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Short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

Morgan Stanley


    • Sep 30, 2022 LATEST EPISODE
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    Latest episodes from Thoughts on the Market

    Global Macro: Intervention & Inflation

    Play Episode Listen Later Sep 30, 2022 10:14


    Amidst increased volatility across credit, equity and FX markets, many investors this week are wondering, what is the path ahead for Fed intervention? Chief Cross Asset Strategist Andrew Sheets, Global Chief Economist Seth Carpenter and Head of Thematic and Public Policy Research Michael Zezas discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts in the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Seth Carpenter: And I'm Seth Carpenter. Morgan Stanley's Global Chief Economist. Michael Zezas: And I'm Michael Zezas, Head of Global Thematic and Public Policy Research. Andrew Sheets: And on this special edition of the podcast, we'll be talking about intervention, inflation and what's ahead for markets. It's Friday, September 30th at 9 a.m. in San Francisco. Michael Zezas: So, Andrew, Seth, we've been on the road all week seeing clients and that's come amidst some very unusual moves in the markets and interventions by a couple of central banks. Andrew, can you put in a context for us what's happened and maybe why it's happened? Andrew Sheets: Thanks, Mike. So I think you have the intersection of three pretty interesting stories that have been happening over the last couple of weeks. The first, and probably most important, is that core inflation in the U.S. remains higher than the Federal Reserve would like, which has kept Fed policy hawkish, which has kept the dollar strong and U.S. yields moving higher. Now, one of the currencies that the dollar has been strongest against is the Japanese yen, which has fallen sharply in value this year. Now we saw Japan finally intervene into the currency markets to a limited extent to try to support the yen but that support was short lived and we saw the dollar continue to strengthen. The other story that we saw occurred in the U.K., a country we discussed on this podcast recently about some of its unique economic challenges. The U.K. has also seen a weak currency against the dollar. But in addition to that, because of the market's reaction to recent fiscal policy proposals, we saw a very large rise in U.K. bond yields, which caused market dislocations and pushed the Bank of England to intervene in bond markets in a way that drove some of the largest moves in U.K. interest rates, really in recorded history. So a lot's been going on, Mike, it's been a very busy couple of weeks, but it's a story at its core about inflation leading to intervention, but ultimately not really changing a core backdrop of higher U.S. yields and a stronger U.S. dollar. Seth Carpenter: I completely agree with you on that, Andrew. And I think it brings up some of the questions that you and I have got in our client meetings this week, which is, 'where can this end?' Any trend that's not sustainable won't last forever, as the saying goes. So what would cause sort of an end to the dollar's run? And I think a natural place to look is, what would cause the Fed to stop hiking? I think the first thing that's worth strongly emphasizing is, from the Fed's perspective, a narrow monetary policy mandate, the rising dollar is actually a good thing. A stronger dollar means lower imported inflation. A stronger dollar means less demand for U.S. exports from the rest of the world. The Fed is fighting inflation by hiking interest rates, trying to slow the economy and thereby reduce inflationary pressures. Right now, this run in the dollar is doing their job for them. Michael Zezas: I would add to that that we've been getting a lot of questions about, 'when would the Fed or the Treasury see this weakness and want to intervene on behalf of markets?' And I think the answer is it's unlikely to happen anytime soon. And there's really kind of two reasons for that. One, doing so would contradict the Fed and the Treasury's own stated goals of fighting inflation right now. I think there are heavy political and policy incentives that haven't changed that support that being the policy direction for those institutions. And then the second is, even if you intervened right now, our FX research team has pointed out it's probably unlikely to work. At the moment, there aren't a tremendous amount of FX reserves in the system with which to intervene. And so any intervention would probably deliver short term results. So long story short, if the intervention is against your goals and wouldn't likely work anyway, it's probably not going to happen. So, Andrew, I think this kind of brings the conversation back around to you. If there really isn't going to be any net change in the Federal Reserve's stance towards monetary policy, then what should investors expect going forward? Andrew Sheets: So at the risk of sounding simplistic, if we're not going to see a change in policy response from the Fed, then we shouldn't expect a major change in market dynamics. Core inflation remains higher than we think the Fed is comfortable with. That will keep pressure on the Fed to keep making hawkish noises that should keep upward pressure on the front end of the curve and keep the curve quite inverted. We think that helps support the dollar because while the dollar might be expensive in many measures of foreign exchange valuation, the dollar is still paying investors much more than currencies like the yen or the UK pound in real interest rates. And that differential is powerful, that differential is important. And I think that differential will keep investors looking for the safety and stability and higher yields of the U.S. dollar. Look, taking a step back, I think markets are adjusting to this dynamic where the Fed is not your friend as an investor. Which is the pattern that we saw through most of financial market history, but was different in the post global financial crisis era, when the level of stress on the markets was so severe that the level of policy support had to be extraordinary. And so that is a dynamic that's shifting now that we're facing a stronger economy, now that we're facing much stronger consumer and corporate demand, we're facing the more normal tradeoff where strong labor markets, strong consumer demand leads to a Federal Reserve that's really trying to tighten the reins and slow the economy down, slow financial market activity down. So, you know, investors are still sailing into that headwind. We think that presents a headwind to risky assets. We think that presents a headwind to the S&P 500. And we think, with the Fed still sounding quite serious on inflation, still erring on the side of caution, that will lead investors to continue to think more rate hikes are possible and support the U.S. dollar against many other currencies in the developed market, which still have lower yields, especially on an inflation adjusted basis. Seth Carpenter: So, Andrew, I think I want to jump in on that because I think what you're saying is, for now, nothing's changing and so we should expect the same market dynamics. Which brings up the question that you and I have got this week as we've been seeing clients, which is, 'what would cause the Fed to pivot? What would cause the Fed to change its policies?' And I think there, I would break it into two parts. Going back to my first point about what the rising interest rates and the rising dollar have been doing, they've been doing exactly what the Fed wants, limiting demand in the United States, slowing growth in the United States, and, as a result, putting downward pressure on inflation. If we get to the point where the US economy is clearly slowing enough, if we get data that is convincing that inflation is on a downward trajectory, that's what the Fed is looking for to pause their hiking cycle. So I think that's the first answer. The other version, though, is the market volatility that we're seeing is being driven by some of this policy action. We could get feedback loops, we could get increasing bouts of volatility where markets start to break, we could get credit markets breaking, we could get more volatility and interest rate markets like we saw in the U.K.. I think at some point we can see where there's a feedback loop from financial market disruptions globally that threatens the United States. And at some point, that kind of feedback could be enough to cause the Fed to take a pause. Andrew Sheets: So Seth, that's a great point. And actually, I want to push you on specifics here. How do you and the economics team think about a scenario where, let's say inflation is 3/10 lower than expected next month, or where we go from a very strong level of reading in the labor market? What would be an indication of the type of market stress that the Fed would care about relative to something it would see as more the normal course of business? Seth Carpenter: I don't think one month's worth of data coming in softer than forecast would be enough to completely change the Fed's mind, but it would be enough to change the Fed's tone. I think in those circumstances, if both nonfarm payrolls and CPI came in substantially below expectations, you would hear Chair Powell at the November meeting saying things like, 'We got some data that came in softer and for now, we're going to monitor the data to see if this same downward trajectory continues.' I think that kind of language from Powell would be a signal that a pivot is probably closer than you might have thought otherwise. Conversely, when it comes to financial markets, I think the key takeaway is that it has to be the type of financial market disruptions that the Fed thinks could spill back to the U.S. and hurt overall growth enough to slow the economy, to bring inflation down. Credit market disruptions are a key issue there. Sometimes we've seen global risk markets and global funding markets get disrupted. I think it's very hard to say ex-ante what it would take. But the key is that it would have to be severe enough that it would start to affect U.S. domestic markets. Andrew Sheets: So, Seth, Mike, it's been great to talk to you. So just to wrap this up, we face a backdrop where inflation still remains higher than the Federal Reserve would like it. We think that keeps policy hawkish, which keeps the dollar strong. And even though we've seen some market interventions to a limited degree, we don't see much larger interventions reversing the direction of the dollar. And we don't think such interventions, at the moment, would be particularly effective. We think that keeps the dollar strong and we think that means headwinds for markets, which leaves us cautious on risky assets in the near term. As always, this is a fast evolving story and we'll do our best to keep you up to date on it. Andrew Sheets: 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.

    Jonathan Garner: An Unusual Cycle for Asia and EM Equities

    Play Episode Listen Later Sep 29, 2022 3:21


    Asia and EM equities are on the verge of the longest bear market in their history, so what is the likelihood that a sharp fall in prices follows soon after?----- Transcript -----Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Market Equity Strategist at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today I'll be discussing the ongoing bear market in Asia and Emerging Market equities. It's Thursday, September the 29th at 8 a.m. in Singapore. We have repeatedly emphasized that patience may be rewarded during what will likely, by the end of this month, become the longest bear market in the history of Asia and Emerging Market equities. Indeed, we argued that the August Jackson Hole speech by Fed Chair Powell, and the mid-September upside surprise in U.S. CPI inflation likely accelerated a downward move towards our bear case targets near term. And in recent weeks, the MSCI Emerging Markets Index has indeed given back almost all of the gains it had recorded from the COVID recession lows. To our mind, this raises the likelihood that a classic capitulation trough, a sudden sharp fall in prices and high trading volumes, could be forming in a matter of weeks. Now, all cycles are not made alike, and this one is unusual in a number of key regards. Most notably, the dislocations in the supply side of the global economy caused by COVID and geopolitics. Moreover, China is not easing policy to the same extent as helped generate troughs in late 2008 and early 2016. Thus, caution is warranted in drawing too firm a set of conclusions from relationships that have held in the past. That said, by the end of this month, the current bear market will likely become the longest in the history of the asset class, overtaking in days duration that triggered by the dot com bust in the early 2000's. And after a more than 35% drawdown, the MSCI Emerging Markets Index is now trading close to prior trough valuations at only 10x price to consensus forward earnings. Our experience covering all previous bear markets back to 1997/1998 suggests to us ten sets of indicators to monitor. We've recently undertaken an exercise to score each indicator from 1, which equates to a trough indicator not enforced at all to 5, which indicates a compelling trough indicator already in place. Currently, the sum of the scores across the factors is 32 out of a maximum of 50, which we view as suggesting that a trough is approaching but not yet fully conclusive at this stage. In our view, the U.S. dollar, which continues to rise, including after the most recent FOMC meeting, gives the least sign of an impending trough in EM equities. Whilst the underperformance of the Korean equity market and the semiconductor sector, the recent sharp fall in oil price and the fall in the oil price relative to the gold price give the strongest signs. In this regard, we would note that within our coverage we recently downgraded the energy sector to neutral, upgrading defensive sectors, including telecoms and utilities. We intend to update the evolution of these indicators as appropriate as we attempt to help clients move through the trough of this unusually long Asia and Emerging Markets equity bear market. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts and recommend Thoughts on the Market to a friend or colleague today.

    Ellen Zentner: The Narrowing Path for a Soft Landing

    Play Episode Listen Later Sep 28, 2022 4:10


    As the Fed continues to increase their peak rate of interest, the path for a soft landing narrows, so what deflationary indicators need to show up in the real economy to take the pressure off of policy tightening?----- Transcript -----Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss the narrowing path for a soft landing for the U.S. economy. It's Wednesday, September 28, at 10 a.m. in New York. Last week, we revised our outlook to reflect the expectation that the Fed will take its policy rate to a higher peak between 4.5% to 4.75% by early next year. And that's 75 basis points additional tightening than what we had envisioned previously. Tighter policy should push the real economy further below potential and substantially slow job gains. And while higher interest rates are needed to create that additional slack in the economy, this dynamic raises the risk of recession. There's still a path to a soft landing here, but it seems clear to us that path has narrowed. Now beyond directly interest sensitive sectors such as housing and durable goods, we've seen little evidence that the real economy is responding to the Fed's policy tightening. Just think about how strong monthly job gains remain in the range of 300,000. So in the absence of a broader slowdown, and facing persistent core inflation pressures such as a worrisome acceleration in rental prices, the Fed is on track to continue tightening at a faster pace than we had originally anticipated. Looking to the November meeting, we expect the Fed to hike rates by 75 basis points, and then begin to step down the pace of those rate hikes to 50 basis points in December and 25 basis points in January. We then expect the Fed to stay on hold until the first 25 basis point rate cut in December 2023. While inflation has remained stubborn, the growth environment has softened, and the lagged effect of monetary policy on economic activity points to further slowing ahead. So in response to substantially more drag from higher interest rates, we've lowered our 2023 growth forecast to just 0.5%. We then think a mild recovery sets in in the second half of 2023, but growth remains well below potential all year. In our forecast, weakness in economic activity will be spread more broadly, and monetary policy acts with a 2 to 3 quarter lag on interest rate sensitive sectors such as durable goods. So the sharper slowdown we envision in 2023 predominantly reflects a downshift in consumption growth. Business investment also tends to respond with a lag and will become a negative for growth in the first half of 2023. With growth falling more rapidly below potential, the labor market is on track to follow suit. We now see job gains bottoming at 55,000 per month by the middle of 2023. Lower job growth in combination with a rising participation rate, lifts the unemployment rate further to 4.4% by the end of next year. Inflation pressures have still not turned decisively lower, in particular because of rising shelter costs. High frequency measures point to eventual deceleration, though it should be gradual, even as the labor market loosens on below potential growth. We see core PCE inflation at 4.6% on a year over year basis in the fourth quarter of this year, and slow to 3.1% year over year in the fourth quarter of next year. So inflation is a good deal lower by the end of next year, but that's still too high to allow for rate cuts much before the end of 2023. Turning to risks, we think the risk to the outlook and monetary policy path now skew to the downside and a policy mistake is coming into focus. At the Fed's current pace of tightening uncertainty as to how the economy will respond a few months down the line is high. The labor market tends to be slow moving, but we and frankly monetary policymakers have no experience with interest rate changes of this magnitude. And activity could come to a halt faster than expected. Essentially, the higher the peak rate of interest the Fed aims for, the greater the risk of recession. We are already moving through sustained below potential GDP growth. We now need to see job gains slow materially over the next few months to ease the pressure on the pace of policy tightening. 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.

    Martijn Rats: Will Oil Prices Continue to Fall?

    Play Episode Listen Later Sep 27, 2022 3:47


    While the global oil market has seen a decrease in demand, supply issues are still prevalent, leaving investors to question where oil prices are headed next.----- Transcript -----Welcome to Thoughts on the Market. I'm Martijn Rats, Morgan Stanley's Global Commodity Strategist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss the current state of the global oil market. It's Tuesday, September 27th, at 2 p.m. in London. U.S. consumers have no doubt noticed and appreciated a welcome relief from the recent pain at the gas pump. Up until last week, U.S. gas prices had been sinking every day for more than three months, marking the second longest such streak on record going back to 2005. This gas price plunge in the U.S. was driven in part by the unprecedented releases of emergency oil by the White House. But what else is happening globally on the macro level? Looking at the telltale signs in the oil markets, they tell a clear story that physical tightness has waned. Spot prices have fallen, forward curves have flattened, physical differentials have come in and refining margins have weakened. A growth slowdown in all main economic blocks has pointed to weaker oil demand for some time, and this is now also visible in oil specific data. China has been a particularly important contributor to this. However, prices have also corrected substantially by now. Adjusted for inflation, Brent crude oil is back below its 15 year average price. In this context, the current price is not particularly high. Also, the Brent futures curve has in fact flattened to such an extent that current time spreads would have historically corresponded with much higher inventories expressed in days of demand. That means, in short, that the market structure is already discounting a significant inventory built and/or a large demand decline. Then there is still meaningful uncertainty over what will happen to oil supply from Russia once the EU import embargo kicks in later this year for crude oil, and early next year for oil products. The EU still imports about three and a half million barrels a day of oil from Russia. Redirecting such a large volume to other buyers, and then redirecting other oil back to Europe is possible over time, but probably not without significant disruption for an extended period. For a while, we suspect that this will lead to a net loss of oil supply to the markets in the order of one and a half million barrels a day. To attract enough other oil to Europe, European oil prices will need to stay elevated. The relative price of oil in Europe is Brent crude oil. Elsewhere, there are supply issues too. We started off the year forecasting nearly a million barrels a day of oil production growth from the United States. But so far this year, actual growth in the first six months of the year has just been half that level. We still assume some back end loaded growth later this year, but have lowered our forecast already several times. Then Nigerian oil production has deteriorated much faster than expected, currently at the lowest level since the early 1970s. Kazakhstan exports via the CBC terminal are hampered, OPEC's spare capacity has fallen to just over 1%, and the rig count recovery in the Middle East remains surprisingly anemic. The long term structural outlook for the oil market still remains one of tightness, but for now this is overshadowed by cyclical demand challenges. As long as macroeconomic conditions remain so weak, oil prices will probably continue to linger on. However, that should not be taken as a sign that the structural issues in the oil market around investment and capacity are solved. As we all know, after recession comes recovery. Once demand picks up, the structural issues will likely reassert themselves. We have lowered our near-term oil price forecast, but still see a firmer market at some point in 2023 again. 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.

    Mike Wilson: A Sudden Drop for Stocks and Bonds

    Play Episode Listen Later Sep 26, 2022 3:50


    After last week's Fed meeting and another rate hike, both stocks and bonds dropped back to June lows. The question is, will this turn to the downside continue to accelerate?----- 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 26, at 11 a.m. in New York. So let's get after it. Last week's Fed meeting gave us the 75 basis point hike most investors were expecting, and similar messaging to what we heard at Jackson Hole a month ago. In short, the Fed means business with inflation and is willing to do whatever it takes to combat it. So why was there such a dramatic reaction in the bond and stock markets? Were investors still hoping the Fed would make a dovish pivot? Whatever the reason, both stocks and bonds are right back to their June lows, with many bellwether stocks and treasuries even lower. As we wrote a few weeks ago, we think investor hopes for a Fed pivot were misplaced, and Chair Powell has now made that crystal clear. Secondly, we noted last week that the only remaining hope for stocks would be if the bond market rallied at the back end on the view that the Fed was finally ahead of the curve and would win its fight against inflation, while slowing the economy materially. Instead, interest rates spiked higher, squelching any hopes for stocks. While 15.6x price earnings ratio is back to the June lows, that P/E still embeds what we think is a mispriced equity risk premium given the risk to earnings. Said another way, with a Fed pivot now off the table, the path on bond and equity prices will come down to growth - economic growth for bonds and earnings growth for stocks. On both counts we are pessimistic, particularly on the latter as supported by our recent cuts to earnings forecasts. We have been discussing these forecasts with clients for the past several weeks and while most are in agreement that consensus 2023 earnings estimates are too high, there is still a debate on how much. Suffice it to say, we are at the low end of client expectations. Interestingly, recent economic data have kept the economic soft landing view alive, and interest rates have moved above our rates team's year end forecast. From an equity market standpoint, that means no relief for valuations as earnings come down. This is a major reason why stocks sank to their June lows on Friday. Ultimately, we do think economic surprise data will likely disappoint again, but until it does there is no end in sight for the rise in 10 year yields, especially with the run off of the Fed's balance sheet increasing. As such, our rates team has raised its year end target for 10 year Treasury yields to 4% from 3.5%. This is a very tough backdrop for stocks and epitomizes our fire and ice thesis to a T. In other words, rising cost of capital and lower liquidity in the face of slower earnings growth or even outright declines. Finally, the Fed's historically hawkish action has led to record strength in the U.S. dollar. On a year over year basis the dollar is now up 21% and still rising. Based on our analysis that every 1% change in the dollar has a .5% impact on S&P 500 earnings growth, fourth quarter S&P 500 earnings will face an approximate 10% headwind to growth all else equal. This is in addition to the other challenges we've been discussing for months, like the pay back in demand and higher cost from inflation to name a few. Bottom line Part 2 of our Fire and ice thesis is now on full display, with rates and the U.S. dollar ratcheting higher, just as the negative revisions for earnings appear set to accelerate to the downside. In our view, the bear market in stocks will not be over until the S&P 500 reaches the range of our base and bear targets, i.e. 3000 to 3400 later this fall. 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 to find the show.

    U.S. Economy: The Fed Continues to Fight Inflation

    Play Episode Listen Later Sep 23, 2022 7:38


    After another Fed meeting and another historically high rate hike, it's clear that the Fed is committed to fighting inflation, but how and when will the real economy see the effects? Chief Cross-Asset Strategist Andrew Sheets and Global Chief Economist Seth Carpenter discuss.----- 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, Morgan Stanley's Global Chief Economist. Andrew Sheets:] And on this special edition of the podcast, we'll be talking about the global economy and the challenges that central banks face. It's Friday, September 23rd at 2 p.m. in New York. Andrew Sheets: So, Seth, it's great to talk to you. It's great to talk to you face to face, in person, we're both sitting here in New York and we're sitting here on a week where there was an enormous amount of focus on the challenges that central banks are facing, particularly the Federal Reserve. So I think that's a good place to start. When you think about the predicament that the Federal Reserve is in, how would you describe it? Seth Carpenter: I think the Federal Reserve is in a such a challenging situation because they have inflation that they know, that everyone knows, is just simply too high. So they're trying to orchestrate what what is sometimes called a soft landing, that is slowing the economy enough so that the inflationary pressures go away, but not so much that the economy starts to contract and we lose millions of jobs. That's a tricky proposition. Andrew Sheets: So we had a Federal Reserve meeting this week where the Fed raised its target interest rate by 75 basis points, a relatively large move by the standards of the last 20 years. What did you take away from that meeting? And as you think about that from kind of a bigger picture perspective, what's the Fed trying to communicate? Seth Carpenter: So the Federal Reserve is clear, they are committed to tightening policy in order to get inflation under control, and the way they will do that is by slowing the economy. That said, every quarter they also provide their own projections for how the economy is likely to evolve over the next several years, and this set of projections go all the way out to 2025. So, a very long term view. And one thing I took away from that was they are willing to be patient with inflation coming down if they can manage to get it down without causing a recession. And what do I mean by patient? In their forecasts, it's still all the way out in 2025 that inflation is just a little bit above their 2% target. So they're not trying to get inflation down this year. They're not trying to get inflation down next year. They're not trying to get inflation down even over a two year period, it's quite a long, protracted process that they have in mind. Andrew Sheets: One question that's coming up a lot in our meetings with investors is, what's the lag between the Fed raising interest rates today and when that interest rate rise really hits the economy? Because, you are dealing with a somewhat unique situation that the American consumer, to an unusual extent, has most of their debt in a 30 year fixed rate mortgage or some sort of less interest rate sensitive vehicle relative to history. And so if a larger share of American debt is in these fixed rate mortgages, what the Fed does today might take longer to work its way through the economy. So how do you think about that and maybe how do you think the Fed thinks about that issue? Seth Carpenter: It's not going to be immediate. In round terms, if you take data for the past 35 years and come up with averages, you know, probably take something like two or three quarters for monetary policy to start to affect the real side of the economy. And then another two or three quarters after that for the slowing in the real side of the economy to start to affect inflation. So, quite a long period of time. Even more complicated is the fact that markets, as you know as well as anyone, start to anticipate central bank. So it's not really from when the central bank changes its policy tools when markets start to build in the tightening. So that gives them a little bit of a head start. So right now, the Fed just pushed its policy rate up to just over 3%, but markets have been pricing in some hiking for some time. So I would say we're already feeling some of the slowing of the real side of the economy from the markets having priced in policy, but there's still a lot more to come. Where is it showing up? You mentioned housing. Mortgage rates have gone up, home prices have appreciated over the past several years, and as a result we have seen new home sales, existing home sales both turnover and start to fall down. So we are starting to see some of it. How much more we see and how deep it goes, I think remains to be seen. Andrew Sheets: So Seth, another issue that investors are struggling with is on the one hand, they're seeing all of these quite large moves by global central banks. We're also seeing a reduction in the central bank balance sheet, a reversal of the quantitative easing that was done to support the economy during COVID, the so-called quantitative tightening. How do you think about quantitative tightening? What is it? How should we think about it? Seth Carpenter: I have to say, during my time at the Federal Reserve, I wrote memos on precisely this topic. So what is quantitative tightening? It is in some sense the opposite of quantitative easing. So the Federal Reserve, after taking short term interest rates all the way to zero, wanted to try to stimulate the economy more. And so they bought a lot of Treasury securities, they bought a lot of mortgage backed securities with an eye to pushing down longer term interest rates even more to try to stimulate more spending. So quantitative tightening is finding a way to reverse that. They are letting the Treasury securities that they have on their balance sheet mature and then they're not reinvesting, and so their balance sheet is shrinking. They're letting the mortgage backed securities on their balance sheet that are prepaying, run off their balance sheet and they're not reinvesting it. And when they make that choice, it means that the market has to absorb more of these types of securities. So what does the market do? Well, the market has to make room for it in someone's portfolio, and usually what that means is to make room on a portfolio prices have to adjust somewhere. Now, markets have been anticipating this move for a long time, and I suspect our colleagues who are in the Rate Strategy Group suspect that most of the effect of this unwind of the balance sheet is already in the price. But the proof is always really in the pudding, and we'll see over time, as the private sector absorbs all these securities, just how much more price adjustment there has to be. Andrew Sheets: And then, I imagine this is a hard question to answer, but if the Fed started to think that it was tightening too much, if the economy was slowing a lot more than expected or there was more stress in the system than expected - do we think it's more likely that they would pause quantitative tightening or that they would pause the rate hikes that the market's expecting? Seth Carpenter: I feel pretty highly convicted that if the slowing in the economy that they're seeing is manageable, if it's within the range of what they're expecting, it's interest rates. Interest rates are, to refer once again to what Chair Powell has said many times, the primary tool for adjusting the stance of monetary policy. So they're hiking rates now, at some point they'll reduce the size of those rate hikes and at some point they'll stop those rate hikes. Then the economy, hopefully in their mind, will be slowing to reduce inflationary pressure. They might judge that it's slowing too much if they feel like the adjustment they have to make is to lower interest rates by 25 basis points, maybe 50 basis points, even a little bit more than that if it happens over the course of a year, I still think the primary tool is short term interest rates. However, if the world changes dramatically, if they feel like, oh my gosh, we totally misjudged that. Then I think they would curtail the run off of the balance sheet. Andrew Sheets: Seth, thanks for taking the time to talk. Seth Carpenter: Andrew, It's always my pleasure to talk to you. Andrew Sheets: And 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.

    Thematic Investing: What is the Next Big Tech Idea?

    Play Episode Listen Later Sep 22, 2022 8:23


    With high returns in mind, investors may be looking to get in on the ground floor with the next ambitious and disruptive technology, but how are these ‘moonshots' identified and which ones could make a near-term impact? Head of Thematic Research in Europe Ed Stanley and Head of the Global Autos and Shared Mobility Team Adam Jonas discuss.----- Transcript -----Ed Stanley: Welcome to Thoughts on the Market. I'm Ed Stanley, Morgan Stanley's Head of Thematic Research based in London. Adam Jonas: And I'm Adam Jonas, Head of the Global Autos and Shared Mobility Team. Ed Stanley: And on this special episode of the podcast, we'll be discussing the bold potential of moonshot technologies, and particularly in the face of deepening global recession fears. It's Thursday, the 22nd of September, at 4 p.m. in London. Adam Jonas: And 11 a.m. in New York. Adam Jonas: Let me start with an eye popping number. Since 2000, 1% of companies have generated roughly 40% of shareholder returns by developing moonshots, that is ambitious and radical solutions to seemingly insurmountable problems using disruptive technology. So here at Morgan Stanley Research, we naturally spend a lot of time wondering what are the potential moonshots of the next decade? What's the next light bulb, airplane, satellite, internet? What technologies are developing literally as I record this that we'll be focused on in 2032? So Ed, I know you really want to dig into the specifics of some of the sectors that are touched on in the Moonshot Technologies report you wrote, but first can you maybe explain the framework for identifying these moonshots? Ed Stanley: So this is a totally different horizon and way of thinking to what most investors are used to. Typically, when looking for investable themes or technologies in public markets, we focus on those that are at or have surpassed a 20% adoption rate, those essentially with the wind at their back already. But clearly, with moonshots, we're looking much, much earlier, but with a much greater risk reward skew. There are a number of potentially groundbreaking technologies out there incubating right now. The next iPhone moment is out there, is being developed, and it should be all of our job to sniff out what, when and where that pivotal product will come from. But the question we've received is how do you whittle that funnel of potential technologies down? So we come at it from first principles. Academic research, either by individuals, governments or companies, tends to be the genesis for most groundbreaking ideas. This then feeds patenting, or in other words R&D, for small and big companies alike to build a moat around that research they pioneered. And then venture capital comes in to support some of those speculative innovations, but importantly, only those that have product market fit, which is what we focus on. Adam Jonas: So Ed, why do you think now is such an interesting time to be thinking about moonshots, given such a challenging macro backdrop? Ed Stanley: It's a great question. So if you take a step back, there are always reasons to be concerned in the markets. But moments of peak anxiety in hindsight tend to be the moments of peak opportunity. I'll steal an overused cliche, necessity is the mother of invention. We're more likely to see breakthroughs in energy technology, for example, at the moment, at the point of peak acute pain than five years ago when there was no real impetus. This is exactly why some of the most innovative companies are born during or just after recession or inflationary periods. In fact, if you look at the stats, one third of Fortune 500 companies were born in the handful of recessionary years over the last century. So macro may be getting worse, but we remain pretty committed to uncovering long term, game changing themes and investments. Adam Jonas: Can you give us a summary of the output and to which moonshots really stood out to you as having the potential for profound change over the medium term? Ed Stanley: Sure. So there are clearly some that are not only profound but frankly unfathomable in terms of their potential impacts. Things like life extension, a startup developing artificial general intelligence, also known as a singularity, and Web3 remains a fascinating sandbox of crypto and blockchain experiments. So there's a wealth of fascinating moonshots in there, but I'd focus on two that have more prescient implications for investors near-term. First is pre-fab housing. It's nothing new as a concept. It's essentially the process of bringing construction into the factory to increase efficiency. But we're now moving from 2D assemblies of walls and roof panels to the real moonshot, which is 3D assembly of the entire house, pre-made, and that is now happening. These pre-built whole houses can be 40 to 50% cheaper and quicker, and so coming back to your question around why now? Moonshots like this have little momentum in good years, but construction input costs up 20% year on year, suddenly you have the catalyst for innovative, greener, low waste pre-fab solutions. And the second one, I think is really fascinating and few people are well versed in it, is deepfakes and the new era of synthetic reality. These are livestream videos and voice renderings to create the impression that you are watching or speaking to someone that you are not. And I think by highlighting this, we are also trying to show that not all moonshots are good news. At the moment, the risk is fake news, but that is the tip of the iceberg. But with that said, Adam, I want to jump to you. You're the perfect person to speak to given your knowledge of EVs in particular. And just like the smartphone market, those were once considered to be far fetched moonshots by some people, and yet they're heading towards ubiquity. So you've written a lot in the last couple of years around the "muskonomy", as you call it. Before we get into some moonshots you're interested in, can you explain to us what the "muskonomy" is? Adam Jonas: We're referring to the portfolio of businesses and endeavors of Elon Musk, of course, across EVs and batteries and renewable energy and autonomous vehicles. Of course, his efforts in space and tunneling technology. Taken together we think he's in a position where any improvement in one of those businesses can help the advancement and accelerate development of the other three domains and then kind of feedback on itself and create a bit of velocity. But the point is, these businesses address huge physical markets. Markets that address the atomic economy, what I mean by that, the periodic table not the not the metaverse. Right, we need to kind of sort reality out here. These are high CapEx businesses, high moat businesses where trillions and trillions of capital will need to be redeployed with regulatory oversight, environmental planning, supply chain, industrialization, standards setting and of course, taxpayer involvement along the way. Ed Stanley: It's a fascinating point, which we touched on in some of our other research around the innovation stack and how building technology on top of other layers of technology accelerates the disruption. I'm keen to understand from an investability perspective, what time horizons do you think we could expect some of these breakthroughs in? And where are the tailwinds coming from? Adam Jonas: Right now, of course his efforts in EVs are well known. What I think is less appreciated is changing how manufacturing is done. Elon wants to make a car, ideally out of a single piece of injected molded aluminum in a 12,000 ton giga press. To really make a fuselage of a car and take the parts count down dramatically. And he wants to inject into this fuselage his structural battery pack, his 4680 battery battery pack. And so changing how vehicles are made and designing the battery into the car is something that really excites us in terms of finally getting that price of EVs down. So the other thing I would highlight that makes us very excited is his tunneling technology, we would watch that. And so we pay attention to Los Angeles and Las Vegas and Austin, Texas and San Antonio and Fort Lauderdale, Miami. These city, city pairs in states where we think Elon Musk can yield influence and we think this could be really the next big thing in infrastructure, not in a 2 to 3 year period, but certainly in a 5 to 10 year period with investment being attracted and relevant right now. Ed Stanley: Well, that's a fantastic synopsis. Plenty to whet the appetite on moonshots of the next 5 to 10 years. Adam, thanks very much for taking the time to talk. Adam Jonas: Great speaking with you, Ed. Ed Stanley: And thanks for listening. If you enjoyed Thoughts on the Market, please leave a review on Apple Podcasts and share the podcast with a friend or a colleague today.

    Michael Zezas: Why Isn't Fed Hiking Impacting Inflation?

    Play Episode Listen Later Sep 21, 2022 2:47


    Though the Fed continues to raise interest rates, inflation is still high year over year, so why haven't rate hikes begun to bring inflation down yet?----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research 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, September 21st at 10 a.m. in New York. The Fed continues to hike interest rates, but inflation is still running hot in the U.S. as demonstrated by last week's 8.3% year over year growth in the Consumer Price Index. When and how the Fed will eventually succeed in dampening inflation is an important consideration for markets, but investors should also focus on another question. Why hasn't fed hiking worked to bring down inflation yet? Well, there's a strong case to be made that the U.S. economy is less sensitive to changes in interest rates today than it has been in the past. In total, about 90% of all household debt today is fixed rate, meaning that as the Fed hikes rates and market rates rise, consumers' debts don't cost them more to service. If they did, then rising interest rates would dampen economic growth by dampening aggregate demand. Those higher rates would in theory crimp consumption, as households direct less of their money toward buying goods and services and more toward paying their debts. That, in turn, would ease inflation. Understanding this dynamic is important for investors in a few ways. Take the housing market, for example. After the housing crisis that touched off the global financial crisis in 2008 and 2009, adjustable rate mortgages only now make up a small fraction of all mortgages. Sure, higher mortgage rates means buying a new home is effectively more expensive, but with so many more mortgages in the U.S. carrying a fixed rate and issued to individuals with higher credit scores, the cost of owning a home to current owners hasn't changed. That means there's little incentive for homeowners to sell and or reduce the asking price for their home. Hence, our housing strategists expect home sales to decline meaningfully, but you may not see a lot of price deterioration in the aggregate. The bond market is another place we see this dynamic on display. Our interest rate strategy team expects you'll see the yield curve continue to flatten and invert, with shorter maturity yields rising faster than longer ones. Why? Because shorter maturities typically track the Fed funds rate, which the Fed has clearly stated will continue going higher until there's clear evidence of inflation deceleration, which could take longer given the economy's lessened sensitivity to rising rates. For bond investors, the bottom line is you should consider something that historically has been pretty unusual - longer maturities might perform better even as rates go higher. 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.

    Robin Xing: Can China's Economy Stabilize Global Growth?

    Play Episode Listen Later Sep 20, 2022 4:05


    As the global economic outlook turns toward a slowdown in growth, some investors may look to China for stability, but, when they do, what will they find?----- Transcript -----Welcome to Thoughts on the Market. I'm Robin Xing, Morgan Stanley's Chief China Economist. Along with my colleagues, bringing you a variety of perspectives, today I will discuss whether China can stabilize global growth amid recession fears. It's Tuesday, September 20th at 9 AM in Hong Kong. The global economic outlook is dimming, and my colleagues have already discussed their expectations for slowdown in developed market economies driven by surging prices and aggressive monetary policy tightening. In this context, investors are likely to turn their attention to China, perhaps hoping it can once again stabilize global growth as it did after the 2008 global financial crisis. China's economy, however, appears to be fragile. While it has bottomed after the contraction due to Shanghai lockdown in the second quarter, it is still modeling not yet through. And we forecast a below consensus 2.8% GDP growth this year, and only a modest rebound to slightly above 5% in 2023. To date, China has deployed the monetary policy easing and the infrastructure investment spending. But these steps have not got a lot of traction because of two key hurdles; continuing COVID restrictions and the trouble in its housing market. We see growth rebounding in next year, but that recovery depends heavily on policy addressing these two key hurdles. Hence, we look for a more concerted policy response in the housing market, and a clearer path towards reopening post the upcoming 20th Party Congress in October. First, to limit the fallout from the housing sector, Beijing will likely ramp up policy support. It is true that China's aging population has pushed the housing market into a structural downward trajectory, but the pace of the recent collapse vastly exceeds that trend. The choke point is homebuyers lack of confidence in developers ability to deliver the pre-sold house, which shrinks new home sales and puts more stress on developers liquidity. We think that Beijing will provide additional funding and intervention to ensure contracted home construction is completed. This, combined with more home purchases, stimulus and the liquidity support to surviving developers could break the negative feedback loop. Second, we expect a gradual exit from COVID-zero next spring. With the more transmissive Omicron, the rolling lockdowns in China are taking their toll on consumption and even posing challenges to supply chains. The renewed lockdowns in several major cities and the recent slowdown in vaccination progress suggest that COVID-zero would not end swiftly after the Party Congress in October. But the key metrics to watch by then will be, first, the pace of vaccination, second, wider adoption of domestic covid treatment and finally shift in public opinion from fearing the virus to a more balanced assessment. Provided that policy can address these two hurdles I just described, China's economic recovery should firm up from second quarter 2023 onwards, with growth of slightly above 5% for next year are our numbers. But even with this rebound, the positives spill over to the rest of the world is unlikely to be on par with history. Construction activities might improve with the stabilizing property sector, which is a familiar driver of Chinese imports. But the key driver will be a turnaround in domestic private consumption, particularly of services, so that demand pull from other economies will be somewhat muted. Thus, while we doubt that China would tip the global economy into recession, neither do we see China at its salvation. 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.

    Seth Carpenter: Tracking the Coming Slowdown

    Play Episode Listen Later Sep 19, 2022 4:09


    From Europe, to China, to the U.S., global economies are facing unique challenges as the brewing storm of recession risks seem to still indicate a slowdown ahead.----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Global Chief Economist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the rising risks of global recession and what might be ahead. It's Thursday, September 22nd at 10 a.m. in New York. About a year ago, I wrote about the brewing storm of recession risks around the world. Some downbeat economics news has come in since then, but the worst of the global slowdown is ahead of us, not behind us. We have an outright recession as our baseline forecast in the euro area and the U.K. The Chinese economy is on the brink with such weak growth that whether we have a global recession or not might just turn out to be a semantic distinction. First, Europe. It's hardly out of consensus at this point to call for a recession there, but we have been forecasting a recession since the start of the summer. The energy crisis caused by the Russian invasion of Ukraine has created a cost shock that is now effectively locked into the outlook for the next couple of quarters. Consumer bills will stay high, sapping purchasing power, fiscal deficits will take a hit and industries are already rationing energy use. For the UK, leaving Europe has not left behind the energy crisis across the channel. And the UK is also suffering from structural changes to its labor supply and trade relationships, and that's dragging down growth beyond these cyclical movements. That said, new leadership in Parliament is pointing to a huge fiscal stimulus that will mitigate the pain to households and reduce the depth of the recession. Now turning to China, markets have looked at China as a possible buoy for global growth, but this time any such hope really needs to be tempered, China's economy is in a fragile position. In our forecasts growth this year will be about 2.75%, below consensus and well below the potential growth of the economy. And then we think there'll be a rebound in growth next year, we're only looking for a modest 5.25% next year. Those sorts of numbers are not the real game changers people hope for. So far, the fiscal and monetary policy that has been deployed has not got a lot of traction. There are two key restraints on the Chinese economy right now; trouble in the housing market and continuing COVID restrictions. After the party Congress in mid-October things should probably start to change, but we're not expecting a quick fix. Right now construction and delivery of new homes is not getting done, so the cash flow is drying up, creating an adverse feedback loop. So far, the PBOC has rolled out about 200 billion renminbi bank loans to support this delivery, and we expect more intervention and funding over time. So as easy as it is to be gloomy on the outlook, a catastrophic collapse in housing doesn't seem likely. As for COVID, we are now expecting only a gradual exit from COVID zero next spring. The key metrics to watch will be the pace of vaccinations and wider adoption of domestic COVID treatments and a shift in public opinion. In particular, we think getting the over 60 population to at least an 80% booster vaccination rate next spring will flag the removal of restrictions. If there is a silver lining, it's that we still think the U.S. avoids a near-term recession. Despite notching a technical recession in the first half of the year, the U.S. outlook is somewhat brighter. For the first half of the year nonfarm payrolls averaged almost 450,000 per month, that's hardly the stuff of nightmares. But we don't want to be too cheerful. From the Fed's perspective, the economy has to slow to bring down inflation. They are raising interest rates expressly to slow the economy. So far, the housing market has clearly turned, but payrolls have only slowed a bit, and the moderation in wage inflation is probably not as much as the Fed is looking for. To date, we have not seen much slowing in consumer durables, so the economy remains beyond its speed limit and the Fed will keep hiking. How much? Well, depends on how strong the economy stays. So there really isn't much upside, only downside. The Fed is committed to hiking until the demand pressures driving inflation back off, so one way or another, the economy is going to slow. Thanks for listening. If you enjoy this show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

    Andrew Sheets: The Case for Credit

    Play Episode Listen Later Sep 16, 2022 3:04


    While credit and equities have both suffered this year, economic conditions in the U.S. and Emerging Markets may lead to credit having a bit more stability in the coming months.----- 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 16th, at 3 p.m. in London. Year-to-date, both credit and equities have suffered. Looking ahead, we think credit is better positioned in both the U.S. and emerging markets, given the outlook for growth, policy and relative valuations. Conventional wisdom can change quickly in markets. Two months ago, there was widespread concern that the United States was already in a recession, given weak readings of quarterly GDP and some of the lowest levels of consumer confidence since the 2009 financial crisis. That weakness drove hope over July and August. Maybe the Federal Reserve had raised interest rates enough. Maybe it was nearly done. But the data since points to an American economy that continues to trundle along. The labor market continues to look extremely healthy, with about 315,000 jobs added last month and over 3.5 million jobs added year-to-date. Manufacturing activity has expanded every month this year. And consumer spending remains solid, one of the reasons core inflation remains elevated. In short, if the U.S. economy is going to slow down, that risk lies ahead of us, not behind us. And as long as the data remains solid and core inflation remains elevated, the Federal Reserve will face pressure to air on the side of caution and keep raising rates to tamp down on inflationary pressure. For investors this backdrop, where economic activity is still solid but might slow in the future, where inflation is high and the central bank is hiking, and where the labor market is tight and the yield curve is inverted, is what's commonly referred to as a "late cycle" environment. It's a set of conditions that has historically been challenging for future returns overall, but it's often been worse for equities relative to credit over the following 12 months, as the former is more sensitive to a potential slowdown in growth that hasn't happened yet. In addition to the economic conditions, relative valuations have also moved in favor of credit markets relative to equities. In the US, 1 to 5 year corporate bonds now yield about 4.9%, rapidly nearing the current earnings yield of the S&P 500 at about 5.9%. Despite just a 1% difference in yield, those short dated bonds have about one fifth of the volatility of stocks over the last 30 days. We hold a similar view on Emerging Markets. The sovereign debt index yields about 7.7%, just 1% less than the earnings yield of the MSCI Emerging Market Equity Index. Not only is EM sovereign debt less volatile than EM equities, but it has more exposure to the countries our analysts think provide the better risk reward. 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.

    U.S. Public Policy: The Impact of Student Loan Forgiveness

    Play Episode Listen Later Sep 15, 2022 6:37


    The White House recently announced a student loan forgiveness program, prompting questions about implementation, economic implications, and whether the program will have an impact on consumer spending. Sarah Wolfe of the U.S. Economics team and Arianna Salvatore of the U.S. Public Policy team discuss.----- Transcript -----Sarah Wolfe: Welcome to Thoughts on the Market. I'm Sarah Wolfe from Morgan Stanley's U.S. Economics Team. Ariana Salvatore: And I'm Ariana Salvatore from Morgan Stanley's U.S. Public Policy Research Team. Sarah Wolfe: And on this episode of the podcast, we'll focus on student loans, in particular the recent student loan forgiveness program, and we'll dig into the impact on consumers and the economy. It's Thursday, September 15th, at 12 p.m. in New York. Sarah Wolfe: So, Ariana, the White House recently announced plans to forgive individuals up to $20,000 in federal student loans and extend the moratorium on interest payments. However, there was some confusion earlier in the year as both President Biden and Speaker Pelosi expressed doubts about the president's authority to cancel student debt. So is this something that requires an act of Congress, or can the president really do it alone? Ariana Salvatore: As you mentioned, prior to the announcement, there was some unresolved questions out there surrounding the legality of canceling student debt. In revealing the program, the administration cited authority from a 2003 law called the 'Heroes Act' that gives the executive the power to reduce or eliminate student debt during a national emergency, “when significant actions with potentially far reaching consequences are often required”. That being said, don't expect it to go over quietly. Reporting indicates that some Republican attorneys general are looking to bring legal challenges to the plan, which could present a risk to execution. But let's put questions about implementation aside for a second. What does reduced student debt impact more, longer term planning or immediate spending? And how do you quantify the impact on consumer spending? Sarah Wolfe: Thanks, Ariana. I'd like to just take a step back for a second before I talk about the economic impact, just so we could size up the program a bit. We estimate that there's going to be $330 to $390 billion in debt directly forgiven as part of this program. However, we estimate that the fiscal multiplier is actually quite small. So every dollar of debt that's forgiven that's going to get spent and put back into the economy, is really estimated at only 0.1. This is really small when you consider the fiscal multiplier of the COVID stimulus programs. So for example, the stimulus checks, supplemental unemployment benefits, that had a fiscal multiplier of 0.5 to 0.9. So it was much larger. The reason for this is because our survey work shows that people who have their student debt forgiven don't actually change their immediate spending patterns. Instead, it really impacts longer term planning. We're talking about paying down other debts, planning for retirement, perhaps buying a house or having a child earlier, and so there's not really an immediate spending impact on the economy. What does have a larger fiscal multiplier is forbearance coming to an end. Prior to COVID, people were on average paying $260 a month in student loan payments. That's been on hold for two and a half years. So when that resumes again in January, it's likely going to be less than $260 a month because of the loan forgiveness and other measures passed by the White House to limit loan payments per month. However, that's an immediate impact to discretionary income, and as a result, we're going to see a lot of households adjust their spending in the near term to make these new loan payments. Arianna, speaking of student loan forbearance, which I mentioned is set to end at the end of this year after a number of extensions, the White House is hoping that forgiveness is going to kick in right when forbearance comes to an end. Can we actually count on the timing working out like this? Ariana Salvatore: So there's definitely a risk that the program is delayed because of normal implementation hurdles, right. Things like determining eligibility for cancellation among millions of borrowers. The Department of Education memo that was released following the announcement says that 8 million borrowers may be eligible to receive relief automatically because relevant income data is already available. However, the department is also in the process of creating an application so borrowers can apply for forgiveness on their own, but that hasn't gone live yet. The DOE said it would be ready no later than when the pause on federal student loan repayments expires at the end of this year. Unfortunately, there's no real way to know when exactly that will be. Sarah Wolfe: So let me just get this clear. The Department of Education only has the information on 8 million student loan borrowers right now. So they're going to need to gather the information for the remaining borrowers up to 43 million in order to start this forgiveness program. Ariana Salvatore: Yeah, exactly. And that's why we tend to see large scale government programs like this take a little bit of time to ramp up rollout and have impacts on the economy. So in the event that all of those eligible to take advantage of the forgiveness program actually do so, let's focus in on the macroeconomic impacts. In this high inflation environment, wouldn't student loan forgiveness also have an additional inflationary effect? Sarah Wolfe: Definitely at face value, student loan forgiveness is inflationary. However, as I mentioned earlier, because it doesn't impact near-term spending decisions and is more about longer term planning, the inflationary impact, I think, is less than people would think. It's estimated to only add 0.1 to 0.5 percentage points to inflation 12 months following the cancellation. However, the forbearance program, as I mentioned, since that's going to have more of an immediate impact on spending decisions, that's going to have a deflationary impact. And it's estimated that forbearance programs are going to shave 0.2 percentage points off inflation over the 12 months following forbearance starting again. And so if you think about forgiveness being inflationary and forbearance being disinflationary, it's likely that forbearance is going to outweigh some of the inflationary impact, if not all of it, from forgiveness. Ariana Salvatore: Okay, so bringing it back to a more micro level. Last question for you here, Sarah. What are the implications for consumer credit and consumer ABS? Sarah Wolfe: We think that student loan payments restarting in January pose quite a bit of risk to consumer credit quality. Although we're seeing consumer credit quality today is very healthy and delinquencies are low, we are starting to see delinquencies rise for subprime borrowers in recent months. Also, if we dig into the data and look at how student loan borrowers have been paying down their student loans over the last 2.5 years versus those who haven't been, the credit quality for those who have not been is much worse than those who have been. That leads us to believe that come January, when everybody needs to start paying down their student loans, that in particular these more subprime, lower income borrowers are really going to struggle and it's going to deteriorate credit quality. Sarah Wolfe: Well, Ariana, thanks for taking the time to talk. Ariana Salvatore: Great speaking with you, Sarah. Sarah Wolfe: 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 colleague today.

    Michael Zezas: Why the Midterm Elections Matter

    Play Episode Listen Later Sep 14, 2022 2:34


    With only 60 days to go until the U.S. midterm elections, investors will want to know how different outcomes could impact markets, both locally and globally.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research 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, September 14th, at 10 a.m. in New York. We're less than 60 days from the U.S. midterm elections and investors should pay attention. A lot has changed since we published our midterm election guide earlier this year, so here's what you need to know now. First, there's still key policies in play. Sure, Democrats have had more legislative success in recent months than many expected. By enacting corporate tax increases, a prescription drug negotiation plan, a major appropriation to clean energy transformation, and the China competition bill, Democrats took off the table many of the policy variables whose outcomes would have relied on the outcome of the election. But some key policy variables remain that matter to markets. In particular tech regulation, crypto regulation and tougher China competition measures, such as outbound investment controls, become more possible if Democrats manage to keep control of Congress. That would give them a greater opportunity to enact policies that could otherwise be held up or watered down by partisan disagreement. Second, this means there's a lot at stake for some pockets of global markets. Tech regulation would be a fundamental challenge to the U.S. Internet sector. Crypto regulation could be a key support for financial services by putting the crypto industry on the same regulatory playing field as the banks. And outbound investment controls could be a clear challenge for China equities by putting a substantial amount of foreign direct investment at risk. Finally, investors should understand these impacts aren't just hypotheticals, because, unlike earlier this year, Democrats electoral prospects have improved. Better showings in polls on key Senate races and the generic ballot have translated into prediction markets and independent models, marking Democrats as a modest favorite to keep Senate control, though they're still rated as an underdog to keep control of the House of Representatives. While it's difficult to pinpoint what's driven this change, voter discontent with the Supreme Court's Roe decision, as well as easing of some inflation pressures, may have contributed. Bottom line, the midterm election remains a market catalyst and it's coming up quickly. We'll keep tracking developments and potential market impacts and keep you informed. 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.

    Daniel Blake: The Resilience of Japanese Equities

    Play Episode Listen Later Sep 13, 2022 3:49


    As various global markets contend with high inflation, recession risks, and monetary policy tightening, Japanese equities may provide some opportunities to diversify away from other developed markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Daniel Blake from Morgan Stanley's Asia and Emerging Markets Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss the resilience of Japanese equities in the face of an expected global downturn. It's Tuesday, September 13, at 8 a.m. in Singapore. As Morgan Stanley's Chief Global Economist Seth Carpenter noted in mid-August, the clouds of recession are gathering globally. In the U.S., the Fed is hiking rates and withdrawing liquidity. Europe is suffering from high inflation, looming recession and an energy shortage. And China is facing a rocky path to recovery. In this global context, the external risks for Japan are rising quickly. And yet, compared to the turbulence in the rest of the world, Japanese equities are enjoying rather calm domestic, macro and policy waters. In Japan, we see support for this cycle coming from three sources; domestic policy, the Japanese yen and capital discipline at the corporate sector. First, the monetary policy divergence between the Bank of Japan and global peers has been remarkable, and in our view justified by differences in inflation and growth backdrops. Japanese core inflation is just 1.4%, and if we strip out food and energy, inflation is a mere 0.4% year over year. And so we don't expect any tightening from the Bank of Japan or of fiscal policy over the next six months. Secondly, the Japanese yen is acting as a funding currency and a buffer for earnings, rather than the typical safe haven that historically tends to amplify earnings drawdowns in an economic downturn. And third, improving capital discipline is contributing to newfound earnings resilience and insulating the return on equity, with buybacks tracking at a record pace of ¥10 trillion annualized year to date. In addition to monetary and fiscal policy, Japan's more cautious approach to reducing COVID restrictions and employment focused stimulus programs have meant that the economy is in a different phase vis-a-vis other developed markets. Our expectation for Japan's economy is low but steady growth of 1.3% on average over 2022 and 2023. As for the Japanese yen, we believe that a weaker yen is still a tailwind for TOPIX earnings. As a result of policy and real rate divergence, as well as the negative terms of trade shock from higher commodity prices, the yen has fallen to fresh record lows on a real effective exchange rate basis. The impact of a historically weak currency on the overall economy is still the subject of some debate, but one of the largest transmission channels of a weaker yen into supporting domestic services and employment is through tourism activity, which has been constrained to date by COVID policies. But looking ahead, the combination of reopening and a highly competitive tourism offering should set up a very strong recovery in passenger volumes and spending, as we saw during the European summer this year. So where do all these global and domestic cross-currents leave us with respect to Japanese equities? We remain overweight on the TOPIX index versus our MSCI Asia-Pacific, ex-Japan and emerging markets coverage. We've been above consensus in forecasting an exceptional recovery in TOPIX earnings per share, but we acknowledge that to date it has been largely driven by export oriented stocks. But currently, the external environment for Asia's major exporters is weakening as a result of tighter policies, slower growth and a revision in spending from goods to services. So while this trend will impact, we think, Taiwan, Korea and Singapore more so, China and Japan will also feel the impacts given their large goods trade surpluses. But with all this said, the Japanese market still provides liquid opportunities to diversify away from the U.S. and Europe, where Morgan Stanley strategists are cautious. So while Japanese equities have historically underperformed in global downturns, the current setup leaves us more optimistic on Japan in particular, compared with other regions like the U.S. and Europe. 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.

    Graham Secker: European Equities Face Earnings Concerns

    Play Episode Listen Later Sep 12, 2022 3:57


    Even as the European equity market contends with inflation, a slowing economy and a climate of decreased earnings, there are positives to be found if you know where to look.-----Transcript-----Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the outlook for European equity markets for the remainder of this year. It's Monday, September 12th, at 2 p.m. in London. After a brief rally in European equities earlier in the summer, reality has reasserted itself over the last month with markets unable to escape a tricky macro backdrop characterized by central banks speeding up rate hikes into what is a deepening economic slowdown. In the last couple of weeks alone, our economists have raised their forecasts for ECB rate hikes and cut their GDP numbers to signal a deeper upcoming recession. So let's dig into the investment implications of these challenges in a bit more detail. First on rates, over the last 20 years there has been a close relationship between interest rates and equity valuations, whereby higher rates lead to lower price to earnings ratios. Hence, the fact that central banks are still in the early stages of their hiking cycle suggests a high probability that PE ratios have further to fall. In addition to higher base rates, the pace of quantitative tightening is also speeding up, and our bond strategists forecast higher sovereign yields ahead. Here in Europe, they see ten year bond yields rising to 2% or more later this year, which will be consistent with a further fall in Europe's PE ratio to around 10x or so. That would imply 15% lower equity prices from here. Second, we expect the European economy to slow over the next couple of quarters and this should put pressure on corporate profits which have been resilient so far this year, thanks to strong commodity sector upgrades and a material boost from the weakness we've seen in the euro and sterling. Looking forward, our models are flagging large downside risks to consensus earnings estimates for the next 12 to 18 months and we are 16% below consensus by the end of 2023. To provide some additional context, we note that consensus expects European earnings, excluding the commodity sectors, to grow faster next year than this year. This acceleration looks odd to us when you consider that our economists see slower GDP growth in 23 than 22, and our own margin lead indicator is suggesting we could face the largest year on year drop in corporate margins since the global financial crisis. Our concern on earnings is a significant factor behind our continued preference for defensives over cyclicals. While some investors argue that the latter group are now sufficiently cheap to buy, we question the sustainability of the earnings that is underpinning the low PE ratios given the, first, we have seen very few downgrades so far. Second, margins are currently at record highs for many of these cyclical sectors. And then lastly, cyclicals tend to see larger earnings declines during downturns than the wider market. This gives rise to the old adage that investors should buy cyclicals on high PE ratios, not low ones. Consistent with this view, we have recently downgraded three cyclical sectors to underweight from our top down perspective, these being autos, capital goods and construction. We are also underweight chemicals and retailing. So what do we like instead? Sectors with more defensive characteristics, such as health care, insurance, telecoms, utilities and energy. We also like stocks that offer a high and secure cash return yield, whether that be driven by dividends, buybacks or both. To end on a positive note, the level of buyback activity in Europe has never been stronger than what we are seeing today, whether we measure it by the number of companies that are repurchasing their shares or the amounts of money they are spending to do so. In addition, we note that those European companies who have offered a healthy buyback yield over time have been consistent outperformers. 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: The Complex U.K. Economy

    Play Episode Listen Later Sep 9, 2022 3:10


    As the world turns to the U.K., the country faces a host of domestic and international economic challenges, but there may yet be some bright spots for investors.-----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 9th at 2:00pm in London.Queen Elizabeth II passed away yesterday. She was the only monarch most in Britain have ever known, a steady constant over a period of enormous global change. She defined an era, and will be missed. The eyes of the world have now turned to the United Kingdom, and they do so at a time when the country is facing an unusually high level of uncertainty.The U.K. economy, which was recently surpassed in size by India, is still the worlds sixth largest. But it's currently being buffeted by a host of economic challenges. Some are domestic, some are international, but combined they create one of the trickiest stories in the global economy.First among these challenges is inflation. Rising costs for energy have driven Consumer prices in the U.K. up 10% year-over-year, but even excluding volatile food and energy, U.K. core inflation is still over 6%. And elevated inflation is not expected to be fleeting. Market-based estimates of U.K. inflation, over the next 10 years, are the highest since 1996.Those elevated prices have driven U.K. interest rates higher, but even so, U.K. rates relative to inflation are still some of the lowest of any major economy, which makes holding the currency less attractive. That has weakened the British Pound, but since the U.K. runs a current account deficit, and imports more than it exports, imported things have become more expensive, creating even more inflationary pressure.The U.K's decision to leave the European Union, its largest trading partner, is another complication. By restricting the movement of labor, it's created a negative supply shock and increased costs. And it has increased the fiction in trading abroad, especially with Europe, making it harder for U.K. exporters to take advantage of the country's weaker currency.The response to all this high inflation will likely be further rate hikes from the bank of England. But this has the potential to feed back into the economy unusually fast. Over here, many student loan payments are tied to the bank of England rate. And the rate on U.K. mortgages is often fixed for only 2 to 5 years, in contrast to the 30 year fixing common in the United States. That means the impact of higher interest rates into higher mortgage costs could be felt very soon.For U.K. assets, the fact that a 10 year U.K. Government bond yields less than a 6-month U.S. Treasury bill, and much less than U.K. inflation, creates poor risk/reward. The Pound could continue to weaken, given all of these myriad economic challenges. But one bright spot might be the equity market, the FTSE 100. Trading at about 9x next year earnings, and benefiting from a weaker currency as many of these companies sell product abroad, we forecast stocks in the U.K. to outperform those in the Eurozone.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.

    Matthew Hornbach: How Markets Price in Quantitative Tightening

    Play Episode Listen Later Sep 8, 2022 4:02


    The impact of quantitative monetary policies is hard to understand, for investors and academics alike, but why are these impacts so complex and how might investors better understand the market implications?-----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, September 8th, at 10 a.m. in New York. QT is the talk of the town. QT stands for quantitative tightening, which is meant to contrast it with QE, or quantitative easing. QT sounds intimidating, especially when respected investors mention the term and, at the same time, ring the fire alarm on financial news networks. Unfortunately, the exact workings of QT and QE and their ultimate impact on markets aren't well understood. And that's not just a comment about the general public's understanding. It even applies to investors who have long dealt with quantitative policies and for academics who have long studied them. There are four reasons why the impact of quantitative monetary policies, as the Fed has implemented them, is hard to understand. First, different institutions take the lead in determining the impact of QE versus QT. The Fed determines the first round impact of quantitative easing, while the U.S. Treasury and mortgage originators determine the first round impact of quantitative tightening. Second, as the phrase "first round impact" implies, there are second round impacts as well. In the case of quantitative easing, the first round occurs when the Fed buys a U.S. Treasury or Agency mortgage backed security, also known as an agency MBS, from an investor. The second round occurs when that investor uses the cash from the Fed to buy something else. In the case of quantitative tightening, the first round occurs when an investor sells something in order to raise the cash that it needs. What does it need the cash for? Well, to buy a forthcoming Treasury Security or agency MBS. The second round occurs when the U.S. Treasury auctions that security or when a mortgage originator issues an agency MBS in order to raise the cash that the Fed is no longer providing. Third, QE and QT affect different markets in different ways. QE affects the Treasury and agency MBS markets directly in the first round. But in the second round, investor decisions about how to invest that cash could affect a wide variety of markets from esoteric loan products to blue chip equities. In that sense, some of the impact of QE is indirect and could affect some markets more than others. Similarly with QT, investor decisions about what to sell could affect a large number of markets, again some more than others. In addition, what the U.S. Treasury issues and what mortgage originators sell can change over time with financing needs and different market environments. Finally, markets price these different effects with different probabilities and at different times. For example, when the Fed announces a QE program, we know with near certainty that the Fed will buy Treasuries and agency MBS and generally know how much of each the Fed will buy. So investors can price in those effects relatively soon after the announcement. But we don't know, with nearly the same probability, what the sellers of those treasuries and agency MBS will do with the cash until they actually get the cash from the Fed. And that could be months after the announcement when the Fed actually buys the securities. Figuring out the effect on markets from QT is even more complicated because even though we know what the Fed will no longer buy, we don't know exactly what or how much the U.S. Treasury or mortgage originators will sell. If all of this sounds complex, believe me it is. There are no easy conclusions to draw for your investment strategies when it comes to QT. So the next time someone rings the fire alarm and yells QT, first look for where there might be smoke before running out of the building or selling all of your risky assets. 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.

    U.S. Housing: Will Housing Prices Continue to Rise?

    Play Episode Listen Later Sep 7, 2022 5:42


    While home price appreciation appears to be slowing, and a rapid increase in supply is hitting the market, how will housing prices fare through the rest of the year and into 2023? Co-Heads of U.S. Securitized Products Research Jay Bacow and Jim Egan discuss.-----Transcript------Jim Egan: Welcome to Thoughts on the Market. I'm Jim 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. Securities Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing supply and demand in the U.S. housing market. It's Wednesday, September 7th, at 3 p.m. in New York. Jay Bacow: All right, Jim. Housing headlines have started to get a little more bleak. Home price appreciation slowed pretty materially with last week's print. Now, your call has been that activity is going to decrease, but home prices are going to keep growing. Where do we stand on that? Jim Egan: We would say that the bifurcation narrative still holds. We think housing activity metrics, and when we say housing activity we're specifically talking about home sales and housing starts, have some continued sharp declines in the months to come. But we do think that home prices are going to continue growing on a year over year basis, even despite a disappointing print that you mentioned from last week. Jay Bacow: But I have to askv, what are you looking at that gives you confidence in your home price call? Where could you be wrong given the slowdown we just saw? Jim Egan: We say a lot of fancy sounding things when we talk about the housing market, but ultimately they're just different ways of describing supply and demand. Demand is weakening. That's that drop in activity we're forecasting. But supply is also very tight and that contributes to our view that while home price growth needs to slow, it should remain positive on a year over year basis. Jay Bacow: All right, but haven't some metrics of supply been moving higher? Jim Egan: Look, we knew we were not going to be able to say that supply was historically tight forever. Existing inventories are now climbing year over year for the first time in 37 months. And another very popular metric of supply, months of supply, is effectively getting a 1-2 punch right now. Months of supply measures how much the current supply of housing listed for sale, would take to clear at current demand levels. So in a world in which supply is increasing and demand is falling, you have a numerator climbing and a denominator falling, so you're effectively supercharging months of supply, if you will. We were at a cycle low of 2.1 months of inventory, the lowest we've seen in at least three and a half decades, in January of this year. We're at 4.1 months of supply just six months later. Jay Bacow: So that number is a lot higher, but 4.1 months of supply is still really low. Isn't there some old saying that anything less than six months of supply is a seller's market? So wouldn't that be good for home prices? Jim Egan: Yes. And given recent work that we've done, we think that that saying is there for good reason. If we go back to the mid 1980s, so the Case-Shiller index that we're forecasting here that's as far back as this index goes. And every single time that months of supply has been below six, the Case-Shiller index was still appreciating six months forward. Home prices were still climbing, six months forward. So the absolute level of inventory is in a pretty healthy place despite the recent increases. However, that rate of change is a little concerning. We've gone from 2.1 months to 4.1 months over just six months of actual time, and when we look at that rate of change historically, it actually does tend to predict falling home prices a year forward. So, absolute level of inventory leaves us confident in continued home price growth, but the rate of change of that underlying inventory calls continued home price growth in 2023 into question. Jay Bacow: So we're going to have more inventory, but the pace has been accelerating. How do we think about the pace of that increase?Jim Egan: If that pace were to continue at its current levels, that would make us really concerned about home prices next year. But we do think the pace of inventory growth is going to slow and we think that for two main reasons. The two biggest inputs into inventory are new inventories and existing. New inventories, and we've talked about this on the podcast before, we think they're about to really slow down. Homebuilder confidence is down 43% from cycle peaks in November of 2020. Part of that's the affordability deterioration we talked about earlier, but it's also because of a backlog in the building process. Single unit starts are back to 1997 levels. Units under construction, so between starts and completions, are back to 2004 levels - it is taking longer to finish those homes. And we have had a forecast that we thought that was going to lead to single unit starts slowing down, it finally has over the past two months after plateauing for almost a year. We think they're going to continue to fall pretty precipitously in the back half of this year, which should mean that new inventory stop climbing at the same pace that they've been climbing. Existing inventories also should stop their current pace of climb because of the lock in effect that we've talked about here before. Effectively, current homeowners have been able to lock in very low mortgage rates over the course of the past two years. They're not going to be incentivized to list their homes at similar rates to historical places because of that lock in effect. So for both of those reasons, we think the pace of increase in inventory is going to slow, and that's why we continue to think that home prices are going to grow on a year over year basis. They're just going to slow from 18% now, to 9% by the end of this year, to 3% by the end of 2023. Jay Bacow: Okay. So effectively the low amount of absolute supply is going to keep home prices supported. The change in the amount of supply makes us a little bit more cautious on home prices on a longer term outlook. But we think that pace of that change is going to slow down.Jay Bacow: Jim, always a pleasure talking to you. Jim Egan: Great talking to you too, Jay. Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app and share the podcast with a friend or colleague today.

    Mike Wilson: Preparing for an Icy Winter

    Play Episode Listen Later Sep 6, 2022 4:22


    While interest rates have already weighed on asset markets this year and growth continues to slow, the Fed seems poised to continue on its tightening path, meaning investors may need to prepare for part two of our Fire and Ice narrative.-----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 Tuesday, September 6th, at 9 a.m. in New York. So let's get after it. At the risk of stating the obvious, 2022 has been a challenging year for stock investors of all stripes. The Russell 3000 is down approximately 18% year to date, and while growth stocks have underperformed significantly it's been no picnic for value investors either. As far as sectors only energy and utilities are up this year, and just 24% of all stocks in the Russell 3000 are in positive territory. To put that into context, in 2008, 48% of the Russell 3000 stocks were up on the year as we entered the month of September and then the bottom dropped out. Suffice it to say, this year has been historically bad for stocks. However, that is not a sufficient reason to be bullish in our view. As bad as has been for stocks, it's been even worse for bonds on a risk adjusted basis. More specifically, 20 year Treasury bonds are now down 24% year to date, and the Barclays AG Index is off by 11%. Finally, commodities have been a mixed bag too, with most commodities down on the year, despite heightened concerns about inflation. For example, the CRB RIND Index, which measures the spot prices of a wide range of commodities, is down 7% year to date. Cash, on the other hand, is no longer trash, especially if one has been able to take advantage of higher front end rates. So what's going on? In our view, asset markets are behaving right in line with the fire and ice narrative we laid out a year ago. In short, after ignoring the warning signs from inflation last year and thinking the Fed would ignore them too, asset markets quickly woke up and discounted the Fed's late but historically hawkish pivot to address the sharp rise in prices. Indeed, very rarely has the Fed tightened policy so quickly. Truth be told, as one of the more hawkish strategists on the street last December, I never would have bet the Fed would be doing multiple 75 basis point hikes this year, but here we are. And remember, don't fight the Fed. While the June low for stocks and bonds was an important one, we've consistently been in the camp that it wasn't the low for the S&P 500 in this bear market. Having said that, we are more confident it was the low for long term treasuries in view of the Fed's aggressive action that has yet to fully play out in the real economy. It may have also been the low for the average stock, given how bad the breadth was at that time and the magnitude of the decline in certain stocks. Our more pessimistic view on the major index is based on analysis that indicates all the 31% de-rating in the forward S&P 500 P/E that occurred from December was due to higher interest rates. We know this because the equity risk premium was flat during this period. Meanwhile, forward earnings estimates for the S&P 500 have come down by only 1.5%, and price earnings ratio's back up 9% from where it was. With interest rates about 25 basis points below the June highs, the equity risk premium has fallen once again to just 280 basis points. This makes little sense in a normal environment, but especially given these significant earnings cuts we think are still to come. With the Fed dashing hopes for a dovish pivot on this policy a few weeks ago, we think asset markets may be entering fire and ice part two. In contrast with part one, this time the decline in stocks will come mostly through a higher equity risk premium and lower earnings rather than higher interest rates. In fact, our earnings models are all flashing red for the S&P 500, and we have high confidence that the decline in forward S&P 500 earnings forecasts is far from over. In short, part two will be more icy than fiery, the opposite of the first half of the year. That's not to say interest rates don't matter, they do and we expect bonds to perform better than stocks in this icier scenario. Importantly, if last Thursday marked a short term low for long duration bonds, i.e. a high in yields, the S&P 500 and many stocks could get some relief again as rates come down prior to the next rounds of earnings cuts that won't begin until later this month. 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 to find the show.

    Andrew Sheets: The State of Play in Markets Globally

    Play Episode Listen Later Sep 2, 2022 3:26


    There has been a lot of market movement in recent months, so as we exit the summer, what are the market stories and valuations that investors should be aware of?-----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 2nd at 3 p.m. in London. As summer draws to a close, there is quite a bit that investors are coming back to. Here's a state of play of our global economic story, and where cross-asset valuations sit today. The global economy faces challenges, but these challenges differ by region. The U.S. economy is seeing elevated inflation and still strong growth, as evidenced by today's report that the U.S. economy added another 315,000 new jobs last month. That makes it likely that the Federal Reserve will have to air on the side of raising rates more to bring inflation down, which would further invert the U.S. yield curve and, in our view, support the U.S. dollar. Europe also has high inflation, but of a different kind. Europe's inflation isn't nearly as pronounced in so-called core elements, and it isn't showing up in wages. Instead, Europe is in the midst of a major energy crunch, that in our base case will push the economy into a mild recession. Markets expect that the European Central Bank will raise rates significantly more than the U.S. Federal Reserve over the next 12 months, but given our risks to growth we disagree, a reason we forecast a weaker euro. The economic situation in the UK is also very challenged, leaving us cautious on gilts and the UK pound. China and Japan are very different and core inflation in both countries is less than 1%. China continues to face dual uncertainties from a weakening property market and zero-covid policy, factors that lead us to think it is still a bit too soon to buy China's equity market, despite large losses this year that have driven much better valuations. We remain more optimistic on Japanese equities on a currency hedged basis, given that it remains one of the few developed market economies where the central bank is not yet tightening policy. To take a closer look at those global equity markets we enter September with the U.S. S&P 500 stock index trading at about 17x earnings. That's down from over 20x earnings at the start of the year, but it's still above average. U.S. small cap valuations, at about 11x earnings, are less extreme. Stocks in Europe, Australia, Japan, China and emerging markets all trade at about 11 to 12x forward earnings at the index level. Of all of these markets our forecasts imply the highest returns, on a currency hedged basis, in Japan. In bonds, it's important to appreciate that yields remain much higher than they were a year ago. As we discussed last week, investors can now earn about 3.3% on 6 month U.S. government treasury bills, U.S. investment grade bonds yield almost 5% and U.S. high yield yields over 8.5%. In Europe, yields on European investment grade credit and Italian 10 year bonds are pretty similar, a spread at which we think European investment grade bonds are more attractive. Markets have been moving over the summer. We hope our listeners have managed some time to rest and recharge and that this discussion has given some helpful context to where the different stories and valuations in the market currently sit. 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.

    Chetan Ahya: Why are Asia's Exports Deflating?

    Play Episode Listen Later Sep 1, 2022 4:06


    As consumers around the globe scale back on goods spending, how are Asian export markets impacted and where might opportunities lie?-----Transcript-----Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanly's Chief Asia Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be focusing on the challenging landscape for Asia's exports post-COVID. It's Thursday, September 1st, at 8:30 a.m. in Hong Kong. As listeners of the show are no doubt aware, the post-COVID recovery around the world has not been uniform, and each region is facing its own specific challenges. In Asia, one of those challenges is that the Asia export engine seems to be losing steam as goods demand continues to deflate. For instance, real export growth decelerated to just an average of 3% on a year on year basis in the past six months, as compared to a peak of 30% in April 2021. Whichever way you slice and dice Asia's exports, it is evident that the underlying trends are soft everywhere. Whether by destination or by product, there is simply pervasive weakness. Let's start with product: when we look at Asia exports by product across the different categories of consumer, capital and intermediate goods exports, we are seeing a synchronized slowdown. Commodities are the only product category which is holding up, supported by trailing elevated prices. But with industrial commodity prices falling by some 30% since their March peak, we think there is every chance that commodity exports will slow significantly too in the coming months. Now let's turn to destination. Demand is slowing in 70% of Asia's export destinations. While exports to the U.S. are still holding up, we expect that the slowing in the U.S. economy plus the continued normalization in goods spending, will weigh on exports to the U.S. too. Against this backdrop of weak aggregate demand, we see more downside for Asia's exports to the U.S. in the coming months. One of the reasons why Asia's exports are deflating rapidly is because developed markets consumers are shifting back into spending on services after an outsized spending on goods earlier during the pandemic. As a case in point, US spending on goods had risen by 20% between January 2020 and March 2021. Since reaching its peak in March 21, goods spending has been on a decelerating path, declining by 5%. We expect further weakness in goods spending as the share of goods spending still has not normalized back towards pre-COVID levels. Against this backdrop, investors should look at countries where domestic demand offsets the weakness in external demand. We continue to be constructive on India, Indonesia and Philippines as they are well placed to generate domestic demand alpha. Within this group, we believe that India is the best placed economy within the region for three reasons. First, we see a key change in India's structural story. Policymakers have made a clear shift in that approach towards lifting the productive capacity of the economy and creating jobs while reducing the focus on redistribution. Second, the India economy is lifting off after a prolonged period of adjustment. The corporate sector has delivered and the balance sheet in the financial sector has also been cleaned up. This backdrop of healthy balance sheets and rising corporate confidence bodes well for the outlook for business investment. Third, against this backdrop, we are seeing unleashing of pent up demand, especially in areas like housing and consumer durables. Finally, what about China - the largest economy in Asia? Typically when export slows down, we would expect China to be able to stimulate domestic demand. But in this cycle, while easing is already underway, the recovery in domestic demand is being held back by the housing market problem and its COVID management approach. We think that China domestic demand recovery should pick up pace by early next year as the full effects of its stimulus kicks in and private confidence lifts, thanks to China's anticipated shift to a living with COVID stance. 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 a colleague today.

    Serena Tang: Global Cross-Asset Risk Premiums

    Play Episode Listen Later Aug 31, 2022 4:18


    While markets wrestle with high inflation and recession worries, investors will want to keep an eye on the rise in risk premiums and the outlook for long-run returns.-----Transcript-----Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's Head of Cross-Asset Strategy for North America. Along with my colleagues, bringing you a variety of perspectives, today I'll focus on the current state of global cross-asset risk premiums. It's Wednesday, August 31st at 10 a.m. in New York. Markets in 2022 have been incredibly turbulent, and global cross-asset risk premiums have shifted dramatically year to date. Various markets have been buffeted by higher inflation and tighter policy, geopolitical risks and worries about recession. Some impacted much more than others. What this means is that there are segments of markets where risk premiums, that is the excess returns an investor can expect for taking on additional risk, and long-run expected returns look much more attractive than they were at the beginning of the year. And while expected returns and risk premiums have broadly risen, the improvements have been uneven across asset classes and regions. For example, we believe that compared to U.S. stocks, rest-of-world equities have seen equity risk premiums move much higher since December, and currently have an edge over U.S. equities in terms of risk reward, in line with our relative preferences. So let me put some actual numbers around some key regional disparities. Our framework, which incorporates expectations on income, inflation, real earnings growth and valuations, see U.S. equities returning about 7.5% annually over the next decade, compared to just 5.7% at the start of the year. However, a steep climb in U.S. Treasury yields from historical lows mean that from a risk premium perspective, U.S. equities is still below its 20 year historical average by nearly one percentage point. This is in contrast to other regions whose risk premiums have increased significantly more during the sell off. Notably, European equity risk premiums are 8.9%, close to a 20 year high, similarly for emerging markets at 5.3%, and Japanese equity risk premiums at 4.7%, also above average. And remember, higher risk premiums typically signal that it's a good time to invest in riskier assets. For fixed income, with nominal yields rising on the back of more persistent inflationary pressures and quantitative tightening, long-run expected returns are now higher than they were 12 months ago. In fact, we're now back to levels last seen in 2019. Our framework now predicts that ten year U.S. Treasuries can return 3.7% annually over the next decade, up from 2.2% just a year ago. Credit risk premiums, such as for corporate bonds, have also readjusted year to date. As with risk free government bonds, rising yields mean that long run expected returns for these bonds have improved significantly since the start of the year. In terms of numbers, our model forecasts for U.S. high yield risk premium, at 188 basis points compared to near nothing 12 months ago. So what does all this mean? Well, for one thing, as my colleague Andrew Sheets has pointed out in a previous Thoughts on the Market episode, lower prices, wider risk premiums and higher 10 year expected returns have raised our long-run expected returns forecasts for a portfolio of 60% equity and 40% high quality bonds to the highest it's been since 2019, above the 10 year average. So we believe that the case for a 60/40 type of approach remains. For another, it means that the opportunities for investors right now lie in relative value rather than beta, given our strategists macro outlook for the next 12 months is more cautious than our long-run expected forecast. So for example, based on our long-run expected returns, our dollar optimal portfolios favor segments of the markets with more credit risk premium, like high yield and emerging market bonds. And similarly, as I've mentioned before, our current cross-asset allocation has a preference for ex-U.S. equities versus the U.S. because of former's higher equity risk premium. The rest of 2022 will likely continue to be turbulent, but there is good news for investors with a longer term focus. 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.

    Seth Carpenter: Is a Global Recession Upon Us?

    Play Episode Listen Later Aug 30, 2022 3:47


    Amid global shocks across supply, commodities and the U.S. Dollar, central banks continue to fight hard against inflation, leading many to wonder if a global recession is imminent.----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's chief global economist, along with my colleagues, bringing you a variety of perspectives. Today, I'll be revisiting a topic that's front and center: concerns about a global recession. It's Tuesday, August 30th, at 2p.m. in New York.One key market narrative right now is that the clouds of recession have been gathering globally. And the question that I get from clients every day, 'is a global recession upon us?'A recession is our baseline scenario for the Euro area. The flow of natural gas from Russia has been restricted and energy prices, as a result, have surged. We expect a recession by the fourth quarter but, as is so often the case, the data will be noisy. A complete gas cutoff, which is our worst-case scenario. That's still possible. On the other hand, even if somehow we had a full normalization of the gas flows, the relief to the European economy would only be modest. Winter energy prices are already partly baked in, and we've got the ECB with an almost single-minded focus on inflation. There are going to be more interest rate hikes there until the hard data force them to stop.Now, I am slightly more optimistic about the U.S. The negative GDP prints in the first two quarters of this year clearly cast a pall but those readings are misleading because of some of the details. Now, bear with me, but a lot of the headline GDP data reflects inventories in international trade, not the underlying domestic economy. Household spending, which is the key driver of the U.S. economy, averaged about 1.5% at an annual rate in the first half and the July jobs report printed at a massive 520,000 jobs. Since the 1970s, the U.S. has never had a recession within a year of creating so many jobs. But the path forward is clearly for slowing. Consumption spending was slammed by surging food and energy prices and more importantly, the Fed is hiking interest rates specifically to slow down the economy.So what is the Fed's plan? Chair Powell keeps noting that the Fed strategy is to slow the economy enough so that inflation pressures abate, but then to pivot or, as he likes to say, 'to be nimble.' That kind of soft landing is by no means assured. So, we're more optimistic in the U.S., but the Fed is going to need some luck to go along with their plan. The situation in China is just completely different. The economy there contracted in the second quarter amid very stringent COVID controls. The COVID Zero policies in place are slowly starting to get eased and we think more relaxation will follow the party Congress in October. But will freedom of mobility be enough to reverse the challenges that we're seeing on consumer spending because of the housing market? The recent policy action to address the housing crisis will probably help some but I fully expect that a much larger package will be needed. Ultimately, we'll need the consumer to be confident in both the economy and the housing market before we can make a rapid recovery.The world has been simultaneously hit by supply shocks, commodity shocks and dollar shocks. Central banks are pulling back on demand to try to contain inflation. Even if we avoid a global recession, it's really hard to see how economic activity gets all the way back to its pre-COVID trend.It's still the summertime, so I hope it's sunny where you are. You can worry about the storm later.Thanks for listening. If you enjoy this show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

    Mike Wilson: The Increasing Risks to Earnings

    Play Episode Listen Later Aug 29, 2022 4:18


    With Fed messaging making it clear they're not yet done fighting inflation, the market is left to contend with the recent rally and prepare to adjust growth expectations.-----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, August 29th, at 11 a.m. in New York. So let's get after it. After the Fed's highly anticipated annual meeting in Jackson Hole has come and gone with a very clear message - the fight against inflation is far from over, and the equity markets did not take it very well. As we discussed in this podcast two weeks ago, the equity markets may have gotten too excited and even pre traded a Fed pivot that isn't coming. For stocks, that means the bear market rally is likely over. Technically speaking, the rally looks rather textbook. In June, we reached oversold conditions with breadth falling to some of the lowest readings on record. However, the rally stalled out exactly at the 200-day moving average for the S&P 500 and many key stocks. On that basis alone, the sharp reversal looks quite ominous to even the most basic tactical analysts. From a fundamental standpoint, having a bullish view on U.S. stocks today is also challenging. First, there is valuation. As we have discussed many times in our research, the Price/Earnings ratio is a function of two inputs; 10 year U.S. Treasury yields and the Equity Risk Premium. Simplistically, the U.S. Treasury yield is a cost of capital component, while the Equity Risk Premium is primarily a function of growth expectations. Typically, the Equity Risk Premium is negatively correlated to growth. In other words, when growth is accelerating, or expected to accelerate, the Equity Risk Premium tends to be lower than normal and vice versa. Our problem with the view that June was the low for the index in this bear market is that the Equity Risk Premium never went above average. Instead, the fall in the Price/Earnings ratio from December to June was entirely a function of the Fed's tightening of financial conditions, and the higher cost of capital. Compounding this challenge, the Equity Risk Premium fell sharply over the past few months and reached near record lows in the post financial crisis period. In fact, the only time the Equity Risk Premium has been lower in the past 14 years was at the end of the bear market rally in March earlier this year, and we know how that ended. Even after Friday's sharp decline in stocks, the S&P 500 Equity Risk Premium remains more than 100 basis points lower than what our model suggests. In short, the S&P 500 price earnings ratio is 17.1x, it's 15% too high in our view. Second, while most investors remain preoccupied with the Fed, we have been more focused on earnings and the risk to forward estimates. In June, many investors began to share our concern, which is why stocks sold off so sharply in our view. Companies began managing the quarter lower, and by the time second quarter earnings season rolled around positioning was quite bearish and valuations were more reasonable at 15.4x. This led to the "bad news is good news" rally or, as many people claim, "better than feared" results. Call us old school, but better than feared is not a good reason to invest in something if the price is high and the earnings are weak. In other words, it's a fine reason for stocks to see some relief from an oversold condition, but we wouldn't commit any real capital to such a strategy. Our analysis of second quarter earnings showed clear deterioration in profitability, a trend we believe is just starting. In short, we believe earnings forecast for next year remains significantly too high. Finally, last week's highly anticipated Fed meeting turned out to be a nonevent for bonds, while it appeared to be a shock for stock investors. Ironically, given the lack of any material move in yields, all of the decline in the Price/Earnings ratio was due to a rising Equity Risk Premium that still remains well below fair market levels. The bottom line, we do think Friday's action could be the beginning of an adjustment period to growth expectations. That's good. In our experience, such adjustments to earnings always take longer than they should. Throw on top of that, the fact that operating leverage is now more extreme than it was prior to COVID, and the negative revision cycle could turn out to be worse than usual. Next week, we will attempt to quantify more specifically how challenging the earnings outcome might be based on an already reported macro data. 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 to find the show.

    Andrew Sheets: Is Cash an Efficient Asset Allocation?

    Play Episode Listen Later Aug 26, 2022 2:59


    Though returns offered by cash have been historically bad over the last 10 years, the tide has begun to turn on cash yields and investors will want to take note.-----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, August 26, at 2 p.m. in London. For much of the last 12 years, the question of whether to hold cash in a portfolio was really a question of negativity. After all, for most of that time, holding cash yielded nothing or less than nothing for those in Europe. Holding it implied you believed almost every other investment option was worse than this low bar. Unsurprisingly, the low returns offered by cash over this period led to... low returns. For 8 of the 10 years from 2010 through 2020, holding cash underperformed both U.S. stocks and U.S. Treasuries. And while cash is often like stocks and bonds over time, the returns to holding cash since 2010 were historically bad. But that's now changing, because cash no longer yields nothing. As central banks have raced to raise rates in the face of high inflation, the return on holding cash or near cash investments has jumped materially. One year ago, a 6 month U.S. Treasury bill yielded 0.04%. It now yields 3.25%. That is 3.25% for an investment with very low volatility backed by the full faith and credit of the U.S. government. That's a higher yield than a U.S. 10 year Treasury bond. It is more than double the dividend yield of the S&P 500 stock index. And it's just a quarter of a percentage point less than the dividend yield on U.S. real estate investment trusts. It's important to note that not all short term liquid investments are created equal. While six month U.S. T-bills now yield 3.25%, the average yield on 6 month bank CD's is less than 1%, and the average U.S. savings account yields just 0.2%. In other words, it pays to shop around. And for those in the business of managing money market and liquidity funds, we think this is a good time to add value and grow assets. What are the market implications? For equity markets, if investors can now receive higher yields on low risk cash, we think it's reasonable to think that that should lead investors to ask for higher returns elsewhere, which should lower valuations on stocks. My colleague Michael Wilson, Morgan Stanley's Chief Investment Officer and Chief U.S. Equity Strategist, sees poor risk reward for U.S. equities at current levels. More broadly, we think it supports holding more U.S. dollar cash in a portfolio. That's true for U.S. investors, but also globally, as we forecast the U.S. dollar to continue to strengthen. Holding cash isn't necessarily a sign of caution, it may simply be efficient allocation to an asset that has recently seen a major jump in yield. 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.

    Martijn Rats: Rising Gas Prices and Shifting Oil Demand

    Play Episode Listen Later Aug 25, 2022 3:46


    This year has seen a sharp rally in the oil and gas markets, leading to high prices and a delicate balancing act for global supply and demand. Important note regarding economic sanctions. This research references country/ies which are generally the subject of selective sanctions programs administered or enforced by the U.S. Department of the Treasury's Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries and multi-national bodies. Users of this report are solely responsible for ensuring that their investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.----- Transcript -----Welcome to Thoughts on the Markets. I'm Martijn Rats, Morgan Stanley's Global Commodity Strategist and the Head of the European Energy Research Team. Along with my colleagues, bringing you a variety of perspectives, today I'll be giving you an update on global oil and the European gas market. It's Thursday, the 25th of August, at 4 p.m. in London. As the world emerged from COVID, commodities have rallied strongly. Between mid 2020 and mid 2022, the Bloomberg Commodity Index more than doubled, outperforming equities significantly and fulfilling its traditional role as an inflation hedge.However, this rally largely ran out of steam in June, even for oil. For nearly two years, the oil market was significantly undersupplied. For a while, storage can help meet the deficit, but at some point, supply and demand simply need to come into balance. If that can't happen via the supply side quick enough, it must happen via the demand side, and so the oil markets effectively searched for the demand destruction price.The price level where that happens can be hard to estimate, but in June we clearly got there. For a brief period, gasoline reached $180 per barrel and diesel even reached $190 a barrel. Those prices are difficult for the global economy to absorb, especially if you take into account that the dollar has been strengthening at the same time. With the world's central banks hiking interest rates in an effort to slow down the economy as well, oil demand has started to soften and prices have given up some of their recent strength.Now these trends can take some time to play out, possibly even several quarters. As long as fears of a recession prevail, oil prices are likely to stay rangebound. However, after recession comes recovery. There is still little margin of safety in the system, so when demand starts to improve again, there is every chance the strong cycle from last year repeats itself. This time next year we may need to ask the question, 'What is the demand destruction price?' once again.Now, one commodity that has defied all gravity is European natural gas. Over much of the last decade, Europe was accustomed to a typical natural gas price of somewhere between sort of $6 to $7 per million British thermal units. Recently, it reached the eye-watering level of $85 per MMBtu. On an energy equivalent basis, that would be similar to oil trading at nearly $500 per barrel.Now, the reason for this is, of course, the sharp reduction in supply from Russia. As the war in Ukraine has unfolded, Russia has steadily supplied less and less natural gas to Europe. Now total volumes have already fallen by around about 75%. Furthermore, Gazprom announced that flows through the critical Nord Stream 1 pipeline would temporarily stop completely later this month for maintenance to one of its turbines. In principle, this will only last three days, but the market is clearly starting to fear that this is a harbinger of a much longer lasting shutdown.These exceptional prices are already leading to large declines in demand. During COVID, industrial gas consumption in Europe fell only 2 or 3%. Last month, industrial gas use was already down 19% year-on-year. With these demand declines, Europe can probably manage with the reduced supply, but to keep demand lower for longer gas prices need to be higher for longer. The gas market has clearly noticed. Even gas for delivery by end 2024 is now trading at close to $50 per MMBtu, 10x the equivalent price in the United States.The full implications of all of this for the European economy going forward are yet to become clear, but we'll be sure to keep listeners up to date on the latest developments.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.

    Jonathan Garner: What's Next for Asia and Emerging Markets?

    Play Episode Listen Later Aug 24, 2022 4:04


    As Asia and EM equities continue to experience what may end up being the longest bear market in the history of the asset class, looking to past bear markets may give investors some insight into when to come off the sidelines.-----Transcript-----Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Market Equity Strategist at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today I'll be discussing whether we're nearing the end of the current bear market in Asia and emerging market equities. It's Wednesday, August the 24th, at 8 a.m. in Singapore. The ongoing bear market in Asia and EM equities is the 11th which I've covered as a strategist. And in this episode I want to talk about some lessons I've learned from those prior experiences, and indeed how close we may be to the end of this current bear market. A first key point to make is that this is already the second longest in duration of the 11 bear markets I've covered. Only that which began with the puncturing of the dot com bubble by a Fed hike cycle in February 2000 was longer. This is already a major bear market by historical standards. My first experience of bear markets was one of the most famous, that which took place from July 1997 to September 1998 and became known as the Asian Financial Crisis. That lasted for 518 days, with a peak to trough decline of 59%. And as with so many others, the trigger was a tightening of U.S. monetary policy at the end of 1996 and a stronger U.S. dollar. That bear market ended only when the U.S. Federal Reserve did three interest rate cuts in quick succession at the end of 1998 in response to the long term capital management and Russia defaults. Indeed, a change in U.S. monetary policy and/or a peak in the U.S. dollar have tended to be crucial in marking the troughs in Asia and EM equity bear markets. And that includes the two bear markets prior to the current one, which ended in March 2020 and October 2018. However, changes in Chinese monetary policy and China's growth cycles, starting with the bear market ending in October 2008, have been of increasing importance in recent cycles. Indeed, easier policy in China in late 2008 preceded a turn in U.S. monetary policy and helped Asia and EM equities lead the recovery in global markets after the global financial crisis. Although China has been easing policy for almost a year thus far, the degree of easing as measured by M2 growth or overall lending growth is smaller than in prior cycles. And at least in part, that's because China is attempting to pull off the difficult feat of restructuring its vast and highly leveraged property sector, whilst also pursuing a strategy of COVID containment involving closed loop production and episodic consumer lockdowns. Those key differences are amongst a number of factors which have led us to recommend staying on the sidelines this year, both in our overall coverage in Asia and emerging markets, but also with respect to China. We have preferred Japan, and parts of ASEAN, the Middle East and Latin America. Finally, as we look ahead I would also note that one feature of being later on in a bear market is a sudden fall in commodity prices. And certainly from mid-June there have been quite material declines in copper, iron ore and more recently, the oil price. Meanwhile, classic defensive sectors are outperforming. And that sort of late cycle behavior within the index itself raises the question of whether by year end Asia and EM equities could once again transition to offering an interesting early cycle cyclical play. That more positive scenario for next year would depend on global and U.S. headline inflation starting to fall back, whether we would see a peak in the U.S. dollar and Fed rate hike pricing.For the time being, though, as the clock ticks down to the current bear market becoming the longest in the history of the asset class, we still think patience will be rewarded a while longer. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts and recommend Thoughts on the Market to a friend or colleague today.

    U.S. Public Policy: The Inflation Reduction Act and Clean Energy

    Play Episode Listen Later Aug 23, 2022 8:13


    The Inflation Reduction Act represents the single biggest climate investment in U.S. history, so how will these provisions influence consumers' pocketbooks and the clean energy market? Head of Global Thematic and Public Policy Research Michael Zezas and Global Head of Sustainability Research Stephen Byrd discuss.----- Transcript -----Michael Zezas Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Global Thematic and Public Policy Research.Stephen Byrd And I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research.Michael Zezas And on this special episode of Thoughts on the Market, we'll focus on the Inflation Reduction Act's bold attempt to stem the tide of climate change. It's Tuesday, August 23rd at noon in New York.Michael Zezas Regular listeners may have heard our previous episodes on the potential impact for the U.S. economy and on taxes from the Inflation Reduction Act. Today, we'll focus on another essential aspect of this new legislation, namely its sweeping support for clean energy, which represents the single biggest climate investment in U.S. history. So, Stephen, there's a ton of important issues to address here. Let's start with an immediate pain point that most of us deal with on a daily basis, the cost of energy. How does the Inflation Reduction Act aim to lower energy costs for Americans?Stephen Byrd The simplest way to think about this is that in the past decade, wind and solar costs in the U.S. declined every year by double digits. What's exciting about the IRA is that there are really important investments that will increase the scale of manufacturing. So, the fundamental point in terms of the benefit of the IRA really is support for a variety of clean energy investments that's going to increase efficiency, reduce per unit costs. This is becoming really essentially a very big business. To put this in context, in the last 12 months utility bills in the U.S. and most of the U.S. have increased by sometimes well into the double digits. And yet clean energy costs remain quite low. Given some of the near-term COVID supply chain dynamics, costs aren't dropping as quickly as they normally would, but before long we're going to see those reductions continue. That should result in lower power costs for customers across the U.S. and that's the single biggest benefit from a sort of deflationary point of view that I can think of around the IRA.Michael Zezas And the IRA also has a stated aim to increase American energy security. In what ways does it attempt to do that?Stephen Byrd Yeah, Michael, it's really interesting. The IRA has some very broad areas of support for domestic manufacturing of all kinds, of not just clean energy but related technologies like energy storage. And we do think that's going to likely result in quite a bit of onshoring of manufacturing activity. That is good for American energy security, that brings our sources of energy production right back home, creates jobs, reduces dependency on other governments. So, for example, the subsidy for solar manufacturing is really very large. It can be as high as essentially $0.17 a watt, and to put that into context, the selling price at the wholesale level for many of these products is around $0.30 a watt. So that subsidy for domestic manufacturing should result in real investment decisions in real U.S. factories, and that will help to improve American energy security.Michael Zezas Now, another aspect of this legislation is its attempt to substantially limit carbon emissions in the U.S. What are some of the measures that are aimed at doing this?Stephen Byrd Decarbonization is a major area of focus, just as you said, for the IRA and this shows up in many ways. I'd say the most direct way would be providing a number of incentives to increase the growth of wind and solar. So, we'll see a great deal of growth there as a result. However, there are other elements that are really interesting. One example is support for nuclear. I think the drafters really wanted to ensure that we didn't lose any additional nuclear power plants. Those plants provide obviously zero carbon energy, but they also provide really important grid reliability services so that's helpful. There is also quite a bit of capital for carbon capture, which should reduce the emissions profile of other sectors as well. There's quite a bit of support for electric vehicles that will help with the pace of electrification. And that's kind of a nice double benefit in the sense that if more consumers choose electric vehicles and the grid becomes cleaner then we get a double benefit. So, we're really seeing very broad-based support for decarbonization in the IRA.Michael Zezas Now, one of the methods here to incentivize decarbonization is through tax credits. What are some of these tax credits? How do they work?Stephen Byrd We have a lot of tax credits in this IRA for what I think of as wholesale players, that is the big clean energy developers. There are tax credits for wind and solar that get extended well into the next decade. We have a new tax credit for energy storage. We have tax credits that have been enhanced for carbon capture and utilization, which is very exciting because that's at a level needed to incent quite a bit of investment in carbon capture. We have a new very large tax credit for green hydrogen. That's great, because today hydrogen is made in a process called ‘gray hydrogen' that does have quite a high carbon profile. So, a variety of tax credits essentially at the wholesale level or at the developer level, but also that could benefit consumers as well, such as on electric vehicles and those are quite sizable as well.Michael Zezas Now these tax credits and the other efforts in the Inflation Reduction Act aimed at carbon reduction, they represent a major pickup in spending on clean technologies. Can you give us some perspective on that? And is the industry ready to supply all the equipment and labor needed to make this a reality?Stephen Byrd I think what we're seeing with many technologies here in clean energy is that the demand is starting to grow very rapidly. Now the industry is really pushing very hard to keep pace, essentially. The limit on growth for some of our companies is really down to people. That is, how many people can they hire and train. So, for some of those companies, that growth rate caps out at about 25% per year. You know, that's quite good and we'll see that continue for many years. I think we're going to see a lot of increased efforts on education. And you'll see also within the IRA a lot of language around prevailing wage and ensuring that employees get paid a fair wage. On top of that, though, there are some areas of shortage. So in energy storage, for example, demand is very high across the U.S., not just for electric vehicles, but also to help with grid reliability. A good example would be in Texas during the winter storm, parts of the Texas grid failed and quite a few people were without power during very cold conditions. That was very challenging. And as a result, a lot of customers, both individuals and corporations, want to have storage. There are limits, there is a shortage essentially globally in terms of energy storage, and that's going to take years to address. That said, the IRA does make important headway in terms of providing incentives and financial support to bring a lot of manufacturing back to the U.S. so we have better control of manufacturing. We'll be able to scale up more quickly and also avoid a lot of the logistics and supply chain issues that have plagued some of our companies that have dealt with very complex and challenging global supply chains.Michael Zezas So, for investors, then, what's the takeaway? Is this perhaps a boon for the clean tech sector, or is it maybe too much, too soon?Stephen Byrd I think this is a boon for not just the clean tech sector. I think ultimately this is going to translate into much more rapid adoption of clean energy, which fundamentally is very much a deflationary force. So what we're going to see is further innovation, further manufacturing in the U.S. That means more jobs in the U.S, that means a faster pace of innovation and a faster rate of cost reduction. So that does look to us to be a virtuous cycle that's going to benefit not just the decarbonization of the U.S. economy but benefit the consumer and provide jobs as well.Michael Zezas Stephen, thanks for taking the time to talk.Stephen Byrd Great speaking 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.

    Mike Wilson: Will the Bear Market Rebound Last?

    Play Episode Listen Later Aug 22, 2022 4:15


    While stocks and bonds have rallied since June, investors should be asking if this bear market rebound is a sign that economic growth is on its way up, or if there are negative earning revisions yet to come.-----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, August 22nd at 11 a.m. in New York. So let's get after it. Taking a few weeks off can sometimes provide a fresh perspective on markets needed at times like today. The fact that it happens to be August, the most popular time for vacations of the year, can also play into that perspective. Over the past 6 weeks many financial markets have had a strong rebound. As an example, both stocks and bonds have rallied sharply from their June lows. The question that equity investors must ask themselves is how much of the rally in stocks is due to the fall in interest rates versus a real improvement in the prospects of a soft landing in the economy? For better or worse our view has remained consistent since April that the primary concern for stocks was no longer inflation, or the Fed's reaction to deal with it, but rather the outlook for growth. In May, the consensus moved strongly into our camp, with the cries for a recession reaching a fever pitch in June. Equity markets became very oversold and the stage was set for a powerful rally. Truth be told, this rally exceeded our expectations for a normal counter trend bear market rally. However, in order to set the stage for the next leg lower, the rally needed to be convincing enough to change the very bearish sentiment to outright bullish. Based on what I have seen in the press and from our peers around the street, that sentiment has flipped with many declaring the end of the bear market and the increasing likelihood of new all time highs as soon as later this year. While there are some strong indications that inflation has peaked from a rate of change standpoint, it's too soon for the Fed to declare victory in our view. In other words, the rising hope for the Fed to pivot away from rising rates or curtailing its balance sheet reduction remains optimistic. Nevertheless, this is the primary justification for why equity markets have rallied and why it can continue. However, even if that were true, there are very few data points suggesting we have reached a trough in growth, either economically or from an earnings growth standpoint. In fact, our growth is suggesting the opposite, with earnings revision breadth accelerating to the downside, along with our other leading indicators. To put it more bluntly, rarely have we been more confident that consensus growth expectations for earnings over the next 12 months are too high. More importantly, the equity market almost never rallies if forward earnings estimates are falling, unless the valuation is completely washed out. In June, one could have credibly argued valuations were discounting a sharp decline in growth and the risk of a recession. At the lows the forward price earnings ratio reached 15.4x and was down almost 30% from the end of last year. At 15.4x is almost exactly our year end target price earnings multiple at the beginning of this year based on our view that the Fed would have to tighten aggressively to combat inflation. The problem with assuming 15.4x was a washed out level for valuations is that all of the degradation was a result of higher interest rates, while the equity risk premium remained flat to down over that time frame. In other words, at no time did the price earnings multiple discount a material slowdown in growth. Now, with the price earnings multiple exceeding 18x last week, valuations are inappropriate if one agrees with our view that earnings estimates are too high. On Friday, stocks reversed lower and that seems to be carrying into this week. Many are once again blaming the Fed and perhaps acknowledging its work in fighting inflation remains unfinished. We agree. However, with price earnings multiples still 17.4x as I record this podcast, valuations are not discounting that resolve, nor is it discounting the negative earnings revisions still to come. The bottom line stocks have experienced a classic bear market rebound after having reached a near record oversold condition on many metrics. With the Fed still very much in the picture and earnings estimates likely to fall further, equity markets are almost as unattractive as they were at the beginning of the year. 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 to find the show.

    Simon Waever: Is an EM Debt Crisis Coming?

    Play Episode Listen Later Aug 19, 2022 3:28


    In the past two years Emerging Market sovereign debt has seen rising risks given increased borrowing, higher interest rates and a greater number of defaults, leading investors to wonder, are we heading towards an EM debt crisis? Important note regarding economic sanctions. This research references country/ies which are generally the subject of comprehensive or selective sanctions programs administered or enforced by the U.S. Department of the Treasury's Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries and multi-national bodies. Any references in this report to entities, debt or equity instruments, projects or persons that may be covered by such sanctions are strictly incidental to general coverage of the relevant Russian economic sector as germane to its overall financial outlook, and should not be read as recommending or advising as to any investment activities in relation to such entities, instruments or projects. Users of this report are solely responsible for ensuring that their investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.----- Transcript -----Welcome to Thoughts on the market. I'm Simon Waever, Morgan Stanley's Global Head of EM Sovereign Credit Strategy. Along with my colleagues, bringing you a variety of perspectives, today, I'll address the possibility of an emerging markets debt crisis. It's Friday, August 19th, 12p.m. in New York.The most frequent question I get from investors right now is, 'are we heading towards an EM debt crisis?' It's not unreasonable to ask this. After all, a lot of the ingredients that led to prior EM debt crises are in place today. First, EM countries have taken on a lot of debt, not just since the pandemic, but in the past ten years, meaning most countries are at or near multi-decade highs. Second, global central banks are quickly hiking rates, with the Fed in particular a key driver in tightening global financial conditions. Third, which is related, is that servicing and rolling over that debt has suddenly become much more expensive, driven not just by a stronger dollar, but also much higher bond yields. And then fourth, which is perhaps the most important one, is that today we are as close to an extended sudden stop in flows to EM as we have been in a long time. That means that many countries have lost access to markets, so that even if they were willing to pay up to borrow, there's just no demand.Markets are telling us the risks are rising as well. Outside of the 2008 Global Financial Crisis and the 2020 pandemic, you'd have to go back 20 years to find EM sovereign credit spreads trading as wide. And high yield credit spreads are much wider than investment grade spreads, so markets are differentiating already.Finally, just looking at actual sovereign defaults and restructurings, they're already higher than in recent history. We have had six in the past two years and now already three in 2022, namely Russia, Belarus and Sri Lanka.From here, there are likely to be more defaults, but three key points are worth making. One, the countries at risk now are very different to the prior debt crisis in EM. Two, none would be systemic defaults. And three, they would not all happen at the same time.Large countries like Brazil, Mexico, South Africa, Indonesia and Malaysia don't seem to be at risk of defaulting. They are completely different to what they were 20 to 30 years ago. They're now inflation targeters, have mostly free-floating currencies, meaning imbalances are less likely to build up, have large effects reserves and have the majority of that debt in local currency.Instead, the concern now is mostly with the newer issuers that benefited from the abundant global liquidity in the past ten years. And by this I mean the frontier credits, many of which are in Africa, but also in Asia and Central America. And then it's key to actually look at who has upcoming Eurobond maturities, as not all countries do. But even among these credits, the International Monetary Fund stands ready to help and there are FX reserves that can be used. So, it's not clear to me that you're going to see multiple defaults and even if you were to see two or more defaults among them, they're very unlikely to be systemic.But, all in, while there's no denying that EM countries are facing debt sustainability issues, let's not paint all EM with the same brush. The nuances should make for some exciting years ahead for sovereign debt analysts and should also open up the potential for significant alpha within the asset class.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.

    U.S. Public Policy: Tax Provisions in the Inflation Reduction Act

    Play Episode Listen Later Aug 18, 2022 4:47


    The Inflation Reduction Act includes a variety of provisions regarding tax policy, so how will these policy changes affect corporations and what should investors be aware of? Head of Public Policy Research and Municipal Strategy Michael Zezas and Head of Global Valuation, Accounting, and Tax Todd Castagno discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Public Policy Research and Municipal Strategy. Todd Castagno: And I'm Todd Castagno, Morgan Stanley's Head of Global Valuation, Accounting and Tax Research. Michael Zezas: And on this special episode of Thoughts on the Market we'll focus on what you need to know about some significant changes to tax policy from the Inflation Reduction Act. It's Thursday, August 18th, at noon in New York. Michael Zezas: President Biden has now signed the Inflation Reduction Act, or IRA, into law. As our listeners may remember, last week we discussed the potential impact of the IRA on the U.S. economic outlook. Today we want to dig deeper into a specific area of this new law, namely taxes. So Todd, there's been some criticism of the IRA with regard to the 15% minimum tax on the largest corporations. What are your thoughts on this provision? Todd Castagno: Thanks, Michael. Let's first discuss how this 15% minimum corporate tax operates. So the law now intends for large corporations that earn on average of $1 billion or more over a three year period to pay at least 15%. Now, what's important is what is that profit base to tax that 15% and its derived from financial statement net income with certain adjustments. That is why this tax is commonly referred to as a book tax, that is primarily based on book or financial statement measures of income. So if you peel back a few layers of what's driving the criticism, there's a recognition that this tax effectively just overrides incentives or timing differences that Congress consciously enacted. Critics will say that Congress should just fix certain areas of the tax codes directly. However, the politics of fixing specific policies directly can be extremely difficult politically. The other point of criticism is that taxing authority has effectively been ceded to independent accounting standards setters. Changes in the accounting rules may now affect changes in minimum tax revenue. There have been some concerns from investors over earnings quality as the tail now wags the dog where accounting can now drive the economics. So those are just a few of the criticisms. It's also important to note, Michael, that we've had a version of a book tax back in the 1980s, so it would be interesting to see longevity of this tax as that tax only lasted effectively 2 to 3 years. Michael Zezas: And another piece of the legislation is a softening and reduction of the Corporate Alternative Minimum Tax on advanced manufacturing activities such as automation, computation, software and networking. What can you tell us about that? Todd Castagno: Good question. When Senator Sinema announced a carve out for advanced manufacturing, we were scratching our heads of what that actually meant. Well, it's quite broader and it really affects most manufacturing. So what the adjustment is, is you start with book income and you'd make an adjustment to basically replace what we book for accounting depreciation with tax depreciation. And so tax depreciation is usually front run it and it's usually accelerated versus book. So what that will mean for manufacturers is that their minimum tax base will be lower given this adjustment. Michael Zezas: And also in the IRA is a 1% stock buyback tax for companies that are repurchasing their own shares. Todd, is that likely to impact corporate profits or change behavior in a meaningful way? Todd Castagno: Overall, we don't believe at a 1% level this will materially affect the level of buybacks or corporate behavior. You could see a modest tilt towards dividends as a more preferential form of capital return. You could also see perhaps some buybacks being pulled forward into 22 as the law takes effect in 2023. You know, we think the bigger risk is that 1% rate skews higher in the future if a future Congress needs more revenue. We should also note that it's net of issuances, so that's important. A lot of firms have large amounts of stock based compensation and they repurchase their shares in order to prevent dilution. And so effect of that issuance will also really reduce the amount of the buyback tax. Michael Zezas: And finally, let's talk about tax credits. Which tax credits stand out to you from this bill and how material might their impact be? Todd Castagno: I think this one is in the eye of the beholder. The reality is that the IRA increased credits significantly across the board for clean energy investment, whether that's electric vehicles, decarbonization. Also, the structure of many of those credits has evolved where they can be monetized more upfront, whether that's the refund ability or transferability to other taxpayers. So I think the magnitude of the investment, the magnitude of the credits, outweighs any specific credit or provision. Michael Zezas: Todd, thanks for taking the time to talk. Todd Castagno: Great speaking 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.

    Allocation, Pt. 2: The Value in Diversification

    Play Episode Listen Later Aug 17, 2022 6:11


    While shifts in stock and bond correlation have increased the volatility of a 60:40 portfolio, investors may still find some balance in diversification. Chief Cross Asset Strategist Andrew Sheets and Chief Investment Officer for Wealth Management Lisa Shalett discuss.-----Transcript-----Andrew Sheets: Welcome to Thoughts on 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 on part two of this special episode, we'll be continuing our discussion of the foundational 60/40 portfolio. It's Wednesday, August 17th at 4:00 PM in London.Lisa Shalett: And it's 11:00 AM here in New York.Andrew Sheets: So Lisa, I know the positive correlations won't lift the 60:40 portfolio's volatility too much, but would you say that investors have been inclined to accept more equity risk in recent decades because the cushioning effect of fixed income and this idea that if anything goes wrong, the Fed will kind of ride to the rescue and support markets?Lisa Shalett: Yes I do. And I think, you know, part of the issue has been that we've been not only in a regime of falling interest rates, which has supported overall equity valuations, but we've lived in a period of suppressed volatility with regard to the direction of policy. We've been in this forward guidance regime, if you will, from the central bank where not only was the central bank holding down the cost of capital but they were telegraphing the speed and order of magnitude and pace of things which took a huge amount of volatility out of the market for both stocks and bonds and permitted risk taking. I mean, my goodness, you know, when was the last time in history that we had such negative “term premiums” in the pricing of bonds? That was a part of this function of this idea that the Fed's going to tell us exactly what they're going to do and there's this Fed put, and any time something unexpected happens, they will, you know, “come to save the day.”And so I think we're at the beginning, we're literally in my humble opinion in the first or second innings of the market fundamentally wrapping their heads around what it means to no longer be in a forward guidance regime. Where the central bank, in their ambitions to normalize policy to crush inflation have to inherently be more data dependent and data dependency is inherently more volatile. And so I do think over time we are going to see these equity risk premiums, which, you know, as we've discussed earlier, had gotten quite compressed, widen back out to something that is more normal for the amount of risk that equities genuinely represent.Andrew Sheets: And Lisa, I think that's such a great point about the predictability of monetary policy cause you're right, you know, that's another interesting similarity with the period prior to 2000. That period was a period of a much more unpredictable Fed between, you know, 1920 and the year 2000 where in more recent years, the Fed has become very predictable. So, that's another good thing that we should, as investors, think about is does that shifting predictability of Fed action, does the rising uncertainty that the Fed is facing, you know, is that also an important driver of this stock bond correlation. So boiling it all down, how are you talking about all of this to clients to help them reposition portfolios to navigate risk and potential return?Lisa Shalett: I think at the end of the day you know, the most important thing that we're sitting with clients and talking about is that these fundamental building blocks of asset allocations, stocks and bonds, while they may correlate to one another differently, while they're each inherent volatilities may move up and therefore the volatility of that 60:40 portfolio may readjust some, the reality is, is that they're still very important building blocks that play different roles in the portfolio that are both still required. So, you know, your stocks are still going to be that asset class that allows you to capture unexpected growth in the economy and in the overall profit stream, while fixed income and your rates market is still going to be that opportunity to cushion, if you will, disappointments in growth.As we know that they, come over the course of a cycle. In that regard, as we look to this repricing of interest rates and what it may mean, we are encouraging our clients to look much more deliberately, actively, at being diversified across styles, across factors, across market capitalizations because these dynamics are changing. If we look back over the last 13 years, because the narrative around falling interest rates and Fed forward guidance and low volatility, and these correlations, these very stable correlations, and everything's going our way, you didn't need to look very far beyond just owning that passive S&P 500 index. Now, as things begin to normalize and get more inherently volatile and idiosyncratic, we look at where there may be, “value” in the traditional factor sense, to look down the market capitalization scheme to smaller and mid-cap stocks, to look at more cyclical oriented stocks that may be responding to this higher interest rate, higher inflation regimes. And so we're encouraging maximum levels of diversification within these building blocks and very active management of riskAndrew Sheets: Lisa as always, thanks for taking the time to talk.Lisa Shalett: It's my pleasure, Andrew.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 Podcasts app. It helps more people find the show.

    Allocation, Pt. 1: Stock & Bond Correlation Shifts

    Play Episode Listen Later Aug 16, 2022 9:54


    In the current era of tighter Fed policy, the status quo of stock and bond correlation has changed, calling the foundational 60:40 portfolio into question. Chief Cross Asset Strategist Andrew Sheets and Chief Investment Officer for Wealth Management Lisa Shalett discuss.-----Transcript-----Andrew Sheets: Welcome to Thoughts on 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 on part one of this special episode, we'll be discussing the foundational 60/40 stock bond portfolio. In an era of tighter policy, is a diversified portfolio of stocks and bonds fundamentally broken? It's Tuesday, August 16th at 4:00 PM in London.Lisa Shalett: And it's 11:00 AM here in New York.Andrew Sheets: Lisa, it's so good to talk to you again. So, you know, one of the most important, fundamental building blocks of asset allocation is the so-called 60/40 portfolio, a portfolio of 60% stocks and 40% bonds, and both of us have been writing about that this year because this strategy of having diversified stocks and bonds worked unusually well for the 40 years up through 2021, but this year has suffered a real historical reversal, seeing some of the worst returns for this diversified balanced strategy we've seen in 40 or 50 years. So when you think about these dynamics, when you think about the historically poor performance, can you give some context of what's been happening here and what our listeners should make of it?Lisa Shalett: Sure, absolutely. I think as we know, we've gone through this 13-year period through the pandemic when the narrative was very much dominated by Federal Reserve intervention repression and keeping down of interest rates and in fact, falling interest rates, that produced financial market returns both for stocks and for bonds. But as we know, entering 2022, that narrative that was so concentrated on the direction of interest rates, you know, faced a major pivot from the Federal Reserve itself who, as we know, was facing an inflation fight which meant that they were going to have to move the federal funds rate up pretty significantly. The implication of that was pretty devastating for both stocks and bonds, that combined 60/40 portfolio delivered aggregate returns of about -12 to -13% on average that's the performance for that diversified portfolio benchmark in over 50 years. But again, we have to remember a lot of that performance was coming from a starting point where both stocks and bonds had been extraordinarily valued with those valuations premised on a continuation of Federal Reserve policy that unfortunately because of inflation has had to changeAndrew Sheets: Lisa I'm so glad you mentioned that starting point of valuations because, you know, it matters, I think in two really important ways. One, it helps us maybe understand better what's been happening this year, but also, you know, usually when prices fall, and this year prices are still down considerably from where they started, that means better valuations and better returns going forward. So, you know, could you just give a little bit more context of you and your team run a lot of estimates for what asset classes can return potentially over longer horizons. You know, maybe what that looked like for a 60/40 portfolio at the start of this year, when, as you mentioned, both stocks and bonds were pretty richly valued, and then how that's been developing as the year has progressed.Lisa Shalett: Yeah. So, fantastic question. And, you know, we came into 2022 quite frankly, on a strategic horizon given where valuations were, not very excited about either asset class. You know for bonds, we were looking for maybe 0-2% or somewhat below coupon, because of the pressures of repricing on bonds. And for stocks we were looking for something in the, you know, 4-5% range, which was significantly below what historical long term capital market assumptions, you know, might expect for many institutional clients who benchmark themselves off of a 7.5 or 8% return ambition. So, when we entered this bear market, this kind of ferocious selloff, as we noted, from January through June, there were many folks who were hoping that perhaps valuations and forward looking expectations of returns were improving. Importantly, however, what we've seen is that hasn't been the case because what you have to do when you're thinking about valuation is you've gotta look at stock valuations relative to the level of interest rates.And we're now in a scenario where, you know, the terminal value for the US economy may be something very different than it was and that means somewhat lower valuations. So, you know, if I had to put a number on it right now, my expectations for equity returns going forward from the current mark to market is really no better, unfortunately, than perhaps where it was in January. For bonds on the other hand, we've made some progress. And so to me, you know, I, I could see our estimates on bonds being a little bit more constructive than where they were with the 10 year yield somewhere in the, in the 2.8 zip code. Lisa Shalett: So Andrew we've talked about the stock bond correlation as keying off the direction of inflation and the path of Fed policy. With both of those changing, do you view a positive correlation as likely over the longer term?Andrew Sheets: Yeah. Thanks. Thanks, Lisa. So I think this issue of stock bond correlation is, is really interesting and, and gets a lot of attention for, for good reasons. And then, I think, can also be a little bit misinterpreted. So the reason the correlation is important is, I think, probably obvious to the listeners, if you have a diversified portfolio of assets, you want them to kind of not all move together. That's the whole point of diversification. You want your assets to go up and down on different days, and that smooths the overall return. Now, you know, interestingly for a lot of the last hundred years, the stock bond correlation was positive. Stock and bond prices tended to move in the same direction, which means stock and bond yields tended to move in the opposite direction. So higher yields meant lower stock prices.That was the history for a lot of time, kind of prior to 2000. The reason I think that happened was because inflation was the dominant fear of markets over a lot of that period and inflation was very volatile. And so higher yields generally meant a worsening inflation backdrop, which was bad for stock prices and lower bond yields tended to mean inflation was getting back under control, and that was better for stocks. Now, what's interesting is in the 90s that dynamic really kinda started to change. And after 2000, after the dot-com bubble burst, the fear really turned to growth. The market became a lot less concerned about inflationary pressure, but a lot more concerned about growth. And that meant that when yields were rising, the market saw that as growth being better. So the thing they were afraid of was getting less bad, which was better for stock prices.So, you had this really interesting flip of correlation where once inflation was tamed really in the 90s, the markets started to see higher yields, meaning better growth rather than higher inflation, which meant that stocks and bonds tend to have a negative correlation. Their prices tend to more often move in opposite directions. And as you alluded to, that really created this golden age of stock bond diversification that created this golden age of 60/40 portfolios, because both of these assets were delivering positive returns, but they were delivering them at different times. And so offsetting and cushioning each other's price movements, which is really, you know, the ideal of anybody trying to invest for the long run and, and diversify a portfolio. So that's changed this year. It's been very apparent this year that both stock and bond prices have gone down and gone down together in a pretty significant way.But I think as we look forward, we also shouldn't overstate this change. You know, I think your point, Lisa, about just how expensive things were at the start of the year is really important. You know, anytime an asset is very expensive, it is much more vulnerable to dropping and given that both stocks and bonds were both expensive at the same time and both very expensive at the same time, you know, their dropping together I think was, was also a function of their valuation as much of anything else. So, I think going forward, it makes sense to assume kind of a middle ground. You know, I don't think we are going to have the same negative correlation we enjoyed over the last, you know, 15 years, but I also don't think we're going back to the very positive correlations we had, you know, kind of prior to the 1990s.And so, you know, I think for investors, we should think about that as less diversification they get to enjoy in a portfolio, but that doesn't mean it's no diversification. And given that bonds are so much less volatile than stocks, you know, bonds might have a third of the volatility of the stock market, if we look at kind of volatility over the last five years. That still is some pretty useful ballast in a portfolio. That still means a large chunk of the portfolio is moving around a lot less and helping to stabilize the overall asset pool. Andrew Sheets: Thanks for listening. Tomorrow I'll be continuing my conversation with Lisa Shalett, and 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.

    Ellen Zentner: Cooling Inflation and Shifting Labor Trends

    Play Episode Listen Later Aug 15, 2022 4:19


    Based on July reports inflation may finally be cooling down, and the labor market remains strong, so how might this new data influence policy changes in the September FOMC meeting?-----Transcript-----Welcome to Thoughts on the Market. I'm Ellen Zentner, Chief U.S. Economist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be catching you up to speed on U.S. inflation, the labor market and our outlook for Fed policy. It's Monday, August 15th, at 11 a.m. in New York. Let me start with some encouraging news. If we look at the July readings for both the Consumer Price Index data and the Producer Price Index, inflation finally appears to be cooling. And that should take some pressure off the Fed to deliver another 75 basis point hike in September. So that's the good news. However, inflation is still elevated and that suggests the Fed still has a lot of work to do, even if there's a reduced need for a third consecutive 75. We're forecasting a 50 basis point hike at the September and November meetings and 25 basis points in December for a peak interest rate of 3.625%. Okay, let's look a bit more under the hood. July CPI on both headline and core measures surprised to the downside, and the PPI came in softer as well. Together, the reports point to a lower than previously anticipated inflation print that will be released on August 26th. Now, the recent blowout July employment report led markets to price a high probability of a 75 basis point hike. But the inflation data then came in lower than expected and pushed the probability back toward 50 basis points. Based on the outlook for declining energy prices, we think headline inflation should continue to come down and do so quite quickly. However, core inflation pressures remain uncomfortably high and are likely to persist. For the Fed signs of a turn around in headline inflation are helpful and are already showing up in lower household inflation expectations. However, trends in core are more indicative of the trajectory for underlying inflation pressures, and Fed officials came out in droves last week to stress that the steep path for rates remains the base case. Sticky core inflation is a key reason why we expect the Fed to hold at 3.625% Fed funds, before making the first cut toward normalizing policy in December 2023. Now, let me speak to July's surprising employment report. As the data showed, the labor market remains strong, even though some of the data flow has begun to diverge in recent months. Leading up to the recent release, the market had taken the softening in employment in the household survey, so that is the employment measure that just goes out to households and polls them, were you employed, were you not, were you part time, were you full time, and generally because that's been very weak, the market was taking it as a potential harbinger of a turn in the payrolls data, payrolls data are collected from companies that just ask each company how many folks are on your payrolls. Household survey employment was again softer in July, coming in at 179,000 versus 528,000 for the payroll survey. Now, this seems like a sizable disparity, but it's actually not unusual for the household and payroll surveys to diverge over shorter periods of time. And these near term divergences largely reflect methodological differences. But what's interesting here and worth noting is that these differences in data likely reflect a shift in the form of employment. While the economy saw a large increase in self-employment in the early stages of the pandemic, the data now suggest workers may be returning to traditional payroll jobs, potentially because of higher nominal wages and better opportunities. If the economy is increasingly pulling workers out of self-employment and into traditional payroll jobs, similar pull effects are likely reaching workers currently out of the labor force. And this brings me to one of our key expectations for the next year and a half, which is a continued increase in labor force participation, in particular driven by prime age workers age 25 to 54. Higher wages, better job opportunities and rising cost of living will likely bring workers back into the labor force, even as overall job growth slows. Fed researchers, in fact, have recently documented that a delayed recovery in labor force participation is quite normal, and that's something we think is likely to play out again in this cycle. 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.

    Consumer Spending: Have Consumers Begun to Trade Down?

    Play Episode Listen Later Aug 12, 2022 5:40


    As inflation persists, economic concerns such as recession rise, and consumer spending patterns begin to shift, is there any evidence to suggest consumers are already trading down to value and discount products? U.S. Softlines Analyst Kimberly Greenberger and Hardlines, Broadlines and Food Retail Analyst Simeon Gutman discuss.-----Transcript-----Kimberly Greenberger: Welcome to Thoughts on the Market. I'm Kimberly Greenberger, Morgan Stanley's U.S. Softlines Analyst. Simeon Gutman: And I'm Simeon Gutman, Hardlines, Broadlines and Food Retail Analyst. Kimberly Greenberger: And on this special episode of Thoughts on the Market, we'll be discussing shifting consumer spending patterns amid persistent inflation and concerns about the economy. It's Friday, August 12th, at 11 a.m. in New York. Kimberly Greenberger: As our listeners are no doubt aware, many retail segments were big pandemic beneficiaries with record sales growth and margins for 2+ years. But now that spending on goods is normalizing from high levels and consumers are facing record high inflation and worrying about a potential recession, we're starting to see signs of what's called "trade down", which is a consumer migration from more expensive products to value priced products. So Simeon, in your broad coverage, are you seeing any evidence that consumers are trading down already? Simeon Gutman: We're seeing it in two primary ways. First, we're seeing some reversion away from durable, high ticket items away to consumable items. And the pace of consumption of some of these high ticket durable items is waning and pretty rapidly. Some of these are items that were very strong during the pandemic, electronics, some sporting goods items, home furnishings, to name a few. So these items we're seeing material sales deceleration as one form of trade down. As another in the food retail sector, we're definitely seeing signs of consumers spending less or finding ways to spend less inside the grocery store. They can do that by trading down from national brands to private brands, buying less expensive alternative, buying frozen instead of fresh and even in the meat counter, buying less expensive forms of protein. So we're seeing it manifest in those two ways. What is the situation in softlines, Kimberly? Is your coverage vulnerable to trade down risk? Kimberly Greenberger: Absolutely. In softlines retail, which is apparel, footwear, accessories retail, these are discretionary categories. Yes, there's sort of a minimum level of spending that's necessary because clothing is part of the essentials, food, shelter, clothing. But Americans' closets are full and they're full because last year there was a great deal of overspending on the apparel category. So where we have seen trade down impact our sector this year, Simeon, is we have seen consumers budget cutting and moving away from some of those more discretionary categories like apparel especially. We just have not yet seen any benefits to some of the more value oriented retailers that we would expect to see in the future if this behavior persists. Simeon Gutman: So when we're thinking about the context of our collaborative work with other Morgan Stanley sector analysts around trade down risks, what do you hear, Kimberly, about the impact on segments such as household products and restaurants? Kimberly Greenberger: We have found most fascinating, actually, the study of those real high frequency purchases. Because in order to understand how consumer behavior is changing at the margin, we think it's most important to look at what consumers were spending on last week, two weeks ago, three weeks ago as a better indication of what they're likely to spend on for the next three or six months. How that behavior has been changing is that on those of very high frequency purchases like the daily tobacco purchase or the daily food at home purchase, as you mentioned, is that there is trade down from higher priced brands and products into more value oriented brands and products. The same thing is happening in fast food. Another category that we consume on a somewhat more frequent basis than, for example, eating in casual dining restaurants where we're sitting down for a meal. So now we've got a good number of months of evidence that this is, in fact, happening, and that gives us more conviction that it's likely to continue through the second half of the year. So Simeon, in your view, what parts of retail are the likely winners and laggards should this trade down behavior persist and broaden out, particularly if a recession did materialize? Simeon Gutman: So in the event of a recession, I think the typical answers here are a little bit easier to identify. The two big beneficiaries, the channel beneficiaries, would be the dollar slash discount stores and then secondarily, off price. First, the dollar and discount stores, they are already seeing some initial signs of trade down and that is mostly in the consumable area. That is the place where the consumer feels the pinch immediately. The other piece of it is the discretionary spend. The longer these conditions persist, high inflation and potential other pressures on the consumer, then you'll start to see a more pronounced trade down and shift of discretionary purchases. And that's where off price plays a role. Kimberly Greenberger: Simeon, thanks so much for taking the time to talk. Simeon Gutman: Great speaking with you, Kimberly. Kimberly Greenberger: 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.

    Sheena Shah: When will Crypto Prices Find a Bottom?

    Play Episode Listen Later Aug 11, 2022 3:55


    As Bitcoin has been experiencing a steep decline in the last 6 months, investors are beginning to wonder when Cryptocurrencies will finally bottom out and start the cycle anew.Digital assets, sometimes known as cryptocurrency, are a digital representation of a value that function as a medium of exchange, a unit of account, or a store of value, but generally do not have legal tender status. Digital assets have no intrinsic value and there is no investment underlying digital assets. The value of digital assets is derived by market forces of supply and demand, and is therefore more volatile than traditional currencies' value. Investing in digital assets is risky, and transacting in digital assets carries various risks, including but not limited to fraud, theft, market volatility, market manipulation, and cybersecurity failures—such as the risk of hacking, theft, programming bugs, and accidental loss. Additionally, there is no guarantee that any entity that currently accepts digital assets as payment will do so in the future. The volatility and unpredictability of the price of digital assets may lead to significant and immediate losses. It may not be possible to liquidate a digital assets position in a timely manner at a reasonable price.Regulation of digital assets continues to develop globally and, as such, federal, state, or foreign governments may restrict the use and exchange of any or all digital assets, further contributing to their volatility. Digital assets stored online are not insured and do not have the same protections or safeguards of bank deposits in the US or other jurisdictions. Digital assets can be exchanged for US dollars or other currencies, but are not generally backed nor supported by any government or central bank.Before purchasing, investors should note that risks applicable to one digital asset may not be the same risks applicable to other forms of digital assets. Markets and exchanges for digital assets are not currently regulated in the same manner and do not provide the customer protections available in equities, fixed income, options, futures, commodities or foreign exchange markets.Morgan Stanley and its affiliates do business that may relate to some of the digital assets or other related products discussed in Morgan Stanley Research. These could include market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking.-----Transcript-----Welcome to Thoughts on the Market. I'm Sheena Shah, Lead Cryptocurrency Strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, today I address the question everyone seems to be asking about the crypto cycle: when will crypto prices find a bottom? It's Thursday, August 11th, at 5 p.m. in London. After a 75% peak to trough fall in Bitcoin's price between November 2021 and June this year, it seems like almost everyone in the market is asking the same question. When will crypto prices find the bottom? We will discuss three topics related to this question; the pace of new Bitcoin creation, past Bitcoin cycles and dollar liquidity. What can Bitcoin's creation tell us about where we are in the crypto cycle? Bitcoin's relatively short history means there is little available data, and yet the data is quite rich. In its short 12 year history, Bitcoin has experienced at least 10 bull and bear cycles. Bitcoin creation follows a 4 year cycle. Within these 4 year cycles, price action has so far followed three distinct phases. First, there is a rapid and almost exponential rise in price. Second, at a peak in price, a bear market follows. And third, prices move sideways, eventually leading into a new bull market. The question for investors today is, is Bitcoin's price moving out of the second phase and into the third? Only time will tell. There have only been three of these halving cycles in the past, and so it is difficult to conclude that these cycles will repeat in the future. What about past bear markets? The 75% peak to trough fall in Bitcoin's price and this cycle is currently faring better than previous cycles, in which the falls after peaks in 2011, 2013 and 2017 ranged between 85 and 95%. There is, therefore, speculation about whether this cycle has further to drop. Previous cycles have shed similar characteristics. In the bull runs there was speculation about the potential of a particular part of the crypto ecosystem. In 2011, it was the excitement about Bitcoin and the development of ecosystem technologies like exchanges and wallets. In 2020 to 2021, this cycle, there were NFTs, DeFi and the rising dominance of the institutional investor. In previous cycles, the bear runs were triggered by regulatory clampdowns or a dominant exchange being hacked. In 2013, a crackdown in China led to the world's largest exchange at that time, BTC China, stopping customer deposits. In this cycle, the liquidity tap dried up as inflation concerns gripped the market. Central bank liquidity and government stimulus fueled the speculation driven 2020-2022 crypto cycle. For this reason, day to day crypto traders are focusing on what the U.S. Federal Reserve plans to do with its interest rates and availability of dollars. To find a bottom, there are two liquidity related factors to look out for. First, market expectations that central banks will continue to tighten the money supply, turn into expectations that central banks will resume monetary expansion. Second, crypto companies increase appetite to build crypto leverage again. Both of these would increase liquidity and drive a new cycle of speculation. Which brings us back to the question about the bottom of the crypto cycle that almost everyone is asking: are we there yet? To answer that question, look at Bitcoin creation, past cycles and above all, liquidity. Thanks for listening. If you enjoyed Thoughts on the Market, share this and other episodes with a friend or colleague today.

    U.S. Public Policy: Will the Inflation Reduction Act Actually Reduce Inflation?

    Play Episode Listen Later Aug 10, 2022 4:48


    The Senate just passed the Inflation Reduction Act which seeks to fight inflation on a variety of fronts, but the most pressing question is, will the IRA actually impact inflation?-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of U.S. Public Policy Research and Municipal Strategy. Ellen Zentner: And I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Michael Zezas: And on this special episode of Thoughts on the Market, we'll discuss the Inflation Reduction Act, or IRA, with a focus on its impact on the U.S. economic outlook. It's Wednesday, August 10th, at noon in New York. Michael Zezas: So, Ellen, the Senate just passed the Democrats Inflation Reduction Act on a party line vote. And we know this has been a long awaited centerpiece to President Biden's agenda. But let me start with one of the more pressing questions here; from your perspective, does the Inflation Reduction Act reduce inflation? Or maybe more specifically, does it reduce inflation in a way that impacts how the Fed looks at inflation and how markets look at inflation? Ellen Zentner: So for it to impact the Fed today and how the markets are looking at inflation, it really has to show very near term effects here, where the IRA focuses more on longer term effects on inflation. So today we've got recent inflation report that came out this week showing that inflation moved lower, so softened. Especially showing the effects of those lower energy prices, which everyone notices because you go and gas up at the pump and so, you know right away what inflation is doing. And that's led to some more optimism from households. That at least gives the Fed some comfort, right, that they're doing the right thing here, raising rates and helping to bring inflation down. But there's a good deal more work for the Fed to do, and we think they raise rates by another 50 basis points at their September meeting. The rates market also took note of some of the inflation metrics of late that are looking a little bit better. But still, it's not definitive for markets what the Fed will do. We need a couple of more data points over the next few months. So the IRA is just a completely separate issue right now for the Fed and markets because that's going to be in the longer run impact. Michael Zezas: So the bill is constructed to actually pay down the federal government deficit by about $300 billion over 10 years, and conventional wisdom is that when you're reducing deficits, you're helping to calm inflation. Is that still the case here? Ellen Zentner: So it's still the case in general because it means less government debt that has to be issued. But let's put it in perspective, $300 billion deficit reduction spread over ten years is 30 billion a year in an economy that's greater than 20 trillion. And so it's very difficult to see. Michael Zezas: Okay, so the Inflation Reduction Act seems like it helps over the long term, but probably not a game changer in the short term. Ellen Zentner: That's right. Michael Zezas: Let's talk about some of the more specific elements within the bill and their potential impact on inflation over the longer term. So, for example, the IRA extends Affordable Care Act subsidies. It also allows Medicare to negotiate prices for prescription drugs, or at least some prescription drugs, for the first time. How do you view the impacts of those provisions? Ellen Zentner: So these are really the provisions that get at the meat of impacting inflation over the longer run. And I'll focus in on health care costs here. So specifically, drug prices have been quite high. Being able to lower drug prices helps lower income households, that helps older cohorts, and the cost of medical services gets a very large weight in overall consumer inflation and it gets a large weight because we spend so much on it. The other thing I'd note here, though, is that since it allows Medicare to negotiate prices for some drugs for the first time, well, that word negotiate is key here. It takes time to negotiate price changes, and that's why this bill is more something that affects longer run inflation rather than near term. Michael Zezas: Right. So bottom line, for market participants, this Inflation Reduction Act might ultimately deliver on its name. But if you want to understand what the Fed is going to do in the short term and how it might impact the rates markets, better off paying attention to incoming data over the next few months. It's also fair to say there's other market effects to watch emanating from the IRA, namely corporate tax effects and spending on clean energy. Those are two topics we're going to get into in podcasts over the next couple of weeks. Michael Zezas: Ellen, thanks for taking the time to talk. Ellen Zentner: Great speaking 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.

    U.S. Housing: Will New Lending Standards Slow Housing Activity?

    Play Episode Listen Later Aug 9, 2022 6:34


    As lending standards tighten and banks get ready to make some tough choices, how will the housing market fare if loan growth slows? Co-Heads of U.S. Securitized Products Research Jim Egan and Jay Bacow discuss.-----Transcript-----Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of U.S. Securitized Products Research here at Morgan Stanley. Jim Egan: And I'm Jim Egan, the other Co-Head of U.S. Securitized Products Research. Jay Bacow: And on this episode of the podcast, we'll be discussing how tightening lending standards could impact housing activity. It's Tuesday, August 9th, at 11 a.m. in New York. Jim Egan: Now Jay, you published a high level report last week with Vishy Tirupattur, who is the Head of Fixed Income Research here at Morgan Stanley, on the coming capital crunch. Basically, rising capital pressures will mean that banks will have to make tough choices in their lending books. Is that about right? Jay Bacow: Yeah, that's it. Basically, we don't think that markets have really appreciated the impact of the combination of how rising rates caused losses on banks portfolios, the regulatory changes and the results of the stress test capital buffers. All of these things are going to require banks to look at the composition of not just the assets that they own, but their business models in general. Our large cap banking analyst Betsy Graseck thinks that banks are going to look at things differently to come up with different solutions depending on the bank, but in general across the industry, expects lending standards to tighten for this year and in 2023, and for loan growth to slow. So, Jim, if banks are going to tighten lending standards then what does that mean for housing activity? Jim Egan: I think, especially if we look at home sales, that's a negative for sales volumes and home sales are already falling. We've talked about affordability deterioration on this podcast a few times now, not just the fact of where affordability is in the housing market, but how rapidly it's deteriorating. If lending standards are going to tighten on top of those affordability pressures, then that just argues for potentially an even more substantial decrease in sales volumes going forward, and we're already seeing this in the data. Through the first half of the year new home sales are down 14% versus the first half of 2021. Purchase applications, that's our highest frequency data point that we have, they're getting progressively weaker each month. They were down 17% year over year in June, 19% year over year in July. Existing home sales, and that's referencing a much larger volume of sales then new home sales, they're down a comparatively strong 8% year to date. But with all of the dynamics that we're discussing, we believe that they're going to see a much more precipitous drop in the second half of the year. We have it down over 15% year over year versus 2021. Now, that's because of affordability pressures. It's because of the potential for tightening lending standards. It's also because of the lock in effect from a rate perspective. Jay Bacow: On that lock in effect, with just 2% of the market having incentive to refinance, lenders are sitting there and saying, well, what do we do in this environment where we can't just give people a rate refi? Now, you mentioned the purchase activity, that's obviously one area, but Black Knight just reported another quarterly record of untapped equity in the housing market, and consumers would love to be able to tap that. The problem is when you do a cash out refinance, you end up increasing the rate on your entire mortgage. And homeowners don't want to do that. So they'd love to do something like a home equity line of credit or second lien where they're getting charged the higher rate on just the equity they take out. But the problem is it's harder to originate those in an environment where lending standards are tightening, particularly given the capital allocation against those type of loans can be onerous. Jim Egan: Right. And the level of conversations around an increase in kind of the second lien or the hill market have certainly been picking up over the past weeks and months, both on the originator side, on the investor side, as people look to find ways to access that record amount of equity that you mentioned in the housing market. Jay Bacow: Thinking about trying, people are still trying to sell houses and you just commented on the housing activity, but what about the prices they're selling at? Some of the recent data was pretty surprising. Jim Egan: The most recent month of data, I think the point that has raised the most eyebrows was the average or median price of new home sales saw a pretty significant month over month decrease. We continue to see month over month increases in the median and average price of existing home sales at. When we think about average and median prices, there's a mix shift issue there. So month over month, depending on the types of homes that sell things can move. What we actually forecast, the repeat sales index Case-Shiller, we're starting to see a slowdown in growth. The past two months have been consecutive deceleration in the pace of home price growth. I think the thing that we'd highlight most is the growing geographic pervasiveness of the slowdown. Two months ago, 11 of the Case-Shiller 20 city index was showing a deceleration month over month. This past month, it was 16. Now, all 20 cities continue to show home price growth, but again, 16 are showing that pace slowdown. There is some regional specificity to this, the cities that continue to accelerate largely in Florida, Miami and Tampa to name two. Jay Bacow: Okay. So that's what we've seen. What do we expect to see on a go forward basis? Jim Egan: We talked about our expectations for sales a few minutes ago. I think the one thing that we do want to highlight is on the starts front, we think that single unit starts are going to start to decrease over the course of the back half of this year. There's a couple of reasons for that. We talked about affordability pressures, another dynamic that's been playing out in the space is that there's been a backlog not just of housing starts, but before those starts to get the completion units under construction has swollen back to 2004 levels, starts themselves are only at 1997 levels. We do think that that is going to kind of disincentivize starts going forward. We're already starting to see it a little bit in the underlying data, trailing 12 month single unit starts had plateaued for largely a year. They've been down the past two months, we think that they're going to continue to fall in the back half of this year. It's already playing through from a sentiment perspective, homebuilder confidence is down 39% from its peak in November of 2020, and that's being driven by their perception of traffic on their sites as well as their perception of future sales conditions. So we do think that starts are going to fall because a number of these dynamics. And we think that home price growth is going to remain positive and we've highlighted this on this podcast before, but the pace is going to start slowing pretty materially in the back half of this year. The most recent print was 19.7%, down from over 20%, but we think it gets all the way to 9% by December 2022, 3% by December 2023. So continued home price growth, but the pace is going to slow pretty materially. Jim Egan: Jay, thanks for taking the time to talk. Jay Bacow: Jim. Always a pleasure. Jim Egan: 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 colleague today.

    Josh Pokrzywinski: Deflationary Opportunities

    Play Episode Listen Later Aug 8, 2022 3:59


    While inflation remains high and the battle to bring it down is top of mind, there may be some opportunities in technologies that could help bring down inflation in some sectors.-----Transcript-----Welcome to Thoughts on the Market. I'm Josh Pokrzywinski, Morgan Stanley's U.S. Electrical Equipment and Multi-Industry Analyst. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about deflationary opportunities in this high inflation environment. It's Monday, August 8th, at 4 p.m. in New York. As most listeners no doubt know, the battle to bring down inflation is the topic of 2022. But today I want to talk about inflation from a slightly different perspective, and that's how automation and productivity enhancing technologies could actually help bring down inflation in areas such as labor, supply chain procurement and energy. And while these technologies require capital investment, something that's often difficult when the economy is uncertain, we believe structural changes in demographics, energy policy and security, and an aging capital base make technologies focused on cost reductions and productivity actually more valuable. So for investors focusing on stocks that enable productivity and cost reduction through automation, efficiency, or their own declining cost curves while maintaining strong barriers to entry and attractive equity risk/reward, is something to consider. To dig into this, the U.S. Equity Strategy Team and equity analysts across the spectrum at Morgan Stanley Research created a deflation enabler shopping list. And that list is composed of stocks that produce tangible cost savings for their customers, where costs themselves are rising due to inflation, such as labor and energy, or scarcity, for example semiconductors or materials. In many cases, the cost of the product itself has also come down through technology or economies of scale, benefitting the purchaser and therefore adoption on both lower cost to implement and higher cost avoidance through use. So where should investors look? Although there are a number of deflationary companies across areas such as automation and semiconductors, we identified three major deflationary technologies which permeate across sectors and which are at long term inflection points in their importance for both enterprise and consumer. The first is artificial intelligence or AI. AI is proving relentless and increasingly deflationary. In biotech, AI could shorten development timelines, lower R&D spend and improve probability of success. The second is clean energy. My colleague Stephen Burd, who covers clean energy and utilities, has pointed out that against the backdrop of inflationary fossil fuels and utility bills, companies with deflationary clean energy technologies and high barriers to entry will be able to grow rapidly and generate increasing margins. And finally, mass energy storage and mobility. Although the cost of batteries have been falling for some time, competition in the space has led to heightened investment. In addition, ambitious top down government emissions goals have facilitated an exponential uplift in demand for batteries and their component raw materials. Although supply chains for batteries remain immature, battery storage technology is only beginning to have profound effects on society mobility, inclusivity and ultimately climate. As investment by automakers rises along with generous European subsidies aimed at staying competitive with U.S. and Chinese investment, the supply chain and innovation in new battery technologies such as solid state mean that the price should continue to fall as innovation and demand rise. This is extended beyond the personal vehicle market, with the cost savings and efficiency improvements driving profound changes and improvements in the range and cost of heavy duty and long haul trucking EV, and ultimately autonomous, markets. To sum up, in an inflationary world we believe companies that have developed deflationary products and services will become increasingly valuable, as long as they have significant barriers to entry with respect to those products and services. 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: What Can We Learn from Market Prices?

    Play Episode Listen Later Aug 6, 2022 3:13


    The current market pricing can tell investors a lot about what the market believes is coming next, but the future is uncertain and investors may not always agree with market expectations. Chief Cross-Asset Strategist Andrew Sheets explains.--- 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, August 5th, at 2 p.m. in London.Trying to predict where financial markets will go is difficult. The future, as they say, is uncertain, and even the most talented investors and forecasters will frequently struggle to get these predictions right.A different form of this question, however, might be easier. What do markets assume will happen? After all, these assumptions are the result of thousands of different actors, most of which are trying very hard to make accurate predictions about future market prices because a lot of money is on the line. Not only is there a lot of information in those assumptions, but understanding them are table stakes for a lot of investment strategy. After all, if our view only matches what is already expected by the market to happen, it is simply much less meaningful.Let's start with central banks, where current market pricing can tell us quite a bit. Markets expect the Fed to raise rates by another 100 basis points between now and February to about three and a half percent. And then from there, the Fed is expected to reverse course, reducing rates by about half a percent by the end of 2023. Meanwhile, the European Central Bank is expected to raise rates steadily from a current level of 0 to 1.1% over the next 12 months.Morgan Stanley's economists see it differently in both regions. In the U.S., we think the Fed will take rates a little higher than markets expect by year end and then leave them higher for longer than markets currently imply. In the U.S., we think the Fed will take rates higher than markets expect by year end and then leave them higher for longer than is currently implied. In Europe, it's the opposite. We think the ECB will raise rates more slowly than markets imply. The idea that the Fed may do more than expected while the ECB does less is one reason we forecast the US dollar to strengthen further against the euro.A rich set of future expectations also exists in the commodity market. For example, markets expect oil prices to be about 10% lower in 12 months time. Gasoline is priced to be about 15% lower between now and the end of the year. The price of gold, in contrast, is expected to be about 3% more expensive over the next 12 months.I'd stress that these predictions are not some sort of cheat code for the market. The fact that oil is priced to decline 10% doesn't mean that you can make 10% today by selling oil. Rather, it means that foreign investor, a 10% decline in oil, or a 3% rise in gold will simply mean you break even over the next 12 months.Again, all of this pricing informs our views. We forecast oil to decline less and gold to decline more than market prices imply. Meanwhile, Morgan Stanley equity analysts can work backwards looking at what these commodity expectations would mean for the companies that produce them. We won't get into that here, but it's yet another way that we can take advantage of information the market is already giving us.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.

    Michael Zezas: The U.S. and China, a History of Competition

    Play Episode Listen Later Aug 4, 2022 2:42


    As investors watch to see if tensions between the U.S. and China will escalate, it's important to understand the underlying competitive dynamic and how U.S. policy may have macro impacts.--- Transcript ---Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public pPolicy 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 Thursday, August 4th, at 1 p.m. in New York.This week, Speaker of the House Nancy Pelosi's Asia trip had the attention of many investors as they watched to see whether her actions would escalate tensions between the U.S. and China. In our view, though, this event wasn't a potential catalyst for tensions, but rather evidence of tensions that persist between the two global powers. Hence, we think investors are better served focusing on the underlying dynamic rather than any particular event.The U.S.-China rivalry has many complicated causes, many of which we've covered on previous podcasts. But the point we want to reemphasize is this; this rivalry is going to persist. China is interested in asserting its global influence, which in ways can be at odds with how the U.S. and Europe want the international economic system to function. Nowhere is this clearer than in the policies the U.S. has adopted in recent years aimed at boosting its competitiveness with China.The latest is the enactment of the Chips Plus Bill, which allocates over $250 billion to help US industries, in particular the semiconductor industry, to devolve its supply chain reliance on China for the purposes of economic security and to protect sensitive technologies. Policies like this have more of a sectoral effect than the macro one. But the primary market impact here being a defraying of rising costs for the semiconductor industry. But investors should be aware that there's potential policy changes on the horizon that could have macro impacts. For example, Congress considered creating an outbound investment restriction mechanism in that Chips Plus bill. Such a restriction could have significantly interrupted foreign direct investment in China with substantial consequences for China equity markets.That provision didn't make it into this bill, and with little legislative time between now and the midterm elections, it's unlikely to resurface this year. That's cause some to conclude that it's likely to be years before such a provision could become enacted, particularly if Republicans take back control of one or both chambers of Congress creating a risk of gridlock.But we'd caution that's too simple of a conclusion. The concept of outbound investment restrictions enjoys bipartisan support. So we think investors should be on guard for this provision to get serious consideration in 2023. We'll, of course, track it and keep you informed.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.

    Matthew Hornbach: The Fed Pivot That Wasn't Quite As It Seemed

    Play Episode Listen Later Aug 3, 2022 3:39


    After the July FOMC meeting, markets took a quick dive and then made an immediate recovery, so what happened?-----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, August 3rd, at 1 p.m. in New York. In the weeks since the July meeting of the Federal Open Market Committee, or FOMC, rates and currency markets have made quite the round trip. Treasury yields from 2 out to10 year maturities fell by over 25 basis points in the three days that followed the meeting. And the U.S. dollar index declined by 2% over the same period. However, looking at these markets today, as I sit here recording this podcast, it's almost as if the July FOMC meeting didn't happen. 10 year Treasury yields are about where they were going into the meeting last week, and 2 year yields are a bit higher even. As for the U.S. dollar index, it's back to the range it was in ahead of the meeting. So what happened? Going into the meeting, investors thought that the Fed would deliver a 75 basis point rate hike, but recognized that there was a tail risk of a larger 100 basis point hike. And even if the tail risk didn't materialize, investors had acknowledged that the additional 25 basis points might be delivered in September instead. And that would make for the third 75 basis point hike in this cycle. In short, investors were positioned for a hawkish outcome. The FOMC statement and Chair Powell's prepared remarks didn't disappoint. The message was on par with what FOMC participants had been saying over recent weeks and months. Inflation is still top of mind, and more work is needed to bring it down to acceptable levels. If the meeting ended with Powell's prepared remarks, rates and currencies would have likely taken a different path to where they trade today. However, the meeting didn't end there, and the Q&A session of Powell's press conference struck a more dovish tone. Three messages contributed to this interpretation. First, Powell suggested that rates had achieved a neutral setting, or one that neither puts upward nor downward pressure on economic activity relative to its potential. Second, he said that because a neutral policy setting had been reached, the pace of subsequent rate hikes could soon begin to slow. And finally, he suggested that the committee's view of the peak policy rate in the cycle hadn't changed since the last FOMC meeting, even though inflation data since then continued to surprise on the higher side. The reason for this seemed to be focused on the deterioration in activity data or growth data. In many ways, investors should have expected these statements from Powell, given guidance coming from the June summary of economic projections. In addition, because Fed policy had tightened financial conditions this year, and those financial conditions helped slow economic growth, the case for a less hawkish performance might have been predictable. The data that arrived in the wake of the meeting underscored the recent themes of slower growth and higher inflation. But the Fedspeak that arrived in the wake of the data, well, it continued to focus on inflation, as it had done before the Fed met in July. Where does all of that leave the Fed on policy and us on markets? Well, the Fed's job bringing inflation down hasn't yet been accomplished, the bond market is pricing less policy tightening than the Fed is last guided towards, and downside risks to global growth are rising. As a result, we remain neutral on bond market duration, but remain bullish on the U.S. dollar, particularly against the euro. 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.

    Pharmaceuticals: The Global Obesity Challenge

    Play Episode Listen Later Aug 3, 2022 7:51


    As studies begin to show that obesity medications may save lives, will governments and insurances begin to consider them preventative primary care? And how might this create opportunity in pharmaceuticals? Head of European Pharmaceuticals Mark Purcell and Head of U.S. Pharmaceuticals Terence Flynn discuss.-----Transcript-----Mark Purcell: Welcome to Thoughts on the Market. I'm Mark Purcell, Head of Morgan Stanley's European Pharmaceuticals Team. Terence Flynn: And I'm Terence Flynn, Head of the U.S. Pharmaceuticals Team. Mark Purcell: And on this special episode of Thoughts on the Market, we'll be talking about the global obesity challenge and our outlook for the next decade. It's Tuesday, August the 2nd, and it's 1 p.m. in London. Terence Flynn: And 8 a.m. in New York. Terence Flynn: So Mark, more than 650 million people worldwide are living with obesity as we speak. The personal, social and economic costs from obesity are huge. The World Health Organization estimates that obesity is responsible for 5% of all global deaths, which impacts global GDP by around 3%. Obesity is linked to over 200 health complications from osteoarthritis, to kidney disease, to early loss of vision. So tackling the obesity epidemic would impact directly or indirectly multiple sectors of the economy. Lots to talk about today, but let's start with one of the key questions here: why are we talking about all this now? Are we at an inflection point? And is the obesity narrative changing? Mark Purcell: Yeah Terence look, there's a category of medicine called GLP-1's which have been used to treat diabetes for over a decade. GLP-1 is an appetite suppressing hormone. It works on GLP-1 receptors, you could think of these as hunger receptors, and it helps to regulate how much food our bodies feel they need to consume. Therefore, these GLP-1 medicines could become an important weapon in the fight against obesity. The latest GLP-1 medicines can help individuals who are obese lose 15 to 20% of their body weight. That is equivalent to 45 to 60% of the excess weight these individuals carry in the form of fat which accumulates around the waist and important organs in our bodies such as the liver. There is a landmark obesity study called SELECT, which has been designed to answer the following key question: does weight management save lives? An interim analysis of this SELECT study is anticipated in the next two months, and our work suggests that GLP-1 medicines could deliver a 27% reduction in the risk of heart attacks, strokes and cardiovascular deaths. We believe that governments and insurance companies will broaden the reimbursement of GLP-1 medicines in obesity if they are proven to save lives. This comes at a time when new GLP-1 medicines are becoming available with increasing levels of effectiveness. It's an exciting time in the war against obesity, and we wanted to understand the implications of the SELECT study before it reads out. Terence Flynn: So, our collaborative work suggests that obesity may be the new hypertension. What exactly do we mean by that, Mark? How do we size the global opportunity and what's the timeline here? Mark Purcell: Back in the 1960s and 1970s, hypertension was seen as a lifestyle disease caused by stress and old age. Over time, it was shown that high blood pressure could be treated, and in doing so, doctors could prevent heart attacks and save lives. A new wave of medicines were introduced to the market in the mid 1980s to treat individuals with high blood pressure and doctors found the most effective way to treat high blood pressure was to use combinations of these medicines. By the end of the 1990's, the hypertension market reached $30 billion in sales, that's equivalent to over $15 billion today adjusting for inflation. Obesity is seen by many as a lifestyle disease caused by a lack of self-control when it comes to eating too much. However, obesity is now classified as a preventable chronic disease by medical associations, just like hypertension. Specialists in the obesity field now recognize that our bodies have evolved over hundreds of thousands of years to put on weight, to survive times where there is a lack of food available and a key way to fight obesity is to reset the balance of how much food our bodies think they need. With the availability of new, effective obesity medicines, we believe that obesity is on the cusp of moving into mainstream primary care management. And the obesity market is where the treatment of high blood pressure was in the mid to late 1980s. We built a detailed obesity model focusing on the key bottlenecks, patient activation, physicians engagement and payer recognition. And we believe that the obesity global sales could exceed $50 billion by the end of this decade. Terence Flynn: So Mark, what are the catalysts aligning to unlock the potential of this $50 billion obesity opportunity? Mark Purcell: We believe there are full catalysts which should begin to unlock this opportunity over the next six months. Firstly, the SELECT study, which we talked about. It could be stopped early in the next two months if GOP P1 medicines are shown overwhelmingly to save lives by reducing excess weight. Secondly, the demand for GLP-1 medicines to treat obesity was underappreciated by the pharmaceutical industry. But through the second half of this year, GLP-1 medicines, supply constraints will be addressed and we'll be able to appreciate the underlying patient demand for these important medicines. Thirdly, analysis shows that social media is already creating a recursive cycle of education, word of mouth and heightened demand for these weight loss medicines. Lastly, diabetes treatment guidelines are actively evolving to recognize important comorbidities, and we expect a greater emphasis on weight treatment goals by the end of this year. Terence Flynn: Mark, you mentioned some bottlenecks with respect to the obesity challenge. One of those was patient activation. What's the story there and how does social media play into it? Mark Purcell: Yes, great question Terence, look it's estimated that less than 10% of individuals suffering from obesity are diagnosed and actively managed by doctors. And that compares to 80 to 90% of individuals who suffer from high blood pressure, or diabetes, or high levels of cholesterol. Once patients come forward to see their doctors, 40% of them are treated with an anti-obesity medicine. And as more effective medicines become available, we just think this percentage is going to rise. Lastly, studies designed to answer the question, what benefit does 15 to 20% weight loss deliver in terms of reducing the risk of high blood pressure, diabetes, kidney disease and cardiovascular disease? Will help activate governments and insurance companies to reimburse obesity medicines. But it all starts with individuals suffering from obesity coming forward and seeking help, and this is where we expect social media to play a really important key role. Terence Flynn: To a layperson, there's significant overlap between diabetes and obesity. How do we conceptualize the obesity challenge vis a vis diabetes, Mark? Mark Purcell: Terence, you're absolutely right. There is significant overlap between diabetes and obesity and it makes it difficult and complicated to model. It's estimated that between 80 to 85% of diabetics are overweight. It's estimated that 35% of diabetics are obese and around 10% of diabetics are severely obese. GLP-1 medicines have been used to treat diabetes for over a decade, not only being extremely effective in lowering blood sugar, but also in reducing the risk of cardiovascular events like heart attacks and removing excess body weight, which is being recognized as increasingly important. This triple whammy of benefit means that the use of GLP-1 medicines is increasing rapidly, and sales in diabetes are expected to reach over $20 billion this year, compared to just over $2 billion in obesity. By the end of the decade our work suggests that the use of GLP-1 based medicines in obesity could exceed the use in diabetes by up to 50%. Terence Flynn: Mark, thanks for taking the time to talk. Mark Purcell: Great speaking with you again, Terrence. Terence Flynn: 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 colleague today.

    Mike Wilson: Are Recession Risks Priced in?

    Play Episode Listen Later Aug 1, 2022 4:01


    As the Fed continues to surprise with large and fast interest rate increases, the market must decide, has the Fed done enough? Or is the recession already here?-----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, August 1st at 11 a.m. in New York. So let's get after it. Over the past year, the Fed has come under scrutiny for their outlook on inflation, and they've even admitted themselves that they misjudged the call when they claimed inflation would be transient. In an effort to regain its credibility, the Fed has swiftly pivoted to its most hawkish policy action since the 1980s. In fact, while we may have been the most hawkish equity strategists on the street at the beginning of the year, we never expected to see this many rate hikes in 2022. Suffice it to say, it hasn't gone unnoticed by markets with both stocks and bonds off to their worst start in many decades. However, since peaking in June, 10 year Treasuries have had one of their largest rallies in history, with the yield curve inverting by as much as 33 basis points. Perhaps more importantly, market based five year inflation expectations have plunged and now sit very close to the Fed's long term target of 2%. Objectively speaking, it appears as though the bond market has quickly turned into a believer that the Fed will get inflation under control. This kind of action from the Fed is bullish for bonds, and one of the main reasons we turned bullish on bonds relative to stocks back in April. Since then, bonds have done better than stocks, even though it's been a flat ride in absolute terms. It also explains why defensively oriented stocks have dominated the leadership board and why we are sticking with it. Meanwhile, stocks have rallied with bonds and are up almost 14% from the June lows. The interpretation here is that the Fed has inflation tamed, and could soon pause its rate hikes, which is usually a good sign for stocks. However, in this particular cycle, we think the time between the last rate hike and the recession will be shorter, and perhaps after the recession starts. In technical terms, a recession has already begun with last week's second quarter GDP release. However, we don't think a true recession can be declared unless the unemployment rate rises by at least a few percentage points. Given the deterioration in profit margins and forward earnings estimates, we think that risk has risen considerably as we are seeing many hiring freezes and even layoffs in certain parts of the economy. This has been most acute in industries affected by higher costs and interest rates and where there's payback in demand from the binge in consumption during the lockdowns. In our conversations with clients over the past few weeks, we've been surprised at how many think a recession was fully priced in June. While talk of recession was rampant during that sell off, and valuations reached our target price earnings ratio of 15.4x, we do not think it properly discounted the earnings damage that will entail if we are actually in a recession right now. As we have noted in that outcome, the earnings revisions which have begun this quarter are likely far from finished in both time or level. Our estimate for S&P 500 earnings going forward in a recession scenario is $195, which is likely to be reached by the first quarter of 2023. Of course, we could still avoid a recession defined as a negative labor cycle, or it might come later next year, which means the Fed pause can happen prior to the arrival of a recession allowing for that bullish window to expand. We remain open minded to any outcome, but our analysis suggests betting on the latter two outcomes is a risky one, especially after the recent rally. The bottom line, last month's rally in stocks was powerful and has investors excited that the bear market is over and looking forward to better times. However, we think it's premature to sound the all-clear with recession and therefore earnings risk is still elevated. For these reasons, we stayed defensively oriented in our equity positioning for now and remain patient with any incremental allocations to stocks. 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.

    Andrew Sheets: Is 60:40 Diversification Broken?

    Play Episode Listen Later Jul 29, 2022 4:10


    One of the most common standards for investment diversification, the 60:40 portfolio, has faced challenges this year with significant losses and shifting correlations between stocks and bonds. Is this the end of 60:40 allocation?---- 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, July 29th, at 2 p.m. in London.The so-called 60:40 portfolio is one of the most common forms of diversified investing, based on the idea of holding a portfolio of 60% equities and 40% high-quality bonds. In theory, the equities provide higher returns over time, while the high-quality bonds provide ballast and diversification, delivering a balanced overall portfolio. But recently, we and many others have been talking about how our estimates suggested historically low returns for this 60:40 type of approach. And frequently these estimates just didn't seem to matter. Global stocks and bonds continued to hum away nicely, delivering unusually strong returns and diversification.And then, all at once, those dour, long term return estimates appeared to come true. From January 1st through June 30th of this year, a 60:40 portfolio of U.S. equities and the aggregate bond index lost about 16% of its value, wiping out all of the portfolio's gains since September of 2020. Portfolios in Europe were a similar story. These moves raise a question: do these large losses, and the fact that they involved stock and bond prices moving in the same direction, mean that diversified portfolios of stocks and bonds are fundamentally broken in an era of tighter policy?Now, one way that 60:40 portfolios could be broken, so to speak, is that they simply can't generate reasonable returns going forward. But on our estimates, this isn't the case. Lower prices for stocks and higher yields on bonds have raised our estimate for what this type of diversified portfolio can return. Leaving those estimates now near the 20-year average.A bigger concern for investors, however, is diversification. The drawdown of 60:40 portfolios this year wasn't necessarily extreme for its magnitude—2002 and 2008 saw larger losses—but rather its uniformity, as both stocks and bonds saw unusually large declines.These fears of less diversification have been given a face, the bond equity correlation. And the story investors are afraid of goes something like this. For most of the last 20 years, bond and equity returns were negatively correlated, moving in opposite directions and diversifying each other. But since 2020, the large interventions of monetary policy into the market have caused this correlation to be positive. Stock and bond prices are now moving in the same direction. The case for diversification is over.This is a tempting story, and it is true that large central bank actions since 2020 have caused stocks and bonds to move together more frequently. But I think there's also a risk of confusing direction and magnitude. Bonds can still be good portfolio diversifiers, even if they aren't quite as good as they've been before.Even if stocks and bonds are now positively correlated, that correlation is still well below 1 to 1. That means there are still plenty of days where they don't move together, and this can matter significantly for how a portfolio behaves, and how diversification is delivered, over time.Another important case for 60:40 style diversification is volatility. Even after one of the worst declines for bond prices in the last 40 years, the trailing one-year volatility of the US aggregate bond index is about 6%. That is one third the volatility of U.S. stocks over the same period. Having 40% of a portfolio in something with one third of the volatility should dampen overall fluctuations. For all these reasons, we think the case for a 60:40 style approach to diversified investing remains.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.

    Andrew Sheets: Big Moves From The Fed

    Play Episode Listen Later Jul 28, 2022 3:25


    Yesterday, the U.S. Federal Reserve raised interest rates by another 75 basis points. What is driving these above average rate hikes and what might the effect on markets be?-----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, July 28th at 4 p.m. in London. Yesterday, the Federal Reserve raised rates by 75 basis points, and the Nasdaq market index had its best day since April of 2020, rising over 4%. It was a day of big moves, but also some large unanswered questions. A 75 basis point rise in Fed funds is large and unusual. In the last 30 years, the Fed has only raised rates by such a large increment three times. Two of those instances were at the last two Federal Reserve meetings, including the one we had yesterday. These large moves are happening because the Fed is racing to catch up with, and get ahead of, inflation, which is currently running at about 9% in the U.S. In theory, higher fed rate should slow the economy and cool inflationary pressure. But that theory also assumes that higher rates work with a lag, perhaps as long as 12 months. There are a couple of reasons for this, but one is that in theory, higher rates work by making it more attractive to save money rather than spend it today. Well, I checked my savings account today and let's just say the rate increases we've had recently haven't exactly shown up. So the incentives to save are still working their way through the system. This is part of the Fed's predicament. In hockey terms, they're trying to skate the proverbial puck, aiming policy to where inflation and the economy might be in 12 months time. But both inflation and their policy changes are moving very fast. This is not an easy thing to calibrate. Given that difficulty, why did the markets celebrate yesterday with both stock and bond prices rising? Well, the Fed was vague about future rate increases, raising market hopes that the central bank is closer to finishing these rate rises and may soon slow down, or pause, its policy tightening as growth and inflation slow. After all, long term inflation expectations have fallen sharply since the start of May, perhaps suggesting that the Fed has done enough. And as my colleague Michael Wilson, Morgan Stanley's chief investment officer and chief U.S. equity strategist, noted on Monday's podcast, markets have often seen some respite when the Fed pauses as part of a hiking cycle. But it's also important to stress that the idea that the Fed is now nearly done with its actions seems optimistic. The last two inflation readings were the highest U.S. inflation readings in 40 years, and Morgan Stanley's economists expect core inflation, which is an important measure excluding things like food and energy, to rise yet again in August. In short, the Fed's vagueness of future increases could suggest an all important shift. But it could also suggest genuine uncertainty on growth, inflation and how quickly the Fed's actions will feed through into the economy. The Fed has produced some welcome summer respite, but incoming data is still going to matter, significantly, for what policy looks like at their next meeting in September. 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.

    Michael Zezas: Midterms Remain a Market Factor

    Play Episode Listen Later Jul 27, 2022 2:17


    While midterm polls have shown a preference for republican candidates, this lead is narrowing as the election grows closer, and the full ramifications of this ever evolving race remain to be seen.-----Transcript-----Welcome the 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, July 27th, at 1 p.m. in New York. We're still months away from the midterm elections, and polls still show strong prospects for Republicans to win back control of Congress. As we previously discussed, such an outcome could result in stalling key policy variables for markets such, as tax changes and regulations for tech and cryptocurrency. But remember not to assume that such an outcome is a sure thing. Take, for example, recent polls showing voters' preference for Republican congressional candidates over Democrats actually narrowing. A month ago, the average polling lead for Republicans was nearly 3%, it's now closer to 0.5%. Some independent forecasting models even now show the Democrats as a slight favorite to hold the Senate, even as they assess Democrats are unlikely to keep control of the House. The reasons for Democrats' improvement in the polls are up for debate, but that's not the point for investors. In our view, the point is that the race is still evolving and that can have market ramifications. Even if Democrats don't ultimately keep control of Congress, making it a closer race means markets may have to account for a higher probability that certain policies get enacted. Take corporate tax hikes, for example. Recent news suggests they're off the table, but if Democrats hold Congress, it's likely they'd be revisited as a means of funding several of their preferred initiatives. That could pressure a U.S. equity market already wary of margin pressures from inflation and slowing growth. A more constructive example is the clean tech sector. Again, reports are that the plan to allocate money to clean energy is off the table, but this could be revisited if Democrats keep control. Hence, improved Democratic prospects could benefit the sector ahead of the election. The bottom line is that the midterm elections are still a market factor over the next few months. We'll keep you in the loop right here about how it all plays out. 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.

    Jorge Kuri: Buy Now, Pay Later in Latin America

    Play Episode Listen Later Jul 26, 2022 3:42


    As young, digitized consumers have popularized the “Buy Now, Pay Later” payment system across global markets, there may yet be related market opportunities in Latin America.-----Transcript-----Welcome to Thoughts on the Market. I'm Jorge Kuri, Morgan Stanley's Latin America Financials Analyst. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the rise of Buy Now, Pay Later, or BNPL, in Latin America. It's Tuesday, July 26th, at 2 p.m. in New York. As many of you no doubt remember, the COVID lockdowns of 2020 and 2021 were boom times for e-commerce, as quarantines made us all habitual online shoppers. This period also helped fuel the Buy Now, Pay Later payment method, which allows online shoppers the ability to make a purchase and defer payments over several installments with no fees or interest when paid on time. Buy Now, Pay Later first gained traction in New Zealand and Australia, then in Europe and most recently in the U.S. and now BNPL could offer a vast market opportunity in Latin America. In fact, we see volumes reaching $23 billion in Mexico and $21 billion in Brazil by 2026. So let's take a closer look at why. BNPL in Latin America is driven by a number of secular tailwinds, starting with favorable demographics: BNPL appeals to young, digitalized consumers who fuel the electronification of payments and e-commerce. Combine that with low credit penetration, growing consumer awareness and merchant acceptance, and you have a recipe for strong and sustainable multi-year growth. Mexico and Brazil offer the most attractive market opportunities within Latin America. In Mexico, the population is very young and digitalized - 65% is 39 years old or younger, and smartphone penetration among individuals 18 to 34 years is 83%. Yet the population of unbanked adults is quite large, 51% do not have a bank account and 80% do not have a credit card. Digitalization of payments is a big tailwind, as cash remains by far the most frequently used payment method, while e-commerce penetration is expected to double and reach 20% by 2026.In Brazil, the situation is a bit different. Similar to Mexico, the population is young and digitalized. But in contrast, credit penetration is higher in Brazil, with 75% of households utilizing at least one form of credit and one or more credit cards. The ubiquity and effectiveness of PIX, the instant payments ecosystem in Brazil, combined with the large and fast growing e-commerce industry and the boom in fintech companies, could facilitate the distribution and acceptance of BNPL in the country.It's worth noting that the BNPL opportunity does not come without risks. Delinquency risk is obvious given the unsecured nature of the product, adverse selection risks and a challenging macroeconomic environment. Most BNPL providers have some funding disadvantages and competition among both BNPL players and incumbent banks will likely ensue. Despite these various risks, BNPL remains one of the most significant multi-year trends to watch in Latin America financials. Thanks for listening. If you enjoy this 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.