Andrew Sheets: Are Emerging Markets Reemerging?

As the confidence level of homebuilders building new homes is increasing, will home sales go along with it? Jim Egan and Jay Bacow, Co-Heads of U.S. Securitized Products Research discuss.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-Head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-Head of U.S. Securitized Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing the U.S. housing and mortgage markets. It's Tuesday, May 23rd at 2 p.m. in New York. Jay Bacow: It's been a while since we talked about the state of the U.S. housing market. And it seems like if I look at least some portions of the data, things are getting better. In particular, the NAHB confidence just showed for the fifth consecutive month that homebuilders are feeling better about building a house, and we're now finally at the point where they say it is a good time to build a house. When you take a step back and just look at the state of the housing market, do you agree? Jim Egan: I think it's a great question. Housing statistics are going in a whole number of different directions right now. So, yeah, let me take a step back. We've talked a lot about affordability on this podcast and it's still challenging. We've talked a lot about supply and it remains very tight, and all of this has really fueled that bifurcation narrative that we've talked about, protected home prices, weaker activity. But if we think about how the lock in effect and that's the fact that all of these current homeowners who have mortgages well below the prevailing mortgage rate just are not going to be incentivized to list their home for sale, then kind of a logical next step from a housing statistics perspective is that new home sales are probably going to increase as a percentage of total home sales. And that's exactly what we're seeing, new home sales in the first quarter of this year, they were roughly 20% of the total single unit sales volumes. That's the largest share of transactions in any quarter since 2006. And this dynamic was actually quoted by the National Association of Homebuilders when describing the increase in homebuilder confidence that you quoted Jay. Jay Bacow: Okay, but when I think about that percentage, aren't building volumes in aggregate coming down? Jim Egan: They are, though, as a caveat, I would say that if we look at that seasonally adjusted annualized rate, it did increase sequentially a little bit, month-over-month in April. What I would point to here is that from the peak in single unit housing starts, and we think the peak in the cycle was April of 2022, those starts are down 22%. Now, that's finally started to make a dent in the backlog of homes under construction. Now, as a reminder, again, this is something we've talked about here, there are a number of factors from supply chain issues to labor shortages, that we're really serving to elongate, build timelines in the months and years after the onset of COVID. And all of those things caused a real backlog in the number of homes under construction, so homes were getting started, but they weren't really getting finished. We see the number of single unit homes under construction is now down 130,000 units from that peak. Now, don't get me wrong, that number is still elevated versus where we'd expected to be, given the sheer number of housing starts that we've seen over the past year. But this is a first step towards turning more positive on housing starts. And again, homebuilder confidence Jay, as you said, it's climbed higher every single month this year. Jay Bacow: Okay, but you said this is a first step in turning more positive on housing starts. We get the start, we get the unit under construction, we get a completion and then eventually we get a home sale, so what does this mean for sales volumes? Jim Egan: We would think that it's probably likely for new home sales to continue making up a larger than normal share of monthly volumes, but we don't think that sales are about to really inflect materially higher here. Purchase applications so far in May, they're still down 26% year-over-year versus the same month in 2022. Now, that's the best year-over-year number since August of last year, but it's not exactly something that screams sales are about to inflect higher. Similarly, pending home sales just printed their weakest March in the history of the index, and it's the sixth consecutive month that they've printed their weakest month in index history. So it was their weakest February, their weakest January, and so on and so forth, so we think all of this is kind of emblematic of a housing market, specifically housing sales that are finding a bottom, but not necessarily about to move much higher. Jay Bacow: Okay. Now, Jim, in the past, when you've talked about your outlook for home prices, you mentioned your four pillars. There is supply, demand, affordability and credit availability. We've talked about the first three of these, we haven't really talked about credit availability yet. Jim Egan: Right. And that's another one of the reasons why we don't necessarily see a real move higher in sales volumes because of the whole new regime for bank assets that we've talked about a lot. Jay, you've talked about how much it's going to impact things like the mortgage market, so what do we mean when we talk about a new regime for bank assets? Jay Bacow: Fundamentally, when you think about the business model of a bank, if you're going to simplify it, it's they get deposits in and then they either make loans or buy securities with those deposits and they try to match up their assets to liabilities. Now, in a world where there's a lot more deposit outflows and happening more frequently, banks are going to have to have shorter assets to match that. And as they have shorter assets, that means they're going to have tighter lending conditions, and that tighter lending conditions is presumably going to play into the credit availability that you're looking for in your space. Jim Egan: And when we combine that with affordability that's no longer deteriorating, but still challenged, supply that's no longer setting record lows each month, but still very tight. All of that is a world in which we don't think you're going to see significant increases in transaction volumes. I will say one thing on the home price front month-over-month increases are back. We've seen some seasonality from a home price perspective, but we still think that that year over year number is going to soften going forward. It remains positive in the cycle, but we think it will turn negative in the next few months for the first time since the first quarter of 2012. We don't think those year-over-year drops will be too substantial. Our base case forecast for the end of the year is down 4%, we think it will be a little bit stronger than that down 4% number, but we think it will be negative. Jay Bacow: Okay. But I like things to be a little bit stronger. And with that, Jim, always great talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app and share the podcast with a friend or colleague today.

23 Touko 20236min

Though the current market narrative has turned bullish, it may not withstand a downturn in earnings.----- 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, May 22nd at 11a.m in New York. So let's get after it. For the past six months, the S&P 500 has been trading in a narrow range with strong rotations under the surface. When we turned tactically bullish on the index last October at 3500, we did so because the price had reached an attractive level and we believed rates and the dollar were topping. When we exited that trade at 4100 in early December, the price was no longer attractive, given our view that 2023 earnings estimates were materially too high. Fast forward to today and the index is showing some signs that it wants to break higher, even though our concerns remain. The primary difference from the early December highs is that we now have dramatically different leadership. Back then the leaders were energy, materials, financials and industrials, while technology was the big laggard. Small caps were also doing much better and market breadth was strong. The bullish narrative centered around China's reopening, which would put a floor in for global growth. Today, breadth is very weak. Technology, communication services and consumer discretionary are the only sectors up on the year, and even those sectors are exhibiting narrow breadth. Yet investors are more bullish than in early December, or at least far less bearish. The bullish narrative today focuses on technology, specifically on artificial intelligence. While we believe artificial intelligence is for real and will likely lead to some great efficiency to help fight inflation, it's unlikely to prevent the deep earnings recession we forecast for this year. Last week's price action showed frenzied buying by investors who cannot afford to miss the next bull market. We believe this will prove to be a head fake, like last summer for many reasons. First, valuations are not attractive, and it's not just the top ten or 20 stocks that are expensive. The median price earnings multiple is 18 times, which is near the top decile the past 20 years. Second, a very healthy reacceleration is baked in the second half consensus earnings estimates. This flies directly in the face of our forecasts, which continue to point materially lower. We remain highly confident in our model, given how accurate it's been over time and recently. We first started talking about the oncoming earnings recession a year ago and received very strong pushback, just like today. However, our model proved to be quite prescient based on the results and is now projecting 20% lower estimates than consensus, for 2023. Third, the markets are pricing in 2 to 3 Fed cuts before year end without any material implications for growth. We think such an outcome is very unlikely. Instead, we think the Fed will only cut rates if we definitively enter into a recession or if credit markets deteriorate significantly.

22 Touko 20234min

While the U.S. economy looks to be on track for a soft landing in 2023, even the smallest of setbacks could spell trouble for the end of the year.----- Transcript -----Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our view around the soft landing for the U.S. economy. It's Friday, May 19th, at 10 a.m. in New York. Last year, we presented our outlook that 2023 would see a soft landing for the U.S. economy. This out of consensus view continues to be our base case expectation. And we looked at several key data points as evidence to support it, including the U.S. housing cycle, income and spending dynamics, the labor market and inflation. To start, economists have long said, "As goes housing, so goes the business cycle." And housing is a very important factor in our outlook for a soft landing. While the decline in housing activity has been record breaking from a national perspective, Morgan Stanley's housing strategists believe the cycle is bottoming. In our forecast, the big drag on economic growth from the housing correction should turn neutral by the third quarter of 2023, providing some cushion against the growth slowdown elsewhere. Second, the incoming data on U.S. income and consumer spending also support our expectation that the economy is slowing but not falling off a cliff. On the one hand, discretionary consumer spending is softening. On the other hand, income is the predominant driver of consumer spending, and even as wage growth continues to slow, our forecasted path for inflation suggests that real wages will finally turn positive in the middle of this year. Third, we look to labor market dynamics, and the April U.S. employment report provides ample evidence that the labor market is slowing but is also not headed for a cliff. The steady decline in job postings with still low unemployment rates since the middle of last year supports our soft landing view. And finally, we closely monitor inflation. The most recent April data suggests that core inflation continues to slowly recede, tracking in line with our forecasts, as well as the Fed's March projections. We think the incoming data continue to support a Fed pause at the June meeting, and after June we can see a wide range of potential outcomes for the policy rate. We expect a gradual slowing in core inflation that keeps the Fed on hold until March 2024, when it begins to normalize policy with quarter percent rate cuts every three months. To be sure, the possibility of a recession remains a concern this year amid banking pressures with unknown spillovers to the economy from tighter credit. Should credit growth slow more than expected, it would bring larger spillovers to investment, consumption and labor. Against this backdrop, we expect the U.S. economy to experience a sharp slowdown in the middle two quarters of the year, so even small hiccups could push us into a recession. We'll continue to keep you abreast of any new developments. 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.

19 Touko 20232min

Although markets remain calm for now, incoming developments across the debt ceiling, inflation and monetary policy could quite quickly turn the tide.----- 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, May 18th at 2 p.m. in London. A notable aspect of the current market is its serenity. Over the last 30 days, U.S. stocks have seen the least day-to-day volatility since December of 2021. It's a similar story for stocks in Europe or the movement of major currencies. Across key markets, things have been calm and investors have become more relaxed, with expectations of future volatility also in decline. But why is this happening? After all, major uncertainties around the path of inflation and central bank policy still exist. And the United States, the world's largest economy and most important borrower, still hasn't reached an agreement to keep borrowing by raising the debt ceiling, raising the risk, according to the U.S. Treasury secretary, of running out of money in less than a month. Well, we think a few things are going on. With the debt ceiling, we think this is a great example that real world investors genuinely struggle with pricing a binary, uncertain outcome. It's very challenging to put precise odds on what is ultimately a political decision and hard to quantify its impact. And further complicating matters, the conventional wisdom generally appears to be that any debt ceiling deal would only get done at the last possible moment. In short, investors are struggling, making big changes to their portfolio in the face of what is little better than a political guess and are finding it easier to wait, and hoping that more clarity emerges. I’d note we saw something very similar before the near-miss on the debt ceiling in 2011. Despite being extremely aware of the deadline back then, stocks moved sideways until the last possible moment in August of 2011, afraid of leaning too heavily in one direction before the event. Other factors are also in limbo. We're nearing the end of what was a reasonably solid first quarter earnings season and don't see larger disappointments arriving, potentially, until later in the year. And on our forecasts, the Federal Reserve just made its last rate hike of the cycle and is now on hold for the remainder of 2023. And volatility does have the tendency to be self-reinforcing. Low volatility often begets low volatility, and in turn drags down expectations of what future movements will look like. But importantly, this doesn't represent some form of clairvoyance, expectations about future levels of market volatility often deviate from what actually happens, in both directions. For now, markets remain calm. But don't assume that means investors have some special insight around the debt ceiling, inflation or monetary policy. Incoming developments across all of these areas can change the picture rather quickly. 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.

18 Touko 20233min

According to the Federal Reserve’s latest Senior Loan Officer Opinion Survey, small businesses may be the most vulnerable to banks tightening their lending standards.----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the takeaways from the Senior Loan Officer Opinion Survey. It's Wednesday, May 17th at 10 a.m. in New York. We've talked a lot about the effects of the turmoil in the regional banks on credit formation, on this podcast. We thought the ongoing liquidity pressures in the regional banking sector may lead to tighter lending standards, which will eventually translate into lower credit formation. The Senior Loan Officer Opinion Survey, conducted quarterly by the Federal Reserve, provides a window on bank lending practices, including the standards and terms for banks to make loans, as well as the demand for bank loans to businesses and households. The survey results published last week, reflect conditions during the first quarter of 2023 and provide a first glimpse on the effect of the regional banking turmoil on banks outlook for lending over the remainder of 2023. The survey showed that banks expect to tighten standards across all loan categories. Banks cited an expected deterioration in the credit quality of their loan portfolios, customer collateral values, a reduction in risk tolerance, concerns about bank funding costs, banks liquidity position and deposit outflows, as reasons for expecting to tighten lending standards over the rest of 2023. While standards for commercial and industrial, the so-called C&I loans, tightened only marginally, the demand for C&I loans fell to levels not seen since the great financial crisis. Even though lending standards only tightened marginally, the tightening came from some loan officers tightening standards considerably. Further, banks reported changes to their modalities of their lending quite substantially. For example, the spread on loans or their cost of funding broke above the pandemic period and entered levels last seen during the great financial crisis. Loan officers also changed credit lines to small businesses drastically, especially regarding the size and cost. They reduced the maximum size and maturity of credit lines, as well as increased collateral requirements and the cost of credit lines. For small businesses in the U.S., such credit tightening comes at a very difficult time. Small business optimism and the outlook for business conditions already deteriorated significantly over the past year, and small businesses acknowledge that the environment isn't conducive for expansion or CapEx. Why does this matter? As small businesses have continued to lower expectations of sales, there were also moderated plans to raise prices in the near term. We see this dynamic raising the risks of downside surprises to upcoming inflation data. Also worth noting that fewer small businesses describe inflation as their number one concern, in fact, more describe interest rates as the number one concern. One of the special questions in this quarter's survey pertained to commercial real estate, so-called CRE. Banks tightened lending standards across all categories of CRE loans. Action cited included, widening loan spreads, reducing loan to value, raising debt service covers ratios and reducing maximum loan sizes. These survey results are consistent with what we had been predicting. Volatility in the regional banking sector has resulted in lower credit formation, due to both lingering liquidity stress and regulatory changes to come. The former is already playing out and the latter is likely to weigh on economic growth over the long term. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

17 Touko 20233min

As investors attempt to find opportunities in an uncertain stock market, earnings disappointments and an ongoing debt ceiling debate loom overhead.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Tuesday, May 16th, at 1 p.m. in New York. So let's get after it. Having spent the last few weeks on the road engaging with clients from around the world, I figured it would be useful to share some thoughts from our meetings and to touch on the most often asked questions, concerns and pushback to our views. First, conviction levels are low, given broadly elevated valuations and a challenging macro backdrop. While many individual longs and shorts have worked well in the context of a buoyant S&P 500, the most favorite trades have largely played out and clients are having trouble finding the next opportunity. Small cap and low quality stocks have underperformed and we continue to see crowding into mega-cap tech and consumer staples stocks as safe havens in a deteriorating growth environment.Second, there isn't much interest in the S&P 500 as either a long or a short anymore. Most clients we speak with have given up on the idea of a big breakdown of the index level. Conversely, there are few who think the S&P 500 can trade much above 4200, which has proven to be a key resistance since the October lows. What has changed is that the floor has been raised, with the large majority of investors thinking 3800 is now unlikely to be broken to the downside. In short, the consensus believes the bear market ended in October, at least for the high quality S&P 500 and NASDAQ. Third, there is little appetite to dive back into the areas of the market that have significantly underperformed like regional banks, small caps and energy. Other deep cyclicals are also out of favor due to either extended valuation and high earnings expectations In the case of industrials, and recession risk in the case of materials. Instead, most clients we spoke with remained comfortably long, large cap tech stocks, especially given the group's recent outperformance. While consumer staples and other defensives have outperformed strongly since March, there's less confidence this outperformance can continue. Our take remains the same. The market is speaking loudly under the surface, with its classic late cycle leadership and extreme narrowness, it is bracing for further macro and earnings disappointments. However, it is not yet pricing these outcomes at the index level. Such is the typical pattern exhibited by equity markets until clearer evidence of an economic recession arrives, or the risks of one are fully extinguished. With our economist forecasting close to 0% growth this year for real GDP and just modest growth next year, valuations at full levels and several other risks in front of us, we suspect 4200 will hold to the upside as most clients suggest. However, we continue to hold a more bearish tactical view than most clients in terms of the downside risk given our earnings forecast. The majority of our fundamental debate with clients has been over earnings. More specifically, there is broad pushback to our view that margins have not yet bottomed. In addition, many clients do not think revenue growth can fall towards zero or go negative given the still elevated inflation across the economy. Our take is that while many companies have taken decisive cost action, including layoffs, they have not yet cut cost nearly enough for a zero-to-negative revenue growth backdrop. But the odds of such an outcome increasing, in our view, we find it notable that many investors are more sanguine today on the earnings backdrop than they were five months ago. Meanwhile, many clients are worried about the debt ceiling. Most believe it will get resolved, but not without some near-term volatility. However, the discussion has evolved, with many clients framing this event as a lose-lose for markets. Assuming the debt ceiling is not resolved before the Treasury runs out of money, market volatility is likely to pick up meaningfully. Conversely, if the debt ceiling is lifted before the Treasury runs out of money, it will likely come with some concessions on the spending front, which could be a headwind for growth. Secondarily, such an outcome will lead to significant, pent up issuance from the Treasury to pay its bills and rebuild its reserves. This issuance from Treasury, could approach $1 trillion in the six months immediately after the ceiling is lifted, and potentially present a materially tightening to liquidity that could tip the S&P 500 back to the downside. To summarize, clients are less bearish on earnings than we are, although most are still fundamentally cautious on growth in the economic backdrop. Given the resilience in the large cap indices and leadership from perennially favored companies this year, many investors are now convicted that the equity market can look through a mild economic or earnings recession at this point. We think this is a very challenging tactical setup should growth or liquidity deteriorate as we expect over the next few weeks and months. We maintain our well below consensus earnings estimates for this year and believe narrow breadth and defensive leadership support our view that this bear market is yet to be completed, especially at the index level. Defensively oriented companies with a focus on operational efficiency should continue to outperform, especially if they exhibit true pricing power. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate the review us on the Apple Podcasts app. It helps more people to find the show.

16 Touko 20234min

Original Release on April 20th, 2023: "Smart chemotherapy" could change the way that cancer is treated, potentially opening up a $140 billion market over the next 15 years.----- Transcript -----Welcome to Thoughts on the Market. I'm Mark Purcell, Head of Morgan Stanley's European Pharmaceuticals Team. Along with my colleagues bringing you a variety of perspectives, today I'll talk about the concept of Smart Chemotherapy. It's Thursday, the 20th of April at 2 p.m. in London. Cancer is still the second leading cause of death globally, accounting for approximately 10 million deaths worldwide in 2020. Despite recent advances in areas like immuno-oncology, we still rely heavily on chemotherapy as the mainstay in the treatment of many cancers. Chemotherapy originated in the early 1900s when German chemist Paul Ehrlich attempted to develop "Magic Bullets", these are chemicals that would kill cancer cells while sparing healthy tissues. The 1960s saw the development of chemotherapy based on Ehrlich's work, and this approach, now known as traditional chemotherapy, has been in wide use since then. Nowadays, it accounts for more than 37% of cancer prescriptions and more than half of patients with colorectal, pancreatic, ovarian and stomach cancers are still treated with traditional chemo. But traditional chemo has many drawbacks and some significant limitations. So here's where "Smart Chemotherapy" comes in. Targeted therapies including antibodies to treat cancer were first developed in the late 1990s. These innovative approaches offer a safer, more effective solution that can be used earlier in treatment and in combination with other cancer medicines. "Smart Chemo" uses antibodies as the guidance system to find the cancer, and once the target is reached, releases chemotherapy inside the cancer cells. Think of it as a marriage of biology and chemistry called an antibody drug conjugate, an ADC. It's essentially a biological missile that hones in on the cancer and avoids collateral damage to the healthy tissues. The first ADC drug was approved for a form of leukemia in the year 2000, but it's taken about 20 years to perfect this "biological missile" to target solid tumors, which are far more complex and harder to infiltrate into. We're now at a major inflection point with 87 new ADC drugs entering development in the past two years alone. We believe smart chemotherapy could open up a $140 billion market over the next 15 years or so, up from a $5 billion sales base in 2022. This would make ADCs one of the biggest growth areas across Global Biopharma, led by colorectal, lung and breast cancer. Large biopharma companies are increasingly aware of the enormous potential of ADC drugs and are more actively deploying capital towards smart chemotherapy. It's important to note, though, that while a smart chemotherapy revolution is well underway in breast and bladder cancer, the focus is now shifting to earlier lines of treatment and combination approaches. The potential to replace traditional chemotherapy in other solid tumors is completely untapped. A year from now, we expect ADC drugs to deliver major advances in the treatment of lung cancer and bladder cancer, as well as really important proof of concept data for colorectal cancer, which is arguably one of the biggest unmet needs out there. Given vastly improved outcomes for cancer patients, we believe that "Smart Chemotherapy" is well on the way to replacing traditional chemotherapy, and we expect the market to start pricing this in over the coming months. Thanks for listening. If you enjoy this show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

15 Touko 20233min

With technology evolving rapidly in education, investors are taking a closer look at how it will financially impact the global education market. Stephen Byrd and Josh Baer discuss.----- Transcript -----Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research. Josh Baer: And I'm Josh Baer from the U.S. Software Team. Stephen Byrd: On the special episode of the podcast will discuss the global education market. It's Friday, May 12th at 10 a.m. in New York. Stephen Byrd: Education is one of the most fragmented sectors globally, and right now it's in the midst of significant tech disruption and transformation. Add to this, a number of dynamically shifting regulatory and policy regimes and you have a complex set up. I wanted to sit down with my colleague Josh to delve into the intersection of the EdTech and the sustainability side of this multi-layered story. Stephen Byrd: So, Josh, let's start by giving a snapshot of global education technology, particularly in this post-COVID and rather uncertain macro context we're dealing with. What are some of the biggest challenges and key debates that you're following? Josh Baer: Thanks, Stephen. One way that I think about the different EdTech players in the market is through the markets that they serve. So in the context of education, that means early learning, K-12, higher ed, corporate skilling and lifelong learning. The key debates here come down to what it usually comes down to for equities, growth and margins. So on the growth side, there's several conversations that we're constantly having with investors. Some business models are exposed to academic enrollments as a driver. To what extent would a weaker macro with higher unemployment lead to stronger enrollments given their historical countercyclical trends? And enrollments have been pressured as current or potential students were attracted to the job market. And on the margin side, some of the companies that we follow in the EdTech space, they're the ones that were experiencing very rapid growth during COVID and investment mode to really capture that opportunity. And so investors debate the unit economics of some of these business models and really the trajectory of margins and free cash flow looking ahead. One other more topical debate, the impact of generative A.I. on education, and maybe we'll hit on that topic later. Josh Baer: Stephen, why do these debates matter from the point of view of ESG, environmental, social and governance perspective? Why should investors view global education through a sustainability lens? Stephen Byrd: Yeah Josh I'd say among sustainability focused investors, typically the number one topic that comes up within the education sector is inequality. So higher education is a key pillar of economic development, but social and economic problems can arise from limited access. Unequal access to education can perpetuate all forms of socioeconomic inequality. It can limit social mobility, and it can also exacerbate health and income disparities among demographic groups. It can also restrict the potential talent pool and diversity of backgrounds and ideas in different academic fields, leading to all kinds of negative economic implications for both growth and innovation. While progress has been made in increasing enrollment among underrepresented students, significant disparities remain in admission and graduation rates. For investors and public equities, I think one of the more useful tools in our note is a proprietary framework that measures sustainability impact. Now that tool is really primarily rooted in the United Nations Sustainable Development goal number four, which lays out targets in education. This framework is rooted in the premise that I mentioned earlier. The COVID-19 pandemic has exacerbated multiple challenges in education. So when we think about business models that we really like, we're focused on models that can improve the quality of student learning, enhance institutions' operations and increase access and affordability. And we think our stocks that we selected really do meet those objectives quite well. Stephen Byrd: Josh, what is the current size of the EdTech and education services markets and why invest now? Josh Baer: First, on the size of the market, we see global education spend of 6 trillion today going to 8 trillion in 2030. So that's a CAGR below the growth of GDP, but we do see faster growth in EdTech. So there's really compelling opportunities for consolidation in the fragmented education market broadly and for EdTech growing at a double digit CAGR, so much faster than the overall education market. Why invest in EdTech? Well, as just mentioned, EdTech addresses these very large markets. It's increasing its share of education spend because it's aligned to several secular trends. So I'm thinking about digital transformation of the entire education industry. The shift from in-person instructor led training to really more efficient or economic online or digital learning. And positives from this shift, as you mentioned, include better scalability, affordability, global access to really high quality education. These EdTech companies are aligned to corporate skilling, which are aligned to companies, strategic goals, digital transformation initiatives. And then from a stock perspective, there's really low investor sentiment broadly and of course, the exposure to ESG trends around inclusion, skilling, education, access. Josh Baer: And Stephen, what is the regulatory landscape around global education and EdTech, both in the U.S. and in other regions? Stephen Byrd: So education policy is not really featured heavily in recent sessions of Congress in the U.S., as it tends to develop at more local levels of government than really at the federal level. The federal government in the United States provides less than 10% of funding for K through 12 education, leaving most of regulation and funding to state and local governments. Now, that said, there have been a few large education policy focused bills enacted into law since the establishment of the U.S. Department of Education in the second half of the 20th century. The most recent was in 2015, when President Obama signed the Every Student Succeeds Act, which granted more autonomy to states to set standards for education that vary based on local needs. In Brazil, there's some really interesting developments that we're very focused on. The Ministry of Education began loosening the rules for distance learning in 2017 to compensate for the lack of public funding and affordability. This was a new modality that didn't depend on campuses and was much cheaper for students. So companies saw this as the next growth opportunity and started investing in digital expansion, especially after COVID-19 lockdowns forced the closure of campuses. Distance learning grew rapidly and surpassed the number of on campus enrollments in 2021. Despite the increase in addressable market, this potential cannibalizes is part of the demand for in-person learning and reduces average prices in the sector. Lastly, in Europe, the European Union has set seven key education targets that it is hoping to achieve by 2025. And by 2030 on education and training. Let me just walk through a couple of the big targets here. By 2025, the goal is to have at least 60% of recent graduates from vocational education and training, that should benefit from exposure to work based learning during their vocational education and training. By 2030, the goal is for less than 15% of 15 year olds to be low achievers in reading, mathematics and science, as well as less than 15% of eighth graders should be low achievers in computer and information literacy. Stephen Byrd: Josh, how are emerging technologies like artificial intelligence and virtual reality disrupting the education space, both in the classroom and in cyberspace? How do you assess their impact and what catalysts should investors watch closely? Josh Baer: Great question. Investors are hyper focused on all the generative A.I. hype, all the risks and opportunities for EdTech. And it's important to remember that all EdTech companies serve different markets and they have different business models and they provide varying services and value to all those different markets. And so there's a wide spectrum from risk to opportunity, and in actuality, I think many businesses will actually have both headwinds and tailwinds from A.I. At the core, the question is not, will generative A.I. change education and learning, but how will it change? And from the way it may change, from the way education content is created and consumed, to the experience of learning and teaching and testing and studying. And on one end of the spectrum, investors should also look for signs of disruption, disruption to the publisher model or tutoring services or solutions, look for signs of students that may meet their learning needs or studying needs with generative A.I. instead of existing solutions. But from an innovation perspective, I think investors should look for new entrants and incumbents to leverage generative A.I. to really enhance the future of education, from personalized and efficient content creation to more adaptive assessments and testing, to more customized learning experiences. And these existing platforms, they're the ones that own vast datasets, really rich taxonomies of learning and skills. And I think those are the ones that are well-positioned to use A.I. technology to vastly improve their capabilities and the education market. Investors can also look for a more direct revenue opportunities, as the EdTech platforms are the platforms that will be teaching and reskilling and upskilling the whole world on how to use these innovative technologies, today and in the future. Stephen Byrd: Josh, thanks for taking the time to talk. Josh Baer: Great speaking with you, Stephen. Stephen Byrd: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts, and share the podcast with a friend and colleague today.

12 Touko 20239min