Short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
The Omicron variant of COVID-19 has investors concerned about potential new restrictions, but the onus lies most on state and local governments who, for now, are awaiting more information on infection rates and severity.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, December 1st at 11:00 a.m. in New York. Not surprisingly, our client conversations this week have been all about Omicron, the new COVID 19 variant that our biotech team thinks may increase infection rates and reduce vaccine effectiveness. In particular, clients want to know if the new variant will lead to fresh government restrictions and crimp the U.S. economic outlook. While the federal government gets much of the attention here, we think the key to sizing up this variable lies in understanding how state and local governments will behave. These are the jurisdictions that have generally driven mask mandates, indoor dining restrictions and other activities. And while there's much to learn about Omicron, here our initial assessment is that the bar is quite high for states and locals to take action, and that should limit downside risk to the economy. What drives our view? In short, ever since states began lifting restrictions in late spring of 2020, their behavior has mostly been influenced by hospital capacity. Of course, some states lifted restrictions faster than others, but in most cases where restrictions were tightened, rising COVID hospitalizations and lack of bed capacity were cited as the culprits. With the availability of vaccinations in the U.S. and the high vaccination rate among vulnerable populations, risks to hospital capacity have lessened. That's because while COVID can infect the vaccinated, they are far less likely to get sick in a way that lands them in the hospital. So that means, when it comes to sizing up if Omicron will lead to government restrictions on economic activity, it's less about whether vaccines will prevent infection, but if they can limit hospitalizations. While there's still not a lot of information, and thus outlooks could easily change as data on the new variant is collected, our biotech research team's base case is that Omicron is not more virulent than the currently dominant Delta variant. Further, the U.S. government continues to express the view that vaccines will provide protection against severe disease. Taken together, this would suggest that as long as the U.S. can sustain its vaccine campaign, including the current push for boosters, the economy may only face manageable headwinds. For fixed income investors, that means Treasury yields should still trend higher. And for credit investors, particularly in COVID sensitive municipal bond sectors like airports and hospitals, we see fundamental risks as manageable. Yet investors should probably focus intently on what would change this view, as this ‘goldilocks outcome’ is mostly in the price of credit and equity markets already. And here again, we say focus on news about Omicron's severity, which is expected within the next few weeks. If data shows it to drive both more infection and more severe sickness, then hospital capacity could be challenged, leading state and local governments to reluctantly reimpose some restrictions. And of course, consumers could react to this signal and change their own behavior - thinking twice about that next flight, for example. Yet perspective is important here, and even this negative outcome is more likely an economic setback than a disaster, as our biotech team notes that pharmaceutical companies may be able to turn around new boosters to address the challenge within a few months. That in turn means there's likely to be opportunities in credit and equity markets if this riskier case is the one that plays out. We'll, of course, be tracking it all here and checking in with you as we learn more. Thanks for listening! If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
3 min 40 sec
Last week’s news of the Omicron variant of COVID-19 has raised questions about transmissibility, vaccine efficacy, and virus mortality. Where does this variant leave us in the fight against COVID-19 and how are markets reacting?----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley Research.Matthew Harrison And I'm Matthew Harrison, Biotechnology AnalystAndrew Sheets And on this special edition of the podcast, we'll be talking about a new COVID variant and its impact on markets. It's Tuesday, November 30th at 2p.m. in London.Matthew Harrison And it's 9:00 a.m. in New York.Andrew Sheets So Matt, first things first, you know, we've seen a pretty major development over the American Thanksgiving holiday. We saw a new COVID variant, the omicron variant, kind of come into the market's attention. Can you talk just a little bit about why this variant has gotten so much focus and what do we know about it?Matthew Harrison Sure. I think there are probably three major factors that have driven the focus. The first thing is there was clear scientific concern because of the number of mutations in the variant. And specifically, there are over 50 mutations, 32 of which are in the spike protein region, which is where vaccines are targeted. And then a number in the receptor binding domain, which is where the antibodies typically tend to bind. So the antibodies that either vaccines or antibody therapies create. And what we know when we look at many of these mutations is they're present in other variants: gamma, delta, alpha, beta and we know that many of these mutations in a pair one or two have led to reduction in vaccine effectiveness. And so, when they're combined all together, from a scientific standpoint, people were very concerned about having all of those mutations together and what that would mean in terms of vaccine escape.Andrew Sheets So Matt, this is obviously a challenging situation because this is a new variant. It's just been discovered. And yet, you know, a lot of people are trying to figure out what the longer-term implications could be. So, you know, when you look at this with the kind of a limited amount of information, you know, what are the key characteristics that you're going to be watching that that you think we should care about?Matthew Harrison There are probably three things that I'm focused on and we can probably touch on in detail. So the first one is transmissibility, and the reason for that is if this variant overtakes Delta and becomes dominant globally, then we're going to care about the two other factors a lot more, which is vaccine escape and lethality. However, if it's not more transmissible than Delta and Delta remains the dominant variant, then this may be an issue in small pockets, but ultimately will fade and continue to be overtaken by Delta. And so that's why transmissibility is the primary focus. And so what do we know about transmissibility right now? We have a couple of pieces of information out of South Africa. The first is they have sequenced a number of recent COVID patients. And in those sequences, the vast majority or almost all of them have been Omicron. So that suggests that it is overtaking Delta. But again, sometimes sequence results can be biased because they're not a population sample and they're a selection of a certain subset of people. The second piece of information, which to me is more compelling, is I'm sure everybody's aware of the PCR tests. There's a certain kind of deletion here in this variant that that that you can pick up with a PCR test and so you can see the frequency of that deletion. And that that frequency has risen from about a background rate of about 5% in the last week and a half to about 50% of the PCR tests coming back suggestive of this variant in South Africa. And so that's a much bigger sample size than the sequencing sample size. And so that suggests at least in the small subset that you're seeing greater transmissibility compared to Delta. Now it's going to take time to confirm that. And now that we've seen cases globally in a lot of countries over the next week or two, everybody's going to be watching how quickly the Omicron cases rise compared to Delta to confirm whether or not it's more transmissible than Delta.Andrew Sheets This question of vaccine evasion. There's there has been some increased concern about this new variant that it might be able to evade vaccines. Why do people think that? And you know, how soon might we know?Matthew Harrison Why don't we start with the timeline, because that's the simpler part. The experiments to figure that out take about two weeks. And just so everybody has the background on this, you need to take the virus, you need to grow it up. And once you have a sample of it, then you take blood from people that have recovered from COVID and blood from people that have been vaccinated that are full of those antibodies. And you put them in the in the dish and you find out how much virus you kill. And that'll tell you how effective the serum from vaccinated or previously infected individuals are against the new variant. So that process typically takes about two weeks. So then why are people worried about vaccine evasion with this variant? Primarily because of the known mutations that it carries and the unknown mutations. And of the known mutations that it carries, it carries the same set of mutations as in beta, and the beta variant had significant vaccine evasion properties that never became dominant, but it did reduce vaccine effectiveness by about six-fold. And so, I think the concern is with those mutations, plus a range of other mutations known to have vaccine evasion properties, having them all together has really significantly increased concern about how much that may hurt the vaccine's ability to stop infection.Andrew Sheets And, Matt, so you talked about the importance of transmissibility, you know, you talked about some of the reasons why the concerns are higher around vaccine evasion with this variant. And the last thing you talked about was the lethality of this variant. And again, you know, what are you looking for there? Is there anything that concerns you with the information that we know and when might we know more?Matthew Harrison So this is the hardest question because as is typical, you get a lot of anecdotal reports about what's happening with recently infected patients, but it takes a while, on order of four to five weeks, to really understand if there is a significant difference in mortality or hospitalization. So we have very little information around those factors. You have seen in the capital region, in South Africa, where you've where you've seen these rising cases, a rise in hospitalizations, but we don't know if all those cases are Omicron cases or not. And we haven't seen mortality at all. But again, with recent infections, it usually takes four or five weeks to start to see the potential impact of those infections on mortality.Matthew Harrison And Andrew, I think one other thing which is important to mention is while we're while we're talking about severity of disease and lethality, we have to remember that in addition to vaccines, we do have now other effective treatments, including antibody therapies and oral therapies. And while some antibody therapies are likely not to work against Omicron, at least two or three of them are. And so you have you will have some effective antibody therapies. And then the oral therapies, given their mechanisms of action, should not be impacted. So we will have oral therapies in terms of treatment. So hopefully, even if we do get a scenario where there is significant impact on vaccine efficacy, this will not be like going back to the beginning of the pandemic, where we didn't have other effective treatments available.Matthew Harrison Andrew, unlike normal episodes, maybe it'll be my chance since the markets have been so volatile. How has this impacted your outlook on the markets in the near to medium term?Matthew Harrison I know inflation and the inflation debate and the impact of central banks on inflation has been a sort of key debate that I've heard you guys reflecting on.Andrew Sheets Yeah. So I think probably the thing I should say up front is at the moment, we don't think we have enough evidence around this variant to change our baseline economic forecast to change that optimistic view on growth. Now what it might change is some of the timing around it, and I think we saw a little bit of this with the Delta variant. Where, you know, that was a big development in 2021, you know, people didn't see that coming. And you know, if you step back and think about this year, the market was still good, yield still rose, there was a lot of market movement, very consistent with better economic growth if you take the year as a whole, even though you had this variant, but the variant did introduce some kind of twists and turns along the way. So you know, that's currently the way that we're thinking about this new omicron variant that it is not likely or we don't know enough yet to be confident that it would really change that economic outlook, especially because we think there are a lot of good reasons why growth could be solid, but it might introduce some near-term uncertainty. You know, the interesting thing about, as you mentioned, inflation is that it could affect inflation in both directions. It could cause inflation to be higher, for example, if it, you know, causes shutdowns in countries that are important for producing key goods. And you can't get the things that you want, and the price goes up. But it could also drive prices down. You know, on last Friday oil prices fell by over 10%. You know, that is a big part of inflation certainly as most people experience it. Gas prices will be lower based on what happened on Friday. So that can drive inflation down so it can cut both ways.Matthew Harrison Andrew, it's been great talking to you. Thanks for your thoughts.Andrew Sheets Matt, always a pleasure to talk to you.Matthew Harrison As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.
9 min 22 sec
With last week’s news of the Omicron variant of COVID-19, markets sold-off sharply on Friday, but beyond the headlines, there may be other underlying factors at play.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 29th at 1:00 p.m. in New York. So let's get after it. Last week, the big news for markets was this new COVID variant named Omicron. While we don't yet know the characteristics of this variant with respect to its transmission and mortality rates, some nations are already acting with new restrictions on travel and other activities. These new restrictions is what markets were fearing the most on Friday, in our view. I'm also confident that markets were already expecting some seasonal increases in cases as we enter the winter months. This is why I'm not so sure Friday's sharp sell-off in equity markets was as much about Omicron as it was just a market looking for an excuse to go lower. In fact, equity markets had already been weak heading into Thanksgiving Day - a period that is almost always positive for stocks. This was before Omicron was a real concern, so why would that be the case? As we laid out in our year-ahead outlook, the combination of tightening financial conditions and decelerating growth is usually not bullish for stocks. When combined with one of the highest valuations on record, this is why we have a very unexciting 12-month price target for the S&P 500. Finally, as discussed on this podcast for the past 6 weeks, stocks typically do well from September to year end if they are already up until that point. However, we felt like that seasonal trade would be tougher after Thanksgiving, as the Fed began to taper its asset purchases and institutional investors moved to lock in profits rather than worrying about missing out on further upside. With retail a large buyer during Friday's sharp sell-off, it appears that the institutional investors were the ones selling. In short, it looks like that switch to locking in profits may have begun. Today's bounce back also makes sense in the context of a market that understands Omicron is probably not going to lead to a significant lockdown. In fact, we're already hearing reassuring words from the authorities making those decisions. The bottom line is that markets were already choppy, with many higher beta indices and stocks trending lower before this latest COVID variant. Breadth has also been weak, with erratic leadership. High dispersion between stocks is another market signal that suggests the rising tide may be going out. Our view remains consistent - the investment environment is no longer rich with opportunity, which means one must be more selective. In a world of supply shortages, we favor companies with high visibility on earnings due to superior pricing power or cost management. We also think it makes sense to be very attendant to valuation and not overpay for open ended growth stories with questionable profitability. From a sector standpoint, Healthcare, REITs and Financials all fit these characteristics. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
3 min 1 sec
The Build Back Better Act took a key step towards becoming law last week, signaling implications for fiscal policy and taxation as the bill heads to the Senate.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 24th at 11:00 a.m. in New York. Last week, the Build Back Better Act took a step toward becoming law when the House of Representatives passed the bill along party lines. While the act now still needs to win Senate approval, likely with some substantive changes, there are two lessons that we learned from the House's actions. First, U.S. fiscal policy will continue to be expansionary in the near term. That's based on analysis from the Congressional Budget Office of the Build Back Better plan, adjusted for some key provisions that likely won't survive the Senate. When added to the analysis of the recently enacted Bipartisan Infrastructure Framework, it shows the combined plans could add around $200B to the deficit over 10 years - close to our base case of about $260B. But more importantly, the analysis suggests most of this deficit increase is front loaded, with around $800B of deficits in the first 5 years - toward the high end of the base case range we flagged earlier this year. This is the number we think matters to the economy and markets, as the durability of the policies that will reduce this deficit beyond 5 years is less certain, as elections can lead to future policy changes. And this number also helps drive some key views, namely our economists' call for above average GDP next year and our rates teams' view that bond yields will continue to move higher. Our second lesson is that the corporate minimum tax looks like it has legs. The provision, also called the Book Profits Tax, survived the house process largely unscathed. While Senate modifications are to be expected, we expect the provision will be enacted. That means investors will have to get smart on the sectoral impacts of this new, somewhat complex, corporate tax. Our base case is that this won't be a game changer for markets. Our equity strategy team calculates a 4% hit to S&P 500 earnings before accounting for any economic growth. And while some sectors, like financials, appear most likely to have a higher tax bill, our banks analyst team expects most of this new expense can be offset by tax credits. Still, this new tax is tricky and untested, so fresh risks can emerge as the bill goes through edits in the Senate. So, we'll be tracking it carefully into year end. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
2 min 40 sec
Our 500th episode! From all of us at Morgan Stanley, thanks to our listeners for all your support!An overview of our expectations for the year ahead across inflation, policy, asset classes and more. As with 2021, we expect many twists and turns along the way.----- Transcript -----Welcome to the 500th episode of Thoughts on the Market. I'm Andrew Sheets, and from all of us here at Morgan Stanley, thank you for your support. Today, as always, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Tuesday, November 23rd at 2:00 p.m. in London. At Morgan Stanley Research. We've just completed our outlook for 2022. This is a large, collaborative effort where all of the economists and strategists in Morgan Stanley Research get together and debate, discuss and forecast what we think holds for the year ahead. This is an inherently uncertain practice, and we expect a lot of twists and turns along the way, but what follows is a bit of what we think the next year might hold. So let's start with the global economy. My colleague Seth Carpenter and our Global Economics team are pretty optimistic. We think growth is strong in the U.S., the Euro area and China next year, with all three of those regions exceeding consensus expectations. A strong consumer, a restocking of low inventories and a strong capital expenditure cycle are all part of this strong, sustainable growth. And because we think consumers saved a lot of the stimulus from 2021, we're not forecasting a big drop off in growth as that stimulus fails to appear again in 2022. While growth remains strong, we think inflation will actually moderate. We forecast developed market inflation to peak in the coming months and then actually decline throughout next year as supply chains normalize and commodity price gains slow. Even though inflation is moderating, monetary policy is going to start to shift. Ultimately, we think moderating inflation and some improvement in labor force participation means that the Fed thinks it can wait a little bit longer to raise interest rates and doesn't ultimately raise rates until the start of 2023. For markets, shifting central bank policy means that the training wheels are coming off, so to speak. After 20 months of unprecedented support from both governments and central banks, this extraordinary aid is now winding down. Asset classes will need to rise and fall or, for lack of a better word, pedal under their own power. In some places, this should be fine. From a strategy perspective, we continue to believe that this is a surprisingly normal cycle, albeit one that's moving hotter and faster given the scale of the drawdown during the recession and then the scale of a subsequent response. As part of our cross-asset strategy framework, we run a cycle indicator that tries to quantify where we are in that economic cycle. We think markets are facing many normal mid-cycle conditions, not unlike 2004/2005. Better growth colliding with higher inflation, shifting central bank policy and more expensive valuations. Overall, we think that those valuations and this stage of the economic cycle supports stocks over corporate bonds or government bonds. We think the case for stocks is stronger in Europe and Japan than in emerging markets or the US, as these former markets enjoy more reasonable valuations, more limited central bank tightening and less risk from legislation or higher taxes. Those same issues drive a below consensus forecast here at Morgan Stanley for the S&P 500. We think that benchmark index will be at 4400 by the end of next year, lower than current levels. How do we get there? Well, we think earnings are actually pretty good, but that the market assigns a lower valuation multiple of those earnings - closer to 18x or around the average of the last 5 years as monetary policy normalizes. For interest rates and foreign exchange, my colleagues really see a year of two parts. As I mentioned before, we think that the Fed will ultimately wait until 2023 to make its first rate hike, but it might not be in any rush to signal that action right away, especially because inflation remains relatively high. As such, we remain positive on the U.S. dollar and think that U.S. interest rates will rise into the start of the year - two factors that mean we think investors should be patient before buying emerging market assets, which tend to do worse when both the U.S. dollar and yields are rising. We forecast the U.S. 10-year Treasury yield to be at 2.1% by the end of 2022 and think the Canadian dollar will appreciate against most currencies as the Bank of Canada moves to raise interest rates. That's a summary of just a few of the things that we think lie ahead in 2022. As with 2021, we're sure they're going to be many twists and turns along the way, and we hope you keep listening to Thoughts on the Market for updates on how we see these changes and how they impact our market views. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
4 min 33 sec
With the release of our outlook for the coming year comes a cycle of feedback and debates from clients and investors. We look at those discussions around equity markets, valuations, and more in 2022.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 22nd at 11:30 a.m. in New York. So let's get after it. Last week, we published our outlook for 2022 and spent a lot of time discussing it with investors. This week, we share feedback from those conversations where there is agreement and pushback. Our first observation is that there wasn't as much engagement as usual. Part of this may be due to the fact that our general view hasn't changed all that much, leaving us with an unexciting overall price target for the main U.S. indices. We also sense there's a bit of macro fatigue setting in, with many investors struggling to generate alpha in what appears to be a runaway bull market for the S&P 500 - the primary U.S. equity benchmark for most asset managers. This lines up with one of our key messages for the upcoming year - focus on the micro and pick stocks if you want to outperform. As the economic recovery matures, more companies are struggling with the imbalances created by the pandemic. To us, this generally means focus on earnings stability and superior execution skills as key factors when identifying winning stocks from here. Going back to our conversations, there's a broad agreement with our more recent tactical view that U.S. equity markets are ahead of the fundamentals, but they can stay elevated in the near-term given incredibly strong flows from retail, systematic strategies and buybacks. Furthermore, pressure to keep up with the benchmarks is curtailing willingness to de-risk early. While there are signs of deterioration under the surface with many individual companies suffering from inflation pressures, supply bottlenecks and even demand destruction in some cases, the S&P 500 earnings forecasts are still moving higher, albeit at a slower pace. More specifically, we are witnessing weak breadth as the major averages make new highs. Most clients feel that in the absence of an outright decline in earnings forecasts, seasonal strength can maintain the market's elevated levels and there's no reason to fight it. Having said that, while there is agreement valuations are currently rich, the primary push back to our outlook for next year is that we are too bearish on valuation. While many investors we speak with think 2022 will be more challenging than this year, most still expect US equity indices to deliver 5-10% returns over the next year, while we project flat to slightly down returns in our base case. The primary difference of opinion is on valuation, which appears vulnerable, in our view, to tightening financial conditions and a more uncertain range of outcomes in the economy and earnings over the next 6 months, and that should lead to higher risk premiums or lower valuations. The other key debate with clients center on the strength of the US consumer. Recent macro data like retail sales, and micro data from strong consumer earnings in the third quarter, suggests that consumers remain ebullient into the holidays. This is very much in line with the survey that we published two weeks ago - the same survey that suggests this strength may not be sustainable into next year due to weakening personal financial conditions from higher inflation. Our analysis and comparison of the Conference Board and University of Michigan consumer confidence surveys appear to support a deterioration into next year - a key reason we are underway the consumer discretionary sector despite strength into the holidays. Bottom line, U.S. equity markets have delivered another stellar year of returns, which is typical in the second year of an economic recovery. However, given the speed of this recovery and record returns over the prior 18 months, we thought it was prudent to reduce our equity exposure back in early September. While our timing on that risk reduction was wrong, higher prices, driven mostly by higher valuations, only make the risk/reward for 2022 worse, not better. In short, stick with larger cap, higher quality stocks at reasonable valuations. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
Andrew Sheets continues his discussion with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022, what’s misunderstood and where it could be wrong.----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.Seth Carpenter And I'm Seth Carpenter. I'm Morgan Stanley's Chief Global Economist.Andrew Sheets And on part two of the special episode of Thoughts on the Market, Seth and I will be continuing our discussion on the 2022 outlook for the global economy and how that outlook could impact markets in the coming year. It's Friday, November 19th at 5:00 p.m. in London.Seth Carpenter And if it's five pm in London, it's noon in New York.Andrew Sheets Seth, you speak to a wide variety of clients, and this topic of the supply chain, you know, keeps coming up in a variety of formats. It comes up in our financial discussions. It comes up in the popular press. Is there a part of this story that you think is poorly understood or maybe misunderstood, you know, amidst all this focus of supply chain stress?Seth Carpenter I think I'd point to two key areas where maybe there could be a little bit more attention focused. The first one, and I was sort of talking in these terms before, is the difference between the price level and inflation. Now, if I am at the store and I'm looking at milk on the shelf, all I care about is the price level itself: is milk more expensive than it was before? Is the price high? When the central bank, when investors look at prices, they're actually measuring inflation, the rate of growth of those prices. And I think that key distinction is one of the big parts here. If supply chains stop getting worse, then it seems like in general, at some point the price level should stop going up. It'd still be a high price and it'd still be unpleasant for consumers. But the inflation on that would end up being zero. And I think that difference between growth rates and price levels is one thing that probably deserves a little bit more scrutiny.Seth Carpenter And I think the second part is-- I'm going to use an economics type term here-- how non-linear some of these effects are. And so what do I mean there? If you think about the auto industry, which has been in the news a lot for having a shortage of microchips, for example. But suppose you had a car that had 95% of the parts already assembled, 5% were missing. That's not a car. That's spare parts. Suppose you had a hundred cars that were 95% done. In a linear version of the world, 95% of one hundred is 95 cars. But you still really just have a pile of spare parts at that point. And so it's not as though you get proportional reduction in output. You can get all of the output disrupted for one of just a few parts. I'm curious to see how it resolves on the other side. Does it turn out then that all of a sudden, we're faced with a glut of extra products because those few missing parts are now delivered and so all of a sudden that final assembly can get done and we have a lot. I don't know what the answer is. We've assumed that it's much smoother than that when things unwind, but there really is a lot of uncertainty here.Andrew Sheets So, Seth, the last 18 months have been really hard. But you know, you could maybe argue that for the Fed, its decisions have been somewhat easy. And we've seen the Fed and other central banks take extraordinary action. But, you know, now the Fed, the European Central Bank, you know, a lot of these central banks are now coming under a lot more pressure on the one side to say, you know, inflation's now picking up, you're making a mistake to, you know, the economy still not normal. It still needs a lot of support. How do you see those debates playing out? And how do you think some of that ultimately resolves itself next year?Seth Carpenter I mean, debate is exactly the right word, and I love to note to clients that my job used to be to argue over what should happen with policy but now my job is just to think about what's likely to happen. And there I turn to the policymakers themselves, and so when I think about Chair Powell, I think about the fact that they announced a tapering of their asset purchases, and he said he expects that to run through the middle of next year. He also said that he expects inflation to come down, but he doesn't expect it to materially come down until Q2 or Q3 of next year. In that context, that to me says he's probably waiting for a while to see how the data resolve themselves.Seth Carpenter What I've also heard Chair Powell say is that their conditions for raising short term interest rates is both having inflation doing what they want it to do, but also full employment. And he's tried to give a few different measures of full employment means to them. It's not just the measured unemployment rate, but it's also people getting jobs. It's also people who have left the labor market coming back into the labor market. And so in the forecast that the US economics team has, inflation is coming down over the course of 2022, labor supply measured by the labor force participation rate in their forecast is going up. And so when the US economics team puts those two together and thinks about how Chair Powell has characterized the Fed's decision making process, they come to the conclusion that it seems natural to think that he's going to want them to wait at least through the end of 2022 and right at the beginning of 2023 before starting to raise short term interest rates. Now you're our cross asset strategist and so you know for a fact that markets have been pricing lots of other things.Andrew Sheets And Seth, it's fair to say that's probably one of our more controversial assumptions for next year, this idea that the Federal Reserve doesn't end up raising interest rates in 2022, even though that is, as you mentioned, what the market's currently expecting.Seth Carpenter Correct. It's definitely a place where we are out of consensus. And I think as we got the recent consumer price index report that showed still quite high inflation. And as markets start to look for, you know, the next couple of months where there's inflation prints go, I think the market is expecting inflation to stay high for sufficiently long that Chair Powell and the Fed change their minds. And that clearly could happen.Andrew Sheets Seth, the thing I wanted to close with was, you know, a real central part of our research process at Morgan Stanley-- and this is true in strategy and economics down to our stock analysts-- is to not just try to think about a likely base case, but also think about a bull and a bear case around it. Kind of realistic, good and bad scenarios that could happen over the next 12 months. So let's get the bad news out of the way. If you think about a realistic bad case for the global economy next year, what does it look like and what gets us there?Seth Carpenter Wow. So this is where I have to admit, being my first time in this outlook process, I may have tipped the apple cart over just a little bit because I threw the team a curveball and I said there are actually two key ways that I could be disappointed in the global economy. And the first one is a worse outcome for the supply side. That is our assumption that supply chains get better over time. That might not happen, right? That might stay bad for longer, we might have more frictions in the labor market than we expect. In that version of the world, we likely get both weaker economic growth than we think and higher inflation than we forecast because the supply disruptions would feed into sustained inflationary pressures that keep those price prices rising and rising and rising over time as supply chains get worse. And at the same time, we could easily see, under those circumstances, central banks globally shifting towards tighter monetary policy. If we get much higher inflationary outcomes than we currently forecast we're just going to see more tightening. And so you get that double whammy of less production, less economic activity because supply disruptions and also tighter financial conditions. And so that's an outcome that we can't rule out. And that's troubling.Seth Carpenter On the other hand, we could be wrong about the lack of a fiscal drag in the United States. We could be wrong about how much fiscal support there is going to be in Europe, for example. We could be wrong about how the Chinese economy recovers from the recent slowdown. And so we could have a demand side bear case, a demand side worse outcome. In that case, though, the world looks a little bit more normal the way, you know, markets and economists would have thought about these things pre-pandemic, i.e. slower growth, lower inflation. In that version of the world though central banks tend to sit back, I think, and wait to see how things turn out. But that, I think, is a really good illustration of just how much uncertainty there is right now. There's a version of the world where we have worse growth and higher inflation. There's a version of the world where we have worse growth and lower inflation. And I have to admit I spent some time wringing my hands, worrying about each of them.Andrew Sheets And finally, Seth, to end on a high note, what's the most realistic, positive case for the global economy next year and how could we get there?Seth Carpenter Andrew, you know, I'm an economist, which means that I'm uncomfortable being cheerful, but I'll give it a shot. So those global supply disruptions, the sort of inability of consumer goods to sort of flow to market as fast as people want to buy them, the restrictions on commodity production that have led to the really high prices. I have to believe there's a version of the world where that all gets resolved much more quickly. Right? Where all of those partially produced goods that only need one or two extra spare parts, that ship arrives, those spare parts come in, and then all of a sudden, we've got a glut of supply instead of a shortage of supply. I think in that version of the world, we have a really virtuous cycle. A couple of things happen. One, inflation starts to come down much more quickly because there's much more availability of all those goods that people are looking to buy. Second, there's a lot more availability of all those goods that people are willing to buy. And so as a result, you can have that economic activity picking up. I think at the same time, in the same spirit of a better supply outlook, the labor supply could fix itself more quickly. In which case wage pressures start to ease a little bit, people feel more comfortable coming back to the labor market. Maybe that's because of the increasing vaccinations, especially among children. Maybe it's because we get past the winter and we have a milder winter when it comes to the to the pandemic. All of those sort of supply things, both physical goods and greater supply and more labor supply-- if those happened together than we should have faster growth. But as it turns out, a bit less in the way of inflationary pressures. And so that really would be sort of a fantastic outcome.Andrew Sheets We'll have to stay tuned. Seth, thanks for taking the time to talk.Seth Carpenter I have to say, Andrew, it's always my pleasure to get to talk to you.Andrew Sheets Thanks for listening. If you enjoy thoughts on the market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.
9 min 54 sec
Andrew Sheets speaks with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022 and how consumer spending, labor, and inflation contribute to that story.----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.Seth Carpenter And I'm Seth Carpenter. I'm Morgan Stanley's Chief Global Economist.Andrew Sheets And on part one of this special episode of Thoughts on the market, we'll be discussing the 2022 outlook for the global economy and how that outlook could impact markets in the coming year. It's Thursday, November 18th at 5:00 p.m. in London.Seth Carpenter And that makes it noon in New York City.Andrew Sheets So, Seth, welcome to Thoughts on the Market. You are Morgan Stanley's new chief global economist and, while we've just sat down to work on our year ahead outlook and we're going to discuss that, I was hoping you could just give listeners a little background around yourself and what brings you to this role?Seth Carpenter Thanks, Andrew. This has been a great experience for me working on the outlook as my introduction to Morgan Stanley. I guess I've been here just a few months now. Before coming to Morgan Stanley, I was at another big sell-side bank for a few years, spent a little time on the buy-side. But most of my career, I have to say, I spent in Washington DC. I spent 15 years of my career at the Federal Reserve working on all sorts of aspects about monetary policy. And then I spent two and a half years at the U.S. Treasury Department. So, I'm really, really a product of Washington more than I am Wall Street.Andrew Sheets Well, that's great. And so well, let's get right into it because, you know, this is a big collaborative process that you and I and a lot of our colleagues work on. And so let's start with that global economic picture. You know, as you step back and you think about our expectations, how good is the global economy going to be next year?Seth Carpenter Yeah, I have to say our economics team around the world is actually fairly optimistic-- call it bullish-- relative to consensus. When I think about the global economy, clearly the two biggest economies are the U.S. and China. And so starting with the U.S., Ellen Zentner, our chief U.S. economist, has an outlook that the U.S. economy is going to slow down next year, but boy, still be going kind of fast. Right around four and a half percent, which is, you know, slower than the growth rate that we're getting this year, but still a really, really solid growth for the for the year as a whole. And I think in that there's a lot of things going on. We're still getting lots of job gains and the more job gains we have, the more consumer spending we get. And of course, consumer spending, that's 70% of US GDP. I think as well, we're looking forward to there being a big restocking of inventories. I think everyone has heard about the global supply chain issue and inventories in the United States in particular are very, very lean. And so we're looking for a bit of an extra boost to the economy coming from that inventory restocking. So it's a pretty optimistic case; slower than this year, to be sure, but still a pretty optimistic outlook.Andrew Sheets And Seth, what about that other big driver of the global economy, China? How do you think its economy looks next year?Seth Carpenter Robin Xing is our chief China economist, and he is also similarly a bit optimistic relative to consensus. Deceleration, to be sure, from where we were before COVID. But five and a half percent growth is still going to put our forecast, you know, higher than most other people making these sorts of forecasts. And there, when I talked to Robin, what he tells me is, you know, there was a slowdown in the Chinese economy this year in Q3, but a lot of that was policy induced as the policymakers in Beijing are trying to take another step in reorienting the Chinese economy. And because the slowdown was policy induced, we're going to get a recovery that's also policy induced. And so, he's actually pretty constructive about how growth for next year is going to turn out.Andrew Sheets So Seth, one question about the economy next year is, well, in 2021, we had all of this fiscal support, all this government support for growth and that's not going to be there in the same way. And you hear a lot about this concept of the fiscal cliff of the government support that was there falling away and even reversing and being a drag on growth. How do you square that with what seemed like pretty optimistic economic projections from our side?Seth Carpenter So here's how the US team would talk about it. When we think about what drove the fiscal policy this year, what drove the high deficit this year, a lot of it was income replacement. Many people had lost their jobs, many people were out of work and government transfers were replacing a fair amount of that income. And so as we move into next year, we're already seeing many of those jobs coming back, to be sure, not all of them yet. But in the forecast, jobs keep coming back and with it, labor income. And so what the government support had been doing, in part, was providing income to allow spending to go on in 2021. Next year in the forecast, it's labor income that allows the same type of spending to go on. And so as a result, there's no discrete step down that's coming from that removal of fiscal policy. And moreover, I think one thing that avid readers of economic data will know is that the saving rate i.e. how much of current income is being spent versus being saved. The saving rate is actually quite elevated. And part of that is this government transfer of income, not all of it being spent in the current period. Well, the US team says we're going to take some of that excess savings and assume that a portion of it actually gets spent in 2022. So that's another factor that's going to reduce the likelihood of us having a fiscal drag the way other forecasters probably have in their numbers.Andrew Sheets Seth, another concern that comes up a lot in these conversations is around the i-word: inflation. You know, you and I and some of our colleagues just did a large webcast for many of our investment clients. And I think without exaggeration, maybe 80% of the questions were in in some way related to inflationary risks and the inflationary backdrop. So, you know, we think growth is going to be good next year-- it might be better than expected-- but what does that imply for the inflation outlook and, how big of a risk is it that inflation is eating away at the spending power of the consumer and other parts of the economy?Seth Carpenter No question that inflation is sort of the key question in macro these days and into next year. And I think there is a real risk that high prices end up eating into purchasing power. It's clear that people who are on fixed income, people who are at the lower end of the income distribution, when the price of gasoline is going up, when the price is food is going up, that's very, very real for those people and it can affect how much extra discretionary spending they have. So I think that that clearly matters a lot. And I think one of the challenges between being an economist, thinking in terms of the technical data side of things, versus communicating to a broader audience is that inflation is about the rate of change of those prices, as opposed to what regular people see every day, which is the level of those prices. So in our-- in the forecast the US team has there are a lot of those prices that actually stay high, but the rate at which they go up in the forecast actually peaks at the beginning of 2022 and then starts to come down. It starts to come down for a few reasons. First: oil. If we look at the futures curve, looks as if oil prices should probably peak around December and then gradually come down over the course of next year. I think in addition to that, everyone has been talking about the global supply chain sort of bottlenecks in terms of consumer goods getting to consumers being a real challenge now takes time. It's proven to be quite durable so far. The maintained assumption that the economics team around the world had was the following: that those supply chain frictions-- be it the Port of Los Angeles and shipping containers, be it semiconductor production in East Asia, the whole kit and caboodle-- goes back to something that looks like normal at the end of 2022. But what that means in the forecast is things are about at their worst now, start to get better at the beginning of the year, and then take the whole year to get better. But if that's the case, then the easier access to the consumer goods should mean that prices on those consumer goods that have been going up so dramatically should probably stop going up sometime around the beginning of the year. And in fact, maybe start to go back towards more normal levels over time. So that's what's in the forecast.Andrew Sheets Seth, another thing I was hoping to ask you about as it relates to inflation is, you know, how much of this with your global hat on is a global phenomenon versus, you know, some more specific, idiosyncratic things related to the U.S. economy. You know, when you when you look across some different regions, some other major markets, are they having similar inflationary dynamics? Is it different? And importantly, could we see more divergence in the inflation picture going forward into next year?Seth Carpenter Oh, absolutely. So, looking across different countries, there's unquestionably a global component to this inflationary surge. I think what can differ, though, is how that inflationary impulse is transmitted to to different economies over time. So, you know, we've talked through our views on what happens in the United States. And in countries where you tend to have more of a history of high and variable inflation, it's easier for those sort of pricing pressures to spread to other components. Add to that in countries where if it's a small, open economy with a floating exchange rate, you can easily imagine that country's currency could decline a bit in value, which means all of their imported goods are more expensive as well, which then leads to more inflation. So clearly a common shock. The net effect across economies, though, can be quite different. I'd say one component that's a bit different in the United States than others is the structure of our of our labor market. In a lot of European countries, there was a mechanism put in place, a policy put in place to essentially try to freeze people in place attached to their employer; in the U.K. they call it 'the furlough scheme.' In the United States there was no similar specific plan that was covering the entire country. That friction in the labor market is quite difficult to overcome. And we're seeing some of that show through by, in some cases, businesses needing to pay more to attract new workers. And so, like I said, a clear common global shock, but the transmission varies by country.Andrew Sheets Thanks for listening. We'll be back in your feed soon for part two of my conversation with Seth Carpenter on the outlook for the global economy in 2022.Andrew Sheets And as a reminder, if you enjoy thoughts on the market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.
9 min 55 sec
This week’s meeting between President Biden and President Xi was not a return to an earlier phase of relations between their two countries. Instead, it suggested the normalization of a sort of ‘competitive confrontation’ that investors and markets may have mixed feelings about.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 17th at 11:00 a.m. in New York. Earlier this week, U.S. President Biden and China President Xi met virtually to discuss the relationship between their two countries. A broad array of security and economic issues were discussed, and the readouts from both countries following the meeting were generally respectful. In many ways, this was a marked contrast from the rancor between the two parties for the last few years. Yet investors expressed to us disappointment with the outcome. They were looking for tariff rollbacks and other signs of a reversion to the US/China relationship that preceded the Trump administration. To those investors, our message is that there's a new normal to embrace for the US and China. And it's neither wholly positive, or negative, for markets and the economy. In short, investors should get comfortable with the US/China relationship as one of intense competition, rather than the laissez faire economic competition that the U.S. engages in with its allies. In fact, we call the US/China dynamic a 'competitive confrontation'. That means both sides are urgently trying to enact policies that preserve their economic and national security ambitions, without creating chaos through wholesale de-linking of their intertwined economies or direct military confrontation. In short, it's complicated. But the motivation is high to follow this path. In the U.S., for example, there's still a bipartisan consensus that the U.S. should be pursuing tougher China policies, and that impulse likely only gets stronger in 2022 - a midterm election year. So if you know this dynamic, it becomes easier to understand why the U.S. hasn't moved to reduce tariffs on China, even if that could ease inflation pressures. Even if the Biden administration would prefer those tariffs didn't exist, they may view reducing them now as short sighted, particularly when they need more time to develop more precise non-tariff tools, and since China continues to fall short on its commitments under the phase 1 trade deal. So those looking to the US/China dynamic to ease inflation pressures and perhaps reduce bond yields, we think will continue to be disappointed. As will those looking for an easing of export restrictions and other non-tariff barriers that have crimped key equity sectors, like semiconductors. But it's not all challenges here. Over time, we think the U.S. and China can get to a dynamic we call ‘constructive competition.’ Both sides will have developed rules of engagement they think preserve their security goals, minimizing trade disruptions and allowing the reduction of blunt force tools like tariffs. At this point, of course, inflation may have already eased, but the impact could be a clearer pathway for international expansion for equity sectors which are increasingly using sensitive technologies, like automobiles. We'll be tracking the transition here and report to you as opportunities emerge. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
3 min 12 sec
The housing market has seen record home price growth this year. But who does this boom benefit and who gets left behind?----- Transcript -----Jim Egan Welcome to Thoughts on the Market. I'm James Egan, co-head of U.S. Securitized Products Research from Morgan Stanley,Sarah Wolfe and I'm Sarah Wolfe from the US economics team, focused on the U.S. consumer.Jim Egan And on this edition of the podcast, we'll be talking about the impact of the housing boom on America's low-income households. It's Tuesday, November 16th, 10:00 a.m. in New York.Jim Egan Regular listeners of the podcast have probably heard me talking with my colleague Jay Bacow about the record level of home price growth that we've seen this year. And we've talked about it from a number of different angles: how high can home price appreciation actually climb? How sustainable is this current level of growth? What's the aftermath going to be? But today, Sarah, you and I are going to be approaching this from a slightly different angle, and we're going to talk about the impact of rising home values on low-income households. So, what were some of the big questions behind your recent research, Sarah?Sarah Wolfe So there's been a lot of discussion this year, as you mentioned, around rising home prices, rising rents and the extremely healthy housing environment. So, we wanted to look at what this meant for households all across the income distribution and, in particular, what it meant for low-income households. There's been a lot of focus on how low-income households are going to fare as we move off of fiscal stimulus - I'm talking about the unemployment insurance benefits, the economic impact payments - and so we wanted to explore real estate wealth as a potential source of equity for this group in order to make the transition away from government stimulus into a more recovery part of the economy easier or not. And so that's really the focus of this report.Jim Egan All right. Now you've spent a lot of time talking about the low-income consumer. We've got the kind of excess savings narrative across the consumer in aggregate. I know that that is appearing in the low-income consumer a little bit, but maybe not as much as further up the spectrum. Can you dig into that for us a little bit? How is the low-income consumer performing right now?Sarah Wolfe So overall, the low-income consumer over the last year and a half has performed very well, and that's because we've seen an unprecedent amount of fiscal stimulus. We've also seen strong job growth among low-income industries, including retail trade, leisure and hospitality. These are where the jobs are coming back. And we're also seeing pretty strong wage growth for low-income workers. And then at the same time, there was a pretty significant pullback in spending like dining out and other services. So together we got this buildup of excess savings and, low-income households had savings as well, and there was excess savings held all across the income distribution. While this is really significant, it's important to know that the dollar amount of excess savings held among lower income households is not that significant. And they also have a higher marginal propensity to consume out of their savings. So, while the savings is there, it likely will not last long. And so, it's not going to be a longer-term source of wealth, and that's why we decided to turn our attention to real estate wealth. Will this be a potential long-term source of wealth and significant for this group of consumers?Jim Egan OK. So, when you looked into housing wealth and particularly for low-income consumers, what did you find?Sarah Wolfe Well, low-income homeowners have actually seen their real estate wealth increased by roughly $18,000 per household. That's from the end of 2019 through mid-2021. Now, in dollar terms, that's less than the rise in real estate for higher income groups. But in percentage change, it's a 19% increase in real estate wealth among low-income homeowners. And that's the largest percentage increase across the entire income distribution when it comes to real estate wealth.Sarah Wolfe So, there's clearly been a substantial amount of real estate wealth for homeowners, but it leads me to ask the question, can they actually access that wealth?Jim Egan That is probably the question we get asked most frequently. The record rise we've seen in home prices has brought equity in the U.S. housing market to levels we haven't seen. We have data going back over 26 years. We've never had more equity in the housing market than we do right now. Part of that's because this rise in home prices just was not accompanied by the rise in mortgage debt that we saw in the early 2000s, the last time home price growth was really anywhere close to where it is right now. So, the question we get from investors pretty frequently is, well are borrowers going to access this? How can borrowers access this? Are we going to see that same sort of mortgage equity withdrawal, that sort of cash out activity that we saw during the last cycle. And look, the high-level answer is it's difficult to say, given the lack of comprehensive data that we see there. Now, we do have some form of data from the GSEs, we have it from Ginnie Mae, that can show us how cash out activity is evolving, and we are seeing cash out activity really pick up in 2021. It wasn't the case in 2020. Falling rates in 2020 meant that a larger percentage of refinancings were more just straight rate-and-term refinances. They didn't have a cash out component. But we are starting to see cash out refinance activity pick up in 2021 from where it was in 2020. Sarah Wolfe And how does mortgage credit availability play into all of this?Jim Egan We do think that's playing a pretty big role. Now we've talked about how mortgage credit availability is running at pretty tight levels. We actually undid six years’ worth of easing lending standards in the six months following COVID, but we have started to see lending standards plateau and they've started to ease from here. Now, how of those tight lending standards manifested themselves in terms of cash out activity? We're actually seeing the dollar amount that is being cashed out, it's lower today than it was in 2019 in terms of absolute dollar amount. If we talk about the amount of equity, the rising home prices we've seen, that means as a percentage of the property value, in 2019, we were seeing cash out refi’s remove roughly about 18% of value from the house. That's down to just 13% today. So people are able to access that equity, but tighter credit standards might be contributing to that dollar amount being lower. And it certainly means that the borrowers who are more likely to be able to access that are probably borrowers that are further up the credit quality spectrum, higher credit scores, for instance, perhaps higher income levels as well. So we do think that tight credit availability plays a role. But Sarah, turning this back to you.Jim Egan Once we get past the borrower's ability to actually remove cash from their home or the borrower's ability to tap that equity in their home. What are you seeing households use that money for?Sarah Wolfe Well, a bulk of the equity goes back into the home in the form of home improvement and repairs. There is a smaller amount that goes towards non-housing expenditures like education and apparel. Also, some of it goes towards paying down debt. But the large majority is back into the house in terms of home repairs and improvements.Jim Egan OK, I want to switch gears from homeowners to renters. Rents have been racing higher in recent months. That doesn't seem great for low-income consumers who don't own their homes. But what are you seeing there?Sarah Wolfe That's true. Home price appreciation is great for those who own a home, but only half of the bottom 20% are homeowners. This compares to 80% homeownership among the top 20%. And so while we've seen a rise in home price appreciation, it's coincided with escalating rents for non-homeowners. To put some numbers around it, CPI inflation-- this is consumer price index-- showed that rents rose 0.4% in October and 0.5% in September. And while that might not seem like a big number, that's the largest two month increase in rent inflation since 1992. We also find that low-income renters spend 63% of their income paying rent nationally, which is quite elevated. And we're forecasting that rent prices are just going to keep going up and up in the coming years, making it harder for Low-Income non-homeowners to afford having a home and leaving them at the mercy of rising rents.Jim Egan Now we've done a lot of work on inequal access to homeownership among minorities. How does this factor into the rising burden of rent?Sarah Wolfe Well, on top of the income disparity in homeownership, the racial disparity adds another dimension to the divide between low-income homeowners and renters. Our ESG strategies find that on average, the gap in homeownership between White and Black and Hispanic households is widest for low to moderate income families. This really limits the benefits of home price appreciation for minorities and further exacerbates racial inequalities.Jim Egan All right, so the record level of home price growth, which has led to a record level of equity in U.S. households, does appear to have increased wealth across the income spectrum. But when we look a little bit closer, that's not necessarily the case for lower income households the same way it is for higher income households. And, across the board, the ability of these different households to tap that equity is still a question.Sarah Wolfe That's correct. But I think that it's important to keep in mind that the picture is not all bad. The low-income household is still healthy, and we have the substantial amount of labor market income coming from lower wage jobs like retail trade, leisure and hospitality, transportation, combined with strong wage growth, all helping and supporting income growth longer term for this group.Jim Egan Sarah, always great speaking with you.Sarah Wolfe Great talking with you, Jim.Jim Egan As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.
9 min 21 sec
Coming out of a year marked by greater uncertainty and volatility, 2022 is poised to be a year which favors single stock investing over a focus on style and sector.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 15th at 11:30 a.m. in New York. So let's get after it. 2021 has been another very good year for U.S. equity indices. What's been different in 2021 is the higher volatility under the surface with greater dispersion of returns between individual stocks. This fits very nicely with our overall mid-cycle transition narrative, with one major exception - valuations. Typically, by this stage of an economic recovery from recession equity valuations would have normalized, particularly with the earnings recovery being even more dramatic than usual. In short, while our sector and style preferences in stock picking was strong in 2021, our S&P 500 price target proved to be too low - in other words, wrong. We think this is more about timing rather than an outright rejection of our fundamental framework or narrative. With financial conditions now tightening and earnings growth slowing, the 12-month risk/reward for the broad indices looks unattractive at current prices. More specifically, we expect solid earnings growth again in 2022 offset by lower valuations. However, strong nominal GDP growth should continue to provide plenty of good investment opportunities at the stock level. In our view, the economic and political environment has been permanently altered from its pre-COVID days, although the changes are not necessarily due to the pandemic itself. What that means from an investment standpoint is higher nominal GDP growth led by higher inflation, which is the only way out from our over indebtedness in the longer term. Such an outcome should lead to greater investment and higher productivity, but it will take years for that to play out. In the meantime, we will have to deal with the excesses created by the extreme nature of this recession and recovery. That breeds higher uncertainty and dispersion, making stock picking more important than ever in the year ahead. While our primary theme for 2022 is to focus more on stocks than sectors and styles, one can't ignore them either. We go into the year-end favoring earnings stability and stocks with undemanding valuations, given our view for a tougher operating environment and higher long term interest rates. This puts us overweight Healthcare, Real Estate, Financials and reasonably priced Software stocks. We are also more constructive on Consumer and Business Services. With our expectation for payback in demand from this year's overconsumption, we are underweight Consumer Discretionary Goods, Tech Hardware and commodity-oriented Semiconductors that are prone to double ordering and cancelations. Small cap stocks have done better recently on the back of newly proposed tax legislation that is much less onerous to smaller domestic companies. However, that is simply the removal of a negative rather than an additional positive for earnings and cash flow. It does nothing to ease the burden of what may be one of the most difficult operating environments for small businesses in decades. In short, we favor large caps over small, especially after the nice seasonal run in a smaller cohort. Finally, the obsession over value versus growth should fade as there is no clear winner, in our view, over the next year, but rather trading opportunities like during 2021. Value and growth have each had periods during which they have done considerably better than the other over the past year. But year-to-date they are neck and neck. We do have a slight bias for value over growth for the rest of the year as interest rates move higher, but this is more of a trading position rather than an aggressive investment view we had coming out of the recession in 2020. Expect our bias to flip flop in 2022 like this year, as macro uncertainty reigns. Although strategy is a macro endeavor, with stock dispersion remaining high due to uncertainty around inflation, supply chains and policy, we will focus even more on specific relative value ideas, rather than the index, over the next year. We wish you all good fortune in 2022. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
4 min 5 sec
Over the last decade, bonds have been a source of stability. But, with surprising moves this past month, they’ve now become a risk-management challenge that stands out amongst other asset classes.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues, bring you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, November 12th at 2:00 p.m. in London.For much of the last decade, an important cross asset story has been how stable bond markets were relative to, well, everything else. A big part of this story was the action taken by central banks. They bought government bonds directly, but also set short-term interest rates at very low levels, which acted as a magnet, holding down other interest rates around the world.There were some big moves, especially when the pandemic hit. But for the most part, bond markets have been a pretty stable place relative to stocks, commodities and other asset classes. This was a global trend, with interest rates unusually placid from Australia to Poland to the United States.But recently, that's reversed. It's been the bond market that's been hit by a wide number of extreme moves, while other asset classes have been pretty calm. The overall market right now is a little like a duck: calm on the surface, but with some really furious churning below.We track a wide variety of cross market relationships at Morgan Stanley research. These represent different ways an investor might express a different view on the market. For example, smaller versus larger capitalization stocks, the US dollar relative to the Japanese yen in currency markets, or 2-year yields relative to 30-year government bond yields in the United Kingdom. While investors are often exposed to the big picture direction of stocks, bonds and currencies in their portfolio, many also take views on these smaller, more 'micro' relationships as a key way to exploit mispricing and generate return.In equities and commodities, these relationships are pretty well behaved. In government bonds, they're not. Excluding the depths of the pandemic, the last month has seen some of the most extreme moves in global bond markets in a decade.There are a few things going on here, much of which ties back to those central banks. The Federal Reserve has signaled it's going to be rolling back its bond buying, reducing one support to the market. The Bank of England surprised markets by not raising interest rates as expected. While on the other hand, Poland's central bank surprised markets by increasing rates much, much more.All of this is happening at a time when bond performance wasn't great to begin with. The U.S. Aggregate Bond Index, a good proxy for the high-quality bonds that most investors hold, is down 1.7% this year, underperforming cash. Rising bond yields in the UK and Australia have created a similar dilemma. And many investors who would normally take advantage of these large moves and potential dislocations have been caught up in them, making it harder for some of these relationships to normalize.What does all that mean for markets? Investors focused on stocks, commodities or foreign exchange should be mindful that their friends over in the bond market are facing a very, very different risk management challenge as we move into the end of the year. And continued bond market volatility could challenge broader market liquidity. More broadly, less central bank support is consistent with our longer run expectations that interest rates are set to move higher. Stay tuned.Thanks for listening! Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
3 min 11 sec
Coming out of last week’s FOMC meeting, the Fed’s wants are becoming clearer but the implications into 2022 for asset prices, interest rates and exchange rates remain to be seen.----- Transcript -----Welcome to Thoughts on the Market. I’m Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I’ll be talking about global macro trends and how investors can interpret these trends for rates and currency markets. It's Thursday, November 11th at noon in New York."Don't fight the Fed." It's an oft-repeated investment principle that could be restated as "What the Fed wants, the Fed gets." Coming out of last week’s FOMC meeting, let’s take a moment to consider what the Fed really wants, and how markets may provide it.So, the Fed wants one of three things from a financial conditions perspective. It either wants financial conditions to loosen with greater availability of money and credit in the marketplace or it may want financial conditions to tighten to cool down an overheated economy. Finally, it may want to keep the status quo with financial conditions in a certain range.Currently, the Fed is easing monetary policy by purchasing bonds from the market. So, it wants to loosen financial conditions. But over the next 6 months, it will be tapering its asset purchases and, therefore, it will be easing policy by less and less. This implies that it wants financial conditions to keep easing starting this month and lasting into the middle of next year, but more gradually than they have been.Coming into this year, we knew the Fed and European Central Bank would deliver monetary policies consistent with an aggressive easing of financial conditions. If we included only 3 prices in our financial conditions framework, a vast oversimplification to be sure, then our calls at Morgan Stanley for higher real yields and a stronger dollar would have implicitly suggested much higher prices for riskier assets. So, what has happened thus far in 2021? Well, risky asset prices have risen tremendously, but the U.S. dollar has only strengthened somewhat, and real yields remained at low levels. So, what about next year? We know the Fed wants financial conditions to loosen further. After all, it will still ease policy through asset purchases over the next 6 months. But it will be easing by less and less until, starting in the middle of 2022, it will no longer ease policy at all. At that point, it will maintain – for a period, short as though it may be – extremely easy financial conditions.Does that mean U.S. real yields will struggle to rise, the U.S. dollar will struggle to rally, and risky asset prices will rise? The first two are certainly possible outcomes. But even if financial conditions loosen in aggregate for a time, and then remain loose for a time thereafter, not every market is guaranteed to move in a direction associated with looser financial conditions.For example, take equities, which is a type of risky asset. A rise in equity prices - which would loosen financial conditions - might be offset somewhat by higher real yields and a stronger U.S. dollar – both of which would tighten them. As long as the final result is an overall set of financial conditions that are looser than before, the circle is squared for the Fed.So, what determines which drivers of financial conditions do the heavy lifting? The answer is changing investor expectations and risk premiums for growth and inflation, both on an absolute basis for equities and real yields, and on a relative basis for the U.S. dollar.Ultimately, we believe the easy monetary policies in place today—and policies that will be in place through most of next year—will keep expectations for real economic growth improving. This should support investor willingness to own riskier assets while placing upward pressure on real rates.Expectations for inflation should remain buoyed by expectations for strong growth, but inflation risk premiums will be influenced by factors in the supply side of the economy, like supply chains and labor force participation. We see downside risks to inflation risk premiums next year, which would place further upward pressure on real interest rates.Finally, in terms of the relative growth outlook, progress in the U.S. on COVID-19, as well as fiscal developments such as infrastructure spending, favor the U.S. over the rest of the world. This should place upward pressure on the U.S. dollar through the first half of next year.Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts App. It helps more people find the show.
4 min 20 sec
The bipartisan infrastructure bill has passed, and while investors will see some short term impacts, the bigger question is how long will it take for markets to see a return on these investments?----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 10th at 11 a.m. in New York. While Congress continues to negotiate the 'Build Back Better' plan, the package of expanded social programs paid for by fresh taxes on companies and wealthier households, it managed to get a key companion piece of legislation over the finish line last week: the bipartisan infrastructure framework. Many investors may have overlooked this event given the framework's smaller relative price tag and lack of tangible tax increases. But don't be fooled. This is a watershed event, and investors should pay attention.In short, the infrastructure framework adds about $550 billion to the existing budget baseline for infrastructure spending in the U.S. That's a nearly doubling of spending over the next 10 years on infrastructure. And that means fresh market and economic impacts to consider. For the broader economy, the story is nuanced. Increased infrastructure spending is generally a good return on investment. However, that impact usually isn't visible right away. In the short term, the money put into the economy to build a new road or train line is funded by money taken out of the economy by taxes. A few years out, that new road leads to more economic activity than there was before. But that might not be tangible enough to move markets in the near term.Something more tangible is the obvious impact to the industries directly involved in infrastructure construction. For example, my colleague Nik Lippman sees material upside to cement companies, who will see major improvements in demand for their product.Bottom line, the infrastructure supercycle is here. We'll track it and all the market impacts for you as they take shape.Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.
2 min 10 sec
Third quarter earnings are heading into the home stretch in Europe and the UK, but while a solid number of companies have beat earnings estimates, market reaction has been a bit curious.----- Transcript -----Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European and UK Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the emerging read on third quarter earnings for the region. It's Tuesday, November the 9th at 3pm in London.Europe and the UK are now more than halfway through third quarter earnings season, and so we're far enough along to form a view on how this quarter's earnings are playing out. And while earnings have been largely solid, price movements on the day of earnings announcements, and in the days following, have been a bit curious. But I'll get into that in a moment.As it stands, third quarter earnings appear on track to deliver a solid number of companies beating earnings per share estimates. As of yesterday, 55% of European companies have beaten earnings estimates, while 23% have missed, leaving a 'net beat' of 32%, which is twice the historic average. If this holds, it would put third quarter results on track to deliver another strong upside surprise, albeit slightly below the pace seen over the last few quarters. Taking it to the sector level, we find that the strongest breadth of earnings beats are coming from Financials and Energy. On the flip side, Communication Services, Healthcare and Industrials have delivered the smallest breadth of beats so far.In addition to a healthy number of companies exceeding estimates, we are also seeing a beat in terms of the aggregate amount of European earnings overall, with weighted earnings per share currently beating consensus by about 10% for this quarter. This good news on earnings has driven a fresh bout of upgrades, which should reduce investor concerns around the risk to corporate profitability from ongoing supply chain issues and high input cost inflation.All that said, earlier, I mentioned a bit of curiosity about price reaction. Typically, if a company beats earnings per share estimates, you might expect to see better stock performance that day or in the days that follow. And of course, the opposite is true for companies who miss estimates. However, a key talking point during this results season has been the surprisingly disappointing price action, even for companies who beat expectations.Currently, the gap between the outperformance of earnings beats on the day of results relative to the underperformance from earnings misses has been very negatively skewed in a historic context. In fact, this negative skew to price action is close to a record low going back to 2007. On our data, we calculate that EPS misses have, on average, underperformed by 1.6% on the day of results, whereas companies that beat estimates have been broadly flat in relative terms. Hence, while the third quarter has been a solid earnings season overall, the hurdle rate to positively surprise the market is currently quite high.In our opinion, this reflects investors' uncertainty about the future earnings outlook and whether company margins will face a delayed hit in the quarters ahead. While understandable, we think this caution is overdone. Rather, we expect Europe's earnings dynamic to remain positive into 2022, with companies benefiting from a strong external demand environment and a record level of pricing power.Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
3 min 14 sec
As we head towards year end, stock and bond markets appear to be sending mixed signals for the year ahead. For investors, the truth could lie somewhere in the middle.----- Transcript -----Welcome to "Thoughts on the Market." I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It’s Monday, November 8th at 2:00PM in New York. So, let's get after it. As we enter the final stretch of the year, various markets appear to be sending very different signals about what to expect over the next year. Let’s start with Bonds where the longer-term yields have fallen sharply over the past few weeks. In fact, the moves have been so dramatic, several leading macro funds had their worst month on record in October. Some of this move is due to the fact that these same investors were all short bonds as central banks were expected to begin the long process of tightening monetary policy, perhaps faster than what was priced a few months ago. The reason for this view was very simple: inflation has proven to be much higher than the central banks expected, and they would be forced to respond to that development by raising rates sooner than what they might prefer to do. Indeed, over the past few months, many central banks around the world have raised rates while others have begun to taper asset purchases and even end them altogether. In other words, these traders were correct in their fundamental assessment of what was about to happen, but long-term rates went down instead of up. While the extreme positioning clearly played a role in the magnitude of the move in longer term rates, the fundamental question is why did they fall at all? One possible reason is the bond market may be discounting what we have been talking about on this podcast for weeks—that the first half of next year is likely to see a material slowing in both economic and earnings growth as fiscal stimulus from this year wears off. Furthermore, with the legislative process breaking down on the Build Back Better program, that risk has only increased. It also means less issuance of Treasury securities which directly helps the supply and demand imbalance many macro and bond traders were expecting as the Fed begins to taper asset purchases this month. On the other side of the spectrum has been stocks. Here, we have seen higher prices for the major indices almost every day for the past 5 weeks, suggesting growth next year is not only going to be fine but may be understated by analysts. Stocks may also be taking the lower interest rates as good news for valuations. After all, much of the correction in September was due to lower valuations as the markets started to worry about central banks tightening and rates moving higher. On that score, price/earnings multiples in the US have risen by 7.5% over the past 5 weeks, one of the largest rises we’ve ever witnessed in such a short period of time. Such a rise in P/Es like this usually happen for one of two reasons: either the market thinks earnings estimates are about to go up a lot or interest rates are going to fall. The conflict here is that better growth is not compatible with lower rates. A valid explanation for the divergence could be that the potential failure of Build Back Better means no new corporate taxes. So, while the economy may be hurt by this legislative delay it could be friendly to earnings. In keeping with our narrative over the past month, we think the main reason for the divergence in messaging between stock and bond markets can be explained by the fact that retail and other passive inflows to equity markets continue at a record pace. It’s also the seasonal time of the year when institutional investors are loathe to leave the party early for fear of missing out and falling behind their benchmarks, something that they have had a harder time keeping up with this year. On that score specifically, the S&P 500, the key benchmark in the US market, has once again outperformed the average stock. This is a very different outcome from 2020 when the average stock did better than the index. What this really means is that the index can diverge from its fundamental value for a while longer. Bottom line is that major indices can grind higher into the holidays. However, it will get more difficult after that if we’re right about growth disappointing next year as rates eventually stabilize at higher levels from central banks tightening. In that environment, we continue to favor companies with reasonable expectations and valuations. We think healthcare, banks and some of the more non-cyclical technology companies in the software and services subsectors offer the best risk-reward. On the other side of the ledger, we would avoid consumer goods and cyclical technology companies that will see the biggest payback in demand next year. Thanks for listening! If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
4 min 28 sec
Global moves in elections, COVID restrictions and energy prices are having ripple effects across markets. How should investors think about these dynamics for Asia and EM equities?----- Transcript -----Welcome to Thoughts on the Market. I'm Jonathan Garner, chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you their perspectives, today I'll be talking about our latest view on Asia and EM equities. It's Friday, November the 5th at 2pm in London.Overall, in our coverage, we continue to prefer Japan to Non-Japan Asia and Emerging Markets. Japan has outperformed Emerging Markets by 500 basis points year to date but remains cheaper to its own recent valuation history than Emerging Markets and with stronger upward earnings revisions. New Liberal Democratic Party leader Kishida-san has recently fought and won a snap election in the lower house of the Japanese parliament. The governing Center-Right coalition, which he now leads, did considerably better than polling had suggested prior to the election outcome. Although there may be some changes in policy emphasis compared with the Abe and Suga premierships, the broad contours of market-friendly macro and micro policy in Japan are likely to continue.Elsewhere within Emerging Markets, we're most constructive on Eastern Europe, Middle East and Africa and in particular Russia, Saudi Arabia and UAE, which are positively leveraged to rising energy prices. We're also warming up to ASEAN, having upgraded Indonesia to overweight alongside our existing overweight on Singapore. ASEAN economies are finally beginning to reopen post-COVID, which is stimulating domestic consumption.However, we have recommended taking profits on Indian equities after a year of exceptionally strong performance. We remain structurally bullish on a cyclical recovery in earnings growth in India, but with forward price earnings valuations now very high to history and peers, and with rising energy prices a headwind for India, we think it's time to move to the sidelines. Within Latin America, we've also established a clear preference for Chile versus Brazil on relative economic momentum and export price dynamics.Finally, we remain underweight Taiwan and equal weight China. For Taiwan, our contrarian negative view relates to our expectation of a semiconductor downcycle in 2022 and a slowing retail investor boom. Meanwhile, China equities continue to face numerous headwinds, including Delta variant COVID outbreaks, property developer deleveraging and the medium to long term impact on private sector growth stocks from the recent regulatory reset. Although valuations have improved in pockets, we expect further earnings downgrades for China and await a clearer pickup in growth and liquidity before turning more constructive.Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
2 min 47 sec
Central bank support has been a key driver of market strength since last year. So how will markets react during the months-long tapering process?----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, November 4th at 2p.m. in London. Since the start of the pandemic, the Federal Reserve, along with many other global central banks, instituted massive purchase programs of government bonds and mortgages. These purchases, known as quantitative easing, or QE, were designed to keep interest rates low and boost liquidity in financial markets during a time of stress. Since February of 2020, these purchases caused the Fed's bond holdings to rise by $4.4 Trillion dollars. On Wednesday, the Federal Reserve announced its intention to start dialing these purchases back. To be clear, the Fed will still be buying a lot of bonds over the coming months. But after buying $120 billion of securities in October, the fed will buy $105 billion in November and $90 billion in December, a trend our economists think mean that they will cease these purchases entirely by June of next year. This ‘tapering’ of purchases and its impact for markets is a major source of debate. One school of thought is that central bank support has been the main driver of market strength, not just recently, but going all the way back to the global financial crisis. Markets, after all, have done better when the Fed has been buying bonds. But as much as you'll hear phrases like "the market is only up because of the Federal Reserve", this idea can suffer from some real statistical fallacies. Yes, markets have done better when the Fed has felt the need to support the economy. But the Fed has generally felt this need when conditions were bad, and bad conditions often meant lower market prices—something that was true in, say, the autumn of 2012 or March of last year. I know this is the type of hard-hitting financial insight you expect from this podcast but buying when prices are low tends to produce superior returns. So what does ‘tapering’ mean? Well, one thing we can look at is the last time the Fed started to dial back its purchases. After a strong year for markets and the economy in 2013, the Fed started to ‘taper’ its bond purchases in January of 2014. That turned out to be a bad month for markets. But the reasons were important. U.S. data was unusually weak, China's economy was slowing and there were troubles in emerging markets, including Argentina. The market's response, we'd argue, was very normal and fundamentally driven. The best example of this? Even though the Fed was reducing its bond purchases in January, bond prices actually rose, which is what you'd expect when concerns around growth increase. The data ultimately improved, and 2014 turned into a reasonable year for stocks, albeit a shadow of the stellar returns of the year before. But putting it all together, we think 2014 provides an important clue for how markets could respond to tapering: as the Fed becomes less involved in the markets, fundamentals matter more, and become a larger driver of whether markets will sink or swim. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
3 min 11 sec
Inflation rates, commodity prices and central bank policy are tied together through self-referential loops. With today’s FOMC meeting, it is worth a closer look at these meta dynamics.----- Transcript -----Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about global macro trends and how investors can interpret these trends for rates and currency markets. It's Wednesday, November 3rd at noon in New York.Is there anything more "meta" than commodity markets, headline inflation rates and inflation markets? The Google dictionary, using definitions from Oxford languages, defines the adjective ‘meta’ as "self-referential, referring to itself or to the conventions of its genre." A great example would be a website that doesn't review movies, it reviews the reviewers who review movies.Rates markets can get pretty meta as well. Commodity prices, inflation rates reported by the government and inflation rates traded in the market often mirror each other in a self-referential loop. When investors see commodity prices going up, they think that inflation rates will go up, so they buy inflation linked bonds. That drives inflation rates in the market higher, which makes othes investors believe that inflation will be a problem, and so they buy commodities as a hedge for higher inflation, which drives commodity prices even higher. And so, the loop continues.This self-referencing loop wouldn't be as problematic if actual inflation reported by the government, which looks at price changes in the past, didn't have a big impact over market-based measures of inflation, which look at what inflation might average in the future. But they do have an impact, especially when movements in actual inflation have been big, like they have been recently.Another check on the self-referencing loop is supposed to be how central bankers react to movements in inflation rates in the marketplace, especially those that relate to inflation over a longer period of time, like five to 10 years in the future. Central bankers know that inflation rates in the market include both expectations and risk premiums. And because central bankers are primarily interested in inflation expectations, they use surveys of consumers and professional forecasters, as well as statistical models, to extract those expectations from market prices.Still, when inflation rates in the market move to extremes, central bankers get nervous, just like investors. And therein form something else that's very ‘meta,’ the self-referential loop that includes investor fears, central banker fears, market pricing of central bank policy and central bank policy itself.It's no wonder that the markets which price the most hawkish central bank policy paths are also the markets that priced the highest inflation rates in the future, and we can't blame investors for allowing this market behavior to persist. I'll give you an example. Looking back to the second half of 2014, the dramatic decline in oil prices allowed the market in Europe to price much lower inflation rates in the future, and the European Central Bank responded by announcing its quantitative easing policy in January 2015.But what goes up – in this case, commodity prices, inflation rates in the market and the pricing of more hawkish central bank policies – can also come down. And given the meta nature of these markets, investors may want to pay close attention to what is happening to commodity prices today.For example, some of the recent supply chain and commodity disruptions have peaked in futures markets like lumber, thermal coal, and natural gas. In addition, the cost of shipping many commodities, such as coal and iron ore, have also peaked.This leaves us feeling that the pricing of central bank policy in markets is increasingly at risk of reversing somewhat. We flag today's FOMC meeting as possibly the last major central bank meeting that could spur even more hawkish pricing of central bank policy.In other words, investors should realize that markets are pricing the high rates of inflation we've experienced – in part driven by higher commodity prices – to continue for some time. And markets are priced for central banks to respond aggressively. But what if commodity prices fall from here? Investors should be prepared for the "meta" nature of these markets to reprice central bank policies again, but this time in a more dovish direction.Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate in reviews on the Apple Podcasts app. It helps more people find the show.
4 min 27 sec
‘Build Back Better’ has gained support from all corners of the Democratic Party, but questions remain over how the framework is paid for. For investors, a look at short term dynamics may provide clarity.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, head of public policy research and municipal strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Tuesday, November 2nd at noon in New York.Over the past few days, the "Build Back Better" framework has gained increasing support from all corners of the Democratic Party. And although Senator Joe Manchin put his support for the framework in question yesterday, and there are still some questions on items such as prescription drug reform, our base case is still that "Build Back Better" and the bipartisan infrastructure bill will likely be enacted before year end.However, still up for debate is whether "Build Back Better" is fully paid for by things like stronger IRS tax enforcement and tax increases on corporations. In its current form, the framework proposes fiscal balance, but over 10 years. In the short term, it doesn't mean zero fiscal expansion.Rather as structured, we think the bill would add to deficits over the first five years but get to balance by having surpluses over the remaining years. This distinction is important, and we argue that investors should focus on the early-year deficit dynamic instead of the 10-year deficit language that Congress generally uses to communicate deficit impact.One reason is that policy uncertainty usually increases with time. For example, several spending and contra-revenue programs including a child tax credit, expanded Affordable Care Act subsidies, and state and local tax cap relief, roll off well before the 10-year look-ahead period ends. And U.S. elections in 2022 and 2024 could conceivably result in changes to government that could mean the continuation or discontinuation of programs and new tax items.Given this uncertainty and the estimated $256 billion dollar deficit for the bipartisan infrastructure bill -- the takeaway for investors is that we expect bond markets will focus on this early-year dynamic since this is the time frame that ultimately impacts GDP forecast horizons, impacts the Treasury supply forecast horizon and is reliable from a policy standpoint.Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
2 min 24 sec
Original Release on October 11th, 2021: As the weather chills and we head towards the end of the mid-cycle transition, the S&P 500 continues to avoid a correction. How long until equities markets cool off?----- Transcript -----In case you missed it, today we are bringing you a special encore release of a recent episode. We’ll be back tomorrow with a brand new episode. Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 11th at 11:30 a.m. in New York. So, let's get after it. With the turning of the calendar from summer to fall, we are treated with the best weather of the year - cool nights, warm days and clear skies. In contrast, the S&P 500 has become much more volatile and choppy than the steady pattern it enjoyed for most of the year. This makes sense as it's just catching up to the rotations and rolling corrections that have been going on under the surface. While the average stock has already experienced a 10-20% correction this year, the S&P 500 has avoided it, at least so far. In our view, the S&P 500's more erratic behavior since the beginning of September coincided with the Fed's more aggressive pivot towards tapering of asset purchases. It also fits neatly with our mid-cycle transition narrative. In short, our Fire and Ice thesis is playing out. Rates are moving higher, both real and nominal, and that is weighing disproportionately on the Nasdaq and consequently the S&P 500, which is heavily weighted to these longer duration stocks. This is how the mid-cycle transition typically ends - multiples compressed for the quality stocks that lead during most of the transition. Once that de-rating is finished, we can move forward again in the bull market with improving breadth. With the Fire outcome clearly playing out over the last month due to a more hawkish Fed and higher rates, the downside risk from here will depend on how much earnings growth cools off. Decelerating growth is normal during the mid-cycle transition. However, this time the deceleration in growth may be greater than normal, especially for earnings. First, the amplitude of this cycle has been much larger than average. The recession was the fastest and steepest on record. Meanwhile, the V-shaped recovery that followed was also a record in terms of speed and acceleration. Finally, as we argued last year, operating leverage would surprise on the upside in this recovery due to the unprecedented government support that acted like a direct subsidy to corporations. Fast forward to today, and there is little doubt companies over earned in the first half of 2021. Furthermore, our analysis suggests those record earnings and margins have been extrapolated into forecasts, which is now a risk for stocks. The good news is that many stocks have already performed poorly over the past six months as the market recognized this risk. Valuations have come down in many cases, even though we see further valuation risk at the index level. The bad news is that earnings revisions and growth may actually decline for many companies. The primary culprits for these declines are threefold: payback in demand, rising costs, supply chain issues and taxes. At the end of the day, forward earnings estimates will only outright decline if management teams reduce guidance, and most will resist it until they are forced to do it. We suspect many will blame costs and even sales shortfalls on supply constraints rather than demand, thereby giving investors an excuse to look through it. As for taxes, we continue to think what ultimately passes will amount to an approximate 5% hit to 2022 S&P 500 EPS forecasts. However, the delay in the infrastructure bill to later this year has likely delayed these adjustments to earnings. The bottom line is that we are getting more confident earnings estimates will need to come down over the next several months, but we are uncertain about the timing. It could very well be right now as the third quarter earnings season brings enough margin pressure and supply chain disruption that companies decide to lower the bar. Conversely, it may take another few months to play out. Either way, we think the risk/reward still skews negatively over the next three months, even though the exact timing of cooler weather is unclear. Bottom line, one should stay more defensive in equity positioning until the winter arrives. Thanks for listening! If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
4 min 7 sec
Investors have had a lot to take in over the past few weeks, but corporate credit markets remain calm despite turbulence elsewhere. Vishy Tirupattur explains. ----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Global Director of Fixed Income Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the current calm in the corporate credit markets. It's Friday, October 29th at 1:00 p.m. in New York.Over the past few weeks, risk markets have been buffeted by volatility from a wide array of sources. It was around a month ago that the regulatory reset in China and the near-term funding pressures on select property developers roiled global markets, as investors fretted all the systemic implications for global growth.Then, a mixed U.S. jobs report, along with sharply higher commodity prices, intensified the debate around stagflation. And the rhetoric from multiple central banks has been increasingly hawkish. So, a lot for investors to take in.The combination of these concerns has resulted in substantial market gyrations. The S&P 500 index declined by about 4% before recovering to all-time highs. The shape of the Treasury yield curve has twisted and turned. The benchmark 10-year Treasury interest rate went from around 1.3% to around 1.7% and back down to 1.56%. The market pricing of the timing of a Fed rate hike has come in sharply.But amidst all these substantial moves, corporate credit markets on both sides of the Atlantic have largely stayed calm. Credit spreads, which are the risk premium investors demand to hold corporate debt or U.S. treasuries, have hovered near 52-week tights in investment grade, high yield and leveraged loans across the U.S. and Europe. And with surprisingly limited volatility.Credit market volatility relative to equity markets remains very low. Market access for companies across the credit spectrum has remained robust, as indicated by strong issuance trends, running at or ahead of the pace of a year ago. So, what explains this stark difference between credit and other markets? The answer boils down to meaningfully improved credit fundamentals and elevated company balance sheet liquidity, leading to a decidedly benign outlook for defaults over the next 12 months, if not longer.Morgan Stanley's credit strategists Srikanth Sankaran and Vishwas Patkar have highlighted that the balance sheet damage from COVID has been reversed. At the end of the second quarter this year, gross leverage in U.S. investment grade credit has declined sharply back to pre-COVID levels. Net leverage is now below pre-COVID levels, while interest coverage has risen sharply to a seven-year high. The trends in the high yield sector are even more impressive, driven not just by the rebound in earnings but also negative debt growth. After four consecutive quarters of declines from the second quarter 2020 peak, median leverage now sits below the pre-COVID trough. That 71% of the issuers are now reporting lower growth levels quarter over quarter, reflects the broad-based improvement we are seeing in the market.Even in the leveraged buyout world, while 2021 has been a bumper year for acquisition activity, unprecedented equity cushions have resulted in a much better alignment of sponsor and lender interests, helping to alleviate concerns.So, what are the implications for investors? A lot, of course, is already in the price. With credit spreads near the tight end of the spectrum, we are more likely to see them widen than tighten. Indeed, the base case expectation of our credit strategists is more modestly wider splits. However, the strength in credit fundamentals suggests that the outlook for defaults is benign, and likely below long term average default levels. Thus, we prefer taking default risk to spread risk here, leading us to favor high yield credit or investment grade credit and, within high yield, loans over bonds.Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts on share Thoughts on the Market with a friend or colleague today.
4 min 5 sec
One of the great conundrums of finance is predicting what markets will return over the long run. But with some historical research and the power of math, the future can become a bit clearer.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, October 28th at 2 p.m. in London.The question of what markets will return over the next decade is a conundrum. It's complicated because of just how much can change in a given year, let alone a decade, but also simple because over longer horizons, valuation measures such as bond yields or stock price-to-earnings ratios tend to matter a lot more for how well a market does. A 10-year horizon really matters to investors saving for the future. But most investors, and also this podcast tend to focus on events happening in the much more immediate future.So what do we think this return picture holds?When estimating what a market will return over the long run, there are really two basic approaches. The first, sometimes called the demand approach, assumes that markets are efficient, and that investors will always demand that the market is priced to deliver an average historical return. In this approach, future returns for the market are simply assumed to be the long run average. We don't use this approach, but others do, and it is appealing for being relatively straightforward.An alternative, which we favor, could be called the supply approach. This attempts to quantify just how much return a given asset can supply. So, for bonds with a fixed yield, this approach is attractively simple. On a 10-year horizon, the return for a broad bond index should be pretty similar to its yield today, regardless of the path that interest rates take between now and then. That might sound somewhat counterintuitive, but there's some pretty good math, we think, to back it up. After making a few minor adjustments, we think the U.S. Aggregate Bond Index may be able to supply a return of about 2% per year, over the next decade.For stocks... now there are more moving parts and more assumptions that can ultimately be proven right or wrong. The long run return of a stock market can be broken down into three parts: the dividends of the stock market pace, the growth in the market's earnings, and the change in the valuation that's applied to those earnings. The dividend yield is relatively easy to estimate, but earnings and valuations create a lot more debate.For earnings, our starting point is to assume that they grow, at least with the rate of inflation. We see a good argument for this, if prices everywhere are rising, companies should book higher sales and profits. This is one reason why equities tend to be a better asset class in higher inflation because they can grow their cash flows much more easily than, say, a bond can.So how much do earnings grow over and above the rate of inflation? We average two trend lines: a very long run trend of historical earnings growth and one that only focuses on more recent history. There are pros and cons of each. For example, only using the recent historical trend may better reflect current conditions in the market, but it also might overstate what's been an unusually favorable environment for companies. By taking the average, we split the difference. Now, with stock market earnings are above trend. We assume that there is some convergence down. And if earnings are depressed, we assume some normalization up. We think there's some good historical arguments for this, as earnings do tend to oscillate around these trend lines over time.Finally, what about those valuations? Well, we assume that valuations move back to long run averages, but do so only gradually, as we believe history says this gravitational pull takes time.Putting all of this together, we think the U.S. stock market could return about 5.2% per year over the next decade. The bad news is that's roughly half the long run average. The good news? It's still two and a half times higher than the return from that broad bond index.So where can investors find higher returns, especially relative to inflation? For equities, our framework suggests the highest so-called real returns are in Europe, where we think stocks could beat inflation by about six percent per year. In fixed income markets, we see the highest inflation adjusted returns in emerging market bonds.Finally, where could our assumptions be wrong? The return for bonds should be pretty well anchored by their yields, but for stock markets, there are several swing factors. Higher corporate taxes, for example, or higher interest rates could mean we're too optimistic about our assumptions for earnings growth and valuations. On the other hand, a stronger economy and importantly, a more permanent shift higher in market profitability could mean that our assumptions for mean reversion back to historical averages are simply too pessimistic. Either way, time will tell.Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
4 min 46 sec
Autonomous trucking may sound like science fiction, but its impacts on transportation costs, the labor market and a breadth of industries may be closer than we think.----- Transcript -----Adam Jonas Welcome to Thoughts on the Market. I'm Adam Jonas, head of Morgan Stanley's Global Auto and shared mobility research team. Ravi Shanker And I'm Ravi Shankar, equity analyst covering the North American freight transportation industry. Adam Jonas And on this episode of the podcast, we'll be talking autonomous. Specifically, the road ahead for autonomous trucking. It's Wednesday, October 27th at 10 a.m. in New York. Adam Jonas Ravi, before we get into the autonomy topic, specifically, your sector really sits at the epicenter of labor inflation and driver shortage. So, just help set the scene for us. How big of a problem is this? Ravi Shanker It's pretty difficult right now. It has been the case for a while. We've had a demographic problem in trucking for pretty much the last two decades and counting. In fact, you can find news stories going back to 1910 talking about a driver shortage in the industry. But it's particularly acute right now. A lot of it is structural, not cyclical. So we think we need to find unconventional solutions to the problem. Adam Jonas So remind us why autonomy progresses faster in trucking than in cars. You and I have had this debate over many years but tell us why it's faster in trucking. Ravi Shanker It's a slightly different problem to solve with trucking. I mean, it's still a very difficult problem to solve. But the fact that 93% of miles driven of a truck are on the highway and autonomous driving is slightly easier to solve on the highway than it is in the middle of Manhattan for instance. That really helps. The fact that this is an industry that's really driven by unit economics and labor accounts for 35-40% of the cost of trucking, and if you can substitute a driver at least partially or maybe completely even, that will significantly reduce the cost of trucking. And obviously, there's a safety aspect; the fact that a truck accident can cause significant damage. And if you can have technology solve that problem and step in, that can save countless lives over time. So we think it's a slightly easier problem to solve. The economic savings may be better or easier to quantify with trucking than with passenger cars. Adam Jonas And that's a really good point, because I find in my conversations with investors that people tend to think of autonomy as this blanket homogeneous technology. But I want to understand a bit more about the economics of autonomy, payback periods, cost benefit. What are some of the highlights from the numbers that you've been running? Ravi Shanker So we think that autonomy can reduce the cost of trucking by 60%, six zero. If you can electrify the truck, that's probably another 10% on top of that. Obviously, if you take a truck company today and reduce their cost of operations by 60%, that's significant savings. On top of that, because you don't have to deal with hours of service regulations for a driver, you can significantly improve your productivity of the truck and hopefully you can gain some market share as well. So, we think that these new technology trucks cost roughly 50 to 70 thousand dollars more than a regular truck today, but the payback period can be measured in weeks and not years. Ravi Shanker So Adam, again, to me, it's relatively clear what the use case is for autonomy in trucking. Where are we with pass cars, where are those passenger robotaxis that we were promised a few years ago? Adam Jonas Well, I actually had the opportunity to ask the chair and CEO of General Motors, Mary Barra, on a Morgan Stanley video series that we published that exact question. And her response, pretty confidently was we're going to see major development in quarters, not years. Now that mission is focused on robotaxi in dense urban cities like San Francisco and other cities. Ravi, I think the definition of success there isn't that they've solved autonomy in two years because that's not something we're going to solve. We think that the definition of success there will be; are they able to fleet many tens or maybe even a couple of hundred robotaxis in a major city or a collection of major U.S. cities with driver out? Even if it's a simple mission doing a giant rectangle on a geofence or, you know, something that can resemble a streetcar without cables or a streetcar without wires. Just that proof point, even if it doesn't completely remove your driving license and substitute your commute entirely, will go a long way to convincing policymakers, investors and the general public that this is not science fiction, we're going to get there, right? Just like the barnstorming age of early aviation, these bigger and bigger feats every week, every month, we think we'll see something similar in autonomy. Ravi Shanker And maybe some of the key benefits of autonomy can be realized even with these kind of small early use cases. But I was thinking like maybe a pretty nice commonality in both our worlds, maybe the center sliver of the Venn diagram, if you will, between autonomous trucking, autonomous pass cars, is autonomous delivery vans. We've done a lot of work on what this means the last mile. Obviously, GM, Ford other OEMs have been talking about this. Where do you think we stand there in terms of these OEMs entering that market again? Adam Jonas Yeah, especially post-COVID. I mean, the growth of e-commerce and our obvious dependency, increasing dependency on final mile. That use case is perfect for electrification and autonomy. And I would just make the point that advancing the state of the art of connected car and connected car ecosystems and electric ecosystems accelerates the development of the autonomous economy too because electric cars make better AVs. And then autonomous cars make better electric cars because you can optimize the utilization and the use case and the inter workings with the infrastructure. So, I think that is a very hot area and I would agree with you there is middle ground that we're going to see in your neighborhood, perhaps sooner than people think, even if it's still at a slow speed or not all the time in all neighborhoods, in all weather conditions. Adam Jonas Before I let you go, I wanted to ask you a question that's always on people's minds and that's the impact on the workforce and jobs. How are your companies talking to current drivers about this autonomy subject? Ravi Shanker This is a really good question and obviously somewhat of a sensitive topic. I think the truck fleet operators want to be very careful and very clear that trucking is not going to displace every truck driver or like hundreds of thousands of truck jobs any time soon. In fact, we had a report that was commissioned and published by the Department of Transportation a few months ago, it was earlier this year that basically said that even with a bullish base of adoption of autonomous trucking, they did not see risk to significant job losses in the trucking space just given the extreme truck driver shortage that we already have and the limited new labor supply that's going into this industry. So, it's something to be very cognizant of, something to be very sensitive about, but at the same time, we think the technology can actually help the industry and not be a hindrance. Ravi Shanker So Adam, taking everything we've discussed today into account, what are the investment implications of this? Adam Jonas There's really lots of different ways you could express an investment opinion. I think Apple CEO Tim Cook once described autonomy as the mother of all AI. In the auto industry, many of our clients see it, as you know, the ultimate internet of things, internet of cars. And so, there are a variety of adjacent industries, both within auto and transportation, but also technology enablers, sensor companies, semiconductors, processors, A.I. companies, network operators, data. There's all sorts of ways to express it across industries. And interestingly, according to your work, the beneficiaries of autonomy ultimately extend across multiple industries, right? Fleet operators and frankly, ultimately, the consumer, too. So, the question might be what sector isn't exposed to this technological revolution? Adam Jonas All right, Ravi, thanks for taking the time to chat. Ravi Shanker Absolutely, Adam. Great speaking with you. Adam Jonas And thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
8 min 11 sec
Debates in D.C. continue to make headlines, but even with lowered expectations for the Biden agenda, we find a robust set of climate-focused provisions likely to survive the process and benefit the clean tech sector. ----- Transcript -----Michael Zezas Welcome to Thoughts on the Market. I'm Michael Zezas, head of U.S. public policy research and municipal strategy for Morgan Stanley.Stephen Byrd And I'm Stephen Byrd, head of Morgan Stanley's North American Research for the Power and Utilities and Clean Energy Industries.Michael Zezas And on this edition of the podcast, we'll be talking about clean energy and the latest developments for the bipartisan infrastructure deal and President Biden's build back better agenda. It's Tuesday, October 26th at 10 a.m. in New York.Michael Zezas So Steven, with the negotiations winding down on the legislation Congress is considering around the president's economic agenda, I wanted to speak with you because you cover a sector, clean tech, that's really at the nexus of many things Congress and the White House are trying to achieve. In particular, even as the size of the economic and climate package has been cut from $6 trillion dollars to $3.5 trillion dollars now, perhaps as low as $1.5 trillion dollars, one constant has been a potentially large amount earmarked for clean energy infrastructure. By our estimate, there could be roughly $500 billion of new money allocated towards this goal. So, last month on the podcast, you outlined eight headline proposals, maybe we could start by updating everyone on those proposals as they stand now in the scaled back version of the bill.Stephen Byrd Yeah, thanks, Mike. There is still a lot of support for clean energy in the draft legislation. Let me walk through the eight elements that investors have been most focused on to give you a sense for just how broad that support is.Stephen Byrd Number one, and the boldest of these proposals is a clean electricity performance program or CEPP. This would essentially push all utilities and load serving entities to adopt clean energy and phase out fossil fuels. Number two is a new tax credit for energy storage and biofuels. Number three is a major extension of tax credits for wind, solar, fuel cells and carbon capture, and the payment for many of these technologies is higher than they've been in the past. Number four is significant incentives for domestic manufacturing of clean energy equipment. Number five is what's often referred to as direct pay for tax credits. This essentially provides owners with the immediate cash benefit of tax losses; that avoids these companies needing to go monetize those tax losses via the tax equity market to the same extent that they do now. Number six is support for nuclear power. There's a production tax credit for nuclear power output. Number seven is a major clean hydrogen tax credit. And number eight is significant capital to reduce the risk of wildfires. So it is very broad, very far reaching. It has impacts across the board.Michael Zezas So, which kinds of companies do you think stand to benefit the most from this funding?Stephen Byrd It's really interesting, quite a few subsectors that I cover would receive significant benefit here, I'll highlight the biggest beneficiary. So first, any company involved in green hydrogen, I see quite a bit of benefit here. The tax credit for green hydrogen is $3 a kilogram. That is a very large amount. And we think will incent customers to adopt green hydrogen more quickly. It will incent developers to build out the infrastructure needed to both produce and distribute green hydrogen. So, a number of companies from fuel cell companies to those involved in the industrial gas business to clean energy developers, I think will see a significant benefit there. Another category would be renewable development companies. So, the tax credit for wind and solar and storage is increased. In the case of storage, this is the first time energy storage would get a tax credit, and this further lowers the cost of clean energy. Another category that could be quite significant is carbon capture and sequestration. This technology would receive a significant benefit in terms of the payment per ton of hydrogen. And we believe in many cases, this is going to be really the amount needed to get essentially over the finish line. That is, to provide enough support for those big carbon capture projects to actually get built, which is really quite exciting. Biofuels gets a big benefit. Anyone who wants nuclear power would receive a significant benefit. And also, companies that are working to reduce the risk of wildfires would receive significant government support. So, you can tell it's just very broad and touches on really every subsector that we cover.Michael Zezas Now, the Clean Electricity Performance Program, or CEPP, will likely end up on the cutting room floor. Why is this program's exclusion not a bigger problem in your mind?Stephen Byrd The CEPP, it's really interesting. It certainly is a very bold effort to reduce fossil fuel usage. What we find here, though, is that all of the other provisions are so significant that we believe the adoption of clean energy will continue at a rapid rate. To give you a sense, in 2020 renewable energy in the United States was about 11 percent of power output. By 2030, we project that that can approach around 40 percent. That is a huge increase in just a decade. That is predominantly driven by economics. The cost of wind, solar and energy storage is dropping so quickly that many customers are adopting clean energy based purely on economic grounds, and the elements of support in this draft legislation would further enhance those economics and push customers in that direction anyway. So, we do see a big shift occurring, with or without the CEPP. Fortunately, there are many other elements of support in this draft legislation that we think is going to really provide a boost to many clean tech technologies, many business models, and we're excited about the growth that that would bring.Michael Zezas What about the other types of companies you cover, utilities? This government investment seems like a step toward developing a very different type of business model for them. What do you think the outlook for the sector is?Stephen Byrd I'd say the government support for clean energy that's in this draft legislation does have a number of benefits for utilities. So, we see in parts of the country a virtuous cycle that's been forming. And let me walk through how this is playing out. The coal power plants in many parts of the U.S. are quite expensive compared to renewable energy. So, for example, in the Midwest, the cash cost to run a coal plant could be three times as high as it costs to build a new wind farm. And so what utilities are doing is they are in a very careful, measured way shutting down coal, replacing that coal typically with a combination of wind and solar and energy storage. And typically, customer bills are not going up as a result, because of the benefit from avoiding the cost of running those coal plants. That virtuous cycle is resulting in better earnings per share growth. Now, with the government support that we're seeing in this draft legislation, that shift will accelerate. We will see more transmission spending, for example, more energy storage spending. It will boost the economics of wind and solar, which is fantastic. Also, in terms of risk mitigation, the capital that's in the bill that would help with dealing with the physical damage from climate change, such as wildfires, is another area of benefit. The cost from climate change to our sector is rising. And so government support there will help essentially defray a cost that's becoming quite significant for some of our utilities. So, you know, I think you're right to point this out. The utility sector is quite a big beneficiary here. And, you know, many of our best-in-class utilities can achieve, we think 7%, sometimes 8% EPS growth over a very long time period. By very long, I mean, a multi-decade time period. That to us is quite exciting because risk adjusted, that growth is quite excellent. For many of our utilities, the risk to achieve that is fairly low because the economics of what they're doing is so clear and so compelling. So, we are excited about the impacts to the utility sector.Michael Zezas Steven, thanks for taking the time to talk.Stephen Byrd Great talking with you, Michael.Michael Zezas As a reminder, if you enjoy Thoughts on the Market, please take a moment to review us on the Apple Podcasts app. It helps more people find the show.
The forecast for inflation still appears hot for both consumers and corporates, but when it comes earnings and economic growth, the outlook looks a bit chilly.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, chief investment officer and chief U.S. equity strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 25th at 11:30 a.m. in New York. So, let's get after it.Over the past few weeks, we've discussed the increasing probability for a colder winter, but a later start than previously expected. In other words, our "fire and ice" narrative remains very much intact, but timing is a bit more uncertain for the ice portion. Having said that, with inflation running hot in both consumer and corporate channels, the Fed is expected to formally announce its tapering schedule at next week's meeting with perhaps a more hawkish tone to convince markets they are on the job. In other words, the fire portion of our narrative—higher rates driven by a less accommodative fed spurring multiple compression—is very much in gear and a focus for investors.With so much attention on rising inflation now from both investors and the Fed, we shift our attention to the ice portion of our narrative - meaning the ongoing macro growth slowdown and when we can expect it to bottom and reverse course. As regular listeners know, we've been expecting a material slowdown in both economic and earnings growth amid a mid-cycle transition. The good news is, so does the consensus, with third quarter economic growth forecast coming down sharply. While consensus’ fourth quarter GDP forecasts have declined too, it expects growth to reaccelerate from here. This is due to the fact that most have blamed the Delta variant, China's crackdown on real estate or power outages around the world for the economic disappointment in third quarter. The assumption is that all three will get better as we move into year end and 2022.Needless to say, we're not so sure about that assumption, mainly because we think the more important driver of the slowdown has been the mid-cycle transition to slowing growth from post-recession peak growth, an adjustment that's not finished. In our view, would be intellectually inconsistent to think that the mid-cycle transition slowdown won't be worse than normal given the greater than normal amplitude of this entire economic cycle so far. We can't help but recall our position over a year ago when we argued for much faster growth driven by greater operating leverage than normal for earnings. This was directly a result of the record fiscal stimulus that effectively served as government subsidies for corporations. Today, we simply find ourselves in the exact opposite side of the argument relative to consensus, but for the same reasons. Since we believe consensus missed that insight last year, it seems plausible it could be missing it this time on the other side.In short, we think the gross slowdown will be worse and last longer than expected as the payback in demand arrives early next year with a sharp year over year decline in personal disposable income. While many have argued the large increase in personal savings will allow consumption to remain well above trend, it looks to us like personal savings have already been depleted to pre-COVID levels. The run up in stock, real estate and crypto asset prices do provide an additional buffer to savings, however, much of that wealth is concentrated in the upper quartile of the population. At the lower end of the income spectrum, consumer confidence has fallen sharply the past few months, and it's not just due to the Delta variant. Instead, surveys suggest many consumers are worried again about their finances, with inflation increasing at double digit percentages in necessities like food, energy, shelter and health care.Bottom line, the fundamental picture for stocks is deteriorating as the Fed begins to tighten monetary policy and growth slows further into next year. However, asset prices remain elevated as the upper income cohort of retail investors continues to plow money into these same investments. With seasonal trends positive this time of year, institutional investors are forced to chase prices higher. If our analysis is correct, we think this can continue into Thanksgiving, but not much longer. Manage your risk accordingly.Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
The market’s long term trajectory for oil suggests a decline in prices, but the 'why' matters, and the transition toward more green energy may imply a different outcome.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross-asset strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, October 22nd at 2:00 p.m. in London. The price of energy has surged this year. While the S&P 500 is up an impressive 21% year to date, that pales in comparison to a broad index of energy commodities - things like oil and natural gas - which are up almost 80%. I wanted to talk today about some of the broader implications of this move and importantly, the somewhat surprising message from future price expectations. Let's actually start with those expectations. While the price for oil is up sharply this year, future prices currently imply a pretty significant decline in the price of oil over the next one, two and three years. Buying a barrel of oil costs about $84 today. But if you want to buy a barrel for delivery in a year's time, the price is $76, a full 10% lower. And for those of you looking ahead to Christmas 2023, that same barrel of oil costs $70, 17% below current levels. Those implied declines in the future price of oil are historically large. If current oil prices simply move sideways over the next year, buying oil 10% below current levels in a year's time will return, well, 10%. That's more than double the return for U.S. high yield bonds, and one reason commodity investors care so much about the shape of these prices over time. Indeed, it's a way for investors to make a pretty healthy return, in this case 10%, in a scenario where the day-to-day price of oil doesn't really move. This dynamic that we see today, where future oil prices are lower than current levels, is called 'backwardation'. And while it matters for commodity investors, it can also have broader implications for how we interpret the economic outlook. When oil prices are rising like they are today, one of the single biggest economic questions is whether this rise is mostly coming from increased demand or more limited oil supply. The price impact may be the same between these two dynamics, but the underlying drivers are very, very different. According to the work by my colleague Chetan Ahya, Morgan Stanley's chief Asia economist, higher demand suggests underlying activity is strengthening and higher oil prices are easier to afford. Limited oil supply, in contrast, works more like a tax and can be more economically disruptive. So how do we know which one of these it is? Well, there are a lot of things that investors can look at, but the shape of oil prices over time, what we've just been discussing, can be a really useful way to quantify this question. Short term oil prices, we'd argue, tend to be influenced more heavily by the demand for oil. If you're going to go on a long road trip, you're going to fill up at the pump today. Longer term oil prices, in contrast, tend to be more linked to supply, as the producers of that oil really do care about selling it over the next one, two, three and five years. So, if demand is strong, short-term prices should be biased higher. And if supply is more plentiful, longer-term prices tend to be biased lower. That downward shape of prices over time, that 'backwardation', is exactly what we were discussing earlier, and that's what we see today. That, in turn, suggests that the current oil price strength is being driven more by demand than supply. I'll close, however, with the idea that the market might have this long-term trajectory of oil prices wrong. As my colleague Martijn Rats, Morgan Stanley's chief commodity strategist, has recently argued, an expectation of a green transition towards renewable energy has caused investment in new oil drilling to plummet. That should mean less supply over time, challenging the market's current assumption that oil prices will decline significantly over the next several years. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.
4 min 3 sec
Sustainably generated hydrogen has great promise as a fuel where electricity alone won’t suffice, but the road to its broad adoption remains complicated for investors to navigate. ----- Transcript -----Jessica Alsford Welcome to Thoughts on the Market. I'm Jessica Alsford, Global Head of Sustainability Research at Morgan Stanley. Ed Stanley And I'm Ed Stanley, Head of Thematic Research at Morgan Stanley. Jessica Alsford And today on the podcast, we're going to be talking about the investment implications of hydrogen. It's Thursday, October the 21st at 3:00 p.m. in London. Jessica Alsford So Ed, hydrogen has been something we've been looking at for some time, given its potential role in a low carbon economy. So why is it that the debates around green hydrogen seem to have intensified over the last 6 to 12 months? Ed Stanley Great question. Massive, centralized support and road mapping in the form of the European Hydrogen Strategy and the US Infrastructure Bill simultaneously thrust hydrogen to center stage around the world. Ed Stanley But the froth has come and gone to some extent from most of these hydrogen names. And so now it's a really interesting time to be relooking at the space from a stock picking perspective. The number of dedicated hydrogen thematic funds is really beginning to accelerate as well. We've reached 10 hydrogen funds in Europe from only 1 two years ago, and many of the pure play equities that these funds are or will be buying are pretty illiquid, which we expect will lead to further volatility in due course for single name equities. The electrolyzer stocks are up to two thirds of their highs, so the reason why now is that as the market froth subsides, we're beginning to see these thematic alpha opportunities all the way along the supply chain in hydrogen. Jessica Alsford Now, projections by the Hydrogen Council suggest that green hydrogen could enable a global emissions reduction of around 6 gigatons by 2050 - so almost 10% of current global emissions. It also has the potential for unlocking something like 30 million jobs and $2.5T of associated revenues. And yet, despite this huge potential, it does feel that we're still at a very early stage. So why is that? What are some of the challenges around the wider adoption of green hydrogen? Ed Stanley That's right, and I don't think you can fault the ambition. The Hydrogen Council, as you mentioned, is over 200 member companies and they have a clearly defined goal and they're pulling in the same direction. And increasingly, governments are also walking the talk. I guess, though, when you ask our analysts what the greatest hindrances are, if I had to boil them down to two factors, it would be these: first, the lack of standards, and that really means we have dual investment and thus potentially wasted investment going on as each stakeholder has their own vested interests on whether to use PEM or alkaline electrolysis, for example; or whether to retrofit existing pipe networks or to rebuild from scratch. So, a lack of agreement on these dichotomies is a risk of diluting the early stage growth and investment. Ed Stanley And the second is much simpler, actually, it’s economics. Costs for renewable energy, predominantly wind and solar, that feed these very power hungry upstream electrolyzers have fallen substantially in cost - over 90% decline in 10 years. But it still requires cost per unit breakthroughs across the rest of the supply chain; from ammonia, for example, or redesigning jet engines to make it viable, particularly for publicly listed companies to make the necessary investments. Ultimately, we should probably expect very generous subsidies for some time if we are to hit that 6 gigatons value, you mentioned. Jessica Alsford So there are challenges, but also clearly opportunities as well. Where do you think the most value can be created and how should investors participate in this market? Ed Stanley Again, our analysts obviously have their own single stock preferences, of course. But if I were to take a step back and look at the supply chain holistically, it's a question of relative risk reward. For example, upstream, some electrolyzer names have over 100% upside in our view, but that has to be taken in the context of an ongoing debate, as I mentioned, into which electrolyzer technology will become the industry standard, and so at risk potentially putting all your eggs in one basket. At the other end of the spectrum, downstream, rail and aviation has potential, but with extremely long time horizons, which risk compounding forecasting errors several decades away. Ed Stanley So in my mind, some of the best plays are midstream - the chemical names, for example, with best-in-class green ammonia platforms. And you can see that in their excellent intellectual property positioning relative to the rest of the supply chain. Other subsectors include the inspection companies, which will benefit to the tune of 0.5% to 1% of all global hydrogen capex being spent on safety testing. And that's irrespective of which technology or country is the first to roll out. And we don't believe some of those fundamentals are being priced in. So given there's a still very high degree of uncertainty as this technology rolls out, our preference is for midstream and particularly technology and country agnostic companies. Ed Stanley On that note, hydrogen is obviously only one of a handful of decarbonization tools. So, what else do you think has promise in the decarbonization outlook? Jessica Alsford Yes, you're right, Ed. And if we are to achieve a net zero scenario by 2050 and achieve the Paris Agreement, then we need to deploy a range of different strategies. Now one of them may be renewables from a power generation perspective. Solar wind is already economically viable, and we expect to see a huge amount of roll out of renewable power capacity over the coming decades. Elsewhere, we need to see electrification of certain types of energy. The great example being on the auto side as you see movement from the combustion engine to electric vehicles. And though again, although adoption rates are still very low, the stimulus has been set. The policy is outlined to really incentivize this drive from the combustion engine to an EV. So, we're very confident it is only a matter of time before you see that greater adoption of EVs globally. Jessica Alsford Then we come on to some of the more innovative technologies. I think CCS - carbon capture and storage - is a great example of this. Just a few years ago, it was really viewed quite negatively as essentially CCS allows you to still use fossil fuels, whether that be in power generation or in industrial processes like steel and cement manufacturing. But I think now there is a greater acceptance that in some situations we're not going to be completely able to remove all fossil fuels, and so by using CCS technology, you can allow coal/gas to be used, but without emissions as a result of that. And so, I do think that CCS is a really interesting technology to also watch alongside hydrogen as an enabler of a low carbon economy. Ed Stanley That's very clear. And I guess the timing is very opportune to speak to you today because COP26 is approaching. And so, I'm keen to find out from you, what do you think we will see from the world leaders or even corporates in terms of decarbonization pledges? And what impact could that have ultimately on the market for hydrogen longer term? Jessica Alsford Absolutely. So COP26 starts on the 31st of October in Glasgow. It has been delayed since last year because of the pandemic. Two things that I'd particularly point to is, first of all, we would expect many world leaders to step up and announce more ambitious carbon reduction targets. Not everyone currently has a 2050 net zero ambition. And we also now need to see that shorter term trajectory about how are we're going to get there at the right pace of decarbonization as well. So, 2030 reduction targets is also something that we'll be looking for at COP. Jessica Alsford The second area I'd point to is then in terms of global carbon markets. So, the EU has been leading the way for a long time in terms of establishing a very broad and effective carbon market through the Emission Trading Scheme. However, in order to really, again accelerate the transition to a low carbon economy, we need to see a broader adoption of higher carbon taxes, higher carbon prices globally. And why is this important for hydrogen? Well, one of the ways I think that you can really incentivize adoption of hydrogen is to make the higher carbon incumbent alternatives more expensive, and you can do that by pricing carbon at a much higher level. Jessica Alsford So I think the combination of more ambitious carbon reduction targets and more acceptance of the need for higher carbon taxes could be two positive catalysts for hydrogen at COP26. Jessica Alsford Ed, thanks for taking the time to talk today. Ed Stanley Great speaking with you, Jess. Jessica Alsford As a reminder, if you enjoy Thoughts on the Market, please do take a moment to rate and reviews on the Apple Podcasts app. It helps more people to find the show.
9 min 50 sec
The bipartisan infrastructure and ‘Build Back Better’ plans remain in legislative limbo, but what could their passage mean for markets? ----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, October 20th at 11:00 a.m. in New York. We spend a lot of time here thinking through exactly how and when Congress will manage to raise the debt ceiling, keep the government open and pass a multitrillion dollar package of spending offset by tax hikes. To be clear, we continue to think it will do all of the above. But for this week, let's deal with DC's policy choices in classic Morgan Stanley Research fashion... by focusing on tangible market impacts. Let's start with new government spending, which can be a positive catalyst in equity sectors such as construction and clean tech: in our view, a conservative estimate is that Congress approves $2.5T over 10 years between both the bipartisan infrastructure and build back better plans. While that amount might fall short of the numbers you might have heard thrown around, it should get your attention. For example, the bipartisan infrastructure framework, which would make up about $500B of this total, would nearly double the US's current baseline infrastructure spend. Our colleagues think this would catalyze an infrastructure ‘supercycle’ where factors like a surge in cement demand could lead to a positive rerating of stocks in the construction sector. Additionally, the framework could include $500B in new spending and tax credits aimed at clean energy production. That means a substantial ramp in demand for clean tech companies, which our colleague Steven Byrd sees as a clear bullish catalyst for that sector. As for corporate taxes - yes, DC is likely to push them higher. Yet for now, we don't see this as more than a near-term challenge that shouldn't get in the way of the positive medium-term outcomes for the equity sectors we've highlighted. As Mike Wilson and the Equity Strategy Team have argued, enacting higher taxes could bring down forward guidance, something investors may not yet be pricing in, given current valuations. In the near term, that may prompt U.S. equity indices to price in a greater chance of a sustained economic slowdown. But such weakness would likely be more of a correction than a bear market signal, as we expect the total fiscal package would ultimately be GDP supportive. Likely incorporating more spending than taxes, our economists expect it to boost net aggregate demand and support the view that the US can continue to grow at a brisk pace in 2022. So, of course, we'll be tracking these policy paths into year end, but it's important to keep an eye on why they matter from a market perspective. We'll stay focused on what's going on, and what you can do about it in your portfolio. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
2 min 58 sec
Moves toward scale and consolidation show promise for what is already a burgeoning content industry. ----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research. Ben Swinburne And I'm Ben Swinburne, Equity Analyst covering Media, Entertainment, Advertising and the cable/satellite industries. Andrew Sheets And today on the podcast will be going a bit meta, as the kids say, as we talk about some interesting upside for podcasting and advertising. It's Tuesday, October 19th at 2pm in London. Ben Swinburne [00:00:25] And 9am in New York. Andrew Sheets So, Ben, you recently wrote a research report titled, a bit surprisingly, “Mic'd Up. Is Podcasting the Next Big Thing?” I say surprisingly, because podcasting has been around for quite a while now. So why do you think that it's now where it's actually going to be it's time to shine? Ben Swinburne You're right. Podcasting has been around probably for at least 15 years, but what we're really seeing is a significant increase in engagement by consumers, investment by platforms and content creators jumping into this space. We think we're at a point now where the business model, at least from an advertiser ROI point of view, has been proven out. You know, advertisers are paying $20-$25 CPMs, or cost per thousand listeners, to access a podcast audience, particularly through host-read ads, that's as high as linear television. And that just shows you that advertising on podcasting works for advertisers. So, what the industry needs from here is significant growth in adoption, which we believe is going to come given the investment we're seeing in content. Wrapping it all up, we think the industry can grow at a 30% CAGR through 2025 and become a $6-7 billion market globally, which is meaningful for the companies that are in this space. Andrew Sheets So to kind of put those numbers in context, if I have a podcast that has 4,000 regular listeners, you know, if I'm getting paid by an advertiser $25 per thousand, that'd be about $100 for that $4,000 advertising block. Is that a good way to kind of think about those numbers. Ben Swinburne Per spot, yes. And then obviously, it's a question for you on your podcast, how many ads you want to run per hour. Andrew Sheets Podcasting is now charging, was it similar advertising rates as local television? Did I hear that correctly? Ben Swinburne You did. You did. Andrew Sheets Would you say though, investors believe in that? Because you cover a wide range of media companies in your equity coverage here at Morgan Stanley, how is the market pricing that advertising opportunity? And do you think the market believes that podcasting can be this major advertising vehicle? Ben Swinburne I think the market's skeptical, frankly. Part of that is because as we talked about earlier, podcasting is not new as a media. But also because even at 15-years-old with a lot of excitement around it, it's a very small market. You know, estimates range from a billion dollars to maybe $2 billion in 2020 of global ad revenue on podcasting. That is a low single digit percentage of the global ad market. it's just been a very slow rise in monetization. And I think the market is skeptical that it can really break out from here. Andrew Sheets So I imagine another area where the market might be skeptical is a lot of people have been stuck inside as a result of the pandemic. They've been listening to more podcasts. But as things normalize, maybe that listening trend will shift. Can you just kind of give us some numbers around, what percentage of the U.S. population listens to podcasts and do you think that that engagement will decline or rise as we look ahead over the next couple of years? Ben Swinburne In 2020, the reach of podcasting in the U.S. accelerated to 25% of the population. If we think about that level of adoption, in a lot of other instances, Andrew, that's a part of the S curve where we start to really see the adoption rate accelerate. In other words, you're going from sort of early adopter to mass market. So that's our expectation here. We actually saw that in streaming music years ago. So, we're optimistic that we're going to see that from here. And frankly, when I look at the investment, the amount of money companies are pouring into content and monetization technology, I'd be really surprised if we don't see it accelerate. The other thing I would add is that even though podcasts consumption held up well in 2020, it was still negatively impacted by the pandemic. People were not commuting, not going to the gym, not going to work. All of that reduced the amount of time people were consuming audio content on their phones. So that is still the primary use case for all audio consumption but including podcasts. So we have started to see already improving data in the last several months on audio consumption as people have started to go back to work and go to school and hit the gym again. Andrew Sheets So then, Ben, can you talk a little bit more about what's been happening on the merger and acquisition front in podcasting? And how this media is getting reshaped by some of the changes that we've seen? Ben Swinburne Absolutely. Yeah, it's a very active market. You can sort of break down the M&A into two broad areas: content and sort of advertising technology. If you think about the media business, in the sort of the pre-internet days, you had media producers and media distributors, it's a pretty simple value chain. The internet, by its nature, but also because it's much less regulated, has created an environment for more vertical integration. Podcasting is rapidly moving in that direction, with distributors buying up podcast IP and creators rapidly. Now, that can probably only go so far because, like music, podcasting is a business built on ubiquitous distribution. So, where we've seen exclusives, they just haven't really worked, and that makes sense from an advertising monetization point of view. On the monetization front, there is a lot of work left to do. I mean, we're still looking at a very, while attractive media for advertisers, pretty old school in the way the ad products actually work. Now this is starting to change. We're seeing more things like advanced measurement, attribution, programmatic buying-- all wonky things us media people like to talk about. But the most popular ad format in podcasting is host-read ads. It's Bill Simmons reading a promo code to go to a website and buy a product. You know, this is like Howard Stern 25 years ago. So, from that point of view, it's still early days. Andrew Sheets So, to kind of put some numbers around that, I mean, could you give us a sense of how much is currently being spent on podcast advertising versus other types of advertising that are out there? Ben Swinburne Oh, yeah, absolutely. I mean, the video market is $100 billion in the United States. Between linear television and streaming video, the radio, traditional radio market in the United States is sort of $15 to $18 billion. And as I mentioned before, podcasting, we think will probably be around 2 billion this year. Andrew Sheets Got it. So, it's still even as ubiquitous as it's starting to seem. It's still very small, still very nascent relative to some of these much bigger areas where companies are already spending a whole lot of money. Ben Swinburne That's right. Andrew Sheets So, Ben, you cover a large number of the largest entertainment and media companies. What do you think is going to be their strategy for podcasting going forward? And do you see this as more of a US opportunity, a global opportunity or something in the middle? Ben Swinburne We think the strategy going forward is primarily one that monetizes podcasting through advertising. And to be successful in that, you're going to need a significant content offering. But also, importantly, a scaled and advanced technology platform. And so, we're seeing companies that are going after this opportunity really invest aggressively in both. In terms of U.S. versus global, we definitely see it as a global opportunity. However, if we think about the TAM for podcast advertising, radio is the obvious one. Radio is very much a U.S. marketplace. A lot of radio outside the U.S., think of BBC One in the U.K., is in fact ad free. So, the global radio advertising opportunity skews very much U.S. That's why it's so important that podcasting can attract digital advertisers or buyers of digital advertising - those that might buy search or display ads - that opens up podcasting to a much larger opportunity and global. Andrew Sheets And Ben, I was hoping you could also talk a little bit about what are the demographics of podcast listeners and how does that impact the advertising landscape? Ben Swinburne So as you can probably guess, particularly since we're in the early adopter phase of podcasting, it does skew, sort of technology savvy, educated and often higher income from an audience point of view. That's part of why advertisers are so attracted to the space and why the ad rates are so high. Clearly, the long-term bull case is widespread adoption now as reach goes from 25% of the population to hopefully 50% and 75%, by definition the audience is going to look much more representative of the overall population, which will bring with it, you know, lower income or advertising targets that have lower propensity to spend. So that will get reflected in ad rates and probably different kinds of ad products. But ultimately, even if that puts some downward pressure on ad rates, we think the growth in engagement will more than offset that, creating a nice growth story over time. Andrew Sheets Ben, I thought you made a really interesting point about just the types of advertising that are most effective here, you know, often, host read, often funny are very engaging. I mean, is there a good precedent in advertising for something that feels that personal? And, is there any other, implications for that just about how advertising feels and sounds, more broadly going forward? Ben Swinburne It's a great point, and it's a good news, bad news situation, I think, for the industry. The good news is that host read ads are incredibly effective. The demand outstrips supply, frankly, and the more widespread, highly popular podcasts that can be developed, the more opportunities there will be for monetization. The bad news is that to really scale the business host read ads are just it's hard to scale them. You can only have so many in an hour. And if you want to start really doing sophisticated, digitally driven ad buys and ad provisioning, you've got to automate all that. And doing host read ads in an automated fashion across the long tail of millions of podcasts really can't be done. The industry now is working on lots of technology and ad products to try to create an ad product or an ad unit that is hopefully not as effective as host read, but more effective than traditional radio. Andrew Sheets So, Ben as somebody whose father back in the day used to sell advertising for a radio station. What do you think are the questions that companies who want to advertise in a podcast should be asking to try to maximize that effectiveness? Ben Swinburne Well, a lot of the measurement in attribution technology today remains pretty early stage, frankly. Most of the podcast business historically has been measured by downloads. But just because you download a podcast doesn't mean you listen to it. And frankly, nobody really downloads podcasts anymore because they're all streamed. That just gives you an example of a key area like measurement that needs to evolve. You can go even beyond that when you think about multichannel attribution. For example, let's say I listen to a podcast ad and then I go online and I buy that product. How does the advertiser know that I went to buy that product because I heard that ad? Those things are all happening at a pretty sophisticated level online in general today. But podcasting is not plugged into that ecosystem in a real way yet. Andrew Sheets And finally, Ben, you know, based on your work and your forecasts, what do you think the next five years hold for the podcasting industry? Ben Swinburne We expect to see continued substantial investment in podcasting content, monetization technology and also personalization and curation. I think one of the challenges that consumers have, as I mentioned earlier is there's well over two million podcasts in a lot of these major platforms, so figuring out what to listen to is challenging. Sampling a song which might be 3 or 4 minutes long is a commitment. Sampling a 30/45 minute podcast is a whole different situation. And so those companies that can help consumers find what they want to listen to, that could be a huge advantage in the marketplace. And I'd say, much like we've seen in streaming video, we think we'll see an explosion of compelling podcast content across genres and across countries. There is so much talent out there which, when combined with the global growth and connectivity and connected devices, means we will all be plugged in all of the time, hopefully feeding our minds and hearts with information and stories from around the world. Andrew Sheets Fantastic. I think that's a great place to leave it. Ben, great chatting with you. Ben Swinburne Great speaking with you, Andrew. Andrew Sheets As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.
12 min 48 sec
With supply chain pressures and rising costs still weighing on markets, retail investors continue to see long term value.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, chief investment officer and chief U.S. equity strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 18th at 11:30 a.m. in New York. So let's get after it. Last week, we noted it may take a bit longer for the Ice portion of our Fire and Ice narrative to play out. More specifically, we cited the potential for markets to look through the near-term supply bottlenecks and shortages as temporary. With the Biden administration directing substantial resources toward addressing the problem, that conclusion is even easier to make. Second, the budget reconciliation process has been pushed out and is unlikely to be resolved until later this year. This delays the negative earnings revisions from higher taxes we think have yet to be incorporated into 2022 consensus forecasts. In short, while earnings revisions' breadth is falling from extreme levels, it isn't falling fast enough to cause a deeper correction in the broader index, at least not yet. Perhaps most importantly for the broader index is the fact that retail continues to be a major buyer of the dip. We highlighted a few weeks ago that the correction in September was taking longer to recover than the prior dips this year. In fact, both the primary uptrend and the 50-day moving average had finally been breached on significant volume. Could it be that the retail investor had finally run out of dry powder or willingness to buy the dip? Fast forward to today, and the answer to that question is a definitive “no”. Instead, our data show retail investors remain steadfast in their commitment to buying equities, particularly on down days. Until these flows subside or reverse, the index will remain supported even as the fundamental picture deteriorates. As already noted, earnings revision breadth is rolling over. Some of this is due to higher cost and supply shortages, which investors seem increasingly willing to look through as temporary. We remain more skeptical as the data also supports sustained supply chain pressures, rising costs and the potential for weaker demand than anticipated next year. Last week, our economics team published its latest Business Conditions Index survey, which showed further material deterioration. While most of this decline is due to supply issues, rather than demand, we're not sure it will matter that much in the end if earnings estimates have to come down one way or the other. As part of our mid-cycle transition call, we have been expecting business confidence to cool. We think it's important to note that our survey suggests it's not just manufacturing businesses that are struggling with cost and supply issues. Service businesses are also showing material deterioration in confidence to manage these pressures. Whether and when it proves to be a concern for equity markets remains unknown, but we think it will matter between now and January. Until proven one way or the other, the seasonal path of least resistance for equity markets is flat to higher. Similar to our Business Conditions Index, consumer confidence surveys have also fallen sharply. Like business managers, the consumer appears to be more concerned with rising costs rather than income. Yet, the retail investor continues to aggressively buy the dip. This jibes with the conclusion other investors are making -- that demand remains robust, and we just need to get through these supply bottlenecks and price spikes. One other possible explanation is that individuals are worried about inflation for the first time in decades, and they know it's not temporary. Stocks offer protection against that rise to some degree, and so we may be finally witnessing the great rotation from bonds to stocks that has been predicted for years. While we have some sympathy for that view in the longer term, the near-term remains challenged by the deteriorating fundamentals in our view. In short, we'd like to see both business and consumer confidence improve before signaling the all clear on supply and demand trends. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
3 min 58 sec
Consumer saving is up, way up. But whether investors put this money into the markets may have more to do with how much wealth is already in play.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, October 15th at 2:00 p.m. in London. Over the course of the pandemic, strong government support and some of the difficulties of spending money as usual, led to a large surge in consumer savings. This was a global trend, seen from the U.S. to Europe to China. For markets, one of the most bullish arguments out there is that these savings can still come into the market. In sports terms, there's cash sitting on the sidelines waiting to come into the game. But we think this story is more complicated. Yes, there are a lot of savings out there by almost every measure that we look at. But to continue with the analogy, while investors may have cash sitting on the sidelines, they also have a lot of wealth already on the field. To put some numbers around this, the amount of cash currently held in US Money Market funds is about 20% of gross domestic product relative to a 30-year average of 15%. But total household wealth, that is the value of all the homes, stocks, bonds, businesses and stamp collections, is now about 590% of GDP, 170pp higher than its average over that same 30-year period. So, yes, overall Americans are holding more cash than normal, but they also have more, a lot more, of everything else. Meanwhile, that everything else is riskier. Stocks, which generally represent the most volatile asset that most households hold has been a growing share of this overall wealth. U.S. households now hold more stocks relative to their other assets than at any time in history. It's possible that people decide to put more money into the market, but many may decide that they already have a reasonable amount of exposure as it is. Indeed, this echoes the comments of someone with real world insights into this dynamic: Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management. Recently on this podcast, Lisa mentioned similar dynamics within the over $4T of assets managed by Morgan Stanley's Wealth Management Group - cash holdings were still ample, but exposure to the equity market for investors was historically high, as market gains have boosted the value of these stock holdings. For investors, we think this has two important implications. First, we think the figures above suggest that many investors actually do have quite a bit of exposure to the market already relative to history. That exposure could rise But while it's always more fun to imagine a market that has to rise because everybody needs to be more invested, we just don't think that that is what the household data really suggests. Second, that high exposure means that fundamentals, rather than more risk taking, may be more important to getting the market to move higher. Strong earnings growth has been an under-appreciated boost to markets this year and will be important for further strength. Third quarter earnings season, which is now beginning, will be an especially important element to watch around the world. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
3 min 15 sec
Last week, over 130 countries announced an agreement to overhaul international tax rules. The changes may seem high-level, but should investors pay closer attention?----- Transcript -----Michael Zezas Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Todd Castagno And I'm Todd Castagno, Head of Global Valuation, Accounting and Tax within Morgan Stanley Research. Michael Zezas And on this edition of the podcast, we'll be talking about recent developments around a major overhaul of international tax rules and what it means for investors. It's Thursday, October 14th at 10 a.m. in New York. Michael Zezas So, Todd, I really wanted to talk with you after last week's announcement by more than 130 countries about an agreement to undertake a major overhaul of international tax rules. Central to the agreement appears to be a change in how companies are taxed and a new 15% global minimum tax rate. So, investors might see a headline like this and think it's one of those things that sounds important, but maybe a bit too high level to matter. But you think investors should pay attention to this. Todd Castagno Right, it's big news. There are really two key motives driving what is referred to as a two-pillar global tax agreement, and this motivation provides really important context. So let's start with pillar one. There's a growing desire from certain countries to change who gets to tax the largest and most profitable corporates. So Michael, in a modern marketplace, companies can engage and transact with consumers in countries where they may not have much or any physical presence. So the first pillar of this agreement proposes to reallocate profits of the largest and most profitable companies to where they transact with customers. Then there is desire to stop what's often referred to as the 'race to zero' in terms of corporate tax rates. So under pillar two of the agreement, countries will need to adopt a 15% minimum tax rate structure on corporate foreign income. So why should investors care? A few reasons: Not to overstate the obvious, but tax rates are likely going up for multinationals if this is implemented. There are also important geopolitical dynamics. These changes have the potential to significantly change where corporates invest. And countries have been increasingly imposing unilateral taxes, particularly on digital services. Those taxes are complicating trade relationships. Pillar one seeks to remove those taxes so trade dynamics may actually improve. Michael Zezas OK, so assuming these guidelines are implemented globally, what's your expectation about which industries overall could see the most headwinds? Todd Castagno Well, it's an interesting question. Not all sectors and industries will be impacted equally. According to our analysis, technology hardware, media services, pharmaceuticals and broader health care appear most exposed to both pillars. Michael Zezas OK, so the concept is that some industries' tax burdens are going to be affected more than others. Can you walk us through a specific example? Todd Castagno Yes. Technology hardware appears predominately exposed to both pillars. Why is that? Manufacturing and IP are centrally located, and the industry currently benefits significantly from tax incentives, which often drive a very low tax rate. This illustrates a potential political tension, as countries are currently motivated to provide more tax and R&D incentives given the current supply constraints. So, it'll be interesting to see how countries attempt to incentivize under a new minimum tax rate system. Michael Zezas OK, so last question here. Just because countries have agreed to pursue these tax changes doesn't mean these changes are imminent. They obviously require countries to go back and change their own laws. And regular listeners may know that our base case is that the US could soon raise corporate taxes, including a potential hike in the global minimum tax rate to 15%. So, how much do the current tax changes proposed in the U.S. already reflect this international tax agreement? Todd Castagno So what's notable is pillar two really emerged as a function of the tax bill passed under the prior U.S. administration. Today, the U.S. is the only country with a minimum tax remotely similar to what's being proposed under pillar two. However, there are both rate and structural differences. Our base case is 15% in line with the agreement. But Michael, as you know, Congress and administration have proposed higher rates. What's also important is the structure. So, today's U.S. system applies a minimum rate on aggregate foreign income. What's notable about Pillar two is it would apply that rate on a country-by-country basis. So, what that means is many companies may be exposed to a new minimum tax rate structure versus what's in the U.S. today. Todd Castagno But before we close, Michael, taking all this into account, what could this mean for markets moving forward? Do we think these changes are already in the price? Michael Zezas You know, it's an important question that really defies having a simple answer. In the view of our Equity Strategy Team, the impact of these tax changes to U.S. companies bottom lines probably isn't fully appreciated yet and could cause some short-term market weakness. But beyond that, these tax changes are part of a broader fiscal package that spends more than it taxes. And so that should continue to support robust economic growth into 2022. So that makes the medium-term outlook rosier for risk assets. Michael Zezas Todd, thanks for taking the time to talk today. Todd Castagno Great talking with you, Michael. Michael Zezas As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.
4 min 43 sec
With supply chain delays in air, ocean and trucking on the minds of investors worldwide, what could it mean for the labor market and consumers headed into the holiday season?----- Transcript -----Ellen Zentner Welcome to Thoughts on the Market. I'm Ellen Zentner, Chief U.S. Economist for Morgan Stanley Research. Ravi Shanker And I'm Ravi Shanker, Equity Analyst covering the North American transportation industry. Ellen Zentner And on this episode of the podcast, we'll be talking transportation - specifically the role of freight in tangled supply chains. It's Wednesday, October 13th at 10:00 a.m. in New York. Ellen Zentner So, Ravi, many listeners have likely heard recent news stories about cargo ships stuck off the California coast waiting to unload cargo into clogged ports or overworked truck drivers struggling to keep up. And there's a very human labor story here, a business story and an economic story all rolled together, and you and your team are at the center of it. So, I really wanted to talk with you to give listeners some clarity on this. Maybe we can start first with the shipping. You know, talk to us about ocean and air. You know, where are we now? Ravi Shanker So, this is a very complicated problem. And like most complicated problems, there isn't an easy explanation for exactly what's going on and also not an easy solution. What's happening in ocean is a combination of many issues. You obviously have a surge in demand coming out of Asia to the rest of the world because of catch up following the pandemic and low inventory levels. In addition to that, you've had some structural problems. For instance, the giant Panamax container ships that they started using in recent years have created a bit of a boom-and-bust situations at the ports - dropping off far too many containers that can be processed, and then there's like a lull and then many more containers show up. So that's a bit of an issue. Third, there's obviously issues with labor availability of the ports themselves, given the pandemic and other reasons. Ravi Shanker And lastly, as we’ll touch on in a second, there is a shortage of rail and truck capacity to evacuate these containers out of the ports. And it's a combination of all of these, plus the air freight situation. Keep in mind that kind of one of the statistics that has come out post the pandemic is that roughly 65% of global air freight moves in the in the belly of a passenger plane rather than a dedicated air freighter. And a lot of these passenger planes obviously have been grounded because of the pandemic over the last 18 months. This has eliminated a lot of the airfreight capacity. Some of that has spilled over into ocean. And so, all of this has kind of created a cascading problem, and that's kind of where we are right now. Ellen Zentner So let me ask a follow up there. You know, in terms of international air flights, it looks like international travel is picking up. But when would you expect it to be back to normal levels? Ravi Shanker So I think that actually happens at some point in 2022. So, we also cover the airlines and we saw a significant amount of pent-up demand in U.S. domestic air traffic when people started getting vaccinated and when mobility restrictions were dropped. We think something very similar will happen on the international side when international restrictions are dropped, and we're already starting to see some of that take place. Whether that fixes the ocean problem completely or not is something we need to wait and watch for. Ellen Zentner So, you know, once we get goods here, we have to move them around. And I know I've heard you say before just how much of it has to move on the back of a truck. So, let's talk about the trucking industry. You know, there's been some structural and labor issues there, but that's even before the pandemic, right? Ravi Shanker That is even before the pandemic. Kind of, you and I collaborated to write a pretty in-depth piece as early as December 2019. We revisited that last year. There are a bunch of new regulations that have gone into place in the trucking industry over the last few years. It's no coincidence that we've had two of the tightest truck markets in history in the last three years. And these factors, whether it's the ELD mandate in 2018, the Driver Drug and Alcohol Clearinghouse in 2020, some of the insurance issues that the industry has seen over the last year; those have really created a structural tightness in the trucking industry. The pandemic made things a lot worse. Obviously, it pushed some driver capacity temporarily, maybe even permanently out of the marketplace. The driving schools were largely closed for the last 18 months, and so that limited the influx of new drivers into the space. And so, some of this pressure will ease, but we think a lot of the driver and the insurance issues that we're seeing in the trucking side the last 18 months are structural and not cyclical. Ellen Zentner So, Ravi, it certainly does seem like the labor supply issues could stretch on for longer. If we think about demographic trends in the U.S., it does appear that generations Y and Z are really leaning away from trucking jobs and toward gig economy like jobs. Some call them new generation jobs. When you think something like driverless trucks would be in place in a way that could alleviate some of those issues, or is that so far off on the horizon? Ravi Shanker We've been writing about driverless trucks since 2015, even longer than that, and we are now getting to a point where we think this can be quite real on somewhat of an investable time horizon. We think the first level for autonomous trucks will be ready for commercial use by the end of 2023 or early 2024. And we actually expect to see some very clear demonstrations of the viability of the technology and the commercial deployment of the technology within the next few months, actually. So, we think autonomous trucks can be a solution to fill that gap for the driver shortage if the demographics kind of are going to be against us for a while, and that could start happening pretty soon. Ravi Shanker With the outlook in mind on the supply chain disruptions you've seen so far and what's currently taking place, Ellen, how does that inform how you look at the inventory cycle and your forecast for inflation for the overall economy? Ellen Zentner It's been very complicated as, you know, about as complicated as you having to cover freight. You know, I think about the relationship that we have with our equity analysts across the firm, you know, these conversations I have with you are extremely important because it gives me a view of when can we get goods to where they need to go. Ellen Zentner So the inventory cycle has been delayed. There are many sectors that are running below normal inventory to sales ratios. And so, we do need production to pick up globally and we can see that exports globally are picking up. So, if I think of building a composite view of, you know, you saying air could be normalized first half of the year, but say certainly by the middle of the year. Trucking is probably going to continue to be a drag for a bit, but when I think about what you say about ocean, it sounds like all together by the middle of the year, things should start to look and move more normally. So, you're going to have a lot of inventory building that happens next year, that should have happened this year. And ironically, that's going to really add to growth, to GDP growth next year. Ellen Zentner Now all of this taking longer to normalize means that inflation pressures due to supply chain bottlenecks and COVID related pressures are going to remain higher for longer. All that's going to start to get alleviated around the middle of the year, but it means that we have to wait longer. And so that's how I'm thinking about it in terms of the inventory cycle and inflation. You know, it's going to support inventory building next year, but it's going to keep inflation elevated for longer. Ravi Shanker Right. So, looks like light at the end of the tunnel by middle of next year, but a tricky few months still to navigate. Obviously, the biggest thing to look forward to in the next couple of months, I think, is its holiday season. And I know that in the transportation and supply chain world, everyone is working overtime to make sure that Christmas isn't canceled. What do you think Christmas season means for retailers and the broader economy? Ellen Zentner Yes, I think our retail team is pretty constructive on the consumer, as are we. Buying power from consumers is very strong. That's helped by labor income, continued government support, as well as some of the savings, excess savings that we have available to pull from. But the goods have to be there as well. We know that shelves are going to be lighter. Let's put it this way, this season than normal. You know, I've heard media reports crying out, you know, do your holiday shopping now. I've heard reports of big retailers using their own ships to transport goods here, although you would sit there and tell them “Yeah, but who's going to unload it for you when it gets here?" Ellen Zentner But all in all, it doesn't sound like from our retail analysts, it's a bad set up for retail. I mean, one thing that I would think about as an economist is if you've got fewer goods through the holiday season with strong consumer demand, which we expect, well then you certainly don't have to go through a big markdown season on the other side of the holiday, which is going to support prices for longer after that. So, I think that's all an interesting combination. Ellen Zentner Well, I think this was a really interesting conversation, Ravi, and I think it starts to tie in some of the themes and what everyone's really focused on. It certainly has far-reaching effects across the broad economy and the global economy. So, thank you so much for taking time to talk today, Ravi. Ravi Shanker Well, thanks for having me on. It's great talking with you as well, Ellen. And I think if there was one major takeaway for our listeners from this podcast, it is please shop early this holiday season. Ellen Zentner Shop early, shop often. That's what I do. Ellen Zentner Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
9 min 26 sec
Investors appear nervous about the economic outlook as 3rd quarter earnings season approaches. Are stagflation concerns justified… or perhaps overdone?----- Transcript -----Welcome to Thoughts on the Market. I'm Graham Secker, Morgan Stanley's Chief European Equity Strategist. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about why we think the current stagflation concerns in Europe are likely overdone. It's Tuesday, October the 12th, at 2:00pm in London. In early September, we argued that investors should reengage with cyclical value stocks ahead of a likely stabilization in macro sentiment and in anticipation of higher bond yields. At this time, the former catalyst is yet to occur, however the latter has prompted a sharp bounce in value stocks, which we think has further to run - this would be in line with our bond strategists target of 1.8% on US 10-year yields by the end of this year. Interestingly, the rally in European value so far has been concentrated in the more disrupted names where specific catalysts have boosted performance - such as the rising oil price lifting energy stocks and higher bond yields boosting financials. In contrast, the more traditional cyclical sectors have been modest underperformers, suggesting to us that investors still remain nervous about the global economic outlook. In recent weeks, this nervousness has taken on a stagflationary tone, with equity and bond prices both falling. In particular, the extent and speed of the rise in interest rates and commodity prices, especially gas and oil, has provoked incremental concerns around the outlook for corporate margins, household disposable incomes and the risk of demand destruction. These concerns are unlikely to dissipate overnight, however we think there is a good chance that stagflationary fears and supply chain issues will start to ease through the fourth quarter, which should allow cyclical shares to rally alongside the value names. If we are wrong and stagflation concerns grow further from here, then we'd expect to see consumer confidence fall sharply, yield curves start to flatten, and defensives outperform. So far, none of these are happening, even in the UK where stagflation concerns are most acute, and the Bank of England is sounding hawkish on the potential for future rate hikes. Away from the economic data, the other major concern weighing on European investors just here is the upcoming third quarter reporting season, which will start in the next couple of weeks. After three consecutive quarters of record profit beats, we expect a more modest outturn this time, however one that is still more good than bad. In contrast, we think investors are more cautious, especially around the ability of companies to protect their margins by passing on higher input costs to their end customers. While some businesses will no doubt struggle in this regard, we believe that the majority of companies will be able to manage the situation well enough to avoid a margin squeeze. Rising input costs are a problem when top line growth is modest and corporate pricing power weak - however, this is definitively not the case today. For example, the latest CBI survey of UK manufacturers show total order volumes and average selling prices at 40-year highs. At the current time, equity markets still feel fragile and could remain volatile for a few more weeks yet. However, as we move through the fourth quarter, we'd expect an OK earnings season, coupled with evidence that the worst of the third quarter dip in the US and China economies are behind us, to ultimately send European equity markets higher into year end. Our key sector preferences remain unchanged at this time. We like the more value-oriented sectors such as financials, commodities and autos, and are more cautious on expensive stocks in an environment where higher interest rates start to encourage investors to become more valuation sensitive going forward. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
3 min 35 sec
As the weather chills and we head towards the end of the mid-cycle transition, the S&P 500 continues to avoid a correction. How long until equities markets cool off?----- Transcript ----- Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 11th at 11:30 a.m. in New York. So, let's get after it. With the turning of the calendar from summer to fall, we are treated with the best weather of the year - cool nights, warm days and clear skies. In contrast, the S&P 500 has become much more volatile and choppy than the steady pattern it enjoyed for most of the year. This makes sense as it's just catching up to the rotations and rolling corrections that have been going on under the surface. While the average stock has already experienced a 10-20% correction this year, the S&P 500 has avoided it, at least so far. In our view, the S&P 500's more erratic behavior since the beginning of September coincided with the Fed's more aggressive pivot towards tapering of asset purchases. It also fits neatly with our mid-cycle transition narrative. In short, our Fire and Ice thesis is playing out. Rates are moving higher, both real and nominal, and that is weighing disproportionately on the Nasdaq and consequently the S&P 500, which is heavily weighted to these longer duration stocks. This is how the mid-cycle transition typically ends - multiples compressed for the quality stocks that lead during most of the transition. Once that de-rating is finished, we can move forward again in the bull market with improving breadth. With the Fire outcome clearly playing out over the last month due to a more hawkish Fed and higher rates, the downside risk from here will depend on how much earnings growth cools off. Decelerating growth is normal during the mid-cycle transition. However, this time the deceleration in growth may be greater than normal, especially for earnings. First, the amplitude of this cycle has been much larger than average. The recession was the fastest and steepest on record. Meanwhile, the V-shaped recovery that followed was also a record in terms of speed and acceleration. Finally, as we argued last year, operating leverage would surprise on the upside in this recovery due to the unprecedented government support that acted like a direct subsidy to corporations. Fast forward to today, and there is little doubt companies over earned in the first half of 2021. Furthermore, our analysis suggests those record earnings and margins have been extrapolated into forecasts, which is now a risk for stocks. The good news is that many stocks have already performed poorly over the past six months as the market recognized this risk. Valuations have come down in many cases, even though we see further valuation risk at the index level. The bad news is that earnings revisions and growth may actually decline for many companies. The primary culprits for these declines are threefold: payback in demand, rising costs, supply chain issues and taxes. At the end of the day, forward earnings estimates will only outright decline if management teams reduce guidance, and most will resist it until they are forced to do it. We suspect many will blame costs and even sales shortfalls on supply constraints rather than demand, thereby giving investors an excuse to look through it. As for taxes, we continue to think what ultimately passes will amount to an approximate 5% hit to 2022 S&P 500 EPS forecasts. However, the delay in the infrastructure bill to later this year has likely delayed these adjustments to earnings. The bottom line is that we are getting more confident earnings estimates will need to come down over the next several months, but we are uncertain about the timing. It could very well be right now as the third quarter earnings season brings enough margin pressure and supply chain disruption that companies decide to lower the bar. Conversely, it may take another few months to play out. Either way, we think the risk/reward still skews negatively over the next three months, even though the exact timing of cooler weather is unclear. Bottom line, one should stay more defensive in equity positioning until the winter arrives. Thanks for listening! If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
4 min 1 sec
Investor worries over growth and inflation have revived the term stagflation—but with growth indicators historically solid, is it an accurate description?----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, October 8th at 2:00 p.m. in London. Near where I live in London, service stations are out of petrol - or to my fellow Americans, the gas stations are out of gas. In Europe, natural gas prices have roughly tripled in the last three months. Year-over-year, Consumer Price Inflation has risen 5.3% in the United States, 5.8% in Poland, 7.4% in Russia, and 9.7% in Brazil. It's not hard to see why one term seems to come up again and again in our conversations with investors: stagflation. Stagflation, broadly, is the idea that you get very weak growth, but also higher inflation together. Yet it's equally hard to miss in these conversations that while this term is widely cited, it's often ill defined. If stagflation means the 1970s, a time of wage price spirals and high unemployment, this clearly isn't it. Unemployment is falling around the world, and inflation markets imply pressures will moderate over time, rather than spiral higher. Market pricing is also very different. Over the last 100 years, the 1970s represented an all-time high in nominal interest rates and an all-time low in equity valuations. Today, it's the opposite. We're near a record low in yields and a record high in those valuations. Instead, what if we say that stagflation is a period where inflation expectations are rising, and growth is slowing? That's an easier, broader definition to apply, but even that hasn't really been happening. In the U.S., market expectations for inflation are roughly where they were in early June. U.S. economic data remains solid. The economic data is a little bit more mixed in Europe, but even here, growth indicators generally remain historically strong. So this clearly isn't a simple story, but we do think there are three takeaways for investors. First, recall that stagflation was also a very hot market topic in 2004/2005. Growth and markets had bounced back sharply in 2003, but by mid 2004, the rate of change on that growth had started to slow. And then energy prices rose. By spring 2005, the market started to worry that it could be the worst of both worlds. In April of that year, U.S. consumer price inflation hit 3.5% while measures of growth stalled. Stagflation graced the cover of the Economist magazine and the editorial pages in the New York Times. Equity valuations fell throughout 2004/2005 even as earnings rose, consistent with the current forecast that my colleague Michael Wilson and our U.S. Equity Strategy team. The second important point is that inflation is already showing up and impacting monetary policy. In just the last three weeks, central banks have increased interest rates by +25bp in New Zealand, +25bp in Russia, +50bp and Peru, +50bp in Poland, +75bp in the Czech Republic and +100bp in Brazil. That's a lot of activity. And all of this is keeping my colleagues busy and also creating opportunity in these markets. Third, while stagflation means different things to different people, past periods of rising inflation and slowing growth have often had one thing in common: higher energy prices. As such, we think some of the best cross-asset hedges for stagflation lie in the energy space. The market is very focused on stagflation; it just hasn't quite decided what that term really means. The 1970s are a long way away from our expectations or market pricing. Scenarios of slower growth and rising inflation clash with our economic forecasts of, well, the opposite. And recent moves in inflation expectations and other growth indicators don't fit this story as nicely as one would otherwise think. Instead, we think investors should focus on three things: 2005 is an interesting and rather recent example of a stagflation scare after a mid-cycle transition. Inflation is impacting central banks, creating movement and opportunity. And finally, the energy sector provides a potentially useful hedge against scenarios where the current disruption is more persistent. Now, with that out of the way, I'm off to find some petrol. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
4 min 23 sec
Affordability pressures continue to mount as housing supply tightens. How long will home prices continue setting records and what could it mean for credit availability?----- Transcript -----James Egan Welcome to Thoughts on the Market. I'm James Egan, Co-Head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow And I'm Jay Bacow, the other Co-Head of U.S. Securitized Products Research here. James Egan And on this edition of the podcast, we'll be talking about continued growth in the housing market and the current state of supply. It's Thursday, October 7th at 10:00 a.m. in New York. Jay Bacow So, Jim, last time we were on this podcast, it seemed like we were seeing record home prices. However, every month since, we've continued to break those records. What's going on? When do we expect to see home prices start to turn? James Egan The most recent print - and so we're talking about Case-Shiller National here that we got in September, it referenced July; 19.7% year over year growth. We're rounding to 20%. Now, we've set new records each of the last few months, but if we remove this specific chapter in history, the prior record from the early 2000s was a little bit over 14%. So, we're well north of anywhere we've been. Jay Bacow All right. But if we are at a record right now, I thought previously you had talked about things slowing down. So, what's going on there? James Egan So, when we talk about the view for home prices, right? We talk about demand, we talk about supply, we talk about affordability, and we talk about mortgage credit availability. And one of the things we highlighted the last time we were on this podcast was that affordability. Those pressures that were building up there were going to lead to a slowdown in home price growth in the second half. The most recent print, as I said, September - references July - technically, we're in the second half of the year. We do think as we move through the third quarter and really as we get into the fourth quarter is when you're going to start to see those affordability pressures take hold. James Egan Most notably, mortgage rates - look, they haven't increased dramatically from all-time lows in January, but they're still off of those lows. Most importantly, they're not setting new lows. And that means they're not acting as a release valve for this increase in home prices. And we're seeing that manifest itself in terms of growing affordability pressures. The monthly payment on the median priced home is up over $200 since January - that's over a 20% increase. On top of that, when we look at consumers attitudes towards buying homes, they're at the lowest point they've been now since the early 1980s, far lower than they were at any point during the global financial crisis earlier this century. But affordability pressures are just one piece of the puzzle here. There are other aspects that might be keeping home prices elevated. Jay Bacow When I’m thinking about home prices, you know, obviously one of the factors is going to be supply; that’s Economics 101. We’ve talked beforehand about how we’re not building enough homes. Is that just the biggest factor here? James Egan I do think that we can’t ignore supply. I mean, when we think about this growth we’ve seen in home prices, the most consistent or persistent part of that narrative has been a shortage in supply. James Egan Now there are a lot of ways that we can go about attempting to size the shortage in supply in the housing market. But two of the things we looked at recently were kind of net supply versus net demand, but also the vacancy rate. So, if we start with that first calculation, we look at net supply in terms of the total amount of single unit completions added to the market every year, the total amount of multi-unit completions added to the market every year, and we control for a small obsolescence rate. Some of the housing stock does come out of use every single year. And we compare that net supply to net demand or household formations. James Egan And you know what? Going back to the early 1980s, those two metrics track each other pretty well. That relationship really fell apart post the global financial crisis. From 2009 to 2019 net demand has exceeded net supply by a total, a cumulative total of 5 million units. Now that’s just one way to size the shortage from purely a building perspective. Another way is to look at vacancy rates. Owner vacancy rates right now are tied for the lowest they’ve been since the Housing Vacancy Survey started getting published in the 1950s. If we were to raise owner vacancy rates to their average level of the past 40 years, that would take over 1.5 million units. So, from a building perspective, we’re anywhere from a 1.5 to 5 million units short. Jay Bacow Alright but new home sales will obviously change the amount of absolute supply. But then there’s also existing home sales – now somebody’s gotta buy a home, someone’s going to sell that home. That’s also gotta be part of that calculation. How do I think about the interplay between new home sales and existing home sales on the supply front? James Egan I mean, you hit the nail on the head there, right? We talk about new builds in terms of a supply perspective, but they're just one piece of the puzzle here. We have to think about existing inventories. We talk about shadow inventories as well with respect to things like foreclosures that play a role in supply, that play a role in housing activity, that play a role in home prices. But it's not just new inventory that's short, existing inventory is short as well. If we look at the number of single unit homes available for sale, we have that data going back to the 1980s and it's never been lower than it is right now. It would take, depending on how we measure it, 1.1 to 1.5 million additional existing units being listed for sale to bring that number back to long run averages. James Egan So supply is really tight across the board. Now, the pace at which that supply is tightening, that has slowed down. We're not seeing the same year over year decreases that we were seeing in 2020. So, we are starting to see a little bit of a plateau there. We do think that you're going to start to see supply increasing a little bit. But these incredible tights from a supply perspective we think are playing a pretty substantial role in keeping home prices this elevated despite the growing affordability pressures that we've noted both earlier and on previous podcasts. Jay Bacow All right. So we addressed supply, we addressed demand, we addressed affordability. The last pillar is credit availability. James Egan Yes, we think that credit availability kind of plays two roles in both supporting the healthy foundation of the housing market here, but also important for the trajectory of the housing market going forward. Credit availability itself. We were easing, from a lending standard perspective, on the margins from 2013 through 2020 - February of 2020 specifically. Then we gave up six years’ worth of easing over the course of the next six months. Lending standards have started to ease a little bit from here, but we're starting from a very conservative place, if you will. That starting point means that we think that delinquencies foreclosures will remain controlled. But the fact that we believe we're going to see easing from here also means that we can see more demand than we otherwise would materialize despite the fact that we're seeing these affordability pressures. James Egan Both of those are positive, but there are reasons to think that we'll see credit easing from here, one of which being the level we're coming from, another being how mortgages are performed. But a big factor here is also what we're hearing out of the administration down in D.C. But Jay, can you kind of walk through what we're seeing from these various FHFA announcements, what the implications could be here? Jay Bacow When we look at the FHFA announcements, there's been a series of them and it's not just FHFA, it's also been from HUD and Ginnie Mae. And they're all aligned with what we believe are the current administration's goals to increase access to homeownership and reduce some of the affordability pressures. And one of the ways that they've done that is they've allowed the GSEs to increase capital via producing more loans that are either for investors and none are occupied where the guarantee fee is accretive to their business via warehousing more cash window loans, along with changing the regulatory relief for doing credit risk transfer deals. And we think the GSEs are going to take this capital and with this capital, they're going to expand the credit box, perhaps in the form of LLPA changes or G-Fee reductions, which will make it both cheaper for homeowners to get a mortgage and perhaps shift the credit box a little bit wider, particularly on the lower end of the credit box. Doing this will help align the affordability pressures and lack of access to homeownership with the current administration's goals. James Egan So, when we think about everything we've talked about on this podcast, from supply to credit availability, what that means for home prices moving forward; look, affordability pressures are real, and they've been building. But a tight supply environment, even if we're seeing it ease a little bit and credit availability easing from here, both of those things should work to keep home prices growing. We think they contribute to the healthy foundation. The pace of growth it will slow from almost 20% today. It'll slow into the end of the year. We think throughout 2022 it continues to slow but remains in the mid-single digits from a growth perspective. James Egan So, Jay, thanks for taking the time. Jay Bacow Always a pleasure. Thanks, Jim. James Egan As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.
8 min 39 sec
Discussions in D.C. over the infrastructure framework, budget reconciliation bill and debt ceiling could impact more than just politics. What could it mean for stocks and bond yields?----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Wednesday, October 6th at 10:30 a.m. in New York. When we checked in last week, the debate was all about fiscal policy. Would Democrats go small and just focus on passing the bipartisan infrastructure framework, or BIF? Or go big, linking the BIF to the bigger plan to expand the social safety net, environmental spending and the tax base. The difference matters, as a small approach could halt the increase in bond yields we've seen in recent weeks, whereas a big approach could keep them moving higher. In short, it looks like the Democrats are at least going to continue to try and go big, as was our expectation. No votes were taken last week as it became obvious that there wasn't enough support for the small approach, which wouldn't fly with a bloc of progressives in the Democratic party. So, despite moderates' demands for a BIF vote by week's end, Democrats were forced to extend negotiations with a new soft deadline for action of October 31st. That reinforced to us the link between both pieces of legislation. So, in our view, we're still headed toward a multitrillion dollar package being enacted in the fourth quarter, which should boost deficits, medium term growth expectations, and therefore bond yields along with it. But in the meantime, the rise in bond yields could take a break as Washington, D.C. deals with the debt ceiling. The Treasury Department says the ceiling must be raised or suspended by October 18th, less than two weeks from today, or else the U.S. could face default and an economic crisis. Republicans and Democrats continue to be at odds over how to avoid this. Without getting into the weeds on this too much, just know that at this point, neither party is showing an inclination to resolving this in a timely manner. That could create substantial uncertainty and it's one of the reasons that our U.S. equity team continues to expect stock prices could remain volatile in the near term. So stay tuned - DC's influence on markets is sure to be felt through the end of the year. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
2 min 19 sec
New data on an oral antiviral treatment could have significant impact on the COVID treatment landscape. What’s next for treatments, booster shots and child vaccines.----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley Research.Matthew Harrison And I'm Matthew Harrison, Biotechnology Analyst.Andrew Sheets And on this special edition of the podcast, we'll be talking about several new developments in the fight against COVID 19. It's Tuesday, October 5th at 3 p.m. in London,Matthew Harrison and it's 10:00 a.m. in New YorkAndrew Sheets So Matt. I really wanted to catch up with you today because there are a number of different storylines involving COVID 19 going on at the moment, from child vaccines to the situation with booster shots. But I suppose the headline story that's getting the most attention is data released last Friday on Merck's new oral COVID treatment pill Molnupiravir or I think I said that right. I'm sure I didn't. So maybe let's start there. What is this treatment and why does it matter?Matthew Harrison Yes. Thanks, Andrew. So Molnupiravir is an oral antiviral against COVID. The way it works is that it stops the virus from replicating effectively, and that reduces the amount of virus in someone's body. It was studied here in patients that were recently diagnosed with COVID 19. And it cut the rate of hospitalization in those patients by 50%. So those that didn't get treated with the drug went to hospital at a rate of 14%, and those that did get treated went to hospital rate of 7%. I think the thing I would want to highlight is that this is something you obviously take after you get infection and vaccines remain the primary way to prevent infection.Andrew Sheets So this is kind of one of the things I felt that was so fascinating when that news was announced. Because on the one hand, this seems like very good news, another treatment that appears highly effective against COVID 19. And yet the market reaction was actually to really punish many of the makers of the current COVID vaccines, so how much do you think this could influence the COVID treatment landscape? And do you think the market or people might be overreacting to some of the impact on whether or not people will still get vaccines or vaccines will remain important?Matthew Harrison Vaccines, their primary measure is prevention. Right? This is a drug to treat people once you get disease. But the hope is, and the way we get out of the pandemic, is still by vaccinating everybody to prevent disease from happening and disease from spreading. So, I think of this drug, along with antibodies as drugs that you use to treat people who either have breakthrough infections or those that aren't vaccinated. But you also have antibodies for people that are at higher risk, patients that might not be compliant with taking oral drugs. Or, you know, a whole another segment of the market that we haven't talked about is those that need to be protected either because they can't get a good response to the vaccine, because they're perhaps immunocompromised or otherwise, and those that need some sort of preventative treatment. Where Merck is studying this pill as a preventative treatment, but the antibodies are already authorized as preventative treatments. So, there's a different section of the landscape, I would say, for each of these drugs.Andrew Sheets So, Matt, what impact do these potentially positive results on a pill mean for vaccine hesitancy in the outlook for vaccinations?Matthew Harrison I think that's one of the things that the market is is struggling a lot with, and I think that's part of the reason you saw many of the vaccine stocks under pressure, right? There's definitely one segment of the market that thinks, if you have effective treatments, especially easy to use treatments like orals, that could give people another reason who don't want to have the vaccine to say, "Look, even if I do get sick, I do have an easy to take treatment." And so, on the margin, right, it may impact vaccination uptake, though the flip side is what I would say is I think what we're seeing in the U.S. is at least that you're seeing broad vaccination mandates and you and you are seeing those mandates lead to increases in vaccination, especially employer based mandates. And so, there are other factors driving vaccine uptake.Andrew Sheets So I think it's safe to say we care about the numbers here on this Thoughts of the Market podcast. Could you just run through the various costs of different treatments if we're thinking about vaccines, you know, potential thoughts on where an oral pill could be and then the antibody treatments, which are obviously another form of treatment that we're seeing being used. Just to give people some sense of how much the relative cost of each one of those things is.Matthew Harrison Yes, so vaccines per shot in the U.S., depending on manufacturer, run between $16.50 And $19.50 in the U.S. So a course of vaccination, let's say costs on average about $40. There are some administration fees and otherwise, but direct to drug costs. Merck has signed a contract with the US government for $1.2 Billion for 1.7 Million courses, so that runs about $700 per course for the oral right now. And then the U.S. government also has contracts with a variety of manufacturers for antibodies, which run about $2100 per course. So treatments are more expensive than vaccination and then usually with treatments, there are other associated medical costs which I didn't cover, and I don't have a great estimate for. But obviously, as those patients that might be getting treatments because they're also hospitalized, those costs are more significant.Andrew Sheets So I want to jump next to the topic of child vaccinations. Last week, Pfizer and BioNTech announced that they had submitted data to the Food and Drug Administration that their coronavirus vaccine is safe and effective in children ages 5-11. What do you think? Is the timeline ahead for the next steps here?Matthew Harrison Yes, right, so they have submitted preliminary data, but they have not submitted the final request for an emergency use authorization. The expectation here is that there will be some back and forth between Pfizer and the regulator to finalize the exact package of data after the FDA has reviewed the initial data. That will then trigger the final submission where they ask for the request for emergency use authorization. Most of us think that would occur sometime, let's say, in the next couple of weeks. And then historically right, the FDA, once they receive that final package, takes on order of two to three weeks to approve the EUA authorization. So, I think this ranges from maybe the earliest in late October towards sometime into early November.Andrew Sheets Matt, I also wanted to cover the issue of booster shots, which is the other kind of large development in the fight against COVID 19, and I think there's been a little bit of confusion on the topic. So, you know, what's the latest in terms of who is eligible for a booster in the U.S. and what the CDC is recommending?Matthew Harrison Originally the FDA had asked their external advisory committee whether or not boosters should be made available for everyone where the original vaccine was authorized, so that would be those 16 and up. The advisory committee then asked to narrow that slightly and specifically what the advisory committee asked was: those 65 years or older, as well as those at high risk, either because of underlying medical conditions or because of occupational hazard. So that would include, hospital workers or workers who are otherwise frontline workers in a high-risk scenario. The CDC has a separate committee called ACIP, which a few days later looked into this as well, and they had voted essentially for those at high medical risk and those 65 years and older. But they had said they were somewhat uncomfortable, and it was a very close vote to be clear, about those at increased occupational risk. After that meeting, the CDC themselves or the director of the CDC said that they believe the booster shot should be made available for all of those groups and essentially overrode the committee on the last piece around occupational risk. So right now, its 65 older, immunocompromised, those at high medical risk and those at high occupational risk.Andrew Sheets So Matt, the final thing I wanted to ask you about is one of the most positive things that seems to have come out of this this terrible pandemic is mRNA vaccination technology. It seems to be a type of medical technology that has really exceeded expectations for how quickly and how effectively a vaccine could be rolled out. Andrew Sheets So Matt, if you think about this technology looking ahead, what do you think are the applications that potentially could go beyond COVID? And also, at what point do you think some of these vaccinations might need to be updated and how difficult will that be?Matthew Harrison So in terms of applications and next steps for RNA, there's a wide variety of disease areas that they're looking at. But in general, the technology is being used to make missing proteins in your body, which occurs a lot with rare genetic diseases. To potentially help various tissues that may need certain proteins or enzymes to help them heal. And also looking at ways that you could, for example, with oncology patients that you could tell the body's own immune system for key flags or markers of the tumors versus normal tissue so that you could redirect the immune system to specifically go after the cancerous tumor. In terms of needing a updated COVID vaccine. I think that all depends on the variant outlook. Currently, what we see is just giving another dose of the current vaccine provides very good protection against Delta. And so, I think as we look out on the outlook, right, it's about if Delta combines with something else, then maybe there is the potential for an update. But the manufacturers are well primed for that, and that process is a couple months process, probably if they had to do that. So, they can adapt quickly.Andrew Sheets Something important to keep an eye on. As always, Matt, it's been great talking with you.Matthew Harrison Thanks, Andrew.Andrew Sheets As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.
10 min 10 sec
After 16 years, German Chancellor Angela Merkel is stepping down. While the full implications for Europe remain unclear, some contours of the post-Merkel government are now taking shape.----- Transcript -----Welcome to Thoughts on the Market. I am Reza Moghadam, Morgan Stanley's Chief Economic Advisor. Along with my colleagues, we bring you a variety of market perspectives. Today, I'll be talking about the implications of the recent German elections and how investors should view the road ahead after a government is formed. It's Monday, October 4, at 2pm in London. After 16 years as German Chancellor, Mrs. Merkel is stepping down. In the run up to the recent elections, there was considerable anxiety in European capitals. Angela Merkel, after all, has been the steady hand that has guided not only Germany's but also Europe's response through numerous crises. These anxieties have not been entirely laid to rest by the results of last week's election. For the first time since 1950s, forming a government would require a coalition of at least three - rather than the traditional two - political parties, which raises concerns about cohesion of the new government. However, there are reasons to be optimistic about broad continuity - that a centrist, pro-European and pro-business coalition would eventually emerge in Berlin. There are perhaps two key issues of importance for investors as discussions get underway. First, who will succeed Mrs. Merkel? And second, what would be the exact composition of the coalition and, therefore, its policies? The candidate most likely to succeed Mrs. Merkel is Olaf Scholz, whose Social Democratic Party narrowly topped the polls. Mr. Schulz is continuity incarnate. He has been Germany's Finance Minister and vice chancellor under Mrs. Merkel. He brings strong pro-European credentials, especially having played a role in ensuring Germany's support for the European Recovery Fund, which is Europe's main vehicle for providing support for the hardest hit countries during the pandemic. Mr. Schulz has also been a very strong proponent of EU banking and capital markets unions. Is there an alternative to Mr. Schulz? Yes, the candidate who led the election campaign for Mrs. Merkel's center right Christian Democrats, Armin Laschet. However, given the poor election results for Christian Democrats and Mr. Laschet's much less favorable public standing, a German government led by Mr. Laschet is unlikely. But it is worth noting that Mr. Schulz and Mr. Laschet are both centrist politicians and not that far apart on key policies. Now let me turn to the second important issue for markets: who are the likely coalition partners for Mr. Schulz or, for that matter, Mr. Laschet? Here, the electoral mathematics are very clear. The Green Party and the pro-business Free Democrats are highly likely to be in the next government. The Greens have one key demand: €50B (or 1.5% of GDP) per year in new investment to reach net zero carbon emissions by 2050. Investment in Germany has been constrained by self-imposed austerity, and increasing investment of that magnitude is likely to underpin growth and innovation and set a benchmark for other European countries. What about the Free Democrats? They are against tax increases and fiscally conservative, but pro green investment. Therefore, they would want to ensure that any fiscal plans are business friendly, and any deficit financing limited. In summary, the contours of the post-Merkel German government are becoming clearer. There will likely be continuity through Mr. Schulz, or perhaps Mr. Laschet. There Is likely to be a strong green investment agenda, and the presence of the Free Democrats ensures support for Mr. Schulz's brand of fiscal moderation and prudence. It is also very clear that while continuing to take a cautious line on fiscal policy, the next German chancellor and government are likely to put a high premium on European solidarity. The process for forming a new government in Germany will likely take time as it requires drawing up a detailed policy agreement that respects the red lines of each political party. But the new government should be in place by the end of this year, just in time for the German presidency of the G7 in 2022. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.
5 min 1 sec
On part two of this special episode, Lisa Shalett and Andrew Sheets dive into meme stocks and individual investor trading advantages… and pitfalls.----- Transcript -----Andrew Sheets Welcome to Thoughts of the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.Lisa Shalett And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.Andrew Sheets And today on part 2 of the podcast, I’ll be continuing my discussion with Lisa on the retail investing landscape and the impact on markets. It's Friday, October 1st, at 2p.m. in London.Lisa Shalett And it's 9:00 a.m. here in New York City.Andrew Sheets So, Lisa, over the last 12 months, we've seen a real boom in the amount of activity in the stock market from these so-called retail investors. And, you know, given your perspective over several market cycles, you know, what do you think is kind of similar and different in terms of individual investor activity now versus what we've seen in the past?Lisa Shalett So you know what's similar to episodes of retail participation that we've seen in the past? I think the first is momentum and crowding. So, as we know in prior market cycles, you know, periods like a 1999-2000 tech bubble, for example. We had a lot of enthusiasm around stocks that perhaps didn't have great profit fundamentals or whose valuation paradigms shifted to expand beyond things like profit to things like, you know, share of eyeballs and things of that nature. And we're you know, we've certainly during this market cycle with the emergence of, you know, zero commission trading platforms, you know, seen some of that type of activity where stocks seem to be moving based on other dynamics, be they momentum, be they you know, social media chatter.Lisa Shalett Obviously, I think one of the things that is different is this role of social media. I think that this idea that a set of investors will crowd or attempt to drive the market through social media postings is an interesting one, if you will. And I think we're going to need to see how it plays out. But I think what we know is very often when we get into periods in the market where we're drawing in a large share of brand-new investors, you know, they are not particularly experienced and they, you know, seemingly have had success by dint of, you know, the benign nature of the environment, which is what we've kind of had. We've had a relatively low vol, high central bank involvement environment. We know how these parties tend to end. And since this seems to happen every couple of times in a generation, this generation of new investors, I think, you know, may be set up to, you know, quote unquote, learn the hard way. But that remains to be seen.Andrew Sheets Lisa, I know another question that you spend a lot of time thinking about is whether or not investors should look to be active or passive in how they're trying to take exposure to markets. How are you thinking about that and kind of what type of environment do you think we're in today?Lisa Shalett We try to take a pretty, you know, systematic and methodical and analytic approach to the active/passive decision. We want to make sure that when we're giving advice that if we think that there's idiosyncratic alpha opportunity out there above and beyond what, you know, the passive market can deliver and we're asking our clients to pay for it, that it's there and with high probability and that it exists. And so, you know, what are the environments where that tends to be true? What we have found is it tends to be environments where you have large valuation dispersions in the market, where you have high levels of controversy in terms of earnings estimate dispersion, tends to be environments where there could be policy inflection points. And so based on some of those type of variables, over the last two to three months, our models have moved us to a maximum setting towards active management. When we look at the passive index today, one of the things that, you know, we continue to point out to our clients is the extent to which the S&P 500 index, for example, has become very concentrated in a short list number of names. So, you know, we contrast that recommendation that we're making right now for a maximum stock picking or maximum active manager selection stance with, you know, perhaps where we were at the beginning of the cycle last March when policy actions are so profound in terms of driving liquidity and the stimulus was coming from the federal government. When you're in an environment where "the rising tide lifts all the boats" and performance dispersion is very narrow and you have, you know, very high breadth where, you know, almost all stocks are rising and they're rising together. Those are certainly markets that are very well played using the passive index. But that's how we make that contrast. And today we are trying to encourage our clients to move to a more active stance where they're reducing their vulnerability to some of the characteristics of the S&P 500 index that we think are fragile.Andrew Sheets Very interesting. So, Lisa the last question I want to ask you is when you think about that retail, that individual investor, what do you think are actually the advantages that this group has, maybe underappreciated advantages? And then what do you think are kind of some of the most common pitfalls that you see and strategies to try to avoid?Lisa Shalett Yeah, no, that's a great question. So, one of the advantages of being an individual investor is you can truly take a long-term view. At least most of our clients can. And so, they don't need to worry about, "mark to market," they don't need to worry about quarterly returns and quarterly benchmarks. They don't even need to worry about benchmarks at all, quite frankly. And that allows the individual investor to take a long view, to be patient to utilize tools like dollar cost averaging in over time and to not necessarily have to buy into the pressures of market timing.Lisa Shalett I think the pitfalls for individual investors are you know, individual investors are just that, they are individuals. Individual investors tend to be motivated by very human behavioral finance concepts of fear and greed. And so, I think one of the things that very often we as private wealth advisors battle are emotions. And when our clients, you know, feel a degree of fear, they will do things that potentially are drastic, i.e., they will, you know, sell and take profit and incur a tax event and get out of the market. And then the challenges of market timing, as we know, are always twofold. Right? If you're going to get out, you've got to have a discipline of when to get back in. And we know that those two things: getting in and getting out, are very hard to do and do well without destroying wealth, without concretizing losses and without, you know, leaving money on the table. So, you know, I think the value of advice, as we always say, is keeping clients in that first bucket, keeping them attached to a long run, process driven plan that avoids market timing, that allows you to take the long view, that measures things in years, not quarters and months, and avoid some of the pit falls.Andrew Sheets I think that's a great place to end it. Lisa, thanks for taking the time to talk and we hope to have you back soon.Lisa Shalett Thank you very much, Andrew. I appreciate it.Andrew Sheets As a reminder, if you enjoy Thoughts of the Market, please take a moment to rate and review us on the Apple Podcasts App. It helps more people find the show.
7 min 48 sec
On part one of this Special Episode, Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management, discusses the new shape of retail investing and the impact on markets.----- Transcript -----Andrew Sheets Welcome to Thoughts of the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.Lisa Shalett And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.Andrew Sheets And today on the podcast, we'll be discussing the retail investing landscape and the impact on markets. It's Thursday, September 30th, at 2p.m. in London.Lisa Shalett And it's 9:00 a.m. here in New York City.Andrew Sheets Lisa, I wanted to have you on today because the advice from our wealth management division is geared towards individual investors, what we often call retail clients instead of institutional investors. You tend to take a longer-term perspective. As chief investment officer, you're juggling the roles of market analyst, client adviser and team manager ultimately to help clients with their asset allocation and portfolio construction.Andrew Sheets Just to take a step back here, can you just give us some context of the level of assets that Morgan Stanley Wealth Management manages and what insight that gives you potentially into different markets?Lisa Shalett Sure. The wealth management business, especially after the most recent acquisition of E-Trade, oversees more than four trillion dollars in assets under management, which gives us a really extraordinary view over the private wealth landscape.Andrew Sheets That’s a pretty significant stock of the market there we have to look at. I'd love to start with what you're hearing right now. How are private investors repositioning portfolios and thinking about current market conditions?Lisa Shalett The individual investor has been incredibly important in terms of the role that they're playing in markets over the last several years as we've come out of the pandemic. What we've seen is actually pretty enthusiastic participation in in markets over the last 18 months with folks, you know, moving, towards their maximum weightings in equities. Really, I think over the last two to three months, we've begun to see some profit taking. And that motivation for some of that profit taking has as kind of come in two forms. One is folks beginning to become concerned that valuations are frothy, that perhaps the Federal Reserve's level of accommodation is going to wane and, quite frankly, that markets are up a lot. The second motivation is obviously concern about potential changes in the U.S. tax code. Our clients, the vast majority of whom manage their wealth in taxable accounts, even though there is a lot of retirement savings, many of them are pretty aggressive about managing their annual tax bill. And so, with uncertainty about whether or not cap gains taxes are going to go up in in 2022, we have seen some tax management activity that has made them a little bit more defensive in their positioning, you know, reducing some equity weights over the last couple of weeks. Importantly, our clients, I think, are different and have moved in a different direction than what we might call overall retail flow where flows into ETFs and mutual funds, as you and your team have noted, has continued to be quite robust over, you know, the last three months. Andrew Sheets So, Lisa, that's something I'd actually like to dig into in more detail, because I think one of the biggest debates we're having in the market right now is the debate over whether it's more accurate to say there's a lot of cash on the sidelines, so to speak, that investors are still overly cautious, they have money that can be put into the market. You know, kind of versus this idea that markets are up a lot, a lot of money has already flowed in and actually investors are pretty fully invested. So, you know, as you think of the backdrop, how do you think about that debate and how do you think people should be thinking about some of the statistics they might be hearing?Lisa Shalett So our perspective is, and we do monitor this on a month-to-month basis has been that that, you know, somewhere in the June/July time frame, you know, we saw, our clients kind of at maximum exposures to the equity market. We saw overall cash levels, had really come down. And it's only been in the last two to three weeks that we've begun to see, cash levels rebuilding. I do think that that's somewhat at odds with this thesis that there's so much more cash on the sidelines. I mean, one piece of data that we have been monitoring is margin debt and among retail individual investors, we've started to see margin debt, you know, start to creep up. And that's another indication to us that perhaps this idea that there's tons of cash on the sidelines may, in fact, not be the case, that people are, "all in and then some," you know, may be something worth exploring in the data because we're starting to see that.Andrew Sheets So, Lisa, the other thing you mentioned at the onset was a focus on the tax environment, and that's the next thing I wanted to ask you about. You know, I imagine this is an issue that's at the top of minds of many investors. And your thoughts on both what sort of reactions we might get to different tax changes and also your advice to how individuals and family offices should navigate this environment.Lisa Shalett Yeah, so that's a fantastic question, because in virtually every meeting, you know, that I'm doing right now, this question comes up of, you know, what should we be doing? And we usually talk to clients on two levels. One is on it in terms of their personal strategies. And what we always talk about is that they should not be making changes in anticipation of changes in the law unless they're really in need of cash over the next year or two. It's really a 12-to-18-month window. In which case we would say, you know, consult with your accountant or your tax advisor. But typically, what we say is, you know, the changes in the tax law come and go. And unless you have an imminent, you know, cash flow need, you should not be making changes simply based on tax law. The second thing that we often talk about is this idea or this mythology among our client base that changes in the tax law, you know, cause market volatility. And historically that there's just no evidence for that. And so, like so many other things there's, you know, headline risk in the days around particular news announcements. But when you really look at things on a 3-month, 6-month, you know, 12- and 24-month trailing basis on some of these things, they end up not really being the thing that drives markets.Andrew Sheets Lisa, one of the biggest questions—well, you know, certainly I'm getting but I imagine you're getting as well—is how to think about the ratio of stocks and bonds together within a portfolio. You know, there's this old rule of thumb, kind of the 60/40, 60% stocks, 40% bonds in portfolio construction. Do you think that's an outdated concept, given where yields are, given what's happening in the stock market? And how do you think investors should think about managing risk maybe differently to how they did in the past?Lisa Shalett Yeah, look, that's a fantastic question. And it's one that we are confronted with, you know, virtually every day. And what we've really tried to do is take a step back and make a couple of points. Number one, talk about goals and objectives and really ascertain what kinds of returns are necessary over what periods of time and what portion of that return, you know, needs to be in current cash flow, you know, annualized income. And try to make the point that perhaps generating that combination of capital appreciation and an income needs to be constructed, if you will, above and beyond the more traditional categories of cash, stocks and bonds given where we are in terms of overall valuations and how rich the valuations are in both stocks and bonds, where we are in terms of cash returns after inflation, and with regards to whether or not stocks and bonds at the current moment are actually behaving in a way that, you know, you're optimizing your diversification.Lisa Shalett So with all those considerations in mind, what we have found ourselves doing is speaking to the stock portion of returns as being comprised not only of, you know, the more traditional long-only strategies that we diversify by sector and by, you know, global regions. But we're including thinking about, you know, hedged vehicles and hedge fund vehicles as part of those equity exposures and how to manage risk. When it comes to the fixed income portion of portfolios, there's a need to be a little bit more creative in hiring managers who have a mandate that can allow them to use things like preferred shares, like bank loans, like convertible shares, like some asset backs, and maybe even including some dividend paying stocks in their income generating portion of the of the portfolio. And what that has really meant to your point about the 60-40 portfolio is that we're kind of recrafting portfolio construction across new asset class lines, really. Where we're saying, OK, what portion of your portfolio and what products and vehicles can we rely on for some equity like capital appreciation and what portion of the portfolio and what strategies can generate income. So, it's a lot more mixing and matching to actually get at goals.Andrew Sheets Tomorrow I’ll be continuing my conversation with Lisa Shalett on retail investing and the implications for markets. As a reminder, if you enjoy Thoughts of the Market, please take a moment to rate and review us on the Apple Podcasts App. It helps more people find the show.
9 min 59 sec
The eventual size of the Democratic Party’s fiscal policy legislation – for taxes and for spending – will likely impact the bond market as well as the policy landscape.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Wednesday, September 29th at 1:00 p.m. in New York. It's shaping up to be one of the most consequential legislative weeks on record in the US. At stake is the size and fate of Democrats' fiscal policy ambitions, specifically their goals of a major tax increase to fund a substantial expansion of infrastructure spending and the social safety net. But intraparty disagreements on the content of these efforts have left investors wondering: what will the final package do to the U.S. fiscal outlook and, therefore, the trajectory for bond yields? Will the Democrats go big, keeping yields moving higher, or go small, potentially meaning the worst of the recent increase in bond yields is behind us? Our current thinking is that the Democrats eventually end up going big. Why? Because neither of the two legislative vehicles they're considering are possible without the other - they're linked. Moderates, particularly in the Senate, may be happy with approving the smaller bipartisan infrastructure framework, or BIF. But progressives don't appear content with just this achievement and continue to argue they'll withhold their votes on the BIF until the whole of the party endorses a specific plan for the bigger budget reconciliation bill. This de facto linking of the two bills may mean that Democrats' planned votes this week to pass the BIF gets delayed, but it keeps the party on track for what we think would be a combined increase in spending of over $3T over 10 years, adding upwards of $1T to the deficit over the first five years. That would help keep support under the economic recovery and the upward trajectory of bond yields over the medium term. It could also mean equity markets are choppy in the near term as they digest a meaningful incoming tax hike. But breaking that link and going small is something we have to consider too. If progressives give in and vote for the BIF without a dependable agreement on reconciliation, the moderates will be in the driver's seat on the rest of the negotiation - and already key moderate Democratic leaders have said they'd delay the timing and dilute the size of the reconciliation bill. In that case, we'd substantially mark down our expectations for the impact to deficits, as well as for the scope of tax hikes. For this outcome to become more likely, look for a public signal from the White House to persuade progressives to vote for the BIF by explicitly endorsing the strategy of voting on it before reconciliation is agreed to. We hope this can be a guide to track how the situation develops over the next few days. And we’ll of course be paying close attention and be back next week to size it all up again. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.
2 min 51 sec
With incoming global growth data missing consensus expectations, emerging markets equity earnings revisions could fall back into negative territory for the first time since May 2020.----- Transcript -----Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you their perspectives, today I'll be talking about a key recent development, which is the deterioration in the global growth outlook and what it means for Asia and EM equities. It's the 29th of September at 7:30 a.m. in Hong Kong. Incoming global growth data is starting to miss expectations by a wide margin. This appears to be mainly due to the impact of Delta-variant covid on consumer confidence, but also continued supply chain bottlenecks on the corporate sector. The Global Economic Surprise Index, i.e., the extent to which top-down global macro data beats or misses economists' expectations, has fallen in a straight line from a level of +90 in mid-June to -24 currently. It was last this low at the end of March 2020, at the beginning of the global impact of the pandemic, and before that in the second quarter of 2018, at the start of US-China tariff hikes and the imposition of non-tariff barriers to trade. So in short, there's been a sudden downward lurch relative to expectations for global macro in relation to the narrative from consensus of a continued strong recovery, broadening out by geography, and entering a virtuous circle of rising consumption and investment. Global equity markets have wobbled recently but are still trading close to their all-time highs set in early September. We think the key to understanding what happens next is to understand the relationship between Economic Surprise data and earnings revisions. We’ve found that changes in the Global Economic Surprise index tend to have a good leading relationship for how bottom-up analyst earnings revisions evolve three months later. And that, in turn drives market performance. And this matters because the covid recession and recovery have already witnessed exceptionally sharp movements, both in economic data - relative to consensus - and earnings estimate revisions. Indeed, they've been more extreme even than the volatility that we saw at the time of the Global Financial Crisis. So, at this level of -24 on economic surprise, our analysis suggests 12-month forward EPS expectations will likely decline by around 150bps over the next three months. That may not sound like much, but it compares with a current positive QoQ upward revision of 530bps and a peak QoQ revision of 1100bps in May of this year. Within our coverage, some markets have already gone through the transition adjustment to slower expected earnings revisions - most notably China, where we remain cautious. Our analysis finds that strong performance and strong revisions are positively correlated and vice versa for weak performance and poor revisions. Japan, Russia and South Africa are the standouts recently for positive revisions, and they may show some resilience to the deteriorating global situation. China, Indonesia, Malaysia and Thailand have had the worst revisions and generally poor performance; but China has also been underperforming due to investors assigning a lower valuation to the market due to this year's regulatory reset. Overall, we continue to prefer Japan to EM and China. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
3 min 30 sec
Real interest rates are on the rise in Europe and the US and central banks are responding. This may impact currency markets headed into the fall. Matt Hornbach, Global Head of Macro Strategy, explains.-----Transcript -----Welcome to Thoughts on the Market. I'm Matt Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about global macro trends and how investors can interpret these trends for rates and currency markets. It's Tuesday, September 28th, at 12:30p.m. in New York. Just like clockwork, markets have become much more interesting and volatile after Labor Day in the U.S. Investors have been confronted with several issues that have collided in a big bang after what had been a relatively quiet summer. And central bank reactions have been a key part of the story going into the fall. To start, supply disruptions in commodity markets have led to inflation fears that have manifested themselves in higher market prices for inflation protection, mostly in Europe and the U.K. In response, the Bank of England has expressed more concern over the inflation outlook, since inflation is having a negative impact on the region's growth outlook. This combination of factors has caused real interest rates in Europe and the UK to remain extremely low and has also put downward pressure on the value of the British pound and the euro. Meanwhile, the U.S. economy has been more insulated from the commodity price shock, and inflation protection in the U.S. was already fully valued. In other words, worries about inflation in the U.S. began to build last year and, as a result, investors had already prepared themselves for the elevated inflation prints we're experiencing in the U.S. today. This means that real interest rates in the U.S. are left marching to the beat of other drummers. In particular, real interest rates in the U.S. have begun to respond to Federal Reserve monetary policy machinations. Last week, the Fed signaled that tapering its asset purchases could begin near term. That means the Fed will start purchasing less Treasury and agency mortgage-backed securities, leading to a decline in the amount of monetary accommodation the Fed has been providing. The question is, is this tapering akin to tightening policy? Participants on the Federal Open Market Committee would have you believe that tapering isn't the same thing as tightening policy. And technically they would be correct. When the Fed purchases assets in the open market such that its balance sheet grows, it is easing monetary policy. It's a different form of cutting interest rates. When the Fed's balance sheet no longer grows because it has stopped purchasing assets on a net basis, it is no longer easing monetary policy. In the transition between these two states, the Fed's balance sheet continues to grow, but at a slower rate than before. In this way, the process of tapering is akin to easing policy, but by less and less each month. But, and this is a big 'but', the process of tapering is the first step towards the process of tightening. Without the Fed tapering its asset purchases and slowing the growth of its balance sheet, rate hikes wouldn't appear on the radar screens of investors. So, the prospect of tapering this year has shown a spotlight on the prospect of rate hikes next year. And that has driven real interest rates higher in the U.S. So, what happens now? As long as real interest rates in the U.S. rise gradually, as they have done so far this year, the overall level of interest rates in the U.S., as you can see in the Treasury market, should also rise gradually. And if U.S. interest rates rise relative to those in Europe, which already began in August and we think will continue through the balance of the year, then the value of the U.S. dollar should appreciate relative to the euro. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.
3 min 40 sec
Our analyst’s equity positioning models have held up well and we continue to rely on an understanding of historical cycles as we move through this mid-cycle transition. Chief Investment Officer Mike Wilson explains.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, September 27th, at 11:30a.m. in New York. So let's get after it. Our equity strategy process has several key components. Most importantly, we focus on the fundamentals of growth and valuation to determine whether the overall market is attractive and which sectors and stocks look the best. The rate of change on growth is more important than the absolute level, and we use a market-based equity risk premium framework that works well as long as you apply the correct regime when using it. In that regard, we're an avid student of market cycles and believe historical analogs can be helpful. For example, the mid-cycle transition narrative that has worked so well this year is derived directly from our study of historical, economic and market cycles. The final component we spend a lot of time studying is price. This is known as technical analysis. Markets aren't always efficient, but we believe they are often very good leading indicators for the fundamentals - the ultimate driver of value. This is especially true if one looks at the internal movements and relative strength of individual securities. In short, we find these internals to be much more helpful than simply looking at the major averages. This year, we think the process has lived up to its promise, with the price action lining up nicely with the fundamental backdrop. More specifically, the large cap quality leadership since March is signaling what we believe is about to happen - decelerating growth and tightening financial conditions. The question for investors at this point is whether the price action has fully discounted those outcomes already, or not. Speaking of price, equity markets sold off sharply last Monday on concerns about a large Chinese property developer bankruptcy. While our house view is that it likely won't lead to a major financial contagion like the Global Financial Crisis a decade ago, it will probably weigh on China growth for the next few quarters. This means that the growth deceleration we were already expecting could be a bit worse. The other reason equity markets were soft early last week had to do with concern about the Fed articulating its plan to taper asset purchases later this year, and perhaps even moving up the timing of rate hikes. On that score, the Fed did not disappoint, as they essentially told us to expect the taper to begin in December. The surprise was the speed in which they expect to be done tapering - by mid 2022. This is about a quarter sooner than the market had been anticipating and increases the odds for a rate hike in the second half of '22. After the Fed meeting on Wednesday, equity markets rallied as bonds sold off sharply. Real 10-year yields were up 11bps in two days and are now up 31bps in just eight weeks. That's a meaningful tightening of financial conditions and it should weigh on asset price valuations, including equities. It also has big implications for what should work at the sector and style level. In short, higher real rates should mean lower equity prices. Secondarily, it may also mean value over growth and small caps over Nasdaq, even as the overall equity market goes lower. This would mean a doubly difficult investment environment, given how most are positioned. For the past month, our strategy has been to favor a barbell of defensive quality sectors like healthcare and staples, with financials. The defensive stocks should hold up better as earnings revisions start to come under pressure from decelerating growth and higher costs, while financials can benefit from the higher interest rate environment. Last week, this barbell outperformed the broader index. On the other side of the ledger is consumer discretionary stocks, which remain vulnerable to a payback in demand from last year's over consumption. Within that bucket, we still favor services over goods where there remains some pent-up demand in our view. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
3 min 56 sec
This week, the Fed hinted that a taper announcement in November could be in store, adding one more wrinkle into events that investors will need to navigate this fall.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, September 24th, at 2:00 p.m. in London. The Federal Reserve, or the Fed, probably receives more attention than any other institution in today's market. At one level, that's easy to explain; it's the central bank for the world's largest economy and reserve currency, and just so happens to be buying $120B of bonds every month. At another level, though, it feels a little excessive. Investors have woken up to the exact same interest rates and purchases from the Fed every day for more than a year. And if you look at global stock markets since May of last year, they've basically just risen in lockstep with the overall level of earnings. Still, the Fed matters, and this week it made some consequential announcements. It suggested strongly that it would begin to slow, or taper, those bond purchases, and do so soon, ending them completely by the middle of next year. Its members increased their expectation for how much they thought interest rates would rise in 2023 and 2024. All of this was driven by ongoing improvement in the economy and signs that inflationary pressures were finally building. One could be forgiven for thinking that the market would look at fewer purchases by the central bank, and higher interest rates, and think this was a bad thing. But markets are fickle, especially over short horizons, and stocks rose sharply both the day of and the day after the Fed's announcement. Interest rates also rose, following the lead of the Fed's shifting projections. Of those two reactions, we find those of the bond market much easier to justify. What really matters, however, is not what these changes mean for the market over the next two days, but over the next two years. And here, three things stand out. First, the Fed hasn't completely left the party, so to speak, but it is sliding towards the exit. Bond purchases by the Fed should still be with us for nine more months, but the signs of a different phase of central bank policy have clearly begun. Second, this next phase, the so-called taper, is likely to be a major focus for investors. The last time the market focused on slowing Fed purchases in 2013 and 2014, equity markets generally climbed. But yields rose and gold prices sank. We see a similar impact for both bonds and gold this time around, with our interest rate strategists particularly focused on how fast the Fed will raise rates - a pace that they think the market is still underestimating. Third, the Fed's actions are divergent from other central banks. While the Fed is shuffling towards the proverbial exit, the Bank of Japan and European Central Bank are much farther away and haven't even seemed to start moving. We think this results in a stronger dollar, relative to the Euro and the Yen, and will lead to better stock market performance in the latter regions. A shifting Fed is just one of several events markets need to navigate over the next several weeks. We think these events remain challenging and investors will get a better opportunity to be more aggressive later in the year. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.
3 min 18 sec
Why two D.C. policy items—the bipartisan infrastructure framework and debt ceiling deliberations—could add one more complication for equities markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Thursday, September 23rd, at 10:30 a.m. in New York. Markets this week have had a lot to focus on - from the Fed's policy decisions to fresh concerns about global growth. But expect that focus to shift next week, or possibly sooner, to events in Washington, D.C. In particular, watch out for two events that could catalyze some market volatility. First, keep an eye on the planned vote on the bipartisan infrastructure framework, or BIF for short. This vote, which could come as soon as Monday, is a key test for whether or not the Democrats will be able to 'go big' on fiscal policy. That's because the BIF - which would add about $550B of new spending over 10 years to the budget - was supposed to be paired with a bigger, budget reconciliation bill that could reach as high as $3.5T over 10 years. The linking of the two was meant to align the interests of moderate and progressive Democrats in Congress. But that reconciliation bill isn't ready yet for a vote alongside the BIF. So, if the smaller bill gets approved, the moderates will have gotten most of what they want and could be more demanding on the bigger bill, either stalling it or shrinking its size. At the moment, it's far from clear that the BIF can get enough votes to pass on its own, meaning the 'all or nothing' dynamic on fiscal policy remains intact. But if the BIF succeeds, that would suggest a smaller fiscal package, smaller deficit impact, and a key challenge to our view that bond yields will rise meaningfully into year end. We'd also keep a close eye on the deliberations around raising the debt ceiling and avoiding a government shutdown. While the 'x' date - the day by which the debt ceiling needs to be raised or suspended in order to avoid a payment default on Treasuries - is likely the more impactful deadline - which our economists expect will be late October, early November - markets may be more focused on September 30th, the date by which Congress must authorize a continuing resolution for new spending, or else the government shuts down. While we ultimately expect these issues to be resolved in a manner that doesn't materially impact the US growth outlook, the path to resolution on these issues likely requires escalated uncertainty in the near term. Since Democrats have paired the continuing resolution with a debt ceiling hike, which Republicans flatly oppose on the idea that Democrats should go it alone using reconciliation, there's no clear path forward at the moment. For example, the House just passed a continuing resolution, which the Senate is unlikely to be able to carry forward given insufficient Republican support. So, headlines around a government shutdown should pick up, and with it the takes that the situation increases the risk that the debt ceiling can't be raised in a timely manner. Taken together, these two concerns could weigh on the equity market, where our colleagues in cross-asset strategy have suggested performance could be sluggish in the near term as investors grapple with the transition from early to mid economic cycle dynamics. The shift from clear D.C. stimulus support to D.C. uncertainty could be one part of that shift. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.
3 min 20 sec
On this special episode, we address key questions around struggles in China's property sector, as well as any potential spillover into the broader economy.----- Transcript -----Chetan Ahya Welcome to Thoughts on the Market, I'm Chetan Ahya, Chief Asia Economist for Morgan Stanley,Robin Xing and I'm Robin Zing Morgan Stanley's Chief China Economist.Chetan Ahya And on this special edition of the podcast we'll be diving into the path forward for China's economy amid challenges in the property sector. It's Wednesday, September 22nd, at 7:30 a.m. in Hong Kong.Chetan Ahya So, Robin, as many listeners likely read earlier this week, China's property market is the subject of a lot of market and media focus right now. And near-term funding pressures for some of China's property developers have led to volatility as markets weigh concerns on any ripple effect into China's economy or even the global economy. To put funding pressures in context, in dollar terms, cumulative default in China's high-yield property names this year are already higher than that combined between 2009 and 2020. Robin, I want to get into your base case for China's economy as policymakers manage the property sector outcome. But to understand the backdrop for listeners, maybe it's worthwhile to take a step back to understand China's regulatory reset and the impact it's had on the housing market.Robin Xing So what we call China's regulatory reset is China's ongoing shift in governance priorities, which policymakers drafted last year. And it covers a number of areas, including technology, education, carbon emission, but also property developers in an effort to address the financial stability risks. So the property related financing has actually been tightening since summer 2020. You know, first with new financing rules for real estate companies--what's called the 'three red lines'--which put a leverage cap on developers, then a cap on property, long exposure for banks, and lately, very strict mortgage approval for homebuyers. In this environment, highly leveraged developers are more prone to refinancing risks. And now the question is, will there be more credit events to come? Going forward, tighter financing conditions may stay for developers, which could increase the risk of credit events.Robin Xing So, Chetan, you have been a close watcher for China's debt and the deleveraging dynamics since 2015. First, with its industrial sectors, then it's local government. Then we fast forward to today's housing market. Now, just to gauge how much deleveraging developers still have to undergo, how are we tracking on the three red lines as laid out by regulators? As I recall, developers are required to attain the 'green category,' meeting all three requirements by end of the first half 2023.Chetan Ahya Yeah, thanks, Robin. So, look, I think, first of all, just to appreciate the way China manages its debt challenges is it ensures that the process is taken up in an organized manner and that there are no uncontrolled defaults, which can have ramifications on the financial system as well as overall financial conditions. And property sector is no different. And on that front, our property analyst has been highlighting that out of 26 developers that we cover, only one developer still fails to meet all the three red lines and nine developers have already passed two of those red lines. The remaining 16 developers have already met all the three requirements, and most developers do target to attain green category by the end of next year. Currently, the total debt exposure of the property developers in China is around 18.4trn RMB, which is similar to the annual contract sales or annual sales of these companies, so the deleveraging pressure when you look at it in the context of the level of debt relative to sales, it does seem to be manageable for usChetan Ahya Having said that, Robin, and when you think about the importance of the property sector to the economy, it's quite a significant sector. Property and property related sectors account for 15% of GDP. So, if there is a problem and a developer faces a challenge in meeting its debt obligations, do you think that China can manage the ramifications?Robin Xing Yes, we do think regulators already have a playbook based on past default cases, which included the property developers. That said, the timing of deployment is what may matter most. Potentially Beijing's first goal would be to maintain normal operations of construction projects so default happens at the holding company level and not at the project level, which could reduce spill over to the physical property market. The second goal would be to go for voluntary debt restructuring and avoid a liquidation scenario which could substantially increase the recovery rate, though both of these actions would require coordination across authorities, creditors, and the company in this scenario. We expect the property sales and the investment in China to slow and the new starts would remain weak for the remainder of the year. However, it would not be a very fast and sharp deterioration because current inventory levels for the housing market are low, with around eight months for the major tier-one/tier-two cities. So, it's much lower than previous downturns. So, the overhang on housing new starts should be much smaller. All in all, in this swift intervention and policy easing scenario, we see China's GDP to rebound modestly from the 4.7% in the third quarter in two-year CAGR terms to slightly above 5% in the fourth quarter.Chetan Ahya So, Robin, when you think of the developments in the property market right now, in the context of the fact that the government has also been taking additional regulatory measures which have been weighing on the private business sentiment, do you think that the government can take up easing measures to ensure that this does not have a meaningful impact on the growth outlook?Robin Xing Yes, your concerns are very legitimate. Given the importance of the property sector to China's economy, Beijing may decide to take action sooner rather than later in order to support the economy. In our base case, we are near an inflection point of policy easing. That would be led by faster fiscal spending to support infrastructure investment from September to December, complemented by another 50 basis point reserve requirement ratio cut by the People's Bank of China probably in mid to late October. We also see some easing in mortgage quotas in the fourth quarter. This altogether should drive a modest rebound in broad credit growth in the fourth quarter, marking the end of a 10-month credit growth downturn. What's more, this momentum can be amplified in early next year when the fiscal spending and the credit quota could be front loaded.Chetan Ahya So, Robin, if I were to summarize, essentially what we are talking about is two sets of policy actions to be taken up by the government. First, to ensure that the debt restructuring is taken up in an organized and timely manner. And second is that to the extent to which there will be some negative impact on business sentiment, we're expecting the government to implement policy easing measures.Chetan Ahya However, if the government were to delay these supportive measures, what will be the implications on your growth forecast?Robin Xing That's certainly a scenario we hope to avoid. So basically, should policy makers fail to take actions in time to manage this restructuring and contain its spillover effect, we could see a rise in liquidity pressures on many more developers as banks cut credit lines and home buyer sentiment cools down. In this case, the fourth quarter growth could fall below 4%, far lower than the annual growth target, which was 6% for this year and probably around 5.5% for next year. In short, such delayed action, more spillover scenario would likely warrant a much bigger stimulus in earlier 2022 to meet the growth target to stabilize the job market.Chetan Ahya Robin, thank you for taking the time.Robin Xing It's been great speaking with you.Chetan Ahya And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or a colleague today.
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