Thoughts on the Market

Our Head of Corporate Credit Research explains why leveraged loans would benefit if bumpy inflation data leads the Federal Reserve to delay interest rate cuts.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I’ll be talking about the ramifications of the fed rate cuts, and what it could mean for credit – and what would benefit if rates stay higher for longer. It's Friday, March 15th at 2pm in London.

The big story in markets this week was inflation. U.S. Consumer Price inflation continues to moderate on a year-over-year basis, but the recent path has been bumpier than expected. 

And as U.S. Economic growth in the first quarter continues to track above initial expectations, there’s growing debate around whether the U.S. economy is still too strong to justify the Federal Reserve lowering rates.

Morgan Stanley’s economic base case is that these inflation readings will remain bumpy – but will trend lower over the course of the year. And if we couple that with our expectations that job growth will moderate, we think this still supports the idea that the Federal Reserve will start to lower interest rates starting in June.

Yet the bumpiness of this recent data does raise questions. What if the Federal Reserve lowers rates later? Or what if they lower rates less than we expect?

For credit, we think the biggest beneficiary of this scenario would be leveraged loans. For background, these represent lending to below-investment grade borrowers, similar to the universe for high yield bonds. But loans are floating rate; their yields to investors rise and fall with central bank policy rates.

Coming into 2024, there were a number of concerns around the levered loan market. Worries around growth had led markets at the start of the year to imply significant rate cuts from the Fed. And that’s a double whammy, so to speak, for loans; as loans are both economically sensitive to that weaker growth scenario and would see their yields to investors decline faster if there are more rate cuts. Meanwhile, an important previous buyer of loans, so-called Collateralized Loan Obligations, or CLOs, had been relatively dormant.

Yet today many of those factors are all looking better. Estimates for US 2024 GDP growth have been creeping up. CLO activity has been restarting. And some of this recent growth and inflation data means that markets are now expecting far fewer rate cuts – which means that the yield on loans would also remain higher for longer. And that’s all happening at a time when the spread on loans is relatively elevated, relative to similar fixed rate high yield bonds.

A question of whether or not U.S. inflation will be sticky remains a key debate. While we think inflation resumes its improvement, we like leveraged loans as a high yielding, floating rate instrument that has a number of key advantages – if rates stay higher, for longer, than we expect.

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. 

Morgan Stanley’s chief economists have their quarterly roundtable discussion, focusing on the state of inflation across global regions, the possible effect of the US election on the economy and more.

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Seth Carpenter: Welcome to Thoughts On the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. On this episode, on this special episode of the podcast, we'll hold our second roundtable discussion covering Morgan Stanley's global economic outlook as we look into the second quarter of 2024.

It's Thursday, March the 14th at 10 am in New York.

Jens Eisenschmidt: And it's 2 pm in London.

Chetan Ahya: And 10pm in Hong Kong.

Seth Carpenter: Excellent. So, things around the world have changed significantly since our roundtable last quarter. US growth is notably stronger with few signs of a substantial slowdown. Inflation is falling, but giving some hints that things could stay -- maybe -- hotter for longer.

In Europe, things are evolving mostly as anticipated, but energy prices are much lower, and some data suggest hope for a recovery. Meanwhile, in China, debt deflation risks are becoming a reality. And the last policy communication shows no sign of reflation. And finally, Japan continues to confirm the shift in equilibrium, and we are expecting the policy rate change imminently.

So, let's dig into these developments. I am joined by the leaders of the economics team in key regions. Ellen Zentner is our Chief US Economist, and she's here with me in New York. Chetan Ahya is our Chief Asia Economist, and Jens Eisenschmidt is our Chief Europe Economist.

Ellen, I'm going to start with you and the US. Have the stronger data fundamentally changed your view on the US economy or the Fed?

Ellen Zentner: So, coming off of 2023, growth was just stronger than expected. And so, carrying that into 2024, we have revised upward our GDP forecast from 1.6 per cent Q4 over Q4 to 1.8 per cent. So already we've got stronger growth this year. We have not changed our inflation forecast though; because this could be another year of stronger data coming from supply side normalization, and in particular the labor market -- where it's come amid higher productivity and decelerating inflation. So, I think we're in store for another year like that. And I would say if I add risks, it would be risk to the upside on growth.

Seth Carpenter: Okay, that makes sense. But if there's risk to the upside on growth -- surely there's some risk that the extra strength in growth, or even some of the slightly stronger inflation that we've seen, that all of that could persist; and the Fed could delay their first cut beyond the June meeting, which is what you've got penciled in for the first cut. So how do you think about the risks to the timing for the Fed?

Ellen Zentner: So, I think you've got a strong backdrop for growth. You've got relatively easy financial conditions. And Fed policymakers have noted that that could pose upside risks to the economy and to inflation. And so, they're very carefully parsing every data point that comes in. Chair Powell said they need a bit more confidence on inflation coming down. And so that means that the year over year rate on core PCE -- their preferred measure of inflation -- needs to continue to take down.

I think that the risk is more how long they stay on hold -- than if the next move is a hike, which investors have been very focused on. Do we get to that point? And so certainly if we don't see the next couple of months and further improvement, then I think it just does lead for a longer hold time for the Fed.

Seth Carpenter: All right. A risk of a longer hold time. Chetan, how do you think about that risk?

Chetan Ahya: That risk is important to consider. We recently published on the idea that Asian central banks will have to wait for the Fed. Even though inflation across Asia is settling back into target ranges, central banks appear to be concerned that real rate differentials versus US are negative and still widening, keeping Asian currencies relatively weak.

This backdrop means that central banks are still concerned about future upside to inflation and that it may not durably stay within the target. Finally, growth momentum in Asia excluding China has been holding up despite the move in higher real rates -- allowing central banks more room to be patient before cutting rates.

Seth Carpenter: I got it. Okay, so Jens, what about for the ECB? Does the same consideration apply if the Fed were to delay its cutting cycle?

Jens Eisenschmidt: I'm glad you're asking that question, Seth, because that's sort of the single most asked question by our clients. And the answer is, well, yes and no. In our baseline, first of all, to stress this, the ECB cuts before the Fed, if only by a week. So, we think the ECB will go on June 6th to be precise. And what we have heard, last Thursday from the ECB meeting exactly confirms that point. The ECB is set to go in June, barring a major catastrophe on growth or disappointments on inflation.

I think what is key if that effect cuts less than what Ellen expects currently; the ECB may also cut less later in the year than we expect.

So just to be precise, we think about a hundred basis points. And of course, that may be subject to downward revision if the Fed decides to go later. So, it's not an idle or phenomenon. It's rather a rather a matter of degree.

Seth Carpenter: Got it. Okay, so that's really helpful to put the, the Fed in the context of global central banks. But, Ellen, let me come back to you. If I'm going to look from here through the end of the year, I trip over the election. So, how are you thinking about what the US election means for the Fed and for the economy as a whole?

Ellen Zentner: Sure. So, I think the important thing to remember is that the Fed has a domestic directive. And so, if there is something impacting the outlook -- regardless, election, geopolitics, anything -- then it comes under their purview to support the economy. And so, you know, best example I can give maybe is the Bush Gore election, when we didn't know who was going to be president for more than two months.

And it had to go to the Supreme Court, and at that time, the uncertainty among households, among businesses on who will be the next president really created this air pocket in the economy. So that's sort of the best example I can give where an election was a bit disruptive, although the economy bounced back on the other side of that.

Seth Carpenter: But can I push you there? So, it sounds like what you're saying is it's not the election per se that the Fed cares about. the Fed's not entering into the political fray. It's more what the ramification of the election is for the economy. Is that a fair statement?

Ellen Zentner: Absolutely. Absolutely fair.

Chetan Ahya: One issue the election does force us to confront is the prospect of geopolitical tension, and in particular the fact that President Trump has discussed further tariffs. For China, it is worth considering the implications, given the current weakness.

Seth Carpenter:  That’s a really good point, Chetan, but before we even get there, maybe it's worth having you just give us a view on where things stand now in China. Is there hope of reflationary fiscal policy?

Chetan Ahya: Unfortunately, doesn’t seem like a lot right now. We have been highlighting that China needs to stimulate domestic demand with expansionary fiscal policy targeted towards boosting consumption. And it is in this context that we were closely watching policy announcement during the National People's Congress a couple of weeks ago.

Unfortunately, the announcement in NPC suggests that there are very limited reflationary policies being implemented right now. More importantly, the broad policy focus remains firmly on supporting investment and the supply side; and not enough on the consumption side. So, it does seem that we are far away from getting that required reflationary and rebalancing policies we think is needed to lift China back to moderate 2 to 3 per cent inflation trajectory.

Jens Eisenschmidt: I would jump in here and say that part of the ongoing weakness we see in Europe and in particularly Germany is tied to the slowdown in global trade and the weakness Chetan is talking about for China.

Seth Carpenter: Okay, Jens, if you're going to jump in, that's great. Could you just let us know where do you think things go in Europe then for the rest of this year and into next year?

Jens Eisenschmidt: So, we see indeed a small rebound. So, things are not looking great on numbers. But, you know, where we are coming from is close to recessionary territory; so everything that's up looks will look better.

So, we have 0. 5 on year and year growth rates; 1 percent next year; 0.5 for this year. In terms of quarterly profiles -- so, essentially we are hitting at some point later this year a velocity between 0.2 to 0.3, which is close to potential growth for the Euro area, which we estimate at 1.1.

Seth Carpenter: Got it. Okay, so outside of the U. S. then. China's week. Europe's lackluster Chetan, I gotta come back to you. Give us some good news. Talk to us about the outlook for Japan. We were early adopters of the Japan reflation story. What does it look like now?

Chetan Ahya: Well, the outlook in Japan is the exact opposite of China. We are constructive on Japan's macro-outlook, and we see Japan transitioning to a moderate but sustainable inflation and higher normal GDP growth environment.

Japan has already experienced one round of inflation and one round of wage growth. But to get to sustained inflation, we need to see wage growth to stay strong and more evidence of wage passing through to inflation. In this context, we are closely watching the next round of wage negotiations between the trade unions and the corporate sector.

We expect the outcome of first round of negotiations to be announced on March 15th, and we think that this will reflect a strong acceleration in wage growth in Japan. And that, we think, will allow Japan's core inflation to be sustained at 1.5 to 1.75 per cent going forward.

This rise in inflation will mean higher normal GDP growth and lower real interest rates, reviving the animal spirits and revitalize the corporate sector. We do see BOJ moving from negative rates to positive rates in March 19th policy meeting and later follow up with another 15 bps (basis points) hike in July policy meeting. But we think overall policy environment will remain accommodative supporting Japan's reflation story.

Seth Carpenter: All right, that does make me feel a little bit better about the global economy outside of the US. But I'm seeing the indication from the producers, we've got to wrap up. So, I'm going to go to each of you, rapid fire questions. Give me two quick risks to your forecast. Ellen for the US…

Ellen Zentner: All right. If we're wrong and the economy keeps growing faster, I think I would peg it on something like fiscal impulse, which has been difficult to get a handle on. Maybe throw in easier than expected financial conditions there that fuel the economy, fuel inflation. I think if we slow a lot more then it's likely because of some stresses in the banking sector.

Let's think about CRE; we say it's contained, maybe it's not contained. And then also if companies decide that they do need to reduce headcounts because economic growth is weaker, and so we lose that narrative of employee retention.

Seth Carpenter: Got it. Okay, Jens, you're up. Two risks.

Jens Eisenschmidt: The key upside risk is clearly consumption. We have a muted part for consumption; but consumption isn't really back to where it has been pre-COVID or just barely so. So, there's certainly more way up and we could be simply wrong because our outlook is too muted.

Downside, think of intensification of supply chain disruptions. Think about Red Sea. The news flow from there is not really encouraging. We have modeled this. We think so far so good. But if persists for longer or intensified, it could well be a downside risk because either inflation goes up and/or growth actually slows down.

Seth Carpenter: Perfect. All right, Chetan, let me end with you and specifically with China. If we are going to be wrong on China, what would that look like?

Chetan Ahya: We think there are two upside risks to our cautious view on China's macro-outlook. Number one, if global trade booms, that helps China to use its excess capacity and enables it to de-lever and lift its inflation. And number two, if we see a shift in the reflationary and rebalancing policies, such that there is aggressive increase in social expenditure on things like healthcare, education, and public housing. This would help households to unlock precautionary saving, boost consumption demand, and get China out of current deflationary environment.

Seth Carpenter: Got it. Ellen, Chetan, Jens, thank you each for joining us today. And to the listener, thank you for listening. If you enjoy the show, please leave us a review wherever you listen to the show and share thoughts on the market with a friend or a colleague today.

Our Freight Transportation & Airlines Analyst unboxes the latest trends around parcel transit times and systems in the U.S. and their impact on the future of e-commerce supply chains.

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Welcome to Thoughts on the Market. I’m Ravi Shanker, Morgan Stanley’s Freight Transportation analyst. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what’s happening in the eCommerce parcel delivery space. 

It’s Wednesday, March 13, at 10 AM in New York.

Most people love the convenience of online shopping. You click, you pay. Next thing you know, your doorbell rings. Turns out, we’ve become so used to this kind of instant gratification that many customers now abandon an online cart – if the delivery process takes too long. 

eCommerce parcel delivery companies are taking notice of consumers' growing impatience and are putting a lot of effort into making parcel transit shorter, faster and tighter. A couple of factors drive this trend. First, we have the retailers’ desire to store inventory at more locations; closer to the end-consumer versus the centralized, nationalized distribution centers of the old model. Second, connecting those inventory locations quickly, easily and cheaply by truck rather than long-haul transportation modes like air or rail. As a result, companies can offer consumers one-day or same-day delivery in a highly cost-effective manner.

This means a shift from long-distance transit via air towards ground transportation – be it express or non-express ground. Such a transition could be a drag on margins at major parcel companies. These players are fully aware of the risk; and they’re making their own structural changes and downsizing their air business. However, even as big parcel companies are trying to keep up with the times and evolving consumer pressures, the transition from long-haul air to short-haul truck makes parcel delivery a less complex operation to run – and that may attract more competitors over time.

Another factor at play is the continued popularity of curbside pickup, also known as Click And Collect or even delivery from the store – these are options that became ubiquitous during the pandemic. Even post-pandemic, major retailers have been attempting to move inventory closer to customers and lowering the cost to ship to homes by treating their physical brick and mortar stores as last-mile fulfillment options.

As inventories have been getting leaner over the last few quarters, Click & Collect, Ship from Store, and other similar services have seen their popularity rise. Indeed, several retailers have expanded their physical footprint to accommodate these options. Or they have leveraged their current stores to offer more of these capabilities.

We think this could have a significant impact on eCommerce supply chains for incumbent parcel companies. In the current long-distance eCommerce supply chain model, the long-haul middle-mile portion accounts for the bulk of the profitability for a parcel carrier. By substituting that middle-mile parcel move with regular inventory channel fill, parcel companies could be effectively excluded from the process, in our view. Given their entrenched long-haul networks, it could be difficult for the parcel companies to be consistently profitable doing last-mile deliveries alone. Instead, this last mile delivery market could go to delivery companies, regional delivery providers, or even in-house delivery solutions.

This is a rapidly evolving landscape, and we’ll continue to keep you updated on major new developments.

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

Our roundtable of experts recaps highlights from the 2024 Morgan Stanley Technology, Media & Telecom Conference, including AI innovation, trends in live entertainment and the need for operational efficiency.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley Research's US thematic strategist. I'm joined by Ben Swinburne, who leads coverage of the media and entertainment, advertising, and cable and satellite industries, and Kieran Kenny, who covers internet. Along with my colleagues, bringing you a variety of perspectives, today we'll discuss some key themes from Morgan Stanley's recently concluded Technology, Media, and Telecom Conference in San Francisco.

It's Tuesday, March 12th, at 10am in New York.

Ben, Kieran, we have to lead off on AI. It was a tech conference. As we've written about in the past, most companies want to either be AI enablers or AI adopters. And we believe that 2024 will be the year of the adopters. We scraped transcripts of the presentations at the conference and found that AI was mentioned 155 times.

There was a particular focus on Generative AI or Gen AI. And one of the means of adopting AI that was repeatedly mentioned was using chatbots for customer service. And chatbots can easily handle commonly asked questions without needing a customer service person to speak live. Kieran, can we start by talking about some of the most interesting ways companies and internet are adopting AI?

Kieran Kenny: So, there's a wide range of use cases so far. What we're seeing more recently is growing adoption for, to your point, AI assistance for customer support types of use cases. We're also seeing increased adoption from advertisers; for generative AI, for image and text creation for advertisements. And in the video game space, we're also seeing demand for generative AI based content creation tools -- to give you a sense of some of the use cases. The most common use case, though, is adoption of generative AI coding assistant tools, which we're seeing that pretty pervasively across the internet space.

Michelle Weaver: Great. And I know you've done a bunch of work around AI. What are some of the areas you think we'll see the quickest AI driven efficiency gains?

Kieran Kenny: I think most likely you'll see the efficiency gains come first in the code assistant use cases. That when we go through and scan company disclosures for efficiency gains related to generative AI and look through some of the empirical studies -- code assistant tools tend to show the most consistent productivity gains in the 20 to 50 per cent range. And because R&D expenses are such a large percent of revenue for internet. It's on average 25 percent. There's a really strong incentive for companies to adopt those tools to drive productivity amongst their software engineers. So, we think that's the area you're likely going to see the benefits first.

Michelle Weaver: Great. Thanks, Kieran. Ben, what do you think some of the most interesting ways companies in your coverage are leveraging AI?

Benjamin Swinburne: I would echo some of the points that Kieran made, particularly around content creation and dealing with customers.

You know, in the content creation area, we're seeing AI leveraged in creative services. So, creating content for marketing purposes is an area we're seeing the ad agencies look for opportunities. In the audio industry, we've seen AI used to more efficiently and more effectively translate podcasts and audio books to different languages, which can be then distributed around the world.

One leading streaming audio company has an AI DJ that they used to drive recommendations for listeners. And on the customer front, we're seeing a lot of companies in the cable industry, basically distribute AI tools into their call centers and into their network diagnostics -- so they can predict where network failures may happen before they happen. Or help call center agents better help customers with issues more effectively using, you know, AI and big data.

Michelle Weaver: Great. Super interesting. I'm sure that's just the tip of the iceberg, too, in terms of what we'll see with AI adoption. Ben, I also noticed that there was a lot of discussion from media companies around live events and whether that's high demand for concert tickets, streaming services offering live events, or demand for theme parks. Can you tell us a little bit about consumer experiences in the media space?

Benjamin Swinburne: Yeah, absolutely. I mean, we believe that there are secular drivers of consumer spending towards experiences, for a variety of reasons. And we're seeing that happen; show up in the results and outlook for a number of companies in our coverage. We had some really positive commentary from a number of companies in the theme park space around current trends, which are pacing better than expected from the conference. We've seen leading streaming companies increase their investment in live content, particularly live sports, which is uniquely powerful and driving customer acquisition and attracting advertising dollars.

And probably no place is consumer spending continuing to grow and grow off record levels as quickly as they are in concerts. Where we really see -- while it's a minority of the population that drives the concert industry. Our survey work and what we heard at the conference last week is that consumers value that live communal experience more than ever. And we're seeing that show up in financial results.

Michelle Weaver: The last theme I want to talk about is operational efficiency and profitable growth. Our research has shown that companies that demonstrate high operational efficiency have outperformed on a relative basis over the past two years; and operational efficiency and cost cutting came up repeatedly and fireside conversations with the phrase ‘do more with less’ being used quite a few times. And it was clear that at the conference companies are very aware of the importance of being the best operators, given the expectations for more tepid economic growth in 2024.

Kieran, what did you hear about profitable growth or the importance of efficiency within internet?

Kieran Kenny: For many of our companies, including one of the largest social media slash advertising companies in the space, 2023 was very much a year of efficiency. But that focus is persisting through 2024 and is likely to continue going forward. So, I think a lot of companies are pointing to that one social media company as the North Star of their ability to operate with a leaner cost structure, to be more disciplined in their investments. And ultimately do that in a way where hopefully it can reaccelerate revenue growth and not be detrimental to revenue growth. So, efficiency and AI, well they go hand in hand. Both of those are two of the biggest focus areas for internet companies broadly.

Michelle Weaver: Ben, same question for you. What did you hear about the importance of efficiency in the media world?

Benjamin Swinburne: Yeah, we’re seeing focus on efficiency, both in sort of an offensive and a defensive posture. I mean, there are companies who are seeing accelerating revenue growth, demonstrating real pricing power in their business who are also reducing headcount and focusing on operating leverage. So, there's no question that efficiency, particularly in the technology industries, has probably never been a bigger focus than it is right now.

We're also seeing companies that are heavily driven by -- you know, service companies driven by labor costs looking at offshoring. That's a big theme in our space. Probably more on the defensive side, companies facing real secular challenges on the revenue front are looking for efficiencies, particularly around content spending. That typically shows up in a shift to more unscripted content, which is less expensive or producing more content offshore with lower cost of production.

Michelle Weaver: Ben, Kieran, thank you for taking the time to talk. And thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share thoughts on the market with a friend or colleague today.

Matt Cost of the firm’s U.S. Internet team shares his key takeaways from the 2024 Morgan Stanley Technology, Media & Telecom Conference, including the online ad market’s rebound and the future of property tech.  

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Welcome to Thoughts on the Market. I’m Matt Cost, from the Morgan Stanley US Internet team.

Along with my colleagues bringing you a variety of perspectives, today I’ll talk about some key trends that emerged in conversations with internet companies at Morgan Stanley’s 2024 Technology Media and Telecom Conference in San Francisco.

It’s Monday, Mar 11th at 8am in New York.

So, we had a busy four days at the conference last week. It was our biggest gathering yet for what’s really the marquee TMT event of the year. And we brought together companies and investors from all over the world for keynotes and meetings and a lot of moments in between to connect with industry insiders about the latest trends in their space.

I want to start with talking about AI. It was a big topic for almost every company we saw. But I’d say that for me, the video game companies stood out the most. Some C-suite executives that we spoke to talked about how their companies could become up to 30 per cent more efficient, as they leverage new AI tools to build and operate their games. But they also talked about the need to reinvest those efficiencies to make sure their products are the biggest, the best, and the most competitive they can be.

This is against a video game market backdrop that remains more mixed though we did hear about some green shoots in mobile games; since there are a number of newly launched games there that are getting good traction – which is actually something we haven’t seen in a few years at this point. On the M&A front, after a wave of game industry consolidation we’ve seen over the past few years, we did hear companies acknowledge that scale matters more than ever – if you want to compete in this space.

When it comes to the advertising companies, it’s clear that we’ve seen a marked improvement in the health of the online ad markets since October and November of [20]23, but there are still pockets of strength and weakness, particularly for smaller players where competition is the most intense.

We’re also seeing a major focus on privacy, which has been a long-term trend in the space. But in the near term, the industry does expect browser cookies to go away later this year. And investors are trying to decide who that might hurt – and in some cases who it might potentially help. And when it comes to AI in the ad space, we’ve heard a mostly positive story about the potential for more personalized and better targeted ads in the future.

Finally on the property tech side. Despite the fact that the residential real estate market is still pretty subdued in the US, many players in the space feel that two years into higher mortgage rates, they have leaner business models that set them up well to benefit when the market does come back. We also heard greater confidence from companies that they don’t expect to see major disruption from the ongoing legal disputes around real estate broker commissions. But that does remain one of the uncertainties in the space that investors are the most focused on into 2024 and beyond.

For more on the Morgan Stanley TMT conference, check out the episode tomorrow, where my colleagues will dive deeper into thematic takeaways from this year's event.

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

Our Head of Corporate Credit Research cites near-term and long-term factors indicating that investors should expect a major boost in merger and acquisition activity.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.

It's Friday, March 8th at 2:00pm in London.

Usually, company activity follows the broader trends in markets. But last year, it diverged. 2023 was generally a strong year for economic growth and the stock market. But Mergers and Acquisition activity was anemic. By our count, global M&A activity in 2023, adjusted for the size of the economy, was the lowest in 30 years. 

We think that’s going to change. There are both near-term and longer-term reasons why we think the buying and selling of companies can pick up. We think we’re going to see the return of M&A.

Near term, we think corporate confidence, which is essential to any large transaction, is improving. While stocks and the economy were ultimately strong last year, a lot of 2023 was still dominated by fears of rising yields, elevated inflation and persistent expectations of recession. Recall that as recently as October of 2023, the median stock in the S&P 500 was actually down about 5 per cent for the year.

All of those factors that were hitting corporate confidence, today are looking better. And with Morgan Stanley’s expectation for 2024, and economic soft landing, we think that improvement will continue. But don’t just take our word for it. The companies that traffic directly in M&A were notably more upbeat about their pipelines when they reported earnings in January.

Incidentally, this is also the message that we get from Morgan Stanley’s industry experts. We recently polled Morgan Stanley Equity Analysts across 150 industry groups around the world. Half of them saw M&A activity increasing in their industry over the next 12 months. Only 6 per cent expected it to decline.

But there’s also a longer run story here.

We think we can argue that depressed corporate activity has actually been a multi-year story. If we think about what factors historically explained M&A activity, such as stock market performance, overall valuations, volatility, Central Bank policy, and so on – the activity that we’ve seen over the last three years has undershot what these variables would usually expect by somewhere between $4-11 trillion. We think that speaks to a multi-year hit to corporate confidence and increased uncertainty from COVID and its aftermath; as that confidence returns, some of this gap might be made up.

And there are other longer-term drivers. We believe Private Equity firms have been sitting on their holdings for an unusually long period of time, putting more pressure on them to do deals and return money to investors. Europe is just starting to emerge from an even longer-drought of activity, while reforms in Japan are encouraging more corporate action. We are positive on both European and Japanese equity markets. 

And other multi-year secular trends – from rising demand in AI capabilities, to clean energy transition, to innovation in life sciences – should also structurally support more M&A over the next cycle.

Mergers and Acquisition activity has been unusually low. We think that’s changing, and investors should expect much more of this activity going forward.

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.

Morgan Stanley’s Europe Telecom Analyst outlines three factors pointing to a boom, the obstacles to overcome and the associated industries most likely to benefit.

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Welcome to Thoughts on the Market. I'm Emmet Kelly, head of Morgan Stanley's European Telecom team. Today, I'll be talking about the rise of data centers in Europe.

The subject of data centers has, until now, largely been confined to the U.S. However, we believe that this is all about to change; and we also think the market significantly underestimates the size and scope of this potential growth in Europe.

Why do we believe that the European data center market is set for such strong growth? Well, we've identified three reasons.

The first reason is cloud computing. The primary driver of data center demand today is cloud and digitalization.

Cloud represents the lion's share of data center growth in Europe on our numbers. Roughly 60 percent of growth by 2035. The second driver is AI. What's interesting is training AI models needs to be done within a single data center, and that's driving demand for large data center campuses across the globe.

The third driver is data sovereignty. Data sovereignty is becoming increasingly important to both companies and also to consumers. Essentially, consumers want their data to be stored at home, and they want this to be subject to local law. A common parallel I've received is: would you want your bank account to be stored in a different country? The answer is probably no. And therefore, we believe that data will be increasingly near-shored across Europe

So what's limiting European data center growth today? There are a number of hurdles in place and these bottlenecks include energy, capital, planning permission, and also regulation

So how do we get around that? Well, having chatted with my colleagues in the utilities and renewables teams, it's been quite clear that Europe needs to invest a lot of money in renewable energy, up to 35 billion euros over the next decade in Europe. This will bring a lot of onshore wind, offshore wind, solar and hydro energy to the market.

In terms of the big data center markets in Europe, we've identified five big data center markets, commonly referred to as FLAP-D.

Now this acronym does not roll off the tongue, but it does stand for Frankfurt, London, Amsterdam, Paris, and Dublin. Today, there are constraints in three of those markets, in Ireland, in Frankfurt and also in Amsterdam. We therefore believe that London and Paris should see outsized growth in data centers over the next decade or so.

We also believe we'll see the emergence of new secondary data center markets.

So, who stands to benefit from the explosive growth of European data centers? Among the key beneficiaries, we would highlight the picks and shovels. I'm talking about electric engineering, construction. I'm talking capital goods. We've also got the hyperscalers, the large providers of cloud computing and storage services. And then there is the co-locators as well. Beyond this, it's also worth looking at private capital and private equity companies as being positively exposed too.

Thanks for listening. If you do enjoy the show, please leave us a review on Apple Podcasts and share thoughts on the market with a friend or colleague today.

Our Global Head of Fixed Income shares some startling data on decarbonization, the widespread use of AI and longevity.  

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about key secular themes impacting markets.

It's Wednesday, Mar 6th at 10:30 am in New York.

We kicked off 2024 by highlighting the three secular themes we think will make the difference between being ahead of or behind the curve in markets – longevity, AI tech diffusion, and decarbonization. 

How’s it going so far? We’ve got some initial insights and opportunities at the sector level worth sharing, and here they are through the lens of three big numbers.

The first number is €5 trillion – that’s how much our global economics and European utilities teams estimate will be spent in Europe by 2030 on efforts to decarbonize the energy system. These attempts will boost both growth and inflation, though by how much remains unclear. A more concrete investment takeaway is to focus on the sectors that will be on the receiving end of decarbonization spending: utilities and grid operators.

The second set of numbers are US$140 billion and US$77 billion – these are our colleagues' total addressable market projections for smart-chemo, over the next 15 years, and obesity treatments, by 2030. In terms of our longevity theme, we see companies increasingly investing in and achieving breakthroughs that can extend life. While the theme will have myriad macro impacts that we’re still exploring, the tangible takeaway here is that there are clear beneficiaries in pharma to pursue.

The last number we’re focusing on is US$500 billion. That’s the opportunity associated with a fivefold increase in the size of the European data center market out to 2035. That should be driven by the need to ramp up to deal with key tech trends, like Generative AI.

So, while those numbers drive some pretty clear equity sector takeaways, the macro market implications are somewhat more complicated. For example, on longevity, a common client question is whether health breakthroughs will have a beneficial impact for bond investors by shrinking fiscal deficits. 

Among US investors, for example, one theory is that breakthroughs in preventative care will reduce Medicare and Medicaid spending. But even if that proved true, we still have to consider potential offsetting effects, such as whether new healthcare costs will arise. After all, if people are living longer, more active lives, they might need more of other types of healthcare, like orthopedic treatments. 

Simply put, the macro market impacts are complicated, but critical to understand. We remain on the case. In the meantime, there’s clearer opportunities from our big themes in utilities, pharma, and other key sectors.

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.

With tax season underway, our U.S. economist explains what the average refund will look like and how people are likely to spend it.

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Welcome to Thoughts on the Market. I’m Sarah Wolfe, from the Morgan Stanley US Economics Team. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the US federal tax refunds season. It’s March 5, at 10 AM in New York. 

The IRS began accepting tax returns for the 2023 tax year on January 29, 2024. This is about a week later than when they started accepting tax returns in 2023. As a result, the number of refunds and the total amount of refunds issued by the end of February is about 12 per cent below where they were at the same time last year. However, if we look at the average refund amount that households are getting in the third and fourth week of the tax refund season, they are about in line with the prior year. 

As such, we expect that total refunds will ramp up to an average amount similar to last year; so that’s about $3100 per person. While data show that refunds can fluctuate notably on a weekly and daily basis, total tax refunds through the end of February ran about in line compared to the same period over the past five years. Let’s remember though that they’re not going to be as high as 2022 when refunds were much larger due to COVID-related stimulus programs. So, we can compare it to the past five years apart from 2022.

February through April remains the period where most tax refunds are received and spent, with the greatest impact on consumer spending in March. Our own AlphaWise survey of household intentions around the refunds reveals that households typically spend about a third of their refunds on everyday purchases – such as grocery, gas, apparel. Another third goes toward paying off debt, and the remaining third into savings. 

Last year, higher inflation pushed more households to use their refunds on everyday purchases. This year, it is likely that everyday purchases will remain a top priority, but we do think that more refunds will go in towards paying off debt than last year. There’s a couple of reasons why we think this. First, there was an expiration of the student loan moratorium at the end of 2023. This is affecting millions of student loan borrowers and putting more pressure on their debt service obligations. And then we’re also seeing rising credit card and consumer loan delinquencies, which reveal pressure to pay down debt. If we look at spending intentions by income group, upper income households are more likely to save any tax refund they may get or spend it on home improvement and vacations. So, a bit more on the discretionary side.

When we think about tax liabilities instead of refunds, anomalous factors make this year’s tax season a poor comparison to last year – because last year several states got an extended deadline due to natural disasters. A delayed Tax Day largely impacts filers who have a tax liability or a complicated financial situation and prefer to file later. This has larger implications for the fiscal deficit since delayed tax remittances caused a larger deficit in the third quarter of 2023, and then it narrowed in the fourth quarter when remittances came in. But in terms of refunds and consumer spending, filers who expect refunds tend to file early and on time. An extension of the deadline has very little impact on this group of consumers.

All in all, based on early data, we think that total tax refunds this year will be similar to last year, though higher than pre-COVID years due to inflation. Barring factors that can lead to a significant shift of the filing deadline, we should see a more normal timeline for tax remittances, but it is still important to track closely how the tax season evolves.

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

The U.S. stock market is rising to new highs, but investors should still try to minimize risk in their portfolios. Our analysts list a few key strategies to navigate this dynamic.

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Stephan Kessler: Welcome to Thoughts on the Market. I'm Stefan Kessler, Morgan Stanley's Global Head of Quantitative Investment Strategies Research, QIS Research in short.

Aris Tentes: And I am Aris Tentes, also from the QIS research team.

Stephan Kessler: Along with our colleagues bringing you a variety of perspectives, today we'll discuss different strategies to hedge equity portfolios.

It's Monday, the 4th of March at 10am in London.

The US equity market has been climbing to record levels, and it seems that long only investors -- and especially investors with long time horizons -- are inclined to keep their positions. But even in the current market environment, it still makes sense to take some risk off the table. With this in mind, we took a closer look at some of the potential hedging strategies for high conviction calls with a quantitative lens. Long only portfolios of high conviction names of opportunities for excess returns, or alpha; but also of exposures to broad market risk, or beta, embedded in these names.

While investors are keen to access the idiosyncratic excess return in individual stocks, they often overlook the systematic market and risk factors that come with owning stocks. Rather than treating these risks as uncontrolled noise, it makes sense to think about hedging such risks.

Aris, let me pass over to you for some popular approaches to hedging such risk exposures.

Aris Tentes: Yes, thank you, Stefan.

Today, investors can use a range of approaches to remove systematic risk exposures. The first one, and maybe the most established approach, is to hedge out broad market risks by shorting equity index futures. Now, this has the benefit of being a low-cost implementation due to the high liquidity of a futures contract.

Second, a more refined approach, is to hedge risks by focusing on specific characteristics of these stocks, or so-called factors, such as market capitalization, growth, or value. Now this strategy is a way to hedge a specific risk driver without affecting the other characteristics of the portfolio. However, a downside of both approaches is that the hedges might interfere with the long alpha names, some of which might end up being effectively shorted.

Stephan Kessler: Okay, so, so these are two interesting approaches. Now you mentioned that there is a potential challenge in which shorting out specific parts of the portfolio and removing risks, we effectively end up shorting individual equities. Can you tell us some approaches which can be used to overcome this issue?

Aris Tentes: Oh, yes. Actually, we suggest an approach based on quantitative tools, which may be the most refined way of overcoming the issues with the other approaches I talked about. Now, this one can hedge risk without interfering with the long alpha positions. And another benefit is that it provides the flexibility of customization.

Stephan Kessler: Aris, maybe it's worth actually mentioning why better hedges are important.

Aris Tentes: So actually, better hedges can make the portfolio more resilient to factor and sector rotations. With optimized hedges, a one percentile style or sector rotation shock leads to only minor losses of no more than a tenth of a percentage point. As a result, risk adjusted returns increase noticeably.

Stephan Kessler: That makes sense. Overall, hedging with factor portfolios gives the most balanced results for diversified, high conviction portfolios. One exception would be portfolios with a small number of names, where the universe remaining for the optimized hedge portfolio is broad enough to construct a robust hedge. This can lead to returns that are stronger than for the other approaches.

However, if the portfolio has many names, the task becomes harder and the factor hedging approach becomes the most attractive way to hedge. Having discussed the benefits of factor hedging, I think we also should talk about the implementation side. Shorting outright futures to remove market beta is rather straightforward. However, it leaves many other sectors and factor risks uncontrolled. To remove such risks, pure factor portfolios are readily available in the marketplace.

Investors can buy or sell those pure factor portfolios to remove or target factor and sector risk exposures as they deem adequate. Pure factor portfolios are constructed in a way that investment in them does not affect other factor or

sector exposures. Hence, we refer to them as “pure.” Running a tailored hedge rather than using factor hedging building blocks can be beneficial in some situations -- but comes, of course, at a substantially increased complexity.

Those are some key considerations we have around performance enhancement through thoughtful hedging approaches.

Aris, thank you so much for helping outline these ideas with me.

Aris Tentes: Great speaking with you, Stefan.

Stephan Kessler: 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.

Our head of Corporate Credit Research explains why the Purchasing Manager’s Index is a key indicator for investors to get a read on the economic outlook.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.

It's Friday, March 1st at 2pm in London.

A perennial problem investors face is the tendency of markets to lead the economic data. We’re always on the lookout for indicators that can be more useful, and especially more useful at identifying turning points. 

And so today, I want to give special attention to one of our favorite economic indicators for doing this: the Purchasing Manager Indices, or PMIs. And how they help with the challenge that economic data can sometimes give us.

PMIs works by surveying individuals working in the manufacturing and services sector – and asking them how they’re viewing current conditions across a variety of metrics: how much are they producing? How many orders are they seeing? Are prices going up or down? These sorts of surveys have been around for a while: the Institute of Supply Management has been running the most famous version of the manufacturing PMI since 1948.

But these PMIs have some intriguing properties that are especially helpful for investors looking to get an edge on the economic outlook.

First, the nature of manufacturing makes the sector cyclical and more sensitive to subtle turns of the economy. If we’re looking for something at the leading edge of the broader economic outlook, manufacturing PMI may just be that thing. And that’s a property that we think still applies -- even as manufacturing over time has become a much smaller part of the overall economic pie. 

Second, the nature of the PMI survey and how it’s conducted – which asks questions whether conditions are improving or deteriorating – helps address that all important rate of change. In other words, PMIs can help give us insight into the overall strength of manufacturing activity, whether that activity is improving or deteriorating, and whether that improvement or deterioration is accelerating. For anyone getting flashbacks to calculus, yes, it potentially can show us both a first and a second derivative.

Why should investors care so much about PMIs?

For markets, historically, Manufacturing PMIs tend to be most supportive for credit when they have been recently weak but starting to improve. Our explanation for this is that recent weakness often means there is still some economic uncertainty out there; and investors aren’t as positive as they otherwise could be. And then improving means the conditions likely are headed to a better place. In both the US and Europe, currently, Manufacturings are in this “recently weak, but improving” regime – an otherwise supported backdrop for credit.

If you’re wondering why I’m mentioning PMI now – the latest readings of PMI were released today; they tend to be released on the 1st of each month. In the Eurozone, they suggest activity remains weak-but-improving, and they were a little bit better than expected. In the US, recent data was weaker than expected, although still showing a trend of improvement since last summer.

PMIs are one of many data points investors may be considering. But in Credit, where turning points are especially important, it’s one of our favorites. 

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. 

Our Global Macro Strategist explains the complex nature of recent U.S. economic reports, and which figures should matter most to investors.

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Welcome to Thoughts on the Market. I’m Matthew Hornbach, Morgan Stanley’s Global Head of Macro Strategy. Along with my colleagues bringing you a variety of perspectives, today I'll talk about what investors should take away from recent economic data. 

It's Thursday, February 29, at 4pm in New York.

There’s been a string of confusing US inflation reports recently, and macro markets have reacted with vigor to the significant upside surprises in the data. Before these inflation reports, our economists thought that January Personal Consumption Expenditures inflation, or PCE inflation, would come at 0.23 per cent for the month. 

On the back of the Consumer Price Index inflation report for January, our economists increased their PCE inflation forecast to 0.29 per cent month-over-month. Then after the Producers’ Price Index, or PPI inflation report, they revised that forecast even higher – to 0.43 per cent month-over-month. Today, core PCE inflation actually printed at 0.42 per cent - very close to our economists’ revised forecast.

That means the economy produced nearly twice as much inflation in January as our economists thought it would originally. The January CPI and PPI inflation reports seem to suggest that while inflation is off the record peaks it had reached, the path down is not going to be smooth and easy. 

Now, the question is: How much weight should investors put on this data? The answer depends on how much weight Federal Open Market Committee participants place on it. After all, the way in which FOMC participants reacted to activity data in the third quarter of 2023 – which was to hold rates steady despite encouraging inflation data – sent US Treasury yields sharply higher.

Sometimes data is irrational. So we would take the recent inflation data with a grain of salt. Let me give you an example of the divergence in recent data that’s just that – an outlying number that investors should treat with some skepticism. 

The Bureau of Labor Statistics, or BLS, calculates two measures of rent for the CPI index: Owner’s equivalent rent, or OER, and rents for primary residences. Both measures use very similar underlying rent data. But the BLS weights different aspects of that rent data differently for OER than for rents.

OER increased by 0.56 per cent month-over-month in January, while primary residence rents increased 0.36 per cent month-over-month. This is extremely rare. If the BLS were to release the inflation data every day of the year, this type of discrepancy would occur only twice in a lifetime – or every 43 years.

The confusing nature of recent economic data suggests to us that investors should interpret the data as the Fed would. Our economists don't think that recent data changed the views of FOMC participants and they still expect a first rate cut at the June FOMC meeting. 

All in all, we suggest that investors move to a neutral stance on the US treasury market while the irrationality of the data passes by.

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.

As the deadline to fund the government rapidly approaches, Michael Zezas explains what economic effect a possible shutdown could have and whether investors should be concerned. 

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the market impacts of a potential US government shutdown.

It's Wednesday, February 28th at 2pm in New York.

Here we go again. The big effort in Washington D.C. this week is about avoiding a government shutdown. The deadline to pass funding bills to avoid this outcome is this weekend. And while many investors tell us they’re fatigued thinking about this issue, others still see the headlines and understandably have concerns about what this could mean for financial markets. Here’s our quick take on it, specifically why investors need not view this as a markets’ catalyst. At least not yet.

In the short term, a shutdown is not a major economic catalyst. Our economists have previously estimated that a shutdown shaves only about .05 percentage points off GDP growth per week, and the current shutdown risk would only affect a part of the government. So, it's difficult to say that this shutdown would mean a heck of a lot for the US growth trajectory or perhaps put the Fed on a more dovish path – boosting performance of bonds relative to stocks. A longer-term shutdown could have that kind of impact as the effects of less government money being spent and government employees missing paychecks can compound over time. But shutdowns beyond a few days are uncommon.

Another important distinction for investors is that a government shutdown is not the same as failing to raise the debt ceiling. So, it doesn’t create risk of missed payments on Treasuries. On the latter, the government is legally constrained as to raising money to pay its bills. But in the case of a shutdown, the government can still issue bonds to raise money and repay debt, it just has limited authority to spend money on typical government services. 

So then should investors just simply shrug and move on with their business if the government shuts down? Well, it's not quite that simple. The frequency of shutdown risks in recent years underscores the challenge of political polarization in the U.S. That theme continues to drive some important takeaways for investors, particularly when it comes to the upcoming US election. In short, unless one party takes control of both Congress and the White House, there’s little domestic policy change on the horizon that directly impacts investors.

But one party taking control can put some meaningful policies into play. For example, a Republican sweep increases the chances of repealing the inflation reduction act – a challenge to the clean tech sector. It also increases the chances of extending tax cuts, which could benefit small caps and domestic-focused sectors. And it also increases the chances of foreign policies that might interfere with current trends in global trade through the levying of tariffs and rethinking geopolitical alliances. That in turn creates incentive for on and near-shoring…an incremental cost challenge to multinationals.

So, we’ll keep watching and keep you in the loop if our thinking changes.  

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.

As grocery and dining costs continue to increase, our analysts break down how this has affected consumers and when food prices may stabilize.

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Sarah Wolfe: Welcome to Thoughts on the Market. I'm Sarah Wolfe from the US economics team.

Simeon Gutman: And I'm Simeon Gutman; Hardlines, Broadlines, and Food Retail Analyst.

Sarah Wolfe: Today on the podcast, we'll discuss what's happening with food prices and how that's affecting the US consumer.

It's Tuesday, February 27th at 10am in New York.

It was almost exactly a year ago when I came on this podcast to talk about why eggs cost so much at the start of 2023. Here we are. It's a year later and food in the US still costs more. The overall inflation basket and personal consumption expenditures inflation was 2.6 per cent year over year in December; but dining out prices are still up 5.2 per cent. I'd like to admit that grocery prices are a little bit better. They're just a tad over 1 per cent. So we've seen a little bit more disinflation there. But overall food is still up and it's still expensive.

Simeon, can you give us a little bit more color on what's actually going on here?

Simeon Gutman: Yeah, so food prices measured by the CPI, as you mentioned, up about a per cent. The good news, Sarah, is that your eggs are actually deflating by about 30 per cent at the moment; so maybe you can buy a couple more eggs. But in general, we're following this descent that we started -- about almost two years ago where food prices were up double digits. A year ago, we were up mid single digits. And now we're down to this one per cent level. Looks like they're gonna hold. But so prices are coming in; but not necessarily deflating, but dis-inflating.

Sarah Wolfe: Can you help me understand that a little bit better? You mentioned that some commodity prices are coming down, like food prices. So why is overall inflation for food still rising? And dining out, grocery stores, both of them are still seeing price increases.

Simeon Gutman: Well, commodity prices, which is the most visible input to a lot of food items -- that's coming down in a lot of cases, and I'll mention some that haven't. But there's many other components into food pricing, besides the pure commodity. That's labor; you have freight; you have transportation. Those costs -- there's still some inflation running through the system -- and those costs make up a decent chunk of the total product costs. And that's why we're still seeing prices higher year over year on average for the entire group of products.

Sarah Wolfe: How are grocery sales actually performing though? Are we seeing demand destruction from the higher pricing? Or has unit growth actually been holding up well?

Simeon Gutman: First of all, total grocery sales are just slightly negative. We saw a little ray of hope in January, positive for the month; but likely driven by some stocking up ahead of weather events that happened in the country. So we were barely positive. It looked like we were getting out of the negative territory; but the first few weeks of February, we're back into the negative territory. Negative one, negative two per cent.

Units are negative. Negative three to four per cent. If we look at CPI as sort of a proxy for the product categories that are doing better than others: dairy and fruit units, those are up mid to high single digits. And as I mentioned, we're seeing egg prices down significantly. We're also seeing a lot of deflation with fish and seafood as well as meat.

So, and if you use that as a way to think about the various product categories that consumers are demanding, but overall industry sales are flat to slightly negative; and we think this negative cadence continues going forward.

Sarah, let me turn it to you. You monitor the U. S. consumer closely. How big a bite of the US wallet is food right now? Groceries, eating out at restaurants, etc., and how does that compare to prior periods?

Sarah Wolfe: Let's start high level with essential spending, which I consider to be groceries, energy and shelter. That typically averages about 40 per cent of household disposable income pre-COVID. And now if you add on all the price increases we've seen across all three categories, it's an additional 5 per cent of disposable income today.

And this matters a lot when you're a lower income household and already over 90 per cent of your disposable income was going towards these essential categories pre-COVID. If I look at grocery prices alone, they're up 20 per cent on average since the start of the pandemic. And prior to COVID on a per household basis, they were spending $4,600 a year on groceries. And now that's $5,700 a year. More than a thousand dollars more each year on groceries.

The last time we saw such extreme food inflation was the 1980s. Granted, I have to mention that we've also seen a really notable rise in disposable income too. So if you look at grocery spending as a share of disposable income, it's only marginally higher than it was pre-COVID. It was six and a half per cent, now it's seven per cent.

What's really driving higher wallet share towards food is this dining out category -- and it's a price and unit story. On the pricing side, we have high labor costs, high food prices still. And on the unit side, there's still a much more notable preference to dine out to enjoy services.

And so you mentioned that unit growth has been a lot weaker for groceries. That's not what we're seeing in the dining out space. And overall, it's been driving total food spend as a share of disposable income to high since the early 1990s.

Simeon Gutman: So food spending is up a lot. But the situation is somewhat confusing. You have US inflation data and forecasts seem to be suggesting that food prices should be coming down. That doesn't seem to be happening. We're still looking for inflation. Can you talk about the macro factors behind these persistently high food prices?

Sarah Wolfe: So as you mentioned, we have seen disinflation, right? So grocery prices are down from 12 per cent year over year in the summer of 2022 to about 1.5 per cent today. Dining out is down from 8 per cent to about 5 per cent. So there's a bit of progress on inflation growth. But price levels are not coming down. They're still rising and that definitely does not feel good to households.

The reason we're still seeing a rise in prices, as you've mentioned, are supply chain disruptions, there was an avian flu, and we see very high labor costs. Some of the forward-looking indicators are pointing to more progress on inflation for food, so we know that labor costs are starting to moderate as supply demand imbalances in the labor market are getting a bit better. We know that supply chain disruptions have been unwinding. But all these things together are not pointing to price deflation. Only disinflation. So growth, but at a slower pace.

Simeon Gutman: Yeah, so some of this backdrop continues. When can the US consumer expect some kind of relief, and then what data and indicators are you watching closely?

Sarah Wolfe: Unfortunately, prices are still going up in our forecast, but they're going to stabilize around one to one and a half per cent year over year for grocery. So kind of where we are right now, that's what we expect for the next year and a half or so. But the price levels are going to remain elevated.

As I mentioned in the last response. We know we're watching the supply chain indicators to see if commodity prices start to come up again. If freight costs start to come up again because of geopolitical tensions. We're not seeing any notable rise there yet but we're watching it very closely. And we're also watching what happens with the labor market. Do we continue to see slack in the labor market that'll bring down wages and bring down labor costs? Or do we continue to run a very tight labor market.

Simeon, thanks for taking the time to talk.

Simeon Gutman: 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.

Our Chief U.S. Equity Strategist reviews how the unusual mix of loose fiscal policy and tight monetary policy has benefited a small number of companies – and why investors should still look beyond the top five stocks.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the investment implications of the unusual policy mix we face.

It's Monday, February 26th at 12pm in New York. 

So let’s get after it.

Four years ago, I wrote a note entitled, The Other 1 Percenters, in which I discussed the ever-growing divide between the haves and have-nots. This divide was not limited to consumers but also included corporates as well. Fast forward to today, and it appears this gap has only gotten wider.

Real GDP growth is similar to back then, while nominal GDP growth is about 100 basis points higher due to inflation. Nevertheless, the earnings headwinds are just as strong despite higher nominal GDP – as many companies find it harder to pass along higher costs without damaging volumes. As a result, market performance is historically narrow. With the top five stocks accounting for a much higher percentage of the S&P 500 market cap than they did back in early 2020. 

In short, the equity market understands that this economy is not that great for the average company or consumer but is working very well for the top 1 per cent.  

In my view, the narrowness is also due to a very unusual mix of loose fiscal and tight monetary policy. Since the pandemic, the fiscal support for the economy has run very hot. Despite the fact we are operating in an extremely tight labor market, significant fiscal spending has continued.

In many ways, this hefty government spending may be working against the Fed. And could explain why the economy has been slow to respond to generationally aggressive interest rate hikes. 

Most importantly, the government’s heavy hand appears to be crowding out the private economy and making it difficult for many companies and individuals. Hence the very narrow performance in stocks and the challenges facing the average consumer.  

The other policy variable at work is the massive liquidity being provided by various funding facilities – like the reverse repo to pay for these deficits. Since the end of 2022, the reverse repo has fallen by over $2 trillion. It’s another reason that financial conditions have loosened to levels not seen since the federal funds rate was closer to 1 per cent. This funding mechanism is part of the policy mix that may be making it challenging for the Fed’s rate hikes to do their intended work on the labor market and inflation. It may also help explain why the Fed continues to walk back market expectations about the timing of the first cut and perhaps the number of cuts that are likely to continue this year.  

Higher interest rates are having a dampening effect on interest-rate-sensitive businesses like housing and autos as well as low to middle income consumers. This is exacerbating the 1 percenter phenomena and helps explain why the market’s performance remains so stratified. For many businesses and consumers, rates remain too high. 

However, the recent hotter than expected inflation reports suggest the Fed may not be able to deliver the necessary rate cuts for the markets to broaden out – at least until the government curtails its deficits and stops crowding out the private economy. Parenthetically, the funding of fiscal deficits may be called into question by the bond market when the reverse repo runs out later this year. 

Bottom line: despite investors' desire for the equity market to broaden out, we continue to recommend investors focus on high-quality growth and operational efficiency factors when looking for stocks outside of the top five which appear to be fully priced. 

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. 

The valuations of stocks and corporate bonds, which have been driven largely by macroeconomic factors since 2020, are finally starting to reflect companies’ underlying performance. Our Head of Corporate Credit Research explains what that means for active investors.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about trends across the global investment landscape – and how we put those ideas together.

It's Friday, February 23rd at 2pm in London.

In theory, investing in corporate securities like stocks or corporate bonds should be about, well, the performance of those companies. But since the outbreak of COVID in 2020, financial markets have often felt driven by other, higher powers. The last several years have seen a number of big picture questions in focus: How fast could the economy recover? How much quantitative easing or quantitative tightening would we see? Would high inflation eventually moderate? And, more recently, when would central banks stop hiking rates, and start to cut.

All of these are important, big picture questions. But you can see where a self-styled investor may feel a little frustrated. None of those debates, really, concerns the underlying performance of a company, and the factors that might distinguish a good operator from a bad one.

If you’ve shared this frustration, we have some good news. While these big-picture debates may still dominate the headlines, underlying performance is starting to tell a different story. We’re seeing an unusual amount of dispersion between individual equities and credits. It is becoming a market of many.

We see this in so-called pairwise correlation, or the average correlation between any two stocks in an equity index. Globally, that’s been unusually low relative to the last 15 years. Notably options markets are implying that this remains the case. We see this in credit, where solid overall performance has occurred along-side significant dispersion by sector, maturity, and individual issuer, especially in telecom, media and technology.

We see this within equities, where my colleague Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist, notes that the S&P 500 and global stocks more broadly have decoupled from Federal Reserve rate expectations.

And we see this in performance. More dispersion between stocks and credit would, in theory, create a better environment for Active Managers, who attempt to pick those winners and losers. And that’s what we’ve seen. Per my colleagues in Morgan Stanley Investment Management, January 2024 was the best month for active management since 2007.

The post-COVID period has often felt dominated by large, macro debates. But more recently, things have been changing. Individual securities are diverging from one another, and moving with unusual independence. That creates its own challenges, of course. But it also suggests a market where picking the right names can be rewarded. And we think that will be music to many investors' ears.

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.

As traditional financial institutions tightened their lending standards last year, private credit stepped in to fill some of the gaps. But with rates now falling, public lenders are poised to compete again on the terrain that private credit has transformed.

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Vishy Tirupattur: Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today we’ll have a conversation with Joyce Jiang, our US leveraged finance strategist, on the topic of private credit.

It's Thursday, February 22nd at noon in New York.

Joyce, thank you for joining. Private credit is all over the news. Let’s first understand – what is private credit. Can you define it for us?

Joyce Jiang: There isn't a consensus on the definition of private credit. But broadly speaking, private credit is a form of lending extended by non-bank lenders. It's negotiated privately on a bilateral basis or with a small number of lenders, bypassing the syndication process which is standard with public credit.

This is a rather broad definition and various types of debt can fall under this umbrella term; such as infrastructure, real estate, or asset-backed financing. But what's most relevant to leveraged finance – is direct lending loans to corporate borrowers.

Private credit lenders typically hold deals until maturity, and these loans aren't traded in the secondary market. So, funding costs in private credit tend to be higher as investors need to be compensated for the illiquidity risk. For example, between 2017 and now, the average spread premium of direct lending loans is 250 basis points higher compared to single B public loans.

Vishy Tirupattur: That’s very helpful Joyce. The size of the private credit market has indeed attracted significant attention due to its rapid growth. You often see estimates in the media of [the] size being around $1.5 to $1.7 trillion. Some market participants expect the market to reach $2.7 trillion by 2027. Joyce, is this how we should think about the market? Especially in the context of public corporate credit market?

Joyce Jiang: I've seen these numbers as well. But to be clear, they reflect assets under management of global private debt funds. So not directly comparable to the market size of high yield bonds or broadly syndicated loans.

In our estimate, the total outstanding amount of US direct lending loans is in the range of $630-710 billion. So, we see the direct lending space as roughly half the size of the high yield bonds or broadly syndicated loan markets in the US.

Vishy Tirupattur: Understood. Can you provide some color on the nature of private credit borrowers and their credit quality in the private credit space?

Joyce Jiang: Traditionally, private credit targets small and medium-sized companies that do not have access to the public credit market. Their EBITDA is typically one-tenth the size of the companies with broadly syndicated loans. However, this is not representative of every direct lending fund because some funds may focus on upper middle-market companies, while others target smaller entities.

Based on the data that’s available to us, total leverage and EBITDA coverage in private credit are comparable to a single B to CCC profile in the public space. Additionally, factors such as smaller size, less diversified business profiles, and limited funding access may also weigh on credit quality.

Given this lower quality skew and smaller size, there have been concerns around how these companies can navigate the 500 basis point of rate hikes. However, based on available data, two years into the hiking cycle, coverage has deteriorated – mainly due to the floating-rate heavy nature of these capital structures. But on the bright side, leverage generally remained stable. Similar to what we’ve seen in public credit.

Now let me turn it around to you, Vishy. What about defaults in private credit and how do they compare to public credit markets?

Vishy Tirupattur: So when it comes to defaults, unlike in the public markets, data that cover the entire private credit market is not really there. We have to depend on the experience of sample portfolios from a variety of sources. These data tend to vary a lot, given the differences in defining what a default is and how to calculate default rates, and so on. So, all of this is a little bit tricky. We should also keep in mind that the data we do have on private credit is over the last few years only. So, we should be careful about generalizing too much.

That said, based on available data we can say that the private credit defaults have remained broadly in the same range as the public credit. In other words, not substantially higher default rates in the private credit markets compared to the public credit defaults.

A few things we should keep in mind as we consider this relatively benign default picture. What contributes to this?

First, private credit deals have stronger lender protections. This is in contrast to the broadly syndicated loan market – which is, as you know, predominantly covenant-lite market. Maintenance covenants in private credit can really act as circuit breakers, reining in borrower behavior before things deteriorate a lot. Second, private credit deals usually involve only a very small number of lenders. So it’s easier to negotiate a restructuring or a workout plan. All of this contributes to the default experience we’ve observed in private credit markets.

Joyce Jiang: And finally, what are your thoughts on the future of private credit?

Vishy Tirupattur: The rapid growth of private credit is really reshaping the landscape of leveraged finance on the whole. Last year, as banks retreated, private credit stepped in and filled the gap – attracting many borrowers, especially those without access to the public market. Now, as rate cuts come into view, we see public credit regaining some of the lost ground. So how private credit adapts to this changing environment is something we’ll be monitoring closely. With substantial dry powder ready to be deployed, the competition between public and private credit is likely to intensify, potentially impacting the overall market.

Joyce, let's wrap it up here, Thanks for coming on the podcast.

Joyce Jiang: Thanks for having me.

Vishy Tirupattur: Thank you all 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.

Central banks in the U.S. and Europe are looking to cut rates this year, but the path to those cuts differs greatly. Our Global Chief Economist explains this stark dichotomy.

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Welcome to Thoughts on the Market. I’m Seth Carpenter, Morgan Stanley’s Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I’ll be talking about the challenges for monetary policy on both sides of the Atlantic.

It’s Wednesday, Feb 21st at 10am in New York.

The Fed, the Bank of England, and the ECB all hiked rates to fight inflation, and now we are looking for each of them to cut rates this year. For our call for a June Fed rate cut, both growth and inflation matter. But our call for a May and June start on the east side of the Atlantic depends only on inflation. “Data dependent” here has two different meanings.

At the January Fed meeting, Chair Powell said continued disinflation like in prior months was needed to cut. But he also emphasized that disinflation needs to be sustainably on track; not simply touching 2 per cent. Until Thursday’s retail sales data, the market narrative began to flirt with a possible re-acceleration of the US economy, spoiling that latter condition of inflation going sustainably to target. January inflation data showed strength in services in particular, and payrolls showed a tight labor market that might pick up steam.

The retail sales data pushed in the opposite direction, and we think that the slower growth will prevail over time. And for now, market pricing is more or less consistent with our call for 100 basis points of cuts this year, starting in June.

Now the Fed’s situation is in stark contrast to that of the Bank of England. Last week’s UK data showed a technical recession in the second half of 2023. And while the UK economy is not collapsing, a strongly surging economy is not a risk either. But until the last print, inflation in the UK had been stubbornly sticky. The January print came in line with our UK economist’s call, but below consensus. But still, one swallow does not mean spring, and the recent inflation data do not guarantee our call for a May rate cut will happen. Rather, broader evidence that inflation will fall notably is needed; and for that reason, the risks to our call are clearly skewed to a later cut.

For the ECB, the inflation focus is the same. And on Thursday, President Lagarde warned against cutting rates too soon – a particularly telling comment in light of the weak growth in the Euro area. Recent data releases suggest that not only did Germany’s GDP decline by three-tenths of a per cent in Q4 of 2023; the second largest economy, France, also experienced stagnation in the second half of the year. And with this weakness expected to persist – well, we forecast a weak half per cent growth this year and about only 1 per cent growth in 2025.

So, why is this dichotomy so stark? The simple answer is the weak state of the economy in the UK and in Europe. More fundamentally, the drivers of inflation started with a jump in food and energy prices, and then surging consumer goods prices as disrupted supply chains met consumer spending shifting toward goods. That inflation has since abated but services inflation tends to be more tied to the real side of the economy. And for the US in particular, housing inflation is driven by the state of the labor market over time.

The Bank of England and the ECB are waiting for services inflation to respond to the already weak economy, and there is little risk of a reacceleration of inflation if that happens. In contrast, the Fed cannot have conviction that inflation won’t reaccelerate because of the continued resilience on the real side of the economy. The retail sales data will help, but the pattern needs to continue.

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.

Our Head of Thematic Research in Europe previews the possible next phase of the AI revolution, and what investors should be monitoring as the technology gains adoption.

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Welcome to Thoughts on the Market. I’m Edward Stanley, Morgan Stanley’s Head of Thematic Research in Europe. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the latest developments around AI Adopters. It’s Tuesday, February the 20th, at 2pm in London.

The current technology shift driven by AI is progressing faster than any tech shift that came before it. 

I came on the show at the beginning of the year to present our thesis – while 2023 was the “Year of the Enablers,” those first line hardware and software companies; 2024 is going to be the “Year of the Adopters,” companies leveraging the Enablers’ hardware and software to better use and monetize their own data for this generative AI world.

And the market is still sort of treating this as a “show me” story. Enablers are still driving returns. Around half of the S&P’s performance this year can be attributed to three Enabler stocks. Yet, be it Consumer or – more importantly – Enterprise adoption, monthly data we’re tracking suggests AI adoption is continuing at a rapid pace.

So let me paint a picture of what we’re actually seeing so far this year.

There has been a widening array of consumer-facing chatbots. Some better for general purpose questions; some better at dealing with maths or travel itineraries; others specialized for creating images or videos for influencers or content creators. But those proving to be the stickiest, or more importantly leading to major behavioral day-to-day changes, are coding assistants, where the productivity upside is now a well-documented greater than 50 per cent efficiency gain.

From a more enterprise perspective, open-source models are interesting to track. And we do, almost daily, to see what’s going on. The people and companies downloading these models are likely to be using them as a starting point – for fine-tuning their own models.

Within that, text models which form the backbone of most chatbots you will have interacted with, now account for less than 50 per cent of all models openly available for download. What’s gaining popularity in its place is multi-modal models. This is: models capable of ingesting and outputting a combination of text, image, audio or video.

Their applications can range from disruption within the music industry, personalized beauty advice, applications in autonomous driving, or machine vision in healthcare. The list goes on and on. The speed of AI diffusion into non-tech sectors is really bewildering.

Despite all these data points, suggesting consumer and enterprise adoption is progressing at a rapid clip, Adopter stocks continue to underperform those picks-and-shovels Enablers I mentioned. The Adopters have re-rated modestly in the first month and a half of the year – but not the whole group. 

Of course, this is a rapidly changing landscape. And many companies have yet to report their outlook for the year ahead. We’ll continue to keep you informed of the newest developments as the years progress.

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

Our Fixed Income Strategist outlines commercial real estate’s post-pandemic challenges, which could make regional bank lenders vulnerable. 

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Welcome to Thoughts on the Market, I’m Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the challenges of the commercial real estate markets. It's Friday, Feb 16th at 3 pm in New York.

Commercial real estate – CRE in short – is back in the spotlight in the aftermath of the loan losses and dividend cuts announced by New York Community Bancorp. Lenders and investors in Japan, Germany, and Canada have also reported sizable credit losses or write-downs related to US commercial real estate. The challenges in CRE have been on a slow burn for several quarters. In our view, the CRE issues should be scrutinized through the lenses of both lenders and property types. We see meaningful challenges in both of them.

From the lenders’ perspective, we now estimate that about a trillion and a half of commercial real estate debt matures by the end of 2025 and needs to be refinanced; about half of this sits on bank balance sheets.

The regulatory landscape for regional banks is changing dramatically. While the timeline for implementing these changes is not finalized, the proposed changes could raise the cost of regional bank liabilities and limit their ability to deploy capital; thereby pressuring margins and profitability. This suggests that the largest commercial real estate lender – the regional banking sector – might be the most vulnerable.

Office as a property type is confronting a secular challenge. The pandemic brought meaningful changes to workplace practice. Hybrid work has now evolved into the norm, with most workers coming into the office only a few days a week, even as other outdoor activities such as air travel or dining out have returned to their pre-Covid patterns. This means that property valuations, leasing arrangements, and financing structures must adjust to the post-pandemic realities of office work. This shift has already begun and there is more to come.

It goes without saying, therefore, that regional banks with office predominant in their CRE exposures will face even more challenges.

Where do we go from here? Property valuations will take time to adjust to shifts in demand, and repurposing office properties for other uses is far from straightforward. Upgrading older buildings turns out to be expensive, especially in the context of energy efficiency improvements that both tenants and authorities now demand. The bottom line is that the CRE challenges should persist, and a quick resolution is very unlikely.

Is it systemic? We get this question a lot. Whether or not CRE challenge escalates to a broader system-wide stress depends really on one’s definition of what systemic risk is. In our view, this risk is unlikely to be systemic along the lines of the global financial crisis of 2008. That said, strong linkages between the regional banks and CRE may impair these banks’ ability to lend to households and small businesses. This, in turn, could lead to lower credit formation, with the potential to weigh on economic growth over the longer term.

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.

Michael Zezas, Global Head of Fixed Income and Thematic Research, gives his take on how the U.S. election may influence European policy on national security, with implications for the defense and cybersecurity sectors.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the impact of the US election on global security and markets. It's Thursday, February 15th at 3pm in New York.

Last week I was in London, spending time with clients who – understandably – are starting to plan for the potential impacts of the US election. A common question was how much could change around current partnerships between the US and Europe on national security and trade ties, in the event that Republicans win the White House. The concern is fed by a raft of media attention to the statements of Republican candidate, Former President Trump, that are skeptical of some of the multinational institutions that the US is involved in – such as the North Atlantic Treaty Organization, or NATO. Investors are naturally concerned about whether a new Trump administration could meaningfully change the US-Europe relationship. In short, the answer is yes. But there’s some important context to keep in mind before jumping to major investment conclusions.

For example, Congress passed a law last year requiring a two-thirds vote to affirm any exit from NATO, which we think is too high a hurdle to clear given the bipartisan consensus favoring NATO membership. So, a chaotic outcome for global security caused by the dissolution of NATO isn’t likely, in our view.

That said, an outcome where Europe and other US allies increasingly feel as if they have to chart their own course on defense is plausible even if the US doesn’t leave NATO. A combination of President Trump’s rhetoric on NATO, a possible shift in the US’s approach to the Russia-Ukraine conflict, and the very real threat of levying tariffs could influence European policymakers to move in a more self-reliant direction. While it's not the chaotic shift that might have been caused by a dissolution of NATO, it still adds up over time to a more multipolar world. 

For investors, such an outcome could create more regular volatility across markets. But we could also see markets reflect this higher geopolitical uncertainty with outperformance of sectors most impacted by the need to spend on all types of security – that includes traditional suppliers of military equipment as well companies providing cyber security. 

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.

Key developments in China and the U.S. will impact global trade and the growth outlook for Asia in 2024.

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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the risk of re-emerging trade tensions and how this might impact the growth outlook for Asia. It’s Thursday, Feb 15, at 9 AM in Hong Kong.

Trade tensions took a back seat during the pandemic when supply-chain disruptions led to a mismatch in the supply-demand of goods and created inflationary pressures around the world. However, these inflationary pressures are now receding and, in addition, there are two developments that we think may cause trade tensions to emerge once again.

First is China’s over-investment and excess capacity. China continues to expand manufacturing capacity at a time when domestic demand is weakening and its producers are continuing to push excess supply to the rest of the world.

China’s role as a large end-market and sizeable competitor means it holds significant influence over pricing power in other parts of the world. This is especially the case in sectors where China’s exports represent significant market share.

For instance, China is already a formidable competitor in traditional, lower value-added segments like household appliances, furniture, and clothing. But it has also emerged as a leading competitor in new strategic sectors where it is competing head-on with the Developed Market economies. Take sectors related to energy transition.

China has already begun cutting prices for key manufactured goods, such as cars, solar cells, lithium batteries and older-generation semiconductors over the last two quarters.

The second development is the upcoming US presidential election. The media is reporting that if reelected, former President Trump would consider trade policy options, such as imposing additional tariffs on imports from China, or taking 10 per cent across-the-board tariffs on imports from around the world, including China.

Drawing on our previous work and experience from 2018, we believe the adverse impact on corporate confidence and capital expenditure will be more damaging than the direct effects of tariffs. The uncertainty around trade policy may reduce the incentive for the corporate sector to invest. Moreover, this time around, the starting point of growth is weaker than was the case in 2018, suggesting that there are fewer buffers to absorb the effects of this potential downside.

Will supply chain diversification efforts help provide an offset? To some extent yes, in a scenario where the US imposes tariffs on just China. The acceleration of friend-shoring would help; but ultimately the lower demand from China would still be a net negative. However, in the event that the US imposes symmetric tariffs on all imports from all economies, the effects would likely be worse.

Bottom line, if trade tensions do re-emerge, we think it will detract from Asia’s growth outlook.

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.

Our expert panel discusses how the Red Sea situation is affecting the global economy and equity markets, as well as key sectors and the shipping industry.

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

Marina Zavolock: And I'm Marina Zavolock, Chief European Equity Strategist.

Cedar Ekblom: And I'm Cedar Ekblom, Shipping and Logistics Analyst.

Jens Eisenschmidt: And on this special episode of the podcast, we will discuss the ongoing Red Sea disruptions and the various markets and economic dislocations caused by it. It's Tuesday, February 13th, 6pm in Frankfurt.

Marina Zavolock: And 5pm in London.

Marina Zavolock: 12 per cent of global trade and 30 per cent of container trade passes through the Suez Canal in Egypt, which connects the Mediterranean Sea and the Red Sea. Safety concerns stemming from the recent attacks on commercial ships in the Red Sea have driven the majority of container liners to divert trade around the Cape of Good Hope, pushing up container freight rates more than 200 per cent versus December of last year on the Asia to Europe route.

Last week, our colleague Michael Zezas touched briefly on the situation in the Red Sea. Now we'd like to dig deeper and examine this from three key lenses. The European economy, the impact on equity markets and industries, as well as on global container shipping in particular.

Marina Zavolock: So Cedar, let's start with you. You’ve had a high conviction call since freight rates peaked in the middle of January – that container shipping rates overshot and were likely to decline. We've started to see the decline. How do you see this developing from here?

Cedar Ekblom: Thanks, Marina. Well, if we take a step back and we think about how far container rates have come from the peak, we're about 15 per cent lower than where we were in the middle of January. But we're still nearly 200 per cent ahead of where we were on the 1st of December before the disruption started.

Cedar Ekblom: The reason why we're so convicted that freight rates are heading lower from here really comes down to the supply demand backdrop in container shipping. We have an outlook of significant excess supply playing out in [20]24 and extending into [20]25. During the COVID boom, container companies enjoyed very high freight rates and generated a lot of cash as a result. And they've put that cash to use in ordering new ships. All of this supply is starting to hit the market. So ultimately, we have a situation of too much supply relative to container demand.

Another thing that we've noticed is that ships are speeding up. We have great data on this. And since boats have been diverted around the Cape of Good Hope, we've seen an increase in sailing speeds, which ultimately blunts the supply impact from those ships being diverted.

And then finally, if we look at the amount of containers actually moving through the Suez Canal, this is down nearly 80 per cent year over year.

Sure, we're not at zero yet, and there is ultimately [a] downside to no ships moving through the canal. But we think we are pretty close to the point of maximum supply side tension. That gives us conviction that freight rates are going lower from here.

Jens Eisenschmidt: Thank you, Cedar, for this clear overview of the outlook for the container shippers. Marina, let's widen our lens and talk about the broader impact of the Red Sea situation. What are the ripple effects to other sectors and industries and are they in any way comparable to supply chain disruptions we saw as a result of the COVID pandemic?

Marina Zavolock: So what we've done in equity strategy is we've worked with over 10 different sector analyst teams where we've seen the most prominent impacts from the situation in the Red Sea. We've worked as well with our commodity strategy team. And what we were interested in is finding the dislocations in stock moves related to the Red Sea disruptions in light of Cedar's high conviction and differentiated view.

And what we found is that if you take the stocks that are pricing in the most earnings upside, and you look at them on a ratio basis versus the stocks that have priced in the most earnings downside. That performance along with container freight rates peaked sometime in January and has been declining. But there's more to go in light of Cedar's view in that decline.

We believe that these moves will continue to fade and the bottom group, the European retailers that are most exposed. They have fully priced in the bear case of Red Sea disruptions continuing and also that the freight rate levels more importantly stay at these recent peaks. So we believe that ratio will continue to fade on both sides.

The second point is you have some sectors, like European Airlines, where there's also been an impact. Air freight yields have risen by 25 per cent in Europe. And we believe that there is the potential for more persistent spillover in demand for certain customers that look to speed up delivery times.

The third point is that in case of an escalation scenario in the Red Sea, we believe that it's less the container shipping companies at this point that would be impacted and we actually see the European refiners as most exposed to any kind of escalation scenario.

And lastly, and I think this is going to tie into Jens’ economics.

We see a fairly idiosyncratic and broadly limited impact on Europe overall. Yes, Europe is the most exposed region of developed market regions globally – but this is nowhere near a COVID 2.0 style supply chain disruption in our view.

Marina Zavolock: And Jens, if I could turn it back to you, how do you estimate the impact of these Red Sea disruptions on the European economy?

Jens Eisenschmidt: That's indeed one thing we were sort of getting busy on and trying to find a way to get a handle on what has happened there and what would be the implications. And of course, the typical thing, what you do is you go back in time and look [at] what has happened last time. We were seeing changes to say delivery time. So basically disruptions in supply chains.

And of course, the big COVID induced supply chain disruptions had [a] significant impact on both inflation and output. And so, it's of course a normal thing to ask yourself, could this be again happening and what would we need to see?

And of course, we have to be careful here because that essentially is assuming that the underlying structure of the shock is similar to the one we have seen in the past, which of course it's not the case.

But you know, again, it's instructive at least to see what the current level of supply chain disruptions as measurable in these PMI sub-indices. What they translate to in inflation? And so we get a very muted impact so far. We have 10 basis points for the EU area, 15 basis points for the UK. But again, that's probably an upper bound estimate because the situation is slightly different than it was back then.

Back then under COVID, there was clearly a limit to demand. So demand was actually pushing hard against the limits of good supply. And so that has to be more inflationary than in the current situation where actually demand, if anything, is weakened by [the] central bank chasing inflation targets and also weak global backdrop.

So, essentially we would say, yes, there could be some small uptick in inflation, but it's really limited. And that's talking about here, core goods inflation. The other point that you could sort of be worried about is commodity prices and here in particular energy commodities.

But so far the price action here is very, very limited.

If anything, so far, TTF prices are, you know, going in the other direction. So all, all in all, we don't really see a risk here for commodity prices, at least. If the tensions in the Red Sea are not persisting longer and intensify further – and here really, this chimes very well in the analysis of Cedar and also with Marina – what you just mentioned.

That doesn't really look like any supply chain disruption we have seen on the COVID. And it also doesn't really look like that it would, sort of, last for so long. And we have the backdrop of a oversupply of containers. So all in all, we think the impact is pretty limited. But let's sort of play the devil's advocate and say, what would happen to inflation if this were to persist?

And again, the backdrop would be similar to COVID. Then we could think of 70 basis points, both in the Euro area and the UK added to inflation. And of course that's sizable. And that's precisely why you have central bankers around the world, not particularly concerned about it – but certainly mentioning it in their public statements that this is a development to watch.

Marina Zavolock: Thank you Jens, and thank you Cedar for taking the time to talk.

Cedar Ekblom: Great speaking with you both.

Jens Eisenschmidt: 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.

Despite a likely softening of the labor market, U.S. consumer spending should remain healthy for 2024.

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Welcome to Thoughts on the Market. I’m Sarah Wolfe from the US Economics Team. Along with my colleagues bringing you a variety of perspectives; today I’ll give you an update on the US consumer. It’s Monday, February 12, at 10 AM in New York.

Lately, there's been a lot of mixed data on the health of the US consumer. We saw a very strong holiday spending in November and December; very strong jobs  reports in recent months. But we’re forecasting somewhat softer data in January for retail sales. And we know that delinquencies have been rising for households.

When we look towards the rest of 2024, we're still expecting a healthy US consumer based on three key factors.

The first is the labor market. Obviously, the labor market has been holding up very well and we’ve actually been seeing a reacceleration in payrolls in the last few months. What this means is that real disposable income has been stronger, and it’s going to remain solid in our forecast horizon. We do overall expect some cooling in disposable income though, as the labor market softens. Overall, this is the most important thing though for consumer spending. If people have jobs, they spend money.

The second is interest rates. This has actually been one of the key calls for why we did not expect the US consumer to be in a recession two and half years ago, when the Fed started raising interest rates. There’s a substantial amount of fixed rate debt, and as a result less sensitivity to debt service obligations. We estimate that 90 per cent of household debt is locked in at a fixed rate. So over the last couple of years, as the Fed has been raising interest rates, we’ve seen just that: less sensitivity to higher interest rates. Right now, debt service costs are still below their 2019 levels. We’re expecting to see a little upward pressure here over the course of this year – as rates are higher for longer, as housing activity picks up a bit; but we expect there will be a cap on it.

The last thing is what’s happening on the wealth side. We’ve seen a 50 percent accumulation in real estate wealth since the start of the pandemic. And we’re expecting to see very little deterioration in housing wealth this year. So people are still feeling pretty good; still have a lot of home equity in their homes. So overall, good for consumer spending. Good for household sentiment.

So to sum it up, this year, we’re seeing a slowing in the US consumer, but still relatively strong. And the fundamentals are still looking good.

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.

Investors in credit markets pay close attention to the latest economic data. Our head of Corporate Credit Research explains why they should be less focused on the newest numbers and more focused on whether and how those numbers are changing.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together. It's Friday, February 9th at 2pm in London.

Almost every week, investors are confronted with a host of economic data. A perennial question hovers over each release: should we focus more on the level of that particular economic indicator; or its rate of change. In many cases, we find that the rate of change is more important for credit. If so, recent data has brought some encouraging developments with surveys of US Manufacturing, as well as bank lending.

I’m mindful that the concept of “economic data” is about as abstract as you can get. So let’s dig into those specific manufacturing and lending releases. Every quarter, the Federal Reserve conducts what is known as their Senior Loan Officer [Opinion] Survey, where they ask senior loan officers – at banks – about how they’re doing their lending. The most recent release showed that more officers are tightening their lending standards than easing them. But the balance between the two is actually getting a little better, or looser, than last quarter. So, should we care more about the fact that lending standards are tight? Or that they’re getting a little less tight than before?

Or consider the Purchasing Managers Index, or PMI, from the Institute of Supply Management. This is a survey of purchasing managers at American manufacturers, asking them about business conditions. The latest readings show conditions are still weaker than normal. But things are getting better, and have improved over the last six months.

In both cases, if we look back at history, the rate of change of the indicator has mattered more. As a credit investor, you’ve preferred tight credit conditions that are getting better versus easy credit that’s getting worse. You’ve preferred weaker manufacturing activity that’s inflecting higher instead of strong conditions that are softening. In that sense, at least for credit, recent readings of both of these indicators are a good thing – all else equal.

But why do we get this result? Why, in many cases, does the rate of change matter more than the level?

There are many different possibilities, and we’d stress this is far from an iron rule. But one explanation could be that markets tend to be quite aware of conditions and forward looking. In that sense, the level of the data at any given point in time is more widely expected; less of a surprise, and less likely to move the market.

But the rate of change can – and we’d stress can – offer some insight into where the data might be headed. That future is less known. And thus anything that gives a hint of where things are headed is more likely to not already be reflected in current prices. No rule applies in all situations. But for credit, when in doubt, root for a positive rate of change.

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.

Our credit experts from Research and Investment Management give their overview of private and public credit markets, comparing their strengths and weaknesses following two years of rate hikes.

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Vishy Tirupattur: Welcome to Thoughts on the Market. I am Vishy Tirupattur, Chief Fixed Income Strategist in Morgan Stanley Research.

David Miller: And I'm David Miller, Head of Global Private Credit and Equity for Morgan Stanley Investment Management.

Vishy Tirupattur: And on this special edition of the podcast, we'll be taking a deep dive into the 2024 credit landscape, both from a private credit and public credit perspective.

Vishy Tirupattur: So, David, you and I come at credit from two different avenues and roles. I cover credit, and other areas of fixed income, from a sell side research perspective. And you work for our investment management division, covering both private credit and private equity. Just to set the table for our listeners, maybe we could start off by you telling listeners how private credit investing differs from public credit.

David Miller: Great. The main differences are: First, privately negotiated loans between lenders and borrowers. They're typically closely held versus widely distributed in public credit. The loans are typically held to maturity and those strategies are typically has that long duration, sort of look. Private credit -- really -- has three things of why their borrowers are valuing it. Certainty, that's committed capital; certainty of pricing. There's speed. There's no ratings -- fewer parties, working on deals. And then flexibility -- structures can be created to meet the needs of borrowers versus more highly standardized parts of the public credit spectrum. Lastly and importantly, you typically get an illiquidity premium in private credit for that holding to maturity and not being able to trade.

Vishy Tirupattur: So, as we look forward to 2024, from your perspective, David, what would you say are some of the trends in private credit?

David Miller: So private credit, broadly speaking, continues to grow -- because of bank regulations, volatility in capital markets. And it is taking some share over the past couple of years from the broadly syndicated markets. The deal structures are quite strong, with large equity contributions -- given rates have gone up and leverage has come down. Higher quality businesses typically are represented, simply as private equity is the main driver here and there tend to be selling their better businesses. And default rates remain reasonably low. Although we're clearly seeing some pressure, on interest coverage, overall. But volumes are starting to pick up and we're seeing pipelines grow into [20]24 here.

Vishy Tirupattur: So obviously, it's interesting, David, that you brought up, interest rates. You know, it's a big conversation right now about the timing of the potential interest rate cuts. But then we also have to keep in mind that we have come through nearly two years of interest rate hikes. How have these 550 basis points of rate hikes impacted the private credit market?

David Miller: The rate hikes have generally been positive. But there are some caveats to that. Obviously, the absolute return in the asset class has gone up significantly. So that's a strong positive, for the new deals. The flip side is -- transaction volumes have come down in the private credit market. Still okay but not at peak levels. Now older deals, right, particularly ones from 2021 when rates were very low -- you're seeing some pressure there, no doubt. The last thing I will say, what's noteworthy from the increase in rates is a much bigger demand for what I'll call capital solutions. And that's junior capital, any type of security that has pick or structure to alleviate some of that pressure. And we're quite excited about that opportunity.

Vishy Tirupattur: David, what sectors and businesses do you particularly like for private credit? And conversely, what are the sectors and businesses you'd like to avoid?

David Miller: Firstly, we really like recurring or re-occurring revenue businesses with stable and growing cash flows through the cycle, low capital intensity, and often in consolidating industries. That allows us to grow with our borrowers over time. You know, certain sectors we continue to like: insurance brokerage, residential services, high quality software businesses that have recurring contracts, and some parts of the healthcare spectrum that really focus on reducing costs and increasing efficiency. The flip side, cyclicals. Any type of retail, restaurants, energy, materials, that are deeply cyclical, capital intensive and have limited pricing power and high concentration of customers.

So, now I get to ask some questions. So, Vishy, I'd love to turn it to you. How do returns, spreads, and yields in private credit compare to the public credit markets?

Vishy Tirupattur: So, David, yields and spreads in private credit markets have been consistently higher relative to the broadly syndicated loan market for the last six or seven years -- for which we have decent data on. You know, likely reflecting, as you mentioned earlier, illiquidity premia and perhaps potentially investor perception of the underlying credit quality. The basis in yields and spreads between the two markets has narrowed somewhat over the last couple of years. Between 2014 and the first half of 2023, private credit, on average, generated higher returns and recorded less volatility relative to the broadly syndicated loan market. For example, since the third quarter of 2014, the private credit market realized negative total returns just in one quarter. And you compare that to eight quarters of negative returns on the broadly syndicated loan market.

David Miller: Something we both encounter is the idea of covenants -- which simply put, are additional terms on lending agreements around cash flow, leverage, liquidity. How do covenants help investors of private credit?

Vishy Tirupattur: Over the last several years, the one thing that stands out in the public credit markets -- especially in the leveraged loan market -- is the loosening of the covenant protection to lenders. Cov-Lite, which means, nearly no maintenance covenants, has effectively become the norm in the broadly syndicated loan market. This is one place that I think private credit markets really stand out. In our view, covenant quality is meaningfully better in private credit. This is mainly because given the much smaller number of lenders in typical private credit deals, private credit has demonstrably stronger loan documentation and creditor protections. Maintenance covenants are typically included. And to a great extent, these covenant breaches could act potentially as circuit breakers to better manage outcomes, you know, as credit gets weaker.

David, we also hear a lot about the risk of defaults, in private credit markets. How much concern do you have around defaults?

David Miller: We are watching, obviously stress on credits and the default rates overall, and they are at historically quite low levels. We do expect them to tick up over time. But there are some reasons why we clearly like private credit from that perspective. First, as mentioned, the covenant protections typically are a little better. If you look historically, depending on the data, private credit, default rates have been, somewhat lower than public leveraged credit and its been quite a resilient asset class, for a number of reasons. We like the amount of private equity dry powder that sits waiting to support some of the companies that are underperforming. And it's important to remember that private credit lenders typically have an easier time resolving some of these stresses and workouts given that they're quite bilateral or a very small group, to make decisions and reach those negotiated settlements. So overall, we feel like there will be a category of businesses that are underperforming and are in structural decline and that will default. But that number will be still very low relative to the universe of overall private credit.

Vishy Tirupattur: So David, it’s been great speaking with you.

David Miller: Thanks for having me on the podcast, Vishy.

Vishy Tirupattur: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on Apple Podcasts app. It helps more people find the show.

With multiple, ongoing geopolitical conflicts, our analyst says investors should separate signals from noise in how these events can impact markets.

Important note regarding economic sanctions. This research may reference jurisdiction(s) or person(s) which are the subject of sanctions administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the United Kingdom, the European Union and/or by other countries and multi-national bodies. Any references in this report to jurisdictions, persons (individuals or entities), debt or equity instruments, or projects that may be covered by such sanctions are strictly incidental to general coverage of the relevant 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 jurisdictions, persons, instruments, or projects. Users of this report are solely responsible for ensuring that their investment activities are carried out in compliance with applicable sanctions.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the impact of geopolitical events on markets. It's Wednesday, February 7 at 5 pm in London.

Geopolitical conflicts around the globe seem to be escalating in recent weeks. Increased US military involvement in the Middle East, fresh uncertainty about Ukraine’s resources in its conflict with Russia, and lingering concerns about the US-China relationship are in focus. And since financial markets and economies around the world have become more interconnected, it's more important than ever for investors to separate signals from noise in how these events can impact markets. So here’s a few key takeaways that, in our view, do just that.

First, fighting in the red sea may influence the supply chain, but the results are probably smaller than you’d think. Yes, there’s been a more than 200 per cent increase in the cost of freight containers moving through a channel that accounts for 12 per cent of global trade. But, the diversion of the freight traffic to longer routes around Africa really just represents a one-time lengthening of the delivery of goods to port. That’s because there’s an oversupply of containers that were built in response to bottlenecks created by increased demand for goods during the pandemic. So now that there’s a steady flow of containers with goods in them, even if they are avoiding the Red Sea, the impact on availability of goods to consumers is manageable, with only a modest effect on inflation expected by our economists.

Second, ramifications on oil prices from the Middle East conflict should continue to be modest. While it might seem nonsensical that fighting in the Middle East hasn’t led to higher oil prices, that’s more or less what’s happened. But that’s because disruptions to the flow of oil don’t appear to be in the interest of any of the actors involved, as it would create political and economic risk on all sides. So, if you’re concerned about movements in the price of oil as a catalyst for growth or inflation, then our team recommends looking at the traditional supply and demand drivers for oil, which appear balanced around current prices.

Finally, as the US election campaigns gear up, so does rhetoric around the US-China economic relationship. And here we see some things worth paying attention to. Simply put, higher tariffs imposed by the US are a real risk in the event that party control of the White House changes. That’s the stated position of Republicans’ likely candidate – former President Trump – and we see no reason to doubt that, based on how the former President levied tariffs last time he was in office. As our chief Asia economist Chetan Ahya recently noted, such an outcome creates downside risk for the China economy, at a time when downside risk is accumulating for other structural reasons. It's one reason our Asia equity strategy team continues to prefer other markets in Asia, in particular Japan.

Of course, these situations and their market implications can obviously evolve quickly. We'll be paying close attention, and keeping you in the loop.

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.

Japan’s experience as one of the first countries to have an aging population offers a glimpse of what’s to come for other countries on the same path. See what an older population could mean in terms of social policy, productivity, immigration reform, medical costs and more.

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

Robert Feldman: And I'm Robert Feldman, Senior Advisor at Morgan Stanley MUFG Securities.

Seth Carpenter: And on this special episode of the podcast, we will talk about longevity, and what the rest of the world can learn from Japan. It’s Tuesday, February 6th, at 8 a. m. in New York.

Robert Feldman: And it's 10 p. m. in Tokyo.

Seth Carpenter: Over the past year, I am guessing that lots of listeners to this podcast have heard many, many stories about new anti obesity drugs, cutting edge cancer treatments. And so today, we're going to address what is perhaps a bigger theme at play here.

Now, the micro human side of things is clearly huge, clearly important. But Robert and I are macroeconomists, and so we're going to think about what the potential for longer human lifespans is. For the economics. So as life spans increase, we're probably going to see micro and macro ramifications for demographics, consumer habits, the healthcare system, government spending, and long-term financial planning.

And so, it follows that investors may want to consider these ramifications across a wide range of sectors. So, Robert, I wanted to talk to you in particular because you've been following this theme in your research on Japan -- which is perhaps at the earliest stage of this with the fastest aging population across developed economies.

So, start us off. Perhaps share some more about the demographic challenges that Japan is facing and what's unique about their experience.

Robert Feldman: Thanks, Seth. First, let me start by saying that Japan is not so much unique as it is early. For example, in the 1960s, Japan's total fertility rate averaged about two children per woman. But it hasn't been above two since 1975. Now it's about 1.34. Population as a whole peaked in 2010 and now is down by about 2.4 per cent.

What about government spending on pensions and healthcare? Well, those went from about 16 per cent of GDP in 1994 to about 27 per cent now. So the speed of these increases is extremely fast. That said, Japan has one very unusual feature. Labor force participation rates have climbed quite sharply, especially for women. So, more people are working and they're working longer.

But at the same time, Japan has actually been pretty successful in holding down costs of many longevity related spending categories. Japan has a nationalized healthcare system. So, the government has lots of power over drug prices, which it has held down. It’s shortened hospital stays. They're still too long -- but it has shortened them. It has also raised retirement ages and has a very clever pension indexing system.

Seth Carpenter: All right, so if I can sum this up then, Robert. Japanese workers are working longer, the Japan economy is spending less on health care. So, does this mean that we can just say Japan has solved most or all of the challenges associated with longer lifespans?

Robert Feldman: Well, it’s not exactly reduced spending on healthcare. It just hasn't gone up as much as it might have.

Seth Carpenter: Okay, that's a good distinction.

Robert Feldman: Yes. Anyway, Japan has not solved all the problems, not by a long shot. So, for example, productivity growth is very important for holding debt costs down. But productivity growth -- and I like the simplest measure, just real output per worker -- has been anemic in Japan.

So, when productivity growth is low and aging is fast, it's kind of hard to pay the cost of longevity; even if labor force growth is high and Japan has been able to suppress ageing costs. That's the wrinkle here.

Seth Carpenter: Okay. So then, if we shifted to think about the fiscal perspective on things. The debt side of things. Is the longer-lived nature of the population; is that going to end up being something like a debt time bomb?

Robert Feldman: Well, I don’t think so. At least not yet. And there are two factors behind my view. One is the potential for productivity growth to accelerate a lot. And the other is some special things about Japan's debt dynamics. Let me start with growth. There is huge room here for productivity growth here in Japan. We still has a lot of labor that's underused. The labor force is very well educated, and it's very disciplined. Therefore, it can be re-skilled for more productive jobs. There's also a lot more room for cost reduction in social spending categories, especially by using IT and AI. In addition, healthier people are more productive workers.

On the debt dynamic side, the national debt is about 250 percent of GDP. Very high. But Japan owns 1.23 trillion dollars of foreign exchange reserves. So, Japan is borrowing a lot at very, very low short-term rates, and very low long-term rates as well. They're below one per cent. That said it’s earning high foreign interest rates on its external assets. In addition, about half the national debt is owned by the central bank. And so when the central bank, the Bank of Japan, collects coupons from the government, it pays them right back to the government in its year end profit.

Seth Carpenter: Okay, so that helps put things into perspective. So, if we're looking forward, do you have any concrete measures that you think Japan as a society, the Japanese government might undertake? And what some of those potential outcomes might be?

Robert Feldman: Well, I'm expecting incremental change that Japan is very good at. Social policy is hard to make. There's a lot of politics involved. Even in the prime minister's policy speech the other day, he mentioned a number of things. There will be changes. For example, ways to keep costs down but also to improve productivity. There will some changes in retirement ages. There will be some flexible labor market rules. This is important because ideas move with people; and when people move more, then productivity should go up. There will be continued easing of the immigration rules for highly skilled workers. Japan now has about 2 million foreign workers and the number will probably keep going up. Medical costs reforms are also very important. For example, it’s important for Japan to allow non doctors to do some things that heretofore only doctors have been permitted to do. Faster deployment of new technologies in high import sectors like energy and agriculture -- this should save us a lot of money in terms of not buying imports that we don't need once technology is deployed domestically. Now, can I ask you some questions?

Seth Carpenter: Of course.

Robert Feldman: Okay. So. From where you sit as a global economist, what aspects of Japan's experience do you think are particularly relevant to other economies?

Seth Carpenter: I would say the part where you were touching on the debt dynamics is particularly salient, right? We know that in the COVID era, lots of countries sort of ran up a really large increase in their national debt. And so, trying to figure out what sort of debt dynamics are sustainable over the long run I think are critical. And I think the factors that you point out in terms of an aging population, sort of, have to be considered in that context.

I think more broadly, the idea of an aging population is pretty widespread. It is not universal, obviously. But we know, for example, that in China, the population growth is coming down. We know that for a long time in Europe, there has been this aging of the population and a fall in fertility rates. So, I think a lot of the same phenomena are relevant. And like you said at the beginning: it's not that Japan is unique, it's that Japan is early.

Robert Feldman: I have another question for you is, and also on this longevity theme -- about the difference between developed and emerging markets. What are the notable differences between those two groups of countries?

Seth Carpenter: Yeah, I mean, I think we can make some generalizations. It is more often the case that slowing population growth, falling fertility rates, aging population is more of a developed market economy than an emerging market economy phenomenon. So, I think in that regard, it's important. I will say, however, that there are some exceptions to every rule.

And I mentioned China that, you know, maybe straddles those two worlds -- developed versus emerging market. And they’re also seeing this slowing in their population growth. But I think within that, what's also interesting is we are seeing more and more pressures on migration. Immigration could be part of the solution. I think you highlighted this about Japan. And therein lies, at times, some of the geopolitical tensions between developed market economies and emerging market economies. But I think, at the same time, it could be part of the solution to any of the challenges posed by longevity.

Seth Carpenter: But, I have to say, we probably need to wrap it up there.

Robert, for me, it is always a pleasure to get to talk to you and hear some of your wisdom.

Robert Feldman: Thank you, Seth. This is great. Always happy to talk with you. And if you want to have me back, I'll be there.

Seth Carpenter: That's fantastic. And for the listeners, thank you 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.

As positive economic data makes it less likely that the Fed will cut rates in March, our Chief US Equity Strategist explains what this could mean for small-cap stocks. 

----- 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 a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, February 5th at 11 am in New York.

So let's get after it. 

Going into the last week, investors had a number of factors to consider. The busiest week of earnings season that included several mega cap tech stocks, a Fed meeting, and some of the most relevant monthly economic data for markets. Around these data releases, we saw significant moves in many macro markets, as well as individual securities.

We started the week with a soft Dallas Fed Manufacturing Index reading, which followed the weak New York Manufacturing Survey two weeks earlier. Meanwhile, the Conference Board Consumer Confidence Index and the University of Michigan Consumer Sentiment Survey both pushed higher.

As the week progressed, we got more data that supported the view that the economy may not be slowing as much as many had started to believe, including perhaps the Fed. In contrast to the Dallas and New York Fed Manufacturing Surveys, The ISM manufacturing PMI ticked higher, and surprised to the upside by a few points.

More importantly, the orders component ticked above 50 to 52, which tends to lead the headline index. The fact that the overall equity market responded favorably to these data makes sense in the context of still present growth uncertainty. However, the fact that cyclical stocks that are levered to manufacturing continue to underperform tells me the market is still very undecided about the macro outcome this year -- as am I.

Finally, the headline non-farm payrolls number on Friday was extremely strong at 353, 000. Manufacturing jobs surprised to the upside, giving credence to the uptick in the ISM Manufacturing PMI cited earlier. However, the release also incorporated the annual revisions, which may be overstating the strength in labor markets.

Employment trends from the Household Survey remain much softer, as do hours worked, quit rates, and layoff announcements. In short, the labor market is fine, but still weakening, as desired by the Fed. The one area of unequivocal strength remains government spending and hiring, which could be working against the Fed's goals.

The bond market went with the stronger read of the data and traded sharply lower on Friday, as so this morning. It has also pushed out the timing of the first Fed interest rate cut, taking the odds of a March cut all the way down to just 20 per cent. Recall this probability was as high as 90 per cent around the end of last year.

Perhaps the market is starting to take the Fed at its word. They aren't planning to cut rates in March. The equity market tried to look through this rate move on Friday driven by a historically narrow move in large cap quality growth stocks. This is very much in line with our recommendation since the beginning of the year to stick with large cap quality growth.

For now, the internals of the stock market appear to agree with our view that a stickier rate backdrop is a disproportionate headwind for stocks with poor balance sheets and a lack of pricing power. In other words, lower quality cyclicals and many areas of small caps. Perhaps the most important data to support this conclusion is that earnings results and prospects for 2024 remain weak for these kinds of companies.

On this front, we continue to get questions from investors on what it will take for small caps to work from here on a relative basis. The Russell 2000, the small cap index, has underperformed the S&P 500 by 7 per cent year to date and is still more than 20 per cent below all time highs reached over two years ago.

While some think this is an opportunity, our view is that we need more confirmation that we're headed for a higher nominal growth regime driven more by the private economy rather than inefficient government spending.

As we've discussed in the past, small caps are particularly economically sensitive and reliant on pricing power to offset their lack of scale.

As they await more definitive confirmation on whether a higher nominal growth environment is coming, small caps are being weighed down by a weakening margin profile, higher leverage, and borrowing costs. In short, stick with what works in a late cycle environment where the macro remains uncertain. Large cap, high quality growth. 

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.

Mortgage rates are down, sales volumes are rising and housing is gradually getting more affordable. Our analysts discuss why they think the U.S. housing market is on a healthy foundation. 

----- Transcript -----

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

Jay Bacow: And I'm Jay Bacow, the other Co Head of Securitized Products Research.

Jim Egan: And on this episode of the podcast, we'll be talking about mortgage rates, home sales volumes and the U. S. housing market.

Jay Bacow: Alright Jim. Mortgage rates are down. Sales volumes are up. [Is] the housing market back?

Jim Egan: Sales volumes might finally be inflecting higher, or at least they might actually be finding that bottom. If we look at the seasonally adjusted annualized figures that came in in December, pending home sales increased 8 per cent to their highest level since July. Purchase applications, which -- little bit more high frequency, we have them through January -- they're up 23 percent from the lows that they put in in late October or early November.

Jay Bacow: Alright, that sounds good, but seasonally adjusted annualized figure sounds like a mouthful. Can you lay that out a little easier for us?

Jim Egan: I think that these numbers just need to be put [00:01:00] into a little bit more context. Yes, pending home sales were up 8 per cent month over month. But if I look at just the December print, it was the weakest pending home sales print for that month in the history of that index. Now, relative to 2022, it is improving. It was only down 1 per cent from December of 2022, and that's the lowest decrease we've had since 2021. But these numbers still aren't strong.

Going around the horn to some of the other demand statistics, existing home sales finished 2023 down 19 per cent. But they also strengthened into year end only down 9 per cent in the fourth quarter. New home sales, as we've mentioned on this podcast before. That is the demand statistic that has actually been showing growth up 4 per cent in 2023 versus 2022. Up 15 per cent in the second half of 2023 versus the second half of 2022.

Jay Bacow: Alright, so we’ve got a pickup or an inflection in housing activity, and we’ve had mortgage rates coming down. Affordability is also independent of home prices. So where does all this stand?    

Jim Egan: Right? [00:02:00] So because of those home price increases that you've mentioned, the monthly payment on the medium price home is still up almost $100 year over year. But the path of affordability, the deterioration that we've been talking about -- it's as small as it's been since February 2021. And if we're not looking at this on a year over year basis; if we're just looking at this on a month, over month, or every two-month basis. The two-month increase that we've seen in affordability is the steepest increase, or the steepest drop in unaffordability, if you will, since January of 2009.

Suffice it to say, we think this is a much healthier housing market than 2009.

Jay Bacow: Alright. Now what about the supply side? Because obviously, [there’s] a lot of ways we can get supply. One of the more straightforward methods is for someone just to build a new home. How’s that data looking?  [00: 03:00]

Jim Egan: We are building more homes. As new home sales have moved higher, single unit housing starts have moved higher as well. Now from cycle peak, which we estimate as April 2022, single unit starts fell about 23 per cent through the middle of 2023. And another thing that we've talked about on this podcast in the past is that build timelines have been elongating. And that was leading to a backlog in homes actually under construction.

That decrease allowed that backlog to clear a little bit, and since the middle of 2023, June till the end of the year, single unit starts were actually up 7 per cent. We are building more homes.

Jay Bacow: Alright. So new home sales are clearly, literally new homes. But people can also list their existing homes. What's that data look like?

Jim Egan: Listing volumes are higher as well. In fact, as of this month, I can no longer say that we are at historic lows when it comes to for sale inventory. While inventory has also climbed throughout the second half of 2022 into the first half of 2023, [00:04:00] that historic low statement is something I could have made every month for the past 8 months.

It's a statement I could have made for 41 of the past 54 months. Months of supply did retreat a little bit in December. But when we think about our models for housing activity and really for home prices, it's that growth in the absolute amount of for sale inventory that really plays a big role.

Jay Bacow: Alright. I don’t have a PhD in economics. You’re the housing strategist. If we have more supply, does that mean prices are coming down?

Jim Egan: That's what we think. We continue to think that these for sale inventory increases that are happening alongside what we do continue to believe will be sales growth in 2024 -- and we think we're seeing the first signs of now -- are going to be enough to bring home prices moderately negative in 2024. And alongside these recent activity prints, the most recent home price print was actually just a little bit softer than we thought it would be.

We had forecasted about it a 15-basis point decrease in home prices in November. We saw an 18-basis point [00:05:00] decrease. It's not unusual for home prices to decrease month over month in November. But this is kind of from our perspective a little bit of validation from a home price forecast perspective.

We're calling for them to fall 3 percent year over year in 2024. We think this is very moderate. We do not think this is a correction. We believe the housing market is on a very healthy foundation. Looks like we're moving towards sales increases. But we do still think you'll see a little bit of price weakness next year.  

Jay Bacow: Jim, thanks for taking the time to talk.

Jim Egan: Great speaking with you, Jay.

Jay Bacow: And thanks 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.

Our analyst explains what parts of the consumer staples sector could benefit from an aging global population.

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Welcome to Thoughts on the Market. I’m Sarah Simon, Head of the European consumer staples team at Morgan Stanley, and today I’ll be talking the increasingly important longevity theme and its impact on consumers. It’s Thursday, the first of February, at 3 PM in London.

It's no secret that global life expectancy is increasing. The rise of modern medicine, improved working conditions, urbanization, and greater access to food and water have all contributed to a greater life expectancy. According to the United Nations, global life expectancy has risen more than 54% since 1950, reaching about 71 years in 2021, with Asia improving the most.

 At the same time people are living longer, birth rates for most developed economies have dropped. Higher levels of education, the increasing proportion of women in the workforce, and modern medicine have all contributed to lower birth rates. In fact, over the last several decades, the global population has aged significantly, with the median global age increasing 8 years since 1950, hitting 30 years in 2021. Looking ahead, the United Nations expects the percentage of population aged 65+ will continue to increase at a faster rate than younger populations.

 An ageing population has far-reaching implications, but let’s consider the spending power of older adults. Real disposable income among older adults has increased throughout the years. In 2022, an older adult had about 50% more than in 2000. As a result, older adults today have more money to spend on consumer goods and services than in the last decades. Here are three categories within the Consumer Staples sector that could benefit from the rise in longevity.

First, Consumer Health. As consumers skew older and their disposable income increases it bodes well for a wide range of consumer health products – think Vitamins, Minerals and Supplements (VMS), denture care, cold and flu remedies and more.

Second, Active Nutrition, including protein supplements and probiotic-rich foods such as kimchi, kombucha, or yogurt, is a likely beneficiary of the longevity theme. This sub-category is currently growing mid- to high single digits on average (over 10% for protein-related categories), and we see room for further long-term growth.

Finally, Medical Nutrition. With age comes increasing prevalence of chronic diseases, including cancers, and with malnutrition. Addressing malnutrition improves the cost, and effectiveness, of medical treatment and also allows for shorter hospital stays. To that end, healthcare providers are increasing turning to medical nutritional solutions--driving demand for these products.

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.

While 2023 was an active year for U.S. mergers and acquisitions, according to Wally Cheng, Head of West Coast M&A in our Technology Investment Banking Group, 2024 is positioned to be a busy year.

Wally Cheng is not a member of Morgan Stanley’s Research department. Unless otherwise indicated, his views are his own and may differ from the views of the Morgan Stanley Research department and from the views of others within Morgan Stanley.

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

Wally Cheng: And I'm Wally Cheng, Head of West Coast Tech M&A for Investment Banking. 

Michael Zezas: And on this special episode of Thoughts on the Market, we'll focus on the outlook ahead for mergers and acquisitions in US tech. 

Michael Zezas: Wally, I really wanted to talk with you because 2023 was arguably the toughest year for U.S. mergers and acquisition markets since the global financial crisis. And we saw a three prong set of challenges in the form of rising interest rates, geopolitical conflicts and recession concerns. And that seems to have weighed on deal activity across the globe. Looking back, the first quarter of 2023 marked the lowest point of the M&A market, and since then we've seen deal activity tick higher. But from your perspective in tech banking, where are we right now and what should investors be watching for this year? 

Wally Cheng: The punch line answer that, Mike, is they should be looking for a bounce back in M&A in 2024 for all the reasons that you mentioned. Activity was very muted in 23. You highlighted rising interest rates. You highlighted geopolitical risks, wars, etc.. In that kind of environment deals just don't get done. There's not a meeting of the minds between buyer and seller. We're in a different environment now, I think what's happened over the last quarter or so is an appreciation or an acceptance of the new normal. The world has a lot of uncertainty around it, and that's no longer a new thing. It's a thing that buyers and sellers now know that they have to face for the foreseeable future. So my expectation for 2024 is much more activity, and we're seeing green shoots of that. And we saw a lot of that happening towards the end of last year. A number of large strategic deals that complemented the flow of private equity driven deals that we've seen for the last couple of years. The playing field now going into the full year of 2024 is really about all groups of buyers and sellers being active. What do I mean by that? I mean, on the buyer side, it's both corporate buyers and private equity buyers. Both active. First half of 2023 was only sponsors. Second half of 2023 was largely only strategics. Now they are both playing in the game. That's on the buyer's side. On the seller side, for the reasons that are articulated, sellers are no longer playing for a material change in the operating environment and a return or snap back, back to 2021 valuation levels. That was a blip on the screen, going to be a very long time to get back to there, if ever, and they're being much more sober and reasonable and realistic about valuations that they can get. So we're seeing much more of a meeting of the minds between buyer and seller. All buyer groups are active. 

Michael Zezas: So drilling down into your area of expertise a little bit more. It's been a slower tech IPO market recently. What's the impact of a slower IPO market on M&A? 

Wally Cheng: That is going to drive more M&A. And what I mean by that is when private companies can't get public, and return money to their private shareholders, they have to seek other ways of doing that. And that's M&A. Last year, and the year before were historically low in terms of IPO volume. Every year, on average over the last decade or so, there's been roughly 40 tech IPOs, last year and the year before less than ten. We're not expecting much more than that this year either. So with that kind of IPO volume, the huge number of private companies, by last count, about 1300 private companies of $1 billion in greater valuation were sitting in the private domain in technology. And of those 1300 companies, just a few of them are going to make it public in the next few years, which means they're going to have to seek other ways of monetizing for their shareholders. And that's going to be through M&A. 

Michael Zezas: So there's obviously a lot of discussion right now about when the Fed will begin cutting interest rates this year. But in any case, the consensus is that even when they are cutting, you're likely to see levels of interest rates also will be somewhat higher than what we saw in the decade between the financial crisis and the pandemic. So what's the potential impact on the next wave of M&A activity from having somewhat higher interest rates? 

Wally Cheng: It will be a factor that is going to hold back a more robust M&A market. But I think the real impact of it is going to be twofold. One is there are going to be many more stock deals. So deals where stock is used as an acquisition currency to buy the target. And then two is I think there's going to be a lot more activity from buyers who have a lot of cash firepower sitting on their balance already. They're going to press their advantage in an environment like this, where for many buyers who don't have that same luxury of cash on their balance sheet and require outside financing at the higher rates that you mentioned to go finance deals, which will make those deals a little bit more difficult to justify economically. So if you've got very inexpensive cash sitting on your balance sheet, now's the time to go use it. 

Michael Zezas: Drilling down a bit here, what sub sectors within technology do you think will see the most M&A activity? 

Wally Cheng: Number one software. And number two Semis with an asterisks on Semis, which I'll get to in a second. In both of those industries consolidation is imperative. In software. Customers are looking for best of platform solutions not best of breed anymore. So in a landscape where there are a thousand plus software companies valued at greater than $1 billion that are either public or private today there's going to be a lot of M&A happening, to get to a product offering that looks more like a best of platform solution for their customers. Similarly, in Semis, the dynamic is the same, a little bit more driven by scale, and that is really what's driving M&A in Semis. There's about 100 semiconductor companies that are public today with more than $1 billion in value. Our expectation is that the need for scale is going to drive that number down to about a third of that through M&A over the next 5 to 10 years. The asterisks that I mentioned on the semiconductor activity is that in order to get the semiconductor deal done today, given the global nature of their revenue, is that they require regulatory approval from governments all over the globe. And in today's environment, where East and West are in a tug of war for tech supremacy, those approvals are really difficult to get. Are they impossible? No. Does it take longer to get them? Yes. So buyers and sellers in semis are really, really taking a hard look at whether or not they can get regulatory approval before announcing their deals, because the last thing they want to do is announce a deal, wait for two years to get it approved, it not be approved, and they've got damaged companies coming out of the end of that.

Michael Zezas: Got it. So geopolitical concerns, still a limiting factor for cross-border M&A, but overall we're seeing tailwinds for M&A activity picking up. 

Wally Cheng: You got it. 

Michael Zezas: Well Wally thanks for taking the time to talk. 

Wally Cheng: Super speaking to you Mike. Thanks. 

Michael Zezas: As a reminder if you enjoy Thoughts on the Market, please take a moment to rate review us on the Apple Podcasts app. It helps more people find the show.

Who is going to buy nearly $11 trillion in new fixed-income assets in 2024? Find out where our Chief Cross-Asset strategist expects to see demand.

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Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's Chief Cross Asset strategist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our outlook for global fixed income supply and demand in 2024. It's Tuesday, January 30th at 10 a.m. in New York.

This year is shaping out to be a big year for bond markets. We see global fixed income growth supply rising 12% to almost $11 trillion in 2024, and expect U.S. Treasury gross supply alone to increase 30% to $4 trillion in 2024. So the big questions investors are grappling with are one, what drives this increase in supply? And two, will there be sufficient demand and from where to meet the supply?

One of the drivers for this rise in supply is quantitative tightening or QT. As G4 central banks have undertaken aggressive measures to curb inflation, they've shrunk their balance sheets by about $250 trillion. Yes, that's trillion with a T, since January 2023, and we expect them to do so by another $245 trillion in 2024. With central bank buying of coupon bonds dropping off, someone else will need to step in. 

A prevailing narrative in 2023 was that markets would get overwhelmed by the amount of fixed income issuance, either because of quantitative tightening or maturing corporate bonds, and this would push yields higher. Yields were indeed pushed higher last year, but it wasn't on the back of supply, instead, the economy turned out to be stronger than expected. And we think that 2024 will be no different. Gross and net issuance across global fixed income products will likely rise versus last year, but demand should be there to meet supply, especially in the second half of 2024, when central banks are expected to start cutting rates and rates volatility normalizes. 

With that said, what is interesting to note is the shift in the type of buyers of bonds. Bank portfolios are the most likely to see a decrease in net buying, while we anticipate that demand will pick up for overseas investors, especially in the second half of the year. 

Meanwhile, we think demand from U.S. pension funds remains strong. They've been big buyers of treasuries in the last few quarters, and should continue to support demand on the very long end of the curve. 

Another important point is that foreign private demand for U.S. treasuries never really went away. Foreign official demand exhibits cyclicality with the fed rate cycle, that is, it decreases as the Fed hike rates and increases when the Fed cuts. Private demand from Japan is particularly cyclical, and we are already seeing signs of Japanese investors returning to the scene as the fed cycle peaks. We also think Japanese investors will find Agency Mortgage-Backed Securities, or MBS, attractive this year, but will likely commit capital only when volatility in both rates and the bases normalize. 

Bottom line: as global fixed income supply rises in 2024, we think there will be sufficient demand to meet this increase. 

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. 

With the rise of technology, media and telecom credit markets, our analyst explains how companies are looking to manage the rapidly changing landscape. 

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

David Hamburger: And I'm David Hamburger, Head of U.S. Sector Corporate Credit Research and Lead Analyst for High Yield TMT here at Morgan Stanley. 

Andrew Sheets: And on today's special episode, the podcast, Dave and I will be discussing corporate credit analysis, the TMT sector and what may be ahead for credit investors. 

Andrew Sheets: David, I think it's safe to say that a lot of listeners are going to be a lot more familiar with what an equity analyst does. So before we get into your sector, I think it'd be great to just take a step back and how do you think about the role of a credit analyst, and how does your job differ from your equity analyst colleagues that sit across on the other side of the floor? 

David Hamburger: So, you know, we're primarily focused on the other side of the balance sheet compared to the equity analyst. So we'll be looking at the liabilities that companies have. Those liabilities do trade in the market and people invest in bonds, loans and otherwise. And importantly, the thing that we really do focus on the most is a company's willingness and ability to service debt and repay that debt. We are certainly concerned with how companies generate shareholder value. But importantly, it's really, really crucial and critical to understand a company's ability again and willingness to repay the debt that's on the balance sheet and the liability part of the balance sheet in particular. 

Andrew Sheets: We're also coming into 2024 at a pretty interesting time for corporate credit markets. You know, you've had yields on some of these high yield bond issuers or loan issuers, a double from where they were in 2021/2022. So you have a market that is offering higher yields than in the past, but also with quite a bit of volatility dispersion between better and weaker balance sheets, and quite a bit that's going on, that's getting investors attention. 

David Hamburger: Yeah. There are a lot of opportunities in corporate credit in general. And you know, people sometimes lose sight of the fact that there's quite a diversity of investment opportunities, whether you're looking at many different sectors in energy, consumer retail or importantly, the TMT sector that we look at, and you can really find situations that suit your risk profile and how much risk appetite an investor might have. 

Andrew Sheets: So let's dive a bit into that sector and how you're thinking about it. And again, there might be some investors that are very familiar with the idea of TMT credit and TMT standing for technology, media and telecom. What has been the story in TMT credit over the last five years? What has brought the sector to its current position? 

David Hamburger: I would say the thing that people have really focused on are some of the technological changes that emerged from the Covid pandemic. If you consider and you look at, you know, where we'll focus a lot of our attention on the telecom and cable sectors. And you look at what transpired during the pandemic. You really had two trends that were overarching. The first was connectivity. I mean, everyone was homebound in a situation where, you know, we were not going into work, going to our normal social interactions that we normally had. And connectivity was paramount. The second thing that it that helped spur huge technological advances, I think during that period of time, you probably saw what the types of technological advances that might have taken a cycle of a couple of years in just a few months, strikingly. And so what had transpired then is really we're seeing the fallout of some of those trends where you saw a number of consumers look at the opportunity to better connect through wireless, through broadband services, new technologies that those companies needed to embrace in order to reach the consumer and reach those new subscribers. And it's really been a trend that, you know, we continue to follow. And has really probably been that had the largest impact on this sector overall. 

Andrew Sheets: I think it's safe to say that consumers access to more media now than they've ever had before, which is a nice thing. But how do you think about the opportunities and the challenges that's created for companies, and how companies are dealing with that just seismic and rapid shift in the landscape. 

David Hamburger: So companies need to be extremely nimble. Management teams need a vision and have a lot of foresight how those technologies will evolve. For many of these companies and for this industry in general, that tend to be very high barriers to entry. Why is that? They're extremely capital intensive. So if you look at like a cable company or a telecom company, even a lot of the big media companies spend an incredible amount of money on their networks, on service, on content production and otherwise. And so importantly, what has ultimately been one of the most defining aspects of this period of time has been companies that are nimble, but really that have financial flexibility. When rates were very low and we had very accommodating credit markets, that helped facilitate a lot of that investment that companies needed. But now when we saw the rising rate environment, it really impacted the fact that a lot of these companies had elevated leverage, that needed it in order to undertake these intensive capital programs. So I would say what really has defined the trend in the space, is those companies with strong balance sheets, financial flexibility, management teams that have remained nimble, have succeeded and thrive in this environment. But on the contrary, companies that were extremely elevated amount of leverage on the balance sheet, found themselves with less financial flexibility to perform and compete. And we're really seeing the fallout from that trend over the last two years. 

Andrew Sheets: So, David, I think you've set that up really well. And so, I guess, as you think about the importance of flexibility, and you kind of highlighted the advantages of being more nimble and being more flexible. Do you think this is going to be a story where the market has already rewarded those better, more nimble companies? Or is this a theme that still has further to play out as the market does further differentiation between the two? 

David Hamburger: Yeah, it certainly has more room to run here in terms of differentiation. A lot of it is really around those new technologies. You begin to see this technological advances around more bandwidth and better networks and upgrades. And so, you know, that creates more competition. But at the same time, as we've seen the acceleration of the adoption of more connectivity, it becomes a more mature market. And so those competitive risks get exacerbated by some of the things like market maturation and even saturation. And as well, you can't minimize things like government subsidies that helped Americans stay connected. And so that dynamic continues to create a tension in the sector in terms of the haves and the have nots and the ability to better compete, the financial wherewithal to compete, and management teams that are very adept and nimble at, you know, embracing those new opportunities. And I think ultimately, what you will see is you're going to see further rationalization of the sector as a result of this, where you'll begin to see and particularly if rates start to come down, one of those follow throughs, or one of the potential outcomes of that is really a potential for more M&A in the space. 

Andrew Sheets: So, David, we started this conversation acknowledging that a credit investor and an equity investor might be looking at the same company, but approach that from a different point of view and different areas of emphasis. And I guess to conclude this conversation, as you look ahead, if you think about your sector, who do you think is in the driver's seat right now in the eyes of management, do you think it's more friendly to the equity holder, more friendly to the bondholder? Or does it really vary company by company?

David Hamburger: A lot of it varies. Certainly in the interest rate regime we've been under for the last couple of years, the companies and their management teams have been more mindful of the balance sheet and more mindful of leverage. You know, we as credit investors, we're always kind of looking at the downside and the downside risks, because clearly we would just want those companies to pay back debt and always examining again the willingness and ability to do so. But to the extent that there's excess capital and excess financial flexibility, all things equal, you want to make sure they're staying nimble and investing in the business and remaining competitive. And one of the things is, you know, we look at this sectors now with a little more caution because of the amount of leverage, because, you know, there might be a tendency to look at the need to the business and to invest more aggressively should rates begin to come back down. We think the, you know, the higher leverage in the face of rising competition and intensity around consumer and enterprise demand, give us pause with regard to the, you know, these companies ability to to continue to focus on the balance sheet and creditors. And I think that's why, again, you're seeing a lot of these stress situations in this sector in particular. 

Andrew Sheets: David, thank you for taking the time to talk. 

David Hamburger: It's been my pleasure. Thank you. 

Andrew Sheets: And 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. 

Listen as our strategist cites which present-day factors and historical precedents should have investors expecting a big year in European equities.

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Welcome to Thoughts on the Market. I'm Marina Zavolock, Morgan Stanley's Chief European Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be discussing our new approach to European equity markets. It's Friday, January 26th at 4:00 pm in London. 

My team and I recently launched coverage of European equities, with a goal of offering investors a more dynamic and modern approach to stocks in the region. Bottom line  we're bullish on European equities and see 11% upside to our year end target for MSCI Europe. This rises to 16% on a total return basis if we incorporate dividends and buybacks. Let me walk you through our thinking. 

We seek to bring traditional equity strategist to the modern data era by blending traditional European equity strategy metrics such as a focus on PMIs, valuations, flows, etc., with bottom up data driven analysis, unconventional factors, an in-depth cycle playbook and integration of important thematics such as AI diffusion, the rise of European M&A and geopolitics. 

For our cycle playbook, we worked closely with our global economics team to determine which specific cycle in long term history is most similar to today. Our work led us to the mid 1990s and specifically 1995, a soft landing in the US and a soft-ish, still very weak growth environment in Europe. This was a period where there was a major focus by market participants over rates and inflation, bad macroeconomic data was seen as good given its implication for future rate cuts, and there was an undercurrent of technological innovation. Other similarities included overoptimistic market pricing on fed rate cuts after the pivot, a later pivot from European central banks, and concerns about deficit reduction and a budget deal in the US.

After an initial sharp Fed pivot related rally, there was a tactical pullback in 1995 in the market, and at this point leadership changed. From a bond proxy leverage cyclical driven rally, very similar to the one we saw into year end, to a rally driven more by idiosyncratic stock specific fundamentals and themes. At the headline level, the market continued to grind higher on the hope trade of future rate cuts and nearing bottom to earnings revisions, and the eventual return of flows into equities from money market funds. Like 1995, we are also seeing a return to M&A from cycle lows, which should further support this rally. Notably, Europe's low valuation starting point and rerating path so far is exactly in line with the 1995 Fed pivot playbook. 

From a factor perspective and to uncover that stock specific, idiosyncratic alpha, I mentioned earlier, we studied over 80 different factors or metrics and uncovered ten that work sustainably to drive relative performance in European equities over time. These range from the conventional, like earnings revisions to the unconventional, such as accruals, an accounting measure that works very well in Europe to predict future earnings quality. 

Bringing everything together, our cycle, factor and thematic analysis, we arrive at 16% total return upside to European equities this year and overweights on European software, aerospace and defense, diversified financials, pharmaceuticals and telecoms, among other sectors. 

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

Investors are concerned that the upcoming election might interfere with policy decisions. Here’s why our view is different.

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Matthew Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy at Morgan Stanley. 

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

Matthew Hornbach: And on this episode of the podcast, we'll discuss whether the election will change Fed policy this year. It's Thursday, January 25th at 10 a.m. in New York. 

Matthew Hornbach: All eyes are on the Fed as 2024 gets underway. Investors are concerned not only about the timing and the magnitude of the expected rate cuts this year, but also on the liquidity in the funding markets, which is intricately linked to the Fed's ongoing quantitative tightening operations, or QT. Seth, let's dig right into it. Does the outcome of the US presidential election in November change your team's baseline view that the Fed will lower rates starting in June? 

Seth Carpenter: Matt, I think the short answer to your question is no. So our baseline forecast is, the Fed starts cutting rates in June. And over the second half of the year, it gets a total of 100 basis points worth of cuts in. But that forecast is predicated on the downward trajectory for inflation and the economy's slowing but not falling off of a cliff, or put simply, it's based on the Fed following their statutory objectives for stable prices and full employment, and not the political cycle. 

Matthew Hornbach: So, Seth, we often hear from investors that they believe that the election will have an impact on Fed policy and we also hear from FOMC participants from time to time about this topic. But why is it that FOMC participants dismiss this wisdom or conventional wisdom amongst investors that the election might interfere with Fed policy? 

Seth Carpenter: I think that question has a really simple answer, which is that the FOMC participants, they're the ones sitting around the table making the decisions, and they don't see themselves as being influenced by the politics. I mean, I can say I was at the Fed for 15 years. I was a staffer preparing memos, doing briefings to the committee in the 2000 election, the 2004 election, the 2008 election, the 2012 election. And I can honestly say from my firsthand experience, there really wasn't anything about the fact of the election that was doing anything to influence the way that monetary policy was being decided. Their eyes were fixed on those statutory objectives of full employment and stable prices. But let me turn it around to you, Matt, because I know that you did a lot of homework. You went back through the historical record and you looked at policy decisions in years when there were elections, in years when there weren't elections. When you do that really careful analysis, what comes out of that pattern? What do you see in the policy decisions that the committee took? 

Matthew Hornbach: Absolutely. We looked at actual policy rate changes going all the way back to 1971. So really getting in that period of time when inflation was also a problem in the 1970s and early 1980s. And we went all the way through the present day. And what we found was that the Fed doesn't shy away from changing policy, whether it be an election year, a general election year, a midterm election year or no election in a given year. They change policy all the time. You know, then we looked at, well, does the policy changes that occur in election years or non election years, does it differ in notable ways? Does the Fed tend to cut rates more in election years or hike rates more in non election years? And we didn't find any notable pattern at all. It just became very apparent in the data that we looked at that there isn't a political bias in terms of the policy rate, whether to change it or not, change it, to move it up, to move it down. The Fed seems, based on the data, to act in the best interest of what's going on in the economy at the time. 

Seth Carpenter: That makes sense to me, and that's very much consistent with my experience there. But let me push a little bit more, because I know that you didn't just do that wave of analysis and then stop. You always burn the midnight oil here, and you went back through the actual transcripts. Because one thing I know I hear from clients and you must hear it as well, is surely the FOMC has to be aware that the election is going on. How could they not be aware of it? It's got to come up during the meetings. It has to come up during the meeting. So when you look at the transcripts themselves, what was said during the meetings, how much do they talk about the election? 

Matthew Hornbach: They're definitely aware that there's an election, as I think most people around the world would be. And when they talk about the elections, you know, typically it comes up almost every election year. You typically get a handful of FOMC participants that bring up the election. 2008 was an interesting exception, where only one person mentioned the election the entire year. 

Seth Carpenter: They may have been thinking about other things.

Matthew Hornbach: They may have other things on their mind, like the great financial crisis that was unfolding. But what we found is that not that many people actually bring it up every election year, but there are a handful here in there that talk about it. You typically find that in the first half of the calendar year, there's not that much discussion about the election. But as the election approaches in November, you get more discussion that ends up showing up in the transcript. So you typically find that the month of October, November and December will have the most discussion about the election by FOMC participants. The second thing we found, Seth, was that when they talk about the election, they typically talk about it in sort of two lines of thinking. One is with respect to fiscal policy. Elections can change fiscal policy, either going into the election or coming out of the election, fiscal policy can differ. And so they typically focus on the state of play with respect to fiscal policy. In 2012, which is when you were there at the fed. I'm sure you noticed that there were lots of discussions about the fiscal cliff. So we noticed that in the transcripts as well. Similarly, in 2016, in December, after the election, in 2016, when the markets were starting to price in the prospect of tax cuts and fiscal stimulus, there was a lot of discussion on the Fed at the time about fiscal policy. 

Seth Carpenter: Matt, it sounds like you're staking out the controversial view that the central bank of the country is paying attention to the macroeconomic environment and the main factors that drive the macro economy. 

Matthew Hornbach: That's absolutely right. We also found that they discussed the election in terms of the uncertainty that elections caused businesses and consumers. They typically grow more concerned about business investment as we head into an election and businesses pulling back on that investment for a short period of time, until they have clarity about the election outcome. So that's generally what they're talking about when they discuss the election, fiscal policy and uncertainty. 

Seth Carpenter: All right. So I feel a little bit relieved that my firsthand experience is fully consistent with all the digging that you did through the transcript through multiple decades.

Matthew Hornbach: Absolutely. So, Seth, with that, let me just thank you for taking the time to talk with me. 

Seth Carpenter: Matt, I could talk to you all day, but particularly on this topic, it was a pleasure to be here. 

Matthew Hornbach: 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.

While it’s too early to tell who will win the U.S. presidential election ­­­– or how markets will respond to it – there are a few factors that investors should consider.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the impact of the US election on markets. It's Wednesday, January 24th at 10 a.m. in New York. 

We're two states into the Republican primary election season. Former President Trump has won both contests, underscoring what polls have been suggesting for months now. That he's the heavy favorite to be the party's nominee for the presidency. But other than that, have we learned anything that might matter to markets? Not particularly in our view. This election will clearly be consequential, the markets, but for the moment we're more in watch and learn mode. Here's two reasons to consider. 

First, knowing who the Republican candidate will be doesn't tell us much about who will become president. While we've heard from some clients that they rate President Biden's chances of reelection as low, and therefore, knowing who will be the Republican nominee is the same as knowing who will be president, we don't agree with this logic. Sitting presidents have had low approval ratings this far ahead of an election and still won before. Also, polls may show that economic factors like inflation are a political weakness for Biden today, but those circumstances could change given how quickly inflation is easing. Now, this doesn't mean we expect Biden will win, it's just that we think it's far from clear who the favorite is in this election.

Our second point is that, even if we know who wins, we don't necessarily know what reliable market impact this would have. That's because there are many crosscurrents to the policies each party is pursuing. Democrats may be interested in more social spending, which could boost consumption, but they may also be interested in taxes to fund it, which could cut against growth. Republicans may be interested in lower taxes, but the presumptive nominee is also interested in increased tariffs, which could mitigate tax impacts. To top it off, neither party may be able to do much with the presidency unless they also control Congress, something that polls show will be difficult to achieve. 

So, this all begs the question. What will make this election matter to markets? The answer, in our view, is time and market context. As we get closer to the election, what's in the price of equity in bond markets will largely shape the stakes for investors. For example, if markets are priced for weak economic outcomes, investors may embrace a unified government outcome regardless of party, as it opens the door to fiscal stimulus measures. Of course, this is only one scenario that may matter, but you can see the point on how context is important. So as the stakes become clearer, we'll define them here and let you know more about it. 

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.

Lisa Shalett, Chief Investment Officer of Morgan Stanley Wealth Management, discusses long-term investors’ biggest concern – the amount and timing of interest rate moves.

Lisa Shalett is a member of Morgan Stanley’s Wealth Management Division and is not a member of Morgan Stanley’s Research Department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research Department and from the views of others within Morgan Stanley.

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

Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management. 

Andrew Sheets: And on this special episode of the podcast, we'll be discussing some of the latest market trends and what they may mean for our retail clients. It's Tuesday, January 23rd at 4 p.m. in London. 

Lisa Shalett: And it's 11 a.m. here in New York.

Andrew Sheets: Lisa, it's great to have you back on. So wealth management clients are typically investing for the long term in order to meet specific goals such as retirement. And with that in mind, let's start with the current market backdrop. You know, we've entered the year with increased market confidence. We've seen implied volatility near some of the lowest levels that we've seen in several years. And yet we've also seen some mixed economic data to start the year. So as you look out into 2024, what are the major risks that you're focused on?

Lisa Shalett: Well, I think one of the first things that, you know, we're trying to impress upon our clients, who tend to be long term, who tend to be multi-asset class investors, very often owning a simple classical 60/40 portfolio, is that we've been in this very interesting potential regime change, where both bonds and stocks are sensitive to the same thing. And that is the level and rate of change of interest rates. And that's meant that the 60/40 portfolio and stocks and bonds are actually positively correlated with one another. And so the very first thing we're talking to clients about is the extent to which we believe they need to focus on diversification. I think a second factor that we're talking, you know, to clients a lot about is liquidity. Now in the macro sense, we know that one of the reasons that markets have been able to resist some of the pressure is coming from the fed. Raising rates 550 basis points in kind of 15, 16 month period has been because there have been huge offsets in the macro backdrop providing liquidity to the marketplace. So we're talking about the fact that some of those supports to liquidity may, in fact, fall away and go from being tailwinds to being headwinds in 2024. So what does that mean? That means that we need to have perhaps more realistic expectations for overall returns. The third and final thing that we're spending a lot of time with clients on is this idea of what is fair valuation, right? In the last eight weeks of the year, clients were, you know, very I think enamored is probably the right word with the move in the last eight weeks of the year, of course, people had, you know, the fear of missing out. And yet we had to point out that valuations were kind of reaching limits, and we therefore haven't been shocked at this January, the first couple of weeks, markets have maybe stalled out a little bit, having to kind of digest the rate that we've come and the level that we're at. So those are some of the themes that, you know, we've begun to talk about, at least with regard to portfolio construction.

Andrew Sheets: So, Lisa, that's a great framing of it. You know, you mentioned the importance of rates to the equity story, this unusually high correlation that we've had between bonds and stocks. And you have this debate in the market, will the Fed make its first rate cut in March? Will it make its first rate cut in June, like the Morgan Stanley research call is calling for? Is that the same thing? And how important to you in terms of the overall market outlook is this question of when the Fed actually makes its first interest rate cut?

Lisa Shalett: Yeah. For our client base and long term investors, you know, we try to push back pretty aggressively on this idea that any of us can time the market and that there's a big distinction and difference between a march cut and a may or June cut. And so what we've said is, you know, the issue is, again, less about when they actually begin, but why do they begin? And one of the reasons that they may begin later than sooner would be that inflation is lumpy. And I know that some of the economists on our global macro team have that perspective that, you know, the heavy lifting, if you will, or the easy money on the inflation trade has been made. And we were able to get from 9 to 4 on many inflation metrics, but getting from 4 to 2 may require patience as we have to, you know, kind of wait for things like owner occupied rents and housing related costs to come down. We have to wait for the lags in wage growth to come out of some of the calculations, and that may require a pickup in unemployment. We may have to wait for some of the services areas where there has been inflation, things related to automotive insurance and things related to health care for some of those items to settle down as well. And so that might be one of the issues that impacts timing. 

Andrew Sheets: So moving to your second key point around market liquidity. Another factor I want to ask you about, which I think is kind of adjacent to that debate, is what about all this cash? You know, we've heard a lot about record inflows into US money market funds over 2023. You have around $6 trillion sitting in US money market funds. How do you see that story playing out, and how do you think investors should think about that question of should I redeploy my cash, given it's still offering relatively high yields? 

Lisa Shalett: So for our clients, you know, one of the things that we're very focused on, again, because we're taking that much longer time frame is saying, look, how does the current 5.3, 5.25 money market yield compare with expected returns for stocks and bonds over the next couple of years? And in that framing from where we sit, what we're saying is cash is reasonably competitive still. Now if rates come down very, very quickly right, we again get back to that question of why. If rates are coming down very quickly because we have disinflationary growth then, then that might be a signal that it's time to redeploy into riskier assets. Alternatively, if they're cutting because they see deteriorating economic conditions, staying in cash for a little while longer during a slowdown might also be the right thing, even though your yields might be going from five to 4 to 3 and a half. And from where we sit, I think our clients know that our capital market assumptions have erred on the conservative side, no doubt about it. But, you know, we think U.S. equities are apt to return at best in 2024 something in the 4 or 5, 6 range against a backdrop where earnings growth could be 10%. And for, you know, investment grade credit, which I know is your expertise. We're saying, you know, we think that rate risk is moderate from here, that it's asymmetric. 

Andrew Sheets: Lisa, just to bring in your third point on valuations, especially valuations and a potentially higher real rate environment. What should investors do in your opinion to build those diversified portfolios given the valuation reality that they're having to deal with? 

Lisa Shalett: So look, I think our perspective is that in a world where, you know, real interest rates are higher, the dynamics around balance sheet quality really come into the fore dynamics around those business models, where you have to ask yourself, are the companies that I own, are the credits that I own truly able to earn their cost of capital? And you know, those questions tend to put pressure on excess valuations. So when we're building portfolios, at least right now, we have a bias to press up against the current skew in the market, right. We're currently skewed to growth versus value. So we've got a preference for value. We've got some skew towards mega-cap versus large mid or small cap. So we're skewing large mid and small cap and active management versus the cap weighted management. We've had this huge skew towards a US bias in our client portfolios, and we're trying to push back against that and say in a relative value context, other regions like parts of emerging markets, like Japan, like parts of Europe are showing genuine interest. So part of this idea of higher real rates in the US is this idea that other asset classes, other regions than this mega cap U.S. growth bias that has really dominated the themes over the last 18 months, that that might get challenged. 

Andrew Sheets: Lisa, thanks for taking the time to talk. We hope to have you back soon. 

Lisa Shalett: It's always great speaking with you, Andrew. 

Andrew Sheets: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show. 

As the current economic cycle plays out, history suggests that stock prices could be in for large price swings in both directions.

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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, January 22nd at 11am in New York. So let's get after it. 

For the past several weeks, we've engaged with many clients from very different disciplines about our outlook for 2024. From these conversations, the primary takeaway is that there isn't much conviction about how this year will play out or how to position one's portfolio. After one of the biggest rallies in history in both bonds and stocks to finish the year, there's a sense that markets need to take a rest before the next theme emerges. Our view isn't that different, except that from our perspective, not much has changed from three months ago other than the price of most assets. 

In our view, we remain very much in a late cycle environment, during which markets will oscillate between good and bad outcomes for the economy. The data continue to support this view, with both positive and negative reports on the economy, earnings and other risk factors. However, as noted, the price of assets are materially higher than three months ago, mainly due to the Fed's pivot from higher for longer, to we're done hiking and likely to be easing in 2024. In addition to the timing and pace of interest rate cuts, investors are also starting to ponder if and when the Fed will end its quantitative tightening or QT campaign. Since embarking on this latest round of QT, the Fed's balance sheet has shrunk by approximately $1.5 trillion. However, it's still $500 billion above the June 2020 levels immediately after the $3 trillion surge to offset the Covid lockdowns. To say that the Fed's balance sheet is normalized to desirable levels is debatable. Nevertheless, our economists and rate strategists think the fed will begin to taper the QT efforts starting sometime this summer. More importantly, we think equity prices now reflect this pivot, and the jury is out on whether it will actually increase the pace of growth and prevent a recession this year. 

Three weeks ago, we published our first note of the year, laying out what we think are three equally likely macro scenarios this year that have very different implications for asset markets. The first scenario is a soft landing with below potential GDP growth and falling inflation. Based on published sell side forecasts and discussions with clients, this is the consensus view, although lower than typical consensus probability of occurring. The second outcome is a soft landing with accelerating growth and stickier inflation, and the third outcome is a hard landing. There's been very little pushback to our suggestion of these three scenarios with equally likely probabilities, and why clients are not that convinced about the next move for asset markets, or what leads and lags. As an aside, this isn't that different from last year's late cycle backdrop, when macro events dictated several large swings in equity prices both up and down. We expect more of the same in 2024. While stock picking is always important, macro will likely remain a primary focus for the direction of the average stock price. 

In our view, the data tells us it's late cycle and the Fed will be easing this year. Under such conditions, quality growth outperforms just like last year. While lower quality cyclicals outperformed during the final two months of 2023, we believe this was mainly due to short covering and performance chasing into year end, rather than a more sustainable change in leadership based on a full reset in the cycle, like 1994. So far in 2024, that's exactly what's happened. The laggards of 2023 are back to lagging and the winners are back to winning. When in doubt, it pays to go with the highest probability winner. In this case it's high quality and defensive growth which will do best under two of the three macro scenarios we think are most likely to pan out this 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 for people to find the show.

Original Release on January 5, 2024: Should investors be concerned about a sluggish beginning to the year, or do they just need to be patient?

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, January 5th at 2 p.m. in London. 

2023 saw a strong finish to a strong year, with stocks higher, spreads and yields lower and minimal market volatility. That strength in turn flowed from three converging hopeful factors. 

First, there was great economic data, which generally pointed to a US economy that was growing with inflation moderating. Second, we had helpful so-called technical factors such as depressed investor sentiment and the historical tendency for markets, especially credit markets, to do well in the last two months of the year. And third, we had reasonable valuations which had cheapened up quite a bit in October. 

Even more broadly, 2024 offered and still offers a lot to look forward to. Morgan Stanley's economists see global growth holding up as inflation in the U.S. and Europe come down. Major central banks from the US to Europe to Latin America should start cutting rates in 2024, while so-called quantitative tightening or the shrinking of central bank balance sheets should begin to wind down. And more specifically, for credit, we see 2024 as a year of strong demand for corporate bonds, against more modest levels of bond issuance, a positive balance of supply versus demand. 

So why, given all of these positives, has January gotten off to a rocky, sluggish start? It's perhaps because those good things don't necessarily arrive right away. 

Starting with the economic data, Morgan Stanley's economists forecast that the recent decline in inflation, so helpful to the rally over November and December, will see a bumpier path over the next several months, leaving the Fed to wait until June to make their first rate cut. The overall trend is still for lower, better inflation in 2024, but the near-term picture may be a little murky. 

Moving to those so-called technical factors, investor sentiment now is substantially higher than where it was in October, making it harder for events to positively surprise. And for credit, seasonally strong performance in November and December often gives way to somewhat weaker January and February returns. At least if we look at the performance over the last ten years. 

And finally, valuations where the cheapening in October was so helpful to the recent rally, have entered the year richer, across stocks, bonds and credit. 

None of these, in our view, are insurmountable problems, and the base case expectation from Morgan Stanley's economists means there is still a lot to look forward to in 2024. From better growth, to lower inflation, to easier monetary policy. The strong end of 2023 may just mean that some extra patience is required to get there. 

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.

Many investors think the boom in Mexico nearshoring is losing steam. See what they may be missing.

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Welcome to Thoughts on the Market. I'm Nik Lippmann, Morgan Stanley Latin American Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll focus on our outlook for nearshoring in Mexico. It's Thursday, January 18th at 10 a.m. in New York. 

As we've discussed frequently on this podcast, we're seeing a rapid transition from a globalized economy to one that is more regionalized and Mexico has been a key beneficiary of this trend. Last spring, notably, it surpassed China to become the US largest trading partner. But many market participants believe that the nearshoring narrative in Mexico is losing steam following the strong performance of nearshoring-exposed names in 2022 and 23. We disagree.  In our view, nearshoring is not cyclical, it's a multi-year structural narrative that is still gaining strength. We continue to believe that nearshoring and subsequent waves could be a long and sustained investment in ways that could bring about new ecosystems in Mexico's well-established manufacturing hubs in the North and Bajío regions. What's more, we believe the next waves of opportunity to be a more comprehensive impact on GDP growth. 

The next wave of opportunity will be investment, which we believe is key for 24. After bottoming out below 20% in 2021 the investment to GDP ratio in Mexico is now above 24%. This increase is driven by increasing capital expenditure for machinery and equipment and foreign direct investment, which is breaking through record levels. In the US, manufacturing construction has risen from about $80 billion annually to $220 billion, and it continues to rise. This is mirrored by nonresidential spending in Mexico, which has grown by a similar magnitude. This is key. The nearshoring process reflects the rewiring of global supply chains, and it's happening simultaneously on both sides of the US-Mexico border. 

Therefore, we believe that the surge in investment driven by nearshoring could lift Mexico's potential GDP. We estimate that potential GDP growth in Mexico could rise from 1.9% in 2022 to 2.4% by 2027, a significant surge that would allow the pace of real growth to pick up in '25 to '27 post a US driven slowdown. Indeed, in a scenario where the output gap gradually closes by end of 2027, real GDP growth could hover around 3% by '25-'27. 

Evidence of nearshoring is overwhelming. Mexico is rapidly growing its 15% market share among US manufacturing imports, gaining ground from China and other US major trading partners. Moreover, as the supply chains and manufacturing ecosystems that facilitate growing exports expanding simultaneously on both sides of the border, investment efforts are also occurring in tandem. The debate is no longer whether re-shoring or nearshoring are happening, but it's about understanding how quickly new capacity can be activated, as well as how much capital can be deployed, how quickly and where. 

The key risk when it comes to nearshoring is electricity. There's no industrial revolution without electricity. We've argued that Mexico needs $30 to $40 billion of additional electricity generation and transmission capacity over the next 5 to 6 years to power its potential. This will require a sense of urgency, legal clarity, and collaboration between Mexico policymakers and their US and Canadian peers, aimed at aligning Mexico's policy objectives with the Paris Climate Accord that will push renewable energy back toward the path of growth. 

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

Elections, geopolitical risks and rate cuts are driving markets in the short term. But there are three trends that could provide long-term investment opportunities.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about three key investment themes for 2024. It's Wednesday, January 17th at 10 a.m. in New York. 

Markets will have plenty of potential near-term catalysts to contend with in 2024. There's elections, geopolitical risks as tensions rise with regional conflicts in Europe and the Middle East, and key debates about the timing and pace of central bank rate cuts. We'll be working hard to understand those debates, which will influence how markets perform this year.

But what if you're thinking a bit longer term? If that's you, we've got you covered. As it's become our annual tradition, we’re rolling out three secular themes that Morgan Stanley research will be focused on developing collaborative, in-depth research for, in an effort to identify ways for investors to create potential alpha in their portfolio for many years to come. 

The first theme is our newest one, longevity. It's the idea that recent breakthroughs in health care could accelerate the trend toward longer and higher quality human lives. To that end, my research colleagues have been focused on the potential impacts of innovations that include GLP-1 drugs and smart chemo. Further, there's reason to believe similar breakthroughs are on the horizon given the promise of AI assisted pharmaceutical development. And when people lead longer lives, you'd expect their economic behavior to change. So there's potential investment implications not just for the companies developing health care solutions, but also for consumer companies, as our team expects that, for example, people may consume 20 to 30% less calories on a daily basis. And even asset managers are impacted, as people start to manage their investments differently, in line with financing a longer life span. In short, there's great value in understanding the ripple effects into the broader investment world. 

The second theme is a carryover from last year, the ongoing attempts to decarbonize the world and transition to clean energy. Recent policies like the Inflation Reduction Act in the US include substantial subsidies for clean energy development. And so we think it's clear that governments and companies will continue to push in this direction. The result may be a tripling of renewable energy capacity by 2030. And while this is happening, climate change is still asserting itself and investment should pick up in physical capital to protect against the impact. So all these efforts put in motion substantial amounts of capital, meaning investors need to be aware of the sectors which will be crimped by new costs and others that will see the benefits of that spend, such as clean energy. 

Our third theme is also a carryover, the development of AI. In 2023, companies we deemed AI enablers, or ones who were actively developing and seeking to deploy that technology, gained about $6 trillion in stock market value. In 2024, we think we'll be able to start seeing how much of that is hype and how much of that is reality, with enduring impacts that can create long term value for investors. We expect clear use cases and impacts to productivity and company's bottom lines to come more into focus and plan active research to that end in the financials, health care, semiconductor, internet and software sectors, just to name a few. So stay tuned. We think these debates could define asset performance for many years to come. And so we're dedicated to learning as much as we can on them this year and passing on the lessons and market insights to you. 

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.

Although China has emerged as one of the world’s largest end markets for technology, its tech sector faces some significant macro hurdles. Here’s what investors need to know.

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Welcome to Thoughts on the Market. I'm Shawn Kim, Head of Morgan Stanley's Asia Technology Research Team. Along with my colleagues bringing you a variety of perspectives, today I'll talk about the impact of macro factors on China's technology sector. It's Tuesday, January 16th at 10 a.m. in Hong Kong.

Over the past year, you've heard my colleagues discuss what we call China's 3D journey. The 3Ds being debt, deflation and demographics. As we enter 2024, it looks like China is now facing greater pressure from these 3Ds, which would cap its economic growth at a slow pace for longer. Given this investor’s currently debating the potential risks of a prolonged deflation environment. In fact, the situation in China, including the rapid contraction of property sales and investment, default risk and initial signs of deflation, has led to comparisons with Japan's extended period of deflation, which was driven by property downturn and the demographic challenge of an aging population. 

At the same time, within the past decade, China has quickly emerged as one of the most important end demand markets for the global information and communication technology industry, accounting for 12% of market share in 2023 versus just 7% back in 2006. This trend is fueled by China's economic growth driving demand for IT infrastructure and China's large population base driving demand for consumer electronics. China has also become the largest end demand market for the semiconductor industry, accounting for about 36 to 40% of global semiconductor revenues in the last decade. As it aims to achieve self-sufficiency and semiconductor localization, China has been aggressively expanding its production capacity. It  currently accounts for about 25% of global capacity.

Over the long term, we believe China's economic slowdown will likely lead to lower trade flows in other countries, misallocation of resources across sectors and countries, and reduced cross-border dissemination of knowledge and technology. China's semiconductor manufacturing, in particular, will continue to face significant challenges. As the world transitions to a multipolar model and supply chains get rewired, a further gradual de-risking of robotic manufacturing away from China is underway, and that includes semiconductor manufacturing. In a more extreme scenario, a complete trade decoupling would resemble the 1980s, when the competition between the US and Japan in the semiconductor industry intensified significantly.

Our economics team believes that China can beat the debt deflation loop threat decisively next 2 to 3 years. It's important to note, however, that risks are skewed to the downside, with a delayed policy response potentially leading to prolonged deflation. And this could send nominal GDP growth to 2.2% in 2025 to 2027. And based on the historical relationship between nominal GDP growth and the information and communication technology total addressable market, we estimate that China's ICT market and semiconductor market could potentially decline 5 to 7% in 2024, and perhaps as much as 20% by 2030, in a bear case scenario. 

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

Changing Fed policy in 2024 is likely to bring down yields from these increasingly popular funds. Here’s what investors can consider instead.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the investment landscape and how we put those ideas together. It's Friday, January 12th at 2 p.m. in London. 

One of the biggest stories in recent years has been the rise of the money market fund. Today, an investor in a US dollar money market fund earns a yield of about 5.3%, a full 1% higher than the yield on a 30 year US government bond and almost 4% higher than the yield on the S&P 500. All investment strategy at the moment, to some extent, flows from the starting point that holding cash pays pretty well. 

Unsurprisingly, those high yields in money market funds for little volatility have been popular. Per data from the Investment Company Institute, U.S. money market fund assets now stand at about $6 trillion, over $1 trillion higher than a year ago, which flows into these funds accelerating over the last few months. 

But we think this could change looking into 2024. The catalyst will be greater confidence that the Federal Reserve has not just stopped raising interest rates, but will start to cut them. If short term rates are set to fall, the outlook for holders of a money market fund changes. Suddenly they may want to lock in those high current yields. 

Morgan Stanley expects the declines and what these money market funds may earn to be significant. We see the Fed reducing rates by 100 basis points in 2024, and another 200 basis points in 2025, leaving short term rates to be a full 3% lower than current levels over the next two years. In Europe, rates on money market funds may fall 2% over the same period. 

While lower short term interest rates can make holding money market funds less attractive, they make holding bonds more attractive. Looking back over the last 40 years, the end of Federal Reserve rate increases, as well as the start of interest rate cuts has often driven higher returns for high quality bonds. 

But would a shift out of money market funds into bonds make sense for household allocations? We think so. Looking at data from the Federal Reserve back to the 1950s, we see that household allocation to bonds remain relatively low, while exposures to the stock market remain historically high. And this is the reason why we think any flows out of money market funds are more likely to go into bonds than stocks. Stock market exposure is already high, and stocks represent a much more volatile asset than bonds, relative to holding cash. 

While the US money market funds saw $1 trillion of inflows into 2024 flows to investment grade and high yield saw almost nothing. That is starting to change. With the Fed done raising rates, we expect higher flows into credit, especially in 1 to 5 year investment grade bonds, the part of the credit market that could be the easiest first step for investors coming out of cash and looking for something to move into. 

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.

Investors are split on the outlook for natural gas as “peak shale” may be on the horizon. Here’s what to expect in 2024.

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Welcome to Thoughts on the Market. I'm Devin McDermott, Head of Morgan Stanley's North American Energy Research Team and the Lead Commodity Strategist for Global Gas and LNG Markets. Today, I'll be talking about some of the big debates around natural gas and shale in 2024. It's Thursday, January 11th at 10 a.m. in New York.

The evolution of shale as a viable, low cost energy resource, has been one of the biggest structural changes in global oil and gas markets of the past few decades. In oil, this turned the U.S. into the world's largest producer, while falling costs also led to sharp deflation in prices and global oversupply. For U.S. natural gas, which is more regionally isolated, it allowed the market to double in size from 2010 to 2020, with demand growing rapidly across nearly every major end-market. Over this period, the U.S. transitioned from a net importer of liquefied natural gas, or LNG, to one of the world's largest exporters. But despite this robust growth, prices actually declined 80% over the period as falling cost of U.S. shale and pipeline expansions unlocked low cost supply. 

Now looking ahead after a multi-year pause, the US is set to begin another cycle of LNG expansion. This comes in response to some of the market shocks from the Russia/Ukraine conflict, including loss of Russian gas into Europe, as well as strong demand growth in Asia, where LNG serves as a key energy transition fuel. In total, projects that are currently under construction should nearly double US LNG export capacity by the later part of this decade. While the last wave didn't drive prices higher, this time can be different as it comes at a time when some investors feel like peak shale might be on the horizon. Shale is maturing, well costs and break-evens are generally no longer falling, and pipe expansions have slowed significantly due to regulatory challenges.

While many of these issues are more apparent on the oil side, there are challenges for gas as well. Notably, the lowest cost US supply region, the Marcellus in Appalachia, is constrained by lack of infrastructure. As a result, meeting this demand likely elicits a call on supply growth from higher cost regions relative to last cycle. This not only includes the Haynesville, a gas play in Louisiana, but also the Eagle Ford in Texas and Basins in Oklahoma, potentially requiring prices in the $4 to $5 per MMBtu range to incentivize sufficient investment. 

Investors are split on the natural gas outlook. Bears argue that abundant, low cost domestic supply will meet LNG demand without higher prices, just like last time, while bulls backed higher prices this time around. Now, strong supply and a mild start to the winter heating season has actually pushed Henry Hub prices lower to close out 2023, bringing year-to-date declines to 50%. While this drives a softer set up for the first half of 2024, lower prices also come with a silver lining. This should help moderate potential investment in new supply ahead of the pending wave of LNG expansions. As a result, we believe the bearish near-term setup may prove bullish for the second half of 2024 and 2025. A dynamic many stocks in the sector do not fully reflect. 

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.

World oil demand is slowing, non-OPEC supply remains strong and OPEC is likely to follow through on planned cuts. Here’s how investors can understand this precarious balance.

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Welcome to Thoughts on the Market. I'm Martjin Rats, Morgan Stanley's Global Commodity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss the 2024 Global Outlook for oil. It's Wednesday, the 10th of January at 2 p.m. in London. 

Around six months ago, oil market forecasters widely forecasted a tight second half for 2023 with considerable inventory draws. This expectation was partially driven by two factors. One, OPEC cuts, and in particular the additional voluntary cut of about 1 million barrels a day announced by Saudi Arabia back in June that took the country's production to 9 million barrels a day, about 10% lower than the average of the first half of 2023. The second factor was a positive view on demand, which had mostly surprised to the upside in the first half of 2023. The market indeed tightened in the third quarter and inventories drew sharply at the time. As a result, Dated Brant rallied and briefly reached $98 a barrel in late September. 

However, this was not to last in the fourth quarter. Demand disappointed, growth and non-OPEC supply remained relentless and inventories built again. Needless to say, these trends have been reflected in prices. Not only did spot prices decline, Dated Brant fell to about $74 a barrel in mid-December, but a number of other indicators, such as calendar spreads for example, signaled a broad weakening of the oil complex. 

Looking ahead, we expect a relatively precarious balance in 2024. Demand growth is set to slow as the post-Covid recovery tailwinds have largely run out of steam by now. Despite low investment in production capacity in recent years, the growth in non-OPEC supply is set to remain strong in 2024 and probably also in 2025, enough to meet all global demand growth. Naturally, this limits the room in the oil market for OPEC oil. When OPEC cuts production in response, as it has recently been doing, this puts downward pressure on its market share and upward pressure on its spare capacity. 

History warns of such periods. On several occasions when non-OPEC supply growth outpaced global demand, eventually, a period of lower prices was needed to reverse that balance. However, we argue that is not quite what lies ahead for 2024. OPEC cohesion has been robust in recent years and will likely continue this year. We expect the production cuts agreed to in late November 2023 to eventually be extended through all of 2024, and we don't exclude a further deepening of those cuts either. 

This would limit the pace of inventory builds in 2024, but probably not prevent them. In our base case projections, we still see inventories built modestly at a rate of about a few hundred thousand barrels a day this year, and our initial 2025 estimates also imply a modest oversupply next year. 

As a result, we see lower oil prices ahead, but again, not a large difference. We estimate Dated Brant will remain close to $80 a barrel in the first half of 2024, but may gradually decline towards the end of the year, trading in the low to mid $70s in 2025. That may also support our economists' call for inflation to moderate further this year. 

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Companies that offer generative AI solutions saw their valuations rise in 2023. This year, investors should look at the companies adopting these solutions.

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Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley's Head of Thematic Research in Europe. And along with my colleagues, bringing you a variety of perspectives, today I'll discuss our views on the broad impacts of AI across global markets. It's Tuesday, the 9th of January at 2 p.m. in London. 

AI has established itself as a critical theme of the last 12 months, but we are clearly in the early innings of its diffusion. More specifically, 2023 was very successful for AI players that we call the enablers, those first line of hardware and software companies that play into the generative AI debate. 

But after the first wave of excitement, how does that trend percolate through the rest of the market, and how much of the hype will translate to sustainable earnings uplift? What is the next move for this entire debate, which so captivated markets in 2023? 

Our team mapped out the next stage of the debate across all regions and industries, and came to three key conclusions. The first, looking back at 2023, the enablers did extraordinarily well, and that shouldn't come as a surprise to any of our regular listeners. Some of those companies saw triple digit returns last year, and we estimate that more than $6 trillion of market cap was added to those names globally. 

But that brings us to our second key conclusion. Namely, looking forward, we think that investors should now turn their attention to the adopters. Meaning companies that are leveraging the enablers software and hardware to better use their own data and monetize that for the AI world. Looking back last year, where the enablers returned more comfortably double digit and triple digit returns, the adopters only gained on average around 6%. 

Of course, we're only in the early innings of the AI revolution, and the market is still treating these adopters as a "show me" story. We think that 2024 is going to be transformative for this adopter group, and we expect to see a wave of product launches using large language models and generative AI, particularly in the second half of 2024. 

Our third key conclusion is around the rate of change. And what do we mean by this? Well, in 2023, the enabler stocks, where AI was moderately important to the investment debate, increased their total market cap by around 28%. But if AI increases in importance to the point where analysts deem it to be core to the thesis for that particular stock, we expect it can add another 40% to market cap of this group based on last year's performance. 

A final point worth noting is that investors should pay close attention to the give and take between enabler and adopter groups. As I mentioned, the adopters were relatively more muted in their performance last year than the enablers. However, we believe in 2024 we will see the virtuous cycle between these two groups come into greater focus for investors. Enablers, consensus upgrades and valuations will depend increasingly on the enterprise IT budgets being deployed by the adopters in 2024-25. The adopters, in turn, are in a race to build both revenue generating and productivity enhancing tools, which completes the virtuous circle by feeding the enablers revenue line. 

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. 

Investors worry that anti-obesity drugs could dent demand for medical procedures and devices. Here’s what they could be missing.

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Welcome to Thoughts on the Market. I'm Patrick Wood, Morgan Stanley's MedTech analyst. And today, I'll be talking about the potential impact of anti-obesity medications on the MedTech industry. It's Monday, January 8th at 10 a.m. in New York.

Anti-obesity drugs have made significant gains in popularity over the past year, and by and large, the market expects them to disrupt numerous MedTech markets as widespread adoption leads to population-level weight reduction and co-morbidity improvement. 

To a certain extent, we agree with the premise that obesity is linked to high health care spend and therefore anti-obesity drugs could represent a risk to device sales. Our research suggests that moderate obesity is associated with about $1,500 a year higher spend on healthcare per capita, with an even greater impact in severe obesity at about $3000 bucks a year. But  we think it would be a mistake to assume reduced rates of obesity are intrinsically negative for medtech makers overall. 

In fact, we think anti-obesity drugs may ultimately prove to be a net positive for MedTech companies as the drugs increased life expectancy and increased demand for procedures or therapies that would not have been a good option for patients who are obese. In some cases, severe obesity can actually be contraindication for ortho or spine surgery, with many patients denied procedures until they shed a certain amount of weight for fear of complications, infection, and other issues. In this context, anti-obesity drugs could actually boost procedure volumes for certain patients. 

Another factor to consider, we believe the importance of life expectancy shifts as a result of potentially lower obesity rates cannot be ignored. In fact, our analysis suggests that obesity reduces life expectancy by about ten years in younger adults and five years in middle age adults. 

Think of it this way, from the standpoint of total healthcare consumption, one incremental year of life expectancy in old age could equate to as much as ten years of obesity in terms of overall healthcare spending. Adults 65 plus spend 2 to 3 times more per year on average, than adults 45 to 64, with a significant $10 to $25,000 step up in dollar terms. 

Furthermore, rates of sudden cardiac death increased dramatically in high body mass index patients, eliminating the possibility of medical intervention to address the underlying obesity issue or the associated co-morbidities. 

Given all this, we think anti-obesity drugs will ultimately prove to be a net benefit for cardiovascular device makers overall, even in certain categories where body mass index is correlated with higher procedure rates. In markets such as structural heart, where we're replacing things like heart valves, we believe the number of patients reaching old age, that is 70 plus, is most important in regards to volumes. Though rates of obesity are contributing factors as well, orthopedics is more of a mixed bag. The strongest evidence we've seen here is on lower BMI's leading to reduced procedure volumes though pertaining to osteoarthritis in the knees and degenerative disc disease in spine. But we think the argument that fewer people with obesity means fewer knee replacements or fewer incidences of spine disease is actually only half the picture. Clearly, age may be a factor here, and our sense is that hip volumes in particular are not dependent on high BMI's as much as on an aging population. 

To sum up, we believe that anti-obesity drugs won't dismantle core MedTech markets. There are more layers to the story here.

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Should investors be concerned about a sluggish beginning to the year, or do they just need to be patient?

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, January 5th at 2 p.m. in London. 

2023 saw a strong finish to a strong year, with stocks higher, spreads and yields lower and minimal market volatility. That strength in turn flowed from three converging hopeful factors. 

First, there was great economic data, which generally pointed to a US economy that was growing with inflation moderating. Second, we had helpful so-called technical factors such as depressed investor sentiment and the historical tendency for markets, especially credit markets, to do well in the last two months of the year. And third, we had reasonable valuations which had cheapened up quite a bit in October. 

Even more broadly, 2024 offered and still offers a lot to look forward to. Morgan Stanley's economists see global growth holding up as inflation in the U.S. and Europe come down. Major central banks from the US to Europe to Latin America should start cutting rates in 2024, while so-called quantitative tightening or the shrinking of central bank balance sheets should begin to wind down. And more specifically, for credit, we see 2024 as a year of strong demand for corporate bonds, against more modest levels of bond issuance, a positive balance of supply versus demand. 

So why, given all of these positives, has January gotten off to a rocky, sluggish start? It's perhaps because those good things don't necessarily arrive right away. 

Starting with the economic data, Morgan Stanley's economists forecast that the recent decline in inflation, so helpful to the rally over November and December, will see a bumpier path over the next several months, leaving the Fed to wait until June to make their first rate cut. The overall trend is still for lower, better inflation in 2024, but the near-term picture may be a little murky. 

Moving to those so-called technical factors, investor sentiment now is substantially higher than where it was in October, making it harder for events to positively surprise. And for credit, seasonally strong performance in November and December often gives way to somewhat weaker January and February returns. At least if we look at the performance over the last ten years. 

And finally, valuations where the cheapening in October was so helpful to the recent rally, have entered the year richer, across stocks, bonds and credit. 

None of these, in our view, are insurmountable problems, and the base case expectation from Morgan Stanley's economists means there is still a lot to look forward to in 2024. From better growth, to lower inflation, to easier monetary policy. The strong end of 2023 may just mean that some extra patience is required to get there. 

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Many investors believe that the value of Japanese stocks will dip as the yen gets stronger. Here’s why we’re forecasting ~10% growth.

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Welcome to Thoughts on the Market. I'm Daniel Blake from Morgan Stanley's Asia and Emerging Market Equity Strategy team. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss one of the big debates in the market around Japanese equities in 2024. It's Thursday, January 4th at 10 a.m. in Singapore.

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As we kick off the new year, one of the most debated investor questions is whether Japanese equities can again perform well if the Yen is now over weakening, but instead strengthens over 2024 as expectations of Fed rate cuts play out. The market is understandably concerned that if the Yen appreciates significantly, Japanese equities will underperform, given the impact on competitiveness and the effects translation of foreign earnings. As a result, global investors remain underweight on Japanese equities versus their benchmark weight, despite the notably improved sentiment on the underlying Japanese economy. 

So in contrast to these concerns, we believe that Japanese equities and the Yen can simultaneously rally in 2024, which will mean even stronger returns for unhedged dollar based investors than for the local index. Our currency strategists forecast modest further gains in the Yen, with a pick up to 140 against the US dollar by end 2024 versus 143 today. And despite this, we see corporate earnings growth still achieving 9% in 2024, underpinned by nominal GDP recovery and corporate reforms. 

So what is the reason for the break in the usually negative relationship between the yen and Japanese equities? 

We still see three drivers supporting the market. First, there’s the return of nominal GDP growth. The Japanese economy is finally exiting deflation that has been prevalent since the 1990s, and we believe a virtuous cycle of higher nominal growth in Japan has started thanks to joint efforts from the Bank of Japan and the corporate sector to move to a positive feedback loop between price hikes and wage growth, underpinned by a productive CapEx cycle. Our chief Japan economist, Takeshi Yamaguchi, forecasts nominal GDP growth for 2023 to have achieved 5%, but to remain above 3% growth in 2024, and a healthy 2 to 2.5 % for the foreseeable future. 

The second driver is corporate reforms, which have been the most crucial driver of underlying Japanese equities performance, and we expect the trend improvement of return on equity to continue. The sea change in corporate governance in Japan has led to major changes in buyback and dividend policies, which combined are almost quadruple the levels they were at ten years ago. And we're seeing a broadening trend of underlying business restructuring underpinned by more engagement from investors, both foreign and domestic. 

Finally, Japan has been a net beneficiary of investment inflows and CapEx orders in the transition to a more multipolar world. And with those flows, while equity valuations are cheap to history, in contrast to the US market, we expect them to be supported by further foreign inflows and domestic inflows that will be boosted by the launch of the new Nippon Individual Savings Account Program this month. 

Bottom line Japan equities remain our top pick globally. We see the TOPIX index moving further into a secular bull market with our December 2024 target for the index standing at 2,600, which implies 10% upside in Yen terms and more in US dollar terms from current levels. 

Thanks for listening. And 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.