements of the physical building impact conversion feasibility. For example, location relative to transit and amenities. Buildings in suboptimal locations are unlikely to be considered. Whether the office asset is vacant or not is also a factor. Office leases are typically longer duration, and a building needs to be close to or fully vacant for a full conversion. And lastly, physical attributes such as architecture, floor-plate depth, windows placement, among others.

And finally, regulation presents a third major hurdle. Zoning and building code requirements differ from city to city and can add substantive time, cost, complexity, and limitations to any conversion project. That said, governments are in a unique position to encourage conversions — for example, via tax incentives – and literally remake cities short on affordable housing but with excess, underutilized office space.

We have looked at conversion opportunities in three key markets: New York, San Francisco, and Washington, D.C. In Manhattan, active office to residential conversions have been concentrated in the Financial District, and we think this trend will continue. We also see the East Side of Manhattan as a uniquely untapped opportunity for future conversions, given higher vacancy today. This would shift existing East Side office tenants to other locations, boosting demand in higher-quality office neighborhoods like Park Avenue and Grand Central.

In San Francisco, we are concerned about other types of real estate properties beyond just office. Retail, multifamily, and lodging in the downtown area are taking longer to recover post-COVID, and we think this will limit conversions in the market.

And finally, in Washington, D.C. we think conversion would work best for older, Class B/C office buildings on the edges of pre-existing residential areas.

In these three markets, and others, conversions could work in specific instances, with specific buildings in specific sub-markets. But on a national basis, the economic and logistic challenges of wide-scale conversions make this an unlikely solution.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

US Election Should Not Dim M&A Resurgence Aug 13, 2024

Our US Public Policy Strategist expects a robust M&A cycle, regardless of the outcome of the US election. But rising antitrust concerns could create additional scrutiny on possible future deals.

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Welcome to Thoughts on the Market. I’m Ariana Salvatore, from Morgan Stanley’s US Public Policy Research Team. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the impact of the US election on M&A.

It’s Tuesday, August 13th, at 10am in New York.

2023 saw the lowest level of global mergers and acquisitions – or M&A – in more than 30 years, relative to the overall size of the economy. But we believe that the cycle is currently reversing in a significant way and that politics won't halt the "Return of M&A."

Why? Because M&A cycles are primarily driven by broader factors. Those include macroeconomics, the business cycle, CEO confidence and financing conditions. More specifically, unusually depressed volumes, open new issue markets, incoming rate cuts and the bottom-up industry trends are powerful tailwinds to an M&A recovery and can offset the political headwinds.

So far this year we’ve seen an increase in deal activity. Announced M&A volume was up 20 per cent year-over-year in the first half of [20]24 versus [20]23, and we continue to expect M&A volumes to rise in 2024 as part of this broader, multi-year recovery.

That being said, one factor that can impact M&A is antitrust regulation. Investors are reasonably concerned about the ways in which the election outcome could impact antitrust enforcement – and whether or not it would even be a tailwind or a headwind. If you think about traditional Republican attitudes toward deregulation, you might think that antitrust enforcement could be weaker in a potential Trump win scenario; but when we look back at the first Trump administration, we did see various antitrust cases pursued across a number of sectors.

Further, we’ve seen this convergence between Republicans and Democrats on antitrust enforcement, specifically the vice presidential pick JD Vance has praised Lina Khan, the current FTC chair, for some of her efforts on antitrust in the Biden administration. In that vein, we do think there are certain circumstances that could cause a deal to come under scrutiny regardless of who wins the election.

First, on a sector basis, we think both parties share a similar approach toward antitrust for tech companies. Voters across the ideological spectrum seem to want their representatives to focus on objectives like 'breaking up big tech' and targeting companies that are perceived to have outsized control.

We also think geopolitics is really important here. National security concerns are increasingly being invoked as a consideration for M&A involving foreign actors, in particular if the deal involves a geopolitical adversary like China. We’ve seen lawmakers invoke these kind of concerns when justifying increased scrutiny for proposed deals.

Finally, key constituencies' positions on proposed deals could also matter. The way that a deal might impact key voter cohorts – think labor unions, for example – could also play a role in determining whether or not that deal comes under extra scrutiny.

We will of course keep you updated on any changes to our M&A outlook.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Pay Attention to Data, Not Market Drama Aug 12, 2024

Recent market volatility has made headlines, but our Global Chief Economist explains why the numbers aren’t as dire as they seem.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about central banks, the Bank of Japan, Federal Reserve, data and how it drove market volatility.

It's Monday, August 12th at 10am in New York.

You know, if life were a Greek tragedy, we might call it foreshadowing. But in reality, it was probably just an unfortunate coincidence. The BOJ's website temporarily went down when the policy announcement came out. As it turns out, expectations for the BOJ and the Fed drove the market last week. Going into the BOJ meeting consensus was for a September hike, but July was clearly in play.

The market's initial reaction to the decision itself was relatively calm; but in the press conference following the decision, Governor Ueda surprised the markets by talking about future hikes. Some hiking was already priced in, and Ueda san's comments pushed the amount priced in up by another, call it 8 basis points, and it increased volatility.

In the aftermath of that market volatility, Deputy Governor Yoshida shifted the narrative again, by stressing that the BOJ was attuned to market conditions and that there was no fundamental change in the BOJ's strategy. But this heightened attention on the BOJ's hiking cycle was a critical backdrop for the US non farm payrolls two days later.

The market knew the BOJ would hike, and knew the Fed would cut, but Ueda san's tone and the downside surprise to payrolls ignited two separate but related market risks: A US growth slowdown and the yen carry trade.

The Fed's July meeting was the same day as the BOJ decision, and Chair Powell guided markets to a September rate cut. Prior to July, the FOMC was much more focused on inflation after the upside surprises in the first quarter. But as inflation softened, the dual mandate came into a finer balance. The shift in focus to both growth and inflation was not missed by markets; and then payrolls at about 114, 000 in July. Well, that was far from disastrous; but because the print was a miss relative to expectations on the heel of a shift in that focus, the market reaction was outsized.

Our baseline view remains a soft landing in the United States; and those details we discussed extensively in our monthly periodical. Now, markets usually trade inflections, but with this cycle, we have tried to stress that you have to look at not just changes, but also the level of the economy. Q2 GDP was at 2.6 per cent. Consumer spending grew at 2.3 per cent. And the three-month average for payrolls was at 170, 000 -- even after the disappointing July print.

Those are not terribly frightening numbers. The unemployment rate at 4.3 per cent is still low for the United States. And 17 basis points of that two-tenths rise last month; well, that was an increase in labor force participation. That's hardly the stuff of a failing labor market.

So, while these data are backward looking, they are far from recessionary. Markets will always be forward looking, of course; but the recent hard data cannot be ignored. We think the economy is on its way to a soft landing, but the market is on alert for any and all signs for more dramatic weakness.

The data just don't indicate any accelerated deterioration in the economy, though. Our FX Strategy colleagues have long said that Fed cuts and BOJ hikes would lead to yen appreciation. But this recent move? It was rapid, to say the least. But if we think about it, the pair really has only come into rough alignment with the Morgan Stanley targets based on just interest rate differentials alone.

We also want to stress the fundamentals here for the Bank of Japan as well. We retain our view for cautious rate hikes by the BOJ with the next one coming in January. That's not anything dramatic because over the whole forecast that means that real rates will stay negative all the way through the end of 2025.

These themes -- the deterioration in the US growth situation and the appreciation of the yen -- they're not going away anytime soon. We're entering a few weeks of sparse US data, though, where second tier indicators like unemployment insurance claims, which are subject to lots of seasonality, and retail sales data, which tend to be volatile month to month and have had less correlation recently with aggregate spending, well, they're going to take center stage in the absence of other harder indicators.

The normalization of inflation and rates in Japan will probably take years, not just months, to sort out. The pace of convergence between the Fed and the BOJ? It's going to continue to ebb and flow. But for now, and despite all the market volatility, we retain our outlook for both economies and both central banks. We see the economic fundamentals still in line with our baseline views.

Thanks for listening. If you enjoy this show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Rate Cut Ripple Aug 09, 2024

As markets adjust to global volatility, our Head of Corporate Credit Research considers when the Fed might choose to cut interest rates and how long the impacts may take to play out.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll discuss the market’s expectation for much larger rate cuts from the Federal Reserve, and how much that actually matters.

It's Friday, August 9that 2pm in London.

Markets have been volatile of late. One of the drivers has been rising concern that the Fed may have left interest rates too high for too long, and now needs to more dramatically course-correct. From July 1st through August 2nd, the market’s expectation for where the Fed’s target interest rate will be in one year’s time has fallen by more than 1 percent.

But…wait a second. We’re talking about interest rates here. Isn’t a shift towards expecting lower interest rates, you know, a good thing? And that seems especially relevant in the recent era, where strong markets often overlapped with fairly low interest rates.

Zoom out over a longer span of history, however, and that’s not always the case.

Interest rates, especially the rates from the Federal Reserve, are often a reflection of economic strength. And so high interest rates often overlap with strong growth, while a weak economy needs the support that lower rates provide. And so if interest rates are falling based on concern that the economy is weakening, which we think describes much of the last two weeks, it’s easier to argue why credit or equity markets wouldn’t like that outcome at all.

That’s especially true because of the so-called lag in monetary policy. If the Fed lowered interest rates tomorrow, the full impact of that cut may not be felt in the economy for 6 to 12 months. And so if people are worried that conditions are weakening right now, they’re going to worry that the help from lower rates won’t arrive in time.

The upshot is that for Credit, and I would say for other asset classes as well, rate cuts have only tended to be helpful if growth remained solid. Rate cuts and weaker growth were bad, and that was more true the larger those rate cuts were. In 2001, 2008 and February of 2020, large rate cuts as the economy weakened led to significant credit losses. Concern about what those lower rates signalled outweighed the direct benefit that a lower rate provided.

We think that dynamic remains in play today, with the market over the last two weeks suggesting that a combination of weaker growth and lower rates may be taken poorly, not taken well.

But there’s also some good news: Our economists think that the market's views on growth, and interest rates, may both be a little overstated. They think the US economy is still on track for a soft-landing, and that last week’s jobs report wasn’t quite as weak as it was made out to be.

Because of all that, they also don’t think that the Fed will reduce interest rates as quickly as the market now expects. And so, if that’s now right, we think a stronger economy and somewhat higher rates is going to be a trade-off that credit is happy to take.

Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Health Care for Longer, Healthier Lives Aug 08, 2024

Our Head of Europe Sustainability Research discusses how rising longevity is revolutionizing our fundamental approach from reactive to proactive treatment.

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Welcome to Thoughts on the Market. I’m Mike Canfield, Morgan Stanley’s European Head of Sustainability Research. Along with my colleagues, we’re bringing you a variety of perspectives; and today we’re focusing on a topic that affects everyone – how much does poor health cost us? And how are ageing populations and longer life expectancy driving a fundamental shift in healthcare?

It’s Thursday, August the 8th, at 4pm in London.

As populations age across the developed world, health systems need to help people live both longer and healthier. The current system is typically built around to focus on acute conditions and it’s more reactive; so it introduces clinical care or drugs to respond to a condition after it’s already arisen, rather than keeping people healthy in the first instance. So increasingly, with the burden of chronic disease becoming by far the greatest health and economic challenge we face, we need to change the structure of the healthcare system.

Essentially, the key question is how much is poor health amongst the ageing population really costing society? To get a true sense of that, we need to keep in mind that workers over 50 already earn one out of every three dollars across the G20 regions. By 2035, they're projected to generate nearly 40 per cent of all household income. So with that in mind, preventable conditions amongst those people aged 50-64 at the moment, are already costing G20 economies over $1 trillion annually in productivity loss. And there’s one more key number: 19 per cent. That's how much age-diverse workforces can raise GDP per capita over the next thirty years,according to estimates from the Organization for Economic Co-operation and Development, or OECD. So clearly, keeping workers healthier for longer underpins a more productive, more efficient, and a profitable global economy. So it’s clear that [if] the current healthcare system were to shift from sick from care to prevention, the global gains would be substantial.

The BioPharma sector is already contributing some targeted novel treatments in areas like smart chemotherapy and in CRISPR – which is a technology that allows for selective DNA modification. While we can credit BioPharma and MedTech for really powerful innovations in diagnostics, in AI deployment for areas like data science and material science, and in sophisticated telemedicine – all these breakthroughs together give a more personalized, targeted health system; which is a big step in the right direction, but honestly they alone can’t solve this much broader longevity challenge we face.

Focus on health and prevention, ultimately, could address those underlying causes of ill-health, so that problems don’t arise even in the first instance. Governments around the world are obviously realizing the value of preventive care over sick care. And as a strategy, disease prevention fundamentally aims to promote wellness across the board, whether that’s in things like mental state, nutrition or even in things like sleep and stress. While it might be easy to kind of conflate that with wellness trends – things like green smoothies or meditation – the underlying benefits of boosting health at the cellular level have much broader and deeper implications. Things like Type 2 diabetes and heart disease, supporting better health across populations can significantly reduce the incidence of a wide range of chronic conditions. It can lower the burden on health systems overall, and actually increase healthy lifespan at the end of the day.

BioPharma advances are significant, but addressing longevity will require a much broader alignment across a myriad of elements; everything really from the food system to sanitation to training healthcare professionals. And of course, all of that will require consistent policy support. Regulators and policymakers are paying very close attention to their ageing population – and so are we. We’ll continue to bring you updates on this topic, which is so important to all of us.

Thanks for listening. If you enjoy the show, please do leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

What This Roller Coaster Week Means for Bonds Aug 07, 2024

Our Global Head of Thematic and Fixed Income Research joins our Chief Fixed Income Strategist to discuss the recent market volatility and how it impacts investor positioning within fixed income.

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Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.

Vishy: And I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist.

Zezas: And on this episode of Thoughts on the Market, we'll talk about the recent market volatility and what it means for fixed income investors.

It's Wednesday, August 7th at 10am in New York.

Vishy, on yesterday's show, you discussed the recent growth of money market funds. But today I want to talk about a topic that's top of mind for investors trying to make sense of recent market volatility. For starters, what do you think tipped off these big moves across global markets?

Vishy: Mike, a confluence of factors contributed to the volatility that we've seen in the last six or seven trading sessions. To be clear, in the last few weeks, there have been some downside surprises in incoming data. They were capped off by last Friday's US employment report that came in soft across the board. In combination, that raised questions on the soft-landing thesis that had been baked into market prices, where valuations were already pretty stretched. And this one came after a hawkish hike by Bank of Japan just two days prior.

While Morgan Stanley economists were expecting it, this hike was far from consensus going in. So, what this means is that this could lead to a greater divergence of monetary policy between the Fed and the Bank of Japan. That is, investors perceiving that the Fed may need to cut more and sooner, and that Bank of Japan may need to hike more; in both cases, more than expected.

As you know, when negative surprises show up together, volatility follows.

Zezas: Got it. And so last week's soft US employment data raises the question of whether the Fed's overtightened and the US economy might be weaker than expected. So, from where you sit, how does this concern impact fixed income assets?

Vishy: To be clear, this is really not our base case. Our economists expect US economy to slow, but not fall off the cliff. Last Friday's data do point to some slowing, on the margin more slowing than market consensus as well as our economists expected. And really what this means is the markets are likely to challenge our soft-landing hypothesis until some good data emerge. And that could take some time. This means recent weakness in spread products is warranted, and especially given tight starting levels.

Zezas: So, it seems in the coming days and maybe even weeks, the path for total fixed income market returns is likely to be lower as the market adjusts to a weaker growth outlook. What areas of fixed income do you think are best positioned to weather this transition and why?

Vishy: We really need more data to confirm or push back on the soft-landing hypothesis. That said, fears of growth challenges will likely build in expectations for more Fed cuts. And that is good for duration through government bonds.

Zezas: And conversely, what segments of fixed income are most exposed to risk?

Vishy: In one way or the other, all spread products are exposed. In my mind, the US corporate credit market recession risks are least priced into high yield single B bonds, where valuations are rich, and positioning is stretched.

Zezas: So clearly the recent market volatility has affected global markets, not just the US and Japan. So, what are you seeing in other markets? And are there any surprises there?

Vishy: Emerging market credit. In emerging market credit, investment grade sovereign bonds will likely outperform high yield bonds, causing us to close our preference for high yield versus investment grade. It is too soon to completely flip our view and turn bearish on the overall emerging market credit index.

We do see a combination of emerging market single name CDSs as an attractive hedge. South Africa, Colombia, Mexico, for example.

Zezas: So finally, where do we go from here? Do you think it's worth buying the dip?

Vishy: Our message overall is that while there have been significant moves, it is not yet the time to buy on dips.

Zezas: Well, Vishy, thanks for taking the time to talk.

Vishy: Great speaking with you, Mike.

Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. And share Thoughts on the Market with a friend or colleague today.

Why Money Market Funds Aren’t ‘Cash On The Sidelines’ Aug 06, 2024

Risk-averse investors have poured trillions into money-market funds since 2019. Our Chief Fixed Income Strategist explains why investors shouldn’t expect this money to pivot to equities and other risk assets as rates fall.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about money market funds.

It's Tuesday, August 6th at 3pm in New York.

Well over $6.5 trillion sit in US money market funds. A popular view in the financial media is that the assets under management in money market funds represent money on sidelines, waiting to be allocated to risk assets, especially stocks. The underlying thesis is that the current level of interest rates and the consequent high money market yields have resulted in accumulation of assets in money market funds; and, when policy easing gets under way and money market yields decline, these funds will be allocated towards risk assets, especially stocks. To that I would say, curb your enthusiasm.

Recent history provides helpful context. Since the end of 2019, money market funds have seen net inflows of about $2.6 trillion, occurring broadly in three phases. The first phase followed the outbreak of COVID, as the global economy suddenly faced a wide array of uncertainties. The second leg mainly comprised retail inflows, starting when the Fed began raising rates in 2022.The third stage came during the regional bank crisis in March-April 2023, with both retail and institutional flows fleeing regional bank deposits into money market funds.

Where do we go from here?

We think money market funds are unlikely to return to their pre-COVID levels of about $4 trillion, even if policy easing begins in September as our economists expect. They see three 25 basis point rate cuts in 2024 and four in 2025 as the economy achieves a soft landing; and they anticipate a shallow rate-cutting cycle, with the Fed stopping around 3.75 per cent. This means money market yields will likely stabilize around that level, albeit with a lag – but still be attractive versus cash alternatives.

In a hard landing scenario, the Fed will likely deliver significantly more cuts over a shorter period of time, but we think investors would be more inclined to seek liquidity and safety, allocating more assets to money market funds than to alternative assets.

Further, money market funds can delay the decline in their yields by simply extending the weighted average maturities of their portfolios and locking in current yields in the run-up to the cutting cycle. This makes money market funds more attractive than both short-term CDs and Treasury bills, whose yields reprice lower in sync with rate cuts. This relative appeal explains much of the lag between rate cuts and the peak in assets under management in money market funds. These have lagged historically, but average lag is around 12 months.

Finally, it is important to distinguish between institutional and retail flows into and out of money market funds, as their motivations are likely to be very different. Institutional funds account for 61 per cent of money market funds, while funds from retail sources amount to about 37 per cent. When they reallocate from money market funds, we think institutional investors are more likely to allocate to high-quality, short-duration fixed income assets rather than riskier assets such as stocks, motivated by safety rather than level of yield. Retail investors, the smaller segment, may have greater inclination to reallocate towards risk assets such as stocks.

The bottom line: While money market fund assets under management have grown meaningfully in the last few years, it is likely to stay high even as policy easing takes hold. Allocation toward risk assets looks to be both lagged and limited. Thus, this 'money on the sidelines' may not be as positive and as imminent a technical for risk assets as some people expect.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Making Sense of the Correction Aug 05, 2024

Although Monday’s correction springs from multiple causes, the real questions may be what’s next and when will the correction become a buying opportunity?

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the recent equity market correction and whether it’s time to step in.

It's Monday, Aug 5th at 11:30am in New York.

So let’s get after it.

Over the past several weeks, global equity markets have taken on a completely different tone with most major averages definitively breaking strong uptrends from last fall. Many are blaming the Fed’s decision last week to hold interest rates steady in the face of weaker jobs data while others have highlighted the technical unwind of the Japanese yen carry trade.

However, if we take a step back, this topping process began in April with the first meaningful sell off since last October’s lows. Even as many stocks and indices rallied back to new highs this summer, the leadership took on a more defensive posture with sectors like Utilities, Staples and even Real Estate doing better than they have in years. As I have been discussing on this podcast this shift in leadership has coincided with softer economic data during the second quarter. This softness has continued into the summer with the all-important labor market data joining in as already noted.

This rotation was an early warning sign that stocks were likely vulnerable to a correction as we highlighted in early July. After all, the third quarter is when such corrections tend to happen seasonally for several reasons. This year has turned out to be no different. The real question now is what’s next and when will this correction become a buying opportunity?

Lost in the blame game is the simple fact that valuations reached very rich levels this year, something we have consistently discussed in our research. In fact, this is the main reason we have no upside to our US major averages over the next year even assuming our economists’ soft landing base case outcome for the economy. In other words, stocks were priced for perfection.

Now, with the deterioration in the growth data, and a Fed that is in no rush to cut rates proactively, markets have started to get nervous. Furthermore, the Fed tends to follow 2-year yields and over the last month 2-year treasury yields have fallen by 100 basis points and is almost 170 basis points below the Fed Funds rate. What this means is that the market is telling the Fed they are way too tight and they need to cut much more aggressively than what they have guided.

The dilemma for the Fed is that the next meeting is six weeks away and that’s a lifetime when markets are trading like they are today. Markets tend to be impatient and so I expect they will continue to trade with high volatility until the Fed appeases the market’s wishes. The flip side, of course, is that the Fed does an intra meeting rate cut; but that may make the markets even more nervous about growth in my view.

Bottom line, markets are likely to remain vulnerable in the near term until we get better growth data or more comfort from Fed on policy support, neither of which we think is forthcoming soon.

Finally, support can also come from cheap valuations, but we don’t have that yet at current prices. As of this recording the S&P 500 is still trading 20x forward 12-month earnings estimates. Our fair value multiple assuming a soft-landing outcome on the economy is closer to 19x, which means things aren’t actually cheap until we reach 17-18x, which is more than 10 per cent away from where we are trading.

In the meantime, we continue to recommend more defensive stocks in sectors like Utilities, Healthcare, Consumer Staples and some Real Estate. Conversely, we continue to dislike smaller cap cyclical stocks that are most vulnerable to the current growth slowdown and tight rate policy.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Looking Back at a Whirlwind Week Aug 02, 2024

After adizzying week of economic and market activity, our Head of Corporate Credit Research breaks down the three top stories.

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It’s been a whirlwind week of economic activity in the markets as we enter the dog days of summer. Our Head of Corporate Credits Research breaks down three top stories.

Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be discussing what we’ve taken away from this eventful week.

It's Friday, August 2ndat 2pm in London.

For all its sophistication, financial activity is still seasonal. This is a business driven by people, and people like to take time off in the summer to rest and recharge. There’s a reason that volumes in August tend to be low.

And so this week felt like that pre-vacation rush to pack, find your keys, and remember your ticket before running out the door. Important earnings releases, central bank meetings and employment numbers all hit with quick succession. Some thoughts on all that whirlwind.

The first story was earnings and continued equity rotation. Equity markets are seeing big shifts between which stocks are doing well and poorly, particularly in larger technology names. These shifts are a big deal for equity investors, but we think they remain much less material for credit.

Technology is a much smaller sector of the bond market than the stock market, as these tech companies have generally issued relatively little debt – relative to their size. Credit actually tends to overlap much more with the average stock, which at the moment continues to do well. And while the Technology sector has been volatile, stocks in the US financial sector – the largest segment for credit – have been seeing much better, steadier gains.

Next up this week was the Bank of Japan, which raised policy rates, a notable shift from many other central banks, which are starting to lower them. For credit, the worry from such a move was somewhat roundabout: that higher rates in Japan would strengthen its currency, the yen. That such strength would be painful for foreign exchange investors, who had positioned themselves the other way around – for yen weakness. And that losses from these investors in foreign exchange could lead them to lower exposure in other areas, potentially credit.

But so far, things look manageable. While the yen did strengthen this week, it hasn’t had the sort of knock-on impact to other markets that some had feared. We think that might be evidence that investor positioning in credit was not nearly as concentrated, or as large, as in certain foreign exchange strategies, and we think that remains the case.

But the biggest story this week was the Federal Reserve on Wednesday, followed by the US Jobs number today. These two events need to be taken together.

On Wednesday, the Fed chose to maintain its high current policy rate, while also hinting it’s open to a cut. But with inflation falling rapidly in recent months, and already at the Fed’s target on market-based measures, the question is whether the Fed should already be cutting rates to even out that policy. After all, lowering rates too late has often been a problem for the Fed in the past.

Today’s weak jobs report brings these fears front-and-center, as highly restrictive monetary policy may start to look out-of-line with labor market weakness. And not cutting this week makes it more awkward for the Fed to now adjust. If they move at the next meeting, later in September; well, that means waiting more than a month and a half. But acting before that time, in an unusual intra-bank meeting cut; well, that could look reactive. The market will understandably worry that the Fed, once again, may be reacting too late. That is a bad outcome for the balance of economic risks and for credit.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Following the Flows Aug 02, 2024

Our Chief Global Cross-Asset Strategist, Serena Tang, explains where funds are moving across global markets currently, and why it matters to investors.

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Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll dig into the concept of fund flows, how they shape global markets and why they matter to investors.

It’s Thursday, August 1, at 10am in New York.

Finance industry professionals often use the term “flows” when looking at where investors are, in the aggregate, moving their money. It refers to net movements of cash in and out of investment vehicles such as mutual funds and exchange-traded funds, or in and out of whole markets. By looking at flows, investors can get a good sense of where market winds are blowing and, essentially, where demand is at any given moment. Now, whether you’re a retail or institutional investor, having a perspective on market sentiment and demand are powerful tools. So today I’m going to give you a snapshot of some key flows, which should give a sense of demand and the mood right now; and what it means for investors.

First of all, despite the recent rally in global equities year-to-date, we've yet to see an investor rotation, or portfolio realignment, from bonds to stocks. Flows into bonds are still leading flows into stocks by a pretty large margin. And unless stocks cheapen materially, we don’t expect this trend to reverse anytime soon. In addition, fund flows into large-cap equities still dwarf those into small-caps year-to-date. Although we saw a brief reversal of this trend in June, large caps flows have swung back to prominence.

We do see hints of sector rotation within equities, as investors shift to what they see as more promising stocks; but it’s not a clean or entirely unambiguous story. The Science & Tech sectors – which saw a notable drop-off in flows from the first to the second quarter of this year – still lead year-to-date; and flows represent nearly a third into all flows into equities. More cyclical sectors like Basic Materials and Financials attracted more capital than in the first and second quarter, while defensive sectors such as Consumer Goods saw a softening of outflows compared to the same period.

From a global perspective, we also look at flows in and out of particular regions or markets. So, year-to-date, US stocks received about US$43 billion in net inflows while rest-of-world stocks saw about US$15 billion in net outflows. Now, there were some exceptions – with India, Korea, and Taiwan leading – seeing significant inflows year-to-date.

We look at flows within categories too, so within fixed income, for example, we are seeing flows toward less risky assets; revealing what we call a risk-off preference. Higher quality, Investment Grade funds – raked in about US$92 billion in net inflows year-to-date, while US treasuries saw only at US$25 billion. That Treasury number is actually significantly higher than what we saw from the first quarter to the second quarter, while inflows to High Yield and low-quality Investment Grade corporates have slowed compared to the start of the year.

Finally, money market funds – that is mutual funds that invest in short-term higher quality securities – have not yet really seen sustained outflows, as one would expect when investors believe shorter term yields would come down, as central banks start to ease. Rather there’s been some $70 billion in net inflows through the first half of this year. Although we’re sympathetic to the view that money market outflows should begin when the Fed starts cutting rates, there’s actually a considerable lag between first cut and those outflows, as we have seen in the last two rate cutting cycles.

But what does all of this mean for investors? Well, it suggests they still have a defensive tilt, and they shouldn’t really be jumping on the rotational story. The current yield environment means rotation from fixed income and money market funds into riskier assets is still some way away. Investors also shouldn’t look at the dry powder/cash on the sidelines narrative as the big tailwind for riskier assets -- because it’s not coming any time soon. That said, we still like non-government bonds because this is where cash would go first if and when those flows begin. We also like global equities, but more so because the benign macro backdrop we are forecasting supports this.

We’ll keep you up to date if there’s any change in the direction of market winds and fund flows.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Will GenAI Help or Hurt Ad Agencies? Jul 31, 2024

As Generative AI continues to accelerate, some agencies will be better positioned than others to reap the benefits. Our Europe Media & Entertainment analyst, Laura Metayer, explains.

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Welcome to Thoughts on the Market. I’m Laura Metayer, from the Morgan Stanley Europe Media & Entertainment team. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what the future may hold for advertising agencies amid fast-paced Generative AI developments.

It’s Wednesday, July 31, at 2 PM in London.

Right now we’re still in the early stages of GenAI’s impact on ad agency offerings; although the debate around technology removing the need for ad agencies is not new.

Soon after the release of ChatGPT in early 2023, my colleagues in North America started mapping out the potential impact of GenAI on the ad agencies. They concluded that GenAI should represent an opportunity for the ad agencies, at least near-term. First, Gen AI would lead to productivity improvements from automatable tasks in creative, media, digital transformation consulting and central functions like HR and Finance. Second, GenAI would boost client demand for advice from agencies to help navigate the coming evolution in digital advertising.

Fast-forward to now and the impact of GenAI on the ad agencies has become an active investor debate, with concerns centering around the Creative business. Many eyes are on the Gen AI-powered text to image/video tools, which could disrupt the ad agencies' Creative & Production business. We this has weighed on agency stock prices recently.

Essentially, the bear case has been – and is – that technology would devalue agencies’ offerings and agency clients may rely more on tech platforms and in-house services. That bear case – twenty years into online advertising – has not played out. We think that in these early days of AI’s impact on marketing, there may be more upside to agency equities than risk over the next 12 to 18 months.

On the one hand, the introduction of Gen AI tools may mean reduced pricing power and challenged top-line growth. At the same time, replacing creative personnel with software may increase earnings power, even with less revenue. We think it's likely that a key value-add of the ad agencies' Creative business would be campaign personalization at scale, powered by data and technology.

Looking back, technology has been commoditizing certain areas of creative and production for years, well ahead of AI; and yet creativity and creative services remain core value propositions by agencies to brands. Overall, there is as much – if not more – opportunity than risk for ad agencies over time.

So let me leave you with two key takeaways:

First, we see the larger ad agencies as better positioned to remain relevant to customers in the GenAI era. However, we would caution that their large scale may also lower their ability to adapt quickly to evolving customer requirements when it comes to GenAI.

Second, we expect GenAI to drive more consolidation in the industry. We think it’s likely that some of the large ad agencies take market share from other large ad agencies.

As these trends play out over time, we’ll continue to keep you updated.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Navigating the Quality and Cap Curves Jul 30, 2024

A later cycle economy and continued uncertainty means that investors should be remain wary of cyclicals such as small caps, explains Mike Wilson, our CIO and Chief US Equity Strategist.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about slowing growth in the context of high valuations.

It's Tuesday, July 30th at 3pm in New York.

So, let’s get after it.

Over the past few weeks, the equity markets have taken on a different complexion with the mega cap stocks lagging and lower quality small caps doing better. What does this mean for investor portfolios? And is the market telling us something about future fundamentals? In our view, we think most of this rotation is due to the de-grossing that is occurring within portfolios that are overweight large cap quality growth and underweight lower quality and smaller cap names.

We have long been in the camp that large cap quality has been the place to be – for equity investors – as opposed to diving down the quality and cap curves. That continues to be the case; though we are watching the fundamental and technical backdrop for small caps closely, and we’re respectful of the pace of the recent move in the space.

For now, however, we continue to think the better risk/reward is to stay up the quality curve and avoid the more cyclical parts in the market like small caps. Our rationale for such positioning is simple — in a later cycle economy where growth is softening or not translating into earnings growth for most companies, large cap quality outperforms.

Exacerbating the many imbalances across the economy is a bloated fiscal budget deficit. In our view, there are diminishing returns to fiscal spending when it starts to crowd out private companies and consumers.As I have been discussing for the past year, this crowding out has contributed to the bifurcation of performance in both the economy and equity markets, while potentially keeping the Fed's Interest rate policy tighter than it would have been otherwise.

While the macro data has been mixed, there is a growing debate around the actual strength of the labor market with the household survey painting a weaker picture than the non-farm payroll data which is based on employer surveys. The bottom line is that we are in a stable, but decelerating late cycle economy from a macro data standpoint. However, on the micro front, the data has not been as stable and is showing a more meaningful deterioration in growth; particularly as it relates to the consumer.

More specifically, earnings revision breadth has broken down recently for many of the cyclical parts of the market.Financials has been a bright spot here but that may be short-lived if the consumer continues to weaken. We continue to favor quality but with a greater focus on defensive sectors like utilities, staples and REITs as opposed to growthier ones like technology. The issue with the growth stocks is valuations and the qualityof the earnings for some of the mega cap tech stocks.

The other variable weighing on stocks at the moment is valuations which remain in the top decile of the past 20 years. It’s worth noting that valuations are very sensitive to earnings revisions breadth. The last time revision breadth rolled over into negative territory was last fall. Between July and October 2023, the market multiple declined from 20x to 17x. Two weeks ago, this multiple was 22x and is now 21x. If earnings revisions continue to fade as we expect, it’s likely these valuations have further to fall. With our 12-month base case target multiple at 19x, the risk reward for equities broadly remains quite unfavorable at the moment.

Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

The Coming Nuclear Power Renaissance Jul 29, 2024

Our sustainability strategists Stephen Byrd and Tim Chan discuss what’s driving new opportunities across the global nuclear power sector and some risks investors should keep in mind.

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Stephen Byrd: Welcome to Thoughts on the Market. I'm Steven Byrd, Morgan Stanley's Global Head of Sustainability Research.

Tim Chan: And I'm Tim Chan, Asia Pacific Head of Sustainability Research.

Stephen Byrd: And on this episode of the podcast, we'll discuss some significant developments in the nuclear power generation space with long term implications for global markets.

It’s Monday, July 29th at 8am in New York.

Tim Chan: And 8 pm in Hong Kong.

Stephen Byrd: Nuclear power remains divisive, but it is making a comeback.

So, Tim, let's set the scene here. What's really driving this resurgence of interest in nuclear power generation?

Tim Chan: One key moment was the COP28 conference last year. Over 20 countries, including the US, Canada, and France, signed a joint declaration to triple nuclear capacity by 2050. Right now, the world has about 390 gigawatts of nuclear capacity providing 10 per cent of global electricity. It took 70 years to bring global nuclear capacity to 390 gigawatts. And now the COP28 target promises to build another 740 gigawatts in less than 30 years.

And if this remarkable nuclear journey is going to be achieved, that will require financing and also shorter construction time.

Stephen Byrd: So, Tim, how do you size the market opportunity on a global scale over the next five to ten years?

Tim Chan: We estimate that nuclear renaissance will be worth $ 1.5 trillion (USD) through 2050, in the form of capital investment in new global nuclear capacity. And the growth globally will be led by China and the US. China will also lead in the investment in nuclear, followed by the US and the EU. In addition, this new capacity will need $128 billion (USD) annually to maintain.

Stephen Byrd: Well, Tim, those are some gigantic numbers, $1.5 trillion (USD) and essentially a doubling of nuclear capacity by 2050. I want to dig into China a bit and if you could just speak to how big of a role China is going to play in this.

Tim Chan: In China, by 2060, nuclear is likely to account for roughly 80 per cent of the total power generation, according to the China Nuclear Association. This figure represents half of the global nuclear capacity in similar stages, which amounts to 520 gigawatts.

And Stephen, can you tell us more about the US?

Stephen Byrd: Sure, during COP 28, the US joined a multinational declaration to triple nuclear power capacity by 2050. In this past year, the US has seen the completion of a new nuclear power plant in Georgia, which is the first new reactor built in the United States in over 30 years.

Now, beyond this, we have not seen a strong pipeline in the US on large scale nuclear plants, according to the World Nuclear Association. And for the US to triple its nuclear capacity from about 100 gigawatts currently, the nation would need to build about 200 gigawatts more capacity to meet the target.

In our nuclear renaissance scenario, we assume only 50 gigawatts will be built, considering a couple of factors. So, first, clean energy options, such as wind and solar are becoming more viable; they're dropping in cost. And also, for new nuclear in the United States, we've seen significant construction delays and cost overruns for the large-scale nuclear plants. Now that said, there is still upside if we're able to meet the target in the US.

And I think that's going to depend heavily on the development of small modular reactors or SMRs. I am optimistic about SMRs in the longer term. They're modular, as the name says. They're easier to design, easier to construct, and easier to install. So, I do think we could see some upside surprises later this decade and into the next decade.

Tim Chan: And nuclear offers a unique opportunity to power Generative AI, which is accounting for a growing share of energy needs.

Stephen Byrd: So, Tim, I was wondering how long it was going to take before we began to talk about AI.

Nuclear power generators do have a unique opportunity to provide power to data centers that are located on site, and those plants can provide consistent, uninterrupted power, potentially without external connections to the grid. In the US, we believe supercomputers, which are essentially extremely large data centers used primarily for GenAI training, will be built behind the fence at one or more nuclear power plants in the US. Now these supercomputers are absolutely massive. They could use the power, potentially, of multiple nuclear power plants.

Now just let that sink in. These supercomputers could cost tens of billions of dollars, possibly even $100 billion plus. And they will bring to bear unprecedented compute power in developing future Large Language Models.

So, Tim, where does regulation factor into the resurgence of nuclear power or the lack of resurgence?

Tim Chan: So, for the regulation, we focus a lot on the framework to provide financing: subsidies, sustainable finance taxonomies and also from the bond investor; although we note that taxonomies are still developing to offer dedicated support to nuclear.

We expect nuclear financing under green bonds will become increasingly common and accepted. However, exclusion on nuclear still exists.

Stephen Byrd: So finally, Tim, what are some of the key risks and constraints for nuclear development?

Tim Chan: I would highlight three risks. Construction time, shortage of labor, and uranium constraint. These remain the key risks for nuclear projects to bring value creation.

US and Europe had high profile delay in the past, which led to massive cost overrun. We are also watching the impacts of shortage of skilled labor, which is more likely in the developed markets versus emerging markets. And the supply of enriched uranium, which is mainly dominated by Russia.

Stephen Byrd: Well, that's interesting, Tim. There are clearly some risks that could derail or slow down this nuclear renaissance. Tim, thanks for taking the time to talk.

Tim Chan: Great speaking with you, Stephen.

Stephen Byrd: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Three Risks for the Third Quarter Jul 26, 2024

Our head of Corporate Credit Research, Andrew Sheets, notes areas of uncertainty in the credit, equity and macro landscapes that are worth tracking as we move into the fall.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about three risks we’re focused on for the third quarter.

It's Friday, July 26that 2pm in London.

We like credit. But there are certainly risks we’re watching. I’d like to discuss three that are top of mind.

The first is probably the mildest. Looking back over the last 35 years, August and September have historically been tougher months for riskier assets like stocks and corporate bonds. US High Yield bonds, for example, lose about 1 per cent relative to safer government bonds over August-September. That’s hardly a cataclysm, but it still represents the worst two-month stretch of any point of the year. And so all-else-equal, treading a little more cautiously in credit over the next two months has, from a seasonal perspective, made sense.

The second risk is probably the most topical. Equity markets, especially US equity markets, are seeing major shifts in which stocks are doing well. Since July 8th, the Nasdaq 100, an index dominated by larger high-quality, often Technology companies, is down over 7 per cent. The Russell 2000, a different index representing smaller, often lower quality companies, is up over 11 per cent. So ask somebody – ‘How is the market?’ – and their answer is probably going to differ based on which market they’re currently in. This so-called rotation in what’s outperforming in the equity market is a risk, as Technology and large-cap equities have outperformed for more than a decade, meaning that they tend to be more widely held. But for credit, we think this risk is pretty modest.

The weakness in these Large, Technology companies is having such a large impact because they make up so much of the market – roughly 40 per cent of the S&P 500 index. But those same sectors are only 6 per cent of the Investment grade credit market, which is weighted differently by the amount of debt somebody is issued. Meanwhile, Banks have been one of the best performing sectors of the stock market. And would you believe it? They are one of the largest sectors of credit, representing over 20 per cent of the US Investment Grade index. Put a slightly different way, when thinking about the Credit market, the average stock is going to map much more closely to what’s in our indices than, say, a market-weighted index.

The third risk on our minds is the most serious: that economic data ends up being much weaker than we at Morgan Stanley expect. Yes, weaker data could lead the Fed and the ECB to make more interest rate cuts. But history suggests this is usually a bad bargain. When the Fed needs to cut a lot as growth weakens, it is often acting too late. And Credit consistently underperforms.

We do worry that the Fed is a bit too confident that it will be able to see softness coming, given the lag that exists between when it cuts rates and the impact on the economy. We also think interest rates are probably higher than they need to be, given that inflation is rapidly falling toward the Fed’s target. But for now, the US Economy is holding up, growing at an impressive 2.8 per cent rate in the second quarter in data announced this week. Good data is good news for credit, in our view. Weaker data would make us worried.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Investors’ Questions After Election Shakeup Jul 25, 2024

Markets are contending with greater uncertainty around the US presidential election following President Biden’s withdrawal. Our Global Head of Fixed Income and Thematic Research breaks down what we know as the campaign enters a new phase.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the latest development in the US presidential race.

It's Thursday, July 25th at 2:30 pm in New York.

Last weekend, when President Biden decided not to seek re-election, it begged some questions from investors.

First, with a new candidate at the top of the ticket, are there new policy impacts, and potential market effects, resulting from Democrats winning that we haven’t previously considered?

For the moment, we think the answer is no. Consider Vice President Harris. Her policy positions are similar to Biden’s on key issues of importance to markets. And even if they weren’t, the details of key legislative policies in a Democratic win scenario will likely be shaped by the party’s elected officials overall. So, our guidance for market impacts that investors should watch for in the event that Democrats win the White House is unchanged.

Second, what does it mean for the state of the race? After all, markets in the past couple of weeks began anticipating a stronger possibility of Republican victory. It was visible in stronger performance in small cap stocks, which our equity strategy team credited to investors seeing greater benefits in that sector from more aggressive tax cuts under possible Republican governance.

It was also visible in steeper yield curves, which could reflect both weaker growth prospects due to tariff risks, pushing shorter maturity yields lower, and greater long-term uncertainty on economic growth, inflation, and bond supply from higher US deficits – something that could push longer-maturity Treasury yields relatively higher. So, it's understandable that investors could question the durability of these market moves if the race appeared more competitive.

But the honest answer here is that it's too early to know how the race has changed. As imperfect as they are, polls are still our best tool to gauge public sentiment. And there’s scant polling on Democratic candidates not named Biden. So, on the question of which candidate more likely enjoys sufficient voter support to win the election, it could be days or weeks before we have reliable information. That said, prediction markets are communicating that they expect the race to tighten – pricing President Trump’s probability of regaining the White House at about 60-65 per cent, down from a recent high of 75-80 per cent.

So bottom line, a change in the Democratic ticket hasn’t changed the very real policy stakes in this election. We’ll keep you informed here of how it's impacting our outlook for markets.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

How Asian Markets View US Elections Jul 24, 2024

Our Chief Asia Economist explains how the region’s economies and markets would be affected by higher tariffs, and other possible scenarios in the US elections.

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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss a question that’s drawing increasing attention – just how the U.S. presidential election would affect Asian economies and markets.

It’s Wednesday, July 24th, at 8 PM in Hong Kong.

As the US presidential race progresses, global markets are beginning to evaluate the possibility of a Trump win and maybe even a Republican sweep. Investors are wondering what this would mean for Asia in particular. We believe there are three channels through which the US election outcome will matter for Asia.

First, financial conditions – how the US dollar and rates will move ahead of and after the US elections. Second, tariffs. And third, US growth outcomes, which will affect global growth and end demand for Asian exports. Well, out of the three our top concern is the growth downside from higher tariffs.

The 2018 experience suggests that the direct effect of tariffs is not what plays the most dominant role in affecting the macro outcomes; but rather the transmission through corporate confidence, capital expenditure, global demand and financial conditions.

Let’s consider two scenarios.

First, in a potential Trump win with divided government, China would likely be more affected from tariffs than Asia ex China. We see potentially two outcomes in this scenario – one where the US imposes tariffs only on China, and another where it also imposes 10 percent tariffs on the rest of the world.

In the case of 60 percent tariffs on imports from China, there would be meaningful adverse effect on Asia's growth and it will be deflationary. China would remain most exposed compared to the rest of the region, which has reduced its export exposure to China over time and could see a positive offset from diversification of the supply chain away from China.

In the case where the US also imposes 10 percent tariffs on imports from the rest of the world, we expect a bigger downside for China and the region. We believe that in this instance – in addition to the direct effect of tariffs on exports – the growth downside will be amplified by significant negative impact on corporate confidence, capex and trade. Corporate confidence will see bigger damage in this instance as compared to the one where tariffs are imposed only on China as corporate sector will have to think about on-shoring rather than continuing with friend-shoring.

In the second scenario, in a potential Trump win with Republican sweep, in addition to the implications from tariffs, we would also be watching the possible fiscal policy outcomes and how they would shift the US yields and the dollar. This means that the tightening of financial conditions would pose further growth downside to Asia, over and above the effects of tariffs.

How would Asia’s policymakers respond to these scenarios? As tariffs are imposed, we would expect Asian currencies to most likely come under depreciation pressure in the near term. While this helps to partly offset the negative implications of tariffs, it will constraint the ability of the central banks to cut rates. In this context, we expect fiscal easing to lead the first part of the policy response before rate cuts follow once currencies stabilize. It’s worth noting that in this cycle, the monetary policy space in Asia is much more limited than in the previous cycles because nominal rates in Asia for the most part are lower than in the US at the starting point.

Of course, this is an evolving situation in the remaining months before the US elections, and we’ll continue to keep you updated on any significant developments.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Almost Human: Robots in Our Near Future Jul 23, 2024

Our Head of Global Autos & Shared Mobility discusses what makes humanoid robots a pivotal trend with implications for the global economy.

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Welcome to Thoughts on the Market. I’m Adam Jonas, Morgan Stanley’s Head of Global Autos & Shared Mobility. Today I’ll be talking about an unusual but hotly debated topic: humanoid robots.

It’s Tuesday, July 23rd, at 10am in New York.

We've seen robots on factory floors, in displays at airports and at trade shows – doing work, performing tasks, even smiling. But over the last eighteen months, we seem to have hit a major inflection point.

What's changed? Large Language Models and Generative AI. The current AI movement is drawing comparisons to the dawn of the Internet. It’s begging big, existential questions about the future of the human species and consciousness itself. But let’s look at this in more practical terms and consider why robots are taking on a human shape.

The simplest answer is that we live in a world built for humans. And we’re getting to the point where – thanks to GenAI – robots are learning through observation. Not just through rudimentary instruction and rules based heuristic models. GenAI means robots can observe humans in action doing boring, dangerous and repetitive tasks in warehouses, in restaurants or in factories. And in order for these robots to learn and function most effectively, their design needs to be anthropomorphic.

Another reason we're bullish on humanoid robots is because developers can have these robots experiment and learn from both simulation and physically in areas where they’re not a serious threat to other humans. You see, many of the enabling technologies driving humanoid robots have come from developments in autonomous cars. The problem with autonomous cars is that you can't train them on public roads without directly involving innocent civilians – pedestrians, children and cyclists -- into that experiment.

Add to all of this the issue of critical labor shortages and challenging demographic trends. The global labor total addressable market is around $30 trillion (USD) or about one-third of global GDP. We’ve built a proprietary US total addressable market model examining labor dynamics and humanoid optionality across 831 job classifications, working with our economic team; and built a comprehensive survey across 40 sectors to understand labor intensity and humanoid ability of the workforce over time.

In the United States, we forecast 40,000 humanoid units by 2030, 8 million by 2040 and 63 million by 2050 – equivalent to around $3 trillion (USD) of salary equivalent. But as early as 2028 we think you're going to see significant adoption beginning in industries like manufacturing, production, warehousing, and logistics, installation, healthcare and food prep.

Then in the 2030s, you’re going to start adding more in healthcare, recreational and transportation. And then after 2040, you may see the adoption of humanoid robots go vertical. Now you might say – that’s 15 years from now. But just like autonomous cars, the end state might be 20 years away, but the capital formation is happening right now. And investors should pay close attention because we think the technological advances will only accelerate from here.

Thanks for listening. And if you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Business Cycle May Trump Politics Jul 22, 2024

Our CIO and Chief US Equity Strategist explains that in the event of a Republican sweep in this fall’s U.S. elections, investors should not expect a repeat of 2016 given the different business environment.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why investors should fade the recent rally in small caps and other pro cyclical trades.

It's Monday, July 22nd at 11:30am in New York.

So let’s get after it.

With Donald Trump’s odds of winning a second Presidency rising substantially over the past few weeks, we’ve fielded many questions on how to position for this outcome. In general, there is an increasing view that growth and interest rates could be higher given Trump's focus on business-friendly policies, de-regulation, higher tariffs, less immigration and additional tax cuts.

While the S&P 500 has risen alongside Trump's presidential odds this year, several of the perceived industry outperformers under this political scenario have only just recently started to show relative outperformance. One could argue a Trump win in conjunction with a Republican sweep could be particularly beneficial for Banks, Small Caps, Energy Infrastructure and perhaps Industrials. Although, the Democrats' heavy fiscal spending and subsidies for the Inflation Reduction Act, Chips Act and other infrastructure projects suggest Industrial stocks may not see as much of an incremental benefit relative to the past four years. The perceived industry underperformers are alternative energy stocks and companies likely to be affected the most by increased tariffs. Consumer stocks stand out in terms of this latter point, and they have underperformed recently. However, macro factors are likely affecting this dynamic as well. For example, concerns around slowing services demand and an increasingly value-focused consumer have risen, too.

It's interesting to note that while these cyclical areas that are perceived to outperform under a Trump Presidency did work in 2016 and through part of 2017, they did even better during Biden's first year. Our rationale on this front is that the cycle plays a larger role in how stocks trade broadly and at the sector level than who is in the White House. As a comparison, we laid out a bullish case at the end of 2016 and in early 2017 when many were less constructive on pro cyclical risk assets than we were post the 2016 election. It’s worth pointing out that the global economy was coming out of a commodity and manufacturing recession at that time, and growth was just starting to reaccelerate, led by another China boom. Today, we face a much different macro landscape. More specifically, several of the cyclical trades mentioned above typically show their best performance in the early cycle phase of an economic expansion like 2020-2021. They show strong, but often not quite as strong performance in mid cycle periods like 2016-17. They tend to show less strong returns later in the cycle like today. Our late cycle view is further supported by the persistent fall in long term interest rates and inverted yield curve.

We believe the recent outperformance of lower quality, small cap stocks has been driven mainly by a combination of softer inflation data and hopes for an earlier Fed cut combined with dealer demand and short covering from investors on the back of Trump’s improved odds. For those looking to the 2016 playbook, we would point out that relative earnings revisions for small cap cyclicals are much weaker today than they were during that period.

Back in December when small caps saw a similar squeeze higher, we explored the combination of factors that would likely need to be in place for small cap equities to see a durable, multi-month period of outperformance. Our view was that the introduction of rate cuts in and of itself was not enough of a factor to drive small cap outperformance versus large caps. In fact, history suggests large cap growth tends to be the best performing style once the Fed begins cutting as nominal growth is often slowing at this point in the cycle, which enables the Fed to begin cutting. We concluded that to see durable small cap outperformance, we would need to see a much more aggressive Fed cutting cycle that revived animal spirits in a significant enough way for growth and pricing power to inflect higher, not lower like recent trends.

We are monitoring small cap earnings expectations and small business sentiment for signs that animal spirits are building in this way. Rates and pricing power are still headwinds; while small businesses are not all that sanguine about expanding operations, they are increasingly viewing the economy more positively — an incremental positive and something worth watching. We will continue to monitor the data in assessing the feasibility of this small cap rally continuing. Based on the evidence to date, we would resist the urge to chase this cohort and lean back into large cap quality and defensives.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Why Credit Markets Like Moderation Jul 19, 2024

Our Head of Corporate Credit Research shares four reasons that he believes credit spreads are likely to stay near their current lows.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why being negative credit isn’t as obvious as it looks, despite historically low spreads.

It's Friday, July 19th at 2pm in London.

We’re constructive on credit. We think the asset class likes moderation, and that’s exactly what Morgan Stanley forecasts expect: moderate growth, moderating inflation and moderating policy rates. Corporate activity is also modest; and even though it’s picking up, we haven’t yet seen the really aggressive types of corporate behavior that tend to make bondholders unhappy.

Meanwhile, demand for the asset class is strong, and we think the start of Fed rate cuts in September could make it even stronger as money comes out of money market funds, looking to lock in current interest rates for longer in all sorts of bonds – including corporate bonds.

And so while spreads are low by historical standards, our call is that helpful fundamentals and demand will keep them low, at least for the time being.

But the question of credit’s valuation is important. Indeed, one of the most compelling bearish arguments in credit is pretty straightforward: current spreads are near some of their lowest levels of several prior cycles. They’ve repeatedly struggled to go lower. And if they can’t go lower, positioning for spreads to go wider and for the market to go weaker, well, it would seem like pretty good risk/reward.

This is an extremely fair question! But there are four reasons why we think the case to be negative isn’t as straightforward as this logic might otherwise imply.

First, a historical quirk of credit valuations is that spreads rarely trade at long-run average. They are often either much wider, in times of stress, or much tighter, in periods of calm. In statistical terms, spreads are bi-modal – and in the mid 1990s or mid 2000’s, they were able to stay near historically tight levels for a pretty extended period of time.

Second, work by my colleague Vishwas Patkar and our US Credit Strategy team notes that, if you make some important adjustments to current credit spreads, for things like quality, bond price, and duration, current spreads don’t look quite as rich relative to prior lows. Current investment grade spreads in the US, for example, may still be 20 basis points wider than levels of January 2020, right before the start of COVID.

Third, a number of the key buyers of corporate bonds at the moment are being driven by the level of yields, which are still high rather than spread, which are admittedly low. That could mean that demand holds up better even in the face of lower spreads.

And fourth, credit is what we’d call a positive carry asset class: sellers lose money if nothing in the market changes. That’s not the case for US Treasuries, or US Equities, where those who are negative – or short – will profit if the market simply moves sideways. It’s one more factor that means that, while spreads are low, we’re mindful that being negative too early can still be costly. It’s not as simple as it looks.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

The Surprising Link Between Auto Insurance and Inflation Jul 18, 2024

Our experts discuss how high prices for auto insurance have been driving inflation, and the implications for consumers and the Fed now that price increases are due to slow.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Diego Anzoategui: I'm Diego Anzoategui from the US Economics team.

Bob Huang: And I'm Bob Huang, the US Life and Property Casualty Insurance Analyst.

Seth Carpenter: And on this episode, we're going to talk about a topic that -- I would have guessed -- historically we weren't going to think about too often in a macro setting; but over the past couple of years it's been a critical part of the whole story on inflation, and probably affects most of our listeners.

It's auto insurance and why we think we're reaching a turning point.

It's Thursday, July 18th at 10am in New York.

All right, let's get started.

If you drive a car in the United States, you almost surely have been hit by a big increase in your auto insurance prices. Over the past couple of years, everyone has been talking about inflation, how much consumer prices have been going up. But one of the components that lots of people see that's really gone up dramatically recently has been auto insurance.

So that's why I wanted to come in and sit down with my colleagues, Diego and Bob, and talk through just what's going on here with auto insurance and how does it matter.

Diego, I'm going to start with you.

One thing that is remarkable is that the inflation that we're seeing now and that we've seen over the past several months is not related to the current state of the economy.

But we know in markets that everyone's looking at the Fed, and the Fed is looking at the CPI data that's coming out. We just got the June CPI data for the US recently. How does this phenomenon of auto insurance fit into that reading on the data?

Diego Anzoategui: Auto insurance is a relatively small component of CPI. It only represents just below 3 per cent of the CPI basket. But it has become a key driver because of the very high inflation rates has been showing. You know, the key aggregate the Fed watches carefully is core services ex-housing inflation. And the general perception is that inflation in these services is a lagged reflection of labor market tightness. But the main component driving this aggregate, at least in CPI, since 2022 has been auto insurance.

So the main story behind core services ex-housing inflation in CPI is just the lagged effect of a cost shock to insurance companies.

Seth Carpenter: Wait, let me stop you there. Did I understand you right? That if we're thinking about core services inflation, if you exclude housing; that is, I think, what a lot of people think is inflation that comes from a tight labor market, inflation that comes from an overheated economy. And you're saying that a lot of the movement in the past year or two is really coming from this auto insurance phenomenon.

Diego Anzoategui: Yes, that's exactly true. It is the main component explaining core services ex-housing inflation.

Seth: What's caused this big acceleration in auto insurance over the past few years? And just how big a deal is it for an economist like us?

Diego Anzoategui: Yeah, so believe it or not, today's auto insurance inflation is related to COVID and the supply chain issues we faced in 2021 and 2022. Key cost components such as used cars, parts and equipment, and repair cost increased significantly, creating cost pressures to insurance companies. But the reaction in terms of pricing was sluggish. Some companies reacted slowly; but perhaps more importantly, regulators in key states didn't approve price increases quickly.

Remember that this is a regulated industry, and insurance companies need approvals from regulators to update premiums. And, of course, losses increased as a result of this sluggish response in pricing, and several insurance started to scale back businesses, creating supply demand imbalances.

And it is when these imbalances became evident that regulators started to approve large rate increases, boosting car insurance inflation rapidly from the second half of 2022 until today.

Seth Carpenter: Okay, so if that's the case, what should we think about as key predictors, then, of auto insurance prices going forward? What should investors be aware of? What should consumers be aware of?

Diego Anzoategui: So in terms of predictors, it is always a good idea to keep track of cost related variables. And these are leading indicators that we both Bob and I would follow closely.

Used car prices, repair costs, which are also CPI components, are leading indicators of auto insurance inflation. And both of them are decelerating. Used car prices are actually falling. So there is deflation in that component. But I think rate filings are a key indicator to identify the turning point we are expecting this cycle.

Seth Carpenter: Can you walk through what that means -- rate filings? Just for our listeners who might not be familiar?

Diego Anzoategui: So, rate filings basically summarize how much insurers are asking to regulators to increase their premiums. And we actually have access to this data at a monthly frequency. Filings from January to May this year -- they are broadly running in line with what happened in 2023. But we are expecting deceleration in the coming months.

If filings start to come down, that will be a confirmation of our view of a turning point coming and a strong sign of future deceleration in car insurance inflation.

Seth Carpenter: So Bob, let me turn to you. Diego outlines with the macro considerations here. You're an analyst, you cover insurers, you cover the equity prices for those insurance, you're very much in the weeds. Are we reaching a turning point? Walk us through what actually has happened.

Bob Huang: Yeah, so we certainly are reaching a turning point. And then, similar to what Diego said before, right, losses have been very high; and then that consequently resulted in ultimately regulators allowing insurance companies to increase price, and then that price increase really is what's impacting this.

Now, going forward, as insurers are slowly achieving profitability in the personal auto space, personal auto insurers are aiming to grow their business. And then, if we believe that the personal auto insurance is more or less a somewhat commoditized product, and then the biggest lever that the insurance companies have really is on the pricing side. And as insurers achieve profitability, aim for growth, and that will consequently cost some more increased pricing competition.

So, yes, we'll see pricing deceleration, and that's what I'm expecting for the second half of the year. And then perhaps even further out, and that could even intensify further. But we'll have to see down the road.

Seth Carpenter: Is there any chance that we actually see decreases in those premiums? Or is the best we can hope for is that they just stopped rising as rapidly as they have been?

Bob Huang: I think the most likely scenario is that the pricing will stabilize. For price to decrease to before COVID level, that losses have to really come down and stabilize as well. There are only a handful of insurers right now that are making what we call an underwriting profit. Some other folks are still trying to make up for the losses from before.

So, from that perspective, I think, when we think about competition, when we think about pricing, stabilization of pricing will be the first point. Can price slightly decrease from here? It's possible depending on how intensive the competition is. But is it going to go back to pre-COVID level? I think that's a hard ask for the entire industry.

Seth Carpenter: You were talking a lot about competition and how competition might drive pricing, but Diego reminded all of us at the beginning that this industry is a regulated industry. So can you walk us through a little bit about how we should think about this going forward?

What's the interaction between competition on the one hand and regulation on the other? How big a deal is regulation? And, is any of that up for grabs given that we've got an election in November?

Bob Huang: Usually what an insurer will have to do in general is that for some states -- well actually, in most cases they would have to ask for rate filings, depending on how severe those rate filings are. Regulators may have to step in and approve those rate filings.

Now, as we believe that competition will gradually intensify, especially with some of the more successful carriers, what they can do is simply just not ask for price increase. And in that case, regulators don't really need to be involved. And then also implies that if you're not asking for a rate increase, then that also means that you're not really getting that pricing -- like upward pricing pressure on the variety of components that we're looking at.

Seth Carpenter: To summarize, what I'm hearing from Bob at the micro level is those rate increases are probably slowing down and probably come to a halt and we'll have a stabilization. But don't get too excited, consumers. It's not clear that car insurance premiums are actually going to fall, at least not by a sizable margin.

And Diego, from you, what I'm hearing is this component of inflation has really mattered when it comes to the aggregate measure of inflation, especially for services. It's been coming down. We expect it to come down further. And so, your team's forecast, the US economics team forecast, for the Fed to cut three times this year on the back of continued falls of inflation -- this is just another reason to be in that situation.

So, thanks to both of you being on this. It was great for me to be able to talk to you, and hopefully our listeners enjoyed it too.

Bob Huang: Thank you for having me here.

Diego Anzoategui: Always a pleasure.

Seth Carpenter: To the listeners, thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen; and share this podcast with a friend or a colleague today.

Navigating Market Reactions to the News Cycle Jul 17, 2024

Financial markets can be sensitive to news cycles, but our Global Head of Fixed Income and Thematic Research offers a word of caution about reacting to recent headlines about the US presidential election.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about development in the upcoming US elections.

It's Wednesday, July 17th at 10:30am in New York.

Financial markets are starting to reflect the possibility of a Trump presidency. Investors may be taking cues from a few current developments. There’s the recent weakening of President Biden’s polling numbers in key swing states such as Pennsylvania, Michigan and Wisconsin. There’s also the ongoing discussion about whether he will remain the Democratic nominee. And there's also former President Trump’s increased win probabilities in prediction markets, as well as the perception that Democrats will have more trouble pursuing their agenda in the wake of the assassination attempt against him.

To that end we’ve seen moves in key areas of markets sensitive to what we have argued will be the policy impacts of a Trump presidency, including a steepening of the US Treasury yield curve. But – a word of caution. These market reactions to recent political events may be rational, but it's not clear they’re sustainable.

First, there are plausible ways investors’ perceptions of the likely outcomes of this election could shift. Voters can have very short memories, resulting in polls shifting to partisan priors. This happened with popular opinion on elected officials following notable incidents in recent years – such as the events of January 6th, 2021, the US withdrawal from Afghanistan, and more. Also, if President Biden were to withdraw as a candidate, it’s possible investors could perceive that a different candidate could tighten the race. For example, there have been recent surveys showing alternate Democratic candidates polling better than President Biden.

Second, there’s also room for investors to misunderstand the policy path that could follow an election outcome as well as the impact of that path. For example, we’ve seen some recent press articles linking the broadening out of positive performance in the equity market to the likelihood of a Trump win on perceived benefits of friendlier tax policies that might result from this outcome. But if investors only focus on that policy, they’re not incorporating the potential offsetting effects that could come from policies that could challenge the economic growth outlook, such as higher tariffs – something former President Trump has advocated for.

So bottom line, it makes sense to interrogate what seems like clear links between the upcoming election and markets.Some linkages are strong, and it’s possible that will makefor a good investment strategy; others are weak and may break under scrutiny. We’ll help you sort it out here.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Beyond the 60/40 Portfolio? Jul 16, 2024

Our Chief Global Cross-Asset Strategist explains why she sees a future for the 60/40 portfolio strategy, which worked well for over half a century and may continue to perform well – with some modifications.

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Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the future of the 60/40 equity/bond portfolio.

It’s Tuesday, July 16th, at 10am in New York.

Now investors have been asking: Is the 60/40 portfolio -- which allocates 60 percent to stocks and 40 percent to bonds -- dead? After all, the last two years saw some of the worst returns of this strategy in decades. Now, we think the concerns about this widely used strategy are not unfounded, but definitely a bit exaggerated. Exactly how one thinks about the right mix of equities and bonds within this type of portfolio though will need to change.

The strategy of investing 60 percent of a portfolio in equities and 40 percent in bonds to lower portfolio risk evolved from modern portfolio theory in the 1950s. To succeed, bonds must be less volatile than stocks and the correlation between stock and bond returns can't be 1 -- because that would mean a perfect positive correlation between stocks and bonds. And this correlation has been below 1 and low for a long time because growth and inflation have moved up and down in tandem for a long time.

Now what does this have to do with anything, you may ask. Well, typically in an environment where equities are rallying on the back of strong growth, inflation is also increasing – which in turn means that nominal yields stay high, dampening bond returns; and vice-versa in a recessionary scenario. Now, in both of those cases, the negative stock-bond return correlations is related to the positive growth inflation correlation. Which explains why the strategy of the 60/40 equity/bond portfolio worked so well for decades, particularly in the low-vol, high-growth inflation correlation, low stock-bond returns correlation environment of the late aughts to 2010s.

Unfortunately for investors though, this has not been the backdrop for the last few years. The highly unusual macro environment coming out of pandemic broke that relationship between growth and inflation, which in turn broke the relationship between stocks and bonds, led to a spike in fixed income volatility, and dragged bond returns to lowest levels in decades over the last couple of years. But we believe these factors will slowly normalize, which means 60/40-like strategies should work again. While the levels of correlation and bond volatility going forward may look different from history, and definitely different from the QE period, as long as bonds have lower risks than stocks – and there’s little to suggest they won’t – bonds will continue to be good diversifiers.

But it’s important for investors to ask themselves: what could drive correlation between stocks and bonds going forward? Well, longer term, the path of correlation between the two assets depends in part on the relationship between economic growth and inflation, as I touched on earlier. And this is where AI can come in. Positive productivity shocks from GenAI tech diffusion and the energy transition may change that dynamic between growth and inflation. And at the same time, decoupling in the world’s key economic regions as a result of the transition to a multipolar world can alter the correlation between regional equities and rates.

So, will the 60/40 portfolio be the strategy of the future? Or is it going to be more like 70/30 or even 50/50? Slower normalization of volatility and correlation means that a portfolio with more equity could yield better risk/reward than a 60/40 mix. On the other hand, as the world’s 65+ year-old population continues to grow over the next decades, this aging demographic may demand higher allocations to less volatile assets, even at the expense of lower returns.

Or maybe, just maybe, there is another solution. Instead of a simple 60/40 like strategy, investors can look beyond government bonds to other diversifiers, and building a multi-asset portfolio with more flexibility.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Retail’s Comeback Plan Jul 15, 2024

Our Retail analyst and U.S. Internet analyst connect the dots on how technology is helping the retail industry to cash in on the future.

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Simeon Gutman: Welcome to Thoughts on the Market. I'm Simeon Gutman, Morgan Stanley's Hardlines, Broadlines, and Food Retail Analyst.

Brian Nowak: And I'm Brian Nowak, Morgan Stanley's US Internet Analyst.

Simeon Gutman: And on this episode of the podcast, we'll hear how retailers are using technology to make a comeback and set themselves up for the future.

It's Monday, July 15th at 6pm in London.

Brian Nowak: And it's 1pm in New York.

Simeon Gutman: Retail has taken a big hit over the last few years. The long tail of the pandemic, outbreaks of war and inflation have had a big impact on the landscape. However, our research suggests retail is finding its feet, and technology is playing a significant role.

Automation, AI, and retail media are the game changers here. And we're seeing retailers of larger scale and larger size disproportionately invest in these technologies -- which means it will not benefit all retailers equally.

My colleague Brian is here to help explain the technology and how these are manifesting themselves across the internet and technology landscapes. Brian, can you talk about how these things are materializing across your coverage universe?

Brian Nowak: Thanks, Simeon. Across the US internet space, we're seeing early emerging use cases for Generative AI of many types. We are seeing improved targeting on the advertising side. We are seeing new diffusion and creative models being built where advertisers can create new types of advertising copy using large language models. We are seeing new forms of customer service using large language models and Generative AI. And in effect, we are seeing companies across the entire internet space better analyze their first party data to drive more new people and customers to their platforms -- to drive higher conversion and share of wallets from those customers. And ultimately more durable multiyear top-line growth, which in some cases is also leading to higher free cash flow growth over the long term as well. It's early, but it's very encouraging with what we're seeing for Generative AI and retail media across the space.

Simeon Gutman: Can you talk about in more detail how retail media is influencing the success and the prospects for some of your companies?

Brian Nowak: Retail media is a emerging, rapidly growing, new high margin revenue stream that is moving across the internet space. Large companies are analyzing more of their data and essentially creating new advertising units that users and consumers can click on to drive transactions. And they're finding ways to better link these advertising dollars to transactions and ultimately creating a new revenue stream that we think is going to drive more durable top-line growth -- and because of its high margin nature, also more durable, multiyear free cash flow growth. It is benefiting the commerce players. It is benefiting the online advertising players. And it's also benefiting the advertising technology players.

So with that as a backdrop, Simeon, where are you seeing Generative AI, retail media, and maybe even automation, start to manifest itself throughout the retail landscape?

Simeon Gutman: Those are the three pillars of technology that are influencing retailers. Taking a quick step back, what's changing is that market share in retail is concentrating and consolidating among the largest players. And if you think about the investments required for some of these new capabilities, the companies that have the greatest ability to invest should see the greatest benefits. That means that the big could get bigger at an even faster rate. And this is why the stakes in retail are growing even faster.

Now with, respect to these technologies. Let's start with AI. AI is helping retailers analyze big pieces of data that they never had an ability to do in such a quick way. That could help them refine their search criteria to consumers scanning a website. That could help them improve the algorithms in a distribution center with robots creating orders.

Second, speaking of robots, bringing automation to distribution centers, supply chains for retailers can cost anywhere between 2 to 6 per cent of sales. There's a significant opportunity to reduce the amount of labor -- human labor -- in these distribution centers by automating them; whether it's dry goods, whether it's grocery items, as tricky as frozen and perishable items.

And then lastly, retail media, the way that you mentioned, Brian, the benefit to your companies is very similar to retailers. There are now advertising dollars that are moving into new channels, whether it's closed loop advertising in store or retail media that's appearing on websites -- where some of the larger and more successful companies have a lot of traffic and advertisers are intrigued to show them offers and deals to try to change their perception or behaviors.

So those three pieces of technology are slowly transforming the retailer. So next time you step into a retail store, there may be more technology that meets the eyes.

Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Why We Believe the Fed Will – and Should – Cut Rates Soon Jul 12, 2024

Our Head of Corporate Credit Research explains why he expects the US Federal Reserve to make three rate cuts before the end of the year, starting in September.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why it's looking more likely that the Fed should, and will, cut interests rates several times this year.

It's Friday, July 12th at 2pm in London.

Last week, we discussed why the case for Fed rate cuts this year was strengthening. Credit markets generally don’t care too much about the exact timing or pace of policy rates, but they do care if a central bank is behind the curve.

That’s because over the last 40 years, the worst returns for credit have repeatedly overlapped with periods where the Fed was too late in reversing tight monetary policy. After all, interest rates impact the economy with a pretty long and variable lag; and a interest rate cut today may not be fully felt in the economy for 12 months – or even longer. It’s therefore important for a central bank to be proactive.

And so, with the recent US economic data softer, and the Fed appearing in little rush to act, the concern was straightforward: if the Fed is waiting for signs of economic weakness to be obvious, it will take too long to lower interest rates to blunt this. The Fed will be behind the curve.

This risk of acting too late hasn’t gone away, and it’s a key reason why we think credit investors should be rooting for economic data in the second half of this year to remain solid, in line with Morgan Stanley’s base case. But this week did bring some events that suggest the Fed may start to adjust rates soon.

First, in testimony before the US Congress, Chair Powell repeatedly emphasized that the risks for the US economy are becoming more balanced. Previously, the Fed had appeared to be much more focused on an upside scenario where conditions are hotter rather than a scenario where growth slowed unexpectedly.

Second, in data released yesterday, US Consumer Price Inflation – or CPI – came in lower than expected. Overall, prices actually fell month-over-month, something that hasn’t happened since May of 2020, a time when the pandemic was raging, and Fed rates were near zero percent. Morgan Stanley’s base case is that moderating inflation will lead the Fed to cut interest rates by 25 basis points in September, November and December of this year.

For credit, the question of “what do these rate cuts” mean is an ‘and’ statement. If the Fed is lowering rates and growth is holding up, you are potentially looking at a mid-1990s scenario, the best period for credit in the modern era. But if the Fed is cutting and growth is weak … well, over and over again, that has not been good.

We remain constructive on credit, expecting three Fed rate cuts this year to coexist with moderate growth. But weaker data remains the risk. For credit, good data is good.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Business Travelers Pack Their Bags Jul 11, 2024

Our Freight Transportation & Airlines Analyst discusses the key takeaways from his mid-year corporate travel survey, which includes a number of positive trends for the second half of 2024.

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Welcome to Thoughts on the Market. I’m Ravi Shanker, Morgan Stanley’s Freight Transportation and Airlines analyst. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss my expectations for corporate travel in the second half of this year.

It’s Thursday, July 11th, at 10am in New York.

More and more business travelers are packing their bags and taking a flight for business meetings. In fact, our corporate travel survey suggests that a record 50 percent of respondents marked their travel itineraries as returning to pre-COVID levels. As well, corporate travel budgets are expected to be up five to seven percent year-over-year in 2024, and about six percent in 2025. This means significantly more flights, hotels and car bookings for corporate travel.

Interestingly, this is the first survey since 2021 that larger enterprises were more optimistic on corporate travel demand compared to smaller enterprises.

The shift to virtual meetings over the next two years will likely be stable. Companies continue to predict that 12-13 percent of travel volume will be replaced by virtual meetings in 2024 and 2025. Looking ahead, respondents expect this level to hold through 2025, supporting some level of permanent shift we think.

For US airlines specifically, we have started to see more signs of life within the corporate space. Several US airlines are pointing to noticeable improvement in the first quarter after fairly stagnant volumes at the end of 2023. We also saw a reversal from prior surveys with larger corporations recovering faster than smaller enterprises, which had initially led the post-COVID recovery.

This positive trend in airline demand is supportive of our attractive view on US aerospace, as well. Even though global air traffic has already reached pre-COVID-19 levels, it is still about 32 percent below where the trendline would have been if COVID-19 had not happened, which leaves more room for growth.

For business aviation, private jet use should remain strong and stable as a large majority of survey participants are not planning to change their business jet travel. Higher interest rates and a potentially slowing economy could lead to a potential slowdown in business jet demand, but this hasn’t happened so far as there continues to be limited excess capacity in the industry as well as continued strong demand for aircraft.

Our colleagues in Europe note that although near-term indicators are positive, 40 percent of European respondents now do not expect corporate travel volumes to return to 2019 levels. This is concerning for the longer-term prospects of European corporate demand growth, which appears to be weaker than US growth.

Whether you're flying private jets or commercial, or choosing to keep your team meetings virtual, we'll continue to monitor corporate travel trends, and let you know of any updates to those flight manifests.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Less Impact Than You Might Think Jul 10, 2024

U.S., French and Indian elections may have a minimal effect on equity markets, particularly in the short term, according to our Global Head of Fixed Income and our Chief Global Cross Asset Strategist.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research.

Serena Tang: And I'm Serena Tang, chief Global Cross Asset Strategist,

Michael Zezas: And on this episode of the podcast, we'll discuss what the elections in the US and Europe mean for global markets.

It's Wednesday, July 9th at 10am in New York.

As investors digest the results of the French election and anticipate the upcoming US presidential election, there's some key debates that are surfacing. And so I wanted to sit down with Serena to dig into these issues that are top of mind for investors.

Serena, do you expect the upcoming US elections will impact markets in the run up to November?

Serena Tang: Significantly, not likely -- because if we look at history, for stocks for example, in any election year, returns don't look significantly different from any other year.

Serena Tang: My team ran some cross asset analysis on market behavior in and out of prior US elections using as much data as we have. And what has been very interesting is that whether a Democrat or Republican candidate eventually takes the White House, that doesn't change the trend of returns into an election.

The form of the future elected government, whether it is divided or unified, that has also never really bothered stock markets before the vote. And you can see very, very similar patterns in bond yields, the dollar and gold. Now, what this means is that even if an investor has perfect foresight and know the results of the elections now, it won't necessarily give them an edge over the next few months.

Serena Tang: Now, beyond the election is really when you see performance in various election outcome scenarios really diverge. So, whether the election was tight or not seemed to have led US rates to see very different levels of returns 12 months out from an election. Whether the outcome means a unified or divided government saw very large swings in gold prices.

Now there are a lot of caveats. Every election is different. The economic conditions in every election is different. And as much as we talk about other historical periods, the truth is there aren't a lot of data points to work with. Data for S&P 500 going back to 1927 reaches the most far back among the major markets, but even then it only covers 23 presidential elections.

So what I'm trying to say is there have been a lot of presidents, but there aren't a lot of precedents, at least for markets.

Michael Zezas: The US election isn't the only election making headlines this year. For example, we just had an election in France that had a surprising result. How does the outcome there affect your outlook on the market?

Serena Tang: It doesn't, in short. It doesn't change our bullish view on European equities at all. As you know, we have been constructive on that market since January and added significant exposure in our asset allocation then -- very much on the back of our European equity strategist Marina Zavolok coming out with an out of consensus bullish call for European stocks.

Serena Tang: We like the market because of its cheap optionality and convexity. It has about 20 per cent revenue exposure to US but at much cheaper valuation. And it has about 20 per cent revenue exposure to EM, meaning should we get a growth surprise to the upside; you're geared to that but at much lower volatility than owning EM equities outright.

Now, none of this has changed post French elections, and we also don't see significant increase in bearish tail risks. If you look at other markets like Euro IG corporate credit or the euro, those markets are suggesting risks in France are idiosyncratic, not systemic. So we maintain our overweight in European stocks.

Serena Tang: Everything that I just said is also true for our bullish view on Indian equities, even after elections a month ago. Ridham Desai, head of India research, argued the election outcome there is likely to usher in more structural reforms and really reinforces our forecast of 20 per cent annual earnings growth over next five years, sustaining India's longest and strongest bull market ever. Bullish secular factors for Indian equities have not changed and therefore our bullish view on Indian equities have not changed.

Michael Zezas: And elections have consequences for how countries interact with one another. And how their policies differ from one another. And one area of the markets that tend to be sensitive to this is the foreign exchange markets. So are there any impacts you're looking for around foreign currencies?

Serena Tang: Yes, in particular, the dollar. But let me start with the euro first. Because I talked earlier about our bullish view on European equities; and in fact, in our asset allocation, we actually have a higher allocation to Europe versus US for stocks, bonds, and corporate credit bonds. The one European market we're more cautious on is the euro. And this actually has nothing to do with the French election results, per se -- because what matters now really is dollar strength. Now, part of this is a rates differential issue. Our US economics team are expecting the Fed to start cutting in September, while the ECB, of course, has already started easing policy. So yield differentials really favor the dollar here.

But we also need to factor in the election, which seems to be the theme for today. Our FX [foreign exchange] strategy team thinks markets really need to start pricing in material likelihoods of dollar positive changes in US fiscal, foreign and trade policy as the election approaches. Meaning the dollar will continue its modest uptrend into the second half. And geopolitical uncertainty, of course, will also be dollar positive.

Michael Zezas: So bottom line then. Elections clearly have consequences for markets but in the run-up to an election, there might not be a reliable pattern.

Serena Tang: Exactly.

Michael Zezas: Great. Well Serena, thanks for taking the time to talk.

Serena Tang: Great speaking with you, Mike.

Michael Zezas: And as a reminder, if you enjoy the podcast, please take a moment to rate and review us wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

US Housing: What Will Slow Home Price Growth? Jul 09, 2024

Record-high prices remain a key concern for buyers in the U.S. housing market. Our Co-Heads of Securitized Product Research dig into the data, explaining why they still believe a deceleration in home price growth will come.

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Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley.

James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley. It's Tuesday, July 9th, at 1pm in New York.

Jay Bacow: Jim, housing headlines just keep coming. Home prices are at record highs. What does that mean? How should we be thinking about that?

James Egan: So, that has been a fun headline, and according to several measures of home prices, we are at record highs. But, let's put that into context. We've actually set a new record high for home prices every month for the past ten months. In fact, prior to a 12-month hiatus from July of ’22 to June of ’23, home prices had actually hit a new record high every month for 68 consecutive months.

Jay Bacow: Alright, so if we're just talking about levels, it's important. But given that I'm a physicist by training, so are rates of change; and for that matter, changes to the rate of change, or acceleration, if you will. If there's something different about the current record of US home prices that is worth discussing, that would be interesting.

James Egan: We think there is. Actually two months ago, home prices set a new record high. But it was also the first time in ten months that the pace of year-over-year home price appreciation did not accelerate. This month the pace of appreciation actually started to decelerate.

As listeners of this podcast might remember, we've been calling for the pace of year-over-year home price appreciation to slow from above 6.5 per cent to just two percent by December. We are still above six percent today, but this could be the beginning of that deceleration.

Jay Bacow: Right. And if there's going to be deceleration, Newton would say there needs to be some force that causes it. And my understanding is you thought that that force that causes it would be sale inventories increasing. Has that been the case?

James Egan: Indeed, it has been actually. Total for sale inventory has increased for six consecutive months. And the pace of that growth is accelerating. Now, we do want to highlight that overall supply remains very tight. That part of the housing narrative hasn't changed. If we take a step back and look at the whole market, total months of supply are at just 4.5 per cent. Anything below six is really considered a seller's market there.

On the other hand, this is the highest level that the market has experienced since the first half of 2020, which is another argument in our minds for the pace of home price appreciation to decelerate. But once we remove these pandemic era lows, four and a half months is close to the lowest level of the past 30 plus years.

Jay Bacow: Alright, now sticking on the level context. Home prices weren't just the only thing that set a record level these days. Pending home sales just set a new record low in May.

James Egan: Right, that's also the case. Now, we do want to put the record into context here. The pending home sales index that we're referring to only goes back to 2001. But over that 23 plus years, the May print was the lowest number that we've seen.

Jay Bacow: Alright, so given all of that, how are you thinking about demand for housing amidst increasing supply?

James Egan: Right. So this is a pretty important question. When it comes to demand at these levels, affordability remains very challenged.

One of the primary questions for the US housing market moving forward is going to be the interplay between the absolute level of affordability and the direction and rate of change. Now, we are far from being able to declare a winner here. Sales volumes have increased off of 12 year lows from the fourth quarter of 2023; but at the same time, there are several demand indicators that are having trouble achieving liftoff, if you will.

Pending home sales, for instance. They're not falling as fast as they have been, over the past two plus years; but they're also having a hard time achieving some sort of escape velocity as they continue to fall on a year-over year-basis. Mortgage applications for purchase -- another one of our leading indicators -- they're experiencing a similar dynamic.

The first half of 2024 has been a noticeable second derivative improvement versus 2023, but that improvement has slowed and applications are still falling on a year-over-year basis. Now, part of this is going to be a function of mortgage rates going forward. Jay, what are we thinking there?

Jay Bacow: Now, the biggest driver of mortgage rates is going to be the level of treasury rates. And our rate strategists are forecasting treasury rates to fall over the end of this year and into the middle of next year. If that happens, we would expect mortgage rates to get towards 6.25 to 6.5 per cent by next summer -- clearly materially lower than they are right now. But once again, the biggest driver of this is treasury rates. Not what's going on with the mortgage market.

James Egan: And we continue to expect with that decrease affordability to improve, and that to drive year-over-year growth and sales in the second half of 2024 versus 2023. But it doesn't have to be a straight line to that outcome. And how are you thinking Jay, from a mortgage market perspective about sales volumes?

Jay Bacow: So, the mortgage market is in a pretty interesting spot because there's almost two sides of it. There's the existing mortgage market, which is mostly made up of homeowners that have very low mortgage rates, and thus the coupon to the investor is relatively low; and they're trading at a discount.

If turnover is low, then those bonds are outstanding for longer, which is bad for those investors. But, if that turnover is low, that means the supply to the market in the new higher coupon mortgages is relatively low, which is good for those investors in the new higher coupon mortgages.

In effect, if turnover is lower, it's good for higher coupon mortgages, not so good for lower coupon mortgages.

James Egan: And that's why all of this is so critical. If I were to, to summarize, we're paying attention to increasing inventory volumes in the housing market. We're paying attention to some of these demand statistics that are coming in a little softer than at least consensus estimates expected them to. We do think that home price growth is going to decelerate as a result. We also think it will remain positive. There continues to be very little overall supply in the US housing market.

Jay, it was nice speaking with you.

Jay Bacow: Jim, nice talking physics in the housing market with you.

James Egan: Thanks for listening. And if you enjoyed this podcast, please leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

2024 US Elections: The Impact of Inflation Jul 08, 2024

Inflation continues to be a key issue for voters in elections around the world. Our CIO and Chief US Equity strategist explains its potential influence on the upcoming US presidential election, and how investors may react to potential outcomes of this race.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the consequences of elections on policy and markets.

It's Monday, July 8th at 2:30pm in New York.

So let’s get after it.

Several important elections around the world have taken place with important implications for policy and markets. Most notably, elections in India, Mexico, the UK and France have all garnered the attention of investors.

While these elections are unique to each country, there does appear to be a growing focus on the issue of economic inequalities and immigration. While these inequalities have been building for decades, the COVID pandemic and policies implemented to deal with it have ushered in a higher focus on these disparities and a general level of uncertainty about the future on the part of many citizens.

Of all the changes affecting the average person most adversely, inflation stands out as the most challenging. While the rate of change on inflation has been steadily falling since 2022, the price levelof a number of goods and services remains challenging for many. Prices for basic items like food, shelter, healthcare, insurance and utilities are 30 to 50 per cent higher than they were pre-pandemic. Offsetting some of this increase has been the rise in home equity and financial asset prices, but this only helps those who are asset owners. Fixed rate mortgages have also been a notable positive offset to rising prices and interest rates. For many, there is a natural arbitrage between these pre-existing, historically low mortgage rates and money market rates. Once again, such an arbitrage is only available to those who have large piles of cash.

In our view, these dynamics further the case that inflation is going to play a major role in this year's upcoming U.S. election much like it is having an impact globally.

The recent US Presidential debate prompted inquiries from investors on what a potential Trump win or a potential Republican sweep could mean for markets. Based on initial market reactions and our conversations with clients, there is a consistent view that both growth and longer-term interest rates could move higher under this outcome. This has led to a greater appetite to rotate one’s equity portfolio toward value and cyclical stocks, which also worked leading into the 2016 election. Market expectations for fiscal expansion, reflation and less regulation under a Trump Presidency support such moves.

However, we think there’s also a couple of important dynamics to consider. First, we would argue that the cycle is more mature today than it was in 2016 as evidenced by the two-and-a-half-year decline in the Conference Board Leading Economic Indicator and the nearly 2-year inversion of the yield curve. Given a later cycle environment is historically a backdrop where the market pays up for quality and liquidity, we advise staying up the quality curve and away from small cap cyclicals, which worked in 2016. In short, the state of the business cycle right now is more important than the election outcome. As such, we think investors should stay selective within cyclicals.

Second, the market welcomed a reflationary playbook in 2016. Inflation was not a headwind to consumers in the way it is now, and the US economy was recovering from a global manufacturing recession, the recovery of which was aided by the prospects of a pro-fiscal/reflationary policy regime. Today, inflation is a notable headwind to consumers as discussed previously and fiscal sustainability dynamics remain top of mind for the bond market.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Special Encore: A Sobering View on the Spirits Sector Jul 05, 2024

Original release date April 15, 2024: Markets are suggesting that spirits consumption will return to historical growth levels post-pandemic, but our Head of European Consumer Staples Research disagrees.

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Welcome to Thoughts on the Market. I’m Sarah Simon, Head of the European Consumer Staples team. Along with my colleagues bringing you a variety of perspectives, today I'll talk about a surprising trend in the global spirits market.

It's Monday, April 15, at 2pm in London.

We all remember vividly the COVID-19 period when we spent much more on goods than services, particularly on goods that could be delivered to our homes. Not surprisingly, spirits consumption experienced a super-cycle during the pandemic. But as the world returned to normal, the demand for spirits has dropped off. The market believes that after a period of normalization, the US spirits market will return to mid-single-digit growth in line with history; but we think that’s too optimistic.

Changes in demographics and consumer behavior make it much more likely that the US market will grow only modestly from here. There are several key challenges to the volume of US alcohol consumption in the coming years. Sobriety and moderation of alcohol intake are two rising trends. In addition, there’s the increased use of GLP-1 anti-obesity drugs, which appear to quell users' appetite for alcoholic beverages. And finally, there’s stiffer regulation, including the lowering of alcohol limits for driving.

A slew of recent survey data points to consumer intention to reduce alcohol intake. A February 2023 IWSR survey reported that 50 per cent of US drinkers are moderating their consumption. Meanwhile, a January 2024 NCSolutions survey reported that 41 per cent of respondents are trying to drink less, an increase of 7 percentage points from the prior year. And importantly, this intention was most concentrated among younger drinkers, with 61 per cent of Gen Z planning to drink less in 2024, up from 40 per cent in the prior year's survey. Meanwhile, 49 per cent of Millennials had a similar intention, up 26 per cent year on year.

Why is all this happening? And why now? Perhaps the increasingly vocal commentary by public bodies linking alcohol to cancer is really hitting home. Last November, the World Health Organization stated that "the higher the amount of alcohol consumed, the higher the risk of developing cancer" but also that "half of all alcohol-attributable cancers in the WHO European Region are caused by ‘light’ and ‘moderate’ alcohol consumption. A recent Gallup survey of Americans indicated that young adults are particularly concerned that moderate drinking is unhealthy, with 52 per cent holding this view, up from 34 per cent five years ago.

Another explanation for the increased prevalence of non-drinking among the youngest group of drinkers may be demographic makeup: the proportion of non-White 18- to 34-year-olds has nearly doubled over the past two decades.

And equally, the cost of alcohol, which saw steep price increases in the last couple of years, seems to be a reason for increased moderation. Spending on alcohol stepped up materially over the COVID-19 period when there were more limited opportunities for spending. With life returning to normal post pandemic, consumers have other – more attractive or more pressing – opportunities for expenditure.

Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts. It helps more people to find the show.

Why Central Banks Still Get It Wrong Sometimes Jul 03, 2024

Central banks play a crucial role in monetary policy and moderating the business cycle. Our Head of Corporate Credit Research explains why, despite their power, these financial institutions can’t quickly steer through choppy economic waters.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley.Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why credit may start to get more concerned that the Fed will make the same mistake it often does.

It's Wednesday, July 3rd at 2pm in London.

Central banks are among the most powerful actors in financial markets, and investors everywhere hang on their every word, and potential next move. If possible, that seemed even more true recently, as central banks first intervened aggressively in bond markets during the height of COVID, and then raised interest rates at the fastest pace in over 40 years.

Indeed, you could even take this a step further: many investors you speak to will argue central banks are the most important force in markets. All else comes second.

But this view of Fed supremacy over the market and economy has an important caveat. For all of their power, the Federal Reserve did not prevent the recession of 1990. It did not prevent the dotcom bust or recession of 2001. It did not prevent the Great Financial Crisis or Great Recession of 2007-2009. These periods have represented the vast majority of credit losses over the last 35 years. And so, for all of the power of central banks, these recessions, and their associated default cycles in credit, have kept happening.

The reasons for this are varied and debatable. But the central issue is that the economy is a bit like a supertanker; it’s hard to turn quickly. You need to make adjustments well in advance, and often well before the signs of danger are clear.

Currently, the Fed is still pressing the economic brakes. Interest rates from the Federal Reserve are well above so-called neutral; that is, where the Fed thinks interest rates neither boost, nor hold back, the economy. The justification for riding the break, so to speak, is that inflation earlier this year has still been higher than expected.

But in the last two months, this inflation has rapidly cooled. Our economists think this trend will accelerate in the second half of the year, and ultimately allow the Fed to cut interest rates in September, November, and December.

Still-high rates and cooling inflation isn’t a problem when the economic data is strong. But more recently, this data has cooled. If that weaker data continues, credit investors may worry that central banks are too focused on the high inflation that’s now behind us, and not focused enough on the potential slowing ahead. They’ll worry that once again, it may be too late to turn the proverbial economic ship.

We’d stress that the risks of this scenario are still low; but late-reacting central banks have – historically, repeatedly – been credit’s biggest vulnerability. It makes it all the more important, that as we head into summer, that the data holds up.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today. And for those in the US, a very happy Fourth of July.

Investors Eye Reactions to US Presidential Debate Jul 02, 2024

Our Global Head of Fixed Income recaps the aftermath of the first U.S. presidential debate, and how markets may react if forthcoming poll data shows a meaningful shift in the race.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the US elections and its impact on markets.

It's Tuesday, July 2nd at 10:30am in New York.

For months, investors have been asking us when markets will start paying attention to the US presidential election. Well, we think that time arrived with last week’s Presidential debate.

The media coverage that followed revealed that many Democratic party officials became concerned about President Biden’s ability to win the November election. This understandably led many to ask if the race for the White House had meaningfully changed; If it was no longer a close one – and if so, what would that mean for markets that might have to start pricing in the impacts of a Trump Presidency.

On the first question: While we think it's too early to conclude that the race is no longer a close one, we expect some data in the next week or two that could clarify this. The few polls that have been released following the debate show that voters are increasingly concerned about Biden’s ability to win; but they also show a level of support for Biden similar to what he enjoyed before the debates.

What we haven’t seen yet is a set of high-quality polls gauging swing state voter preferences. And even modest deterioration in Biden’s support there could meaningfully boost Trump’s prospects. That’s because, going into the debate, polls showed former President Trump with a small but consistent lead in national and key swing state polls.

Nothing outside the polling margin of error. But it still suggested that for President Biden to improve his odds of winning, he’d be served well by having a strong debate performance that moved the polls more in his favor.

It doesn’t appear that this has happened, and if polls show movement in the other direction for Biden, it would be fair to think of Trump as something of a favorite. But only for the time being. There’d still be time and catalysts for the race to change – including another scheduled debate in September.

If we do end up with a race where Former President Trump is a more clear favorite, even if just for a short time, there could be reflections in the market. As we’ve previously discussed, a Trump win increases the chances of more of the expiring tax cuts being extended. The benefits of those cuts most clearly accrue to key sectors like energy and telecom, so there’s potential outperformance there.

In fixed-income – a steeper US Treasury yield curve is an outcome our macro strategy team is particularly attuned to. That’s because a Trump presidency brings greater uncertainty about future fiscal policy, which could be reflected in relatively higher yields for longer maturity bonds. But it also increases the chances of policy choices that create near term pressure on economic growth that could push shorter maturity yields lower. This includes higher tariffs and tighter immigration policies.

So bottom line, the markets are paying attention. And the race is sure to have many more twists and turns. We’ll keep you updated on how we’re navigating it.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Housing Update: Home Prices Unlikely to Decline Jul 01, 2024

Rising rents and mortgage payments have been at the center of the inflation discussion. Our Global Chief Economist assesses whether monetary policy can effectively blunt those figures.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the housing market, inflation, growth and monetary policy.

It's Monday, July 1st, at 11am in New York.

Housing is at the center of many macro debates from growth to inflation. And when you put those two together – monetary policy. House prices have continued to rise despite high interest rates, which gives the impression to some of stalled deflation and forces consumers at times to make some really difficult choices. And in some economies, there's a seeming lack of responsiveness of housing to higher interest rates. All of which tends to prompt questions about the efficacy of monetary policy.

So where are we? We think monetary policy is still working through housing as it usually does, but supply shortages, or in some places just idiosyncratic factors like buildable lands or permitting, that's supported home prices. And as has been the case across several sectors in this business cycle, there really are some factors about housing that's just different in this cycle than in previous ones. For the U.S., a key part of the housing story has been the mortgage lock in for homeowners. Our strategists have noted that the gap between the current new mortgage rate and the average effective mortgage rate is at historical highs. And the share of 30 year fixed rate mortgages is at its highest in a decade.

Consequently, the inventory of existing houses has remained low because homeowners who have those really low mortgages are reluctant to move unless they have to. The market has become thinner with less available supply; and then if we think more broadly for the economy, there's a risk of labor market frictions if that mortgage lock in also reduces labor mobility.

Now, there will be a decline in mortgage rates if we get the modest easing cycle from the Fed that we expect. But that decline will be similarly modest so that gap in rates will not be fully closed even if it narrows. And so there might be some uplift to supply of housing, but it might not be huge. That decline in mortgage rates can also supply demand, so then we have to think about the net of this shift in demand and the shift in supply. And ultimately what we think is going to happen is that there'll be a moderation in home price appreciation, but not an outright decline in home prices.

First, the choice of housing for a lot of households is do you buy or do you rent? If you've got high home prices and high mortgages, buying is much less affordable and so it pushes people into renting, which could push up rents. That phenomenon is partly responsible for the surge in rents that we've seen over the past few years.

In the longer run, there should be a sort of arbitrage condition between home prices and rents. And while rising home prices can impinge the spending power for first time homebuyers, rising house prices can actually boost sentiment and consumption for existing homeowners.

And that mortgage lock in that I talked about before? Well, that can actually support aggregate consumption to some degree because now there's predictability of cash flows and the monthly payment is pretty low.

So what do we do when we take all of this together? The housing market might be telling us that monetary policy is working a bit less effectively than historically, but not that monetary policy is not working.

Home price appreciation is moderating. Housing starts have slowed, as usual, following those big rate increases. But that slowing? It's actually been a bit inconsistent because mortgage lock has meant that new supply is the only supply. Existing home sales, by contrast, are just plain weak. They're about as weak as they were around the financial crisis.

We do not think the housing market overall is at risk of collapse, but monetary policy is restraining activity in a very familiar way.

Thanks for listening, and if you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Why Good Data Is Good For Markets Jun 28, 2024

Our Head of Corporate Credit Research makes the case against the popular notion that solid economic data would be bad for markets, and instead offers a rationale for why now, more than ever, is the time for investors to root for positive economic developments.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why good data … is good.

It's Friday, June 28th at 2pm in London.

One of the bigger investor debates of 2024 is whether stronger or weaker economic data is the preferred outcome for the market. This isn’t a trick question.

Post-COVID, a large spike of inflation led to the fastest pace of interest rate hikes by central banks in over forty years. And so there’s been an idea that weaker economic data, which would reduce that inflationary pressure and make central banks more likely to cut interest rates, is actually the better outcome for the market. Those lower interest rates after all might be helpful for moving the market higher or tighter. And stronger economic data, in contrast, could lead to more inflationary pressure, and even more rate increases. And so by this logic, bad data is good … and good data, well, would be bad.

This “bad is good” mindset was prominent in the Autumn of 2022 and again in September of 2023, as markets weakened on stronger data and fears that it could drive further rate hikes. We saw the idea return this year, amidst higher-than-expected inflation readings in the first quarter.

But we currently think this logic is misplaced. For markets, and certainly for credit, we think those who are constructive, like ourselves, are very much rooting for solid economic data. For now, good is good.

Our first argument here is general. Over a long swath of available data, the worst returns for credit have consistently overlapped with the worst economic growth. Hoping for weaker data is, historically speaking, playing with fire, raising the odds that such weakness isn’t just a blip, and opens the door for much worse outcomes for both the economy and credit.

But our second reason is more specific to right now. Central to this idea that bad data would be better for the market is the assumption that central banks would look at any poor data, change their tune and come to the market’s aid by lowering interest rates quickly. I think recent events really challenge that sort of thinking.

While the European central bank did lower interest rates earlier this month, it struck a pretty cautious tone about any further easing. And the Federal Reserve actually raised its expected level of inflation and projected rate path on the same day that consumer price inflation in the US came in much lower than expected. Both increased the risk that these central banks are being more backward looking, and will be slow to react to weaker economic data if it materialises.

And so, we think, credit investors should be hoping for good data, which would avoid a scenario where backward-looking central banks are too slow to change their tune. I’d note that this is what Morgan Stanley’s economists are forecasting, with expectations that growth is a little over 2 percent this year in the US and a little over 1 percent in the Euro Area for this year. We expect the economic data to hold up, and for that to be the better scenario for credit. If the data turns down, we may need to change our tune.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Introducing: What Should I Do With My Money Season 2 Jun 28, 2024

If you're a listener to Thoughts on the Market you may be interested in Season 2of our podcast: What Should I Do With My Money?

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Money is emotional and that can make it difficult to know if we’re making the right decisions.This season, the stakes are high. From prenups to passing a legacy to their children, from affording a dream home to literally wanting to save the planet, our guests get to the heart of what matters to them most and you get answers to some of the questions you might have yourself.

No matter where you are with your finances, you don’t have to navigate them alone. Our Financial Advisors show once again that a little guidance can go a long way. Join us to hear how a conversation can turn concern into confidence, hosted by Morgan Stanley Wealth Management’s Jamie Roô.

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Signal Awards 2023 – Bronze Winner

Source: Signal Award Winners (October 2023) 2023 Signal Awards receive votes from the public voting stage, podcast fans cast over 130,000 votes for the Signal Listener’s Choice award. Signal Award Winners were selected by the Signal Academy. Morgan Stanley Smith Barney LLC is not affiliated with Signal Awards. For more information, see www.signalawards.com. ©2024 Morgan Stanley Smith Barney LLC. Member SIPC.

FCS Portfolio Awards 2024 – Bronze

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Shorty Awards Finalist 2024

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Webby Award Nominee 2024

Source: 2024 Webby Awards (May 2024) The Webby Awards is the Internet’s most respected symbol of success. The 28th Annual Webby Awards received nearly 13,000 entries from all 50 states and over 70 countries worldwide. Podcasts: News & Politics, Best Host, Best Series, Best Live Podcast Recording & more. Associate Academy members are former Webby winners and nominees and other invited industry professionals who are leaders in their peer groups because of their creative and technical accomplishments. Associate members are invited to take part in Round 1 Judging, the initial phase of the Webby evaluation process. Morgan Stanley Smith Barney LLC is not affiliated with The Webby Awards. For more information, see https://www.webbyawards.com/. ©2024 Morgan Stanley Smith Barney LLC. Member SIPC.

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Funding the AI Revolution Jun 27, 2024

As the infrastructure needs for artificial intelligence soar, so does the need for financing. Our Chief Fixed Income Strategist talks about the role credit markets can play in providing capital to power the sector.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the role of credit markets in the artificial intelligence (AI) revolution.

It's Thursday, June 27th at 1 pm in New York.

Technology diffusion driven by artificial intelligence has been a defining theme for investors over the last few years. Recent developments in generative AI, or GenAI powered by large language models, have the potential to bring transformational changes across the economy. Today, I want to talk about the role of credit markets in this AI revolution.

The infrastructure requirements of AI – semi fabs, data centers and the energy resources to power the Gen AI models – are enormous. Our analysts estimate that GenAI power demand will rise rapidly, reaching 224 Trillion Watt hours by 2027 in their base case which is roughly close to Spain's total 2022 power consumption.

So, it goes without saying that AI infrastructure will need substantial capex. Early on, much of the AI capex has been funded by a combination of venture capital and retained earnings from cash-rich technology companies; in other words funded by equity capital. As the focus shifts from early innovators and enablers of AI to adopters of AI, these needs are bound to grow and will require more efficient forms of capital. We think that credit markets in various forms – unsecured, secured, securitized and asset-backed – will have a major role to play in this transformation.

So far, debt financing has played a relatively small part in funding technology companies, especially AI beneficiaries. The sector has significant capacity to add debt without a material deterioration in their credit metrics. This capacity is also complemented by an investor base with a significant dry powder to absorb incremental issuance, thereby avoiding a demand-supply mismatch.

Of course, the story is not that simple. Cash-rich companies may not have a compelling need to access credit markets if the equity market continues to reward redirection of these free cash flows. But then the path of the interest rate markets will also matter, as monetary policy eases, the cost of debt becomes incrementally even more attractive. It’s clearly early innings, but credit markets holistically should play a bigger role as the cycle matures.

In addition, as the capex cycle broadens out from enablers to adopters, we note that most sectors are nearly not as cash-rich as the technology sectors. For example, the median cash to debt ratio for the technology sector is over 50 percent, but then for the remaining sectors, it is just 15 percent. So as capital needs driven by these infrastructure needs increase, we expect the reliance on credit markets also to increase.

In some ways, this has already begun to happen. The first data center asset backed security was issued in 2018. The market has now grown to over 20 billion outstanding and it is poised for a rapid growth. The bottom line is simply this: As AI driven technology diffusion takes center stage, credit markets, broadly defined, will likely play a growing role. As always, there will be winners and there will be losers. But AI as a theme for credit investors is here to stay.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Fiscal Sustainability and the French and US Elections Jun 26, 2024

Our Global Chief Economist explains why markets are concerned about uncertainty around the French and US elections, and how their outcomes may affect each economy’s debt load.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about elections, and what they might mean for fiscal sustainability.

It's Wednesday, June 26th at 10am in New York.

Elections have unexpectedly become a key risk in an otherwise positive growth narrative for France this year. And there are a wide range of possible outcomes for the next government.

Fiscal sustainability is one key market narrative we have been flagging. And in France, the fiscal position is expected to deteriorate. Our strategists note that the 10-year OAT boon spreads have widened more than 20 basis points. And in their view, further discounts on OATs are likely due to the deficit trajectories in the different political scenarios and heightened political and economic uncertainty.

In recent work we've done on developed market government sustainability, we flagged that across DMs, even if fiscal deficits remain steady, interest expense on the debt will continue to rise, pushing up the debt to GDP ratios. Larger deficits would necessarily exacerbate the situation. Austerity is necessary to stabilize or lower the debt to GDP ratios.

For France in particular, the maturity profile and forward rates had meant there could be relatively more time for the repricing to happen; but the market reaction to the election has meant higher yields, effectively pulling forward that repricing. Relative to our analysis in the first quarter of 2024, the debt surfacing costs are already higher.

The election results have now led to expectations of higher deficits, implying faster rising debt to GDP ratios as well. This combination of higher rates and higher deficits is self-reinforcing. The market will pay close attention to specific policy proposals -- and the coalitions that result from the election.

For the US elections, debt sustainability has so far been lower on the list of topics that clients bring up. The elections are expected to be close. In a recent joint note with our US public policy colleagues, we noted four basic scenarios: a Republican sweep; a Democratic sweep; or divided governments with either a Republican or a Democratic president.

Our public policy colleagues see very different outcomes across a 10-year time horizon for the deficit, ranging from an increase of [$]1.6 trillion under the Republican sweep scenario to an increase of about $600 billion in the Democratic sweep scenario, and the split government scenario is somewhere in between.

Of course, fiscal policy is not the only consideration for debt sustainability. Tariffs could generate some higher revenues, but the adverse hit to GDP means that the denominator of the debt to GDP ratio will fall and push the ratio higher.

Our policy colleagues have also flagged a big range of possible immigration policy outcomes. The current positive supply shock to the labor force has allowed for faster GDP growth and consequently, higher revenues. Under the strictest immigration policies, the so-called break-even monthly payrolls flow could fall from a baseline now of just over 200,000 per month to as low as 45,000 per month.

Such an outcome would imply lower revenues and lower GDP, meaning both the numerator and the denominator of the debt to GDP ratio would be pushing upward.

Thanks for listening. And if you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Navigating the Narrow Stock Market Jun 25, 2024

Our CIO and Chief US Equity Strategist explains how to make sense of the equity market’s narrow performance, and why stock picking takes on greater importance for investors.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the narrowness in breadth and why that supports our preference for high quality and defensive stocks.

It's Tuesday, June 25th at 11:30am in New York.

So let’s get after it.

I am fond of the saying that the economy is not the stock market, and the stock market is not the economy. Often, a strong economy is not good for stocks, while a soft one can lead to higher equity prices. This latter case is the classic late cycle period in which we find ourselves. More specifically, when the economy is slowing from previous tightening by the Federal Reserve, the equity market starts to get excited about the Fed reversing course, and it looks forward to loosening policy and valuations rise in anticipation. With price/earnings multiples and other valuation metrics now in the top decile, the question is when will valuations matter and begin to fall faster than earnings growth and lead to a meaningful correction?

At the stock level, this is already happening as illustrated by the weakest breadth since 1965. In other words, most stocks are seeing valuations fall more than earnings are rising. This is exactly why stock picking has become so important for equity investors to outperform the S&P 500. While this creates a great long and short opportunity, the list of longs has become harder to find and why the momentum in a few stocks continues unabated. This also syncs with our view for the past year that large cap quality is likely to continue to outperform until something material changes in the macro environment. I see three potential candidates to change this seemingly very stable and benign outcome for equity markets.

First, inflation and growth reaccelerate in a way that forces the Fed to reconsider rate hikes. Right now, that does not appear likely and why there is virtually no risk of such an outcome priced into either bond or stock markets. Such an outcome would likely lead to a broadening out of the equity rally to areas that have lagged persistently over the past 2 years—areas like small caps, lower quality consumer cyclicals, regional banks and transports. The S&P 500 would likely trade poorly under this scenario as higher rates would potentially weigh on valuations for the big winners.

Second, the liquidity picture deteriorates and money flows out of equities. A key risk in this regard relates to the funding of the extraordinary government deficit. A good way to monitor this risk is the term premium in the bond market which remains near zero. Should this change and the term premium rise like last fall, the decline in equities would likely be broad with few stocks doing well. This does not appear to be a concern at the moment given the liquidity provisions still in place.

The third possible risk is a growth scare that is substantial enough to turn bad economic data into bad news for equity multiples across the board. This is the most likely risk to upset the apple cart in our view. Under this outcome, large cap quality should continue to do ok on a relative basis, but defensives are likely to do better.

The economic growth surprises have been trending lower all year. So far, the S&P 500 has taken these weaker data in stride assuming bad economic data is still good for large cap quality stocks as the market looks forward to rate cuts from the Fed. Meanwhile, weaker indices and stocks have broken down with many now down on the year.

The bottom line is that the ongoing policy mix of heavy fiscal spending and tight interest rate policy is crowding out many companies and consumers in a waythat is unsustainable in our view. Investors have correctly recognized this outcome by bidding up the few stocks of the companies that are doing well in this environment. Until the bond market pushes back via higher term premium or growth slows down in a more meaningful way, we expect this narrow market performance to persist. As such, we continue to recommend a barbell of large cap quality growth with defensives while fading cyclicals and avoiding the temptation to play for a true broadening out until the macro regime makes a meaningful shift.

Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Economics Roundtable: Global Elections in Focus Jun 24, 2024

Halfway through a historic year for elections around the world, Morgan Stanley’s chief economists assess the impact of recent results on the global economy, and weigh potential effects from key elections to come.

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Seth Carpenter: Welcome to Thoughts on the Market, and welcome back to the second part of a special two-part episode of the podcast. We've been covering Morgan Stanley's global economic outlook as we look into the third quarter of 2024. In the first part, we covered the twin themes of inflation in central banks. In this part, we're going to look at elections, with my colleagues Ellen Zentner, our Chief US Economist, Jens Eisenschmidt, our Chief Europe Economist, and Chetan Ahya, who is our Chief Asia Economist.

It's Monday, June 24th at 10 am in New York.

It is astounding if we look around the world just how many elections there have already been this year and how many more there are going to be. We will get to the US, but before we do, Chetan, in Asia, India is one of the most important economies; and in India they recently had elections. Can you just let our listeners know basically what happened and what do you think are the implications for that election for the Indian economy?

Chetan Ahya: Yeah Seth. So Definitely there was a big change in India in terms of the political outcome. So the ruling party did not get the full majority and they have had to form a government under a coalition structure. There is a question though, as a result of that, whether the policy shift will happen in India and the government will go back to redistribution instead of focusing on boosting investment and jobs.

Well, we think that, you know, there is no change. There is policy continuity. We think that this government is very much aligned in thinking that they want to keep inflation in check and current account deficit in check, i.e. macro stability should be in control. And they still believe that job creation is the way to ensure that the general masses and the bottom 20 per cent see the benefit and then vote for them back again.

So, for us, we are not changing our view that this is India's decade. We are still maintaining our growth forecast that India will be achieving 6.5 per cent until 2030, and at the same time as India continues to build this growth rates on a high base, India will be at $8 trillion by 2032. Back to you, Seth.

Seth Carpenter: Thanks, Chetan. super interesting. And EM elections have had a lot of surprises. We had South Africa. We had a surprise -- in terms of the margin in the opposite direction of what you said for India -- when it comes to the case of Mexico, where Scheinbaum won, but the majority was even bigger than I think most people were expected.

But there are other elections that had some big surprises. Jens, let me come to you. In Europe, we had the European elections, and there were some big surprises there, to say the very least. First, can you just walk us through, what do the European level elections mean, in terms of our outlook? And then, part of the fallout from those surprises was that President Macron in France called for snap elections. What do you think we need to take away from that fact?

Jens Eisenschmidt: We have had a look at the manifestos, what is known so far from those that are competing for government in France, say, and I think one of our key takeaways is that might be more fiscal spending. And of course, short run this might get you more growth. But of course, the question is always, what's the price for us to pay? There might be higher interest rates and that in the longer term may be detrimental. So, I think overall we have to wait until we see really and observe the full election outcome.

Now, more generally, we had the European elections and we get a lot of questions by clients -- what the implications are here. Now, if you, sort of just look again from very high up, far away, then we see that the coalition that has last time, voted and elected, Ursula von der Leyen, the currently sitting, President of the European Commission. That coalition still stands or commands a majority in the European Parliament post the elections. Just that that majority, of course, is a little bit smaller than before.

It's very likely that von der Leyen will have to reach out to either the Greens that were not in the past part of her coalition, voting for her; or the bloc around the Italian Prime Minister Meloni. The implication of it is that we have to see which side the reach out is for – for the consequences for the commission priorities. But I would say from today's perspective, and again giving that there is some logic of averaging here, it's very unlikely to be dramatic changes that we are going to see at the European level.

Seth Carpenter: Staying on, on your side of the Atlantic, of course the UK is going to have elections as well. And notably on July 4th, the anniversary of the US independence from Great Britain. I love that timing. What's the story with the UK elections and are they going to change at all, your team's outlook for what goes on in the UK?

Jens Eisenschmidt: So on current polls, they were remarkably stable. There seems to be a change in government in the making, say. The Tories, the Conservative Party in the UK, it's very likely to have to give away power to a new labor government. That's essentially what polls currently suggest.

Now, we've had a look at both manifestos, and there are differences here and there. Typically, you would think, there's a bit more fiscal spending coming out of one government and the other. But, you know, if you really sort of compare notes and if you also see the constraints that both contenders -- conservative or labor -- would have to work with, it's hard to see a material difference, at least for the growth outlook, from their policies.

Again, it's early days. We will have to see what exactly then will be implemented after July 4th. But from today's perspective, it's hardly a game changer.

Seth Carpenter: Okay, great, thanks. I want to bring it back to this side of the Atlantic, back to the United States. Ellen, Morgan Stanley Research put out a big piece last week about the US election scenarios. Can you just run us through the key points there, because I will say, everyone around the world looks at the US election and has to take some notice.

Ellen Zentner: Ah yes. I love elections. I thought you'd never ask. So, in the US it's not just about Biden versus Trump. The outcome for the Congress matters critically for fiscal outcomes as well. So, broadly for deficits, we see a rank ordering of a Republican sweep leading to the biggest deficit expansion. Then a smaller deficit with a split government because there will not be unity to get things done. And then the smallest deficit comes with a Dem sweep because we do think that tax increases could be meaningful.

Seth Carpenter: Okay, whoa. Let me stop you there because it sounds like if we've got this rank ordering of how much the deficit expands, can we just take that and then translate it into a forecast for economic growth? So bigger deficit, more fiscal boost; smaller deficit, less fiscal boost; smallest deficit, sort of weakest growth. Is that the way we should think about this fiscal plan translates into projections of growth?

Ellen Zentner: Okay, I wish it were that easy and I know you're asking that because it would definitely poke me a bit. So, there are other policies that are going to matter. So tariffs, for example, and they're likely to differ substantially. So, you know, former President Trump has talked about 60 per cent tariffs on Chinese imports and 10 per cent tariffs broadly on global imports. And there are specifics that are hard to forecast now. Some of the broader plans might require congressional action; but what we learned from 2018 is that there is some inflationary impulse. But you can have a meaningful adverse hit to the economy from tariffs, and then that tends to have a pull on inflation thereafter. So, you can't just take the fiscal deficit, as a direction for growth.

And as I noted earlier, immigration has been a key part of the macro story in the US for the past year. I promised I would come back to that. You know, you've got, wildly different scenarios for immigration, depending on the congressional makeup and depending on who's president, as well. So, if I just take you to the most extreme example. So if you could see, immigration scenario under former president Trump, where he's talked about shutting down the border, and also deporting unauthorized immigrants that are already here. You know, you could damage the potential growth rate of the economy that would be slower.

To put it into numbers, the extreme version we published would result in a break even for non-farm payrolls going to 45, 000 from our current estimate of around 250, 000. So that would be a big shift. And I think immigration, rather than just the size of the deficit, is probably going to be one of the bigger things to watch out of the election.

Seth Carpenter: So as the saying goes, elections have consequences, not just in the United States, but around the world.

All right. Ellen, Chetan, Jens, thank you so much for joining today. And to our listeners, thank you for listening.

If you enjoy the show, please leave a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Economics Roundtable: Investors Eye Central Banks Jun 21, 2024

Morgan Stanley’s chief economists examine the varied responses of global central banks to noisy inflation data in their quarterly roundtable discussion.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's global chief economist. We have a special two-part episode of the podcast where we'll cover Morgan Stanley's global economic outlook as we look into the third quarter of 2024.

It's Friday, June 21st at 10am in New York.

Jens Eisenschmidt: And 4pm in Frankfurt.

Chetan Ahya: And 10pm in Hong Kong.

Seth Carpenter: Alright, so a lot's happened since our last economics roundtable on this podcast back in March and since we published our mid-year outlook in May. My travels have taken me to many corners of the globe, including Tokyo, Sao Paulo, Sydney, Washington D. C., Chicago.

Two themes have dominated every one of my meetings. Inflation in central banks on the one hand, and then on the other hand, elections.

In the first part of this special episode, I wanted to discuss these key topics with the leaders of Morgan Stanley Economics in key regions. Ellen Zentner is our Chief US Economist, Jens Eisenschmidt is our Chief Europe Economist, and Chetan Ahya is our Chief Asia Economist.

Ellen, I'm going to start with you. You've also been traveling. You were in London recently, for example. In your conversations with folks, what are you explaining to people? Where do things stand now for the Fed and inflation in the US?

Ellen Zentner: Thanks, Seth. So, we told people that the inflation boost that we saw in the first quarter was really noise, not signal, and it would be temporary; and certainly, the past three months of data have supported that view. But the Fed got spooked by that re-acceleration in inflation, and it was quite volatile. And so, they did shift their dot plot from a median of three cuts to a median of just one cut this year. Now, we're not moved by the dot plot. And Chair Powell told everyone to take the projections with a grain of salt. And we still see three cuts starting in September.

Jens Eisenschmidt: If you don't mind me jumping in here, on this side of the Atlantic, inflation has also been noisy and the key driver behind repricing in rate expectations. The ECB delivered its cut in June as expected, but it didn't commit to much more than that. And we had, in fact, anticipated that cautious outcome simply because we have seen surprises to the upside in the April, and in particular in the May numbers. And here, again, the upside surprise was all in services inflation.

If you look at inflation and compare between the US experience and euro area experience, what stands out at that on both sides of the Atlantic, services inflation appears to be the sticky part. So, the upside surprises in May in particular probably have left the feeling in the governing council that the process -- by which they got more and more confidence in their ability to forecast inflation developments and hence put more weight on their forecast and on their medium-term projections – that confidence and that ability has suffered a slight setback. Which means there is more focus now for the next month on current inflation and how it basically compares to their forecast.

So, by implication, we think upside surprises or continued upside surprises relative to the ECB's path, which coincides in the short term with our path, will be a problem; will mean that the September rate cut is put into question.

For now, our baseline is a cut in September and another one in December. So, two more this year. And another four next year.

Seth Carpenter: Okay, I get it. So, from my perspective, then, listening to you, Jens, listening to Ellen, we're in similar areas; the timing of it a little bit different with the upside surprise to inflation, but downward trend in inflation in both places. ECB already cutting once. Fed set to start cutting in September, so it feels similar.

Chetan, the Bank of Japan is going in exactly the opposite direction. So, our view on the reflation in Japan, from my conversations with clients, is now becoming more or less consensus. Can you just walk us through where things stand? What do you expect coming out of Japan for the rest of this year?

Chetan Ahya: Thanks, Seth. So, Japan's reflation story is very much on track. We think a generational shift from low-flation to new equilibrium of sustainable moderate inflation is taking hold. And we see two key factors sustaining this story going forward. First is, we expect Japan's policymakers to continue to keep macro policies accommodative. And second, we think a virtuous cycle of higher prices and wages is underway.

The strong spring wage negotiation results this year will mean wage growth will rise to 3 percent by third quarter and crucially the pass through of wages to prices is now much stronger than in the past -- and will keep inflation sustainably higher at 1.5 to 2 per cent. This is why we expect BOJ to hike by 15 basis points in July and then again in January of next year by 25 basis points, bringing policy rates to 0.5 per cent.

We don't expect further rate hikes beyond that, as we don't see inflation overshooting the 2 percent target sustainably. We think Governor Ueda would want to keep monetary policy accommodative in order for reflation to become embedded. The main risk to our outlook is if inflation surprises to the downside. This could materialize if the wage to price pass through turns out to be weaker than our estimates.

Seth Carpenter: All of that was a great place to start. Inflation, central banking, like I said before, literally every single meeting I've had with clients has had a start there. Equity clients want to know if interest rates are coming down. Rates clients want to know where interest rates are going and what's going on with inflation.

But we can't forget about the overall economy: economic activity, economic growth. I will say, as a house, collectively for the whole globe, we've got a pretty benign outlook on growth, with global growth running about the same pace this year as last year. But that top level view masks some heterogeneity across the globe.

And Chetan I'm going to come right back to you, staying with topics in Asia. Because as far as I can remember, every conversation about global economic activity has to have China as part of it. China's been a key part of the global story. What's our current thinking there in China? What's going on this year and into next year?

Chetan Ahya: So, Seth, in China, cyclically improving exports trend has helped to stabilize growth, but the structural challenges are still persisting. The biggest structural challenge that China faces is deflation. The key source of deflationary pressure is the housing sector. While there is policy action being taken to address this issue, we are of the view that housing will still be a drag on aggregate demand. To contextualize, the inventory of new homes is around 20 million units, as compared to the sales of about 7 to 8 million units annually. Moreover, there is another 23 million units of existing home inventory.

So, we think it would take multiple years for this huge inventory overhang to

be digested to a more reasonable level. And as downturn in the property sector is resulting in downward pressures on aggregate demand, policy makers are supporting growth by boosting supply.

Consider the shifts in flow of credit. Over the past few years, new loans to property sector have declined by about $700 billion, but this has been more than offset by a rise of about $500 billion in new loans for industrial sector, i.e. manufacturing investment, and $200 billion loans for infrastructure. This supply -centric policy response has led to a buildup of excess capacities in a number of key manufacturing sectors, and that is keeping deflationary pressures alive for longer. Indeed, we continue to see the diversions of real GDP growth and normal GDP growth outcomes. While real GDP growth will stabilize at 4.8 per cent this year, normal GDP growth will still be somewhat subdued at 4.5 per cent.

Seth Carpenter: Thanks, Chetan. That's super helpful.

Jens, let's think about the euro area, where there had, been a lot of slower growth relative to the US. I will say, when I'm in Europe, I get that question, why is the US outperforming Europe? You know, I think, my read on it, and you should tell me if I'm right or not -- recent data suggests that things, in terms of growth at least have bottomed out in Europe and might be starting to look up. So, what are you thinking about the outlook for European growth for the rest of the year? Should we expect just a real bounce back in Europe or what's it going to look like?

Jens Eisenschmidt: Indeed, growth has bottomed. In fact, we are emerging from a period of stagnation last year; and as expected in our NTIA Outlook in November we had outlined the script -- that based on a recovery in consumption, which in turn is based on real wage gains. And fading restrictiveness of monetary policy, we would get a growth rebound this year. And the signs are there that we are exactly getting this, as expected.

So, we had a very strong first quarter, which actually led us to upgrade still our growth that we had before at 0.5 to 0.7. And we have the PMIs, the survey indicators indicating indeed that the growth rebound is set to continue. And we have also upgraded the growth outlook for 2025 from 1 to 1.2 per cent here on the back of stronger external demand assumptions. So, all in all, the picture looks pretty consistent with that rebound.

At the same time, one word of caution is that it won't get very fast. We will see growth very likely peaking below the levels that were previous peaks simply because potential growth is lower; we think is lower than it has been before the pandemic. So just as a measure, we think, for instance, that potential growth in Europe could be here lie between one, maybe one, 1 per cent, whereas before it would be rather 1.5 per cent.

Seth Carpenter: Okay, that makes a lot of sense. So, some acceleration, maybe not booming, maybe not catching the US, but getting a little bit of convergence. So, Ellen, bring it back to the US for us. What are you thinking about growth for the US? Are we going to slump and slow down and start to look like Europe? Are things going to take off from here?

Things have been pretty good. What do you think is going to happen for the rest of this year and into next year?

Ellen Zentner: Yes, I think for the year overall, you know, growth is still going to be solid in the US, but it has been slowing compared with last year. And if I put a ‘the big picture view’ around it, you've got a fiscal impulse, where it's fading, right? So, we had big fiscal stimulus around COVID, which continues to fade. You had big infrastructure packages around the CHIPS Act and the IRA, where the bulk of that spending has been absorbed. And so that fiscal impulse is fading. But you've still got the monetary policy drag, which continues to build.

Now, within that, the immigration story is a very big offset. What does it mean, you know, for the mid-year outlook? We had upgraded growth for this year and next quite meaningfully. And we completely changed how we were thinking about sort of the normal run rate of job growth that would keep the unemployment rate steady.

So, whereas just six months ago, we thought it was around 100,000 to 120,000 a month, now we think that we can grow the labor market at about 250,000 a month, without being inflationary. And so that allows for that bigger but not tighter economy, which has been a big theme of ours since the mid-year outlook.

And so, I'm throwing in the importance of immigration in here because I know you want to talk about elections later on. So, I want to flag that as not just a positive for the economy, but a risk to the outlook as well.

Now, finally, key upcoming data is going to inform our view for this year. So, I'm looking for: Do households slow their spending because labor income growth is slowing? Does inflation continue to come down? And do job gains hold up?

Seth Carpenter: Alright, thanks Ellen. That helps a lot, and it puts things into perspective. And you're right, I do want to move on to elections, but that will be for the second part of this special episode. Catch that in your podcast feeds on Monday.

For now, thank you for listening. And if you enjoy the podcast, please leave a review wherever you listen and share Thoughts On the Market with a friend or colleague today.

Volatility Doesn’t Necessarily Rock the Boat Jun 20, 2024

Our head of corporate credit research dives into the question of correlation and market volatility, and explains why stock indices can remain stable despite a certain level of turmoil, as we have seen recently in Europe.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about correlations, and why they are currently so important to markets being calmer than they would otherwise be.

It’s Thursday, June 20th at 2pm in London.

Imagine you’re on a boat, maybe looking for sea life. People are milling around the deck, watching the vessel ripple through the waves. Suddenly someone spotsa whale, and everybody runs to port. The whale swims under the boat, and everybody now runs to starboard. The boat rocks significantly.

But imagine the same scenario where marine life is popping up on both sides of the vessel. You and your fellow passengers are all now running past each other in both directions. The movements balance out. The boat is pretty stable.

Believe it or not, this is how the volatility in the stock indices work. The individual passengers can be thought of as individual stocks, and how much they’re each moving around can be thought of as each stock’s volatility. The boat is the overall index – say, the S&P 500, the EuroStoxx 50, or an index of corporate bonds.

When everybody on the boat moves together, what we’d call a high correlation environment, you’d get a lot of rocking, or volatility, at the index level. But when people are moving in opposite directions, moving past each other; you can still have a lot of running, or individual vol – but the market, or the boat, will appear much more calm.

That is exactly what’s been happening, especially last week. Stocks within the S&P 500 are moving with unusual independence from each other, running to opposite sides of the boat, with the lowest such correlation in almost 20 years. That is a big reason why, despite all the volatile headlines out of Europe, and more stocks falling than rising in the US, the overall market has been surprisingly calm – and going up.

Even in Europe, this phenomenon of low correlation has really helped. That volatility I mentioned relates to upcoming elections in France, which led the difference between French and German bond yields to jump to their highest level in more than a decade.

But because this spread of France to Germany moved in the opposite direction as overall French yields, the overall result for French government bonds was not much. Last week, despite all the apparent ruckus, the yield on French government bonds was basically unchanged. Markets have been calmer than you would usually expect them to be.

These correlations are a big reason why.

We think they suggest a still healthy dynamic where markets are differentiating between different types of risks. To go back to our original analogy, there is still plenty of sea life out there for the market to look at. But these correlations are also worth watching, were they to rise significantly. If one thing were to dominate the focus and lead everybody to run to the same side of the boat, overall market volatility could rise surprisingly fast.

It's something, you could say, that we're on the lookout for.

Thanks for listening. If you enjoy the podcast, please leave us a review, wherever you listen, and share Thoughts on the Market with a friend or colleague today.

Investment Discipline In An Election Year Jun 18, 2024

Investors watching for market reactions would do well to stick to their existing plans in an environment where the economic impacts of any particular US election outcome remains unclear. Our Global Head of Fixed Income and Thematic Research explains.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the US elections and its impacts on markets.

It's Tuesday, June 18th at 10:30am in New York.

We first started covering the 2024 US election in December of last year. With about five months to go until the event, it’s a good time to take stock of what we’ve learned that might be useful for investors. In short, there’s a lot of noise around this election, and recognizing that noise is a first step toward not making mistakes around the event.

First, don’t make the mistake of confidently predicting an outcome. All indicators suggest it’s very unlikely that we’ll have a good sense about which candidate will win the election in the run up to the Election Day, and perhaps even in the days that follow. Neither candidate has a lead beyond a polling margin of error in sufficient states to suggest that if the election were held today that they would win the electoral college.

Prediction markets and polling models also point to a race that’s a toss-up. It all suggests a tight race going into Election Day. And with the sustained popularity of voting by mail, vote counts could move slowly, as they did in 2020; meaning we may have to dig in for another election week.

Second, don’t make the mistake of making big strategic changes in your portfolio just because it’s an election year. We recently studied this and there’s little pattern for how markets behave in the run up to an election, even when filtering for factors like similar outcomes and closeness of the race. Markets in the aggregate don’t seem to consistently price in US election outcomes ahead of time. There’s more evidence that they price in expected policy impacts once the outcome is known, which brings me to my third point.

Don’t make the mistake of overconfidence when it comes to how post-election policies will impact the economy. Sure, if we knew one outcome was bad for growth and the other good, it might be advisable to buy risk assets on the news of the latter outcome occurring. But especially in this election it’s not that simple.

For example, in scenarios where Republicans win the White House, you can expect greater tariffs, immigration curbs, and – if they also control congress – bigger deficits driven by tax cuts relative to alternative outcomes. According to our economists, these policies have different effects on growth, inflation and monetary policy depending on how they are constructed and timed; and so it defies simple conclusions of growth positive or growth negative, at least at this point.

So bottom line, don’t mistake noise for signal when it comes to the election. Stick to the plan, such as the cross-asset framework recently put forward in our mid-year outlook. And maybe focus on some equity sectors, such as industrials and defense, which are well placed currently but have upside in certain election scenarios.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Tracking the Rebound in Tech IPOs Jun 17, 2024

The AI revolution has helped fuel the tech IPO sector’s resurgence following a two-year lull. Our Co-Heads of Technology Equity Capital Markets join our Global Head of Fixed Income and Thematic Research to discuss the sustainability of this trend.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley.

Diana Doyle: I am Diana Doyle, Managing Director and Co-Head of Technology Equity Capital Markets in the Americas.

Lauren Garcia Belmonte: And I'm Lauren Garcia Belmonte, Managing Director, Co-Head of Technology Equity Capital Markets Americas.

Michael Zezas: And on this episode of the podcast, we'll dive into what's ahead for the tech IPO market this year.

It's Monday, June 17th, at 11 am in New York.

Diana Doyle: And 8 am in San Francisco.

Michael Zezas: Since 2023 only nine technology companies completed an initial public offering, which is one of the longest periods of reduced IPO activity in history. For context, compare that with the all-time record of124 technologyIPOs in 2021. But with the first quarter of 2024 behind us, we're starting to see that picture improve. With tech and AI in focus right now, on today's episode, I want to speak with Diana and Lauren from our global capital markets team to get their take on where the tech IPO environment might be headed and what investors may want to watch for.

Lauren, maybe to start -- what's contributing to this resurgence in IPO activity this year?

Lauren Garcia Belmonte: Well, the market backdrop has been constructive. We've had the SMP and NASDAQ trading up 10 -- 11 per cent this year and multiples have been stable for technology businesses. And against this backdrop, we've seen some IPO issuers recognize that this is a good environment in which to move forward with their IPO event. There are several benefits to becoming a public company, not just the opportunity to raise capital -- but to give liquidity to employees and to early investors in the business, and to set the company up to be a real industry leader as a public company.

So, issuers are seeing the opportunity; and meanwhile, the demand side from investors has been encouraging as well. Investors in the public equities recognize that there's limited opportunity, in some instances, to underwrite growth. Right now, 55 per cent of publicly traded technology businesses are growing top line 10 per cent or less. So, the IPO opportunity, where companies generally have an attractive growth profile, is a way for these investors to get access to an opportunity to underwrite exciting growth profiles -- even when that opportunity isn't so prevalent in the public markets right now.

Michael Zezas: And Diana, do you see the rebound in IPO activity as a durable trend? Maybe take us into 2025.

Diana Doyle: Well, 2024 is definitely going to be better than 2022 and 2023. Now, it'll be a long time before we get back to that 124 tech IPOs in 2021 that you mentioned, Michael. But in an average year, we have about 35 to 40 IPOs, and we expect 2025 to approach more of an average. So, as Lauren said, we're encouraged by the breadth of investor demand for IPOs that we've done this year, and investors’ appetite to take risk. And all that lays the foundation for a healthy IPO market in 12 to 18 months.

But it will be a slow build because IPOs are not a quick turnaround financing. It takes about six months on average to get through an IPO process. So, if you're not already underway, you're likely looking at 2025. In the meantime, we're seeing many late-stage private companies. They have plenty of cash. They're doing secondary raises to provide liquidity to employees and early investors, and they're waiting for growth rates to be more predictable -- for profitability to improve and to get more scale.

So, we're excited for 2025, and the IPO market is wide open for companies that have growth and scale, profitability and that offer investors something different than what's available in the public market today.

Michael Zezas: Got it. And what about macro conditions, Lauren? So perhaps the Fed's pivoting to cutting rates, the overall economic backdrop, geopolitical considerations. How do those things impact the tech IPO market?

Lauren Garcia Belmonte: Yeah, absolutely. The tech IPO market is influenced by these macro considerations -- and it's in a few different ways.

First, of course, and importantly, the valuation impact is real for technology businesses that have a lot of their growth on the come and a higher rate environment. Of course, that future growth needs to be discounted more significantly. The second key impact is around just how these management teams are able to manage, predict, and model out their business.

In a more uncertain environment, it can be more challenging to articulate and defend the forward model that is a part of all IPO processes where you're explaining to the research analysts and investors how your business will perform, as a public company. And, of course, management teams want to set their companies up for success as public companies -- and set up for a beat and raise cadence -- which can be difficult to do when you're dealing with an uncertain macro backdrop.

I think one encouraging signal -- as much as we haven't seen the Fed cut as much as people had anticipated as would have happened at the start of this year -- is that the rate of change has slowed.

So, the rate increase environment was one of the quickest that we've seen; and although we haven't seen the cuts as people had anticipated, I think it's encouraging that that rate of change has adjusted and that will allow for, hopefully, more predictability in businesses going forward

Michael Zezas: Got it. That connection between predictability and rates makes a lot of sense. And it seems that the market's particularly hungry for AI names. Diana, what AI related trends are you seeing?

Diana Doyle: Well, AI is this black hole right now that's drawing all the energy and attention in the private markets. There's this huge enthusiasm because the technology is improving so quickly, and there's an uncertainty how long that rapid pace of advancement will continue. This cycle, in fact, is an exaggerated version of what we've seen in prior cycles, where the monetization typically accrues first to the semiconductors and hardware, then eventually to software. So right now, a lot of the investment is going into the semiconductors and hardware, the picks and shovels, and the fundamental model of research.

But in software, there's still a lot to play out in private companies to create the type of profitable, proven business models that public market investors are looking for. There are big unknowns in how enterprises are going to reallocate spend in a world of AI, what happens with all the efficiency these new tools create, how a lower barrier to entry for software creation impacts margins.

Michael Zezas: And aside from AI, Lauren, what other areas within tech are seeing more activity?

Lauren Garcia Belmonte: I would say that these businesses aren't in a particular spot within the tech landscape, but rather have certain characteristics in that they share -- namely that they are in attractive markets.

Additionally, being a market leader is of critical importance today. No longer do people want to back the third, fourth, fifth player in a market. I think people are really focused on market leadership. So that one or two spot is going to be really important. And investors are looking for businesses that are already scaled. That market leadership typically comes along with a certain scale qualifier. But that is absolutely going to be an important feature of the businesses that are successful transitioning from the private to public markets.

These companies are in the software space and the internet side. So, there's a diversity of companies that have this in common, and that could be great IPO candidates on that timeline that Diana was mentioning.

Michael Zezas: And finally, I'm curious how the political election cycle might have an impact on IPO activity during the rest of this year. Diana, what's your read?

Diana Doyle: Well, we do expect to see some volatility in the pre-election window in the fall, like we do in every presidential election cycle. But what's different this time is that we have a pretty good sense, not only of who the candidates will be -- but also what their presidency is likely to look like and what policies they're likely to prioritize.

So that de-risks the election as a market event materially versus prior cycles. And for the IPO market, any company that's been looking at an IPO in the second half of 2024 has already evaluated pulling it forward to hit the September-October time frame and get ahead of that likely market event.

But there's a narrow window for anyone who hasn't yet pulled the trigger to accelerate. Before the holidays, post-election -- where some IPOs will be able to squeeze in. In practice, most of the companies that aren't already in the pipeline now -- have their eye on 2025.

Michael Zezas: Okay, so, putting it all together, seems you're both pretty confident that there's going to be a durable pickup in IPO activity.

Lauren Garcia Belmonte: That's right.

Diana Doyle: Yes.

Michael Zezas: Okay, great. So, our audience should stay tuned. Well, Diana, Lauren, thanks for taking the time to talk.

Diana Doyle: Great speaking with you, Michael.

Lauren Garcia Belmonte: Yes. Thank you for having us.

Michael Zezas: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen, and share the podcast with a friend or colleague today.

This Is Still India’s Decade Jun 14, 2024

Our Head of India Research and Chief India Equity Strategist lays out his bullish post-election view on India, explaining why the market is likely to drive a fifth of global growth in the coming decade.

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Welcome to Thoughts on the Market. I’m Ridham Desai, Morgan Stanley’s Head of India Research and Chief India Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss our take on India’s election results and why we still believe this is India’s decade.

It’s Friday, June 14th, at 2pm in Mumbai.

India’s general election results are in, and the world is paying close attention. The most important aspect of the BJP led NDA retaining its majority is policy predictability – something equities tend to thrive on. We believe the market can look forward to further structural reforms. This gives us more confidence in our forecast of a 20 per cent annual earnings growth over the next five years. Macro stability with rising GDP growth relative to real rates should extend India's outperformance over Emerging Market equities.

We’ve been bullish on India since April 2020, and we still believe that India is likely to drive a fifth of global growth in the coming decade. This will be underpinned by increased offshoring of both services and manufacturing, as well as the energy transition and the country's advanced digital infrastructure. India's stock market has been making new highs. The big investor debate now is what could take the India market even higher from here.

We believe share prices have yet to bake in a number of positives, such as India's newfound macro stability, a likely fall in its primary deficit moving into a primary balance, and a fast-evolving deep tech sector, to name just a few.

We expect critical reforms to be made in Modi’s third term. Here are three more important ones.

Number one, further consolidation of India’s fiscal deficit. From a market perspective this lends itself to sustained credit growth, which we think is going to be good for India’s private banks.

Number two, a continuing buildout of both physical and social infrastructure. The physical infrastructure will likely focus on railways. Social infrastructure may include more low-income housing as well as water and electricity security. These reforms make us bullish on industrial stocks.

Number three, further growth in India’s manufacturing prowess. The government will likely focus on improving competitiveness via fiscal incentives and by building infrastructure within such industries as defense, electronics, aerospace, food processing and renewables. We expect India’s energy consumption to rise by around 50 per cent over the next five years with increasing contribution from renewables.

From an equities perspective, we think consumer stocks are well-positioned as nearly 100 million families could move into the middle-income bracket in the next decade.At the top end of the income pyramid, India’s affluent households could quintuple to 25 million over the coming decade, which should support a surge in luxury consumption.

Of course, there are plenty of risks, even with the elections behind us – from various capacity constraints to geopolitics, the impact of AI and climate change. But even with all these in mind, we still believe this is set to be India's longest and strongest bull market ever. Stay invested.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Cautious Corporate Boards Extend the Credit Cycle Jun 13, 2024

A strong economy and global stock market surge may suggest market euphoria. However, our Head of Corporate Credit Research explains why the corporate sector caution is, in fact, a good sign.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the surprising lack of confidence in corporate boardrooms, and why it could extend the cycle.

It's Thursday, June 13th at 2pm in London.

“Buy low, sell high.” That age-old advice is rooted in the idea that investors should try to buy when others are fearful and sell when others are euphoric. The high in prices, after all, should occur when people are as positive, and things are as good as they can possibly be.

At the moment, there is plenty of focus on this idea that the market pendulum may have swung too far towards excessive positivity. The economy is strong, with US growth tracking above 2 per cent, inflation moderating and the unemployment rate still near a 60 year low. US and global stock markets are near all-time highs. And many quantitative measures of investor optimism are elevated, whether it's the low levels of expected volatility, polls of investor outlooks or ownership of equity futures.

But we think there is one missing piece of this story, with relevance for credit and beyond. While investors are optimistic, corporate boardrooms remain much more restrained. And that caution could help extend the cycle.

One way to measure corporate optimism is whether or not companies are adding debt; a company is more likely to borrow when it feels better about the future. Well, as of the first quarter of 2024, the growth in US non-financial corporate borrowing was at a 10-year low. And among lower rated borrowers, the issuance of high yield bonds and loans remains dominated by borrowing to repay or refinance existing debt – the most conservative type of issuance that you can get.

Another way to measure corporate optimism is Mergers & Acquisitions, or M&A, as it really takes confidence in the future to acquire another company. Well, global M&A volumes in 2023 were the lowest, adjusted for the size of the economy in over 30 years. While this has picked up a bit, and we do think M&A recovers significantly over the next two years, it’s currently still very low.

On the surface, there are plenty of signs that investors are entering the summer optimistic. But the corporate sector remains surprisingly restrained, especially given that solid economic data, record profits and record highs in the stock market. We’d further note that the Tech sector, where there is more optimism and much more investment spending, generally isn’t borrowing to fund this, and also enjoys unusually strong balance sheets.

All of this matters because it’s been high levels of corporate optimism that have often been very bad for credit, as it’s excessive optimism that often leads to excessive risk taking, hubris, and an eventual payback that is bad for lenders. The lack of optimism, at the moment, is a good sign, and one of several reasons why we think spreads can remain tight, and the credit cycle has further to run.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Convenience Is Compelling Jun 12, 2024

Our US Thematic Strategist explains the premium that consumers will pay for convenience, and what that means for sectors including online retail, dining and package delivery.

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Welcome to Thoughts on the Market. I’m Michelle Weaver, Morgan Stanley’s US Thematic Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about convenience and why it’s such an important factor for a number of industries.

It’s Wednesday, June 12, at 11am in New York.

The consumer has been weakening around the edges, and this is flowing through to companies' bottom line. Our Consumer Economist thinks that consumption is likely to continue to slow this year and even into 2025 as the labor market cools and that weighs on real disposable income, elevated rates continue to pressure debt service costs, and tighter lending standards limit credit availability.

And given this setup, companies have been focusing on their value offerings, and we saw a lot of commentary around this during first quarter earnings calls. Mentions of just the word value itself were elevated. But value isn't the whole story, and consumers aren’t always just choosing the cheapest option.

You and I are consumers. We are all consumers. Think about the last time you bought something. Did you pick one retailer over another because buying the item was easier? Did the company have a better website or a better mobile app? Did they offer faster shipping options or free shipping? Would the product itself save you time? And how much more were you willing to pay to make the more convenient choice?

Convenience is a valuable product and a key factor in consumer choice. In fact, our survey shows that 77 percent of US consumers rate it as important and base purchasing decisions on it.

Our work suggests three key conclusions. On average, consumers would be willing to pay about a 5 percent price premium for convenience. And there are two groups that place a particular emphasis on it - those who are younger and those who are more affluent.

Second, consumers are willing to choose one company's product or service over another's because of convenience. Staples products and food away from home are the industries where consumers are especially likely to pick one option over another.

And third, shipping features like free shipping or fast shipping are the most important convenience-related criteria when shopping online.

Several industries stand to benefit from providing convenience. And convenience has been a long-term, persistent driver of eCommerce. Consumers love the combination of an ever-expanding assortment of goods and services and shrinking delivery times – and this is convenience really at its best. Convenience is easier to deliver for categories with standardized, durable products with lower purchase frequency that are easier to deliver like electronics or travel. But even within an already winning industry there is still a lot of opportunity, especially within the least penetrated categories, grocery and household and personal care.

In Restaurants, fast casual is likely to continue to take share given the combination of quality and convenience. Restaurants that have led digital access -- like mobile and online orders as well as online reservations – have posted impressive growth over time. Some fast-food chains have also invested in a digital approach and will likely to continue to build on this in the future.

Now unlike internet and restaurants, the parcels industry is facing a large threat from convenience, specifically fast and free shipping and easy returns. Their networks were not built to handle the quick delivery required of ecommerce volumes today, and the business-to-consumer shipping that is offered by the largest online vendors.

We think convenience is an important factor for companies and one they can use to differentiate themselves in customers minds.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Presidential Elections Aren’t the Only Important Ones Jun 11, 2024

Our Global Chief Economist takes stock of recent elections in India, Mexico and South Africa -- and what they suggest about the market implications of the upcoming UK and US elections.

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Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about recent elections and upcoming elections and what they mean for the economy.

It's Tuesday, June 11th at 10am in New York.

Markets usually prefer simple narratives, but this week it's shown us that simplicity can be elusive. In particular, for elections, legislative outcomes can be more complicated but are consequential. Here in the US, clients often ask about the economic implications of a Trump vs. Biden presidency -- but we immediately have to flag that the congressional outcome has to be a big part of the conversation.

Indeed, three important elections in the past weeks have emphasized the importance of a legislative focus. But the surprise was not in who won -- rather, in how big the legislative decisions were.

In India, Prime Minister Modi was re-elected, but his BJP party lost its outright majority. Exit polls on June 1st had predicted a resounding victory for the BJP, prompting a rally in the lead up to the final results.

The results surprised markets and caused a reversal. Markets have since recovered to roughly where they were before the exit polls,

We expect policy predictability with the continued focus on macro stability. This focus implies moderate inflation, smaller primary deficits, along with support for domestic manufacturing and infrastructure in upcoming years. Those have been the core of our view that the Indian economy is set for continued expansion.

The Mexican election was almost the reverse, where the winning candidate's party won far more votes than was expected. In response to the news, equity markets sold off and the Mexican peso depreciated. Scheinbaum was largely expected to win after the endorsement of Obrador; but by winning a supermajority, the market focus turned to Mexican fiscal discipline based on a view that there may be less restraint on government spending.

Fiscal policy has been in focus for us because for the first time in recent years the government there ran a fiscal deficit. While the party has sought to reassure markets, concern has mounted regarding the risks of fiscal slippage without a more balanced legislature.

Compared to India and Mexico, The South African market reaction to the election was modest, though not for a lack of surprise in the legislature. The ANC lost more of its majority than polls had predicted, which narrows the options for a coalition. The market now expects a more reform-oriented coalition to take power and support a continued improvement in the economy. For example, frequent power outages had impeded the economy for a long time, but the energy sector now appears to be more stable, and those sorts of reforms can help catalyze an improved economic outlook.

Examples of India, Mexico, and South Africa have reinforced why we've remained focused on the upcoming general elections in the UK, and also the congressional outcomes in the US. In the UK, a change in government is predicted by the polls, and fiscal considerations will be in focus.

So back here in the US, the fiscal outcome will largely be determined by the congressional results. To meaningfully change federal tax or spending requires legislation. And our colleagues in public policy research have flagged that under a Republican sweep, they expect lower taxes and higher spending; contrasted with a Democratic sweep that might bring somewhat higher spending, but also higher taxes leading to a narrower deficit.

A split government, where the party in the White House not the same as the party controlling each of the Houses of Congress, however, probably implies more muted outcomes. While we should focus on the legislative outcomes, there are important authorities, of course, that the President can exercise independently of the Congress.

So, when we highlight the importance of the legislative outcomes, we are not denying the criticality of the presidency.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague.

Investors Riding an Unpredictable Wave Jun 10, 2024

Our CIO and Chief U.S. Equity Strategist explains why economic fluctuations have made it more difficult to project a possible soft or no landing outcome, and how investors can navigate this continuing market volatility.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the continued uncertainty in economic data and its impact on markets.

It's Monday, June 10th at 11:30am in New York.

So let’s get after it.

Over the past few months, the economic growth data has surprised to the downside with more data releases coming in below expectations than usual. Meanwhile, inflation surprises have skewed more to the upside. This is a challenging combination because it means the Fed can't cut rates yet even though it may make sense to keep the economic expansion going.

As we have been discussing for months, aggressive fiscal spending is keeping the headline economy looking good on the surface. The bad news is that inflation remains too high for the Fed which has to keep interest rate policy too tight for many economic participants. Some may disagree with that statement, but we think it's hard to argue with the yield curve which remains significantly inverted and a valid indicator of interest rate policy. When combined with high price levels for many goods and services, the end result is a crowding out of many parts of the economy and consumers. From our perspective, this is most evident in the persistent underperformance of small cap stocks. In fact, this past week, small cap equities relative performance fell to new cycle lows.

Even more concerning is that while small caps are showing greater interest rate sensitivity than large caps, it’s also asymmetric. While higher rates are an obvious headwind for small caps, we're skeptical that lower rates offer a comparable benefit. Last week was a good example of this dynamic when small caps underperformed early in the week when rates rose and later in the week when rates fell.

All of this argues for what we have been recommending — in an uncertain macro world, we think investors should stay up the quality curve with a barbell of both growth and cyclicals to participate in both the soft and no landing outcomes. We also think it makes sense to have some defensive exposure as a hedge against the above average risk of a recession that still looms. Given the more negative skew in the economic surprise data as noted, we think the defensive part of the portfolio should outweigh cyclicals at this point. We favor staples and utilities specifically in this regard.

With markets sensitive to unpredictable inflation and labor data, it's very difficult to have an edge going into these releases, particularly on the labor front where the data itself has been subject to significant and ongoing revisions. While many market participants focus on the non-farm payroll data, these data have been subject to some of the larger revisions we’ve seen in recent history. Meanwhile, the household survey has been weaker than the non-farm payroll data and job openings have fallen persistently over the last 18 months. These diverging labor dynamics are classic late cycle phenomena based on our experience. For investors, it's just another reason to stay up the quality curve and to avoid positioning for a broadening out to lower quality areas. In our view, such a broadening is unlikely in any kind of sustainable way until the Fed cuts meaningfully — and by that we mean several hundred basis points rather than the one-to-two cuts that are now priced into the markets for this year.

Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

What Global Elections Mean for Markets Jun 07, 2024

Our Global Head of Emerging Markets Sovereign Credit reviews key insights and strategies for investors following the recent elections in Mexico, South Africa and India.

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Welcome to Thoughts on the Market. I’m Simon Waever, Morgan Stanley’s Global Head of EM Sovereign Credit and Latin America Fixed Income Strategy. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the far-reaching impact of emerging market elections on global markets.

It’s Friday, June 7, at 10am in New York.

Elections in 2024 will impact roughly 4 billion people around the globe – that’s the most in history. And within emerging markets, elections this year will impact nearly half the market cap of both hard and local currency debt indices and 60 percent of equities. With a dozen elections in the emerging markets sovereign credit universe already behind us, there are still almost another twenty more to go.

We find that elections in emerging markets matter for both credit spreads and fiscal balances. And a frequent investor question is how to trade positive and negative election outcomes. This can be defined in many ways, of course, but we focus on whether credit spreads widen – which is a negative – or tighten – which is a positive – in the week post-elections. And history suggests that buying into negative election surprises has been a profitable strategy. But on the other hand, positive elections, they’re priced in beforehand and should not be chased post-outcome.

So why is that, exactly? Well, for positive elections, markets tend to rally nearly continuously into the elections; but after the initial week of tightening, spreads then revert and end up trading only slightly tight to the levels prior to the elections.

And then for negative elections, there’s actually no real trend ahead of the elections, with spreads largely flat. But then, after the initial sell-off, credit spreads end up reversing the initial move wider, and three months out the spreads are tighter than immediately post-elections.

So, with this in mind, let’s consider the three most recent election outcomes in Mexico, India, and South Africa. And actually, all three had an element of surprise.

In Mexico, they elected their first female president, Claudia Sheinbaum. That was expected – but the surprise was that she got a much larger majority than polls suggested, which means that it becomes easier to push through constitutional changes. So, I think it’s fair to say that uncertainty has increased, and markets are now in a wait-and-see mode looking for what policy she will prioritize.

And from my side, I’m paying particularly close attention to the many reforms submitted by the executive to the Congress back in February, and then any signs of fiscal consolidation, which is needed.

South Africa saw the ANC fall below 50 per cent for the first time, and they now need to form a coalition or at least agree on a confidence and supply model. Well, I would say that at this point, markets are already pricing a lot of that uncertainty.

Finally, in India, the BJP led New Democratic Alliance is set to form a government for the third term, and we think the most important aspect of this is policy predictability. And in particular we see a number of critical structural reforms made in this third term; and then importantly for fixed income, we see a reduction in the primary budget deficit.

We will continue to monitor closely the remaining emerging markets elections in this landmark election year, and we’ll come back with more investment updates.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Inside Japan’s Economic Transformation Jun 06, 2024

Our four-person panel explains Japan’s economic boom, from growing GDP to corporate sector vibrancy, and which upward trends will sustain.

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Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.

Japan is undergoing a once in a generation transformation. A country once associated with its lost decades is now seeing multi-decade highs for nominal GDP growth and equity indices.

On this special episode of the podcast, we will discuss why we are so optimistic on Japan's trajectory from here. I'm joined by our Chief Japan Economist Takeshi Yamaguchi, our Chief Asia and EM Strategist Jonathan Garner, and our Japan Equity Strategist Sho Nakazawa.

This episode was recorded last Friday, May 31st at 9 am in Hong Kong.

Jonathan Garner: And 9 am in Singapore.

Takeshi Yamaguchi: And 10 am in Tokyo.

Chetan Ahya: Japan's nominal GDP growth reached a 32 year high in 2023. Equity markets have reached multi decade highs, and ROE and productivity growth have been on an improving trend. Corporate sector vibrancy is returning, and animal spirits are reviving. A new, stronger equilibrium is one of robust nominal GDP growth and a sustainable moderate inflation.

This new equilibrium of stronger normal GDP growth and low real interest rates will also be supportive of Japan's capex trends. With that backdrop, let me now turn to Yamaguchi san.

Yamaguchi-san, what makes us confident that this virtuous cycle of rising wages and prices will continue to play out?

Takeshi Yamaguchi: We think Japan's social norm of no price hike, no wage hike is changing, and a good feedback loop between wages and prices is emerging. Workers demand higher wages with higher inflation expectations and the corporate management accept their demand, as they also expect higher inflation. Japan's labor market remains structurally tight and aggregated corporate profits are now at a record high level. In addition to the pass-through from prices to wages, we are beginning to see the pass-through in the other direction from wages to prices, especially in service prices.

The average wage hike in these spring wage negotiations was the highest in the last 33 years. So, we expect to see a gradual rise in service inflation going ahead with a rise in wages.

Chetan Ahya: Could you elaborate a bit on the details of the capex outlook?

Takeshi Yamaguchi: Yes. We expect Japan's private capex to exceed its previous 1991 peak this year. In the previous deflationary period, domestic nominal GDP remained in a flat range, and Japanese firms mainly invested abroad. That said, the trend of Japanese nominal GDP growth has shifted up, which will likely positively affect Japanese firms’ decision to increase domestic investment.

Also, there are various other factors supporting domestic capex, such as real interest rates remaining low, the weak yen, the government's new industrial policy supporting onshoring and semiconductor investment, and the need for digitalization and labor-saving investment on the back of structural labor shortage driven by demographic shifts.

Chetan Ahya: Thank you, Yamaguchi-san. And, you know, I can't let you go without answering this question, which is much of the focus of the markets right now. If yen depreciates to 160 again, how much upside risk to your rate path do you see?

Takeshi Yamaguchi: Our FX team expects the yen to gradually appreciate to 146 by the end of 2024, and under the assumption, we expect one hike this year in July and another one in January next year. However, if sustained yen depreciation raises domestic underlying inflation trend, we think the BOJ will respond by raising the policy rate further to 0.75 per cent in 2025.

Chetan Ahya: Thank you, Yamaguchi-san. Jonathan, let me come over to you now. You have led the debate on Japan's ROE improvement and have been bullish since 2018. How are we thinking about Japan equities from a broader Asia market allocation perspective now?

Jonathan Garner: Back in 2018, we highlighted Japan equities as what we called the most underappreciated turnaround story in global equities. And at the heart of our thesis was the idea that monetary and fiscal policy dials were now set to exit deflation, driving an improved top-down environment for corporations from an asset utilization perspective.

It's worth recalling that during the deflation era, Japan listed equities ROE averaged just 4.2 per cent for two decades, by far the lowest in global markets. That's now reached almost 10 per cent, and we're confident that by the end of next year we can be approaching 12 per cent, which would put Japan back in the middle of the pack in global equity markets.

And we think further re-rating in line with the improved ROE is likely, over the medium term.

Chetan Ahya: And how much upside do we see from here?

Jonathan Garner: Well, in terms of the target price that we published in our midyear outlook, that now stands at 3,200 for June 2025 for TOPIX. And the way that we derive that is through an earnings forecast for TOPIX, which is around 5 per cent above current consensus levels.

And in addition, a forward PE multiple assumption of 15 times, which is close to where the market is currently trading, and around about a 4 PE point discount to our target multiple for the S&P 500. So that gives us around 16 per cent upside versus current spot levels.

Chetan Ahya: Thank you, Jonathan. And you mentioned about corporate governance changes helping Japan equity markets. Sho, let me bring you in here. How will corporate governance changes drive further improvement in Japan's ROE?

Sho Nakazawa: I would say corporate governance reform, which is Tokyo Stock Exchange initiative will help fuel OE gains going forward. From the last year below 1x P/B has been a buzz word in the market, growing sense of shame and peer pressure to enhance capital efficiency for the corporate executives. And this is not just a psychological change. If we look at cumulative share buybacks amount, last fiscal year it hit a record high of ¥10 trillion, and we are seeing further record growth into this fiscal year as well.

Chetan Ahya: And what are the key alpha generation themes still to pay for within Japan equities space?

Sho Nakazawa: In terms of alpha generation, we explored three key themes within the Japanese equity landscape. So one, identifying companies with labor productivity and pricing power that can pay and absorb higher real wages; and two, finding the next cohort of corporate reform beneficiaries. Three, assessing the impact of NISA, Nippon Individual Saving Account, inflows.

I think this will drive large cap, high-liquidity value and high dividend stock. Still plenty to play for in Japan.

Chetan Ahya: Yamaguchi-san, Jonathan, Nakazawa-san, thank you all for taking the time to talk. And thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.

Special Encore: The Curious Connection Between Airlines and Fashion Jun 05, 2024

Original release date April 29, 2024: Our analysts find that despite the obvious differences between retail fashion and airlines, struggling brands in both industries can use a similar playbook for a turnaround.

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Ravi Shanker: Welcome to Thoughts on the Market. I'm Ravi Shanker, Morgan Stanley's North American Freight Transportation and Airlines Analyst.

Alex Straton: And I'm Alex Straton, Morgan Stanley's North America Softlines, Retail and Brands Analyst.

Ravi Shanker: On this episode of the podcast, we'll discuss some really surprising parallels between fashion, retail, and airlines.

It's Monday, April 29th at 10am in New York.

Now, you're probably wondering why we're talking about airlines and fashion retail in the same sentence. And that's because even though they may seem worlds apart, they actually have a lot in common. They're both highly cyclical industries driven by consumer spending, inventory pressure, and brand attrition over time.

And so, we would argue that what applies to one industry actually has relevance to the other industry as well. So, Alex, you've been observing some remarkable turnaround stories in your space recently. Can you paint a picture of what some fashion retail businesses have done to engineer a successful turnaround? Maybe go over some of the fundamentals first?

Alex Straton: What I'll lead with here is that in my North America apparel retail coverage, turnarounds are incredibly hard to come by, to the point where I'd argue I'm skeptical when any business tries to architect one. And part of that difficulty directly pertains to your question, Ravi -- the fundamental backdrop of the industry.

So, what are we working with here? Apparel is a low single digit growing category here in North America, where the average retailer operates at a mid single digit plus margin level. This is super meager compared to other more profitable industries that Ravi and I don't necessarily have the joy of covering. But part of why my industry is characterized by such low operating performance is the fact that there are incredibly low barriers to entry in the space. And you can really see that in two dynamics.

The first being how fragmented the competitive landscape is. That means that there are many players as opposed to consolidation across a select few. Just think of how many options you have out there as you shop for clothing and then how much that has changed over time. And then second, and somewhat due to that fragmentation, the category has historically been deflationary, meaning prices have actually fallen over time as retailers compete mostly on price to garner consumer attention and market share.

So put differently, historically, retailers’ key tool for drawing in the consumer and driving sales has been based on being price competitive, often through promotions and discounting, which, along with other structural headwinds, like declining mall traffic, e-commerce growth and then rising wages, rent and product input costs has actually meant the average retailers’ margin was in a steady and unfortunately structural decline prior to the pandemic.

So, this reliance on promotions and discounting in tandem with those other pressures I just mentioned, not only hurt many retailers’ earnings power but in many cases also degraded consumer brand perception, creating a super tough cycle to break out of and thus turnarounds very tough to come by -- bringing it full circle.

So, in a nutshell, what you should hear is apparel is a low barrier to entry, fragmented market with subsequently thin margins and little to no precedent for successful turnarounds. That's not to say a retail turnaround isn't possible, though, Ravi.

Ravi Shanker: Got it. So that's great background. And you've identified some very specific key levers that these fashion retail companies can pull in order to boost their profitability. What are some of these levers?

Alex Straton: We do have a recent example in the space of a company that was able to break free of that rather vicious cycle I just went through, and it actually lifted its sales growth and profitability levels above industry average. From our standpoint, this super rare retail turnaround relied on five key levers, and the first was targeting a different customer demographic. Think going from a teens focused customer with limited brand loyalty to an older, wealthier and less fickle shopper; more reliable, but differently.

Second, you know, evolving the product assortment. So, think mixing the assortment into higher priced, less seasonal items that come with better margins. To bring this to life, imagine a jeans and tees business widening its offering to include things like tailored pants and dresses that are often higher margin.

Third, we saw that changing the pricing strategy was also key. You can retrain or reposition a brand as not only higher priced through the two levers I just mentioned, but also try and be less promotional overall. This is arguably, from my experience, one of the hardest things for a retailer to execute over time. So, this is the thing I would typically, you know, red flag if you hear it.

Fourth, and this is very, very key, reducing the store footprint, re-examining your costs. So, as I mentioned in my coverage, cost inflation across the P&L (profit and loss) historically, consumers moving online over time, and what it means is retailers are sitting on a cost base that might not necessarily be right for the new demand or the new structure of the business. So, finding cost savings on that front can really do wonders for the margins.

Fifth, and I list this last because it's a little bit more of a qualitative type of lever -- is that you can focus on digital. That really matters in this modern era. What we saw was a retailer use digital driven data to inform decision making across the business, aligning consumer experience across channels and doing this in a profitable way, which is no easy feat, to say the least.

So, look, we identified five broad enablers of a turnaround. But there were, of course, little changes along the way that were also done.

Ravi Shanker: Right.

Alex Straton: So, Ravi, given what we've discussed, how do you think this turnaround model from fashion retail can apply to airlines?

Ravi Shanker: Look, I mean, as we discussed, at the top here, we think there are significant similarities between the world of fashion retail and airlines; even though it may not seem obvious, at first glance. I mean, they're both very consumer discretionary type, demand environments. The vicious circle that you described, the price deflation, the competition, the brand attrition, all of that applies to retail and to airlines as well.

And so, I think when you look at the five enablers of the turnaround or levers that you pull to make it happen, I think those can apply from retail to airlines as well. For instance, you target a different customer, one that likes to travel, one that is a premium customer and, and wants to sit in the front of the plane and spend more money.

Second, you have a different product out there. Kind of you make your product better, and it's a better experience in the sky, and you give the customer an opportunity to subscribe to credit cards and loyalty program and have a full-service experience when they travel.

Third, you change your distribution method. You kind of go more digital, as you said. We don't have inventory here, so it'd be more of -- you don't fly everywhere all the time and be everything to everyone. You are a more focused airline and give your customer a better experience. So, all of those things can drive better outcomes and better financial performance, both in the world of fashion retail as well as in the world of airlines.

Alex Straton: So, Ravi, we've definitely identified some pretty startling similarities between fashion retail and airlines. Definitely more so than I appreciated when you called me a couple months ago to explore this topic. So, with that in mind, what are some of the differences and challenges to applying to airlines, a playbook taken from the world of fashion retail?

Ravi Shanker: Right, so, look, I mean, they are obviously very different industries, right? For instance, clothing is a basic human staple; air travel and going on vacations is not. It's a lot more discretionary. The industry is a lot more consolidated in the airline space compared to the world of retail. Air travel is also a lot more premium compared to the entire retail industry. But when you look at premium retail and what some of those brands have done where brands really make a difference, the product really makes a difference. I think there are a lot more similarities than differences between those premium retail brands on the airline industry.

So, Alex, going back to you, given the success of the turnaround model that you've discussed, do you think more retail businesses will adopt it? And are there any risks if that becomes a norm?

Alex Straton: The reality is Ravi, I breezed through those five key enablers in a super clear manner. But, first, you know, the enablers of a turnaround in my view are only super clear in hindsight. And then secondly, one thing I want to just re-emphasize again is that a turnaround of the nature I described isn't something that happens overnight. Shifting something like your consumer base or changing investor perception of discounting activity is a multi year, incredibly difficult task; meaning turnarounds are also often multi year affairs, if ever successful at all.

So, looking ahead, given how rare retail turnarounds have proven to be historically, I think while many businesses in my coverage area are super intrigued by some of this recent success; at the same time, I think they're eyes wide open that it's much easier said than done, with execution far from certain in any given turnaround.

Ravi Shanker: Got it. I think the good news from my perspective is that hindsight and time both the best teachers, especially when put together. And so, I think the learnings of some of the success stories in your sector can not only be lessons for other companies in your space; they can also be lessons in my space. And like I said, I think some airlines have already started embarking on this turnaround, others are looking to see what they can do here. And I'm sure again, best practices and lessons can be shared from one sector to another. So, Alex, thanks so much for taking the time to talk to us today.

Alex Straton: It was great to speak with you, Ravi.

Ravi Shanker: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

Spirited Debates Around Our Midyear Outlooks Jun 04, 2024

Our Chief Fixed Income Strategist takes listeners behind the curtain on Morgan Stanley’s expectations for markets over the next 12 months.

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Welcome to Thoughts on the Market. I am Vishy Tirupathur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the key debates we engaged in during the mid-year outlook process.

It's Tuesday, June 4th at 1pm in New York.

Over the last few episodes, you've been hearing a lot about Morgan Stanley's midyear outlook, where our economists have forecasted a sunny macro environment of decelerating growth and inflation, and policy easing in most developed market economies, leading to a positive backdrop for risk assets in the base case, especially in the second half of the year.

But beyond the year end, many uncertainties -- uncertainties of outcomes and uncertainties of the consequences of those outcomes -- point to a wider range of outcomes, driving a wider than normal bull versus bear skew in our expectations for markets over the next 12 months.

As always, these outlooks are the culmination of a process involving much deliberation and spirited debate among economists and strategists across all the regions and asset classes we cover. I thought it might be useful to detail some of these debates that we've had during the process to shed a better light on the forecast in our outlook.

First, given the many changes to market pricing of Fed's rate cuts year to date, driven by higher-than-expected inflation, the path ahead for US inflation was heavily debated. Our economists argued that the acceleration in goods and financial services prices, which explains a substantial portion of the upside in the first quarter inflation data should decelerate from here. And also that leading indicators point to a weaker shelter inflation ahead. Their analysis also showed that residual seasonality contributed to the unexpected strength in first quarter [20]24 inflation data, suggesting a payback has to happen in the second half of 2024.

The outlook for China economy and our cautious stance on the market was another point of debate, mainly because China's growth has surprised to the upside relative to our 2024 year ahead outlook. Our economists argued that while there are a few policy positives on housing and green products mitigating the debt deflation spiral, growth remains unbalanced and subpar. So, we discussed our cautious stance on China equity markets against this backdrop and concluded that the equity market recovery is still very challenging in China.

Third, given the combination of favorable technicals, solid fundamentals, and a relatively benign economic outlook, we debated whether corporate credit, on which we are constructive, should we be even more constructive in our forecasts. After all, the setup for corporate credit has many elements similar to those during the mid 1990s, when, for example, US IG index spreads were about 30 basis points tighter versus the current spread targets.

Our strategist highlighted the significant differences in the market structure, the composition of the index, and the duration of the underlying bonds that make up this index today, versus 1990s -- all of which put a higher floor on spreads, which explains our spread targets.

The debates notwithstanding, we cannot argue with the benign macro backdrop and what that means for the second half of 2024. We turn overweight in global equities and overweight in a range of spread products within fixed income, most notably agency MBS, EM Sovereign credit, leveraged loans, securitized credit, especially CLO equity tranches.

Thanks for listening. If you enjoyed the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Why an ‘Everything Rally’ Is Still Possible Jun 03, 2024

Our Chief Cross-Asset Strategist explains why the high correlation between stocks and bonds could work in investors’ favor throughout the second half of this year.

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Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why we believe bonds and equities can both rally this year, with the still-elevated correlations between the two assets a boon rather than a bane to investors.

It’s Monday, June 3rd at 10am in New York.

In our mid-year outlook two weeks ago, we expressed our bullish view on both global equities and parts of fixed income space like agency mortgage-backed securities and leveraged loans, on the back of the benign economic backdrop our economists are forecasting for in the second half of 2024.

Now, this may be surprising to some. Received wisdom is that in an environment of rate cuts and falling yields, equities can't perform well because the former usually maps to growth slowdowns. When equities see double-digit upside – which is what we’re projecting for European equities – it’s unusual for bonds to also see strong and positive returns, which is what we’re projecting for German government bonds.

And I want to push back on this received wisdom that we can’t have an ‘everything rally’. When we look at the annual performance of global stocks and 10-year US Treasuries every year going back to 1988, in the 13 times when the Fed cut rates over the course of the year, bond yields were lower and equities were up 43 per cent of the time. And in those periods, stock returns averaged 18 per cent while yields fell over 1 percentage points. ‘Everything rallies’ happen often in this very macro backdrop of benign growth and Fed cuts we’re expecting, And when they do happen, everything indeed rallies – strongly.

Or to frame it another way – our expectations for both global equities and fixed income to see strong total returns this year is the flipside of what markets had experienced in 2022. Now back then, unlike in most other prior cycles, stock-bond return correlations were high because inflation was elevated even as growth was sluggish, meaning that bonds sold off on higher rates expectations, and equities on bad earnings. Today, with our view that global growth can be robust while disinflation continues, the opposite will likely be true; bonds should rally on lower rates expectations, and equities on strong earnings revisions. Stock-bond return correlations are still elevated, but it should work in an investor’s favor this year.

Lean into it. Good macro, fair fundamentals, pockets of attractive valuations all make for a strong environment for risk assets, a reason for us to get more bullish on European and Japanese equities, but also in fixed income products like leveraged loans and Collateralized Loan Obligations.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Why TMT Bonds Are Underperforming May 31, 2024

In a generally positive environment for corporate credit, the recent performance of high-yield bonds in the telecom, media and technology (TMT) sector offers a market contrast. Our Lead Analyst for High-Yield TMT joins our Head of Corporate Credit Research to explain the divergence.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research for Morgan Stanley.

David Hamburger: And I'm David Hamburger, Head of US Sector Corporate Credit Research and Lead Analyst for the high yield telecom, media, and technology sectors.

Andrew Sheets: And today on the podcast we'll be discussing the contrast between strong overall markets in credit and a whole lot of volatility in the high yield TMT space.

It's Friday, May 31st at 10am in New York.

So, David, it's great to talk to you. You know, listeners have probably been hearing about our views on overall markets and credit markets for the 12 months ahead.

We have US growth at 2 percent. We have inflation coming down. We had the Fed lowering interest rates. But there’s needless to say; there's some pretty notable contrast between that sort of backdrop and the backdrop we've had for credit year to date, which has been pretty calm, pretty strong -- and what's been going on in your sector.

So maybe before we get into the why -- let's talk about the what and bring people up to speed on the saga that's been high yield TMT year.

David Hamburger: Yeah. I'm here today to disavow you of any notion that everything is fine and dandy in the market today. So, if you look at the high yield communications sector, it's trading about 325 basis points wide of the overall high yield index. And just to give you that magnitude of that -- the high yield index trading around 300 basis points -- we're talking about 625 basis points over. Now, the high yield communication sector as well is trading about 275 basis points, wider than the next widest sector in the index.

And so, it's pretty astounding today, given the market backdrop, how much underperformance we've seen in this sector.

Andrew Sheets: What's been causing this just large divergence between high yield TMT and what seems like a lot of other things?

David Hamburger: Yeah, I think there are two forces at work here. One's kind of a broader set of issues that I can outline for you. Really, I think it's a combination of one, the maturation of the communications marketplace. Coming out of COVID, we certainly had accelerated adoption of broadband and wireless services. That in and of itself has created a lot of intense competition.

And as such, we've seen a lot of technological advances that have created some secular pressures on the space. As well, when you pair that up with elevated financial leverage, all coming together at a time when the marginal cost of capital for companies has increased due to higher interest rates. Those are really some of the underlying forces at work that have driven underperformance in this sector.

But some companies have managed to navigate this environment. And I would say by and large, it's those with really strong balance sheets. But that has really cast a shadow on this sector -- is the fundamental and financing issues.

When you think about the bloated balance sheets that some of the other companies have had, they've been exploring a whole new set of transactions and, evaluating different options for their balance sheets. And that's probably the more sinister thing that we've seen in the market of late.

Andrew Sheets: So, so tell me a little bit more about this. You know, what are some of the types of things that companies can do that often leave the bond holder unhappy?

David Hamburger: We all became all too aware of what private equity sponsors might do back in the heyday of LBOs, and we still live in that world today, and it's really fairly well known.

You know, I've been in the credit markets for more than 20 years, but I can't recall a time we've seen so many management teams and controlling shareholders now that are at odds with their creditors because of elevated leverage and the business risks they face. So really, the prospect of real and expected liability management has created a lot of dislocation across companies’ capital structures.

So, what have they done? We look and see companies that have been exploring liability manage, taking advantage of weak protections in certain credit documentation in their structure at the expense of other creditors in the same capital structure. So, we have one company where you see this dislocation in their term loans. They have the same pool of collateral between two different term loans with two different maturities. The later dated maturity is trading higher than the nearer dated maturity, strictly or solely because of the better protections in that documentation. And the premise being, you can negotiate with that class of creditors, give them an advantaged position in the capital structure at the expense of other creditors -- in order to somehow manage the balance sheet and manage those liabilities.

Andrew Sheets: And David, is it fair to say that this is a direct outcrop of, you know -- a term some people might have heard of -- of covenant light debt, where, you know, usually debt has certain legal protections that mean that the bondholder is more assured of getting paid back or not being made a less well off than other lenders. But you know, we did see some of that change during different, stronger market conditions. Is that a partial explanation of what's going on?

David Hamburger: That's exactly right, Andrew. We are seeing the result, if I might say, the hangover from some of these covenant light deals that came to market over the last few years; almost to the point of speak to some clients and they will just want to know what is the vintage of that secured debt issue that you're talking about because there were certain years where they were far more flexible documentation and protections. And now, given where the equity markets are trading and the financing environment, you see a lot of those securities trading at severe discounts to par, which is unusual because, again, in my 20-year career, I've not often seen companies with billion-dollar equity market caps and bonds trading in the 20, 30, or 40 cents on the dollar.

You would think that if a company had a substantial market cap, that their bonds would be trading closer to par and would have value. But what really the market's, I think, pricing in is this transference of value from creditors to shareholders; and the opportunity cost associated with these shareholders; or controlling shareholders or management teams looking to capture those discounts that they now see in their bonds; or in their loans to the benefit of equity shareholders -- really puts all constituents in the company's balance sheet, if you will, at odds with one another.

Andrew Sheets: So, David, this is so interesting because again, I think, you know, for a lot of listeners, you can read the newspaper, you see the headlines, the market looks very strong and stable. And yet, there's definitely a tempest that's been brewing, you know, in your sector. For people who are investing in high yield TMT, what are you think the most important things that you're looking out for in your credit coverage?

David Hamburger: Well, look, we're forced to really dig in and scrutinize these credit docs and really understand what protections are there, understanding how companies might navigate through those protections in order to prolong or preserve their equity value or the equity options in their companies.

It's not like we're trying to be alarmists in saying this is a canary in the coal mine, but it is certainly a cautionary tale for any high yield investor to be well versed in those credit documentation, understanding the protections in those debt securities.

And we have seen bondholders and creditors, largely even in loans, you know, get together in co-op agreements to push back on some of these aggressive liability management transactions. And that, I think, is really important in an environment where yields have come back in and, you know, where people look at opportunities and maybe we could, once again, see two things. One, a reach for yield, where you're looking at sectors that have underperformed. And secondly, should we get back into an environment of covenant light docks once again? So, I don't want to be talking about this again in a few years’ time. And it's not something that the market has helped resolve rather than just perpetuate.

Andrew Sheets: David, it's fascinating as always. Thanks for taking the time to talk.

David Hamburger: Thank you Andrew. Glad to be here.

Andrew Sheets: And thanks for listening. If you enjoy the show, please leave us a review wherever you get your podcast and share Thoughts on the Market with a friend or colleague today.

European Economic Outlook: Decidedly More Optimistic May 30, 2024

Our Chief Europe Economist explains why the region’s outlook over the next year is trending upward, including how higher growth will lead to lower interest rates this cycle.

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Welcome to Thoughts on the Market. I’m Jens Eisenschmidt, Morgan Stanley’s Chief Europe Economist. Along with my colleagues bringing you a variety of perspectives, today I will discuss our outlook for Europe’s economy in the second half of 2024 and into next year.

It’s Thursday, May 30 at 10am in Frankfurt.

So, over the last year, we have had a relatively downbeat outlook for Europe's economy, but as we head into the second half of this year our view is decidedly more optimistic. After bottoming last year, euro area growth should reach 0.7 per cent annualized terms in 2024 and 1.2 per cent in 2025 on the back of stronger consumption and exports. Inflation is on its way to the European Central Bank’s target, paving the way for the ECB to start cutting rates in June with three cuts in 2024, for a total of 75 basis points, and four more cuts in 2025, for a total of 100 basis points.

What’s particularly notable, though, is the set-up of this growth rebound is highly unusual for several reasons.

Let's start with inflation. In a normal environment, higher growth leads to higher inflation and vice versa. This time is different. The euro area needs to grow faster to get inflation down. The reason is that faster growth should lead to better resource utilization in sectors characterized by labor hoarding or keeping a surplus of employees. This should keep unit labor costs – or how much a business pays its workers to produce one unit of output – in check. We’re expecting further wage increases, mostly driven by the catch-up with past inflation, and so higher productivity is a way to cushion the pass-through to prices.

So again, just to repeat, we are in a cycle where we need higher growth to get inflation down and not as usual, we have higher growth and that gets us more inflation. Of course, there is a limit to that. If we get too much growth, that would be an issue potentially for the ECB. And if you get too little growth, that is another issue because then we won't get the productivity rebound.

In some sense, you could think of the growth we need as a landing strip and we need to come in at that landing strip precisely; and so far, the signs are there that is exactly the picture we are getting in 2024 and 2025 in Europe.

Now the monetary and fiscal policy mix is another area where this cycle stands out. So normally, monetary policy would tighten into an upswing and ease into a downturn, while fiscal policy would be expansionary in a downturn and contractionary in an upswing. Euro area monetary policy is currently restrictive – but it’s set to get less restrictive over time. The likelihood of rates coming down is hardly bad news for growth. But policymakers will need to take care to not reignite inflation in the process.

So all of that gives rise to the gradualism that the European Central Bank has been signaling it will use in its policy easing approach. And again, think about the landing strip metaphor. If we are not gradual enough and we reignite a growth too much, and with it inflation, we might be exiting the landing strip in one way or the other.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Global Questions About the US Elections May 29, 2024

Our Global Head of Fixed Income and Thematic Research reflects on Japanese investors’ interest in the outcome of the upcoming presidential vote in the US.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the upcoming US elections.

It's Wednesday, May 29th at 10:30am in New York.

I recently returned from Tokyo, having attended and presented at Morgan Stanley's inaugural Japan summit. And while I was asked to present on topics ranging from our fixed income markets outlook to the role of Japan in an increasingly multipolar world, my one-on-one conversations always tracked back to the same client question: who will win the US election.

Of course this is a matter of great importance globally. But the investor in Japan is particularly interested in whether possible election outcomes could disrupt their rosy economic outlook – either through new tariffs or increased geopolitical tensions between the US and China, and also North Korea. To that end, many were focused on polls showing former President Trump with sufficient support to win the election, asking how predictive this would be of the ultimate outcome.

Here our view remains, for all investors, that polls aren't giving a reliable signal yet. The election is still several months away. And Trump doesn't have leads beyond a normal polling error in sufficient states to win the presidency.

So, investors still need to consider the potential impacts of a variety of US electoral outcomes. That's perhaps not the most settling answer for investors, who strive to limit uncertainties. But we think it's the most honest one. And as we've been doing in this space all year, we'll continue to walk you through the outcomes, policy impacts, and resulting market effects you need to be aware of.

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Midyear European Equities Outlook: In the Sweet Spot May 28, 2024

Our Chief Europe Equity Strategist explains why she is forecasting a 23 percent total return for European equities over the next year.

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Welcome to Thoughts on the Market. I’m Marina Zavolock, Morgan Stanley’s Chief European Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why our mid-year outlook extends our bullish view on European equities.

It’s Tuesday, May 28, at 10am in London.

We have recently updated our outlook for the year ahead, maintaining our bullish view on European equities as we fully incorporate and roll forward our mid-1990s “soft landing” playbook. Like today, the mid-1990's was a period where markets focused on rates, inflation, and related data above anything else. The US and Europe saw soft and “softish” landings, the Fed’s cutting cycle was slower than investors initially expected, and there was an undercurrent of technological innovation. European equities, in particular, are following the mid-1990s path closely, and that means both a mid-cycle extension and a strong market set-up.

We have high conviction in our constructive European equities view and have recently raised our one year forward MSCI Europe Index target to 2,500 – 18 percent potential upside. This brings potential total return upside – if we incorporate dividends and buybacks – to 23 percent.

So why do we remain bullish? Over the second half of this year in particular we anticipate European equities ongoing re-rating is likely to combine with an emerging European equities earnings recovery. We’ve just come out of one of the strongest earnings seasons Europe has had in several quarters and we anticipate this is only the beginning. Our earnings model projects 7.5 percent earnings growth by year end for MSCI Europe, which is almost double consensus estimates. On top of this, we think the market underappreciates a number of significant thematic tailwinds that benefit European equities. These include rising corporate confidence, an M&A cycle recovery that is leading the global trend, an imminent start to rate cuts, high and rising capital distributions including buybacks, and underappreciated AI diffusion.

In terms of our sector preferences, structurally, we continue to prefer Europe’s quality growth sectors. These include Software, Aerospace & Defense, Pharma, and Semiconductors, along with the Banks sector.

Shorter-term, we also believe a recovery in bond yield-sensitive stocks has begun, which is expected at this stage in our mid-1990s playbook. We expect this rally to be tactical and bumpy but ultimately more powerful than a similar rotation that occurred around the Fed pivot late last year. We recently upgraded Building & Construction to overweight to play this rotation.

Although we believe European equities are in the sweet spot over the second half of 2024, we expect the bar for continued performance to become tougher by the time we get into first half of 2025. Also, our bear case incorporates rising geopolitical risks and lower-than-expected economic growth – the latter in line with our economists' bear case. A US election scenario that would bring a change in the status quo is also a risk for European equities, albeit it’s far more idiosyncratic than broad-based according to our in-depth analysis.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Midyear Credit Outlook Favors Moderation May 24, 2024

OurHead of Corporate Credit Research explains why moderate economic growth offers opportunities in credit markets – if investors choose carefully.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley, along with my colleagues, bring you a variety of perspectives Today, I'll be talking about our outlook for credit markets over the next 12 months.

It's Friday, May 24th, at 9 a. m. in New York. Morgan Stanley's global economic and strategy teams have recently published our mid year outlook. Twice a year, all of us get together to take a step back, debating what we think the outlook could look like over the 12 months ahead. For credit, we think that backdrop still looks pretty good.

Corporate credit, in representing lending to companies, is an asset class that loves moderation and hates extremes. An economy that's too weak raises the risk that companies fail, and has been consistently bad for returns. But an economy that's too strong also causes challenges, as companies take more risks, the rewards of which often go to stockholders, not their lenders.

The good news for credit is that Morgan Stanley's latest economic forecasts are absolutely full of moderation for economic growth. We see the U.S. growing at about 2 percent this year and next and Europe growing at about 1%. Right in that temperate zone, the credit usually finds optimal.

We see inflation falling, with core inflation back to 2 percent in the U. S. and Europe over the next 12 months. And monetary policy should also moderate, with the Federal Reserve, European Central Bank, and the Bank of England All lowering interest rates as this inflation comes down.

For credit, forecasts that expect moderate growth, moderating inflation, and moderating interest rates are exactly that down the fairway outcome that we think markets generally like. The challenge, of course, is that spreads have narrowed and lower risk premiums are discounting a lot of good news. So how do investors navigate richer valuations within what we think is still a very supportive economic backdrop?

One thing we continue to like is leveraged loans, where yields and spreads we think are more attractive. In the U. S., yields on loans are still north of 9%. We like short dated investment grade bonds, which we think offer a good mix of income and stability, and also happen to correspond to the maturity range that our interest rate colleagues expect yields to see the largest decline.

That should help total returns. And in Europe, we don't think spreads are particularly tight. And that should be further supported by relatively upbeat views on the European stock market from our equity strategies. Morgan Stanley's macroeconomic backdrop, which is full of moderation, is supportive for credit.

Tighter valuations are a challenge, but given this moderate backdrop, we think they can stay expensive. We still think there are good opportunities within credit, but investors will have to pick their spots. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen, and share thoughts on the market with a friend or colleague today.

Midyear Housing Outlook: Is Home Sale Activity Picking Up? May 23, 2024

With cooling inflation and an expected drop for mortgage rates, will more affordable housing lead to a big spike in sales? Our Co-Heads of Securitized Product Research take stock of the US housing market.

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Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley.

James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley.

Jay Bacow: And on this episode of the podcast, we'll discuss our outlook for mortgage rates and the housing market over the next 12 months.

It's Thursday, May 23rd, at 1pm in New York.

James Egan: Jay, I want to talk about mortgage rates. From November through January, mortgage rates decreased over 120 basis points. But then from February to May, they've given back more than half of that decline. Where are mortgage rates headed from here?

Jay Bacow: So, day to day, week to week, it's hard to have a lot of conviction, a lot of things can happen. But, over the next 12 months, we think mortgage rates are coming down. We estimate that by summer 2025, the 30-year fixed rate mortgage will be roughly 6.25 per cent.

James Egan: Alright, that is a significant amount lower than about 7 per cent where we are right now. And that's good news for affordability in the US housing market. What gets us there?

Jay Bacow: We think inflation is going to cool, and our economists are forecasting that the Fed is going to cut their policy rate by 75 basis points this year and 100 basis points next year. In fact, our economists are forecasting eight of the G10 central banks to cut rates next year.

Now, mortgage rates are 30 year fixed rate products, so they're based more on where the longer end of the treasury curve is than the front end. But our rate strategists think ten year notes are going to rally to 375 by next summer.

When you combine all of that with our expectation for secondary mortgage rates to tighten versus treasuries, that's how we end up with that forecast for the primary rate to rally.

James Egan: All right, I want to dig in there. I really like how you highlighted the secondary mortgage rates tightening versus treasuries. One thing I know that we've both gotten a lot of questions on over the course of the past year plus is how wide mortgages are trading versus treasuries right now. So, what do you think drives that tightening basis?

Jay Bacow: There’s a lot of factors -- but in end, two of them that are always going to drive things are supply and demand. One of the interesting things is that while housing activity has picked up, we're near the decade high in the percentage of homes that are bought with all cash, which means that the supply of mortgages to the market is actually not that high.

On the demand front, we think you're going to get demand from a broad spread of investors. We think there's been some money manager supported inflows into the mortgage market. We think that as the Fed cuts rates and you get the Basel III endgame resolution, domestic banks are going to come back to the market as they get more regulatory clarity.

And then also as the Fed cuts rates, that means that FX (foreign exchange) hedging costs for overseas investors will be improved and so you think Japanese life insurance companies can go back to the market and we think there's going to be continued demand from Chinese commercial banks. But, if you get all of this support, then as mortgage rates come down, that should be good news on the affordability front in the housing market, right Jim?

James Egan: Exactly. When we combine that decrease in mortgage rates with what our US economics team is saying will be about mid-single digit growth in nominal incomes, we get an improvement in affordability over the next 12 months that we've only seen a handful of times over the past 30 years.

Jay Bacow: Now this six and a quarter forecast is certainly good news versus spot rates. It's almost two per cent below the peaks we saw last year, but I don't really think it solves the lock-in effect that we've discussed on this podcast previously.

Close to 80 per cent of homeowners have a mortgage rate below 5 per cent. So, they're still out of the money versus our expectations for our mortgage rates going next year.

James Egan: Right, and we think that's a very important point. You made the point earlier about thinking about supply and demand with respect to mortgage rates versus treasuries, and we're going to talk about it here in the housing market. We have to think about affordability improvement in terms of both that supply and demand piece.

If we look back towards the start of this year, I'd say that demand increased a little bit faster, a little bit stronger than we thought. Typically, when you see sharp improvements in affordability, it doesn't always lead to immediate increases in sales volumes. However, what we saw from November to January seemed to be a little bit quicker to stir animal spirits, perhaps because of how healthy this improvement in affordability was. Home prices were still climbing. Mortgage rates weren't even coming down because the Fed was cutting; it was because of market expectations for future fed cuts in a soft landing environment. But on the supply side, while we expect for sale listing volumes to increase as rates come down, they aren't going to race higher because of that lock-in dynamic that you just described.

Jay Bacow: So, Jim, you think more people will list their homes; but what will actually happen to sales volumes? Will people buy them?

James Egan: Right. So, I think we have to delineate between existing home sales and new home sales here. Yes, we think existing listings are going to increase on the margins. New home inventory has already increased.

Historically, new homes make up about 10 to 20 per cent of the for-sale inventory on a monthly basis. Right now, they're between 30 and 35 per cent, and that's been the case for a little while. So, when we think about our forecasts for sales volumes, we're confident that new home sales will increase more than existing home sales. And that that growth in new home sales will spur single unit starts to increase more than both of them.

Our specific spot forecasts, 10 per cent growth in new home sales, 5 per cent growth in existing home sales, with single unit starts edging out a double digit return of about 15 per cent growth.

Jay Bacow: Do you have specific spot forecasts for home prices as well?

James Egan: We do. As supply increases, the pace of home price growth should slow from where it is right now. It's been accelerating for the past several months, but the absolute level of supply is still pretty tight. We're at 3.8 months of supply as we're recording this podcast. Any reading below 6 is really associated with home price growth, not just today, but at least over the course of the next 6 months -- and we're well below 6 months of inventory.

Right now, home prices are growing at about 6.5 per cent. We think they're growing to slow to about 2 per cent by the end of 2024, before accelerating to 3 per cent in 2025. So, while growing inventory leads to deceleration, tight inventory keeps home price appreciation positive.

Jay Bacow: Alright so, home sale activity is going to pick up. It's going to be led by starts, which we think will be up 15 percent and more new home sales than existing home sales. There’s new home sales up 10 per cent. Home prices we now think will end the year positive; up 2 per cent in 2024 and up 3 per cent in 2025.

Jim, always a pleasure talking.

James Egan: Great speaking with you, Jay.

Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Midyear US Economic Outlook: Continued Resilience May 22, 2024

Why is the US economy poised for a strong second half of the year, despite slowing GDP growth? Our Chief US Economist points to population growth, housing demand and anticipated Fed rate cuts.

----- Transcript -----

Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief US Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our mid-year outlook for the US economy.

As we near the midpoint of this year, we refresh our outlook for the second half of the year. In our base case, the US economy remains strong, but US GDP growth is slowing, and slowing from 3.1 percent on a fourth quarter over fourth quarter basis last year, to 2.1 percent this year and in 2025.

Okay, so what's behind the continued strength? Well, it's something we've been intensely following this year. Faster immigration and population growth will continue to expand the labor supply and support economic activity, and all without increasing inflationary pressures. So, whereas the mid-pandemic labor market was characterized by persistent shortage of labor, the supply of labor is now increasing, and we think will outstrip demand this year.

This will drive the unemployment rate higher, which we expect will end this year half a point above 2023 at 4.2 per cent and rise further to 4.5 per cent in 2025. And wage gains should moderate further as the unemployment rate rises. We think consumer activity will continue to slow this year and into 2025 as that cooling labor market weighs on growth in real disposable income and elevated interest rates keep borrowing costs high.

Tight lending standards also limit credit availability. That said, we do think lower rates are on the horizon, and this should spur a pickup in housing demand and goods spending around the middle of next year. In fact, after substantial reflation numbers in the first quarter of 2024, we expect lower inflation numbers ahead. We've already seen that in the April data, as rents, goods, and services prices decelerate.

The Fed has held the policy rate steady at a range of 5.25 to 5.5 per cent since July 2023, and we expect it will deliver the first quarter point cut in September this year. In total, we expect three quarter point cuts this year, and four more by the middle of next year, which lowers the policy rate to around 4.5 per cent in the fourth quarter this year to about 3.5 per cent in the fourth quarter of 2025. But even before rate cuts, the Fed has announced it will start phasing out Quantitative Tightening, or QT, in June. We expect QT to end around March 2025, when the Fed's balance sheet is a little above 3 trillion.

Finally, let's talk about housing. We expect continued growth in residential investment through 2025, with a rapid rise in housing starts, solid new home sales, and a bit more turnover in existing home sales as mortgage rates fall. Home building and increased brokerage commissions should keep residential investment on the boil, posting a 4.6 per cent rise on a 4th quarter over 4th quarter basis this year and 3.2 per cent in 2025. Our residential investment forecasts are a good deal stronger than we expected in the year ahead outlook we published last November. Booming first quarter growth probably reflected a combination of the warm winter and the temporary downswing in mortgage rates. We don't expect the same outperformance later in the year. But at the same time, housing demand is greater than we had anticipated amid that faster population growth.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Midyear Cross-Asset Outlook: Bullish Possibilities May 21, 2024

Our Global Cross-Asset Strategist and Global Chief Economist discuss the state of asset markets at the midway point of 2024, and why the current backdrop suggests positive directions for several key markets.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Serena Tang: And I'm Serena Tang, Morgan Stanley's Chief Global Cross Asset Strategist.

Seth Carpenter: And yesterday, Serena, you and I discussed Morgan Stanley's global economic mid-year outlook. And today, I'm going to turn the tables on you, and we'll talk about asset markets.

It's Tuesday, May 21st, at 10am in New York.

Okay, so yesterday we talked about all sorts of different parts of the macro environment. Disinflation, inflation, central bank policy, growth. But when you think about all of that -- that macro backdrop -- what does it mean to you for markets across the world?

Serena Tang: Right, I think the outlook laid out by your team of stable growth, disinflation, rate cuts. That is a great backdrop for risk assets, one of the reasons why we got overweight in global equities. Now, there will likely be low visibility and uncertainty beyond year end, and why we recommend investors should focus on the triple C's of cheap optionality, convexity, and carry.

That very benign backdrop suggests more bullish possibilities. Your team has noted several times now that the patterns we're seeing now and what we expect have parallels to what happened in the mid 1990s -- when the Fed cut in small increments, US growth was sustained at high levels, and the labor market was strong. And now I'm not suggesting that this is 1990s and we should party like it. But just that the last time we found ourselves in this kind of benign macro environment, risk assets -- actually most markets did really well.

Seth Carpenter: So, I will say the 1990s was a pretty good decade for me. However, you mentioned some uncertainty ahead, low visibility. We titled our macroeconomic outlook ‘Are we there yet?’ Because I agree, we do feel like we're on a path to something pretty good, but we're not out of the woods yet. So, when you say there's some low visibility about where asset markets are going, maybe beyond year end, what do you mean by that?

Serena Tang: I think there's less visibility going into 2025. And specifically, I'm talking about the US elections. When I think about the range of possible outcomes, all I can confidently say is that it's wide, which I think you can see reflected in our strategist's latest forecast. Most teams actually have relatively constructive forecast returns for their assets in the base case, but there's an unusually wide gap between their bull and bear cases for bond and equity markets.

Seth Carpenter: Let me narrow it down a little bit because equity markets have actually performed pretty well during the first half of the year. So what do you think is going to happen specifically with equities going forward? How should we be thinking about equity markets per se?

Serena Tang: Equities have rallied a lot, but we've actually gotten more bullish. I talked about the three Cs of cheap optionality, convexity, and carry earlier, and I think European and Japanese equities really tick these boxes. Both of these markets also have above average dividend yields, especially for a dollar-based FX hedge investor.

Serena Tang: Where we think there might be some underperformance is really in EM equities, but it's a bit nuanced. Our China equity strategy team thinks that consensus mid-teens earnings growth expectation for this year will still likely to disappoint given the Chinese growth forecast that you talked about yesterday.

Seth Carpenter: Alright, in that case. Let me flip over to fixed income. A lot of that is often driven by central banks. Around the world, you just mentioned EM equities may be struggling a little bit. A lot of EM central banks are either cutting a little bit ahead of the Fed, but being cautious, worrying about not getting too far ahead of the Fed. So, if that's what's going on with policy rates at the very front end of the curve, what's happening in fixed income more broadly?

Serena Tang: We generally see government bond yields lower over the forecast horizon for two reasons. On your team's forecast of central banks cutting rates and also in the US, an optical rise in the unemployment rate, our macro strategy team forecasts for the 10 year U.S. Treasury yields to fall to just above 4 per cent by the end of this year. And because government bond yields will be coming down, we also expect yields for spread products like agency MBS, investment grade, etc. to also come down. But I think for these spread products, returns can be positive beyond that duration piece.

Serena Tang: So, credit loves moderation, and I think the mild growth backdrop your team is forecasting for is exactly that. US fixed income more generally should also see renewed flows from Japanese investors as FX hedging costs come down over the next six months. All of this supports tighter than average spreads.

Seth Carpenter: Okay, so we talked about equities, we talked about fixed income. Big asset class that we haven't talked about yet are commodities. How bullish are you going into the summer? What do you think is going to go on and can that bullish view that you guys have last even longer?

Serena Tang: So for crude oil, our strategists see market tightness over the summer, which could drive Brent to about $90 per barrel. You have demand coming in stronger than expected, and of course OPEC has extended its production agreement.

But we also don't really expect prices to hold over the medium term. Non-OPEC supply should meet most of the global demand growth later this year and into 2025, which sort of leaves very little room for OPEC to unwind production cuts. We expect Brent to revert back steadily to its long-term anchor, which is probably somewhere around $80 per barrel.

Serena Tang: For copper, it’s actually our metal strategist's top pick right now, and it's very much driven by, I think, tightening supply and demand balance. You've had significant mine supply disruptions, but also better than expected demand and new drivers such as -- we've talked about AI a lot, data centers and increasing participation.

Serena Tang: And on gold, in our view, pricing is likely to remain pretty choppy as investors have to weigh inflation risk, incoming data, and the Fed path. But historically, that first rate cut tends to be a very positive catalyst for gold. And we see risks more skewed to our bull case at the moment.

Seth Carpenter: Okay, so talked about equities, talked about fixed income, talked about commodities. These are global markets, and often when investors are looking around the world and thinking about what it means for them, currencies come into it, and everybody's always going to be looking at the dollar. So why don't you run us through the Morgan Stanley view on where the US dollar is going to go over the rest of this year, and maybe over the next 12 months.

Serena Tang: The short answer is we see the dollar staying stronger for longer. Yes, we expect central banks to begin cutting this year. But the pace of cuts and ultimate destinations are likely to vary widely. Now another potential dollar tailwind is an increased risk premium being priced for the 2024 US elections. We think that investors may begin to price in material risks to dollar positive changes in US foreign and trade policy as the election approaches, which we assume will sort of begin ramping up in the third quarter.

Seth Carpenter: All right, let's step back from the details. I want you to bring us home now. Give me some strategy. So where should people lean in, where should we be looking for the best returns and where do we need to be super cautious?

Serena Tang: In our asset allocation recommendation, we recommend overweight in global equities, overweight in spread products, equal weight in commodities, and underweight in cash.

We really like European and Japanese equities on the back of pretty strong earnings revision, attractive relative valuations, and good carry for a dollar based investor. We like spread products. Not so much that our strategists are not expecting duration to do well. We are still expecting yields to come down.

Serena Tang: Where we are most cautious on, really, continues to be EM equities. From a very top down perspective, the outlook we have is constructive stable growth, continued disinflation, rate cuts. These make for a good environment for risk assets. But uncertainties beyond year end, that really argues for investors to look for assets which have those triple Cs, cheap optionality, convexity, and carry.

And we think Japanese and European equities and spread products within fixed income take those boxes.

Seth Carpenter: Alright, looking at the clock, I'm going to have to cut you off there. I could talk to you all day. Thank you for coming in and letting me turn the tables relative to yesterday when you were asking me all the questions.

Serena Tang: Great speaking with you, Seth. And yes, I know we can go on forever.

Seth Carpenter: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you get your podcasts. And share this episode with a friend or a colleague today.

Midyear Economic Outlook: Reasons for Optimism May 20, 2024

Our Global Chief Economist and Global Cross-Asset Strategist discuss the state of the global economy at the midpoint of 2024, including how the U.S. and Europe are on growth trajectories despite volatile economic data.

----- Transcript -----

Serena Tang: Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's chief global cross-asset strategist.

Seth Carpenter: And I’m Seth Carpenter. Morgan Stanley's global chief economist.

Serena Tang: And on this two-part episode of the podcast, we'll discuss Morgan Stanley's global mid-year outlook. Today we'll focus on economics, and tomorrow we'll turn our attention to strategy.

It's Monday, May 20th, at 10am in New York.

So, Seth, we've seen a lot of volatile economic data since you published your 2024 year ahead outlook last November. The US has gone through a few months of downside inflation and upside growth surprises, followed by renewed inflationary pressures; and in China, real growth surprise to the upside, but deflation deepened. In contrast, India and Japan, your two strongest conviction bullish views, have played out so far.

So, with all this in mind, Seth, what is your outlook for the global economy and its growth trajectory for the second half of this year and into 2025?

Seth Carpenter: So, we're pretty optimistic. We see some mild deceleration in the US relative to last year's particularly strong growth but not collapsing. And I think that part is really important. The euro area growth, all the signs that we've had since we wrote the outlook in November, updating now it says that growth is actually bottomed out there and we're starting to see the initial recovery. Now, don't get carried away. It's not that it's gonna be this massive rebound. But there should be now a bottoming out gradual growth as inflation keeps coming down. That means that real wage growth is actually going to get stronger, and we think consumption starts to lead the way.

China though, there we've surprised the upside but just an inflation adjusted growth because fiscal policy has been adding to capacity they're adding to the ability. And so, deflation has stayed. It's one of the longest and deepest deflationary episodes China has had. We think that's actually going to be exporting deflation to the rest of the world. But in terms of real growth, they're actually hanging in there around 5 per cent.

Serena Tang: I'm glad you kind of highlighted the difference between what we're expecting for the US and Europe and what we're expecting for China, because one of the themes that I think you touched on in this outlook is divergence that you see some slowing in the US -- even though it's very stable, while the rest of the world really is where growth starts to pick up.

So, what is driving this divergence? How persistent do you think it will be? And what does it mean for central bank policy?

Seth Carpenter: Let me start with Europe and the US, the way you framed it. Like I said, European growth is probably bottom. They had more adverse shocks than the US did. So, the energy shock -- that was particularly damaging to German manufacturing, really slowed the European economy down. Whereas in the US, we had a lot of strong growth last year. Last year we had growth in the US at just over three per cent. Non-trivial amount of that growth was enabled by the surge of immigration, but we still see some residual impetus from fiscal policy.

And so, where are we now? Inflation in the euro area is continuing to fall. In fact, it's clearer signal down than it has been, at least for the fourth quarter this year in the US. Growth is picking up, but not so much that it's going to re-spark inflation. So, we think the ECB is going to start to cut rates as soon as next month, as soon as the June meeting. Whereas for the US, we still have strong growth. Inflation sort of gave us that head fake in the first quarter, so the Fed's going to have to wait, we think probably until September.

Serena Tang: And on the point of inflation, can you actually give us a snapshot of where we are right now and what your projections from here will be? You know, you talked about disinflation in the US. What's gonna be driving that?

Seth Carpenter: I think the first thing to keep in mind is that just globally we see further disinflation and so the run up in inflation that was, by and large, a global phenomenon, we do see as abating. For the US specifically, though, I think there are a few parts that are really important and always the conversation has to deal with housing.

There, in the United States, we measure housing inflation through rents, and we know various things. One recent readings on rents in the market right now have actually been moving roughly sideways. The statistical agency, the Bureau of Labor Statistics, that creates the CPI, takes those market-based rents and then spreads it through an algorithm. And the official statistics reflect what's going on now over the next couple of quarters. So, for that reason alone, we think rent inflation, which is 40 per cent of core CPI, we think that keeps trending down over the rest of the year.

We see some deflation in consumer goods. That's especially in automobiles. The deflation that we see in China, that's probably being exported to the rest of the world, contributes a little bit more to that downward pressure. So, we feel pretty convicted that the high inflation that we saw in the first quarter was more noise than signal, and we get greater disinflation as the year goes on.

Serena Tang: So finally, I want to ask you about Japan specifically. It's the region where we're actually expecting rate hikes. Since it has gone through a structural shift recently, decades of deflation are now over, seems to be over. And so, what are your expectations there?

Seth Carpenter: I think it is a fundamental shift here. We did have decades of essentially zero nominal growth and that is now clearly, in the rear-view mirror. We see wage inflation; we see price inflation. When I talk to our colleagues in research in Tokyo who cover the consumer sector, the mindset has shifted, and consumers are willing to accept these higher inflation prints.

And so, in that regard, we do think very much we've shifted from that zero nominal growth, that sort of disinflationary-deflationary equilibrium, to one where inflation will be sustained above target. As a result, the Bank of Japan got rid of negative interest rate policy. And we think they're gonna hike into positive territory in July of this year. Probably again in the beginning of next year.

All, as long as we're right, that inflation is here to stay and that seems very much the case. Now, why only two rate hikes then as opposed to more if the world is fundamentally different? And this, I think, is critical. Governor Ueda, the BOJ, is committed to making sure that we have shifted to this reflationary environment. And so, I do think he's going to be cautious and only hike as much as he can be confident that inflation stays high for the foreseeable future.

Serena Tang: Seth, thanks so much for taking the time to talk.

Seth Carpenter: Serena, it's always great to talk to you.

Serena Tang: And thanks for listening. Please be sure to tune in for Part Two of this episode, where Seth and I will discuss our mid-year strategy outlook. If you enjoy Thoughts on the Market, please leave us a review wherever you listen, and share the podcast with a friend or colleague today.

Seeking Better Value in Emerging Market Debt May 17, 2024

Our Head of Corporate Credit Research explains why the debt of high-rated EM countries is a viable alternative for investors looking for high yields with longer duration.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why – for buyers of investment grade bonds – we see better value in Emerging Markets.

It's Friday May 17th at 2pm in London.

This is a good backdrop for corporate credit. The asset class loves moderation and our forecasts at Morgan Stanley see a US soft landing with growth about 2 percent comfortably above recession, but also not so strong that we think we need further rate increases from the Federal Reserve. Corporate balance sheets are in good shape, especially in the financial sector and the demand for investment grade corporate bonds remains high – thanks to yields, which hover around five and a half percent.

For all these reasons, even though the additional yield that you currently get on corporate bonds, relative to say government bonds is low, we think that spread can remain around current levels, given this unusually favorable backdrop. But we're less confident about longer maturity bonds. Here, credit spreads are much more extreme, near their lowest levels than 20 years. So, what can investors do if they're looking to get some of the advantages of this macro backdrop but still access higher risk premiums.

For investors who are looking for high rated yield with longer duration, we see a better alternative: the debt of high rated countries in the Emerging Markets, or EM. Adjusting for rating, high grade Emerging Market debt currently trades at a discount to corporate bonds. That is for bonds of similar ratings, the spreads on EM debt are generally higher. And this is even more pronounced when we're looking at those longer dated borrowings; the bonds with the maturity over 10 years. In investment grade credit, you get paid relatively little incremental risk premium to lend to a company over 30 years, relative to lending it to 10. But that's not the case in Emerging Market sovereigns. There, these curves are steep. The incremental premium you get for lending at a longer maturity is much higher.

So, what's driving this difference? Well one has been relatively different flows between these different but related asset classes. Corporate bonds have been very popular with investors, enjoying strong inflows year to date. But Emerging Market bond funds have not, and have seen money come out. Relatively weaker flows may help explain why risk premiums in the EM debt market are higher.

Another reason is that the same EM investors who are often seeing outflows have been asked to buy an unusually large amount of EM bonds. Issuance from Emerging Market sovereigns has been unusually high year to date and unusually focused on longer dated debt. We think this may help explain why Emerging Market risk premiums are even higher for longer dated bonds.

The good news? Our EM strategy team thinks some of this issuance surge will moderate in the second half of the year. It's a good backdrop for high rated credit and this week's CPI number, which showed continued moderation. And inflation is further reinforcing the idea that the US can see a soft landing. The challenge is that – that good news has tightened spreads in the corporate market.

While we think those risk premiums can stay low, we currently see better relative value for investors, looking for yield and risk premium in high-rated EM sovereigns – especially for those looking at longer maturities.

Thanks for listening. Subscribe to Thoughts on the Market wherever you get your podcasts and leave us a review. We'd love to hear from you.

Get Ready for a Summer Travel Boom May 16, 2024

Our research shows travelers are willing to spend more this summer than last. U.S. Thematic Strategist Michelle Weaver explains how this will impact the airline, cruise and lodging industries.

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Welcome to Thoughts on the Market. I’m Michelle Weaver, Morgan Stanley’s US Thematic Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the summer travel trends we’re expecting to see this year.

It’s Thursday, May 16th at 10am in New York.

With Memorial Day just around the corner, most of us are getting really excited about our summer vacation plans. We recently ran a survey, and our work shows that nearly 60 percent of US consumers are planning to travel this summer. This figure though skews significantly higher for upper income consumers. 75 percent of consumers making $75,000 to $150,000 are planning to travel and this figure rises to 78 percent for those who make more than $150,000.

And travel remains a key spending priority for higher-income consumers. They place travel as one of their top priorities when compared to other discretionary purchases. This picture reverses though when you look at lower-income consumers making less than $50,000 a year. Travel tends to be among their lowest priorities when they are thinking about their discretionary purchases.

What really matters for companies though is if consumers are going to spend more this year than they did last year. And consumers who are planning a vacation are inclined to spend more this year, with 49 percent expecting to spend more and 16 percent intending to spend less. So that yields a net plus-32 percent increase in spending intentions for summer travel.

And what does this mean for key players in the travel industry? For starters, let’s look at airlines, where demand no longer seems to be a market debate within the space. It’s remained very resilient so far in 2024, contrary to what many had feared when we were going into this year. Our Transportation Analyst also has a positive view of US Airlines, especially Premium carriers. And the reason: This category caters to high-end consumers who are more likely to fly regardless of the state of the economy. Since the pandemic, Premium air travel has been one of the fastest growing and likely most resilient parts of the US Airlines industry, with premium cabin outperforming the main cabin consistently.

And then what’s in store for cruise companies this summer? The outlook seems to be broadly positive, according to our analysts. The largest cruise operators source the majority of their guests from the US. And these companies provide leisure travel – as opposed to business travel – almost exclusively, so their revenues are closely tied to the health of the US consumer. Of the 60 percent of consumers who are planning to travel this summer, 6 percent are planning a cruise. That’s a little bit lower than pre-COVID, but cruise passengers tend to skew older and more affluent. So, they take more than one vacation frequently. This keeps the outlook broadly supportive for cruise companies.

Finally, let’s think about Gaming and Lodging. These are your hotels and casinos. Investor sentiment is generally cautious for this space, but our analyst believes the data is encouraging. Yes, there’s been a slowdown in demand, compounded by continued – but moderating – labor inflation. This has created margin pressure for companies with higher operating leverage but the data suggests that upscale and luxury operators are outpacing midscale and economy ones. In addition, the Las Vegas strip, which tends to skew higher end, has outpaced regional casinos. And even when you look within the Las Vegas strip, baccarat is outpacing slot demand and luxury properties are outpacing more affordable options.

So, all in all, the summer looks bright for travel operators, especially those who have more exposure to the high-end consumer.

Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

The Narrow Scope of US Tariffs on China May 15, 2024

Our Global Head of Fixed Income and Thematic Research explains that the Biden administration’s new tariffs on Chinese imports are narrower than those of 2018 and 2019, but still send a signal about the economic relationship between the US and China.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the impact of newly announced tariffs by the United States.

It's Wednesday, May 15th at 10:30am in New York.

Yesterday, the Biden administration announced new tariffs on the import of certain goods from China. These include semiconductors, batteries, solar cells and critical minerals among other products. For investors, this might remind them of the tariff escalation in 2018 and 2019 that led to global economic concerns. But we’d caution investors not to arrive at similar conclusions from this latest action.

Consider that the scope of this action is far more muted than the tariffs actions from a few years ago. New tariffs will affect a projected $18 billion of imports, or only about 0.5 percent of all China’s exports. And as our chief Asia economist Chetan Ahya has explained in his recent work, the sectors in scope for this round are areas where China has substantial spare capacity. Said differently, the tariffs are narrowly scoped and appear to be targeted at areas where the US perceives specific risk of imbalanced trade and market conditions. That contrasts with tariffs on roughly $360 billion of imports from China in the 2018-2019 period – a much broader approach that was in part aimed at forcing broad trade concessions from China but carried greater economic consequences by crimping corporate’s capital spending globally as they re-evaluated their production strategies.

There is some signal for investors here though. While the scope of the Biden administration's efforts here are more narrow, it does signal something we’ve known for a few years now. There’s continuity across presidential administrations and across political parties in the US on the topic of the economic relationship with China. While each party has different tactics, there’s clear overlap in their goals, in particular on the idea that the US must continue taking steps to protect critical and emerging technologies in order to preserve its economic and national security.

This suggests that the laws of gravity won’t apply to US tariffs any time soon, regardless of the US election outcome. So, the rewiring of the global economy in the emerging multipolar world will continue, and investors can still focus on some key regional beneficiaries of this secular trend – namely Mexico, India, and Japan.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Lessons from Retail Success Stories May 14, 2024

Our Retail Analyst discusses the key strategies that have propelled a select few companies in U.S. consumer retail amid a challenging demand backdrop.

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Welcome to Thoughts on the Market. I’m Simeon Gutman, Morgan Stanley’s Hardlines, Broadlines & Food Retail Analyst. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss how some retail businesses are responding to daunting consumer challenges.

It’s Tuesday, May 14th at 10am in New York.

There have been dramatic shifts within the consumer sector over the past three years. During the pandemic, we all had to redirect our spending away from services, such as travel and leisure, to various goods, which we were able to purchase online and have delivered at home. Consumer packaged goods, for example, experienced two years of outsized growth during the pandemic. But since 2022, consumption has been declining across the value chain.

For some categories, this dynamic may not be a temporary, post-COVID phenomenon, but rather a continuation of a longer-standing secular trend that had started prior to the pandemic. For example, non-durable goods – such as clothing, footwear and food at home – were already losing wallet share pre-COVID. Grocery spend was losing to dining out, as consumers placed more value on convenience. And although some sectors experienced unprecedented pricing power between 2020 and 2023, they’re now seeing this pricing power decline as inflation moderates.

Against this backdrop, Consumer Packaged Goods companies and retailers are attempting to find new growth levers in the face of stagnating – or even declining – sales and decreasing pricing power. A select few companies in US consumer retail, automotive, communication services and IT hardware have been able to navigate the current consumer environment of slowing growth. We believe there’s a powerful lesson in the combination of strategies these successful outliers have deployed to reposition themselves in the face of tepid demand.

For example, these companies are shifting their value proposition by focusing on products in faster-growing markets. They are also exiting underperforming areas to optimize their core brand and product portfolios. They’re streamlining their internal operations by changing organizational structures, revamping their supply chains, and using AI to automate processes. All of this helps to reduce costs and enhance productivity. Successful retail companies are also looking to alternative revenue sources and profit pools to grow their businesses, focusing on higher growth areas within their industries. Discount retail is a prime example as it focuses on high margin digital media, which has the potential to lift operating profit margins for the entire sector. Furthermore, a shift to omni-channel has revolutionized Retail, by capturing greater consumer wallet share and reducing delivery costs. And finally, successful companies have prioritized free cash flow by divesting non-core assets in less profitable areas.

Businesses that have been able to deploy these strategies have been rewarded by the market. They have seen their average 12-month price to earnings multiples expand more than 35 percent over the past five years, meaning that the market's outlook for these companies is considerably better than it was previously. Several of these strategies have also led to stronger top-line growth and margin expansion, which our US equity strategists identify as the two major drivers of shareholder value across consumer staples and consumer discretionary.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Spring IMF Meetings Spark Cautious Optimism May 13, 2024

Our experts highlight their biggest takeaways from the International Monetary Fund’s recent meetings, including which markets around the globe are on an upward trajectory.

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Simon Waever: Welcome to Thoughts on the Market. I'm Simon Waever, Morgan Stanley's Global Head of Emerging Markets, Sovereign Credit and Latin America Fixed income strategy.

Neville Mandimika: And I'm Neville Mandimika from the Emerging Markets Credit Strategy team with a focus on Central and Eastern Europe, Middle East and Africa.

Simon Waever: And on this episode of Thoughts on the Market, we'll discuss what we believe investors should take away from the International Monetary Fund’s Spring Meetings in Washington, DC.

It's Monday, May 13th at 10am in New York.

Neville Mandimika: And it's 3 pm in London.

To give some context, every year, the Spring Meetings of the International Monetary Fund (IMF) and the World Bank provide a forum for country officials, private sector market participants and academics to discuss critical global economic issues. This time around, the meetings were held against a backdrop, as you might imagine, of rising geopolitical tensions, monetary policy pivots, and limited fiscal space.

Simon, we were both at the event, and I wanted to discuss what we took away from our own meetings, as well as discussions with other market participants. How would you describe the mood this time around compared to the annual meetings in October last year?

Simon Waever: So, I would say sentiment was cautiously optimistic. Of course, it did happen in the backdrop of inflation; the first quarter not being as well behaved as everyone had hoped for. So that really put the focus on central banks being more cautious in their easing paths, which is actually a point the IMF also made back in October.

But away from that, growth has held up better than expected. In the US for sure, but also more globally. So, I would say it could have been a lot worse.

Neville Mandimika: Was it just me or there was a particular focus on fiscals this time around? What did you make of this?

Simon Waever: No, there was for sure and interestingly it was focused on both developed economies and developing economies, which isn't usually the case. And I think it's clear that not only the IMF but also the markets are worried that we're still some distance away from stabilizing debt in most countries. And not only that but that it's going to be hard to close that gap due to lower growth and spending pressures. So that meant that there was a lot of discussions on how much term premier there needs to be in government bond curves and whether they need to be steeper.

Neville Mandimika: It's often very difficult to talk about, you know, the global economic dynamics without talking about AI, which seems to be the catchphrase this year. How is the fund viewing this in light of the potential for the global economy?

Simon Waever: So, the issue is that the IMF has often had to revise down medium-term growth outlook; something that it pretty much had to do every year since 2010, actually. And today it stands at only 2.8 globally. If you look at the IMF's publications, they attribute the key reasons to this to misallocation of capital and labor.

But what they also did this time around was look at what could turn it around; and maybe unsurprisingly structural reforms that reduces that misallocation would be the larger potential factor that could boost this up again. They estimate about around 1.2 per cent of GDP. But then to your point the adoption of AI is seen as another new driver.

Of course, it's also a lot more uncertain because there needs to be a lot of a lot more work done around it. But they think it could add nearly one percentage point to global growth in a positive scenario.

But Neville, with that, let's dig deeper into the issues of developing countries which, after all, is the focus of the meetings. The cost of debt is rising, which has led to some countries experience debt distress. But from our side, we've also frequently pushed back against the idea that there is a growing debt crisis. So, coming back from the meetings, what kind of debt restructuring progress has been made? And how do you see it playing out for the remainder of the year?

Neville Mandimika: Yeah, interestingly, there was still plenty of talk in the meetings about EM (emerging market) debt crisis, but the backdrop to the conversation was significantly better this time around compared to October 2023.

Since last year, we've seen progress from Suriname, which is a small part of the Emerging Market Bond Index, close its restructuring, Zambia reaching a deal with private bondholders with the expectation that all of this could be buttoned up by June this year, multiple proposals in Sri Lanka and Ukraine making some progress.

This gives me some hope that the number of sovereigns in default will be lower by the end of this year. And I think more importantly, we don't expect any country, any new country, to get into default -- as countries like Pakistan and Tunisia have made some progress in avoiding restructuring its own debt.

The other important thing that came out from my vantage point is that the Global Sovereign Debt Roundtable seems to be making some progress, particularly on outlining the structure of EM debt crises, which is, you know, emphasizing parallel negotiations between official and private creditors and, of course, timely sharing of information between stakeholders.

Simon Waever: Then another focus has been that the IMF has been making some concessions to try to increase financing for countries that need it. Do you think there was progress on this front?

Neville Mandimika: Yeah, it certainly seems so. You know, there seems to be some momentum on that front. You'd remember that last year, there was a resolution to increase the IMF's lending capacity by increasing country quotas by 50 per cent. Once this is buttoned up, heavy borrowers like Egypt and Argentina would greatly benefit, I think.

Until this is done, the fund extended its temporary higher access limits to allow countries to borrow more in the meantime. There was also increased dialogue on reducing surcharges, which is the additional interest payments the IMF imposes on borrowers. The reduction of these would greatly help the likes of Argentina and Ecuador. Unfortunately, not much concrete progress has been made on this front.

Simon Waever: And then finally, across all the meetings we held, which countries did you come away more positive on and which ones would still be of concern?

Neville Mandimika: Yeah, I certainly came out a lot more positive on Senegal, as fears of large policy changes like leaving the CFA franc were eased. Egypt was also another clear positive, given the commitment to reforms, despite large financing that was received earlier this year. Nigeria, there was also some momentum on this front as reforms is still very much front and center from the political authorities. And lastly, Turkey saw authorities affirming their commitment to fighting inflation and loosening the grip on the foreign exchange market.

And I'll throw the same question to you, Simon. Which countries are you positive on?

Simon Waever: Yeah, I mean, it was pretty hard to take away the excitement from Egypt, but I would say that Argentina is another country where people came away pretty positive. The imbalances are significant, but they're just making very good headway in unwinding them; and they have the support of the IMF to do so. Ecuador would be the other one where sentiment in general is positive. On the more cautious side, I would point towards those countries where fiscal deficits are heading in the wrong direction, which goes back to the worries about fiscals we spoke about earlier -- and Colombia is one such example.

But with that, let's wrap it up. Neville, thanks for taking the time to talk.

Neville Mandimika: Great speaking with you, Simon.

Simon Waever: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to the podcast. It helps more people find the show.

How Mexico’s Elections Could Change Global Markets May 10, 2024

Morgan Stanley’s Chief Latin America Strategist explains the importance of Mexico’s upcoming presidential election, laying out the possible investment implications of potential policy reforms.

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Welcome to Thoughts on the Market. I’m Nik Lippman, Morgan Stanley’s Chief Latin America Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll talk about why Mexico’s upcoming election matters for markets.

It's Friday, May 10, at 10am in Sao Paulo.

Voters in Mexico will choose a new president in less than a month, on June 2. The two leading candidates – Claudia Sheinbaum and Xóchitl Gálvez – have presented strong campaigns amidst a tense political backdrop. And yet, asset prices have not yet begun to react to potential election outcomes.

There’s significant policy differences between Sheinbaum and Galvez – thus an important investment debate around each of them. However, polls suggest a strong lead for Sheinbaum, who is the candidate from the ruling party Morena. In fact, it seems that the key debate that markets are focused on right now is not so much who wins, but rather what type of president Sheinbaum would be, if she does get elected.

If she does indeed win, the expectation is for policy continuity post-election—particularly as it relates to Mexico’s nearshoring – or moving industrial supply chains from Asia to North America. This trend has been a major driver of the country’s economy and major asset classes.

And so the market seems to be focusing squarely on policy decisions that may be taken by the incoming administration. Mexico is in a strong position to benefit from its relationship with the United States and as well as the nearshoring opportunities. We see a positive skew for both equities and credit, and think the election can act as a catalyst for assets that have traded cheaply.

Yet, significant reforms are necessary to take full advantage of this setup. Indeed, we would argue that rapid and deep structural reforms would be crucial, especially when it comes to fiscals and the energy space. For example, we think there could be a need for stronger partnership between the public and the private sector and a rethink of parts of Mexico’s electricity model. If Mexico solves its electricity supply-side challenges, it can build on its favorable nearshoring position. But on the other hand, there’s no industrial revolution without electricity.

However, the risk-reward for the Mexican peso is slightly different. It has already benefited from the rise in foreign investment - and the high interest rate differential between Mexico and the United States.

With all that said, there are risks from the elections, too. If any political party wins two-thirds majority, it opens the possibility for changes to the constitution. And current proposals by Mexico’s sitting president could open the door for larger fiscal deficits; and potentially some more unorthodox policies down the road. We will continue to keep you posted on Mexico’s election outcomes.

Thank you for listening. If you enjoy Thoughts on the Market, take a moment to rate and review us wherever you listen. It helps more people find the show.

The Fed Sends a Clear Message May 09, 2024

Our Chief Fixed Income Strategist explains why the Federal Reserve’s most recent meeting was so consequential, and the likeliest path ahead for interest rates.

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Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about last week’s FOMC meeting and its impact on fixed income markets.

It's Thursday, May 9th at 1pm in New York.

Last week’s Fed meeting was consequential. It had a clear and unambiguous messaging about the path ahead for Fed’s monetary policy. Fed’s next move in policy rate is unlikely to be a hike. The Fed’s focus now is on how long the current target range for the fed funds rate will be maintained; and the next move, whenever it happens, is likely a cut. Importantly, the FOMC’s decision was unanimous and their statement maintained an overall easing bias.

In the aftermath of recent upside surprises to inflation and the reaction in the rates market, many market participants, yours truly included, were apprehensive that the FOMC’s tone might be overtly hawkish. Turns out, that was not the case. By setting a very high bar for the next move to be a hike, the Fed’s message has meaningfully narrowed the distribution of outcomes for policy rates, at least in 2024 As our economists led by Ellen Zentner note, the two likely policy outcomes now are keeping the rates on hold or cutting.

Given the prospect that policy rates may remain in the current target range, the negative carry of an inverted yield curve keeps us from pounding the table to move to outright long in duration, although the direction of travel does suggest that. We would note that Guneet Dhingra, our head of US interest rate strategy, sees better risk/reward in duration longs through 3 month 10 year receivers than in the very crowded curve steepener trade. In general, spread products in fixed income – agency MBS, corporate credit and securitized credit – stand to benefit the most from this notably less hawkish messaging, in our view.

As Jay Bacow, our head of agency MBS strategy, observes, the backdrop in which tail risks of higher policy rates are much more remote than they were before the FOMC meeting is supportive for agency MBS. At current valuations, agency MBS offers an attractive expression for investors seeking to play for lower interest rates, lower interest rate volatility or both.

Their high all-in yields have bolstered strong inflows and sustained demand for corporate credit across a wide range of investor types. If policy rates remain in the current range, we expect the demand for corporate credit to accelerate. If policy rates stay in the current range or go lower, pressures on interest coverage are unlikely to get worse going forward. Given their high single-digit all-in yields, we see an attractive risk/reward calculus favoring leveraged loans. We like expressing this view directly in loans as well as in securitized credit through CLO tranches.

In sum, the message from the Fed was clear and unambiguous. The policy rate path ahead is for rates to remain in the current range or decline, and the bar for the next move to be a hike is very high. This bodes well for a wide range of instruments in fixed income.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Can US Dollar Dominance Continue? May 08, 2024

Our expert panel explains the U.S. dollar’s current status as the primary global reserve currency and whether the euro and renminbi, or even crypto currencies are positioned to take over that role.

Digital assets, sometimes known as cryptocurrency, are a digital representation of a value that function as a medium of exchange, a unit of account, or a store of value, but generally do not have legal tender status. Digital assets have no intrinsic value and there is no investment underlying digital assets. The value of digital assets is derived by market forces of supply and demand, and is therefore more volatile than traditional currencies’ value. Investing in digital assets is risky, and transacting in digital assets carries various risks, including but not limited to fraud, theft, market volatility, market manipulation, and cybersecurity failures—such as the risk of hacking, theft, programming bugs, and accidental loss. Additionally, there is no guarantee that any entity that currently accepts digital assets as payment will do so in the future. The volatility and unpredictability of the price of digital assets may lead to significant and immediate losses. It may not be possible to liquidate a digital assets position in a timely manner at a reasonable price.

Regulation of digital assets continues to develop globally and, as such, federal, state, or foreign governments may restrict the use and exchange of any or all digital assets, further contributing to their volatility. Digital assets stored online are not insured and do not have the same protections or safeguards of bank deposits in the US or other jurisdictions. Digital assets can be exchanged for US dollars or other currencies, but are not generally backed nor supported by any government or central bank.

Before purchasing, investors should note that risks applicable to one digital asset may not be the same risks applicable to other forms of digital assets. Markets and exchanges for digital assets are not currently regulated in the same manner and do not provide the customer protections available in equities, fixed income, options, futures, commodities or foreign exchange markets.

Morgan Stanley and its affiliates do business that may relate to some of the digital assets or other related products discussed in Morgan Stanley Research. These could include market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking.

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Michael Zezas: Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research.

James Lord: I'm James Lord, Head of FX Strategy for Emerging Markets.

David Adams: And I'm Dave Adams, head of G10 FX Strategy.

Michael Zezas: And on this episode of Thoughts on the Market, we'll discuss whether the US status as the world's major reserve currency can be challenged, and how.

It's Wednesday, May 8th, at 3pm in London.

Last week, you both joined me to discuss the historic strength of the US dollar and its impact on the global economy. Today, I'd like us to dive into one aspect of the dollar's dominance, namely the fact that the dollar remains the primary global reserve asset.

James, let's start with the basics. What is a reserve currency and why should investors care about this?

James Lord: The most simplistic and straightforward definition of a reserve currency is simply that central banks around the world hold that currency as part of its foreign currency reserves. So, the set of reserve currencies in the world is defined by the revealed preferences of the world's central banks. They hold around 60 percent of those reserves in U.S. dollars, with the euro around 20 percent, and the rest divided up between the British pound, Japanese yen, Swiss franc, and more recently, the Chinese renminbi.

But the true essence of a global reserve currency is broader than this, and it really revolves around which currency is most commonly used for cross border transactions of various kinds internationally. That could be international trade, and the US dollar is the most commonly used currency for trade invoicing, including for commodity prices. It could also be in cross border lending or in the foreign currency debt issuance that global companies and emerging market governments issue. These all involve cross border transactions.

But for me, two of the most powerful indications of a currency's global status.

One, are third parties using it without the involvement of a home country? So, when Japan imports commodities from abroad, it probably pays for it in US dollars and the exporting country receives US dollars, even though the US is not involved in that transaction. And secondly, I think, which currency tends to strengthen when risk aversion rises in the global economy? That tends to be the US dollar because it remains the highly trusted asset and investors put a premium on safety.

So why should investors care? Well, which currency would you want to own when global stock markets start to fall, and the global economy tends to head into recession? You want to be positioning in US dollars because that has historically been the exchange rate reaction to those kinds of events.

Michael Zezas: And so, Dave, what's the dollar's current status as a reserve currency?

David Adams: The dollar is the most dominant currency and has been for almost a hundred years. We looked at a lot of different ways to measure currency dominance or reserve currency status, and the dollar really does reign supreme in all of them.

It is the highest share of global FX reserves, as James mentioned. It is the highest share of usage to invoice global trade. It's got the highest usage for cross border lending by banks. And when corporates or foreign governments borrow in foreign currency, it's usually in dollars. This dominant status has been pretty stable over recent decades and doesn't really show any major signs of abating at this point.

Michael Zezas: And the British pound was the first truly global reserve currency. How and when did it lose its position?

David Adams: It surprises investors how quick it really was. It only took about 10 years from 1913 to 1923 for the pound to begin losing its crown to king Dollar. But of course, such a quick change requires a shock with the enormity of the First World War.

It's worth remembering that the war fundamentally shifted the US' role in the global economy, bringing it from a large but regional second tier financial power to a global financial powerhouse. Shocks like that are pretty rare. But the lesson I really draw from this period is that a necessary condition for a currency like sterling to lose its dominant status is a credible alternative waiting in the wings.

In the absence of that credible alternative, changes in dominance are at most gradual and at least minimal.

Michael Zezas: This is helpful background about the British pound. Now let's talk about potential challengers to the dollar status as the world's major reserve currency. The currency most often discussed in this regard is the Chinese renminbi. James, what's your view on this?

James Lord: It seems unlikely to challenge the US dollar meaningfully any time soon. To do so, we think China would need to relax control of its currency and open the capital account. It doesn't seem likely that Beijing will want to do this any time soon. And global investors remain concerned about the outlook for the Chinese economy, and so are probably unwilling to hold substantial amounts of RNB denominated assets. China may make some progress in denominating more of its bilateral trade in US dollars, but the impact that that has on global metrics of currency dominance is likely to be incremental.

David Adams: It’s an interesting point, James, because when we talk to investors, there does seem to be an increasing concern about the end of dollar dominance driven by both a perceived unsustainable fiscal outlook and concerns about sanctions overreach.

Mike, what do you think about these in the context of dollar dominance?

Michael Zezas: So, I understand the concern, but for the foreseeable future, there's not much to it. Depending on the election outcome in the US, there's some fiscal expansion on the table, but it's not egregious in our view, and unless we think the Fed can't fight inflation -- and our economists definitely think they can -- then it's hard to see a channel toward the dollar becoming an unstable currency, which I believe is what you're saying is one of the very important things here.

But James, in your view, are there alternatives to the US led financial system?

James Lord: At present, no, not really. I think, as I mentioned in last week's episode, few economies and markets can really match the liquidity and the safety that the US financial system offers. The Eurozone is a possible contender, but that region offers a suboptimal currency union, given the lack of common fiscal policy; and its capital markets there are just simply not deep enough.

Michael Zezas: And Dave, could cryptocurrency serve as an alternative reserve currency?

David Adams: It's a question we get from time to time. I think a challenge crypto faces as an alternative dominant currency is its store of value function. One of the key functions of a dominant currency is its use for cross border transactions. It greases the wheels of foreign trade. Stability and value is important here. Now, usually when we talk to investors about value stability, they think in terms of downside. What's the risk I lose money holding this asset?

But when we think about currencies and trade, asset appreciation is important too. If I'm holding a crypto coin that rises, say, 10 per cent a month, I'm less likely to use that for trade and instead just hoard it in my wallet to benefit from its price appreciation. Now, reasonable people can disagree about whether cryptocurrencies are going to appreciate or depreciate, but I'd argue that the best outcome for a dominant currency is neither. Stability and value that allows it to function as a medium of exchange rather than as an asset.

Michael Zezas: So, James, Dave, bottom line, king dollar doesn't really have any challengers.

James Lord: Yeah, that pretty much sums it up.

Michael Zezas: Well, both of you, thanks for taking the time to talk.

David Adams: Thanks much for having us.

James Lord: Yeah, great speaking with you, Mike.

Michael Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Managing for Economic Uncertainty May 07, 2024

As the U.S. economy continues to send mixed signals, our CIO and Chief US Equity Strategist explains how markets are likely to oscillate between “soft landing” and “no landing” outcomes.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the higher-than-normal uncertainty in economic data and its impact on markets.

It's Tuesday, May 7th at 1:30 pm in New York.

So let’s get after it.

In recent research, I’ve discussed how markets are likely to oscillate between the "soft landing" and “no landing" outcomes in today's late cycle environment. Continued mixed and unpredictable macro data should foster that back and forth, and last week was a microcosm in that respect. Tuesday's Employment Cost Index report came in stronger than expected, leading to a rise in the 10-year Treasury yield to nearly 4.7 per cent. Meanwhile, the Conference Board Consumer Confidence Index turned down, falling to its lowest level since July of 2022.

On Friday, the equity market rose sharply as bond yields fell on the back of a weaker labor report, while the ISM Services headline series fell to its lowest level since December of 2022.

In our view, this uncertain economic backdrop warrants an investment approach that can work as market pricing and sector/factor leadership bounces between these potential outcomes. As such, we recommend a barbell of quality cyclicals which should outperform in a "no landing" scenario and quality growth, the relative winner in a "soft landing.” One might even want to consider adding a bit of exposure to defensive sectors like Utilities and Staples in the event that growth slows further.

Meanwhile, last week's Fed meeting materialized largely as expected. Chair Powell expressed somewhat lower confidence on the timing of the first cut given recent inflation data, but he pushed back on the notion that the next move would be a hike which eased some concerns going into the meeting. The April Consumer Price Index released on May 15th is the next key macro event informing the path of monetary policy and the market's pricing of that path. As usual, the price reaction on the back of this release may be more important than the data itself given how influential price action has been on investor sentiment amid an uncertain macro set up.

On the rate front, our view remains consistent with our recent research—the relationship between the 6-month rate of change on the 10-year yield and the S&P 500 price earnings multiple implies that yields around current levels are about 10 per cent headwind to valuation through the end of June but a tailwind thereafter, all else equal.

Given the uncertainty and unpredictability of the economic data more recently, we think it's useful to look at the technicals for insight into what comes next. In early April, we highlighted that the breakdown in the S&P 500 from its well-defined uptrend was an important early warning sign that performance could become more challenged.

Based on our analysis, this headwind to valuation is likely to remain with us through the end of June unless yields fall significantly in the near term. Assuming interest rates stay around current levels, stronger valuation support lies closer to 19 times earnings, which would also imply price support closer to the 200-day moving average or 4800.

Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

What If Rates Are Higher for Longer? May 06, 2024

Lisa Shalett is a member of Morgan Stanley’s Wealth Management Division and is not a member of Morgan Stanley’s Research Department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research Department and from the views of others within Morgan Stanley.

Our CIO for Wealth Management, Lisa Shalett, and our Head of Corporate Credit Research continue their discussion of the impact of interest rates on different asset classes, the high concentration of value in equity markets and more.

----- Transcript -----

Welcome to Thoughts on the Market, and to part two of a conversation with Lisa Shalett, chief investment officer for Morgan Stanley wealth management.

I'm Andrew Sheets, head of corporate credit research at Morgan Stanley.

Today, we'll be continuing that conversation, focusing on how higher interest rates could impact asset classes, and also some recent work about the unusually high concentration of stocks within the equity market.

We begin with Lisa's very topical question about how higher interest rates might impact credit.

Lisa Shalett: So, Andrew, let me ask you this. From your perspective as the Global Head of Corporate Credit Research, what happens if we're, in fact, in this new regime of rates being higher for longer?

Andrew Sheets: Yeah, thanks, Lisa. It seems more topical by the day as we see yields continuing to march higher. So I think like a lot of things in the market, it kind of depends a little bit on what the fundamental backdrop is that's driving those interest rates higher. Because if I think about the modern era for credit, which I’ll define as maybe the last 40 years, the tightest that we've ever seen corporate credit spreads was not when the Fed or the European central bank was buying bonds. It was not when you had lots of leverage building up in the financial system prior to the financial crisis.

It was in the mid 90s when the economy was pretty good. The Fed had hiked rates a lot in [19]94 and then it cut them a little. And, you know, the mid nineties, I think, are one of the poster children for, kind of, a higher for longer rate environment amidst a pretty strong economy.

So, if that is what we're looking at, we're looking at rates being higher for longer because the economic output of the US and other regions is generally stronger. I think that's an environment where you can have the overall credit market performing still pretty well. You'll certainly have dispersion around that as not every balance sheet, not every capital structure was planned, was created with that sort of rate environment in mind.

Overall, if you had to say, is credit more afraid of a kind of higher for longer scenario or is it more afraid of, growth being a lot weaker than expected, but that would bring low rates. I actually think a lot of credit investors would much rather have a more stable growth environment, even if that brings somewhat fewer rate cuts and higher for longer rates.

Lisa Shalett: One other thing, I know that the Global Investment Committee has been debating is this idea between the haves and the have nots that's been somewhat unique to this business cycle where, there's been a portion of the mega cap and large cap universes who have demonstrated, quite frankly, total insensitivity to interest rates because of their cash balances. Or because of their lack of need for actual borrowing. And then there's smaller midsize companies, these smaller cap or unprofitable tech companies, some of the companies that may have been born in the venture capital boom of the early 2020s.

How is this have, have not, debate playing out in the credit markets? Are there parts of the credit markets that are starting to worry that there's a tail?

Andrew Sheets: Yeah, I think that's just a fascinating question at the moment because we’ve lived in this very macro world where it seemed like big picture questions about central banks: Will we go into recession? What will commodity prices do is driving everything. And even this week, questions about interest rates are dominating the headlines on TV and on the news.

But I think if you peel things back a little bit, this is an incredibly micro market, you know, we're seeing some of the lowest correlations and co-movement between individual stocks in the US and Europe that we haven't in 15 years. If I think about the credit market, the credit market is not just sailing into this environment, happy go lucky, no risk on the horizon. It's showing some of the highest tiering that we've seen in a very long time between CCC rated issuers, which is the lowest rated, main part of performing credit and Single-B issuers, which are still below investment grade rated, but are somewhat better. Market is charging a very high price premium between those two, which suggests that it is exactly as you mentioned, differentiating based on business model strength and level of leverage and the likes.

So, this environment of differentiation -- where the overall market is kind of okay, but you have lots of churning below the surface -- I think it's a very accurate description of credit. I think it's a very accurate description of the broader market, and it's certainly something that we're seeing investors take advantage of we see it in the data.

Andrew Sheets: Lisa, you recently published a special report on the consequences of concentration, which focuses on some of these mega cap stocks and how they may present underappreciated risks for investors. What were the key takeaways from that that we should keep in mind when it comes to market concentration and how should we think about that?

Lisa Shalett: The fundamental point we were trying to make -- and it really has to do with some of the unintended risks potentially that passive investors may be embracing that they don't fully appreciate -- is really through the end of 2023, US equity indices became extraordinarily, concentrated; where the top 10 names were accounting for greater than, a third of the market capitalization. And history has shown that such high levels of concentration are rarely sustainable. But what was particularly unique about the era of the Magnificent Seven or these top 10 mega cap tech stocks is not only were they a huge portion of the whole index, but in many ways they had become correlated to one another, right? Both, in terms of their trading dynamics and their valuations, but in terms of their factor exposures, right?

They were all momentum oriented. They were all tech stocks. They were all moving on an AI, narrative. In many cases, they had begun competing with each other; one another directly in businesses, like the cloud, like streaming services and media, et cetera.

Andrew Sheets: And Lisa, kind of further on that idea, I assume that one counterpoint that you get to this work is that some of these very large mega cap names are just great companies. They've got strong competitive positions; they've got opportunities for future growth. As an investor, how do you think about how much you are supposed to pay up for quality, so to speak? And, you know, maybe you could talk just a little bit more about how you see the valuations of some of these larger names in the market.

Lisa Shalett: What we always remind clients is, there is no doubt that, these are great companies and they have cash flows, footprints, dominant positions, and markets that are growing. But the question is twofold. When is that story fully discounted, right?

And when do great companies cease to be great stocks? And if you look back in history, history is littered with great companies who cease to be great stocks and very often, clients quote unquote never saw it coming because they hung their hat on this idea, but it's a great company.

Andrew Sheets: Any parting thoughts as we move closer to the midpoint for 2024?

Lisa Shalett: The line that I'm using most with clients is that, I fundamentally believe that uncertainty in terms of the economic scenarios that could play out from here. Whether we're talking about a no landing, we're talking about a hard landing, we talk about a stagflation. And the policy responses to that, whether it's the timing of the Fed, and what they do. And what's their mix between balance sheet and rates, and then what happens post the presidential elections in the US. And is there a policy change that shifts some of the growth drivers in the economy.

I just think overall uncertainty is rising through the end of the year, and that continues to argue, for a position as we've noted, where clients and their advisors are particularly active towards risk management, and where the premium to diversification is above average.

Andrew Sheets: Lisa, thanks for taking the time to talk. Hope we can have you back again soon.

Lisa Shalett: It's great to speak with you, as always, Andrew.

Andrew Sheets: As a reminder, if you enjoy Thoughts in the Market, please take a moment to rate and review us wherever you get your podcasts. It helps more people find the show.

Separating the Cyclical from the Systemic May 03, 2024

Lisa Shalett, our CIO for Wealth Management, and our Head of Corporate Credit Research discuss how to forecast expected returns over the long term, and whether historic cycles can help make sense of the market environment today.

----- Transcript -----

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

Andrew Sheets: And on part one of this special episode of the podcast, we'll be discussing long run expected returns across markets, how we think about cross asset correlations and portfolio construction, and what are the special considerations that investors might want to have in mind in the current environment.

It's Friday, May 3rd at 4pm in London.

Lisa Shalett: And it's 11am here in New York City.

Andrew Sheets: Lisa, you and I are both members of Morgan Stanley's Global Investment Committee, which brings together nine of our firm's market, economic, and portfolio management thought leaders to provide a strategic framework for advice that we give to clients.

Andrew Sheets: I wanted to touch on a unique aspect of that process because, you know, we're talking about estimating returns over different horizons for markets. And I think there's something that's kind of unique about that challenge. I mean, I think in most aspects of life, it's probably safe to say that the next decade is more uncertain than the next six months or next year. But when we're thinking about asset class returns, it's not quite as simple as that.

Lisa Shalett: Not at all. And very often this is where our understanding of history needs to play a big part. When we think about the future, what are the patterns that we think might be persistent? And therefore, encourage us to think about long run trends and mean reversion. And what dynamics might actually be disconnected, or one offs that are characteristic of maybe structural change in the economy or geopolitics or in policymaking stance.

Andrew Sheets: How have these latest capital market assumptions changed over the last year?

Lisa Shalett: I think one of the most profound changes has been our willingness to embrace the idea that, in fact, we are in a higher for longer inflation regime. And that has a couple of implications. The first has to do, of course, with nominal returns. A higher inflation environment suggests that nominal returns are actually likely to be higher. The second really has to do with where we are in the cycle and its implications for correlations. We've been through periods most recently, where stocks and bonds were, in fact, anti-correlated; or there was a diversifying property, if you will to the 60 40 portfolio. Most recently, as inflation and level of interest rates has had profound importance to both stock valuations and bond valuations, we have found that these correlations have turned positive. And that creates a imperative, really, for clients to have to look elsewhere beyond cash, bonds, and stocks to get appropriate diversification in their portfolios.

Andrew Sheets: Well, it's been less than a month since we updated our strategic recommendations. We've recently also published an update to our tactical asset allocation recommendations. So, Lisa, I guess I have two questions. One is, how do you think about these different horizons, the strategic versus the tactical? And can you also summarize what's changed?

Lisa Shalett: Sure. You know, we very often talk to clients about the tactical horizon as being in the 12 to 18-month time frame.

In our most recent adjustment, we moved from what had been roughly a, year old underweight in US large cap stocks, and we neutralized that, kind of quote unquote, back to benchmark. So, we added some exposure, and we funded that exposure by selling out of two other positions; one that we had had in both small cap value and small cap growth, as well as a position we had, that we had put on as a hedging oriented position and long duration treasuries.

Now, some might say well, given the move in interest rates, is now the right time to take that hedge off? Our decision was basically premised on the fact that we're just not seeing the value in holding duration today given the inversion of the yield curve, and we're not getting paid for the risk of duration. And so, you know, we thought redeploying into those large cap stocks was prudent.

Now, the other rationale, really has to do with earnings achievability. A lot of our thoughts were premised early in the year on this idea of a soft landing -- and a soft landing that would include deceleration in top line growth. And so, we were skeptical that could produce what consensus was looking for, which was a 10 to 11 per cent bottom line in 2024.

As it turns out, it looks like, nominal GDP in the US is going to continue to persist at levels above 5 per cent, and that kind of tailwind, suggested that our skepticism would prove too conservative; and that, in fact, in a, 10 per cent bottom line could be achievable -- especially if it were being driven by manufacturing oriented companies who are seeing a pick up from global growth.

Andrew Sheets: Lisa, maybe if I could just ask you kind of one more question related to some of these longer-term assumptions, you know, I imagine you get some skepticism to say, ‘Well, you know, is the market of today really comparable to, say, the stock market of 30 or 40 years ago? Can we really use metrics or mean reversion that's worked in the past when, you know, the world is different.’

Lisa Shalett: Yeah, no, that, that's a fantastic question. I mean, some of the bigger variables in the world that we look at have shown over very long periods of time tendencies to cycle, whether those are things around the business cycle, valuations, cost of capital. Those are the types of variables that over long periods of time tend to mean revert. Same thing volatility. There tend to be long term characteristics. And the history book is pretty convincing that even if sometimes mean reversion is delayed, it ultimately plays out.

But we do think that there are elements that we need to continue to question, right. One of them is, you know, has monetary policy and central bank intervention fundamentally changed the rules of the game? Where central banks implicitly or explicitly are managing market liquidity as much as they are managing cost of capital; and as a result, the way markets interact with the central bank and the guidance -- is that different?

A second, factor has to do with market structure, right? And in a world where market prices were really being determined almost exclusively by fundamentals, right? There was this constant rotational shift between growth style and value style and where value could be determined in the market. As we've moved to a market that is increasingly driven by passive flows; there's a question that many market participants have raised about whether or not markets have gotten more inefficient because price discovery is actually, in the short run, not what's driving prices, but rather flows; passive flows are driving prices.

And so, you know, how do we account for these leads and lags in prices being actually remarked to fundamentals? So those are at least two of the things that I know we are constantly tossing around as we think about our methodologies and capital market assumptions.

Andrew Sheets: That was part one of my conversation with Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

Look out for part two of our conversation, where we'll be discussing the impact of higher interest rates on asset classes. And how investors should think about an unusually concentrated stock market.

Andrew Sheets: As a reminder, if you enjoy Thoughts in the Market, please take a moment to rate and review us wherever you get your podcasts. It helps more people find the show.

Special Encore: Seth Carpenter: Looking Back for the Future May 03, 2024

Original release date April 8, 2024: Our Global Chief Economist explains why the rapid hikes, pause and pivot of the current interest rate cycle are reminiscent of the 1990s.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the current interest rate cycle and the parallels we can draw from the 1990s.

It's Monday, April 8th, at 10am in New York.

Last year, we reiterated the view that the 1990s remain a useful cycle to consider for understanding the current cycle. Our European equity strategy colleagues shared our view, and they've used that episode to inform their ‘out of consensus, bullish initiation on European equities’ in January. No two cycles are identical, but as we move closer to a Fed cut, we reassess the key aspects of that comparison.

We had previously argued that the current interest rate cycle and the mid 90s cycle differ from the intervening cycles because the goal now is to bring inflation down, rather than preventing it from rising. Of course, inflation was already falling when the 1994 cycle started, in part, because of the recession in 1991.

This cycle -- because much of the inflation was driven by COVID-related shocks, like supply chains for consumer goods and shifts in housing for shelter inflation -- inflation started falling rapidly from its peak before the first hike could have possibly had any effect. In recent months, our economic growth forecasts have been regularly revised upward, even as we have largely hit our expected path for inflation.

A labor supply shock appears to be a contributing factor that accounts for some of that forecast deviation, although fiscal policy likely contributed to the real side's strength as well. Supply shocks to the labor market are an interesting point of comparison for the two cycles. In the 1990s, labor force growth was still benefiting from this multi-decade rise in labor force participation among females. The aggregate labor force participation rate did not reach its peak until 2000.

Now, as we've noted in several publications, the surge in immigration is providing a similar supply side boost, at least for a couple of years. But the key lesson for me for the policy cycle is that monetary policy is not on a pre-set, predetermined course merely rising, peaking and then falling. Cycles can be nuanced. In 1994, the Fed hiked the funds rate to 6 per cent, paused at that peak and then cut 75 basis points over 1995 and 1996. After that, the next policy move was actually a hike, not a cut.

Currently, we think the Fed starts cutting rates in June; and for now, we expect that cutting to continue into next year. But as our US team has noted, the supply side revisions mean that the path for policy next year is just highly uncertain and subject to review. From 1994 to 1996, job gains trended down, much like they have over the past two years.

That slowing was reflective of a broader slowing in the economy that prompted the Fed to stop hiking and partially reverse course. So, should we expect the same now, only a very partial reversal? Well, it's too soon to tell, and as we've argued, the faster labor supply growth expands both aggregate demand and aggregate supply -- so a somewhat tighter policy stance could be appropriate.

In 1996, inflation stopped falling, and subsequently rose into 1997, and it was that development that supported the Fed's decision to maintain their somewhat restrictive policy. But we can't forget, afterward, inflation resumed its downward trajectory, with core PCE inflation eventually falling below 1.5 per cent, suggesting that that need to stop cutting and resume hiking, well, probably needs to be re-examined.

So, no two cycles match, and the comparison may break down. To date, the rapid hikes, pause and pivot, along with a seeming soft landing, keeps that comparison alive. The labor supply shock parallel is notable, but it also points to what might be, just might be, another possible parallel.

In the late 1990s, there was a rise in labor productivity, and we've written here many times about the potential contributions that AI might bring to labor productivity in coming years.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Where Is the US Dollar Headed? May 02, 2024

Our experts discuss U.S. dollar strength and its far-reaching impact on the global economy and the world’s stock markets.

----- Transcript -----

Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research.

James Lord: I'm James Lord, Head of FX Strategy for Emerging Markets.

David Adams: And I'm Dave Adams, Head of G10 FX Strategy.

Michael Zezas: And on this episode of Thoughts on the Market, we'll discuss one of the most debated topics in world markets right now, the strength of the US dollar.

It's Wednesday, May 1st, at 3 pm in London.

Michael Zezas: Currencies around the world are falling as a strong US dollar continues its reign. This is an unusual situation. So much so that the finance ministers of Japan, South Korea, and the United States released a joint statement last month to address the effects being felt in Asia. The US dollar's dominance can have vast implications for the global economy and the world stock markets.

So, I wanted to sit down with my colleagues, James and David, who are Morgan Stanley's currency strategy experts for emerging markets and developed markets. James, just how dominant is the US dollar right now and what's driving the strength?

James Lord: So, we should distinguish between the role the US dollar plays as the world's dominant reserve currency and its value, which can go up and down for other reasons.

Right now, the dollar remains just as dominant in the international monetary system as it has been over the past several decades, whilst it also happens to be very strong in terms of its value, as you mentioned. That strength in its value is really being driven by the continued outperformance of the US economy and the ongoing rise in US interest rates, while growth in the rest of the world is more subdued.

The dollar's international role remains dominant simply because no other economy or market can match the depth of the US capital markets and the liquidity that it provides, both as a means of raising capital, but also as a store of value for investment; while also offering the strong protection of property rights, strong sovereign credit ratings, the rule of law, and an open capital account. There simply isn't another market that can challenge the US in that respect.

Michael Zezas: And can you talk a bit more specifically about the various ways in which the dollar impacts the global economy?

James Lord: So, one of the strongest impacts is through the price of the dollar, and the price of dollar debt, which have an impact beyond the borders of the US economy. Because the majority of foreign currency denominated debt that corporates outside of the US issue is denominated in US dollars, the interest rate that's set by the US Federal Reserve has a big impact on the cost of borrowing. It's also the same for many emerging market sovereigns that also issue heavily in US dollars. The US dollar is also used heavily in international trade, cross border lending, because the majority of international trade is denominated in US dollars. So, when US interest rates rise, it also tightens monetary conditions for the rest of the world. That is why the US Federal Reserve is often referred to as the world's central bank, even though Fed only sets policy with respect to the US economy.

And the US dollar strengthens, as it has been over the past 10 years, it also makes it more challenging for countries that borrow in dollars to repay that debt, unless they have enough dollar assets.

Again, that's another tightening of financial conditions for the rest of the world. I think it was a US Treasury Secretary from several decades ago who said that the US dollar is our currency, but your problem. And that neatly sums up the global influence the US dollar has.

Michael Zezas: And David, nothing seems to typify the strength of the US dollar recently, like the currency moves we're seeing with the Japanese Yen. It looks very weak at the moment, and yet the Japanese stock market is very strong.

David Adams: Yeah, weak is an understatement for the Japanese yen. In nominal terms, the yen is at its weakest level versus the dollar since 1990. And if we look in real terms, it hasn't been this weak since the late 1960s. Why it's weak is pretty easy to explain, though. It's monetary policy divergence. Theory tells us that as long as capital is free to move, a country can't both control its interest rates and control the exchange rate at the same time.

G10 economies typically choose to control rates and leave their currencies to float, and the US and Japan are no exception. So, while the while the Fed's policy rate has risen to multi-decade highs, Japan's has been left basically unchanged, consistent with its economic fundamentals.

Now, you mentioned Japanese equities, which is also increasingly important to this story. As foreign investors have deployed more cash into the Japanese stock market, a lot of them have hedged their FX [foreign exchange] exposure, which means they're buying back dollars in the forward market. The more that Japanese equities rise, the more hedges they add, increasing dollar demand versus the yen.

So, put simply, the best outcome for dollar yen to keep rising is for US rates versus Japan and Japanese equities to both keep marching higher. And for a lot of investors, this seems increasingly like their base case.

Michael Zezas: That makes sense. And yet, despite the dollar's clear dominance at the moment, the consensus view on the dollar is that it's going to get weaker. Why is that the case and what's the market missing?

James Lord: Yeah, the consensus has been on the wrong side of the dollar call for quite a few years now, with a persistently bearish outlook, which has largely been incorrect. I think for the most part this is because the consensus has underestimated the strength of the US economy. It wasn't that long ago when the consensus was calling for a hard landing in the US economy and a pretty deep easing cycle from the Fed. And yet here we are with GDP growth north of 2 per cent and murmurings of another rate hike entering the narrative. I also wonder whether this debate about de-dollarization, whereby the dollar's global influence starts to wane, has impacted the sentiment of forecasters a bit as well.

We have seen over the past three to four years much more noise in the media on this topic, and there appears to be a correlation between the extent to which the consensus is expecting dollar weakness and the number of media articles that are discussing the dollar's status as the world's major reserve currency.

Maybe that's coincidence, but it's also consistent with our view that the market generally worries too much about this issue and the impact that it could have on the dollar's outlook.

Michael Zezas: Now there've been a few notable changes to Morgan Stanley's macro forecasts over the last few weeks. Our US economist, Ellen Zentner revised up her forecast for US growth and inflation. And she also pushed back our expectations for the first Fed cut. Along with this, our US rate strategy team also revised their 10-year treasury yield expectations higher. Do these updates to the macro-outlook impact your bullish view on the dollar, both near term and longer term?

David Adams: So, higher US rates are often helpful for the dollar, but we think some nuance is required. It's not that US rates are moving; it's why they're moving. And our four-regime dollar framework shows that increases or decreases in rates can give us very different dollar outcomes depending on the reason why rates are moving.

So far this year, rates have been moving higher in a pretty benign risk environment. And in a world where US real interest rates rise alongside equities; the dollar tends to go nowhere in the aggregate. It gains versus low yielding funders like the Japanese yen, the Swiss franc, and the euro, but it tends to weaken versus those higher beta currencies with positive carry, like the Mexican peso. It's why we've been neutral on the dollar overall since the start of the year, but we still emphasize dollar strength, especially versus the euro.

If rising rates were to start weighing on equities, that would lead the dollar to start rallying broadly, what we call Regime 3 of our framework. It's not our base case, but it's a risk we think markets are starting to get more nervous about. It suggests that the balance of risks are increasingly towards a higher dollar rather than a lower one.

Michael Zezas: And finally, Dave, I wanted to ask about potential risks to the US dollar's current strength.

David Adams: I'd say the clearest dollar negative risk for me is a rebound in European and Chinese growth. It's hard for investors to get excited about selling the dollar without a clear alternative to buy. A big rebound in rest of world growth could easily make those alternatives look more attractive, though how probable that outcome is remains debatable.

Michael Zezas: Got it. So, this discussion of risk to the strong dollar may be a good time to pause. There's so much more to talk about here. We've barely scratched the surface. So, let's continue the conversation in the near future when we can talk more about the dollar status as the world's dominant reserve currency and potential challenges to that position.

James Lord: This sounds like a great idea, Mike. Talk to you soon.

David Adams: Likewise. Thanks for having me on the show and look forward to our next conversation.

Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

Decarbonizing Real Estate Apr 30, 2024

Our analysts survey the hurdles, opportunities and investment trends in energy renovation.

Please note that Laurel Durkay is not a member of Morgan Stanley’s Research department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research department and from the views of others within Morgan Stanley. We make no claim that Ms Durkay’s representations are accurate or complete.

----- Transcript -----

Cedar Ekblom: Welcome to Thoughts on the Market. I'm Cedar Ekblom, Equity Research Analyst, covering the European building and construction sector for Morgan Stanley Research.

Laurel Durkay: And I'm Laurel Durkay, head of the Global Listed Real Assets Team within Morgan Stanley Investment Management.

Cedar Ekblom: And on this special episode of Thoughts on the Market, we'll discuss the opportunities, risks, and latest investment trends when it comes to decarbonizing buildings.

It's Tuesday, April 30th, at 2pm in London.

Laurel Durkay: And 9am in New York.

Cedar Ekblom: So, let's take a step back. Picture the gleaming towers of New York, London, or Hong Kong. Now think about these buildings breathing out carbon dioxide. The built environment is responsible for about a third of all global energy consumption and CO2 emissions. And so, if we want to get to Net Zero by 2050, which means emitting as much CO2 into the atmosphere as we take out of it, decarbonizing the building stock is essential.

We've been doing a lot of work in Europe from the research side to try and understand how the investment trends are linked to this topic. But Laurel, I wanted to have you on the podcast because I wanted to understand how you're coming at it from the other side as a real estate investor and portfolio manager.

Laurel Durkay: Yeah, Cedar, so I've seen some of your notes and I actually wasn't too surprised by your conclusion that energy renovation is seeing rising investment momentum in Europe. And this is despite the high upfront costs which are driven by government regulation, build cost inflation and higher interest rates.

Cedar Ekblom: Yeah, we decided to do this work because we've had a lot of incoming from investors around what's happening from an investment perspective because we have seen a few government policy sidesteps or backtracks in the last 12 to 18 months around this topic. And so, we did some proprietary survey work in the residential, non-residential and providers of capital space. And we had some really interesting outcomes.

I think the most interesting was that despite the fact that government subsidies have been dialed back a little bit, and the cost of investment has gone up because of inflation, actually private investment is really robust. And I think it's because there is a clear economic incentive that both homeowners and non-residential building owners are actually talking to.

I mean, the first one is that homeowners are telling us that they see a 12 per cent increase in their home equity value if they green that property. And when we look at the non-residential space, what we're seeing is that renovation budgets are up 4 per cent year over year, even in a backdrop of higher interest rates.

We see a huge runway of investment to come through on this topic. It is multi-decade. It's not going to happen overnight.

You're talking about 2.8 trillion euros of investment by 2030 on our estimates, and that number extending to potentially 5 trillion euros by 2050. And that's just in Europe.

Laurel Durkay: So the scope and need for investment really is huge. What do you think are the hurdles to delivering this opportunity?

Cedar Ekblom: It's such an interesting question. I mean, there are so many. It's a little bit daunting at points when you think about it, but we're looking at really complicated projects. We're looking at skills bottlenecks. We're looking at upfront costs being really high. We're also looking at energy policy, not necessarily being aligned in every region in Europe.

So yes, it's going to cost you a lot, but basically the respondents to the surveys tend to suggest that the benefits are actually starting to outweigh those potential costs.

So, Laurel, I think that there's been some really interesting overlaps between what you and I cover, but from different angles. Let me pivot to you. How do you think about sustainability when it comes to real estate investment in your seat?

Laurel Durkay: Yeah, bottom line is that understanding and incorporating sustainability and real estate investing really is very important; and we need to be aware not only of the physical risks, but also those transition risks associated with buildings. Taking a step back, what I'm observing is that real estate is seeing the sustainability focus really play out from three different constituents, and that's from investors, from regulators, and from tenants.

So, from that investor perspective, we're seeing increasing demand for sustainable linked financing investing. Think green bonds. In some cases, you're actually seeing more favorable spreads for green financing versus traditional -- and ultimately that means better cash flows for companies.

We also have that coming from the government. What we see is a continued evolution on regulations, and there have been several real estate specific laws being adopted across the states.

All of these have the objective of providing greater transparency on carbon emissions with the ultimate goal of reducing such emissions. Now lastly, for tenants, we're seeing increasing demand for sustainable and best in class buildings.

There's actually a growing body of evidence that shows sustainability is impacting leasing decisions and resulting in rent premiums

Cedar Ekblom: So, how do we think about integrating ESG into your investment process?

Laurel Durkay: So, there's a number of different metrics that we're looking at. We've run a proprietary analysis really trying to identify the most financially material factors. And we've ultimately concluded that the most important factors to be looking at are the absolute level of emissions and then the progress towards reducing those emissions -- water and waste usage, green certified buildings -- among a number of other factors.

Ultimately, what we need to do is put together a framework that helps us assess the expenditures in order to really adhere to the regulatory requirements that I was just describing and ultimately allow the buildings to enjoy operational cost savings from implementing sustainability measures.

This is really about future proofing buildings and enhancing value.

Cedar Ekblom: So, it sounds like really a topic around trying to understand where they may or may not be stranded assets. We've spoken a lot about this topic in Europe, but maybe you could talk a little bit about what's happening from a sort of policy backdrop in the US.

Laurel Durkay: Yeah, so government really is driving a lot of this change, both at a federal and at a state level. So, from a federal perspective, it really is more of a carrot as opposed to a stick with regard to implementation and adoption, really rewarding those who embrace sustainability. Now, interestingly, from a state perspective, it's a bit more of a stick than a carrot.

Buildings not in compliance will be subject to fines and penalties. I should also mention that the SEC is getting really involved with the adoption of new climate related disclosure requirements.

Now this isn't real estate specific, but it is impactful, nonetheless. New requirements mandate companies to disclose material Scope 1 and Scope 2 greenhouse gas emissions.

Right now, less than 30 per cent of US companies even attempt to disclose Scope 3, and that's even less for real estate. Now Cedar, these scope three emissions are really where our worlds intersect most given the built environment.

So, for a typical property owner, Scope 1 emissions represent about 25 per cent. Scope 2 is about 55 per cent of their missions. And then the remainder is going to be this Scope 3. But if you look at a developer and an owner, that's where you see Scope 3 emissions range between 80 to 95 per cent of their total emissions.

Cedar Ekblom: So, if we look towards the future, what are you hearing from clients and colleagues about where sustainability investment trends go from here?

Laurel Durkay: I think the trends have to be towards reducing these Scope 3 emissions, or maybe I just I hope that's where the trend is. You really need for building developers and owners to focus on development processes, building products and materials, and you need to see innovation within that space.

Now, how about from your side, Cedar? What are you hearing from various companies you cover about the trends they foresee?

Cedar Ekblom: The building materials and products businesses are really bullish on the long-term investment horizon on this topic. And we can see that in some of the data in Europe. The new build environment is under a lot of pressure. Higher interest rates have impacted affordability, and we have some activity in new build down 20 to 30 per cent.

And yet when you look at the renovation and the refurbishment sector, we actually have a much more resilient backdrop.

So look, our companies are really bullish on this. We ultimately see this manifesting in a higher multiple for businesses linked to this theme over the medium term. In all honesty, we're really just at the beginning of this theme. We think there's a lot of runway of investment still to come and we're keeping an eye on it.

So, with that, Laurel, I'd like to say, thanks for taking the time to talk.

Laurel Durkay: It was great speaking with you, Cedar.

Cedar Ekblom: And as a reminder to our listeners, if you've enjoyed thoughts on the market, please take a moment to rate and review us wherever you listen to the podcast. It helps more people to find the show.

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