Private vs. Public Credit Competition Intensifies

The Federal Reserve continues to face a host of uncertainties, leading to volatility in the Treasuries market. This trend may lead some investors to reconsider the municipal bond market.----- Transcript -----Welcome the Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, February 2nd at 10 a.m. in New York. A couple weeks back, we focused on the tough job ahead for the Federal Reserve. It's grappling with an uncertain inflation outlook driven by unprecedented circumstances, including the trajectory of the pandemic, and the still unanswered questions about whether supply chain bottlenecks and swelling demand by U.S. consumers for goods over services have become a persistent economic challenge. Against that backdrop, it's understandable that keeping open the possibility of continued revisions to monetary policy is part of the Fed's strategy. Not surprisingly, that uncertainty has translated to volatility in the Treasury market and, as expected, some fresh opportunity for bond investors.For that, we looked in the market for municipal bonds, which are issued by state and local governments, as well as nonprofits. Credit quality is good for munis as the combination of substantial COVID aid to municipal entities and a strong economic recovery have likely locked in credit stability for 2022. But until recently, the price of munis was quite rich, in part reflecting this credit outlook, an expectation of higher taxes that would improve the benefit of munis tax exempt coupon, and a recent track record of low market volatility. But the bond market's reaction to the Fed undermined that last pillar, resulting in muni mutual fund outflows and, as a result, a move lower in relative prices for muni versus other types of bonds.While this adjustment in valuations doesn't exactly make munis cheap, for individuals in higher tax brackets, they're now looking more reasonably priced. And, as a general rule of thumb, when the fundamentals of an investment remain good, but prices adjust for purely technical reasons, that's a good signal to pay attention.So what does this mean for investors? Well, that fed driven volatility isn't going away, so munis could certainly still underperform some more from here. But for a certain type of investor, we wouldn't let the perfect be the enemy of the good. If you're in a higher tax bracket and need to replenish the fixed income portion of your portfolio, it could be time to curb your caution and start adding back some muni exposure.Thanks for listening! If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

2 Helmi 20222min

The European Central Bank has indicated it would not raise rates this year, but markets are not fully convinced as shifts in inflation, gas prices and labor could force the ECB to reconsider.----- Transcript -----Welcome to Thoughts on the Market. I am Reza Moghadam, Morgan Stanley's chief economic adviser. Along with my colleagues, we bring you a variety of market perspectives. Today I'll be talking about the European Central Bank and whether it is likely to follow the Federal Reserve and the Bank of England in raising interest rates this year. It is Tuesday, February 1st at 2:00 p.m. in London. The European Central Bank, or the ECB, has long said it would not raise interest rates until it has concluded its bond purchase program. Since the ECB only recently announced that its taper would take at least till the end of this year to complete, this in theory rules out rate increases in 2022. The ECB president, Madame Lagarde, has reiterated that rate increases this year are "highly unlikely." However, the market is not fully convinced and is pricing some modest rate hikes. Many investors are also concerned that inflation could prove higher and more persistent than the ECB is projecting and could force it to follow the Fed and the Bank of England in tightening policy. We should start by recognizing that euro area inflation is nowhere near as high as in the United States, and expectations of longer-term inflation are below 2% - unlike in the US. Labor market conditions are easier, with low and stable wage growth. But even if the case for tightening is not as clear cut, this does not preclude a preemptive move by the ECB. Whether it does so will hinge on the continued viability of the ECB's inflation projections, which see inflation falling below its 2% target by the end of the year. It is too early to conclude that this inflation path has become too optimistic. Certainly, the second-round effects of recent high inflation outcomes - on wages and long-term inflation expectations - has so far been moderate. But this could change, and we would keep an eye on three triggers that might force a reconsideration. First, long-term inflation expectations. If perceptions start to drift up in the face of chronic supply shortages and higher gas prices, the process risks becoming a self-fulfilling prophecy, and un-anchoring inflation expectations. The ECB will want to nip this in the bud. Second, gas prices have jumped in the face of supply shortages and geopolitical tensions in Ukraine. Normally, the ECB looks through energy prices - not only because they are usually temporary, but also because, even when permanent, they imply a higher price level - not permanently higher inflation. But evidence of energy prices finding their way into long term inflation expectations could force action. Third, the current benign labor market situation could tighten. In that case, the ECB would want to react before the process goes too far. So if the ECB decides to tighten policy, what would that look like, and when could we expect it? A faster taper is the most likely vehicle for tightening monetary policy. Still, if inflation proves more resilient than currently projected, rate hikes while tapering cannot be definitively ruled out. We see limited risk of a policy shift at the ECB meeting later this week. There could be some action in March, but we expect this to be more likely in June, when there will be a fresh forecast and some hard data to base decisions on. So stay tuned. Thank you for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on Apple Podcasts. It helps more people find the show.

2 Helmi 20224min

Investing strategies can be categorized into two broad categories: subjective and systematic. While some prefer one over the other, the best outcomes are realized when they are used together.----- 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 Monday, January 31st at 2:00 p.m. in London.There are as many different approaches to investing as there are investors. These can generally be divided into two camps. In one, which I'll call ‘subjective,’ the investor ultimately uses their own judgment and expertise to decide what inputs to look at, and what those inputs mean.Reasonable people often disagree, what variables matter and what they're telling us, which is why at this very moment you can find plenty of very smart, very experienced investors in complete disagreement over practically any investment debate you can think of.A lot of the research that myself and my colleagues at Morgan Stanley do fall into this more subjective camp. We're constantly in the process of trying to decide which variables matter and what we think these mean. But there's another approach which I'll call ‘systematic.’ Systematic investing is about writing down very strict rules and then following them over and over again, no matter what, with no leeway. Think of it a bit like computer code, if A happens - I will do B.The advantage of this systematic approach is that it isn't swayed by fear, or greed, or any other weaknesses in human psychology. The drawbacks are that very strict rules may not be flexible enough to adjust for genuine changes in the economy, in markets, or large, unforeseen shocks like a global pandemic. Think about it this way: Autopilot has been a great technological innovation in commercial aviation, but we all still feel much better knowing that there is a human at the controls that can take over if needed.I mention all this because alongside our normal subjective research, we also run a systematic approach called our Cross Assets Systematic Trading Strategy, or CAST. CAST looks at what data has historically been most meaningful to market returns, and then makes rule-based recommendations on where that data sits today.For example, if the key to investing in commodities historically has been favoring those with lower valuations, higher yields, and stronger recent price performance, CAST will look at current commodities and favor those with lower valuations, higher yields, and stronger recent price performance. And it will dislike commodities with the opposite characteristics. CAST then applies this thinking across lots of different asset classes and lots of different characteristics of those asset classes. It looks at equities, currencies, interest rates, credit and, of course, commodities.At the moment there are a number of areas where our systematic approach CAST and are more subjective strategy work, are in agreement. Both approaches see US assets underperforming those in the rest of the world. Both expect European stocks to outperform European bonds to a large degree. Both see higher energy prices, and both see underperformance in mortgages and investment grade credit spreads.When thinking about systematic versus subjective investment strategy, there's no right answer. But like our pilot analogy, we think things can work best when human and automated approaches can complement each other and work with each other.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.

31 Tammi 20223min

Consumer prices reached an all-time high this past December, and a new year brings new challenges across inflation, wage growth and interest rates.----- Transcript -----Ellen Zentner Welcome to Thoughts on the Market. I'm Ellen Zentner, Chief U.S. Economist for Morgan Stanley Research. Sarah Wolfe And I'm Sarah Wolfe, also on Morgan Stanley's U.S. Economics team. Ellen Zentner And on this episode of the podcast, we'll be talking about the outlook for consumer spending in the face of inflation, Omicron, rising interest rates and other headwinds. It's Friday, January 28th at 10:00 a.m. in New York. Ellen Zentner So Sarah, as most listeners have observed since the Fall, inflation is on everyone's mind, with consumer prices reaching a 39-year high in December, and we're forecasting inflation to recede throughout this year from about 7% now down to 2.9% by the fourth quarter. But let's talk about right now. Ellen Zentner So, you've got your finger on the pulse of the consumer. You're a consumer specialist on the team. And so, I want to ask, how quickly have consumers adjusted their spending over the past few months because of inflation? What evidence have we seen? Sarah Wolfe The consumer buying power has been very resilient in the face of high inflation. This week we got the fourth quarter GDP data and we saw the real PCE expanded by 3.3%. So that is another very strong quarter for consumer spending. And that brings spending to nearly 8% year over year in 2021, so very elevated. However, we are beginning to see that consumers may be reaching the upper echelon of their price tolerance in December. We got the retail sales report a couple of weeks ago for December, and we saw a very large contraction in consumer spending declined by more than 3%, and the decline was pretty broad based across all categories that have seen very high inflation, and this is largely reflective of goods spending. So, this is a pretty clear signal to us that while Omicron may be weighing on spending, inflation is largely at play here. And we still expect inflation to be peaking in January and February, so we likely will see some deterioration in consumer spending as we enter the first quarter of 2022. Ellen Zentner How weak could consumer spending be this quarter? Sarah Wolfe Right now, we just started our tracking for the first quarter of 2022 at 1.5% GDP growth, but within that, we have 1-2% contraction in real PCE. I will note that inflation's high so nominal PCE is still tracking positive, but it's not looking very good as we enter the first quarter. Ellen Zentner Yeah, it seems clear that inflation is taking a bite. And remind me, we have this great consumer pulse survey that we've been putting out, and I think it was back in November, right? That the people were actually saying, "Look, I'm more worried about inflation than Omicron or than COVID 19". And that's incredible. I mean, that's a pandemic that's been weighing on people's minds and yet inflation usurped. Sarah Wolfe We're also seeing it in the consumer sentiment surveys. The University of Michigan surveys inflation expectations each month. Near term inflation expectations have reached all-time highs. They're at 4.9%, and we're starting to see longer term expectations also start to tick up. In January, they hit 3.1%, which is a high since 2011. So, it's definitely being felt by consumers and causing a lot of uncertainty among them as well. Ellen Zentner But now, because we have this forecast that inflation is going to peak in February, which is data we have in hand in March, if we're right on that, can that give us a lot of confidence that at least households can see that there's light at the end of the tunnel and start to breathe a sigh of relief? Sarah Wolfe Yeah. As you mentioned, there are few headwinds facing the consumer right now. We think most of them are going to recede by the end of the first quarter. Ellen Zentner Another big change for the consumer versus last year, that you've been writing about is the roll off of government stimulus for a lot of Americans. That had really helped bolster consumer spending, getting us to that big growth rate in 2021 that you mentioned. But now that that's rolling off, what impact might it have on spending this year? Sarah Wolfe So, the big impact to spending is going to be felt this quarter in the beginning of 2022. And that's for two reasons. The first is that the child tax credits have come to an end. That did not get extended because the Build Back Better plan was not passed in time. and the child tax credits were boosting income for lower, middle-income households by $15B a month. And that included $300-360 payments per child per month. A lot of that was going straight into spending, food, other essential items, school supplies. So, we're going to get a level shift down in income and spending in January alone just because of the expiration. So, the other reason that first quarter is going to be hard for consumers is because a lot of the stimulus came through one year ago in 1Q21. That's when we got the $600 checks per person, then the $1400 checks and then also the supplemental $300 unemployment insurance benefit. So, when you're looking at income and spending year over year, especially for lower middle-income households, this is going to be a tough quarter. Ellen Zentner All right. So that's a lot of stimulus that came in, not just over 2020, but all the way into early 2021. So, does that mean that they spent all of that money that they got? Because you've been writing a lot about this idea of an excess savings. So, what do you mean by that? How do we define excess savings? Who's holding that excess savings, and can it make its way into the economy? Sarah Wolfe So, to define what excess savings is, it's basically cumulative savings above the pre-COVID savings trend. And how does that compare to the savings rate? The savings rate is just a monthly snapshot of income and spending, but excess savings is looking at how much is building up over time. And so excess savings, as many have heard this number, was over $2T throughout 2020 and 2021. We have data that shows that some of it was held all the way across the income distribution, but 80% of that was held among the top 20%. And so, a lot of that excess savings is still sitting with the wealthiest people. Sarah Wolfe What about the excess savings for lower income people? It's a smaller dollar amount, and for that reason, it just does not go as far. We have been dealing with, I mentioned, with six to eight months of high inflation. We've seen consumer spending throughout all of this high inflation. And part of that was likely driven by the drawdown in excess savings for lower income households. And so, when I think about spending for 2022, excess savings is not the main driver. Ellen Zentner So in this battle that households have with inflation, right? You got excess savings. There's a lot of uncertainty around how and when that might filter into the economy. And so, it seems that in the face of higher inflation then it makes labor income all that much more important. So, when you're looking at income or prices, how do you weigh that tug of war? Sarah Wolfe So it's OK if prices are going up as long as wages are going up by more. And so, people continue to spend. What we're seeing in the data right now is that, on net, real wages are negative. I mean, we're dealing with 7% inflation. However, and this is very important, real wages for the lowest income group are actually positive. They're the group that's seen the strongest wage growth and it actually is outpacing inflation. I say this is really important because of all we have discussed. The rolling off of fiscal stimulus - this is a group that gets hurt the most by that. Inflation - this is also the group that gets hurt the most by that. When we think about the spending bucket of lower middle-income households, most of their spending goes to essential items like food, energy and shelter. Energy prices alone have increased by over 8% in the last three months. Sarah Wolfe So, seeing real wage growth is very important, and we expect real wages to enter a positive territory for middle- and higher-income households as well as we enter mid 2022, and inflation comes down to about 4% or so. Ellen Zentner Yeah, so for those of you not able to see us, Sarah rolls her eyeballs when she says "come down to 4%" because that's still such a high rate of inflation. But it is quite a few percentage points lower than where we've peaked. So, it's really about the direction. Households can start to breathe a sigh of relief that indeed this is not some sort of permanently higher inflation and ultimately just that labor market improvement, remains the most important piece of the consumer spending outlook. Would you agree? Sarah Wolfe I would agree. Fundamentally, income is what drives spending and a large chunk of income is labor compensation. So as long as we're seeing job gains and wage growth outpacing inflation, we should continue to see spending as we move through a tough first quarter. Ellen Zentner But importantly, we've got to be right on those inflation forecasts. You know, finally, let me just say a couple of things about the Fed's meeting here. So, we do believe that the Fed has laid the groundwork to start raising rates in March, and so higher interest rates are meant to slow activity and specifically through the credit channel, right? They're going to raise the cost of access to credit this year. But in terms of, sort of what contributes most to, say, downturns when the Fed is tightening is the interest expense on the household balance sheet, right? All that debt we carry, which is a tremendous amount, that interest expense rises. So, should we be worried about household balance sheets in this environment because the Fed is going to be raising rates? Sarah Wolfe Yeah, I mean, households are carrying over $14T in debt, but things are not as bad as they sound. 70% of household debt is in mortgages and another 10% is in auto debt. And luckily, those are largely locked in at fixed rates. 90% of mortgages are at fixed rates, so that alone is 68% of the household balance sheet. Sarah Wolfe So, the picture looks better on net for households. Obviously, you need to be a homeowner for it to be in that fixed rate. So, there are non-homeowners that are more susceptible to changing rates. So, people that are holding more credit card debt, that's more lower income people. So that is the group that's going to be the most affected by a raising rates environment. Ellen Zentner Right. Good point. And so, it's even more important that we keep the labor market strong and wage growth strong for those lower income cohorts. Ellen Zentner So we've talked a lot about the consumer, Sarah, but I could do this all day long. So, thanks for taking the time today. Sarah Wolfe It was great talking with you, Ellen. Thanks for having me on. Ellen Zentner 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.

28 Tammi 202210min

Despite two good years for Treasury Inflation-Protected Securities, or TIPS, a dramatic rise in real yields may be cause for investors to reexamine their potential for 2022.----- 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, January 27th at noon in New York. Today, I want to talk about the Treasury market, and I want to get real. Yields on Treasury notes and bonds have risen dramatically to start the year, but real yields have risen more. What are "real yields"? Let me start by assuring you that yields on regular Treasury notes and bonds aren't fake. They are very real, but not in the same way as yields on Treasury inflation-protected securities. Those inflation-protected bonds, known as TIPS, offer investors an inflation-adjusted yield. You can think about an inflation-adjusted yield as having two parts. The first part is a yield without an inflation adjustment. That's what we call the real yield. And the second part is a yield that adjusts for inflation. So, if the rate of inflation is positive, you get more than just the real yield. Last year, a lot of investors bought TIPS because inflation was high and rising. The news media covered the topic of inflation like never before in my career. So, buying a security that offered inflation protection would have made sense last year. Consumer prices rose 7% over the year, and the TIPS index returned almost 6%. So that investment strategy worked out. But, did you know that TIPS returned almost 11% in 2020, when consumer prices only rose 1.4%? That's right. TIPS were a much better investment in 2020, when there was less inflation than there was in 2021. How could that be? Well, remember the real yield that TIPS offer investors? That yield can be a very important contributor to the total return of TIPS. And, at times, it can be even more important than the yield that adjusts for inflation. Over the past couple of years, the real yields that TIPS have offered investors have been negative. So, imagine if there hadn't been any inflation over these past two years. An investment in TIPS might have been a bad one because investors would have been left with nothing but a negative yielding bond. Of course, the yield on a bond is just one factor in driving the total return that investors receive. The other is capital gain - or loss. And the change in yields over time drive capital gains or losses. If bond yields fall, bond prices rise and that improves total returns. But if bond yields rise, well, falling prices hurt total returns. And the same applies to the real yield on TIPS. Rising real yields hurts the total return of TIPS and can do so even during periods of high inflation, like today. The period since last Thanksgiving is a perfect example: inflation continued to surprise to the upside, but the real yield on 10-year maturity TIPS rose by over half a percentage point. As a result, TIPS delivered a negative total return of 3.5% during this period. This should be a valuable lesson for TIPS investors. TIPS aren't just about inflation protection, although they do offer more inflation protection than most other bonds. TIPS perform best when inflation is high and rising, and real yields are stable or they're falling. We saw that environment in 2020 and through most of 2021. But things have started to change. We expect real yields to keep rising this year and our economists expect inflation to fall. That means investors should get less yield that adjusts for inflation while having to cope with capital losses from rising real yields. It would be the worst combination for TIPS performance and stand in quite a contrast to the past two years. So our advice is to stop thinking about TIPS as just protecting against inflation. Instead, investors should think about how TIPS performance could be impacted by higher real yields. And as the Fed raises interest rates this year, real yields should rise and hurt the performance of TIPS. Thanks for listening. And 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.

27 Tammi 20224min

2022 is likely to bring fresh challenges for the U.S.-China dynamic. Investors can expect an increase in non-tariff barriers and continued commitment to re- and near-shoring of supply chains in the US.----- 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 26th at 10:00 a.m. in New York. While the ongoing situation between the Ukraine and Russia remains an obvious geopolitical risk to pay attention to, we shouldn't lose sight of the ongoing developments in the relationship between the U.S. and China. There's plenty of reason to expect that, in 2022, the two countries’ economic relationship - perhaps the most consequential in the world - will face fresh challenges. From the US's perspective, there's unfinished business. For example, the 'phase one' trade deal, signed back in January of 2020, expired at the end of 2021, and the results fell short of the agreement. Per data from the Peterson Institute, China only purchased 62% of the manufactured products, 76% of the agricultural products and 47% of the energy products it had committed to. These stats likely won't change the perception of the American voter, where issue polls show a bipartisan consensus that the U.S. relationship with China continues to be a problematic one. And since 2022 is a midterm election year, don't expect U.S. policymakers to stand pat on the issue. So what can we expect? We've covered before how the U.S. has, and likely will continue, to raise non-tariff barriers with China - things like export controls around sensitive technologies and investment restrictions. These deployments will continue to make for a more challenging environment for U.S. companies seeking easy access to China's markets, either to sell or produce goods. But one thing you can also expect is fresh legislative action to invest in the US's capabilities in key industries and supply chains that have been declared essential for economic and national security purposes. For example, news broke this week that the U.S. House of Representatives was starting its work to advance the U.S. Innovation and Competition Act, or USICA. The bill passed the Senate last year with substantial bipartisan support and would spend over $200B on research in artificial intelligence, quantum computing and biotechnology, in addition to cultivating local supply chain sources for key tech needs, like rare earths. This dynamic underscores a trend we've been focused on for many years. The slow but steady re and near shoring of supply chains for U.S. companies. It's a key reason our colleagues in equity research continue to see an opportunity in the capital goods sector, calling for a 'generational capex cycle over the next several years, driven by supply chain investment'. So stay tuned. We'll keep tracking this trend and keep you informed. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

27 Tammi 20222min

With inflation on the minds of consumers and the Fed reacting with a sharp turn towards tightening, 2022 may be a year for investors to focus on incorporating tax-efficient strategies into their portfolios. Morgan Stanley Wealth Management’s Chief Investment Officer Lisa Shalett and Chief Cross-Asset Strategist Andrew Sheets discuss.----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley Research.Lisa Shalett And I'm Lisa Shalett, chief investment officer for Morgan Stanley Wealth Management.Andrew Sheets And today on the podcast, we'll be discussing the importance of tax efficiency as a pillar of portfolio construction. It's Tuesday, January 25th at three p.m. in London.Lisa Shalett And it's 10:00 a.m. here in New York.Andrew Sheets Lisa, welcome back to the podcast! Now, as members of Morgan Stanley Wealth Management's Global Investment Committee, we both agree that the current portfolio construction backdrop is increasingly complicated and constrained. But tax considerations are also important, and this is something you and your team have written a lot on recently. So I'd really like to talk to you about both of these issues, both the challenges of portfolio construction and some of the unique considerations around tax that can really make a difference to the bottom line of investment returns. So Lisa, let's start with that current environment. Can you highlight why we believe that standard stock bond portfolios face a number of challenges going forward?Lisa Shalett We've been through an extraordinary period over the last 13 years where both stocks and bonds have benefited profoundly from Federal Reserve policy, just to put it bluntly, and, you know, the direction of overall interest rates. And so, our observation has been that, you know, over the last 13 years, U.S. stocks have compounded at close to 15% per year, U.S. bonds have compounded at 9% per year. Both of those are well above long run averages. And so we're now at a point where both stocks and bonds are quite expensive. They are both correlated to each other, and they are both correlated to a large extent with Federal Reserve policy. And as we know, Federal Reserve policy by dint of what appears to be inflation that is not as transitory as the Fed originally thought is causing the Fed to have to accelerate their shift in policy. And I think, as we noted over the last three to six weeks, you know, the Fed's position has gone from, you know, we're going to taper and have three hikes to we're going to taper be done by March. We may have as many as four or five hikes and we're going to consider a balance sheet runoff. That's an awful lot for both stocks and bonds to digest at the same time, especially when they're correlated with one another.Andrew Sheets And Lisa, you know, if I can just dive into this a little bit more, how do you think about portfolio diversification in that environment you just described, where both stocks and bonds seem increasingly linked to a single common factor, this this direction of Federal Reserve policy?Lisa Shalett One of the things that we've been emphasizing is to take a step back and to recognize that diversification can happen beyond the simple passive betas of stocks and bonds, which we would, you know, typically represent by, you know, exposures to things like the S&P 500 or a Barclays aggregate. And so what we're saying is, within stocks, you've got to really make an effort to move away from the indexes to higher active managers who tend to take a diversified approach by sector, by style, by market cap. And within fixed income, you know, we're encouraging, clients to hire what we've described as non-core managers. These are managers who may have the ability to navigate the yield curve and navigate the credit environment by using, perhaps what are nontraditional type products. They may employ strategies that include things like preferred shares or covered call strategies, or own asset backed securities. These are all more esoteric instruments that that hiring a manager can give our clients sources of income. And last, you know, we're obviously thinking about generating income and diversification using real assets and alternatives as well.Andrew Sheets And so, Lisa, one other thing you know, related to that portfolio construction challenge, I also just want to ask you about was how you think about inflation protection. I mean, obviously, I think a lot of investors are trying to achieve the highest return relative to the overall level of prices relative to inflation. You know, how do you think from a portfolio context, investors can try to add some inflation protection here in a smart, you know, intelligent way?Lisa Shalett So you know what we've tried to say is let's take a step back and think about, you know, our forecast for, you know, whether inflation is going to accelerate from here or decelerate. And you know, I think our position has broadly been that that we do think we're probably at a rate of change turning point for inflation, that we're not headed for a 1970s style level of inflation and that, you know, current readings are probably, you know, closer to peak than not and that we're probably going to mean revert to something closer to the, you know, two and a half to three and a half percent range sooner rather than later. And so in the short term, you know, we've tried to take an approach that says, not only do you want to think about real assets, these are things like real estate, like commodities like gold, like energy infrastructure linked assets that have historically provided some protection to inflation but really go back to those tried and true quality oriented stocks where there is pricing power. Because, you know, 2.5-3.5% Inflation is the type of inflation environment where companies who do have very strong brands who do have very moored competitive positions tend to be able to navigate, you know, better than others and pass some of that the cost increases on to consumers.Andrew Sheets So, Lisa, that takes me to the next thing I want to talk to you about. You know, investors also care about their return after the effects of tax, and the effects of tax can be quite complex and quite varied. So, you know, as you think about that challenge from a portfolio construction standpoint, why do you think it's critical that investors incorporate tax efficient investing strategies into their portfolios?Lisa Shalett Well, look, you know, managing, tax and what we call tax drag is always important. And the reason is it's that invisible levy, if you will, on performance. Most of our clients are savvy enough to suss out, you know, the fees that they're paying and understand how the returns are, you know, gross returns are diluted by high fees. But what is less obvious is that some of the investment structures that clients routinely use-- things like mutual funds, things like limited partnership stakes-- very often in both public and private settings, are highly tax inefficient where, you know, taxable gain pass throughs are highly unpredictable, and clients tend to get hit with them. And so that's, you know, part of what we try to do year in, year out is be attentive to making sure that the clients are in tax efficient strategies. That having been said, what we also want to do is minimize tax drag over time. But in a year like 2022, where you know, we're potentially looking at low single digit or even negative returns for some of these asset classes, saving money in taxes can make the difference between, you know, an account that that is at a loss for the full year or at a gain. So there's work to be done. There's this unique window of opportunity right now in the beginning of 2022 to do it. And happily, we have, you know, some of these tools to speed the implementation of that type of an approach.Andrew Sheets So Lisa, let's wrap this up with how investors can implement this advice with their investments. You know, what strategies could they consider? And I'm also just wondering, you know, if there's any way to just kind of put some numbers around, you know, what are kind of the upper limits of how much these kind of tax drags, you know, can have on performance?Lisa Shalett Yeah. So that's a great question. So over time, through the studies that we've done, we believe that tax optimization in any given year can add, you know, somewhere between 200 and 300 full basis points to portfolio performance, literally by reducing that tax bill through intelligent tax loss harvesting, intelligent product selection, you know, choosing products that are more tax efficient, et cetera.Andrew Sheets Well, Lisa, I think that's a great place to end it. Thanks for taking the time to talk. We hope to have you back soon.Lisa Shalett Absolutely, Andrew. Happy New Year!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.

26 Tammi 20228min

All eyes are on the Fed as they implement a sharp pivot to account for higher inflation being felt by consumers and businesses alike. With these shifts we turn our attention to the ‘Ice’ portion of our ‘Fire & Ice’ narrative: slowing growth.----- 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, January 24th at 11:30 a.m. in New York. So let's get after it. Investors have recently become fixated on the Fed's every move. That makes sense, with the Fed pivoting so aggressively on policy over the past few months. It also fits nicely with the first part of our well-established "Fire and Ice" narrative and our view that equity valuations are vulnerable. The reason for the Fed's sharp pivot is obvious, as inflation has overshot its goals - leading to problems for the real economy, not to mention the White House. When the Fed first announced its inflation targeting policy in the summer of 2020, it was appropriate given the deflationary effects of the pandemic. Therefore, it's now just as appropriate for the Fed to tighten at an accelerated pace to fight the inflation overshoot. However, this is a big change for a Fed that has been fighting the risk of deflation for 20+ years, and it has market implications. Importantly, consumers are truly starting to feel the impacts of inflation, with the University of Michigan Confidence Survey currently at levels typically observed only in recessions. Small businesses are also feeling the pain, as demonstrated by their difficulty finding employees and the prices that they are paying for supply and logistics. In short, the Fed is serious about fighting inflation, and it's unlikely they will be turning dovish anytime soon, given the seriousness of these economic threats and the political cover to take action. The good news is that markets have been digesting this tightening for months. Despite the fact that major U.S. large cap equity indices are only down 10-15% from their highs, the damage under the surface has been much worse for many individual stocks. Expensive, unprofitable companies are down 30-50%. This is appropriate, in our view, not just because the Fed is pivoting, but because these kinds of valuations don't make sense in any kind of investment environment. In short, the froth is coming out of an equity market that simply got too extended on valuation - the key part of our 2022 outlook published in November. But attention should now turn to the Ice part of our narrative - slowing growth. As we've been writing for months, we view the current deceleration in growth as more about the natural ebbing of the cycle than the latest variant of COVID. In fact, there are reasons to believe that we are closer to the end than the beginning of this pandemic. However, that also means the end of extraordinary stimulus, both monetary and fiscal. It also means looser supply chains as restrictions ease and people fully return back to work. Better supply is good for fighting inflation, but it may also reveal the degree to which demand has been supported and overstated by double ordering. This would fit nicely with the 1940s analogy that we have also detailed in our 2022 outlook. In brief, the end of the Second World War freed pent up savings and unleashed demand into an economy unable to supply it. Double digit inflation ensued, which led to the first Fed rate hike in over a decade and the beginning of the end of financial repression. Sound familiar? Shortly thereafter, inflation plummeted as demand normalized, but the Fed never returned to the zero bound on interest rates. Instead, we began a new era of shorter booms and busts as the world adjusted to the higher levels of demand, as well as cost of capital and labor. The end of secular stagnation and financial repression has arrived, in our view, but it won't be a smooth ride. In the near term, hunker down for a few more months of winter as slowing growth overtakes the Fed as the primary concern for markets. In such a world, we continue to favor value over growth, but with a defensive rather than cyclical bias. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

24 Tammi 20223min