Thoughts on the Market

Despite last year’s strong showing for European equities, will the recent spread of the Omicron variant derail our positive outlook for the region in 2022?

----- Transcript -----

Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European Equity Strategy team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the recent rise in Omicron cases and whether this could derail our constructive view on European equities for 2022. It's Thursday, January the 6th at 2:00 p.m. in London.

Before touching on Omicron and the case for European stocks in 2022, I want to start by looking back at last year, which ended up being a very good one for the region. True European equities did lag US stocks again in 2021, however, this is hard to avoid when global markets are led higher by technology shares given Europe has fewer large cap companies in this space. More impressive was Europe's performance against other regions such as Japan, Asia and emerging markets. In fact, when we measure the performance of MSCI Europe against the MSCI All Countries World Index, excluding U.S. stocks, then we find that Europe enjoyed its best year of outperformance since 1998 which, to provide some context, was the year before the euro came into existence.

As ever, past performance is not necessarily a good guide to future returns. However, in this instance, we do expect another year of positive returns for European stocks in 2022, with 7% upside to our index target in price terms, which rises to 10% once dividends are included. This is considerably better than our Chief US Equity Strategist, Mike Wilson, expects for the S&P, while Jonathan Garner, our Chief Asian Equity Strategist, also remains cautious on Asian and emerging markets at this time.

While we think the underlying assumptions behind that positive view on European stocks are actually quite conservative - we model 10% EPS growth and a modest PE de-rating - equity investors are likely to have to navigate greater volatility going forward, given scope for higher uncertainty around COVID, inflation, and the impact of tighter monetary policy on asset markets. The first of these factors was arguably the most important for markets through November and December, however, recent evidence that emerged very late in the year - that Omicron is indeed considerably less severe than prior mutations - has boosted risk appetite across the region, helping push bond yields and equity prices higher. From a more fundamental perspective, we are also encouraged that the sharp rise in COVID cases across Europe over the last couple of months does not appear to be having a significant impact on the economy. Yes, we did see quite a sharp drop in business surveys in Germany through December, however, this doesn't appear to be replicated elsewhere with the PMI services data in France and consumer confidence data in Italy staying strong for now.

Going forward, we expect the driver of volatility and uncertainty to shift from COVID to central banks and the impact of tighter monetary policy on asset markets. While this issue will be relevant across all global markets, Europe should be less negatively impacted than elsewhere given the European Central Bank is unlikely to raise interest rates through 2022. In addition, the European equity market's greater exposure to the more value-oriented sectors such as commodities and financials, should make it a relative beneficiary of rising bond yields, especially if - as our Macro Strategy team forecast - this is accompanied by rising real yields (which should weigh most on the more expensive stocks in the US) or a stronger US dollar (which is more of a headwind for emerging markets).

Consistent with this outlook, we maintain a strong bias for value over growth here in Europe, with a particular focus on banks, commodity stocks and auto manufacturers. While all three of these sectors outperformed last year, we think they are still cheap and hence offer more upside from here.

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.

As 2022 gets underway, investors are concerned about the Omicron variant of COVID-19, yet markets are taking developments in stride, with higher stock prices and bond yields. Is this economic confidence misplaced?

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, January 5th at 10:00 a.m. in New York.

As we settle in for 2022, the early line of questioning from clients regards the impact of the Omicron variant of COVID 19. It's been shattering records for infections globally and in the US, disrupting air travel as workers stay home sick. So why then are markets so far this week taking this in stride? Higher stock prices and bond yields reflect more economic confidence than concern. Is that confidence misplaced?

Not necessarily, in our view. That's because while Omicron is clearly a serious public health risk, the data suggests it may not trigger the level of public policy response that sustainably crimps economic activity, such as indoor capacity restrictions on service establishments or stay at home orders. Since the pandemic's onset, such responses have largely been dictated by state and local governments, and as we pointed out in this podcast a month ago, in most cases where restrictions were tightened, rising COVID hospitalizations and lack of bed capacity were cited as the culprit. So far, the data suggests hospital capacity may not be a problem with Omicron.

Consider studies from the UK and South Africa, which have shown that Omicron is substantially less likely than the previously dominant Delta variant to land people in the hospital. This likelihood is lessened even more if an infected person was previously vaccinated. So even as case counts soar above those prior waves, it's not surprising to see that measures of hospital capacity stress across the US are yet to exceed those of prior waves. Further, as our colleagues in the Biotech Research team point out, the contagiousness of Omicron and subsequent protection against reinfection that the infected develop, at least for a time, has led to bigger but shorter infection waves in places like South Africa. This is why US government officials point out that Omicron could peak and fall quickly sometime this month.

In short, the wave and any attendant economic risk could be over quickly, and this may be why investors are looking through it. Hence, we expect markets will refocus on inflation and Fed policy as key drivers for 2022, continuing to push bond yields higher this year in line with our team's forecast.

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.

As the Omicron variant spreads across Asia, renewed lockdowns and other earnings outlook disruptions have investors on alert, reinforcing our approach of cautious patience in the region.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Market Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the impact of Omicron on China and Emerging Market Equities. It's Tuesday, January the 4th at 7:30 a.m. in Hong Kong.

As 2022 begins, our approach to Asia and EM equities remains one of cautious patience. Although these markets underperformed their peers in the U.S. and Europe last year, simple arguments of performance mean reversion in 2022 are not strong enough to warrant anything more aggressive at this juncture.

We hear a lot these days about a turn in the Chinese policy cycle as a catalyst. And it's fair to say that historically one would have been more optimistic at this juncture of the monetary and fiscal cycle for the outlook for domestic demand in China. This demand is crucial both for China's own growth outlook to stabilize, as well as to give a boost to most other markets in Asia and EM. But this is not a normal cycle.

China's ‘zero COVID’ approach must now face off against Omicron. As this episode is being recorded, Xian - a major Chinese city with a population of over 13 million - is in its 12th day of a lockdown, which is now more severe in terms of restrictions on normal daily life than any seen in China since the original lockdown of Wuhan at the start of the pandemic.

Two global companies with major semiconductor plants in the city have recently warned of production problems. And though there's no formal national policy to curtail celebration of Chinese New Year at the end of this month, domestic media is already beginning to broadcast a message of staying at home and avoiding long distance travel. In China, as in EM, we're continuing to track earnings estimates that are declining, which undermines the case for valuations - now roughly in line with long run averages - being sufficiently attractive to reengage. The situation is slightly better in Japan, where estimates are tracking sideways and individual markets - notably India and parts of Asean and Eastern Europe, Mid East and Africa - have been doing better than the EM overall.

However, disruption caused by Omicron could change individual economic and hence earnings outlooks over the short to medium term. For example, India's most recent COVID case count was up 35% day-on-day, with Omicron now present in 23 of 28 states. Maharashtra, Delhi and Tamil Nadu have reimposed restrictions on visits to public parks, beaches and other public spaces. Indeed, most of the countries we cover that had moved to a "living with COVID" approach are now having to reverse course. Take South Korea, which in mid-December, as ICU usage rose significantly, reimposed early closing restrictions on nightlife and a rule limiting public gatherings to no more than four fully vaccinated persons.

Finally, our weekly track of flows to dedicated Asia and EM equity funds is now showing steady and persistent redemptions, as some of the very large inflows from this time a year ago start to reverse course. Those flows were driven by the notion that a strong, synchronized upswing was underway globally, which it was argued would lead to outperformance by Asia and EM, whose economies generally perform strongly in a global economic upswing. We argued at the time that 2021 would not be like 2006/07 and 2016/17 when that narrative did hold true. As 2022 begins, the global and local economic outlook is clearly weakening again, and hence our mantra of continued cautious patience.

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 a new calendar year, the narrative in markets may not be shifting but there are still opportunities for investors to consider as growth rates, policy proposals, and interest rates shift in the coming year.

----- Transcript -----

Welcome to Thoughts on the Market and Happy New Year! 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 3rd at 11:30 a.m. in New York. So let's get after it.

A new year brings new investment opportunities, even if the narrative isn't changing. More specifically, tightening monetary policy and decelerating growth supports our large cap defensive quality bias - a strategy that has worked well since we first started recommending it back in mid-November. On the first score, the Fed and other central banks appear to be determined to remove monetary accommodation in the face of higher inflation. Not only is inflation turning out to be an economic issue, but it's quickly becoming a political one given this is a midterm election year. What this means is the Fed will likely turn out to be more hawkish than investors expect, and that hawkishness is likely to be front-end loaded so markets have time to recover by November.

As for the second part of the narrative, we think growth will decelerate this year as most of our leading indicators point to that outcome. Furthermore, this dynamic should be supportive of defensives outperforming cyclicals amid large cap quality leadership. This week, we expand our analysis to the industry level and illustrate that within defensives, Health Care, REITS and Consumer Staples tend to be the best performers in a decelerating but positive growth regime.

As we reflect on 2021's strong performance from large cap U.S. equity indices last year, it's hard to get too excited about any remaining upside this year. Having said that, most individual stocks have gone nowhere since March, with many in a deep bear market. In many ways, 2021 looked a lot like 2018 - a year of rolling corrections and rotations as investors continually sought out higher ground in the high-quality S&P 500 index. As we enter 2022, the key question for investors is to decide if they want to stay with the relative winners, or is it time to go bottom fishing? New calendar years tend to support the latter strategy as the pressure of keeping up with the index eases. Hence, the new opportunities for investors.

While we continue to favor the large cap defensive tilt that has been working, we recommend creating a barbell with stocks that have already corrected but still offer good prospects at a reasonable valuation. Over the past nine months, the quality bias has driven more and more money into a handful of large cap growth stocks - further highlighting the importance of favoring large over small since March. But as we already noted, this crowding has left many smaller stocks behind. A few areas we think make sense to consider include consumer services and other businesses with pent up demand. In the more growth-y segments, we think biotech and China Internet are good bottom fishing candidates. Meanwhile, we would still be careful with very expensive tech stocks that remain unprofitable.

One final development to watch closely is long term interest rates. With a significant move higher in inflation and the Fed's pivot on policy, we think long term interest rates look too low. The sharp move higher today looks like the beginning of something more meaningful, and it could lead to new 52-week highs in short order if our technical view is correct. As such, we remain positive on financials as our sole cyclical overweight. A backup in rates is the reason, and that could be happening now.

Bottom line, stick with a large cap defensive quality bias as we enter 2022, but balance it with financials and small mid-cap value stocks, particularly with the Fed and other central banks tightening policy faster than investors expect and rates likely back up.

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.

Original Release on August 24th, 2021: Recent developments in space travel may be setting the stage for a striking new era of tech investment. Are investors paying attention?

----- Transcript -----

Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays!

Adam Jonas Welcome to Thoughts on the Market. I'm Adam Jonas, Head of Morgan Stanley's Space and Global Auto & Shared Mobility teams. With the help of my research colleagues across asset classes and regions, I try to connect ideas and relationships across the Morgan Stanley platform to bring you insights that help you think outside the screen. Today, I'll be talking about the Apollo Effect and the arrival of a new space race. It's Tuesday, August 24th, at 10:00 a.m. in New York.

In May of 1961, President John F. Kennedy announced America's plan to send a man to the moon and bring him back safely to Earth before the end of the decade. This audacious goal set in motion one of the most explosive periods of technological innovation in history. The achievements transcended the politics and Cold War machinations of the time and represented what many still see today as a defining milestone of human achievement. In its wake, millions of second graders wanted to become astronauts, our math and science programs flourished, and almost every example of advanced technology today can trace its roots in some way back to those lunar missions. The ultimate innovation catalyst: the Apollo Effect.

60 years after JFK's famous proclamation, we once again need to draw on the spirit of Apollo to address today's formidable global challenges and to deliver the solutions that improve our world for generations to come. The first space race had clear underpinnings of the Cold War between the U.S. and the Soviet Union. Today's space race is getting increased visibility due to a confluence of profound technological change, accelerated capital formation - fueled by the SPAC phenomenon - and private space flight missions from the likes of Richard Branson and Jeff Bezos. We think space tourism is the ultimate advertisement for the realities and the possibilities of Space livestreamed to the broadest audience.

The message to our listeners is: get ready. This stuff is really happening. Talking about Space before the rollout of the SpaceX Starship mated to a Super Heavy booster is akin to talking about the Internet before Google Search, or talking about the auto industry before the Model T.

We are entering an exciting new era of space exploration, one that involves the hand of government and private enterprises - from traditional aerospace companies to audacious new startups. This race is driven by commerce and national rivalry. And the relevance for markets and investors, while seemingly nuanced at first, will become increasingly clear to a wide range of industries and enterprises.

The Morgan Stanley Space team divides the space economy into 3 principal domains: communications, transportation and earth observation. Our team forecasts the global space economy to surpass $1T by the year 2040. And at the rate things are going, it may eclipse this level far earlier.

When I first started publishing on the future of the global space economy with my Morgan Stanley research colleagues back in 2017, very few people seemed to care, and even fewer thought it was material for the stock market. I would regularly ask my clients "on a scale of 0 to 10, how important is space to your investment process?" And by far the most common answer I received was 0 out of 10. A lot of folks said 0.0 out of 10, just to make the point. Not even four years later and, oh my goodness, how things have changed. The investment community and the general public are rapidly embracing the genre and becoming aware of its importance economically and strategically.

So whatever your own area of market expertise, this next era of space exploration and the innovation and commerce that spawn from it, will matter to your work, and to your life. But beyond the national competition, the triumph, the glory, the failures and the many hundreds of billions of dollars that'll be spent on launches, missions and infrastructure - is a reminder of something far bigger that we learned over a half a century ago during the Apollo era - that Space is one of the greatest monuments of human achievement, and a unifying force for the planet.

Thanks for listening. And remember, 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.

Original Release on September 30th, 2021: Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management, discusses the new shape of retail investing and the impact on markets.

----- Transcript -----

Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays!

Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.

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

Andrew Sheets And today on the podcast, we'll be discussing the retail investing landscape and the impact on markets. It's Thursday, September 30th, at 2p.m. in London.

Lisa Shalett And it's 9:00 a.m. here in New York City.

Andrew Sheets Lisa, I wanted to have you on today because the advice from our wealth management division is geared towards individual investors, what we often call retail clients instead of institutional investors. You tend to take a longer-term perspective. As chief investment officer, you're juggling the roles of market analyst, client adviser and team manager ultimately to help clients with their asset allocation and portfolio construction.

Andrew Sheets Just to take a step back here, can you just give us some context of the level of assets that Morgan Stanley Wealth Management manages and what insight that gives you potentially into different markets?

Lisa Shalett Sure. The wealth management business, especially after the most recent acquisition of E-Trade, oversees more than four trillion dollars in assets under management, which gives us a really extraordinary view over the private wealth landscape.

Andrew Sheets That’s a pretty significant stock of the market there we have to look at. I'd love to start with what you're hearing right now. How are private investors repositioning portfolios and thinking about current market conditions?

Lisa Shalett The individual investor has been important in terms of the role that they're playing in markets over the last several years as we've come out of the pandemic. What we've seen is actually pretty enthusiastic participation in markets over the last 18 months with folks, you know, moving, towards their maximum weightings in equities. Really, I think over the last two to three months, we've begun to see some profit taking. And that motivation for some of that profit taking has kind of come in two forms. One is folks beginning to become concerned that valuations are frothy, that perhaps the Federal Reserve's level of accommodation is going to wane and, quite frankly, that markets are up a lot. The second motivation is obviously concern about potential changes in the U.S. tax code. Our clients, the vast majority of whom manage their wealth in taxable accounts, even though there is a lot of retirement savings, many of them are pretty aggressive about managing their annual tax bill. And so, with uncertainty about whether or not cap gains taxes are going to go up in in 2022, we have seen some tax management activity that has made them a little bit more defensive in their positioning, you know, reducing some equity weights over the last couple of weeks. Importantly, our clients, I think, are different and have moved in a different direction than what we might call overall retail flow where flows into ETFs and mutual funds, as you and your team have noted, has continued to be quite robust over, you know, the last three months.

Andrew Sheets So, Lisa, that's something I'd actually like to dig into in more detail, because I think one of the biggest debates we're having in the market right now is the debate over whether it's more accurate to say there's a lot of cash on the sidelines, so to speak, that investors are still overly cautious, they have money that can be put into the market. You know, kind of versus this idea that markets are up a lot, a lot of money has already flowed in and actually investors are pretty fully invested. So, you know, as you think of the backdrop, how do you think about that debate and how do you think people should be thinking about some of the statistics they might be hearing?

Lisa Shalett So our perspective is, and we do monitor this on a month-to-month basis has been that, you know, somewhere in the June/July time frame, you know, we saw, our clients kind of at maximum exposures to the equity market. We saw overall cash levels, had really come down. And it's only been in the last two to three weeks that we've begun to see, cash levels rebuilding. I do think that that's somewhat at odds with this thesis that there's so much more cash on the sidelines. I mean, one piece of data that we have been monitoring is margin debt and among retail individual investors, we've started to see margin debt, you know, start to creep up. And that's another indication to us that perhaps this idea that there's tons of cash on the sidelines may, in fact, not be the case, that people are, "all in and then some," you know, may be something worth exploring in the data because we're starting to see that.

Andrew Sheets So, Lisa, the other thing you mentioned at the onset was a focus on the tax environment, and that's the next thing I wanted to ask you about. You know, I imagine this is an issue that's at the top of minds of many investors. And your thoughts on both what sort of reactions we might get to different tax changes and also your advice to how individuals and family offices should navigate this environment.

Lisa Shalett Yeah, so that's a fantastic question, because in virtually every meeting, you know, that I'm doing right now, this question, comes up of, you know, what should we be doing? And we usually talk to clients on two levels. One is on it in terms of their personal strategies. And what we always talk about is that they should not be making changes in anticipation of changes in the law unless they're really in need of cash over the next year or two. It's really a 12-to-18-month window. In which case we would say, you know, consult with your accountant or your tax advisor. But typically, what we say is, you know, the changes in the tax law come and go. And unless you have an imminent, you know, cash flow need, you should not be making changes simply based on tax law. The second thing that we often talk about is this idea or this mythology among our client base that changes in the tax law, you know, cause market volatility. And historically that there's just no evidence for that. And so, like so many other things there's, you know, headline risk in the days around particular news announcements. But when you really look at things on a 3-month, 6-month, you know, 12- and 24-month, trailing basis on some of these things, they end up not really being the thing that drives markets.

Andrew Sheets Lisa, one of the biggest questions—well, you know, certainly I'm getting but I imagine you're getting as well—is how to think about the ratio of stocks and bonds together within a portfolio. You know, there's this old rule of thumb, kind of the 60/40, 60% stocks, 40% bonds in portfolio construction. Do you think that's an outdated concept, given where yields are, given what's happening in the stock market? And how do you think investors should think about managing risk maybe differently to how they did in the past?

Lisa Shalett That's a fantastic question. And it's one that we are confronted with, you know, virtually every day. And what we've really tried to do is take a step back and, make a couple of points. Number one, talk about, goals and objectives and really ascertain, you know, what kinds of returns are necessary over what periods of time and what portion of that return, you know, needs to be in current cash flow, you know, annualized income. And try to make the point that perhaps generating that combination of capital appreciation and income needs to be constructed, if you will, above and beyond the more traditional categories of cash, stocks and bonds given where we are in terms of overall valuations and how rich the valuations are in both stocks and bonds, where we are in terms of cash returns after inflation, and with regards to whether or not stocks and bonds at the current moment are actually behaving in a way that, you know, you're optimizing your diversification.

Lisa Shalett So with all those considerations in mind, what we have found ourselves doing is speaking to the stock portion of returns as being comprised not only of, you know, the more traditional long-only strategies that we diversify by sector and by, you know, global regions. But we're including thinking about, you know, hedged vehicles and hedge fund vehicles as part of those equity exposures and how to manage risk. When it comes to the fixed income portion of portfolios, there's a need to be a little bit more creative in hiring managers who have a mandate that can allow them to use things like preferred shares, like bank loans, like convertible shares, like some asset backs, and maybe even including some dividend paying stocks in, their income generating portion of the portfolio. And what that has really meant to your point about the 60-40 portfolio is it’s meant that we're kind of recrafting portfolio construction across new asset class lines, really. Where we're saying, OK, what portion of your portfolio and what products and vehicles can we rely on for some equity like capital appreciation and what portion of the portfolio and what strategies can generate income. So, it's a lot more mixing and matching to actually get at goals.

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

Original Release on August 12th, 2021: Investor interest in thematic equity products such as ETFs has rapidly surged, particularly among tech themes. Why the momentum may only grow.

----- Transcript -----

Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays!

Graham Secker Welcome to Thoughts on the Market. I'm Graham Secker, Head of the European and UK Equity Strategy Team.

Ed Stanley And I'm Ed Stanley, Head of European Thematic Research.

Graham Secker And today on the podcast, we'll be talking about the continued interest in thematic investing in Europe. It's Thursday, August the 12th, at 3 p.m. in London.

Graham Secker So, Ed, I really wanted to talk to you today because investor appetite for thematic related equity products such as ETFs, mutual funds and the like has grown to the point that thematics has actually been carved out from our traditional sector research at Morgan Stanley. So as head of the European Thematic Investing team, can you walk us through what's behind the increased interest in this area and how you see the thematic landscape evolving over the next couple of years?

Ed Stanley Thanks, Graham. To understand thematics, first you have to look at the geographies. And when you do that, it's really a two-horse race. Of the $450 billion in global thematic mutual funds in June this year, 60% of that was in Europe. So the lion's share. And then there's the U.S., which is the second largest geography for thematic investing, but growing very quickly indeed. If you look in the US year to date, for example, there have been over 100 thematic ETF launches-- comfortably double the run rate of thematic starts in 2020. Once you've looked at geography, then you have to look at the landscape by theme. And this is where thematic investing gets really interesting. The breadth of and growth in thematic strategies is truly extraordinary. Fund starts are compounding over 40% over the last three years and inflows for those funds have seen high double digit, and even triple digit growth, so far this year. Most obviously, themes like genomics and eSports fall into that high growth category. We even saw a dedicated ETF launch in June this year, particularly trying to gain exposure to the metaverse, which is the first of its kind. So while we don't make explicit forecasts on where we think thematic investing is going to be in a one year view, the momentum is showing no signs of slowing down. In fact, quite the opposite.

Graham Secker So with any number of themes to choose from, the world really is your oyster, I think. So how do you whittle down or cherry pick where you spend your time?

Ed Stanley It's a great question and that's really my number one challenge. While we're never short of ideas, determining which theme is the zeitgeist of the day is absolutely critical. And to do that, our thematic research really hinges on two streams of analysis. On the one hand, demographic change and on the other, disruptive innovation. We believe that these two groupings and the subthemes therein hold the key to shifting future consumption patterns, which ultimately all investors need to be conscious of. But with that said, for most investors to be interested in a theme, it needs to be actionable within at least three to five years. Consequently, for a theme to work, investors need a relatively near-term catalyst. So when we're looking within disruptive innovation, for example, we need to think what's the catalyst to make investors care about this theme? Be that a product launch, start-up funding, falling technology costs, regulation or government policy. When you can twin up an interesting thematic idea with a catalyst, that's really where we focus our attention.

Graham Secker Another question I want to ask is, how do you test the pulse of the market to determine what is a live thematic debate and where you think investors may be too early or late to a theme?

Ed Stanley Well, I suppose this really narrows down the previous point. So we now have our theme, so to speak. We have to ask ourselves, does the market already care about this theme or will the market care in the not-too-distant future? And this is where we think we've come up with a relatively interesting and novel solution to screen for that. Through a combination of four things: patent analysis, capital spending patterns by companies, the velocity of comments made by company management teams and finally, using Google Trends momentum data, we believe that we can relatively accurately pick which themes are either gathering momentum or, on the flip side, those that may have been past their initial peak of excitement.

Graham Secker Okay. And on that point, what are some of the key themes you're watching right now?

Ed Stanley Well, I suppose one that we can't ignore, particularly given my previous comments, is hydrogen. On all of the metrics I just mentioned, it's flashing green. Whether that's pattern analysis, company transcripts, CapEx intensity. It's a hotly debated theme as investors try to grapple with this long-term potential for the fuel. But even more simply, if we take a step back, one really only needs to look at the fund startups to see where the really exciting themes are. If we look back to January 2018, for example, there are only a handful of fintech funds around the world. Today, there are nearly 200 that we're keeping track of. Part of my role is to predict what is going to be the next fintech when it comes to themes. And the themes that are most likely to tick those boxes are, in my view, the near-term ones, electric vehicles, cybersecurity, 5G; the medium term, which encompasses augmented, virtual reality as well as eSports; and then longer term, you have space, quantum computing are all beginning to show telltale signs of thematic focus areas.

Graham Secker Thanks, Ed. And finally, I want to ask you about concerns over a thematic bubble. There's been an exponential rise in the number of thematic products being set up recently. There's also been a high degree of attrition for thematic ETFs. So to what degree do you think the ongoing growth in thematic investing is here to stay? And how vulnerable do you think it could be to a prolonged technology bear market, for example?

Ed Stanley You're absolutely right. Plenty of thematic ETFs, particularly in the US, have come and gone. That will likely continue to happen, particularly in themes where hopes exceed reality. What happens in a prolonged downturn remains to be seen in all honesty. We don't have enough back history from a wide enough variety or sample of these thematic funds, to be sure. But the test case of covid highlighted the early signs of structural growth in this market. There are more thematic funds post-covid than pre-. So my view is that this is absolutely a structural rather than a cyclical phenomenon, particularly as younger marginal investors increasingly want exposure to themes rather than sectors and geographies. But while I believe that thematic investing is a structural trend, no doubt it clearly leans towards tech-heavy equities and growth as a factor, particularly. So the bigger existential threat perhaps isn't so much a bear market, but instead persistently high interest rate environments, which remains to be seen. But for now, at the very least, the future looks pretty bright for thematics in our view.

Graham Secker Very interesting. Thanks for taking the time to talk today, Ed.

Ed Stanley Great speaking with you, Graham.

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

Original Release on August 26th, 2021: Equity investors have applied factor-driven strategies for years, but the approach has seen slow adoption in bond markets. Here’s why that may be changing.

----- Transcript -----

Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays!

Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley,

Vishy Tirupattur And I am Vishy Tirupattur, Head of Fixed Income Research at Morgan Stanley.

Andrew Sheets And on this special edition. And on this special edition of the podcast, we'll be talking about factor investing strategies and liquidity in corporate credit markets. It's Thursday, August 26th, at 3:00 p.m. in London

Vishy Tirupattur And 10:00 a.m. in New York.

Andrew Sheets So Vishy, before we start talking about factor investing and credit, we should probably talk about what is factor investing and why are we talking about it. So, what is this concept and why is it important?

Vishy Tirupattur Factor investing whose intellectual roots are from a seminal paper from two University of Chicago professors in the early 90s, Eugene Fama and Ken French. It effectively is a way of identifying companies to invest using rules based systematic investing strategies, be it identifying quality, identifying value, identifying momentum or volatility or risk adjusted carry. A bunch of these strategies involve setting up a set of rules and systematically in following those rules to build a portfolio. And we've seen that these strategies in the context of equities have substantially outperformed more discretionary strategies.

Andrew Sheets So you can kind of think about it as the Moneyball approach to investing, that you think over time doing certain types of things in certain situations over and over again systematically is going to ultimately deliver a better long run result.

Vishy Tirupattur Exactly right.

Andrew Sheets So you mentioned that this has been a strategy that's been around a long time in equity markets. Why hasn't it been around in credit? And what's changing there?

Vishy Tirupattur The key for systematical rules-based investing strategies or factor investing is being an abundance of liquidity in the market. And the complexity of credit markets means that this has been a big challenge to implementing these types of strategies. For example, you know, S&P 500, not surprisingly, has 500 stocks. And underlying those 500 stocks are literally thousands of bonds that underlie those 500 stocks, that weigh in maturity, in coupon, in rating, in seniority, etc... Each of these introduces an element of complexity that just complicates the challenge associated with factor investing.

Andrew Sheets So Vishy, that's a great point, because if I want to buy a stock, there's one stock, but if I want to buy a bond of that same company, there might be many of them with different maturities and different coupons. They're just not interchangeable, and that does introduce complexity.

Vishy Tirupattur So one big thing that's happened is the advent of electronic trading. Electronic trading today accounts for almost a third of all trading in investment grade corporate credit and in over 20% of all trading in high yield corporate credit. This has made a significant difference and enables factor investing possible in the context of credit.

Andrew Sheets So more electronic trading, more portfolio trading is improved liquidity and made certain types of factors, systematic strategies possible in credit. Are ETFs a part of this story? Obviously, those represent a portfolio of credit. We're seeing rising volumes within the credit market of exchange traded funds. How do you see that playing into this trend? And what do you think is the outlook there?

Vishy Tirupattur Absolutely. ETFs constitute portfolio trades and portfolio trading indeed has become a very, very big part of trading here. Even five years ago, ETFs accounted for about 5% of all the traded volumes in investment grade and maybe about 20% in high yield. Today, they account for 16% of all traded volumes investment grade and 50% of all the traded volumes in high yield. So, ETF and portfolio trading in general has enabled not only greater liquidity, but smaller issue sizes and smaller issuers, and that's an important distinction.

Andrew Sheets So how would this actually work in practice? You know, I could go out and I could just buy a credit fund that owns all the bonds in a particular market. Or I could try one of these factor strategies. What would the factory strategy actually be doing? I mean, what are the characteristics that our research suggests credit investors should be trying to favor versus avoid?

Vishy Tirupattur Let me talk about two strategies. First is a risk adjusted carry strategy. So, you take the spread of the bond over Treasuries, so that gets the credit risk premium, divided by the volatility of excess returns of that particular bond over the last 12 months. Group all these bonds, sort them, and invest in the top decile that has the best risk adjusted return. And then rinse and repeat every month. And we have shown that using this strategy in investment grade, you can consistently beat the benchmark corporate bond index. So that's one strategy.

Vishy Tirupattur The other one is a momentum strategy. Momentum can be both from the bond returns as well as from the underlying stock returns. Our research has shown that by combining equity momentum signals and corporate bond momentum signals, we can also achieve substantial outperformance over the benchmark indices both in investment grade and high yield, even though in high yield the outperformance is even more significant.

Andrew Sheets So Vishy, why do you think that works? Because it would seem really obvious that, you know, investors wouldn't want to own bonds with a good return versus their volatility, that investors would want to own things that are going up and avoid things that are going down. So why would doing those things, why would following those rules, do you think, still deliver risk premium, still deliver return? Why do you think the market is kind of leaving those nickels kind of lying on the street for lack of a better word, for investors to pick up?

Vishy Tirupattur Andrew, in the past this kind of a strategy that would involve, say, a monthly rebalancing, would mean very substantial transaction costs. What we would measure through the bid offer spreads in the bond market. So, 10 years ago, in plain vanilla investment grade bonds, the bid offer spreads, the spread in the difference between the spread of buying and selling bonds, was as high as 12 basis points. And today that number is 2-3 basis points. So, this means that transaction costs, thanks to the electronification, thanks to portfolio trading and ETF volumes, has meant very substantially lower transaction costs that makes these returns possible. And since factor investing is still at the very early stages of practice in credit markets, there are still large, unharvested risk premia in the credit markets for these types of strategies.

Andrew Sheets And Vishy, my final question for you is, what are the risks here? If investors are going to look at the market from a systematic, more rules-based approach, what sort of questions should they be asking?

Vishy Tirupattur I think key question to ask is how much dependencies there are on liquidity and how long will liquidity continue to be there in the markets. I think looking at this kind of analysis over multiple credit cycles, the four cycles, lower liquidity, higher liquidity periods, which is what we have done, those are the kinds of analyzes one would need to do to start paying greater attention to systematic investing strategies in credit.

Andrew Sheets Vishy. Thanks for taking the time to talk.

Vishy Tirupattur Andrew, always fun to talk with you.

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

Recent signals from the Fed are indicative of a willingness to change its mind quickly. While bond investors may be wary of the volatility this could bring, it may also create opportunities in the new year.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, December 22nd at 10:00 a.m. in New York.

While investors may be focused on the gridlock on the Build Back Better fiscal plan, we think it makes sense to shift our focus from Capitol Hill to the Federal Reserve, which just made a big move, and one that arguably matters more to markets in the near term than developments out of Congress. Last week, the Fed announced a more aggressive tapering of asset purchases. Perhaps more importantly, it signaled an expectation of hiking interest rates three times next year, rather than the two times most forecasters expected. In the press conference following the announcement, Chair Powell repeatedly signaled his intent was to demonstrate both that the Fed takes seriously the risk posed by a recent uptick in inflation, as well as the flexibility of the Fed's monetary policy, by discussing his willingness to adjust the taper and rate hike outlooks as data comes in.

This last point is an important one for bond markets. In dealing with substantial uncertainty around the inflation outlook, you have a Fed that elected a pragmatic approach - a willingness to change its mind quickly as it sees fit. That's not a novel approach, but it may be fresh to many investors today who may be more accustomed to the slower, more deliberate approach that economic conditions pressed the Fed to take under its previous two chairs. But such an approach means it's harder to predict with confidence what will happen next to monetary rates. That uncertainty means more disagreement among investors, which in turn means more sustained volatility in the Treasury market.

That's not necessarily bad news for investors, though. In our view, it actually may lead to some interesting opportunities in 2022 for credit investors. In the muni market, for example, elevated rates volatility has, more often than not, caused market weakness as investors shy away from price uncertainty in an asset class they generally want to own for reasons of capital preservation and asset allocation. But muni credit quality, in our view, is likely to remain quite strong in 2022, with continued strong economic growth allowing municipal entities to lock in their credit gains from government aid and a sharp GDP recovery in 2020 and 2021. So, if volatility leads to price weakness, we're likely to see this as an opportunity to add good credit, just at a cheaper valuation.

So, beware the Fed and volatility, but don't fear it. We'll keep you updated here for the opportunities it may create.

Happy holidays from all of us here at Thoughts on the Market. We'll be back in the new year with more episodes.

And 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.

With shifting focus across regulatory, monetary and fiscal policy, there is renewed confidence in the growth and recovery outlook for China in 2022.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Asia Economist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives. I'll be talking about the prospects for China's recovery amid regulatory, monetary and fiscal policy easing. It's Tuesday, December 21st at 7:00 p.m. in Hong Kong.

China's policy stance is clearly shifting from over-tightening to easing, and with it, we think the cycle is also turning from a mini downturn to an upswing. We are more bullish than the consensus and see GDP growth accelerating to 5.5% in 2022.

Over the years, China has experienced a number of mini cycles. These mini cycles in growth tend to follow the policy cycles. While tightening starts out as countercyclical, it eventually becomes pro-cyclical, and sometimes because external demand conditions deteriorate - for example, the onset of trade tensions in mid-2018. Once growth decelerates beyond policymakers' comfort zone, their priorities shift to stabilizing growth and preventing an adverse spillover impact into the labor market.

In the current cycle, with sharp pick-up in external demand, policymakers stuck to their playbook and tightened macro policies to slow infrastructure and property spending. But from the summer of this year, as Delta wave-led restrictions weighed further on consumption growth, continued policy tightening pushed growth lower than policymakers' comfort zone.

This time around, policy tightening was unusually aggressive, leading to a 10 percentage point drop in debt to GDP in 2021. Indeed, we have not seen this magnitude of debt to GDP reduction in a year since 2003-07 cycle. Moreover, the rapid succession of regulatory tightening actions related to the tech sector and decarbonization has taken markets by surprise, adding uncertainty and keeping market concerns on the boil.

Now, with GDP growth decelerating to just 3.3% on a year-on-year basis in 4Q21, which would be 4.9% adjusted for high base effect, policymakers have hit pause on deleveraging and began to ease both monetary and fiscal policy a few weeks ago. Bank reserve requirement ratio cuts were coupled with guidance to banks to allocate more credit to priority sectors. At the same time, local government bond issuance has increased significantly, which in turn will translate into stronger infrastructure spending. And several local governments have also lifted property purchase restrictions.

Two Fridays ago, policymakers convened at the Central Economic Working Conference - an annual meeting that sets the agenda for the economy in the year ahead - and the resulting statement suggested to us that there is a clear shift in policy stance, and they will continue to take action in a number of areas to stem the downturn, increasing our confidence in China's recovery.

These policy easing measures will complement the sustained strength in exports and a pickup in private capex, driving the recovery.

And in terms of market implications, our China Equity Strategy team continues to prefer A-shares rather than offshore markets, and our China Property and Asia Credit Strategy analysts are optimistic on the China property sector as well as China high yield property.

The key risk to our call in the near-term is the Omicron variant. The effectiveness of China's containment and tracing capabilities has improved over time, such that each successive wave of COVID outbreaks has had a smaller impact on mobility and growth. However, Omicron's greater transmissibility suggests to us that it will keep China's COVID zero policy in place for longer and potentially force China to impose more selective lockdowns than during the Delta wave.

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 narrative of tightening monetary policy and decelerating growth continues to play out amidst developments in Omicron, failed legislation and signals from the Fed.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, December 20th at 11:30 a.m. in New York. So let's get after it.

Our Fire and Ice narrative for tightening monetary policy and decelerating growth is playing out, with the central banks taking aggressive steps to deal with the higher-than-expected inflation. Meanwhile, Omicron and the failure to pass President Biden's Build Back Better bill have awakened investors to the risk of slower growth that we think is as much about the ongoing cyclical downturn as these external shocks. In short, stay defensive with your equity positioning.

First, with the Fed preparing investors over the past four months for what could be a very long process of removing monetary accommodation from markets that have become dependent on it, the most expensive and speculative stocks have already been hit exceptionally hard. Furthermore, the quality trade has taken on a more defensive posture. Both of these shifts are very much in line with our 2022 outlook - be wary of high valuations and focus on earnings stability. In other words, favor large cap defensive quality.

Second, with the market and the Fed now fully appreciating that inflation is not going to be transitory, investors must contend with the Ice part of our narrative. How much further will growth decelerate, and how much is due to Omicron versus the ongoing cyclical downturn that began in April? As noted in prior episodes of this podcast, we remain optimistic that this latest wave will prove to be the last notable one. Meanwhile, the peak rate of change in the recovery was way back in April of this year. Since then, we've seen a steady deceleration in growth that has little to do with COVID, in our view. Instead, this is the natural ebb of the business cycle and mid-cycle transition, which is not yet complete. Of course, this latest variant will be a drag on certain parts of the economy and perhaps bring forward the end of the mid-cycle transition more quickly. Finally, this past weekend Senator Manchin effectively put an end to the president's latest fiscal stimulus plan - another negative for growth in the near term.

All of these developments fit nicely with our year ahead outlook for U.S. equities. Therefore, we continue to think most stocks will see valuations come down as central banks remove monetary accommodation and growth slows more than investors expect. Favor defensively oriented stocks over cyclical ones. This includes Healthcare, REITs and Consumer Staples. Meanwhile, consumer discretionary and certain technology stocks look to be the most vulnerable as we experience a payback in demand from this year's overconsumption. While other cyclical areas like energy, materials and industrials could also underperform, ownership of these sectors is not nearly as extreme as the discretionary and tech, nor are they as expensive.

Finally, while major U.S. equity indices remain vulnerable, in our view, many individual stocks have been in a bear market for most of the year. As a reminder, almost 80% of all stocks in the Russell 2000 have seen a 20% drawdown during 2021. For the Nasdaq, it's close to 60%, while 40% of the S&P 500 has corrected by 20% or more. In our view, it makes sense to look for new investments in stocks that have already corrected, rather than the ones that have held up the best. We would recommend a barbell of these kinds of stocks with the more classic large cap defensive names that fit our current macro view.

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

A quick preview of what you'll hear on the Thoughts On The Market podcast, which features short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

With recent signals from the Federal Reserve and new data on the Omicron variant, there’s a lot that could impact the shape of 2022, but for now the core of our outlook remains unchanged.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues, bring you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, December 17th, at 2 p.m. in London.

Every year, the economists and strategists at Morgan Stanley come together and try to forecast what the next year could look like. And then, as always seems to be the case, something happens. The world, after all, is an unpredictable place.

This year, these 'somethings' have come thick and fast. As my colleague Matthew Harrison, U.S. biotechnology analyst, and I discussed on this program last week, the Omicron variant appears to be highly contagious and likely to lead to a large wave of winter infections.

At almost the same time, the US Federal Reserve, arguably the world's most important central bank, has been sounding less tolerant of inflation, leading Morgan Stanley's economists to now expect a quicker end to the central bank's bond purchases and also a larger, faster increase in Federal Reserve interest rates relative to what we thought just a month ago.

Both are major developments. But while they change some of our investment strategy around the edges, we don't think, for now, they change the main story for 2022.

To understand why, let's start with the Federal Reserve. Yes, the Fed is now likely to end bond purchases and raise interest rates sooner than we had previously assumed. But from an investment perspective, we always thought the central bank would signal an intent to be less supportive to start the new year, hoping to convince markets that they were taking inflation seriously. We had previously thought that this 'tough talk' might shift in the spring, when inflation data would come down, and the Fed wouldn't ultimately follow through on interest rate hikes. But now, it looks like they will.

But in either scenario, the strategy for investors should be to position for a central bank that is indicating it wants to be less supportive. As such, we expect interest rates to move higher, especially around five-year maturities, the dollar to appreciate and U.S. and emerging markets stocks to underperform those in Europe and Japan, where the central banks are going to be more accommodating for longer. We think financials outperform as an equity sector, seeing them as a beneficiary of less central bank accommodation.

The other development, of course, is Omicron, while the new variant appears to be highly contagious. Our economists at Morgan Stanley had always assumed some form of a 'winter wave' of COVID in their growth numbers, given the virus's seasonal characteristics. Economic data, for the moment, has actually held up quite well and global activity has been less impacted by each incremental COVID wave. And we also need to consider the entire year, not just what could be a very difficult month or two of high COVID cases. All of these together are why our base case remains for strong global growth in the next year, despite the currently worrying headlines.

Both new developments, however, require close observation. The Fed looks much more willing to shift in either direction than it has before, while the full impact of Omicron may not be seen for several more weeks. For now, however, we think a backdrop of good global growth and less central bank support remains the outlook for 2022.

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 last week brought new evidence regarding the transmissibility, immune evasion and disease severity of Omicron, and with it, more clarity on the coming weeks and months.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Matthew Harrison, Biotechnology Analyst. Along with my colleagues, bringing you a variety of perspectives, today I'll be discussing our updated thoughts on the COVID 19 pandemic and the impact of Omicron. It's Thursday, December 16th at 10:00 a.m. in New York.

Since Omicron was first discovered, we've been using the framework of transmissibility, immune evasion and disease severity to think about its impact. Over the last week, the level of evidence on all three topics has increased significantly.

So first, on transmissibility. The ability of Omicron to outcompete the prior dominant variant, Delta, now appears clear. We have evidence in South Africa, the UK and Denmark, with Omicron now dominant in central London and set to be the dominant variant in the UK over the next few days. The US is a few weeks behind Europe in terms of spread, but we would expect a similar pattern. Cases are now rising globally, driven by Omicron's transmissibility. This is a combination of factors driven by one, its innate transmissibility, and second, its immune evasion properties, which have dramatically increased the percentage of the population susceptible to infection.

We now have multiple studies, which generally come to a similar conclusion. Two doses of vaccination or a single prior infection provide little to no barrier against infection. Two doses of vaccination do, however, provide protection against severe outcomes like hospitalization or death. This is around a 70% relative reduction versus those who are not vaccinated based on preliminary data. Three doses of vaccination or two doses of vaccination and a prior infection provide a greater barrier against infection. Preliminary data here suggests a 75% relative reduction to those without three doses or two doses and a prior infection. Importantly, since a limited proportion of the population has been boosted - we estimate at about mid-teens percentage of the total US population - the vast majority of the population is again susceptible to an infection with Omicron.

And finally, on disease severity. The data out of South Africa continue to suggest the percentage of patients with severe outcomes is lower relative to the prior Delta wave. This means that there are less people in the ICU and less people on a ventilator as a proportion of the total people infected compared with Delta. That said, it's important to remember that even with a lower proportion of people having severe disease, if Omicron drives a wave of infections that is much higher than Delta, the overall disease burden could still be very high.

So this leads us to what is our outlook on infections and the ultimate impact of Omicron. The variant is likely to be dominant quickly, and we would expect to be in the steeper part of the exponential rise in cases here in the US in the next two to three weeks. We believe it is possible that the Omicron wave could have a peak in terms of total number of infections that is somewhere between 2 and 3 times higher than the prior Delta wave. However importantly, vaccination should help protect against severe outcomes.

For more on Omicron, we also recently sat down for an interview with the Moderna CEO Stephane Bancel to discuss his views on that topic and more. You can see the full interview on MorganStanley.com.

Thanks for listening! We hope you have a safe and enjoyable holiday season. If you enjoy Thoughts on the Market, please be sure to rate and review us on the Apple Podcast app. It helps more people find the show.

While many are hopeful for an easing of supply chain delays in 2022, the resolution of these issues may lead to new challenges and opportunities in key stock sectors investors should be watching.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, December 15th at 10:00 a.m. in New York.

Inflation is a hot topic in Washington, D.C. The president talks about it regularly in his Twitter feed and on camera. It's also a favorite concern of Senator Manchin, who openly ponders whether inflation concerns will keep him from casting the deciding vote on the Build Back Better plan. Yet for investors, inflation has always been a necessary obsession, as its presence or lack thereof, typically drives impacts in the bond and foreign exchange markets. But today we want to focus not on the potential effects of inflation, but one of its causes - namely supply chain issues and how the resolution creates challenges and opportunities in some key stock sectors.

But let's start with the why of supply chain issues. Why are the reports of shortages, ships waiting at ports to deliver goods, and rising prices because of the scarcity it creates? In short, it has to do with the extraordinary impact of the pandemic. Social distancing initially drove sharp but short-lived declines in consumer demand and companies' consumer demand expectations. But substantial fiscal aid to the economy led to a rebound in economic activity. Yet this was mostly focused on goods over services as COVID concerns continued to crimp the demand for activities, like eating out. This led to some abnormal and astonishing data. For example, personal consumption of durable goods declined 20% in the early days of the pandemic, more than 10x the decline from the prior recession. Yet by this past October, consumption of durable goods was 40% higher than pre-COVID. It's no wonder that container shipping rates from Shanghai to Los Angeles are 5x their normal run rate.

Yet our colleagues see these pressures starting to abate in the US. Vaccines appear to have eased concerns among the population in consuming services in public spaces and service consumption is now rising sharply, whereas goods consumption growth has leveled off. Our economists expect this will help ease the pace of inflation starting in the first quarter of next year.

While this would be good news for the economy overall, the story could be more mixed across stock sectors. Our tech hardware team, for example, sees a period of weaker orders for semiconductors after customers receive their currently delayed orders. This dynamic could open the door for earnings disappointment. On the other hand, our Capital Goods team sees opportunity, as the current bottleneck may have persuaded a variety of industries that they need to invest in reinventing their supply chains and potentially engage in some re or near shoring, which would require substantial equipment and materials investment.

So as we head into the end of the year, supply chain delays are likely to continue to raise concerns around inflation, but the first half of 2022 will be telling. We'll keep you updated as the story develops.

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.

Cryptocurrency companies have begun to act as banks in the US, and while regulators have expressed concerns over interest rates and the primacy of the dollar, this interplay has only just begun.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Sheena Shah, Lead Cryptocurrency Analyst for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the escalating financialization of cryptocurrency markets. It's Tuesday, December 14th at 2:00 p.m. in London.

BYOB - Be Your Own Bank. This has been the clarion call of Bitcoin evangelists since its very inception. But in an ironic turn of events, crypto companies Avanti, Anchorage and Kraken have all become banks in the US. Not in the sense espoused by bitcoin maximalists, but in the fiat - that is to say, government regulated sense.

And regulators have shone much of their spotlight on the conspicuously outsized interest rates on offer to depositors through crypto lending. On the 10th of December, you could deposit a cryptocurrency called USDC with a company called BlockFi and receive an interest rate of 9%.

Concern has arisen from the fact that the issuers of USDC aim to control its value, such that a single USDC should, in theory at least, always fetch a value of approximately one U.S. dollar. The disparity between a 9% rate on what is essentially a proxy for the dollar and the historically low rates on actual dollar deposits at retail banks, has regulators concerned about the emergence of a parallel banking system.

The irony here is that it was preexisting banking regulation itself that played a hand in creating this high rate. Traditional banks have turned down crypto traders due to regulatory risk, and so these traders were forced to borrow from the crypto markets and offer lenders higher rates of return.

Nevertheless, US regulators appear to be taking measures to limit competition with the dollar banking system. New Jersey regulators have ordered BlockFi to stop offering high interest crypto deposit accounts from February next year. And in September, the Securities and Exchange Commission sent Coinbase a Wells notice, following which Coinbase aborted a plan to offer 4% interest on USDC deposits.

Ultimately, regulators will have to decide how aggressively they want to safeguard the primacy of the dollar. They could stymie much of the industry to be sure or hope the dollar stands up to scrutiny in order to allow the crypto industry to grow. The longer they wait, the higher the risk. Following multi-trillion stimulus packages and over a decade of quantitative easing, the dollar has been left as open to competitors as it has been since the Bretton Woods agreement in 1944. Investors should keep an eye on the direction that regulators take in the face of this and the broad spectrum of outcomes those regulations might portend for crypto valuations, ranging anywhere from new highs to the old lows of bygone price cycles.

The meeting of crypto culture and traditional banking regulation is a seminal moment for the crypto industry. I, for one, am excited to see how this interplay evolves. Crypto companies are becoming more like banks, just as traditional banks have themselves begun to offer crypto products.

Thanks for listening! If you enjoy Thoughts on the Market, share this and other episodes with a friend or colleague today.

Our 2022 outlook presented a wider than normal range of potential paths. While our base case still appears likely, shifts in supply and Fed policy could cause a change in course.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, December 13th at 11:30 a.m. in New York. So let's get after it.

In writing our year ahead outlook, we were faced with what we think is a wider than normal range of potential economic and policy outcomes. This higher "uncertainty" was one of the inputs to our key conclusion - that valuations for U.S. equity markets were likely to come down over the next 3-6 months. In our discussions with hundreds of clients since publishing our outlook, the conversations have centered on these three potential outcomes and how to handicap them.

First is Goldilocks. When we published our outlook on November 15th, this was the prevailing view by most clients. In this outcome, supply picks up in Q1 to meet the excess demand companies are having a hard time fulfilling. Inflation has a relatively fast but soft landing towards 2-3%, which allows for growth to remain strong and multiples to remain high. The S&P 500 reaches 5000 by year end 2022. And this was our bull case in our outlook with a 20% probability.

In the second outcome, inflation remains hot and the Fed responds more aggressively. Under this outcome, inflation proves to be stickier as supply chains and labor shortages remain difficult to fix in the short term. The Fed is forced to taper faster and even raise rates on a more aggressive path. This was our base case, as it essentially lined up with our hotter but shorter cycle view we first wrote about back in March. At the same time, operating leverage fades as costs increase more in line with revenues. This leaves market breadth narrow in the near-term as valuations fully normalize in line with the typical mid-cycle transition. While there is some debate around how much P/Es need to fall, we believe 18x is the right number to use for year-end 2022. When combined with 10% earnings growth, that gives us a slight downside to the index from current prices, or 4400 on the S&P 500. We put a 60% probability on this outcome.

The third outcome assumes supply ticks up, but demand fades. Under this scenario, we assume supply comes too late to meet what has been an unsustainable level of consumption for many goods. It's also too expensive for customers who have become wary of higher prices, which leads to demand destruction for many areas of the economy. While services should fare better and keep the economy growing, goods producing companies suffer. Under this scenario, the Fed may back off on their more aggressive tightening path. Rates fall, but not enough to offset the negative impact on margins and earnings, which will end up disappointing. This is essentially the "Ice" part of our Fire and Ice narrative turning out to be chillier. Equity risk premiums soar and multiples fall more than under our base case. This was our bear case with a 20% probability.

Since publishing, we feel more confident about our base case being the most likely outcome. Inflation data continues to come in hot and companies are having little problem passing it along, for now. While this will likely lead to another good quarter of earnings, we suspect there will be more casualties too, as execution risk is increasing. This will leave dispersion high and leadership inconsistent - two more conclusions in our outlook. Stock picking will be difficult, but a necessary condition to generate meaningful returns in 2022 as the market index is flat to down over the next 12 months.

This is a big week on policy outcomes, with the Fed likely to announce a more aggressive timeline for tapering its asset purchases. In short, we expect the Fed to tell us that they will end its asset purchase program by March 31st. While our base case always assumed the Fed would respond appropriately to higher inflation, this is a more aggressive pivot than what we expected a month ago. Importantly, the Fed is now suggesting stable prices are important to achieving its primary goal of full employment, which means inflation is taking center stage until it's under control. Finally, we think Jay Powell and the Fed will be under much less pressure from the White House versus the last time they were aggressively removing monetary accommodation in late 2018. Part of this is due to the fact that inflation is a much bigger problem today than it was in 2018, and part of it is due to the observation that the White House today is not as preoccupied with the stock market. Bottom line, the Fed is determined to bring down inflation, and falling stock prices are unlikely to stop them from trying.

In this kind of an environment, we continue to favor companies with earnings stability and reasonable valuations. That means large cap defensive quality stocks. In short, boring can be beautiful.

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 recent central bank action raising questions on monetary policy, Global Head of Macro Strategy Matthew Hornbach takes us through the implications for the trajectory of rates and currency markets in the year ahead.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the 2022 outlook for rates and currency markets. It's Friday, December 10th at 10:00 a.m. in New York.

Every November my colleagues within research come together to discuss the year ahead outlook. And almost every year something happens in the month after we publish our forecast that changes one or more of our views. This year, several Morgan Stanley economists have changed their calls on central bank policies given higher than expected inflation and shifting central bank reaction functions.

Our monetary policy projections have become more hawkish for central banks in emerging markets, mostly. But earlier this week, our projection for Federal Reserve policy became more hawkish as well. Our economists now see the Fed raising rates twice next year, whereas before they didn't see the Fed raising rates at all.

Does this change alter our view on how macro markets will move next year?

Well, it doesn't change our view on the direction of markets. We still think U.S. Treasury yields will rise and the U.S. dollar will strengthen in the first half of the year. But now we see a flatter U.S. yield curve and the U.S. dollar performing better than before.

What hasn't changed in our outlook? We still see macro markets dealing with variable central bank policies in 2022. Some policies will be aimed at outright tightening financial conditions, such as in the UK, Canada, New Zealand and now the U.S. Other central banks will attempt to ease financial conditions further, albeit at a slower pace than before, like the European Central Bank. And some will aim to maintain accommodative financial conditions like the Reserve Bank of Australia and the Bank of Japan.

For rates markets, we expect yields around the developed world to move higher over the forecast horizon, but only moderately so. And while we see real yields leading the charge, we don't foresee a tantrum occurring next year. We forecast 10-year Treasury yields will end 2022 just above 2%. That would represent a similar increase to what we saw in 2021.

As for the US dollar, we see two primary factors lifting it higher next year. First, we see a continued divergence between U.S. and European economic data. Recent U.S. economic strength should continue into the first half of the year. And expectations for future growth should stay elevated, assuming additional fiscal stimulus measures are approved by the U.S. Congress, in line with the Morgan Stanley base case.

At the same time, our economists have been expecting data in Europe to weaken. In addition, the worrying surge in COVID cases and the government responses across Europe pose additional downside risks. To be clear, we expect eurozone growth to be strong over the full year of 2022, yet it is likely that the economic divergence between the U.S. and Europe continues for a while longer.

This should keep the U.S. dollar appreciating against low yielding G10 currencies, such as the euro. We also expect further upside for the US dollar against the Japanese yen, driven by higher U.S. Treasury yields.

The second factor arguing for a stronger US dollar is central bank policy divergence. The Fed could strike a more upbeat and hawkish tone throughout next year, just as it has done more recently. On the other hand, the risk for the ECB is that its more hawkish members adjust their views in a more dovish direction, and then the ECB delivers more accommodation than expected, not less. If the upcoming Fed and ECB meetings this December go as we expect, they would set up the dollar for additional strength in the first half of next year.

As for higher yielding riskier currencies, we think four factors will support them. First, our economists forecast robust global growth next year. Second, they also forecast inflation will moderate from unusually high levels. Third, they see central banks maintaining abundant pools of global liquidity. And finally, we think this leads to only a moderate rise in real yields.

As a result, we have constructive views on the risk sensitive G10 currencies. In particular, we expect the Canadian dollar and the Norwegian krona to outperform the US dollar and lead the G10 pack. We see buoyant energy prices and hawkish central bank policies keeping these currencies running ahead of the U.S. dollar and far ahead of the euro and the yen.

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

The US economy is in a unique moment of uncertainty but headed into 2022, shifts in inflation, the labor market and Fed policy tell a constructive story.

----- Transcript -----

Ellen Zentner Welcome to Thoughts on the Market. I'm Ellen Zentner, Chief U.S. Economist for Morgan Stanley Research.

Robert Rosener And I'm Robert Rosener, Senior U.S. Economist.

Ellen Zentner And on this episode of the podcast, we'll be talking about the 2022 outlook for the U.S. economy. It's Thursday, December 9th at noon in New York.

Robert Rosener So, Ellen, we're headed into 2022. We're in a pretty unique moment for the U.S. economy. We see rising inflation, supply chain issues and uncertainty about Fed policy. Of course, we also had disappointing job growth in the month of November, but unemployment that is now not far from pre-COVID lows. So we've got a lot of different indicators sending very different messages right now. How should listeners be thinking about the U.S. economy right now and what that means for the outlook into 2022?

Ellen Zentner Yeah. So we're pretty constructive on the U.S. economy, and it may be surprising with all the uncertainties that you noted. You know, consumers are in very good shape. We've been talking about excess savings for a long time on these podcasts. Excess savings is still there as a cushion. Look, inflation is rising and continues to rise, but it's rising because demand is still strong. At the same time, we don't have enough goods of what people want to buy. So I don't think we're out of the woods yet for rising inflation. I think we're going to get some more prints here that are even higher. But we already are getting indications from our equity analysts that their companies are saying that their supply chains are easing. So I think, within just a matter of months, we should start to see inflation come down. And while households are telling us in our surveys that inflation worries them even more so than COVID, they're still spending. And we expect that as we move into next year, we're going to recoup some of that deferred demand from goods that are going to be available that weren't there before.

Ellen Zentner But the other thing that's really important for consumer spending is the jobs numbers, and you mentioned that, Robert, explained to people-- because this was the number one question we got after that jobs report: how is it that you get a headline number? That's so disappointing, but unemployment rate is that low? I mean, is it good? Is it bad?

Robert Rosener Yeah, it's a really mixed picture and a lot of different indicators pointing in a lot of different directions. So of course, we got our latest read on the labor market that showed a slower than anticipated rise in jobs. In the month of November, we created 210,000 jobs. That was less than half of what was expected, but overall, the report still had a solid tone. And one of the reasons why there are still solid indications coming from the labor market is that we're seeing continued healing from some of the biggest effects of the pandemic and that came through, most notably in November in labor force participation. One of the biggest shortfalls in the labor market has been the number of individuals who are actually actively participating in the labor force. We saw the labor force participation rate, in total, rise 20 basis points in November to 61.8%. That's still well below the 63.4% peak we saw pre-COVID, but it's notably out of the very sticky range it's been in since the summer. So we're seeing continued healing there. We're expecting that healing is going to continue, and that's going to be a very important part of this labor market recovery.

Ellen Zentner So what are you telling clients then that are worried about wage pressures and where those might go? Because participation, rising participation, does matter there. So what's our message?

Robert Rosener Well, much like the inflation backdrop, we're moving through a period of more elevated wage growth. There's been a significant amount of disruption in the labor market and alongside it, wage pressures have risen. But labor supply opening back up is a very important way that we're going to see supply and demand come back into balance in the labor market. We just got data on job openings, which showed that aggregate job openings in the economy are in excess of 11 million. There's one and a half open jobs for every unemployed individual in the labor market. If we boost the number of people who are actively participating in the labor market, it's going to bring those supply and demand metrics in better balance, and it should help to ease wage pressures alongside that.

Ellen Zentner OK, that's interesting because, you know, one conversation that we have with our equity investors quite a bit is, you know, how should companies be looking at higher wage pressures? And of course, if you talk to economists and academics, right, we love to see higher nominal wages because that means stronger backdrop for aggregate demand. But the other reason why I really like higher nominal wages, they precede capital deepening. So if companies want to offset a higher wage bill, then you've got to find efficiencies and to find efficiencies, you've got to invest. So we're seeing companies invest in IT and equipment. We are calling it 'the global COVID capex cycle.' And that's really a bright spot in the economy for next year's outlook as well. So we would expect that to continue.

Robert Rosener So, Ellen, we talked about a lot there. We've got elevated inflation now, some of which may be passing as supply chain disruptions ease. We have labor markets that, on the one hand, look tight, on the other hand, look like they have scope for further recovery. What does this mean for Fed policymakers and how do they put together the puzzle of what's going on in the economy when they're thinking about normalizing monetary policy?

Ellen Zentner Yeah, it's not an easy job, is it? But Chair Powell is going to continue that job, as we've learned, and it's not going to be an easy backdrop for him. The Fed is concerned about what looks like more persistent inflationary pressures than they had previously thought. So no doubt, you know, you and I can sit down and pick apart the data and easily point to areas of inflation that are clearly temporary. But we've just not seen evidence of it as early as expected. And markets are starting to pressure the Fed on really giving more weight to price stability. And so we have seen a shift from the Fed. Last week, we heard Chair Powell say that price stability is important and only price stability would then beget maximum employment. And so really putting a lot more pressure on the price stability side of things. So we think at this upcoming FOMC meeting next week that we're going to see quite a hawkish shift from the Fed, both in their message around how quickly they are reducing the pace of their purchases. We think that they'll end that early. And then we'll see their so-called dot plot show an indication that they're going to start rate hikes earlier than expected, probably two quarters earlier than expected. And so I think that's a really important shift. And what it means is that going forward, our forecast that inflation will eventually start slowing in the first quarter will be very important in determining when the Fed actually does start increasing rate hikes.

Ellen Zentner So that was a lot to unpack about the outlook. There's many more details, and we'll pick out interesting parts for folks as we go along. A new podcast to come. And Robert. Thanks for taking the time to talk.

Robert Rosener Great speaking with you, as always, Ellen.

Ellen Zentner 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.

Headed into next year, ‘Build Back Better’ legislation remains a work in progress, but Congress may find common ground in both parties’ concerns around one issue: tech regulation.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Thursday, December 9th at 10:00 a.m. in New York.

Congress continued to check things off its year end to do list this week, following up its funding deal to avoid a shutdown with an agreement to raise the debt ceiling. The Build Back Better plan, which features new spending on environmental and social issues backed by new taxes, remains a work in progress. So, this week we want to look ahead a little to an issue which could feature heavily in congressional debate next year: regulation of the tech industry.

Now, to be clear, we think the prospects for congressional action ahead of the midterms are quite low. But major legislation that drives sea changes in policy often is a multi-year process and you can learn a lot by paying attention to that process. Republicans spent a decade crafting the tax reform that would drive their actions in 2018. The same for Democrats with the years preceding the Affordable Care Act and the Dodd-Frank reforms of the banking industry. And this coming year could be a particularly educational one in terms of how DC wants to tackle the tech industry. That's because the industry could continue to be a popular issue for both Republicans and Democrats. Both parties share concerns about content moderation, data privacy and company size, though they differ on the approach to dealing with these issues. Crucially, they also share a political motivation, with a recent poll showing the tech industry's approval rating with the American public at 11%, one of the few institutions with a lower approval rating than Congress.

So what do we think we'll learn as Congress focuses on this issue? Policymakers are likely to update existing templates for regulating traditional broadcast media. That's because there are already institutions in place to do this, and it's easier for voters to understand the process.

A bear case for what this could look like comes from overseas. The United Kingdom's Online Safety Bill and the European Union's Digital Markets Act spell out some big and potentially costly regulatory challenges for social media companies. This includes requirements to allow users to easily move their data, disallowing product tie-ins and preferential product placement, and potentially, legal and financial liability for harmful content. If such measures were adopted in the US, our colleague and coauthor Brian Nowak estimates this could meaningfully crimp social media companies’ ad revenue, leading to underperformance of the sector.

But for now, we expect next year will reveal the U.S. is likely headed in a more moderate direction. Early legislative proposals tend to gravitate toward codifying data transparency, portability rights and content moderation. Here, our colleague Brian Nowak notes that internet companies have already begun investing heavily to develop internal infrastructure that deals with these types of regulations, potentially limiting the cost impact of new laws. That's a key reason he still sees value in this stock sector. But of course, that also means if we've read the policy direction in the US incorrectly, there's downside for the sector. So, we'll be watching carefully in 2022 to see if the U.S. continues to forge its own path or follows Europe in its approach to tech regulation.

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.

With early data in on the Omicron variant, biotechnology analyst Matthew Harrison takes us through where we stand on vaccine efficacy headed into the winter.

----- Transcript -----

Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research.

Matthew Harrison And I'm Matthew Harrison, Biotechnology Analyst.

Andrew Sheets And on this special edition of the podcast, we'll be talking about updates on the Omicron variant and vaccine efficacy. It's Wednesday, December 8th at 4:00 p.m. in London.

Matthew Harrison And it's 11:00 a.m. in New York.

Andrew Sheets So, Matt, it's great to talk to you again. We've had a lot of small pieces of data come out recently on the Omicron variant and its ability or not to evade vaccines. What's the latest and what do we know?

Matthew Harrison So, we've had three studies published so far. I would caution that the samples are small, and we have to take them as that, but we do have some interesting trends developing. So, the first one is: most of the data has demonstrated a substantial drop in what are called 'neutralizing titers' against two doses of the vaccine. And so that unfortunately means that protection against symptomatic infection for people that have had two doses of the vaccine is quite limited. We don't know exactly what, but it's definitely below or at 50%. What we've also learned is that a third dose can help restore some of that protection. We don't know the durability of that dose and we don't know how much protection it restores, but it does restore some protection. I think importantly, though, one of the things to remember is that most of the globe has only had two doses. And as we run through this potential spread of Omicron over the next few months, most of the globe will continue to only have two doses. So that data on two doses does suggest that there can be substantial reinfection risk for those that have had the vaccine.

Andrew Sheets So Matthew, you know, when we're thinking about these numbers and we think about vaccine efficacy, maybe dropping to 50%, what does that mean in terms of the risks versus current variants and then the risks if you're not vaccinated at all?

Matthew Harrison Right. So, I think there are two important things that I would say. So, the first is, what we're talking about here is symptomatic infection. Some of the other data that's come out has been on T cells. T cells are the second component of your immune system. They help kill virus once it's already infected in cells, and the T cell data looks like there remains substantial protection driven by T cells. And so, I think what that says is even though we're seeing substantial drops in protection against symptomatic infection, my hope continues to be based on these data and other data we've looked at, that protection against severe outcomes such as hospitalization and death could remain quite high.

Andrew Sheets So that seems quite important for both the public health outcomes. And then, as would follow the impact in the economy, is that it might be more likely that somebody with two shots of a vaccination regime would get some form of COVID, would show symptoms, but it might be still much less likely that they would end up in the hospital with severe cases, as the vaccines would still help the body protect against those more extreme outcomes.

Matthew Harrison That is my hope and based on the data that we're seeing so far, I would note, as we talked about at the beginning, that all of these studies that we're seeing come out right now are preliminary. You know, my hope is over the course of the next week or so, we're going to have a lot broader data set available to answer many of the questions we're talking about. And so, we're still going to have to, take our time with this because we don't have complete information yet.

Matthew Harrison So, Andrew, one of the questions I've been thinking about here is, and you touched on it in some of the questions you were asking me, is how does the market handle a substantial increase in the number of infections, but maybe a lower proportion of those infections ending up with severe disease than we've seen in previous waves?

Andrew Sheets Yeah, thanks Matthew. So look, I think this distinction between, you know, any case of COVID that shows symptoms and a case of COVID that results in somebody being hospitalized, you know, that is a pretty big distinction. And again, it's quite possible to see headlines and get quite worried about headlines that you know this variant evades vaccines and kind of to think that, "oh, then vaccines are powerless to stop it" when you know, I think as your research has rightly highlighted, if the vaccines can still provide a powerful mitigant against the most severe cases against hospitalizations, and you can still avoid some of the most severe public health outcomes that really would force much bigger restrictions. And those are the types of things that would really slow economic activity and really disrupt the economy, in addition to obviously having a really tragic impact on human life. So I think that distinction is important.

Andrew Sheets We obviously, as you mentioned, it's early and we need to watch it in terms of just more cases, you know, evolving again, I think we have to see how public health officials react to that. How do consumers react to it? Does it impact consumer behavior around the holidays? And you know, we do think U.S. economic activity and European economic activity are pretty strong at the moment, so they have some cushion. But obviously it needs to be monitored.

Andrew Sheets I think the other economy we need to watch is China, which is operating with a zero COVID policy. So, a quite restrictive policy trying to prevent any COVID cases. You know, if the indications are that we are dealing with now two more contagious variants: the Delta variant, and the Omicron variant, you know, there's a question of, does that complicate any sort of zero COVID strategy when you are dealing with a more contagious virus? And that's another big economic story that we have to keep our eye on.

Matthew Harrison Andrew, that's great. Thanks for taking the time to chat today.

Andrew Sheets Matt, always great to talk to you.

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

With investors expected to deal with an increase in volatility in 2022, our outlook for European equities remains strong into next year.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Graham Secker, Head of Morgan Stanley’s European and UK equity strategy team. Along with my colleagues, bringing you a variety of perspectives, I’ll be talking about the recent volatility in asset markets and how it impacts our 2022 outlook for European equities. It’s Tuesday, December the 7th at 4pm in London. 

In recent weeks we have been arguing that equity investors would likely face an increase in volatility over the coming year. However, we hadn't envisaged this manifesting itself quite so soon, or that markets would face a double challenge from a renewed covid-driven growth scare and a tighter US monetary policy shift weighing on sentiment at the same time. To make matters worse, calendar effects are magnifying these uncertainties, with investors wary of adding risk - or alternatively encouraged to de-risk further - as we approach year-end. 

In the very short-term market volatility may remain high, however absent a severe hit to growth from the new variant we think this will prove to be an attractive entry point over the medium term for two reasons. First, European equity valuations look increasingly appealing. We can find plenty of attractively valued stocks here in Europe with 28% of listed companies trading on a PE below 12. 

Second, some of our tactical indicators are now quite extreme, with the number of 'bears' in the AAII investor survey now up to its 90th percentile – an occurrence that has historically proved a very strong buy signal.

Post this drop in both equity valuations and investor sentiment we think that the worst of this equity correction is now behind us - absent a material profit disappointment that we just don’t see at this time. Such a scenario would likely require a more extensive and sustained hit to activity from the Omicron virus and/or a sharp deceleration in end demand that could signal that inflation is morphing into a more stagflationary environment. 

Neither do we see any growth implications from the apparent recent shift in Fed policy. Here we think the biggest implications for equity markets comes from a potential increase in real yields which traditionally occurs at the start of a new Fed tightening cycle. Such a move would fit with our bond strategists forecast for a significant rise in US real yields up to -30bps next year, an outcome that would likely cause substantial disruption within equity markets. Specifically, higher real yields should increase valuation sensitivity and push equity investors to skew portfolios away from some of the most popular and expensive stocks in the market and towards those offering better value. 

At the regional level such a shift should favor European stocks over US peers as valuations here have already normalized. Looking out over the next 12 months our index target for MSCI Europe suggests 13% price upside from here, which rises to over 16% when we add in the dividend yield too. Within the market we prefer the more value-oriented sectors given the prospect of higher bond yields, attractive valuations and greater scope for earnings upgrades given that current expectations look unduly low. In particular, we like Autos, Banks and Energy – all three have outperformed the market in 2021 and we see more upside next year too.

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

The past few weeks have seen weak valuations across equity markets. While many look to the Omicron variant as the main culprit, the correction may have more to do with the recent Fed pivot.

----- 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, bring you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, December 6th at 2:30 p.m. in New York. So let's get after it.

While there's evidence the past few weeks have been rough for equity investors, there's a lot of debate around why stocks have been so weak. To us, it seemed like too much attention had been put on the new COVID variant, Omicron, as the primary culprit. Our focus has been much more on the Fed's more aggressive pivot on tapering asset purchases. Last Tuesday, Fed Chair Jay Powell told Congress that it was time to retire the word 'transient' when talking about inflation. This was a significant change for a Fed that had been arguing inflation would likely settle back down next year as supply chains adjusted to the increased demand. As a result, the Fed is now likely to reduce its asset purchase program - known as quantitative easing, or QE - twice as fast as it had previously told us. In short, we now expect the Fed to be completely done with its QE program by the end of March. That is quite a speedy exit in our view and is likely to leave a mark on asset prices. Hence, the sharp correction in stocks last week, especially the most expensive ones.

Importantly, this move by the Fed is very much in line with our mid-cycle transition narrative that regular listeners should recognize. From an investment standpoint, the most important thing one needs to know about the mid-cycle transition is that valuations typically come down. In S&P 500 terms, it's typically 20%. So far, we've seen valuations come down by only 10%, making this normalization process only about halfway done, at least at the index level. The good news is many individual stocks have gone through a derating of much greater than 20% already. The bad news is that while some of the most expensive stocks have been hit the hardest, they still look expensive when normalizing for the period of over-earning these companies enjoyed in 2021. Sectors we think look particularly vulnerable include consumer discretionary and technology stocks. Sectors that look cheap are health care and financials.

Another consideration for investors is the fact that this White House appears to be more focused on getting inflation under control, rather than keeping the stock market propped up. This might give the Fed cover to stay the course on its plans to withdraw policy accommodation more aggressively. In other words, investors should not be so confident the Fed will reverse course quickly if stocks continue to wobble into year end.

Finally, the new variant can't be completely ignored and does pose a risk to demand. However, we always expected another big wave of COVID this winter as the cold weather set in. In fact, the recent spike in cases in the US are almost exclusively the Delta variant. In other words, we would be seeing this spike with or without Omicron's arrival. This is one of the reasons we've been expecting demand to disappoint in the first quarter and another thing that markets will have to deal with as we go into next year.

Bottom line, expect markets to remain volatile into year-end as investors are forced to chase and de-risk depending on the price action. In short, moves up and down will be accentuated by asset managers trying to keep up with their benchmarks. In such an environment, we recommend investors continue to keep their risk lower than normal with a focus on large cap quality stocks trading at a reasonable valuation. We expect that over the next three to four months, markets will give us a much fatter pitch to swing at as the Fed completes its exit from QE and growth bottoms.

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.

One of our most controversial calls for 2022, that the Fed won’t hike interest rates next year, faces renewed scrutiny amidst high inflation, signals on tapering, and today's employment report.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, December 3rd at 2:00 p.m. in London.

We recently published our year ahead outlook for 2022 and right there on the cover, near the top, is one of Morgan Stanley Research's most controversial calls: that the U.S. Federal Reserve will not raise interest rates next year.

Over the last week, more than one investor has pointed to this report and asked if it still applies. After all, inflation has been high, a situation that tends to call for higher interest rates to cool the economy. And Federal Reserve officials have been increasingly vocal about the merits of slowing their bond buying, accelerating the so-called tapering, even more quickly than they originally intended. Seeing the economy is strong and in less need of that additional support.

If the Fed is going to slow down and then stop its bond buying more quickly, the argument goes, surely higher interest rates must be right around the corner. But there's an interesting phenomenon here. When you talk to most investors, they view both higher interest rates and fewer bond purchases as pretty similar things. Both actions, at their core, signal less central bank support for the economy and for markets.

But maybe, just maybe, central banks view the world a little differently. For them, buying any bond, even fewer of them, still represents additional support for the economy. But in contrast, increasing interest rates... well, that's different. That's not additional support, that's actively tightening monetary policy.

At the end of the day, this question is up to the central bankers. But if they do see a genuine distinction between these two actions - a difference that isn't necessarily as apparent to many investors - a faster taper may be able to coexist with a later first interest rate hike. That, at least, is how we see it at Morgan Stanley Research where our forecast is for exactly that - the Fed to accelerate the pace of its taper but not raise interest rates next year.

But there's one more wrinkle in this story. While we think the Federal Reserve will ultimately wait longer than most people expect to raise interest rates next year, there's little reason for them to make that clear now. Inflation is still high and probably won't start to fall for several months. Economic data has been strong and today's employment report showed yet another decline in the unemployment rate. We see little reason why the Fed would want to commit not to take action right now, even if we think that's what they ultimately might do.

Why does that matter? It will mean that in the near term, the Federal Reserve will appear to be taking support away from the economy and for markets. After extraordinary intervention to support markets and the economy, the central bank training wheels are coming off, so to speak, and this impact may be uneven. We think this creates the greatest challenge for highly valued growth stocks in the U.S. and emerging market assets and suggests that investors be patient before trying to buy both.

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.

Chief Asia and Emerging Markets Strategist Jonathan Garner highlights the key debates around his team’s outlook on the region’s growth, policy changes and more in the coming year.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Jonathan Gardner, Chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the 2022 outlook for Asia equities and some of the key debates for next year. It's Thursday, December the 2nd at 7:30am in Hong Kong.

Since we published our year ahead outlook in mid-November, we've had the opportunity to debate the contents with clients in a number of formats, including presentations at our 20th Annual Asia Summit. So today I'd like to share that feedback and focus on some key debates.

Our first debate is, why aren't we more bullish on Asia equities given our economics team's constructive view on 2022 global growth? The answer is that mapping GDP growth forecasts into company earnings growth forecasts is problematic since headline revenue growth is only one driver of earnings per share growth. Margins and leverage are also crucial, and even then, the sector breakdown of earnings growth in listed equities does not always match that of the economy as a whole. That said, broadly speaking, we are more constructive on Japan earnings growth than Emerging Markets and Asia earnings growth, given stronger relative gearing to the US, Europe and developed markets GDP growth, and the broad sector mix of export earnings and global cyclicals in Japan.

We are anticipating earnings growth to continue next year and beyond consistent with continued global economic expansion. We expect 13% earnings per share growth from Tokyo's Stock Price Index “TOPIX" - in Yen - but only 8% for the MSCI Emerging Markets Index - in dollar terms. But it's fair to say that whilst we’re in line with bottom-up consensus for TOPIX, we're around 500 basis points below consensus for emerging markets. And in aggregate, this has a lot to do with the macro headwinds of our house forecast of dollar strength for Emerging Markets, but also specific sectoral headwinds which we anticipate in areas like China Internet and Asia Semis and Tech hardware in Korea and Taiwan. Another key factor to consider is clearly what's in the price, and we think emerging markets, which are trading around 13x consensus forward P/E - or around the 60th percentile of the 5-year range - still have some downside to valuations over the next year as a whole, whilst we are comfortable with Japan valuations.

Our second debate was, why we're not enthusiastic about buying back China equities. Here, we think risk/reward has not yet tilted definitively to the positive, particularly for offshore China growth stocks. We think earnings estimates still need to come down significantly further and similarly to Asia and emerging markets overall, valuations are not particularly cheap - at around 13x consensus forward price to earnings multiple for MSCI China.

For sure, China's monetary policy is gradually changing to be more accommodative, and some measures have been taken to re-stimulate property sector demand. However, the Chinese economy has developed downward momentum over the summer and autumn and still faces significant downside risk this winter as a result of prior policy tightening and factors such as COVID Zero lockdowns on the consumer and the impact of regulatory reset on private sector capital spending.

Our proprietary indicator of Global Multinational Corporations' sentiment, vis-a-vis their Chinese operations, has just reported its biggest ever quarterly decline and is now at the second lowest since we began our regular quarterly survey.

The third debate was, why are we constructive on emerging markets energy? Our answer is that the energy sector and energy sensitive markets are typically later cycle performers, and early next year will mark the second anniversary of the short but intense COVID-driven recession, which at one point marked the first time ever that oil prices went negative. We've come a long way since then in terms of demand recovery, but more is likely still to come if our commodities team is right that Brent can trade over $90 a barrel in 2022. This is the payback for underinvestment in conventional energy supply in recent years, mainly due to ESG concerns. So, it's an example of where our house view on strong global growth in 2022 and 2023 does lead directly to an investment conclusion for a particular sector. And MSCI EM Energy is trading at book value versus 1.9x price to book for the index, and with a free cash flow yield of almost 9%.

Before I close, there is a lot of discussion around the new COVID 19 variant, Omicron, and whether it changes our views. At present, we're in early days on this variant and as such, it doesn't change our already cautious view on the outlook for Asia equities.

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

The Omicron variant of COVID-19 has investors concerned about potential new restrictions, but the onus lies most on state and local governments who, for now, are awaiting more information on infection rates and severity.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, December 1st at 11:00 a.m. in New York.

Not surprisingly, our client conversations this week have been all about Omicron, the new COVID 19 variant that our biotech team thinks may increase infection rates and reduce vaccine effectiveness. In particular, clients want to know if the new variant will lead to fresh government restrictions and crimp the U.S. economic outlook. While the federal government gets much of the attention here, we think the key to sizing up this variable lies in understanding how state and local governments will behave. These are the jurisdictions that have generally driven mask mandates, indoor dining restrictions and other activities. And while there's much to learn about Omicron, here our initial assessment is that the bar is quite high for states and locals to take action, and that should limit downside risk to the economy.

What drives our view? In short, ever since states began lifting restrictions in late spring of 2020, their behavior has mostly been influenced by hospital capacity. Of course, some states lifted restrictions faster than others, but in most cases where restrictions were tightened, rising COVID hospitalizations and lack of bed capacity were cited as the culprits. With the availability of vaccinations in the U.S. and the high vaccination rate among vulnerable populations, risks to hospital capacity have lessened. That's because while COVID can infect the vaccinated, they are far less likely to get sick in a way that lands them in the hospital.

So that means, when it comes to sizing up if Omicron will lead to government restrictions on economic activity, it's less about whether vaccines will prevent infection, but if they can limit hospitalizations. While there's still not a lot of information, and thus outlooks could easily change as data on the new variant is collected, our biotech research team's base case is that Omicron is not more virulent than the currently dominant Delta variant. Further, the U.S. government continues to express the view that vaccines will provide protection against severe disease. Taken together, this would suggest that as long as the U.S. can sustain its vaccine campaign, including the current push for boosters, the economy may only face manageable headwinds. For fixed income investors, that means Treasury yields should still trend higher. And for credit investors, particularly in COVID sensitive municipal bond sectors like airports and hospitals, we see fundamental risks as manageable.

Yet investors should probably focus intently on what would change this view, as this ‘goldilocks outcome’ is mostly in the price of credit and equity markets already. And here again, we say focus on news about Omicron's severity, which is expected within the next few weeks. If data shows it to drive both more infection and more severe sickness, then hospital capacity could be challenged, leading state and local governments to reluctantly reimpose some restrictions. And of course, consumers could react to this signal and change their own behavior - thinking twice about that next flight, for example.

Yet perspective is important here, and even this negative outcome is more likely an economic setback than a disaster, as our biotech team notes that pharmaceutical companies may be able to turn around new boosters to address the challenge within a few months. That in turn means there's likely to be opportunities in credit and equity markets if this riskier case is the one that plays out. We'll, of course, be tracking it all here and checking in with you as we learn more.

Thanks for listening! If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

Last week’s news of the Omicron variant of COVID-19 has raised questions about transmissibility, vaccine efficacy, and virus mortality. Where does this variant leave us in the fight against COVID-19 and how are markets reacting?

----- Transcript -----

Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley Research.

Matthew Harrison And I'm Matthew Harrison, Biotechnology Analyst

Andrew Sheets And on this special edition of the podcast, we'll be talking about a new COVID variant and its impact on markets. It's Tuesday, November 30th at 2p.m. in London.

Matthew Harrison And it's 9:00 a.m. in New York.

Andrew Sheets So Matt, first things first, you know, we've seen a pretty major development over the American Thanksgiving holiday. We saw a new COVID variant, the omicron variant, kind of come into the market's attention. Can you talk just a little bit about why this variant has gotten so much focus and what do we know about it?

Matthew Harrison Sure. I think there are probably three major factors that have driven the focus. The first thing is there was clear scientific concern because of the number of mutations in the variant. And specifically, there are over 50 mutations, 32 of which are in the spike protein region, which is where vaccines are targeted. And then a number in the receptor binding domain, which is where the antibodies typically tend to bind. So the antibodies that either vaccines or antibody therapies create. And what we know when we look at many of these mutations is they're present in other variants: gamma, delta, alpha, beta and we know that many of these mutations in a pair one or two have led to reduction in vaccine effectiveness. And so, when they're combined all together, from a scientific standpoint, people were very concerned about having all of those mutations together and what that would mean in terms of vaccine escape.

Andrew Sheets So Matt, this is obviously a challenging situation because this is a new variant. It's just been discovered. And yet, you know, a lot of people are trying to figure out what the longer-term implications could be. So, you know, when you look at this with the kind of a limited amount of information, you know, what are the key characteristics that you're going to be watching that that you think we should care about?

Matthew Harrison There are probably three things that I'm focused on and we can probably touch on in detail. So the first one is transmissibility, and the reason for that is if this variant overtakes Delta and becomes dominant globally, then we're going to care about the two other factors a lot more, which is vaccine escape and lethality. However, if it's not more transmissible than Delta and Delta remains the dominant variant, then this may be an issue in small pockets, but ultimately will fade and continue to be overtaken by Delta. And so that's why transmissibility is the primary focus. And so what do we know about transmissibility right now? We have a couple of pieces of information out of South Africa. The first is they have sequenced a number of recent COVID patients. And in those sequences, the vast majority or almost all of them have been Omicron. So that suggests that it is overtaking Delta. But again, sometimes sequence results can be biased because they're not a population sample and they're a selection of a certain subset of people. The second piece of information, which to me is more compelling, is I'm sure everybody's aware of the PCR tests. There's a certain kind of deletion here in this variant that that that you can pick up with a PCR test and so you can see the frequency of that deletion. And that that frequency has risen from about a background rate of about 5% in the last week and a half to about 50% of the PCR tests coming back suggestive of this variant in South Africa. And so that's a much bigger sample size than the sequencing sample size. And so that suggests at least in the small subset that you're seeing greater transmissibility compared to Delta. Now it's going to take time to confirm that. And now that we've seen cases globally in a lot of countries over the next week or two, everybody's going to be watching how quickly the Omicron cases rise compared to Delta to confirm whether or not it's more transmissible than Delta.

Andrew Sheets This question of vaccine evasion. There's there has been some increased concern about this new variant that it might be able to evade vaccines. Why do people think that? And you know, how soon might we know?

Matthew Harrison Why don't we start with the timeline, because that's the simpler part. The experiments to figure that out take about two weeks. And just so everybody has the background on this, you need to take the virus, you need to grow it up. And once you have a sample of it, then you take blood from people that have recovered from COVID and blood from people that have been vaccinated that are full of those antibodies. And you put them in the in the dish and you find out how much virus you kill. And that'll tell you how effective the serum from vaccinated or previously infected individuals are against the new variant. So that process typically takes about two weeks. So then why are people worried about vaccine evasion with this variant? Primarily because of the known mutations that it carries and the unknown mutations. And of the known mutations that it carries, it carries the same set of mutations as in beta, and the beta variant had significant vaccine evasion properties that never became dominant, but it did reduce vaccine effectiveness by about six-fold. And so, I think the concern is with those mutations, plus a range of other mutations known to have vaccine evasion properties, having them all together has really significantly increased concern about how much that may hurt the vaccine's ability to stop infection.

Andrew Sheets And, Matt, so you talked about the importance of transmissibility, you know, you talked about some of the reasons why the concerns are higher around vaccine evasion with this variant. And the last thing you talked about was the lethality of this variant. And again, you know, what are you looking for there? Is there anything that concerns you with the information that we know and when might we know more?

Matthew Harrison So this is the hardest question because as is typical, you get a lot of anecdotal reports about what's happening with recently infected patients, but it takes a while, on order of four to five weeks, to really understand if there is a significant difference in mortality or hospitalization. So we have very little information around those factors. You have seen in the capital region, in South Africa, where you've where you've seen these rising cases, a rise in hospitalizations, but we don't know if all those cases are Omicron cases or not. And we haven't seen mortality at all. But again, with recent infections, it usually takes four or five weeks to start to see the potential impact of those infections on mortality.

Matthew Harrison And Andrew, I think one other thing which is important to mention is while we're while we're talking about severity of disease and lethality, we have to remember that in addition to vaccines, we do have now other effective treatments, including antibody therapies and oral therapies. And while some antibody therapies are likely not to work against Omicron, at least two or three of them are. And so you have you will have some effective antibody therapies. And then the oral therapies, given their mechanisms of action, should not be impacted. So we will have oral therapies in terms of treatment. So hopefully, even if we do get a scenario where there is significant impact on vaccine efficacy, this will not be like going back to the beginning of the pandemic, where we didn't have other effective treatments available.

Matthew Harrison Andrew, unlike normal episodes, maybe it'll be my chance since the markets have been so volatile. How has this impacted your outlook on the markets in the near to medium term?

Matthew Harrison I know inflation and the inflation debate and the impact of central banks on inflation has been a sort of key debate that I've heard you guys reflecting on.

Andrew Sheets Yeah. So I think probably the thing I should say up front is at the moment, we don't think we have enough evidence around this variant to change our baseline economic forecast to change that optimistic view on growth. Now what it might change is some of the timing around it, and I think we saw a little bit of this with the Delta variant. Where, you know, that was a big development in 2021, you know, people didn't see that coming. And you know, if you step back and think about this year, the market was still good, yield still rose, there was a lot of market movement, very consistent with better economic growth if you take the year as a whole, even though you had this variant, but the variant did introduce some kind of twists and turns along the way. So you know, that's currently the way that we're thinking about this new omicron variant that it is not likely or we don't know enough yet to be confident that it would really change that economic outlook, especially because we think there are a lot of good reasons why growth could be solid, but it might introduce some near-term uncertainty. You know, the interesting thing about, as you mentioned, inflation is that it could affect inflation in both directions. It could cause inflation to be higher, for example, if it, you know, causes shutdowns in countries that are important for producing key goods. And you can't get the things that you want, and the price goes up. But it could also drive prices down. You know, on last Friday oil prices fell by over 10%. You know, that is a big part of inflation certainly as most people experience it. Gas prices will be lower based on what happened on Friday. So that can drive inflation down so it can cut both ways.

Matthew Harrison Andrew, it's been great talking to you. Thanks for your thoughts.

Andrew Sheets Matt, always a pleasure to talk to you.

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

With last week’s news of the Omicron variant of COVID-19, markets sold-off sharply on Friday, but beyond the headlines, there may be other underlying factors at play.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 29th at 1:00 p.m. in New York. So let's get after it.

Last week, the big news for markets was this new COVID variant named Omicron. While we don't yet know the characteristics of this variant with respect to its transmission and mortality rates, some nations are already acting with new restrictions on travel and other activities. These new restrictions is what markets were fearing the most on Friday, in our view.

I'm also confident that markets were already expecting some seasonal increases in cases as we enter the winter months. This is why I'm not so sure Friday's sharp sell-off in equity markets was as much about Omicron as it was just a market looking for an excuse to go lower. In fact, equity markets had already been weak heading into Thanksgiving Day - a period that is almost always positive for stocks. This was before Omicron was a real concern, so why would that be the case?

As we laid out in our year-ahead outlook, the combination of tightening financial conditions and decelerating growth is usually not bullish for stocks. When combined with one of the highest valuations on record, this is why we have a very unexciting 12-month price target for the S&P 500. Finally, as discussed on this podcast for the past 6 weeks, stocks typically do well from September to year end if they are already up until that point. However, we felt like that seasonal trade would be tougher after Thanksgiving, as the Fed began to taper its asset purchases and institutional investors moved to lock in profits rather than worrying about missing out on further upside. With retail a large buyer during Friday's sharp sell-off, it appears that the institutional investors were the ones selling. In short, it looks like that switch to locking in profits may have begun.

Today's bounce back also makes sense in the context of a market that understands Omicron is probably not going to lead to a significant lockdown. In fact, we're already hearing reassuring words from the authorities making those decisions.

The bottom line is that markets were already choppy, with many higher beta indices and stocks trending lower before this latest COVID variant. Breadth has also been weak, with erratic leadership. High dispersion between stocks is another market signal that suggests the rising tide may be going out. Our view remains consistent - the investment environment is no longer rich with opportunity, which means one must be more selective. In a world of supply shortages, we favor companies with high visibility on earnings due to superior pricing power or cost management. We also think it makes sense to be very attendant to valuation and not overpay for open ended growth stories with questionable profitability. From a sector standpoint, Healthcare, REITs and Financials all fit these characteristics.

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

The Build Back Better Act took a key step towards becoming law last week, signaling implications for fiscal policy and taxation as the bill heads to the Senate.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 24th at 11:00 a.m. in New York.

Last week, the Build Back Better Act took a step toward becoming law when the House of Representatives passed the bill along party lines. While the act now still needs to win Senate approval, likely with some substantive changes, there are two lessons that we learned from the House's actions.

First, U.S. fiscal policy will continue to be expansionary in the near term. That's based on analysis from the Congressional Budget Office of the Build Back Better plan, adjusted for some key provisions that likely won't survive the Senate. When added to the analysis of the recently enacted Bipartisan Infrastructure Framework, it shows the combined plans could add around $200B to the deficit over 10 years - close to our base case of about $260B. But more importantly, the analysis suggests most of this deficit increase is front loaded, with around $800B of deficits in the first 5 years - toward the high end of the base case range we flagged earlier this year. This is the number we think matters to the economy and markets, as the durability of the policies that will reduce this deficit beyond 5 years is less certain, as elections can lead to future policy changes. And this number also helps drive some key views, namely our economists' call for above average GDP next year and our rates teams' view that bond yields will continue to move higher.

Our second lesson is that the corporate minimum tax looks like it has legs. The provision, also called the Book Profits Tax, survived the house process largely unscathed. While Senate modifications are to be expected, we expect the provision will be enacted. That means investors will have to get smart on the sectoral impacts of this new, somewhat complex, corporate tax. Our base case is that this won't be a game changer for markets. Our equity strategy team calculates a 4% hit to S&P 500 earnings before accounting for any economic growth. And while some sectors, like financials, appear most likely to have a higher tax bill, our banks analyst team expects most of this new expense can be offset by tax credits. Still, this new tax is tricky and untested, so fresh risks can emerge as the bill goes through edits in the Senate. So, we'll be tracking it carefully into year end.

Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

Our 500th episode! From all of us at Morgan Stanley, thanks to our listeners for all your support!

An overview of our expectations for the year ahead across inflation, policy, asset classes and more. As with 2021, we expect many twists and turns along the way.

----- Transcript -----

Welcome to the 500th episode of Thoughts on the Market. I'm Andrew Sheets, and from all of us here at Morgan Stanley, thank you for your support. Today, as always, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Tuesday, November 23rd at 2:00 p.m. in London.

At Morgan Stanley Research. We've just completed our outlook for 2022. This is a large, collaborative effort where all of the economists and strategists in Morgan Stanley Research get together and debate, discuss and forecast what we think holds for the year ahead. This is an inherently uncertain practice, and we expect a lot of twists and turns along the way, but what follows is a bit of what we think the next year might hold.

So let's start with the global economy. My colleague Seth Carpenter and our Global Economics team are pretty optimistic. We think growth is strong in the U.S., the Euro area and China next year, with all three of those regions exceeding consensus expectations. A strong consumer, a restocking of low inventories and a strong capital expenditure cycle are all part of this strong, sustainable growth. And because we think consumers saved a lot of the stimulus from 2021, we're not forecasting a big drop off in growth as that stimulus fails to appear again in 2022.

While growth remains strong, we think inflation will actually moderate. We forecast developed market inflation to peak in the coming months and then actually decline throughout next year as supply chains normalize and commodity price gains slow.

Even though inflation is moderating, monetary policy is going to start to shift. Ultimately, we think moderating inflation and some improvement in labor force participation means that the Fed thinks it can wait a little bit longer to raise interest rates and doesn't ultimately raise rates until the start of 2023.

For markets, shifting central bank policy means that the training wheels are coming off, so to speak. After 20 months of unprecedented support from both governments and central banks, this extraordinary aid is now winding down. Asset classes will need to rise and fall or, for lack of a better word, pedal under their own power.

In some places, this should be fine. From a strategy perspective, we continue to believe that this is a surprisingly normal cycle, albeit one that's moving hotter and faster given the scale of the drawdown during the recession and then the scale of a subsequent response. As part of our cross-asset strategy framework, we run a cycle indicator that tries to quantify where we are in that economic cycle. We think markets are facing many normal mid-cycle conditions, not unlike 2004/2005. Better growth colliding with higher inflation, shifting central bank policy and more expensive valuations.

Overall, we think that those valuations and this stage of the economic cycle supports stocks over corporate bonds or government bonds. We think the case for stocks is stronger in Europe and Japan than in emerging markets or the US, as these former markets enjoy more reasonable valuations, more limited central bank tightening and less risk from legislation or higher taxes. Those same issues drive a below consensus forecast here at Morgan Stanley for the S&P 500. We think that benchmark index will be at 4400 by the end of next year, lower than current levels. How do we get there? Well, we think earnings are actually pretty good, but that the market assigns a lower valuation multiple of those earnings - closer to 18x or around the average of the last 5 years as monetary policy normalizes.

For interest rates and foreign exchange, my colleagues really see a year of two parts. As I mentioned before, we think that the Fed will ultimately wait until 2023 to make its first rate hike, but it might not be in any rush to signal that action right away, especially because inflation remains relatively high. As such, we remain positive on the U.S. dollar and think that U.S. interest rates will rise into the start of the year - two factors that mean we think investors should be patient before buying emerging market assets, which tend to do worse when both the U.S. dollar and yields are rising. We forecast the U.S. 10-year Treasury yield to be at 2.1% by the end of 2022 and think the Canadian dollar will appreciate against most currencies as the Bank of Canada moves to raise interest rates.

That's a summary of just a few of the things that we think lie ahead in 2022. As with 2021, we're sure they're going to be many twists and turns along the way, and we hope you keep listening to Thoughts on the Market for updates on how we see these changes and how they impact our market views.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

With the release of our outlook for the coming year comes a cycle of feedback and debates from clients and investors. We look at those discussions around equity markets, valuations, and more in 2022.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 22nd at 11:30 a.m. in New York. So let's get after it.

Last week, we published our outlook for 2022 and spent a lot of time discussing it with investors. This week, we share feedback from those conversations where there is agreement and pushback. Our first observation is that there wasn't as much engagement as usual. Part of this may be due to the fact that our general view hasn't changed all that much, leaving us with an unexciting overall price target for the main U.S. indices. We also sense there's a bit of macro fatigue setting in, with many investors struggling to generate alpha in what appears to be a runaway bull market for the S&P 500 - the primary U.S. equity benchmark for most asset managers. This lines up with one of our key messages for the upcoming year - focus on the micro and pick stocks if you want to outperform. As the economic recovery matures, more companies are struggling with the imbalances created by the pandemic. To us, this generally means focus on earnings stability and superior execution skills as key factors when identifying winning stocks from here.

Going back to our conversations, there's a broad agreement with our more recent tactical view that U.S. equity markets are ahead of the fundamentals, but they can stay elevated in the near-term given incredibly strong flows from retail, systematic strategies and buybacks. Furthermore, pressure to keep up with the benchmarks is curtailing willingness to de-risk early. While there are signs of deterioration under the surface with many individual companies suffering from inflation pressures, supply bottlenecks and even demand destruction in some cases, the S&P 500 earnings forecasts are still moving higher, albeit at a slower pace. More specifically, we are witnessing weak breadth as the major averages make new highs.

Most clients feel that in the absence of an outright decline in earnings forecasts, seasonal strength can maintain the market's elevated levels and there's no reason to fight it. Having said that, while there is agreement valuations are currently rich, the primary push back to our outlook for next year is that we are too bearish on valuation. While many investors we speak with think 2022 will be more challenging than this year, most still expect US equity indices to deliver 5-10% returns over the next year, while we project flat to slightly down returns in our base case. The primary difference of opinion is on valuation, which appears vulnerable, in our view, to tightening financial conditions and a more uncertain range of outcomes in the economy and earnings over the next 6 months, and that should lead to higher risk premiums or lower valuations.

The other key debate with clients center on the strength of the US consumer. Recent macro data like retail sales, and micro data from strong consumer earnings in the third quarter, suggests that consumers remain ebullient into the holidays. This is very much in line with the survey that we published two weeks ago - the same survey that suggests this strength may not be sustainable into next year due to weakening personal financial conditions from higher inflation. Our analysis and comparison of the Conference Board and University of Michigan consumer confidence surveys appear to support a deterioration into next year - a key reason we are underway the consumer discretionary sector despite strength into the holidays.

Bottom line, U.S. equity markets have delivered another stellar year of returns, which is typical in the second year of an economic recovery. However, given the speed of this recovery and record returns over the prior 18 months, we thought it was prudent to reduce our equity exposure back in early September. While our timing on that risk reduction was wrong, higher prices, driven mostly by higher valuations, only make the risk/reward for 2022 worse, not better. In short, stick with larger cap, higher quality stocks at reasonable valuations.

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

Andrew Sheets continues his discussion with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022, what’s misunderstood and where it could be wrong.

----- Transcript -----

Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.

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

Andrew Sheets And on part two of the special episode of Thoughts on the Market, Seth and I will be continuing our discussion on the 2022 outlook for the global economy and how that outlook could impact markets in the coming year. It's Friday, November 19th at 5:00 p.m. in London.

Seth Carpenter And if it's five pm in London, it's noon in New York.

Andrew Sheets Seth, you speak to a wide variety of clients, and this topic of the supply chain, you know, keeps coming up in a variety of formats. It comes up in our financial discussions. It comes up in the popular press. Is there a part of this story that you think is poorly understood or maybe misunderstood, you know, amidst all this focus of supply chain stress?

Seth Carpenter I think I'd point to two key areas where maybe there could be a little bit more attention focused. The first one, and I was sort of talking in these terms before, is the difference between the price level and inflation. Now, if I am at the store and I'm looking at milk on the shelf, all I care about is the price level itself: is milk more expensive than it was before? Is the price high? When the central bank, when investors look at prices, they're actually measuring inflation, the rate of growth of those prices. And I think that key distinction is one of the big parts here. If supply chains stop getting worse, then it seems like in general, at some point the price level should stop going up. It'd still be a high price and it'd still be unpleasant for consumers. But the inflation on that would end up being zero. And I think that difference between growth rates and price levels is one thing that probably deserves a little bit more scrutiny.

Seth Carpenter And I think the second part is-- I'm going to use an economics type term here-- how non-linear some of these effects are. And so what do I mean there? If you think about the auto industry, which has been in the news a lot for having a shortage of microchips, for example. But suppose you had a car that had 95% of the parts already assembled, 5% were missing. That's not a car. That's spare parts. Suppose you had a hundred cars that were 95% done. In a linear version of the world, 95% of one hundred is 95 cars. But you still really just have a pile of spare parts at that point. And so it's not as though you get proportional reduction in output. You can get all of the output disrupted for one of just a few parts. I'm curious to see how it resolves on the other side. Does it turn out then that all of a sudden, we're faced with a glut of extra products because those few missing parts are now delivered and so all of a sudden that final assembly can get done and we have a lot. I don't know what the answer is. We've assumed that it's much smoother than that when things unwind, but there really is a lot of uncertainty here.

Andrew Sheets So, Seth, the last 18 months have been really hard. But you know, you could maybe argue that for the Fed, its decisions have been somewhat easy. And we've seen the Fed and other central banks take extraordinary action. But, you know, now the Fed, the European Central Bank, you know, a lot of these central banks are now coming under a lot more pressure on the one side to say, you know, inflation's now picking up, you're making a mistake to, you know, the economy still not normal. It still needs a lot of support. How do you see those debates playing out? And how do you think some of that ultimately resolves itself next year?

Seth Carpenter I mean, debate is exactly the right word, and I love to note to clients that my job used to be to argue over what should happen with policy but now my job is just to think about what's likely to happen. And there I turn to the policymakers themselves, and so when I think about Chair Powell, I think about the fact that they announced a tapering of their asset purchases, and he said he expects that to run through the middle of next year. He also said that he expects inflation to come down, but he doesn't expect it to materially come down until Q2 or Q3 of next year. In that context, that to me says he's probably waiting for a while to see how the data resolve themselves.

Seth Carpenter What I've also heard Chair Powell say is that their conditions for raising short term interest rates is both having inflation doing what they want it to do, but also full employment. And he's tried to give a few different measures of full employment means to them. It's not just the measured unemployment rate, but it's also people getting jobs. It's also people who have left the labor market coming back into the labor market. And so in the forecast that the US economics team has, inflation is coming down over the course of 2022, labor supply measured by the labor force participation rate in their forecast is going up. And so when the US economics team puts those two together and thinks about how Chair Powell has characterized the Fed's decision making process, they come to the conclusion that it seems natural to think that he's going to want them to wait at least through the end of 2022 and right at the beginning of 2023 before starting to raise short term interest rates. Now you're our cross asset strategist and so you know for a fact that markets have been pricing lots of other things.

Andrew Sheets And Seth, it's fair to say that's probably one of our more controversial assumptions for next year, this idea that the Federal Reserve doesn't end up raising interest rates in 2022, even though that is, as you mentioned, what the market's currently expecting.

Seth Carpenter Correct. It's definitely a place where we are out of consensus. And I think as we got the recent consumer price index report that showed still quite high inflation. And as markets start to look for, you know, the next couple of months where there's inflation prints go, I think the market is expecting inflation to stay high for sufficiently long that Chair Powell and the Fed change their minds. And that clearly could happen.

Andrew Sheets Seth, the thing I wanted to close with was, you know, a real central part of our research process at Morgan Stanley-- and this is true in strategy and economics down to our stock analysts-- is to not just try to think about a likely base case, but also think about a bull and a bear case around it. Kind of realistic, good and bad scenarios that could happen over the next 12 months. So let's get the bad news out of the way. If you think about a realistic bad case for the global economy next year, what does it look like and what gets us there?

Seth Carpenter Wow. So this is where I have to admit, being my first time in this outlook process, I may have tipped the apple cart over just a little bit because I threw the team a curveball and I said there are actually two key ways that I could be disappointed in the global economy. And the first one is a worse outcome for the supply side. That is our assumption that supply chains get better over time. That might not happen, right? That might stay bad for longer, we might have more frictions in the labor market than we expect. In that version of the world, we likely get both weaker economic growth than we think and higher inflation than we forecast because the supply disruptions would feed into sustained inflationary pressures that keep those price prices rising and rising and rising over time as supply chains get worse. And at the same time, we could easily see, under those circumstances, central banks globally shifting towards tighter monetary policy. If we get much higher inflationary outcomes than we currently forecast we're just going to see more tightening. And so you get that double whammy of less production, less economic activity because supply disruptions and also tighter financial conditions. And so that's an outcome that we can't rule out. And that's troubling.

Seth Carpenter On the other hand, we could be wrong about the lack of a fiscal drag in the United States. We could be wrong about how much fiscal support there is going to be in Europe, for example. We could be wrong about how the Chinese economy recovers from the recent slowdown. And so we could have a demand side bear case, a demand side worse outcome. In that case, though, the world looks a little bit more normal the way, you know, markets and economists would have thought about these things pre-pandemic, i.e. slower growth, lower inflation. In that version of the world though central banks tend to sit back, I think, and wait to see how things turn out. But that, I think, is a really good illustration of just how much uncertainty there is right now. There's a version of the world where we have worse growth and higher inflation. There's a version of the world where we have worse growth and lower inflation. And I have to admit I spent some time wringing my hands, worrying about each of them.

Andrew Sheets And finally, Seth, to end on a high note, what's the most realistic, positive case for the global economy next year and how could we get there?

Seth Carpenter Andrew, you know, I'm an economist, which means that I'm uncomfortable being cheerful, but I'll give it a shot. So those global supply disruptions, the sort of inability of consumer goods to sort of flow to market as fast as people want to buy them, the restrictions on commodity production that have led to the really high prices. I have to believe there's a version of the world where that all gets resolved much more quickly. Right? Where all of those partially produced goods that only need one or two extra spare parts, that ship arrives, those spare parts come in, and then all of a sudden, we've got a glut of supply instead of a shortage of supply. I think in that version of the world, we have a really virtuous cycle. A couple of things happen. One, inflation starts to come down much more quickly because there's much more availability of all those goods that people are looking to buy. Second, there's a lot more availability of all those goods that people are willing to buy. And so as a result, you can have that economic activity picking up. I think at the same time, in the same spirit of a better supply outlook, the labor supply could fix itself more quickly. In which case wage pressures start to ease a little bit, people feel more comfortable coming back to the labor market. Maybe that's because of the increasing vaccinations, especially among children. Maybe it's because we get past the winter and we have a milder winter when it comes to the to the pandemic. All of those sort of supply things, both physical goods and greater supply and more labor supply-- if those happened together than we should have faster growth. But as it turns out, a bit less in the way of inflationary pressures. And so that really would be sort of a fantastic outcome.

Andrew Sheets We'll have to stay tuned. Seth, thanks for taking the time to talk.

Seth Carpenter I have to say, Andrew, it's always my pleasure to get to talk to you.

Andrew Sheets Thanks for listening. If you enjoy thoughts on the market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.

Andrew Sheets speaks with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022 and how consumer spending, labor, and inflation contribute to that story.

----- Transcript -----

Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.

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

Andrew Sheets And on part one of this special episode of Thoughts on the market, we'll be discussing the 2022 outlook for the global economy and how that outlook could impact markets in the coming year. It's Thursday, November 18th at 5:00 p.m. in London.

Seth Carpenter And that makes it noon in New York City.

Andrew Sheets So, Seth, welcome to Thoughts on the Market. You are Morgan Stanley's new chief global economist and, while we've just sat down to work on our year ahead outlook and we're going to discuss that, I was hoping you could just give listeners a little background around yourself and what brings you to this role?

Seth Carpenter Thanks, Andrew. This has been a great experience for me working on the outlook as my introduction to Morgan Stanley. I guess I've been here just a few months now. Before coming to Morgan Stanley, I was at another big sell-side bank for a few years, spent a little time on the buy-side. But most of my career, I have to say, I spent in Washington DC. I spent 15 years of my career at the Federal Reserve working on all sorts of aspects about monetary policy. And then I spent two and a half years at the U.S. Treasury Department. So, I'm really, really a product of Washington more than I am Wall Street.

Andrew Sheets Well, that's great. And so well, let's get right into it because, you know, this is a big collaborative process that you and I and a lot of our colleagues work on. And so let's start with that global economic picture. You know, as you step back and you think about our expectations, how good is the global economy going to be next year?

Seth Carpenter Yeah, I have to say our economics team around the world is actually fairly optimistic-- call it bullish-- relative to consensus. When I think about the global economy, clearly the two biggest economies are the U.S. and China. And so starting with the U.S., Ellen Zentner, our chief U.S. economist, has an outlook that the U.S. economy is going to slow down next year, but boy, still be going kind of fast. Right around four and a half percent, which is, you know, slower than the growth rate that we're getting this year, but still a really, really solid growth for the for the year as a whole. And I think in that there's a lot of things going on. We're still getting lots of job gains and the more job gains we have, the more consumer spending we get. And of course, consumer spending, that's 70% of US GDP. I think as well, we're looking forward to there being a big restocking of inventories. I think everyone has heard about the global supply chain issue and inventories in the United States in particular are very, very lean. And so we're looking for a bit of an extra boost to the economy coming from that inventory restocking. So it's a pretty optimistic case; slower than this year, to be sure, but still a pretty optimistic outlook.

Andrew Sheets And Seth, what about that other big driver of the global economy, China? How do you think its economy looks next year?

Seth Carpenter Robin Xing is our chief China economist, and he is also similarly a bit optimistic relative to consensus. Deceleration, to be sure, from where we were before COVID. But five and a half percent growth is still going to put our forecast, you know, higher than most other people making these sorts of forecasts. And there, when I talked to Robin, what he tells me is, you know, there was a slowdown in the Chinese economy this year in Q3, but a lot of that was policy induced as the policymakers in Beijing are trying to take another step in reorienting the Chinese economy. And because the slowdown was policy induced, we're going to get a recovery that's also policy induced. And so, he's actually pretty constructive about how growth for next year is going to turn out.

Andrew Sheets So Seth, one question about the economy next year is, well, in 2021, we had all of this fiscal support, all this government support for growth and that's not going to be there in the same way. And you hear a lot about this concept of the fiscal cliff of the government support that was there falling away and even reversing and being a drag on growth. How do you square that with what seemed like pretty optimistic economic projections from our side?

Seth Carpenter So here's how the US team would talk about it. When we think about what drove the fiscal policy this year, what drove the high deficit this year, a lot of it was income replacement. Many people had lost their jobs, many people were out of work and government transfers were replacing a fair amount of that income. And so as we move into next year, we're already seeing many of those jobs coming back, to be sure, not all of them yet. But in the forecast, jobs keep coming back and with it, labor income. And so what the government support had been doing, in part, was providing income to allow spending to go on in 2021. Next year in the forecast, it's labor income that allows the same type of spending to go on. And so as a result, there's no discrete step down that's coming from that removal of fiscal policy. And moreover, I think one thing that avid readers of economic data will know is that the saving rate i.e. how much of current income is being spent versus being saved. The saving rate is actually quite elevated. And part of that is this government transfer of income, not all of it being spent in the current period. Well, the US team says we're going to take some of that excess savings and assume that a portion of it actually gets spent in 2022. So that's another factor that's going to reduce the likelihood of us having a fiscal drag the way other forecasters probably have in their numbers.

Andrew Sheets Seth, another concern that comes up a lot in these conversations is around the i-word: inflation. You know, you and I and some of our colleagues just did a large webcast for many of our investment clients. And I think without exaggeration, maybe 80% of the questions were in in some way related to inflationary risks and the inflationary backdrop. So, you know, we think growth is going to be good next year-- it might be better than expected-- but what does that imply for the inflation outlook and, how big of a risk is it that inflation is eating away at the spending power of the consumer and other parts of the economy?

Seth Carpenter No question that inflation is sort of the key question in macro these days and into next year. And I think there is a real risk that high prices end up eating into purchasing power. It's clear that people who are on fixed income, people who are at the lower end of the income distribution, when the price of gasoline is going up, when the price is food is going up, that's very, very real for those people and it can affect how much extra discretionary spending they have. So I think that that clearly matters a lot. And I think one of the challenges between being an economist, thinking in terms of the technical data side of things, versus communicating to a broader audience is that inflation is about the rate of change of those prices, as opposed to what regular people see every day, which is the level of those prices. So in our-- in the forecast the US team has there are a lot of those prices that actually stay high, but the rate at which they go up in the forecast actually peaks at the beginning of 2022 and then starts to come down. It starts to come down for a few reasons. First: oil. If we look at the futures curve, looks as if oil prices should probably peak around December and then gradually come down over the course of next year. I think in addition to that, everyone has been talking about the global supply chain sort of bottlenecks in terms of consumer goods getting to consumers being a real challenge now takes time. It's proven to be quite durable so far. The maintained assumption that the economics team around the world had was the following: that those supply chain frictions-- be it the Port of Los Angeles and shipping containers, be it semiconductor production in East Asia, the whole kit and caboodle-- goes back to something that looks like normal at the end of 2022. But what that means in the forecast is things are about at their worst now, start to get better at the beginning of the year, and then take the whole year to get better. But if that's the case, then the easier access to the consumer goods should mean that prices on those consumer goods that have been going up so dramatically should probably stop going up sometime around the beginning of the year. And in fact, maybe start to go back towards more normal levels over time. So that's what's in the forecast.

Andrew Sheets Seth, another thing I was hoping to ask you about as it relates to inflation is, you know, how much of this with your global hat on is a global phenomenon versus, you know, some more specific, idiosyncratic things related to the U.S. economy. You know, when you when you look across some different regions, some other major markets, are they having similar inflationary dynamics? Is it different? And importantly, could we see more divergence in the inflation picture going forward into next year?

Seth Carpenter Oh, absolutely. So, looking across different countries, there's unquestionably a global component to this inflationary surge. I think what can differ, though, is how that inflationary impulse is transmitted to to different economies over time. So, you know, we've talked through our views on what happens in the United States. And in countries where you tend to have more of a history of high and variable inflation, it's easier for those sort of pricing pressures to spread to other components. Add to that in countries where if it's a small, open economy with a floating exchange rate, you can easily imagine that country's currency could decline a bit in value, which means all of their imported goods are more expensive as well, which then leads to more inflation. So clearly a common shock. The net effect across economies, though, can be quite different. I'd say one component that's a bit different in the United States than others is the structure of our of our labor market. In a lot of European countries, there was a mechanism put in place, a policy put in place to essentially try to freeze people in place attached to their employer; in the U.K. they call it 'the furlough scheme.' In the United States there was no similar specific plan that was covering the entire country. That friction in the labor market is quite difficult to overcome. And we're seeing some of that show through by, in some cases, businesses needing to pay more to attract new workers. And so, like I said, a clear common global shock, but the transmission varies by country.

Andrew Sheets Thanks for listening. We'll be back in your feed soon for part two of my conversation with Seth Carpenter on the outlook for the global economy in 2022.

Andrew Sheets And as a reminder, if you enjoy thoughts on the market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.

This week’s meeting between President Biden and President Xi was not a return to an earlier phase of relations between their two countries. Instead, it suggested the normalization of a sort of ‘competitive confrontation’ that investors and markets may have mixed feelings about.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 17th at 11:00 a.m. in New York.

Earlier this week, U.S. President Biden and China President Xi met virtually to discuss the relationship between their two countries. A broad array of security and economic issues were discussed, and the readouts from both countries following the meeting were generally respectful. In many ways, this was a marked contrast from the rancor between the two parties for the last few years. Yet investors expressed to us disappointment with the outcome. They were looking for tariff rollbacks and other signs of a reversion to the US/China relationship that preceded the Trump administration. To those investors, our message is that there's a new normal to embrace for the US and China. And it's neither wholly positive, or negative, for markets and the economy.

In short, investors should get comfortable with the US/China relationship as one of intense competition, rather than the laissez faire economic competition that the U.S. engages in with its allies. In fact, we call the US/China dynamic a 'competitive confrontation'. That means both sides are urgently trying to enact policies that preserve their economic and national security ambitions, without creating chaos through wholesale de-linking of their intertwined economies or direct military confrontation. In short, it's complicated. But the motivation is high to follow this path. In the U.S., for example, there's still a bipartisan consensus that the U.S. should be pursuing tougher China policies, and that impulse likely only gets stronger in 2022 - a midterm election year.

So if you know this dynamic, it becomes easier to understand why the U.S. hasn't moved to reduce tariffs on China, even if that could ease inflation pressures. Even if the Biden administration would prefer those tariffs didn't exist, they may view reducing them now as short sighted, particularly when they need more time to develop more precise non-tariff tools, and since China continues to fall short on its commitments under the phase 1 trade deal. So those looking to the US/China dynamic to ease inflation pressures and perhaps reduce bond yields, we think will continue to be disappointed. As will those looking for an easing of export restrictions and other non-tariff barriers that have crimped key equity sectors, like semiconductors.

But it's not all challenges here. Over time, we think the U.S. and China can get to a dynamic we call ‘constructive competition.’ Both sides will have developed rules of engagement they think preserve their security goals, minimizing trade disruptions and allowing the reduction of blunt force tools like tariffs. At this point, of course, inflation may have already eased, but the impact could be a clearer pathway for international expansion for equity sectors which are increasingly using sensitive technologies, like automobiles. We'll be tracking the transition here and report to you as opportunities emerge.

Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

The housing market has seen record home price growth this year. But who does this boom benefit and who gets left behind?

----- Transcript -----

Jim Egan Welcome to Thoughts on the Market. I'm James Egan, co-head of U.S. Securitized Products Research from Morgan Stanley,

Sarah Wolfe and I'm Sarah Wolfe from the US economics team, focused on the U.S. consumer.

Jim Egan And on this edition of the podcast, we'll be talking about the impact of the housing boom on America's low-income households. It's Tuesday, November 16th, 10:00 a.m. in New York.

Jim Egan Regular listeners of the podcast have probably heard me talking with my colleague Jay Bacow about the record level of home price growth that we've seen this year. And we've talked about it from a number of different angles: how high can home price appreciation actually climb? How sustainable is this current level of growth? What's the aftermath going to be? But today, Sarah, you and I are going to be approaching this from a slightly different angle, and we're going to talk about the impact of rising home values on low-income households. So, what were some of the big questions behind your recent research, Sarah?

Sarah Wolfe So there's been a lot of discussion this year, as you mentioned, around rising home prices, rising rents and the extremely healthy housing environment. So, we wanted to look at what this meant for households all across the income distribution and, in particular, what it meant for low-income households. There's been a lot of focus on how low-income households are going to fare as we move off of fiscal stimulus - I'm talking about the unemployment insurance benefits, the economic impact payments - and so we wanted to explore real estate wealth as a potential source of equity for this group in order to make the transition away from government stimulus into a more recovery part of the economy easier or not. And so that's really the focus of this report.

Jim Egan All right. Now you've spent a lot of time talking about the low-income consumer. We've got the kind of excess savings narrative across the consumer in aggregate. I know that that is appearing in the low-income consumer a little bit, but maybe not as much as further up the spectrum. Can you dig into that for us a little bit? How is the low-income consumer performing right now?

Sarah Wolfe So overall, the low-income consumer over the last year and a half has performed very well, and that's because we've seen an unprecedent amount of fiscal stimulus. We've also seen strong job growth among low-income industries, including retail trade, leisure and hospitality. These are where the jobs are coming back. And we're also seeing pretty strong wage growth for low-income workers. And then at the same time, there was a pretty significant pullback in spending like dining out and other services. So together we got this buildup of excess savings and, low-income households had savings as well, and there was excess savings held all across the income distribution. While this is really significant, it's important to know that the dollar amount of excess savings held among lower income households is not that significant. And they also have a higher marginal propensity to consume out of their savings. So, while the savings is there, it likely will not last long. And so, it's not going to be a longer-term source of wealth, and that's why we decided to turn our attention to real estate wealth. Will this be a potential long-term source of wealth and significant for this group of consumers?

Jim Egan OK. So, when you looked into housing wealth and particularly for low-income consumers, what did you find?

Sarah Wolfe Well, low-income homeowners have actually seen their real estate wealth increased by roughly $18,000 per household. That's from the end of 2019 through mid-2021. Now, in dollar terms, that's less than the rise in real estate for higher income groups. But in percentage change, it's a 19% increase in real estate wealth among low-income homeowners. And that's the largest percentage increase across the entire income distribution when it comes to real estate wealth.

Sarah Wolfe So, there's clearly been a substantial amount of real estate wealth for homeowners, but it leads me to ask the question, can they actually access that wealth?

Jim Egan That is probably the question we get asked most frequently. The record rise we've seen in home prices has brought equity in the U.S. housing market to levels we haven't seen. We have data going back over 26 years. We've never had more equity in the housing market than we do right now. Part of that's because this rise in home prices just was not accompanied by the rise in mortgage debt that we saw in the early 2000s, the last time home price growth was really anywhere close to where it is right now. So, the question we get from investors pretty frequently is, well are borrowers going to access this? How can borrowers access this? Are we going to see that same sort of mortgage equity withdrawal, that sort of cash out activity that we saw during the last cycle. And look, the high-level answer is it's difficult to say, given the lack of comprehensive data that we see there. Now, we do have some form of data from the GSEs, we have it from Ginnie Mae, that can show us how cash out activity is evolving, and we are seeing cash out activity really pick up in 2021. It wasn't the case in 2020. Falling rates in 2020 meant that a larger percentage of refinancings were more just straight rate-and-term refinances. They didn't have a cash out component. But we are starting to see cash out refinance activity pick up in 2021 from where it was in 2020.

Sarah Wolfe And how does mortgage credit availability play into all of this?

Jim Egan We do think that's playing a pretty big role. Now we've talked about how mortgage credit availability is running at pretty tight levels. We actually undid six years’ worth of easing lending standards in the six months following COVID, but we have started to see lending standards plateau and they've started to ease from here. Now, how of those tight lending standards manifested themselves in terms of cash out activity? We're actually seeing the dollar amount that is being cashed out, it's lower today than it was in 2019 in terms of absolute dollar amount. If we talk about the amount of equity, the rising home prices we've seen, that means as a percentage of the property value, in 2019, we were seeing cash out refi’s remove roughly about 18% of value from the house. That's down to just 13% today. So people are able to access that equity, but tighter credit standards might be contributing to that dollar amount being lower. And it certainly means that the borrowers who are more likely to be able to access that are probably borrowers that are further up the credit quality spectrum, higher credit scores, for instance, perhaps higher income levels as well. So we do think that tight credit availability plays a role. But Sarah, turning this back to you.

Jim Egan Once we get past the borrower's ability to actually remove cash from their home or the borrower's ability to tap that equity in their home. What are you seeing households use that money for?

Sarah Wolfe Well, a bulk of the equity goes back into the home in the form of home improvement and repairs. There is a smaller amount that goes towards non-housing expenditures like education and apparel. Also, some of it goes towards paying down debt. But the large majority is back into the house in terms of home repairs and improvements.

Jim Egan OK, I want to switch gears from homeowners to renters. Rents have been racing higher in recent months. That doesn't seem great for low-income consumers who don't own their homes. But what are you seeing there?

Sarah Wolfe That's true. Home price appreciation is great for those who own a home, but only half of the bottom 20% are homeowners. This compares to 80% homeownership among the top 20%. And so while we've seen a rise in home price appreciation, it's coincided with escalating rents for non-homeowners. To put some numbers around it, CPI inflation-- this is consumer price index-- showed that rents rose 0.4% in October and 0.5% in September. And while that might not seem like a big number, that's the largest two month increase in rent inflation since 1992. We also find that low-income renters spend 63% of their income paying rent nationally, which is quite elevated. And we're forecasting that rent prices are just going to keep going up and up in the coming years, making it harder for Low-Income non-homeowners to afford having a home and leaving them at the mercy of rising rents.

Jim Egan Now we've done a lot of work on inequal access to homeownership among minorities. How does this factor into the rising burden of rent?

Sarah Wolfe Well, on top of the income disparity in homeownership, the racial disparity adds another dimension to the divide between low-income homeowners and renters. Our ESG strategies find that on average, the gap in homeownership between White and Black and Hispanic households is widest for low to moderate income families. This really limits the benefits of home price appreciation for minorities and further exacerbates racial inequalities.

Jim Egan All right, so the record level of home price growth, which has led to a record level of equity in U.S. households, does appear to have increased wealth across the income spectrum. But when we look a little bit closer, that's not necessarily the case for lower income households the same way it is for higher income households. And, across the board, the ability of these different households to tap that equity is still a question.

Sarah Wolfe That's correct. But I think that it's important to keep in mind that the picture is not all bad. The low-income household is still healthy, and we have the substantial amount of labor market income coming from lower wage jobs like retail trade, leisure and hospitality, transportation, combined with strong wage growth, all helping and supporting income growth longer term for this group.

Jim Egan Sarah, always great speaking with you.

Sarah Wolfe Great talking with you, Jim.

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

Coming out of a year marked by greater uncertainty and volatility, 2022 is poised to be a year which favors single stock investing over a focus on style and sector.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 15th at 11:30 a.m. in New York. So let's get after it.

2021 has been another very good year for U.S. equity indices. What's been different in 2021 is the higher volatility under the surface with greater dispersion of returns between individual stocks. This fits very nicely with our overall mid-cycle transition narrative, with one major exception - valuations. Typically, by this stage of an economic recovery from recession equity valuations would have normalized, particularly with the earnings recovery being even more dramatic than usual. In short, while our sector and style preferences in stock picking was strong in 2021, our S&P 500 price target proved to be too low - in other words, wrong. We think this is more about timing rather than an outright rejection of our fundamental framework or narrative. With financial conditions now tightening and earnings growth slowing, the 12-month risk/reward for the broad indices looks unattractive at current prices. More specifically, we expect solid earnings growth again in 2022 offset by lower valuations. However, strong nominal GDP growth should continue to provide plenty of good investment opportunities at the stock level.

In our view, the economic and political environment has been permanently altered from its pre-COVID days, although the changes are not necessarily due to the pandemic itself. What that means from an investment standpoint is higher nominal GDP growth led by higher inflation, which is the only way out from our over indebtedness in the longer term. Such an outcome should lead to greater investment and higher productivity, but it will take years for that to play out. In the meantime, we will have to deal with the excesses created by the extreme nature of this recession and recovery. That breeds higher uncertainty and dispersion, making stock picking more important than ever in the year ahead.

While our primary theme for 2022 is to focus more on stocks than sectors and styles, one can't ignore them either. We go into the year-end favoring earnings stability and stocks with undemanding valuations, given our view for a tougher operating environment and higher long term interest rates. This puts us overweight Healthcare, Real Estate, Financials and reasonably priced Software stocks. We are also more constructive on Consumer and Business Services. With our expectation for payback in demand from this year's overconsumption, we are underweight Consumer Discretionary Goods, Tech Hardware and commodity-oriented Semiconductors that are prone to double ordering and cancelations.

Small cap stocks have done better recently on the back of newly proposed tax legislation that is much less onerous to smaller domestic companies. However, that is simply the removal of a negative rather than an additional positive for earnings and cash flow. It does nothing to ease the burden of what may be one of the most difficult operating environments for small businesses in decades. In short, we favor large caps over small, especially after the nice seasonal run in a smaller cohort. Finally, the obsession over value versus growth should fade as there is no clear winner, in our view, over the next year, but rather trading opportunities like during 2021. Value and growth have each had periods during which they have done considerably better than the other over the past year. But year-to-date they are neck and neck. We do have a slight bias for value over growth for the rest of the year as interest rates move higher, but this is more of a trading position rather than an aggressive investment view we had coming out of the recession in 2020. Expect our bias to flip flop in 2022 like this year, as macro uncertainty reigns.

Although strategy is a macro endeavor, with stock dispersion remaining high due to uncertainty around inflation, supply chains and policy, we will focus even more on specific relative value ideas, rather than the index, over the next year. We wish you all good fortune in 2022.

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

Over the last decade, bonds have been a source of stability. But, with surprising moves this past month, they’ve now become a risk-management challenge that stands out amongst other asset classes.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues, bring you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, November 12th at 2:00 p.m. in London.

For much of the last decade, an important cross asset story has been how stable bond markets were relative to, well, everything else. A big part of this story was the action taken by central banks. They bought government bonds directly, but also set short-term interest rates at very low levels, which acted as a magnet, holding down other interest rates around the world.

There were some big moves, especially when the pandemic hit. But for the most part, bond markets have been a pretty stable place relative to stocks, commodities and other asset classes. This was a global trend, with interest rates unusually placid from Australia to Poland to the United States.

But recently, that's reversed. It's been the bond market that's been hit by a wide number of extreme moves, while other asset classes have been pretty calm. The overall market right now is a little like a duck: calm on the surface, but with some really furious churning below.

We track a wide variety of cross market relationships at Morgan Stanley research. These represent different ways an investor might express a different view on the market. For example, smaller versus larger capitalization stocks, the US dollar relative to the Japanese yen in currency markets, or 2-year yields relative to 30-year government bond yields in the United Kingdom. While investors are often exposed to the big picture direction of stocks, bonds and currencies in their portfolio, many also take views on these smaller, more 'micro' relationships as a key way to exploit mispricing and generate return.

In equities and commodities, these relationships are pretty well behaved. In government bonds, they're not. Excluding the depths of the pandemic, the last month has seen some of the most extreme moves in global bond markets in a decade.

There are a few things going on here, much of which ties back to those central banks. The Federal Reserve has signaled it's going to be rolling back its bond buying, reducing one support to the market. The Bank of England surprised markets by not raising interest rates as expected. While on the other hand, Poland's central bank surprised markets by increasing rates much, much more.

All of this is happening at a time when bond performance wasn't great to begin with. The U.S. Aggregate Bond Index, a good proxy for the high-quality bonds that most investors hold, is down 1.7% this year, underperforming cash. Rising bond yields in the UK and Australia have created a similar dilemma. And many investors who would normally take advantage of these large moves and potential dislocations have been caught up in them, making it harder for some of these relationships to normalize.

What does all that mean for markets? Investors focused on stocks, commodities or foreign exchange should be mindful that their friends over in the bond market are facing a very, very different risk management challenge as we move into the end of the year. And continued bond market volatility could challenge broader market liquidity. More broadly, less central bank support is consistent with our longer run expectations that interest rates are set to move higher. Stay tuned.

Thanks for listening! Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

Coming out of last week’s FOMC meeting, the Fed’s wants are becoming clearer but the implications into 2022 for asset prices, interest rates and exchange rates remain to be seen.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I’ll be talking about global macro trends and how investors can interpret these trends for rates and currency markets. It's Thursday, November 11th at noon in New York.

"Don't fight the Fed." It's an oft-repeated investment principle that could be restated as "What the Fed wants, the Fed gets." Coming out of last week’s FOMC meeting, let’s take a moment to consider what the Fed really wants, and how markets may provide it.

So, the Fed wants one of three things from a financial conditions perspective. It either wants financial conditions to loosen with greater availability of money and credit in the marketplace or it may want financial conditions to tighten to cool down an overheated economy. Finally, it may want to keep the status quo with financial conditions in a certain range.

Currently, the Fed is easing monetary policy by purchasing bonds from the market. So, it wants to loosen financial conditions. But over the next 6 months, it will be tapering its asset purchases and, therefore, it will be easing policy by less and less. This implies that it wants financial conditions to keep easing starting this month and lasting into the middle of next year, but more gradually than they have been.

Coming into this year, we knew the Fed and European Central Bank would deliver monetary policies consistent with an aggressive easing of financial conditions. If we included only 3 prices in our financial conditions framework, a vast oversimplification to be sure, then our calls at Morgan Stanley for higher real yields and a stronger dollar would have implicitly suggested much higher prices for riskier assets. 

So, what has happened thus far in 2021? Well, risky asset prices have risen tremendously, but the U.S. dollar has only strengthened somewhat, and real yields remained at low levels. 

So, what about next year? We know the Fed wants financial conditions to loosen further. After all, it will still ease policy through asset purchases over the next 6 months. But it will be easing by less and less until, starting in the middle of 2022, it will no longer ease policy at all. At that point, it will maintain – for a period, short as though it may be – extremely easy financial conditions.

Does that mean U.S. real yields will struggle to rise, the U.S. dollar will struggle to rally, and risky asset prices will rise? The first two are certainly possible outcomes. But even if financial conditions loosen in aggregate for a time, and then remain loose for a time thereafter, not every market is guaranteed to move in a direction associated with looser financial conditions.

For example, take equities, which is a type of risky asset. A rise in equity prices - which would loosen financial conditions - might be offset somewhat by higher real yields and a stronger U.S. dollar – both of which would tighten them. As long as the final result is an overall set of financial conditions that are looser than before, the circle is squared for the Fed.

So, what determines which drivers of financial conditions do the heavy lifting? The answer is changing investor expectations and risk premiums for growth and inflation, both on an absolute basis for equities and real yields, and on a relative basis for the U.S. dollar.

Ultimately, we believe the easy monetary policies in place today—and policies that will be in place through most of next year—will keep expectations for real economic growth improving. This should support investor willingness to own riskier assets while placing upward pressure on real rates.

Expectations for inflation should remain buoyed by expectations for strong growth, but inflation risk premiums will be influenced by factors in the supply side of the economy, like supply chains and labor force participation. We see downside risks to inflation risk premiums next year, which would place further upward pressure on real interest rates.

Finally, in terms of the relative growth outlook, progress in the U.S. on COVID-19, as well as fiscal developments such as infrastructure spending, favor the U.S. over the rest of the world. This should place upward pressure on the U.S. dollar through the first half of next year.

Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts App. It helps more people find the show.

The bipartisan infrastructure bill has passed, and while investors will see some short term impacts, the bigger question is how long will it take for markets to see a return on these investments?

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 10th at 11 a.m. in New York.

While Congress continues to negotiate the 'Build Back Better' plan, the package of expanded social programs paid for by fresh taxes on companies and wealthier households, it managed to get a key companion piece of legislation over the finish line last week: the bipartisan infrastructure framework. Many investors may have overlooked this event given the framework's smaller relative price tag and lack of tangible tax increases. But don't be fooled. This is a watershed event, and investors should pay attention.

In short, the infrastructure framework adds about $550 billion to the existing budget baseline for infrastructure spending in the U.S. That's a nearly doubling of spending over the next 10 years on infrastructure. And that means fresh market and economic impacts to consider.

For the broader economy, the story is nuanced. Increased infrastructure spending is generally a good return on investment. However, that impact usually isn't visible right away. In the short term, the money put into the economy to build a new road or train line is funded by money taken out of the economy by taxes. A few years out, that new road leads to more economic activity than there was before. But that might not be tangible enough to move markets in the near term.

Something more tangible is the obvious impact to the industries directly involved in infrastructure construction. For example, my colleague Nik Lippman sees material upside to cement companies, who will see major improvements in demand for their product.

Bottom line, the infrastructure supercycle is here. We'll track it and all the market impacts for you as they take shape.

Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

Third quarter earnings are heading into the home stretch in Europe and the UK, but while a solid number of companies have beat earnings estimates, market reaction has been a bit curious.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European and UK Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the emerging read on third quarter earnings for the region. It's Tuesday, November the 9th at 3pm in London.

Europe and the UK are now more than halfway through third quarter earnings season, and so we're far enough along to form a view on how this quarter's earnings are playing out. And while earnings have been largely solid, price movements on the day of earnings announcements, and in the days following, have been a bit curious. But I'll get into that in a moment.

As it stands, third quarter earnings appear on track to deliver a solid number of companies beating earnings per share estimates. As of yesterday, 55% of European companies have beaten earnings estimates, while 23% have missed, leaving a 'net beat' of 32%, which is twice the historic average. If this holds, it would put third quarter results on track to deliver another strong upside surprise, albeit slightly below the pace seen over the last few quarters. Taking it to the sector level, we find that the strongest breadth of earnings beats are coming from Financials and Energy. On the flip side, Communication Services, Healthcare and Industrials have delivered the smallest breadth of beats so far.

In addition to a healthy number of companies exceeding estimates, we are also seeing a beat in terms of the aggregate amount of European earnings overall, with weighted earnings per share currently beating consensus by about 10% for this quarter. This good news on earnings has driven a fresh bout of upgrades, which should reduce investor concerns around the risk to corporate profitability from ongoing supply chain issues and high input cost inflation.

All that said, earlier, I mentioned a bit of curiosity about price reaction. Typically, if a company beats earnings per share estimates, you might expect to see better stock performance that day or in the days that follow. And of course, the opposite is true for companies who miss estimates. However, a key talking point during this results season has been the surprisingly disappointing price action, even for companies who beat expectations.

Currently, the gap between the outperformance of earnings beats on the day of results relative to the underperformance from earnings misses has been very negatively skewed in a historic context. In fact, this negative skew to price action is close to a record low going back to 2007. On our data, we calculate that EPS misses have, on average, underperformed by 1.6% on the day of results, whereas companies that beat estimates have been broadly flat in relative terms. Hence, while the third quarter has been a solid earnings season overall, the hurdle rate to positively surprise the market is currently quite high.

In our opinion, this reflects investors' uncertainty about the future earnings outlook and whether company margins will face a delayed hit in the quarters ahead. While understandable, we think this caution is overdone. Rather, we expect Europe's earnings dynamic to remain positive into 2022, with companies benefiting from a strong external demand environment and a record level of pricing power.

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

As we head towards year end, stock and bond markets appear to be sending mixed signals for the year ahead. For investors, the truth could lie somewhere in the middle.

----- Transcript -----

Welcome to "Thoughts on the Market." I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace.

It’s Monday, November 8th at 2:00PM in New York. So, let's get after it.

As we enter the final stretch of the year, various markets appear to be sending very different signals about what to expect over the next year. Let’s start with Bonds where the longer-term yields have fallen sharply over the past few weeks. In fact, the moves have been so dramatic, several leading macro funds had their worst month on record in October. Some of this move is due to the fact that these same investors were all short bonds as central banks were expected to begin the long process of tightening monetary policy, perhaps faster than what was priced a few months ago.

The reason for this view was very simple: inflation has proven to be much higher than the central banks expected, and they would be forced to respond to that development by raising rates sooner than what they might prefer to do. Indeed, over the past few months, many central banks around the world have raised rates while others have begun to taper asset purchases and even end them altogether. In other words, these traders were correct in their fundamental assessment of what was about to happen, but long-term rates went down instead of up.

While the extreme positioning clearly played a role in the magnitude of the move in longer term rates, the fundamental question is why did they fall at all? One possible reason is the bond market may be discounting what we have been talking about on this podcast for weeks—that the first half of next year is likely to see a material slowing in both economic and earnings growth as fiscal stimulus from this year wears off. Furthermore, with the legislative process breaking down on the Build Back Better program, that risk has only increased. It also means less issuance of Treasury securities which directly helps the supply and demand imbalance many macro and bond traders were expecting as the Fed begins to taper asset purchases this month.

On the other side of the spectrum has been stocks. Here, we have seen higher prices for the major indices almost every day for the past 5 weeks, suggesting growth next year is not only going to be fine but may be understated by analysts. Stocks may also be taking the lower interest rates as good news for valuations. After all, much of the correction in September was due to lower valuations as the markets started to worry about central banks tightening and rates moving higher. On that score, price/earnings multiples in the US have risen by 7.5% over the past 5 weeks, one of the largest rises we’ve ever witnessed in such a short period of time. Such a rise in P/Es like this usually happen for one of two reasons: either the market thinks earnings estimates are about to go up a lot or interest rates are going to fall. The conflict here is that better growth is not compatible with lower rates. A valid explanation for the divergence could be that the potential failure of Build Back Better means no new corporate taxes. So, while the economy may be hurt by this legislative delay it could be friendly to earnings.

In keeping with our narrative over the past month, we think the main reason for the divergence in messaging between stock and bond markets can be explained by the fact that retail and other passive inflows to equity markets continue at a record pace. It’s also the seasonal time of the year when institutional investors are loathe to leave the party early for fear of missing out and falling behind their benchmarks, something that they have had a harder time keeping up with this year. On that score specifically, the S&P 500, the key benchmark in the US market, has once again outperformed the average stock. This is a very different outcome from 2020 when the average stock did better than the index. What this really means is that the index can diverge from its fundamental value for a while longer.

Bottom line is that major indices can grind higher into the holidays. However, it will get more difficult after that if we’re right about growth disappointing next year as rates eventually stabilize at higher levels from central banks tightening. In that environment, we continue to favor companies with reasonable expectations and valuations. We think healthcare, banks and some of the more non-cyclical technology companies in the software and services subsectors offer the best risk-reward. On the other side of the ledger, we would avoid consumer goods and cyclical technology companies that will see the biggest payback in demand next year.

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

Global moves in elections, COVID restrictions and energy prices are having ripple effects across markets. How should investors think about these dynamics for Asia and EM equities?

----- Transcript -----

Welcome to Thoughts on the Market. I'm Jonathan Garner, chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you their perspectives, today I'll be talking about our latest view on Asia and EM equities. It's Friday, November the 5th at 2pm in London.

Overall, in our coverage, we continue to prefer Japan to Non-Japan Asia and Emerging Markets. Japan has outperformed Emerging Markets by 500 basis points year to date but remains cheaper to its own recent valuation history than Emerging Markets and with stronger upward earnings revisions. New Liberal Democratic Party leader Kishida-san has recently fought and won a snap election in the lower house of the Japanese parliament. The governing Center-Right coalition, which he now leads, did considerably better than polling had suggested prior to the election outcome. Although there may be some changes in policy emphasis compared with the Abe and Suga premierships, the broad contours of market-friendly macro and micro policy in Japan are likely to continue.

Elsewhere within Emerging Markets, we're most constructive on Eastern Europe, Middle East and Africa and in particular Russia, Saudi Arabia and UAE, which are positively leveraged to rising energy prices. We're also warming up to ASEAN, having upgraded Indonesia to overweight alongside our existing overweight on Singapore. ASEAN economies are finally beginning to reopen post-COVID, which is stimulating domestic consumption.

However, we have recommended taking profits on Indian equities after a year of exceptionally strong performance. We remain structurally bullish on a cyclical recovery in earnings growth in India, but with forward price earnings valuations now very high to history and peers, and with rising energy prices a headwind for India, we think it's time to move to the sidelines. Within Latin America, we've also established a clear preference for Chile versus Brazil on relative economic momentum and export price dynamics.

Finally, we remain underweight Taiwan and equal weight China. For Taiwan, our contrarian negative view relates to our expectation of a semiconductor downcycle in 2022 and a slowing retail investor boom. Meanwhile, China equities continue to face numerous headwinds, including Delta variant COVID outbreaks, property developer deleveraging and the medium to long term impact on private sector growth stocks from the recent regulatory reset. Although valuations have improved in pockets, we expect further earnings downgrades for China and await a clearer pickup in growth and liquidity before turning more constructive.

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

Central bank support has been a key driver of market strength since last year. So how will markets react during the months-long tapering process?

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, November 4th at 2p.m. in London.

 Since the start of the pandemic, the Federal Reserve, along with many other global central banks, instituted massive purchase programs of government bonds and mortgages. These purchases, known as quantitative easing, or QE, were designed to keep interest rates low and boost liquidity in financial markets during a time of stress. Since February of 2020, these purchases caused the Fed's bond holdings to rise by $4.4 Trillion dollars. On Wednesday, the Federal Reserve announced its intention to start dialing these purchases back.

To be clear, the Fed will still be buying a lot of bonds over the coming months. But after buying $120 billion of securities in October, the fed will buy $105 billion in November and $90 billion in December, a trend our economists think mean that they will cease these purchases entirely by June of next year. This ‘tapering’ of purchases and its impact for markets is a major source of debate.

One school of thought is that central bank support has been the main driver of market strength, not just recently, but going all the way back to the global financial crisis. Markets, after all, have done better when the Fed has been buying bonds.

But as much as you'll hear phrases like "the market is only up because of the Federal Reserve", this idea can suffer from some real statistical fallacies. Yes, markets have done better when the Fed has felt the need to support the economy. But the Fed has generally felt this need when conditions were bad, and bad conditions often meant lower market prices—something that was true in, say, the autumn of 2012 or March of last year. I know this is the type of hard-hitting financial insight you expect from this podcast but buying when prices are low tends to produce superior returns.

So what does ‘tapering’ mean? Well, one thing we can look at is the last time the Fed started to dial back its purchases. After a strong year for markets and the economy in 2013, the Fed started to ‘taper’ its bond purchases in January of 2014.

That turned out to be a bad month for markets. But the reasons were important. U.S. data was unusually weak, China's economy was slowing and there were troubles in emerging markets, including Argentina. The market's response, we'd argue, was very normal and fundamentally driven. The best example of this? Even though the Fed was reducing its bond purchases in January, bond prices actually rose, which is what you'd expect when concerns around growth increase.

The data ultimately improved, and 2014 turned into a reasonable year for stocks, albeit a shadow of the stellar returns of the year before. But putting it all together, we think 2014 provides an important clue for how markets could respond to tapering: as the Fed becomes less involved in the markets, fundamentals matter more, and become a larger driver of whether markets will sink or swim.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

Inflation rates, commodity prices and central bank policy are tied together through self-referential loops. With today’s FOMC meeting, it is worth a closer look at these meta dynamics.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about global macro trends and how investors can interpret these trends for rates and currency markets. It's Wednesday, November 3rd at noon in New York.

Is there anything more "meta" than commodity markets, headline inflation rates and inflation markets? The Google dictionary, using definitions from Oxford languages, defines the adjective ‘meta’ as "self-referential, referring to itself or to the conventions of its genre." A great example would be a website that doesn't review movies, it reviews the reviewers who review movies.

Rates markets can get pretty meta as well. Commodity prices, inflation rates reported by the government and inflation rates traded in the market often mirror each other in a self-referential loop. When investors see commodity prices going up, they think that inflation rates will go up, so they buy inflation linked bonds. That drives inflation rates in the market higher, which makes othes investors believe that inflation will be a problem, and so they buy commodities as a hedge for higher inflation, which drives commodity prices even higher. And so, the loop continues.

This self-referencing loop wouldn't be as problematic if actual inflation reported by the government, which looks at price changes in the past, didn't have a big impact over market-based measures of inflation, which look at what inflation might average in the future. But they do have an impact, especially when movements in actual inflation have been big, like they have been recently.

Another check on the self-referencing loop is supposed to be how central bankers react to movements in inflation rates in the marketplace, especially those that relate to inflation over a longer period of time, like five to 10 years in the future. Central bankers know that inflation rates in the market include both expectations and risk premiums. And because central bankers are primarily interested in inflation expectations, they use surveys of consumers and professional forecasters, as well as statistical models, to extract those expectations from market prices.

Still, when inflation rates in the market move to extremes, central bankers get nervous, just like investors. And therein form something else that's very ‘meta,’ the self-referential loop that includes investor fears, central banker fears, market pricing of central bank policy and central bank policy itself.

It's no wonder that the markets which price the most hawkish central bank policy paths are also the markets that priced the highest inflation rates in the future, and we can't blame investors for allowing this market behavior to persist. I'll give you an example. Looking back to the second half of 2014, the dramatic decline in oil prices allowed the market in Europe to price much lower inflation rates in the future, and the European Central Bank responded by announcing its quantitative easing policy in January 2015.

But what goes up – in this case, commodity prices, inflation rates in the market and the pricing of more hawkish central bank policies – can also come down. And given the meta nature of these markets, investors may want to pay close attention to what is happening to commodity prices today.

For example, some of the recent supply chain and commodity disruptions have peaked in futures markets like lumber, thermal coal, and natural gas. In addition, the cost of shipping many commodities, such as coal and iron ore, have also peaked.

This leaves us feeling that the pricing of central bank policy in markets is increasingly at risk of reversing somewhat. We flag today's FOMC meeting as possibly the last major central bank meeting that could spur even more hawkish pricing of central bank policy.

In other words, investors should realize that markets are pricing the high rates of inflation we've experienced – in part driven by higher commodity prices – to continue for some time. And markets are priced for central banks to respond aggressively. But what if commodity prices fall from here? Investors should be prepared for the "meta" nature of these markets to reprice central bank policies again, but this time in a more dovish direction.

Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate in reviews on the Apple Podcasts app. It helps more people find the show.

‘Build Back Better’ has gained support from all corners of the Democratic Party, but questions remain over how the framework is paid for. For investors, a look at short term dynamics may provide clarity.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, head of public policy research and municipal strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Tuesday, November 2nd at noon in New York.

Over the past few days, the "Build Back Better" framework has gained increasing support from all corners of the Democratic Party. And although Senator Joe Manchin put his support for the framework in question yesterday, and there are still some questions on items such as prescription drug reform, our base case is still that "Build Back Better" and the bipartisan infrastructure bill will likely be enacted before year end.

However, still up for debate is whether "Build Back Better" is fully paid for by things like stronger IRS tax enforcement and tax increases on corporations. In its current form, the framework proposes fiscal balance, but over 10 years. In the short term, it doesn't mean zero fiscal expansion.

Rather as structured, we think the bill would add to deficits over the first five years but get to balance by having surpluses over the remaining years. This distinction is important, and we argue that investors should focus on the early-year deficit dynamic instead of the 10-year deficit language that Congress generally uses to communicate deficit impact.

One reason is that policy uncertainty usually increases with time. For example, several spending and contra-revenue programs including a child tax credit, expanded Affordable Care Act subsidies, and state and local tax cap relief, roll off well before the 10-year look-ahead period ends. And U.S. elections in 2022 and 2024 could conceivably result in changes to government that could mean the continuation or discontinuation of programs and new tax items.

Given this uncertainty and the estimated $256 billion dollar deficit for the bipartisan infrastructure bill -- the takeaway for investors is that we expect bond markets will focus on this early-year dynamic since this is the time frame that ultimately impacts GDP forecast horizons, impacts the Treasury supply forecast horizon and is reliable from a policy standpoint.

Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

Original Release on October 11th, 2021: As the weather chills and we head towards the end of the mid-cycle transition, the S&P 500 continues to avoid a correction. How long until equities markets cool off?

----- Transcript -----

In case you missed it, today we are bringing you a special encore release of a recent episode. We’ll be back tomorrow with a brand new episode.

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 11th at 11:30 a.m. in New York. So, let's get after it.

With the turning of the calendar from summer to fall, we are treated with the best weather of the year - cool nights, warm days and clear skies. In contrast, the S&P 500 has become much more volatile and choppy than the steady pattern it enjoyed for most of the year. This makes sense as it's just catching up to the rotations and rolling corrections that have been going on under the surface. While the average stock has already experienced a 10-20% correction this year, the S&P 500 has avoided it, at least so far.

In our view, the S&P 500's more erratic behavior since the beginning of September coincided with the Fed's more aggressive pivot towards tapering of asset purchases. It also fits neatly with our mid-cycle transition narrative. In short, our Fire and Ice thesis is playing out. Rates are moving higher, both real and nominal, and that is weighing disproportionately on the Nasdaq and consequently the S&P 500, which is heavily weighted to these longer duration stocks. This is how the mid-cycle transition typically ends - multiples compressed for the quality stocks that lead during most of the transition. Once that de-rating is finished, we can move forward again in the bull market with improving breadth.

With the Fire outcome clearly playing out over the last month due to a more hawkish Fed and higher rates, the downside risk from here will depend on how much earnings growth cools off. Decelerating growth is normal during the mid-cycle transition. However, this time the deceleration in growth may be greater than normal, especially for earnings. First, the amplitude of this cycle has been much larger than average. The recession was the fastest and steepest on record. Meanwhile, the V-shaped recovery that followed was also a record in terms of speed and acceleration. Finally, as we argued last year, operating leverage would surprise on the upside in this recovery due to the unprecedented government support that acted like a direct subsidy to corporations.

Fast forward to today, and there is little doubt companies over earned in the first half of 2021. Furthermore, our analysis suggests those record earnings and margins have been extrapolated into forecasts, which is now a risk for stocks. The good news is that many stocks have already performed poorly over the past six months as the market recognized this risk. Valuations have come down in many cases, even though we see further valuation risk at the index level. The bad news is that earnings revisions and growth may actually decline for many companies. The primary culprits for these declines are threefold: payback in demand, rising costs, supply chain issues and taxes.

At the end of the day, forward earnings estimates will only outright decline if management teams reduce guidance, and most will resist it until they are forced to do it. We suspect many will blame costs and even sales shortfalls on supply constraints rather than demand, thereby giving investors an excuse to look through it. As for taxes, we continue to think what ultimately passes will amount to an approximate 5% hit to 2022 S&P 500 EPS forecasts. However, the delay in the infrastructure bill to later this year has likely delayed these adjustments to earnings.

The bottom line is that we are getting more confident earnings estimates will need to come down over the next several months, but we are uncertain about the timing. It could very well be right now as the third quarter earnings season brings enough margin pressure and supply chain disruption that companies decide to lower the bar. Conversely, it may take another few months to play out. Either way, we think the risk/reward still skews negatively over the next three months, even though the exact timing of cooler weather is unclear. Bottom line, one should stay more defensive in equity positioning until the winter arrives.

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

Investors have had a lot to take in over the past few weeks, but corporate credit markets remain calm despite turbulence elsewhere. Vishy Tirupattur explains. 

----- Transcript -----

Welcome to Thoughts on the Market. I am Vishy Tirupattur, Global Director of Fixed Income Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the current calm in the corporate credit markets. It's Friday, October 29th at 1:00 p.m. in New York.

Over the past few weeks, risk markets have been buffeted by volatility from a wide array of sources. It was around a month ago that the regulatory reset in China and the near-term funding pressures on select property developers roiled global markets, as investors fretted all the systemic implications for global growth.

Then, a mixed U.S. jobs report, along with sharply higher commodity prices, intensified the debate around stagflation. And the rhetoric from multiple central banks has been increasingly hawkish. So, a lot for investors to take in.

The combination of these concerns has resulted in substantial market gyrations. The S&P 500 index declined by about 4% before recovering to all-time highs. The shape of the Treasury yield curve has twisted and turned. The benchmark 10-year Treasury interest rate went from around 1.3% to around 1.7% and back down to 1.56%. The market pricing of the timing of a Fed rate hike has come in sharply.

But amidst all these substantial moves, corporate credit markets on both sides of the Atlantic have largely stayed calm. Credit spreads, which are the risk premium investors demand to hold corporate debt or U.S. treasuries, have hovered near 52-week tights in investment grade, high yield and leveraged loans across the U.S. and Europe. And with surprisingly limited volatility.

Credit market volatility relative to equity markets remains very low. Market access for companies across the credit spectrum has remained robust, as indicated by strong issuance trends, running at or ahead of the pace of a year ago. So, what explains this stark difference between credit and other markets? The answer boils down to meaningfully improved credit fundamentals and elevated company balance sheet liquidity, leading to a decidedly benign outlook for defaults over the next 12 months, if not longer.

Morgan Stanley's credit strategists Srikanth Sankaran and Vishwas Patkar have highlighted that the balance sheet damage from COVID has been reversed. At the end of the second quarter this year, gross leverage in U.S. investment grade credit has declined sharply back to pre-COVID levels. Net leverage is now below pre-COVID levels, while interest coverage has risen sharply to a seven-year high.

The trends in the high yield sector are even more impressive, driven not just by the rebound in earnings but also negative debt growth. After four consecutive quarters of declines from the second quarter 2020 peak, median leverage now sits below the pre-COVID trough. That 71% of the issuers are now reporting lower growth levels quarter over quarter, reflects the broad-based improvement we are seeing in the market.

Even in the leveraged buyout world, while 2021 has been a bumper year for acquisition activity, unprecedented equity cushions have resulted in a much better alignment of sponsor and lender interests, helping to alleviate concerns.

So, what are the implications for investors? A lot, of course, is already in the price. With credit spreads near the tight end of the spectrum, we are more likely to see them widen than tighten. Indeed, the base case expectation of our credit strategists is more modestly wider splits. However, the strength in credit fundamentals suggests that the outlook for defaults is benign, and likely below long term average default levels. Thus, we prefer taking default risk to spread risk here, leading us to favor high yield credit or investment grade credit and, within high yield, loans over bonds.

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

One of the great conundrums of finance is predicting what markets will return over the long run. But with some historical research and the power of math, the future can become a bit clearer.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, October 28th at 2 p.m. in London.

The question of what markets will return over the next decade is a conundrum. It's complicated because of just how much can change in a given year, let alone a decade, but also simple because over longer horizons, valuation measures such as bond yields or stock price-to-earnings ratios tend to matter a lot more for how well a market does. A 10-year horizon really matters to investors saving for the future. But most investors, and also this podcast tend to focus on events happening in the much more immediate future.

So what do we think this return picture holds?

When estimating what a market will return over the long run, there are really two basic approaches. The first, sometimes called the demand approach, assumes that markets are efficient, and that investors will always demand that the market is priced to deliver an average historical return. In this approach, future returns for the market are simply assumed to be the long run average. We don't use this approach, but others do, and it is appealing for being relatively straightforward.

An alternative, which we favor, could be called the supply approach. This attempts to quantify just how much return a given asset can supply. So, for bonds with a fixed yield, this approach is attractively simple. On a 10-year horizon, the return for a broad bond index should be pretty similar to its yield today, regardless of the path that interest rates take between now and then. That might sound somewhat counterintuitive, but there's some pretty good math, we think, to back it up. After making a few minor adjustments, we think the U.S. Aggregate Bond Index may be able to supply a return of about 2% per year, over the next decade.

For stocks... now there are more moving parts and more assumptions that can ultimately be proven right or wrong. The long run return of a stock market can be broken down into three parts: the dividends of the stock market pace, the growth in the market's earnings, and the change in the valuation that's applied to those earnings. The dividend yield is relatively easy to estimate, but earnings and valuations create a lot more debate.

For earnings, our starting point is to assume that they grow, at least with the rate of inflation. We see a good argument for this, if prices everywhere are rising, companies should book higher sales and profits. This is one reason why equities tend to be a better asset class in higher inflation because they can grow their cash flows much more easily than, say, a bond can.

So how much do earnings grow over and above the rate of inflation? We average two trend lines: a very long run trend of historical earnings growth and one that only focuses on more recent history. There are pros and cons of each. For example, only using the recent historical trend may better reflect current conditions in the market, but it also might overstate what's been an unusually favorable environment for companies. By taking the average, we split the difference. Now, with stock market earnings are above trend. We assume that there is some convergence down. And if earnings are depressed, we assume some normalization up. We think there's some good historical arguments for this, as earnings do tend to oscillate around these trend lines over time.

Finally, what about those valuations? Well, we assume that valuations move back to long run averages, but do so only gradually, as we believe history says this gravitational pull takes time.

Putting all of this together, we think the U.S. stock market could return about 5.2% per year over the next decade. The bad news is that's roughly half the long run average. The good news? It's still two and a half times higher than the return from that broad bond index.

So where can investors find higher returns, especially relative to inflation? For equities, our framework suggests the highest so-called real returns are in Europe, where we think stocks could beat inflation by about six percent per year. In fixed income markets, we see the highest inflation adjusted returns in emerging market bonds.

Finally, where could our assumptions be wrong? The return for bonds should be pretty well anchored by their yields, but for stock markets, there are several swing factors. Higher corporate taxes, for example, or higher interest rates could mean we're too optimistic about our assumptions for earnings growth and valuations. On the other hand, a stronger economy and importantly, a more permanent shift higher in market profitability could mean that our assumptions for mean reversion back to historical averages are simply too pessimistic. Either way, time will tell.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

Autonomous trucking may sound like science fiction, but its impacts on transportation costs, the labor market and a breadth of industries may be closer than we think.

----- Transcript -----

Adam Jonas Welcome to Thoughts on the Market. I'm Adam Jonas, head of Morgan Stanley's Global Auto and shared mobility research team.

Ravi Shanker And I'm Ravi Shankar, equity analyst covering the North American freight transportation industry.

Adam Jonas And on this episode of the podcast, we'll be talking autonomous. Specifically, the road ahead for autonomous trucking. It's Wednesday, October 27th at 10 a.m. in New York.

Adam Jonas Ravi, before we get into the autonomy topic, specifically, your sector really sits at the epicenter of labor inflation and driver shortage. So, just help set the scene for us. How big of a problem is this?

Ravi Shanker It's pretty difficult right now. It has been the case for a while. We've had a demographic problem in trucking for pretty much the last two decades and counting. In fact, you can find news stories going back to 1910 talking about a driver shortage in the industry. But it's particularly acute right now. A lot of it is structural, not cyclical. So we think we need to find unconventional solutions to the problem.

Adam Jonas So remind us why autonomy progresses faster in trucking than in cars. You and I have had this debate over many years but tell us why it's faster in trucking.

Ravi Shanker It's a slightly different problem to solve with trucking. I mean, it's still a very difficult problem to solve. But the fact that 93% of miles driven of a truck are on the highway and autonomous driving is slightly easier to solve on the highway than it is in the middle of Manhattan for instance. That really helps. The fact that this is an industry that's really driven by unit economics and labor accounts for 35-40% of the cost of trucking, and if you can substitute a driver at least partially or maybe completely even, that will significantly reduce the cost of trucking. And obviously, there's a safety aspect; the fact that a truck accident can cause significant damage. And if you can have technology solve that problem and step in, that can save countless lives over time. So we think it's a slightly easier problem to solve. The economic savings may be better or easier to quantify with trucking than with passenger cars.

Adam Jonas And that's a really good point, because I find in my conversations with investors that people tend to think of autonomy as this blanket homogeneous technology. But I want to understand a bit more about the economics of autonomy, payback periods, cost benefit. What are some of the highlights from the numbers that you've been running?

Ravi Shanker So we think that autonomy can reduce the cost of trucking by 60%, six zero. If you can electrify the truck, that's probably another 10% on top of that. Obviously, if you take a truck company today and reduce their cost of operations by 60%, that's significant savings. On top of that, because you don't have to deal with hours of service regulations for a driver, you can significantly improve your productivity of the truck and hopefully you can gain some market share as well. So, we think that these new technology trucks cost roughly 50 to 70 thousand dollars more than a regular truck today, but the payback period can be measured in weeks and not years.

Ravi Shanker So Adam, again, to me, it's relatively clear what the use case is for autonomy in trucking. Where are we with pass cars, where are those passenger robotaxis that we were promised a few years ago?

Adam Jonas Well, I actually had the opportunity to ask the chair and CEO of General Motors, Mary Barra, on a Morgan Stanley video series that we published that exact question. And her response, pretty confidently was we're going to see major development in quarters, not years. Now that mission is focused on robotaxi in dense urban cities like San Francisco and other cities. Ravi, I think the definition of success there isn't that they've solved autonomy in two years because that's not something we're going to solve. We think that the definition of success there will be; are they able to fleet many tens or maybe even a couple of hundred robotaxis in a major city or a collection of major U.S. cities with driver out? Even if it's a simple mission doing a giant rectangle on a geofence or, you know, something that can resemble a streetcar without cables or a streetcar without wires. Just that proof point, even if it doesn't completely remove your driving license and substitute your commute entirely, will go a long way to convincing policymakers, investors and the general public that this is not science fiction, we're going to get there, right? Just like the barnstorming age of early aviation, these bigger and bigger feats every week, every month, we think we'll see something similar in autonomy.

Ravi Shanker And maybe some of the key benefits of autonomy can be realized even with these kind of small early use cases. But I was thinking like maybe a pretty nice commonality in both our worlds, maybe the center sliver of the Venn diagram, if you will, between autonomous trucking, autonomous pass cars, is autonomous delivery vans. We've done a lot of work on what this means the last mile. Obviously, GM, Ford other OEMs have been talking about this. Where do you think we stand there in terms of these OEMs entering that market again?

Adam Jonas Yeah, especially post-COVID. I mean, the growth of e-commerce and our obvious dependency, increasing dependency on final mile. That use case is perfect for electrification and autonomy. And I would just make the point that advancing the state of the art of connected car and connected car ecosystems and electric ecosystems accelerates the development of the autonomous economy too because electric cars make better AVs. And then autonomous cars make better electric cars because you can optimize the utilization and the use case and the inter workings with the infrastructure. So, I think that is a very hot area and I would agree with you there is middle ground that we're going to see in your neighborhood, perhaps sooner than people think, even if it's still at a slow speed or not all the time in all neighborhoods, in all weather conditions.

Adam Jonas Before I let you go, I wanted to ask you a question that's always on people's minds and that's the impact on the workforce and jobs. How are your companies talking to current drivers about this autonomy subject?

Ravi Shanker This is a really good question and obviously somewhat of a sensitive topic. I think the truck fleet operators want to be very careful and very clear that trucking is not going to displace every truck driver or like hundreds of thousands of truck jobs any time soon. In fact, we had a report that was commissioned and published by the Department of Transportation a few months ago, it was earlier this year that basically said that even with a bullish base of adoption of autonomous trucking, they did not see risk to significant job losses in the trucking space just given the extreme truck driver shortage that we already have and the limited new labor supply that's going into this industry. So, it's something to be very cognizant of, something to be very sensitive about, but at the same time, we think the technology can actually help the industry and not be a hindrance.

Ravi Shanker So Adam, taking everything we've discussed today into account, what are the investment implications of this?

Adam Jonas There's really lots of different ways you could express an investment opinion. I think Apple CEO Tim Cook once described autonomy as the mother of all AI. In the auto industry, many of our clients see it, as you know, the ultimate internet of things, internet of cars. And so, there are a variety of adjacent industries, both within auto and transportation, but also technology enablers, sensor companies, semiconductors, processors, A.I. companies, network operators, data. There's all sorts of ways to express it across industries. And interestingly, according to your work, the beneficiaries of autonomy ultimately extend across multiple industries, right? Fleet operators and frankly, ultimately, the consumer, too. So, the question might be what sector isn't exposed to this technological revolution?

Adam Jonas All right, Ravi, thanks for taking the time to chat.

Ravi Shanker Absolutely, Adam. Great speaking with you.

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

Debates in D.C. continue to make headlines, but even with lowered expectations for the Biden agenda, we find a robust set of climate-focused provisions likely to survive the process and benefit the clean tech sector. 

----- Transcript -----

Michael Zezas Welcome to Thoughts on the Market. I'm Michael Zezas, head of U.S. public policy research and municipal strategy for Morgan Stanley.

Stephen Byrd And I'm Stephen Byrd, head of Morgan Stanley's North American Research for the Power and Utilities and Clean Energy Industries.

Michael Zezas And on this edition of the podcast, we'll be talking about clean energy and the latest developments for the bipartisan infrastructure deal and President Biden's build back better agenda. It's Tuesday, October 26th at 10 a.m. in New York.

Michael Zezas So Steven, with the negotiations winding down on the legislation Congress is considering around the president's economic agenda, I wanted to speak with you because you cover a sector, clean tech, that's really at the nexus of many things Congress and the White House are trying to achieve. In particular, even as the size of the economic and climate package has been cut from $6 trillion dollars to $3.5 trillion dollars now, perhaps as low as $1.5 trillion dollars, one constant has been a potentially large amount earmarked for clean energy infrastructure. By our estimate, there could be roughly $500 billion of new money allocated towards this goal. So, last month on the podcast, you outlined eight headline proposals, maybe we could start by updating everyone on those proposals as they stand now in the scaled back version of the bill.

Stephen Byrd Yeah, thanks, Mike. There is still a lot of support for clean energy in the draft legislation. Let me walk through the eight elements that investors have been most focused on to give you a sense for just how broad that support is.

Stephen Byrd Number one, and the boldest of these proposals is a clean electricity performance program or CEPP. This would essentially push all utilities and load serving entities to adopt clean energy and phase out fossil fuels. Number two is a new tax credit for energy storage and biofuels. Number three is a major extension of tax credits for wind, solar, fuel cells and carbon capture, and the payment for many of these technologies is higher than they've been in the past. Number four is significant incentives for domestic manufacturing of clean energy equipment. Number five is what's often referred to as direct pay for tax credits. This essentially provides owners with the immediate cash benefit of tax losses; that avoids these companies needing to go monetize those tax losses via the tax equity market to the same extent that they do now. Number six is support for nuclear power. There's a production tax credit for nuclear power output. Number seven is a major clean hydrogen tax credit. And number eight is significant capital to reduce the risk of wildfires. So it is very broad, very far reaching. It has impacts across the board.

Michael Zezas So, which kinds of companies do you think stand to benefit the most from this funding?

Stephen Byrd It's really interesting, quite a few subsectors that I cover would receive significant benefit here, I'll highlight the biggest beneficiary. So first, any company involved in green hydrogen, I see quite a bit of benefit here. The tax credit for green hydrogen is $3 a kilogram. That is a very large amount. And we think will incent customers to adopt green hydrogen more quickly. It will incent developers to build out the infrastructure needed to both produce and distribute green hydrogen. So, a number of companies from fuel cell companies to those involved in the industrial gas business to clean energy developers, I think will see a significant benefit there. Another category would be renewable development companies. So, the tax credit for wind and solar and storage is increased. In the case of storage, this is the first time energy storage would get a tax credit, and this further lowers the cost of clean energy. Another category that could be quite significant is carbon capture and sequestration. This technology would receive a significant benefit in terms of the payment per ton of hydrogen. And we believe in many cases, this is going to be really the amount needed to get essentially over the finish line. That is, to provide enough support for those big carbon capture projects to actually get built, which is really quite exciting. Biofuels gets a big benefit. Anyone who wants nuclear power would receive a significant benefit. And also, companies that are working to reduce the risk of wildfires would receive significant government support. So, you can tell it's just very broad and touches on really every subsector that we cover.

Michael Zezas Now, the Clean Electricity Performance Program, or CEPP, will likely end up on the cutting room floor. Why is this program's exclusion not a bigger problem in your mind?

Stephen Byrd The CEPP, it's really interesting. It certainly is a very bold effort to reduce fossil fuel usage. What we find here, though, is that all of the other provisions are so significant that we believe the adoption of clean energy will continue at a rapid rate. To give you a sense, in 2020 renewable energy in the United States was about 11 percent of power output. By 2030, we project that that can approach around 40 percent. That is a huge increase in just a decade. That is predominantly driven by economics. The cost of wind, solar and energy storage is dropping so quickly that many customers are adopting clean energy based purely on economic grounds, and the elements of support in this draft legislation would further enhance those economics and push customers in that direction anyway. So, we do see a big shift occurring, with or without the CEPP. Fortunately, there are many other elements of support in this draft legislation that we think is going to really provide a boost to many clean tech technologies, many business models, and we're excited about the growth that that would bring.

Michael Zezas What about the other types of companies you cover, utilities? This government investment seems like a step toward developing a very different type of business model for them. What do you think the outlook for the sector is?

Stephen Byrd I'd say the government support for clean energy that's in this draft legislation does have a number of benefits for utilities. So, we see in parts of the country a virtuous cycle that's been forming. And let me walk through how this is playing out. The coal power plants in many parts of the U.S. are quite expensive compared to renewable energy. So, for example, in the Midwest, the cash cost to run a coal plant could be three times as high as it costs to build a new wind farm. And so what utilities are doing is they are in a very careful, measured way shutting down coal, replacing that coal typically with a combination of wind and solar and energy storage. And typically, customer bills are not going up as a result, because of the benefit from avoiding the cost of running those coal plants. That virtuous cycle is resulting in better earnings per share growth. Now, with the government support that we're seeing in this draft legislation, that shift will accelerate. We will see more transmission spending, for example, more energy storage spending. It will boost the economics of wind and solar, which is fantastic. Also, in terms of risk mitigation, the capital that's in the bill that would help with dealing with the physical damage from climate change, such as wildfires, is another area of benefit. The cost from climate change to our sector is rising. And so government support there will help essentially defray a cost that's becoming quite significant for some of our utilities. So, you know, I think you're right to point this out. The utility sector is quite a big beneficiary here. And, you know, many of our best-in-class utilities can achieve, we think 7%, sometimes 8% EPS growth over a very long time period. By very long, I mean, a multi-decade time period. That to us is quite exciting because risk adjusted, that growth is quite excellent. For many of our utilities, the risk to achieve that is fairly low because the economics of what they're doing is so clear and so compelling. So, we are excited about the impacts to the utility sector.

Michael Zezas Steven, thanks for taking the time to talk.

Stephen Byrd Great talking with you, Michael.

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