Japan Summit: Consumer Resilience and Trade Uncertainty

As the U.S. government attempts to combat high gas prices by drawing on its oil reserves, investors should pay attention to the impacts on the U.S. economy and consumer behavior.----- 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, April 6th at 10 a.m. in New York.Last week President Biden announced the largest release of oil reserves in history, about 1 million barrels per day for the next 6 months from the government's Strategic Petroleum Reserve. The move is intended to put downward pressure on the price of gasoline by increasing the supply of oil, thereby relieving pressure on the American consumer from higher costs at the pump. Will it work? That remains to be seen, but investors should pay close attention, not just because it impacts their cost of driving, but also because it impacts the outlook for the U.S. economy by affecting how consumers behave.Our U.S. economics team, led by Ellen Zentner, has done some work worth highlighting here. The big takeaway is this; oil price shocks do dampen consumer activity, but not right away. The jump in oil prices seems to have to sustain itself before having a big impact. For example, consumption in real dollar terms seems to weaken after initial oil price increases, but it's not until 2 to 3 months after that shock that consumers start to buy less of other things in order to have enough money to pay the higher costs of filling up their cars. Looking at this effect on a specific product, for instance automobiles, you can see a similar pattern. Spending on cars doesn't seem to change in the first month after a price shock but drops almost 10% thereafter for 8 months.So the bottom line is this; the White House's move on releasing oil reserves has some time to play out. But if it doesn't reduce gas prices in the next couple months, then it becomes one cost pressure among several, including labor costs, that could start slowing the U.S. economy from its currently healthy pace. It's one reason our equity strategy team continues to see higher costs creating some pressure in key sectors of the stock market, notably consumer services, apparel and staples.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.

6 Huhti 20222min

Original Release on March 30th, 2022: As the Fed kicks off a new rate hiking cycle, investors are looking back at the previous hiking cycle to ease their concerns today. Head of Public Policy Research and Municipal Strategy Michael Zezas and Global Head of Macro Strategy Matthew Hornbach discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Matthew Hornbach: And I'm Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Michael Zezas: And today on the podcast, we'll be discussing the last Fed hiking cycle and what it might mean for investors today. It's Wednesday, March 30th at 11:00 a.m. in New York. Michael Zezas: Matt, we've recently entered a new Fed hiking cycle as the Fed deals with inflation. But it seems like clients have been focusing with you of late on the question of what drove the Fed during the last hiking cycle, where they paused their tightening and started to reverse course. Why is that something investors are focusing on right now? Matthew Hornbach: Well, Mike, investors are looking for answers about this hiking cycle, and a good place to start is the last cycle. The past week saw U.S. Treasury yields reach new highs and the Treasury curve flattened even more. Markets are now pricing Fed policy to reach a neutral setting this year of around 2.5%. The market also prices Fed policy to reach 3% next year. For context, the Fed was only able to raise its policy rate to 2.5% in the last cycle. So the fact that markets now price a higher policy rate than in the last cycle, after which the Fed ended up cutting interest rates, has people nervous. It's worth noting, though, that a 3% policy rate is still some distance below policy rates in the mid 1990s and the mid 2000s. Michael Zezas: Got it. So then, what do you think of the argument that the Fed may have over tightened in the last cycle? Matthew Hornbach: Well, instead of telling you what I think, let me tell you what FOMC participants were thinking at the time. I went back and read the minutes from the June 2019 FOMC meeting. That was the meeting before the Fed first cut rates, which they did in July. I chose to focus on that meeting because that's when several FOMC participants first projected lower policy rates. And according to the account of that decision, participants thought that a slowdown in global growth was weighing on the U.S. economy. In fact, evidence from global purchasing manager data showed that growth in emerging market and developed market economies was slowing, and was occurring well before the U.S. economy began to slow. And also, data suggested that global trade volumes were well below trend. So Mike, let me put it back to you then. It seems to me that Fed policy wasn't driving economic weakness back then, but that something else was driving this change in global economic activity. And I think, you know where I'm going with this... Michael Zezas: Yes, you're talking about the trade conflict between the U.S. and China, where from 2017 to 2019 there was a slow and then rapidly escalating series of tariff hikes between the two countries. It was a very public pattern of response and counter response, interspersed with negotiations and sharp rhetoric from both sides, eventually resulted in tariffs on hundreds of billions of dollars in traded goods. Now, those tariffs endure to this day, but the tariff hikes stopped in late 2019 after the two sides made a stopgap agreement. But even though this was just a few years ago and perhaps seems tame in comparison to the global challenges that have come up since, like the pandemic and now the Russia-Ukraine conflict, I think it's important to remember that at the time this was a big deal and created a lot of concern for companies, economists and investors. You have to remember that before 2017, the consensus in the US and most of Europe was that free trade was good, and anything that raised trade barriers was playing with fire for the economy. We'd often hear from clients that raising tariffs was just like Smoot-Hawley, the legislation in the U.S. that hiked tariffs in many textbooks credit as a key cause of the Great Depression. So, as the U.S. and China engage in their tariff escalation and in many ways demonstrate, at least on the U.S. side, that the political consensus no longer viewed low trade barriers as intrinsically good, you have corporations becoming increasingly concerned about the direction of the global economy and starting to take steps to protect themselves, like limiting capital investment to keep cash on hand. And this, of course, concerned investors and economists. Matthew Hornbach: Right. So this is more or less what the Fed suggested when it actually moved to cut its policy rate in July of 2019. The opening paragraph of the FOMC statement, in fact, suggested that U.S. labor markets remain strong and that economic activity had been rising at a moderate rate. But to your point, Mike, the statement also said that growth of business fixed investment had been soft. And in describing the motivation to cut rates, the statement pointed to implications from global developments and muted inflation pressures at home. Michael Zezas: OK, so then if it wasn't tight Fed policy, it was instead this exogenous shock, the trade conflict between the US and China. What does that tell us about how investors should look at the risks and benefits of the Fed's policy stance today? Matthew Hornbach: Well, it first tells us that policy rates near 2.5% shouldn't worry us very much. Of course, a 2.5% policy rate today may not be the same as it was in 2018 at the height of the last hiking cycle. It may be more, or it may be less restrictive, only time will tell. But we know the economy we have today is arguably stronger than it was at the end of the last hiking cycle. The unemployment rate's about the same, but the level of real gross domestic product is higher, its rate of change is higher and inflation is higher as well, both for consumer prices and for wages. All of this suggests that Fed policy could go above 2.5%, like our economists suggest it will, without causing a recession. But as the last hiking cycle shows us, we need to keep our eyes out for other risks on the horizon unrelated to Fed policy. Michael Zezas: Well, Matt, thank you for taking the time to talk with me today. Matthew Hornbach: It was great talking with you, Michael, Michael Zezas: 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.

5 Huhti 20226min

With the end of the first financial quarter of 2022 the market has begun to price in some of the continuing risks to economic growth, forcing investors to reconsider the trajectory for the rest of the year.-----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, April 4th, at 11:00 a.m. in New York. So let's get after it. Given how bad first quarter returns were for both stocks and bonds, most investors were probably happy to see it end. Furthermore, the rally in the second half of March made it considerably better for stocks than it was looking just a few weeks ago. In the end, though, bond returns ranked worse than stocks from a historical perspective, with Treasuries posting the worst quarter in 50 years. The tough first quarter was very much in line with our view coming into 2022. To recall, we didn't see many fat pitches given the Fed's resolve to fight the surge in inflation in the face of slowing growth. Whether it was for technical or fundamental reasons, bond and stock markets ignored this risk into year-end. Apparently, they required a more obvious signal, which appeared on January 5th with the minutes of the Fed's December meeting. From that moment, both stocks and bonds made a sharp U-turn and never really looked back for the entire first month of the year. In short, headline indices for both stocks and bonds finally adjusted to the fire part of our narrative, a risk that started to price under the surface back in November. With inflation and the Fed the number one concern during the first quarter, it makes sense that bonds would be worse than equities. It also makes sense that stocks more vulnerable to higher interest rates underperformed. As an example, the Nasdaq performance was considerably worse than both the S&P 500 and the small cap Russell 2000, a very rare occurrence over the past few years. And this is after a major rally in the past two weeks that was led by the Nasdaq. Our conclusion is that markets were preoccupied in the first quarter with the Fed's sharp pivot, more than anything else, and it played out in asset prices appropriately. Of course, the other major driver for markets in the first quarter was the war in Ukraine. While tensions had been building since late last year, it's fair to say markets had ignored that risk, too. The only difference is that the Fed's pivot was well telegraphed, while Russia's invasion was far from a sure thing and more of an unknown known to most, including us. Obviously, such an event did materially factor into the risk for the first quarter by accentuating the fire and ice by making inflation worse whilst simultaneously dampening growth prospects. It also has rattled confidence for both businesses and consumers, especially in Europe. This was not in our calculus when we made our forecast for 2022. As such, we find ourselves incrementally more negative on growth trends than we were at the end of last year. Last fall, we pushed out the timing of the ice part of our narrative to the first half of this year, when we realized that the economy still had plenty of strength left for companies to deliver on earnings growth. But now investors face multiple headwinds to growth that will be harder to ignore. These include the payback in demand from last year's fiscal stimulus, demand destruction from higher prices, food and energy price spikes from the war that serves as a tax and inventory bills that have now caught up to demand. While the employment report for March last Monday was strong once again, the Purchasing Managers Survey for Manufacturing showed a sharp deterioration in the orders component. Relative to inventories it looks even worse, with the inventory component of the index now below orders for the first time since the recovery began. Think of this ratio as the book to bill for the broader manufacturing economy. Perhaps this survey is the moment of recognition for the slowdown, much like the Fed's minutes were for inflation and Fed policy. The bottom line is that the fundamental outlook for stocks has deteriorated in our view since the end of last year. While markets have reflected some of this deterioration, we think it remains vulnerable to disappointing growth and increased risk of a recession next year. As such, we continue to recommend investors position for this late cycle setup. More specifically, that means favor defensively oriented sectors like Utilities, REITs and Healthcare, while avoiding stocks more vulnerable to a payback in consumer demand. Thanks for listening. If you enjoyed 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.

4 Huhti 20224min

Investors are looking to the U.S. Treasury bond market as concerns rise around what the flattening, and potential inversion, of the yield curve might mean.-----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, April 1st at 2:00 p.m. in London. The so-called flattening and inversion of the U.S. yield curve is a dominant story in financial markets. As rates have risen, short term interest rates have risen more, meaning investors receive about the same yield on a 2 year U.S. Treasury as its 10 year version. This is unusual, and raises big questions for both bond investors and the economic outlook overall. Unsurprisingly, investors are usually paid more for investing in longer term bonds because these are generally more volatile. When that's not the case, it often means the market thinks the economy is going to be good in the near term, keeping short term central bank rates high, but possibly weaker in the longer term, which would imply lower future central bank rates and more supportive policy further out. And that feels like a pretty decent encapsulation of the current market debate. The U.S. economy is very strong at the moment, with the US unemployment rate recently falling to just 3.6%. But that strength is driving inflation and leading the Federal Reserve to raise interest rates more aggressively, rate increases that investors fear could weaken growth further out in the future. With implications like this it's no wonder that a lot of other asset classes, from credit markets, to equity markets, to commodities, really care about what the bond market is doing. And for these investors, we think there are a number of interesting implications. Let me start by saying that similar yields on 2 year and 10 year government bonds is not, in itself, a sell signal. Indeed, the last five times these rates were the same, global stocks rose by an average of about 10% over the following year. What we do see, however, is that a flat yield curve starts to support the outperformance of higher quality, more defensive assets. I try to explain this by the idea that investors do try to retain some growth in income exposure, given the strong current economic conditions, but try to move away from assets that could be much more vulnerable if growth deteriorates in the future. Specifically, when the U.S. 2 year and 10 year yields become similar, investment grade bonds start to outperform high yield bonds. Developed market stocks start to outperform emerging market stocks. And defensive sectors like health care and utilities outperform the broader market over the ensuing 12 months. Today, we think all of those strategies make sense. That's not because we necessarily think a recession is likely. Rather, we think it's a prudent reading of history in response to current bond market signals. 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.

1 Huhti 20223min

As interest in using cryptocurrencies for transactions continues to rise for both consumers and businesses, crypto has begun a cycle of increased stability and popularity - but the question is, can this cycle continue? -----Transcript-----Welcome to Thoughts on the Market. I'm Sheena Shah, Lead Cryptocurrency Strategist for Morgan Stanley Research. Along with my colleagues bringing you a variety of perspectives, today I will be asking the question - are cryptocurrencies currency? It's Thursday, March 31st at 2:00 p.m. in London. Did you really buy that house with crypto? Or did you just sell your crypto for dollars and use dollars to buy the house? Crypto skeptics think that goods cannot be priced in cryptocurrencies like bitcoin, primarily because their price is too volatile. But at some point, if crypto begins to be used for enough purchases of everyday goods and services, prices may begin to stabilize. Increased stability will further entice consumers to use crypto, and the cycle will continue. The question has always been, will this virtuous cycle ever begin? The answer is now clear, it has already begun. Here are some examples. Firstly, paying with cryptocurrency needs to be as easy as paying with a credit or debit card today. Over 50 crypto companies and exchanges have issued their own crypto cards, and these are attached to the Visa or MasterCard payments networks, meaning they're accepted all around the world. In the last quarter of 2021, Visa said its crypto related cards handled $2.5 billion worth of payments. Now that may sound small, at less than 1% of all Visa's transactions, but it is growing quickly. The difficulty in increasing crypto adoption is getting the merchant to accept crypto. It needs to be easy and cheap, which is something lots of new crypto companies and products are trying to achieve. Secondly, many would argue that something can only be a currency if you can pay your taxes with it. Even that is changing today. Over the past year, local and some national governments have introduced or proposed laws that will allow its residents to use cryptocurrency to pay their taxes. El Salvador famously made bitcoin legal tender in its country in 2021. In the past week, Rio de Janeiro announced it will become the first city in Brazil to allow cryptocurrency payments for taxes starting next year. It isn't just emerging economies, though, that are trying to attract global crypto investors. The city of Lugano in Switzerland has teamed up with Tether, the creator of the largest stablecoin - a type of cryptocurrency that's kept stable versus the U.S. dollar, to make bitcoin and two other cryptocurrencies de facto legal tender. In the U.S., Colorado is hoping to become the first state to accept crypto for taxes later in the year, and Florida's governor is investigating the logistics of doing the same. Both these proposals may be difficult to put into law in the end, as the U.S. constitution doesn't allow individual states to create their own legal tender, but it hasn't stopped these proposals and more from coming in. In both these examples, the receiver of the crypto typically immediately converts to fiat currency, like U.S. dollars, through an intermediary service provider. So let's come back to our original question - did you really buy that house with crypto? In February, a house in Florida was sold for 210 Ether, the second largest crypto, or the equivalent of over $650,000 dollars. Interestingly, the seller received the ether but didn't liquidate into U.S. dollars soon afterwards due to market volatility, because the value of ether in U.S. dollars fell by around 10%. Consumers and businesses are increasingly wanting to transact in cryptocurrency. Maybe most are simply wanting to trade the value of the asset, but as it becomes easier to transact in crypto and legal structures are defined, cryptocurrencies could start to become currency. The question is, will the virtuous cycle continue or be broken? Cryptocurrencies are beginning the long journey of challenging U.S. dollar primacy, and the president's recent executive order on digital assets shows little sign of regulators getting in their way for now. Thanks for listening. If you enjoy Thoughts on the Market, share this and other episodes with a friend or colleague today.

31 Maalis 20224min

As the Fed kicks off a new rate hiking cycle, investors are looking back at the previous hiking cycle to ease their concerns today. Head of Public Policy Research and Municipal Strategy Michael Zezas and Global Head of Macro Strategy Matthew Hornbach discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Matthew Hornbach: And I'm Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley. Michael Zezas: And today on the podcast, we'll be discussing the last Fed hiking cycle and what it might mean for investors today. It's Wednesday, March 30th at 11:00 a.m. in New York. Michael Zezas: Matt, we've recently entered a new Fed hiking cycle as the Fed deals with inflation. But it seems like clients have been focusing with you of late on the question of what drove the Fed during the last hiking cycle, where they paused their tightening and started to reverse course. Why is that something investors are focusing on right now? Matthew Hornbach: Well, Mike, investors are looking for answers about this hiking cycle, and a good place to start is the last cycle. The past week saw U.S. Treasury yields reach new highs and the Treasury curve flattened even more. Markets are now pricing Fed policy to reach a neutral setting this year of around 2.5%. The market also prices Fed policy to reach 3% next year. For context, the Fed was only able to raise its policy rate to 2.5% in the last cycle. So the fact that markets now price a higher policy rate than in the last cycle, after which the Fed ended up cutting interest rates, has people nervous. It's worth noting, though, that a 3% policy rate is still some distance below policy rates in the mid 1990s and the mid 2000s. Michael Zezas: Got it. So then, what do you think of the argument that the Fed may have over tightened in the last cycle? Matthew Hornbach: Well, instead of telling you what I think, let me tell you what FOMC participants were thinking at the time. I went back and read the minutes from the June 2019 FOMC meeting. That was the meeting before the Fed first cut rates, which they did in July. I chose to focus on that meeting because that's when several FOMC participants first projected lower policy rates. And according to the account of that decision, participants thought that a slowdown in global growth was weighing on the U.S. economy. In fact, evidence from global purchasing manager data showed that growth in emerging market and developed market economies was slowing, and was occurring well before the U.S. economy began to slow. And also, data suggested that global trade volumes were well below trend. So Mike, let me put it back to you then. It seems to me that Fed policy wasn't driving economic weakness back then, but that something else was driving this change in global economic activity. And I think, you know where I'm going with this... Michael Zezas: Yes, you're talking about the trade conflict between the U.S. and China, where from 2017 to 2019 there was a slow and then rapidly escalating series of tariff hikes between the two countries. It was a very public pattern of response and counter response, interspersed with negotiations and sharp rhetoric from both sides, eventually resulted in tariffs on hundreds of billions of dollars in traded goods. Now, those tariffs endure to this day, but the tariff hikes stopped in late 2019 after the two sides made a stopgap agreement. But even though this was just a few years ago and perhaps seems tame in comparison to the global challenges that have come up since, like the pandemic and now the Russia-Ukraine conflict, I think it's important to remember that at the time this was a big deal and created a lot of concern for companies, economists and investors. You have to remember that before 2017, the consensus in the US and most of Europe was that free trade was good, and anything that raised trade barriers was playing with fire for the economy. We'd often hear from clients that raising tariffs was just like Smoot-Hawley, the legislation in the U.S. that hiked tariffs in many textbooks credit as a key cause of the Great Depression. So, as the U.S. and China engage in their tariff escalation and in many ways demonstrate, at least on the U.S. side, that the political consensus no longer viewed low trade barriers as intrinsically good, you have corporations becoming increasingly concerned about the direction of the global economy and starting to take steps to protect themselves, like limiting capital investment to keep cash on hand. And this, of course, concerned investors and economists. Matthew Hornbach: Right. So this is more or less what the Fed suggested when it actually moved to cut its policy rate in July of 2019. The opening paragraph of the FOMC statement, in fact, suggested that U.S. labor markets remain strong and that economic activity had been rising at a moderate rate. But to your point, Mike, the statement also said that growth of business fixed investment had been soft. And in describing the motivation to cut rates, the statement pointed to implications from global developments and muted inflation pressures at home. Michael Zezas: OK, so then if it wasn't tight Fed policy, it was instead this exogenous shock, the trade conflict between the US and China. What does that tell us about how investors should look at the risks and benefits of the Fed's policy stance today? Matthew Hornbach: Well, it first tells us that policy rates near 2.5% shouldn't worry us very much. Of course, a 2.5% policy rate today may not be the same as it was in 2018 at the height of the last hiking cycle. It may be more, or it may be less restrictive, only time will tell. But we know the economy we have today is arguably stronger than it was at the end of the last hiking cycle. The unemployment rate's about the same, but the level of real gross domestic product is higher, its rate of change is higher and inflation is higher as well, both for consumer prices and for wages. All of this suggests that Fed policy could go above 2.5%, like our economists suggest it will, without causing a recession. But as the last hiking cycle shows us, we need to keep our eyes out for other risks on the horizon unrelated to Fed policy. Michael Zezas: Well, Matt, thank you for taking the time to talk with me today. Matthew Hornbach: It was great talking with you, Michael, Michael Zezas: 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.

30 Maalis 20226min

As oil and gas prices rise, governments and investors must weigh investment in clean energy initiatives and new capacity in traditional energy commodities. Head of North American Power & Utilities and Clean Energy Research Stephen Byrd and Head of North American Oil and Gas Research Devin McDermott discuss.Important note regarding economic sanctions. This research references country/ies which are generally the subject of comprehensive or selective sanctions programs administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries and multi-national bodies. Any references in this report to entities, debt or equity instruments, projects or persons that may be covered by such sanctions are strictly informational, and should not be read as recommending or advising as to any investment activities in relation to such entities, instruments or projects. Users of this report are solely responsible for ensuring that their investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.-----Transcript-----Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Head of North American Power and Utilities, and Clean Energy Research. Devin McDermott: And I'm Devin McDermott, Head of Morgan Stanley's North American Oil and Gas Research. Stephen Byrd: And today on the podcast, we'll be discussing the key debate around energy security and energy transition amid the Ukraine Russia conflict. It's Tuesday, March 29th, at 9 a.m. in New York. Stephen Byrd: So, Devin, the Russia-Ukraine conflict has, among other concerns, really put a spotlight on energy supply and demand. I want to get into this perceived tension between energy security, that is making sure there's enough supply to meet demand, and the transition to clean energy. But first, maybe let's start with the backdrop. There's been a lot of discussion around higher energy prices. This is a world you live in every day, and I wondered if you could paint us a picture of both oil and natural gas supply and demand globally. Devin McDermott: Yeah, certainly, Stephen, and it's definitely been a dynamic market here over the last several years, coming out of COVID and the price declines that we saw then and the sharp recovery that we've been in now for about a year and a half across the energy commodity complex. If we start with oil first, we had record demand destruction in the second quarter of 2020 around global lockdowns, industrial activity slowing and along with that, oil prices broke negative for the first time in history. And then coming out of that, we've had the combination of a few factors that drove prices higher. The first has been demand has been on a very strong recovery path since that bottom in the second quarter of 2020, growing alongside people getting out again, aviation starting to pick up, the economy growing on the back of the stimulus that was injected over the past few years around the world, not just in the US. And then constrained supply, and that constrained supply comes from a mix of different factors, but the biggest of which is a reduction in investment around the world. The other factor is decarbonization goals, in particular with the global oil majors, which are big investors in global oil and gas capacity, and they've put their marginal dollar increasingly into low carbon initiatives, New Energy's platforms, renewables, driving decarbonization goals across their global footprint. Now, shifting over to the gas side, gas is a fascinating market. Globally, it's fairly regionally disconnected historically, but we've had this big investment over the past decade in liquefied natural gas or LNG that's really brought these regional markets together into one global picture. And we've been on, up until COVID, a declining path on prices. LNG projects take many years to build, they're expensive, they have long paybacks, and they were first to get chopped when companies cut capital budgets to preserve liquidity back in 2020, but demand was still growing through that timeframe. So it pushed us into this period of supply shortfall and higher prices. And actually, last year, on three separate occasions, we set new all time highs for global non-U.S. natural gas prices, and that recovery path and period of stronger for longer prices has persisted here into 2022. And even prior to Russia Ukraine, it was something that we thought would persist for at least the next several years. Stephen Byrd: You know, it's fascinating before the Russia-Ukraine conflict we already had, you know, tight markets, rising pricing. Now we really need to dig into the Russia-Ukraine conflict and all the impacts. Maybe let's just start Devin with, sort of, how big of a player Russia is in terms of oil and gas, and what the impact is of any current or future sanctions against Russia. Devin McDermott: Russia is one of the world's largest producers of oil and also one of the world's largest producers of natural gas. And to put some numbers around that, Russia represents about 10% of the world's oil supply, about half of that gets exported to the rest of the world. And they represent about 17% of the world's natural gas supply, about 7 of that gets exported to the rest of the world. These are big numbers. And if you look at Europe specifically, about 30% of their gas needs are coming from Russia on pipeline gas right now. So any disruptions to those flows have significant impacts to the global oil and gas market on top of this already tight backdrop. Stephen Byrd: And Devin I guess as we think about Europe, there's tremendous focus, as you point out Russia is a major player in energy and a major exporter. And I wonder if you could just talk to the current situation and what do you think would be feasible in terms of satisfying energy demand as Europe thinks about looking for other sources of energy? Devin McDermott: Yeah, it's a good question, Stephen and our European energy team has done a lot of work around this and they think that because of the events that have happened so far, not including any potential incremental sanctions or disruption of supply, that we'll lose about a million barrels a day of Russian oil here over the next several months, starting in April through the balance of this year. And again, just to put that in the context, that's about 10% of Russian supply, about 1% of the world's supply on a normalized pre-COVID basis. Now, some of the disruption in flows to Europe will be bought by other countries. You've seen India and China step in and pick up some of this Russian crude that's no longer going to Europe, but it's not going to fill the entire gap. So it leaves us tighter in the oil market than we were just a few weeks ago. On the natural gas side, it'll be a gradual pivot away from Russian pipeline gas within the European market toward a range of different things, one of which is LNG liquefied natural gas. But, as I mentioned before, that market was already in a shortfall, meaning there was not enough supply to meet demand prior to this. So this transition away from Russian gas is going to require substantial investment and take a long time, 5 to 10 years plus, to carry out. It means that these high prices that we're seeing likely have some sustainability to them. Devin McDermott: Stephen, that brings me to a question that I wanted to ask you on the clean energy side. Do you think that we might see a greater policy, and even energy consumer push, to clean energy both in the US and globally on the back of these elevated commodity prices and what's going on in Russia and Ukraine at the moment? Stephen Byrd: Yeah, Devin, we've been seeing a lot of interest among investors in exactly what is going to be the policy response both in Europe and the United States and elsewhere. And I'd say the EU has taken action already. The European Commission laid out a repower EU plan that is very aggressive in terms of additional renewables growth, additional growth in green hydrogen. We see quite a few European utilities and clean energy developers benefiting from the EU's increased emphasis and push towards more and more clean energy. And Rob Pulleyn, my colleague who covers European utilities and clean energy developers and is also a commodities strategist with respect to carbon, has been spending a lot of time on this, has laid out a suite of companies that would benefit quite significantly. There does seem to be a really big policy push in Europe. The United States is not clear. The real question is whether some version of build back better legislation will pass. We just don't know. Now, there is a reason to believe that there could be a compromise position in which some elements of a support for fossil fuel production are included, along with the whole suite of clean energy support that we already know is there. That said, it's possible that compromise simply won't be met. And in that case, we won't get any kind of additional support at the federal level. What's fascinating in the United States, though, is frankly, we don't necessarily need to see that support in order to see tremendous growth in clean energy, we are already seeing a big shift. And as we stand today, we think that clean energy in the United States will more than triple between now and 2030. It's one of the fastest growth rates globally. That is driven mostly by economics, in some cases by state policy, but mostly by economics. Devin McDermott: So, Stephen, I wanted to go back to this question on the tension between energy security and the energy transition. Is it an either or? Stephen Byrd: You know, Devin, we get asked that question a great deal, and I strongly believe the answer is no, those two ideas are not mutually exclusive. And in fact, what we're seeing is both the policy push as well as a business push in both directions. And a good example of that would be the U.S. Utilities that I cover. They are certainly very focused on deploying more renewable energy. And as a group, for example, we see that utilities will decarbonize in the United States by about 75% by 2030 off of 2005 baseline. So very aggressive decarbonization. At the same time, those utilities are very focused on ensuring grid reliability. Now, as we deploy more renewable energy, we're learning quite a few lessons. One lesson is the importance of more energy storage, so demand has been picking up a great deal for that. Another lesson we're learning is the importance of nuclear generation, we're learning that they're critical. They provide both reliability and also zero carbon energy. And in the U.S., we've had a very strong operational track record for our nuclear fleet. So we're learning lessons along the way, but what we're seeing is a push in both directions. Now, as you know, clean energy relative to the world that you live in, oil and gas, is still fairly small. It's going to take many years before clean energy really makes a meaningful impact in terms of global energy consumption. That said, for example, coal generation in places like the United States will decline over time and be replaced with mostly renewable energy, but also with some degree of natural gas generation to ensure reliability. So we're seeing really both ideas play out, and both investment theses are very rational, and we see really good opportunities on both of those ideas. Devin McDermott: And let's take it one step further and talk investment opportunities and themes on the back of this. As you think about the different subsets of clean energy and clean tech, where would you be focused for opportunities here? Stephen Byrd: You know, it's interesting. One group of stocks that we generally like are clean energy developers. And the reason we like those stocks is essentially this spread between what we're thinking of as inflationary traditional energy like oil and gas, and this deflationary dynamic of clean energy. One example is in places like California, the traditional utility costs to customers are rising very rapidly above 10% a year. If you look in the long term, the cost of our clean energy solutions are dropping anywhere from 5% a year, to 10, 15% per year. That's a tremendous economic wedge, and we think the developers will be able to essentially capture a lot of that spread. On the manufacturers side there are still some supply chain dynamics, which can cause some near-term margin compression that concerns us, in some cases. I would say another area of really interesting growth is green hydrogen, especially in Europe. A number of our companies are focused on that market as well. So those would be a couple of the buckets of opportunity that we see. Devin McDermott: Great. Stephen, thanks so much for the time today. It's really a fascinating topic and one that's unfolding right before our eyes today. Stephen Byrd: Well, it was great speaking with you, Devin. Devin McDermott: And thanks for listening. If you enjoy Thoughts on the Market, please give us a review on Apple Podcasts and share the podcast with a friend or colleague today.

29 Maalis 202211min

As the Fed continues down a hawkish road for 2022, investors must consider the impact of policy tightening on economic growth and equity risk premiums.-----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, March 28th at 11:00 a.m. in New York. So let's get after it. 2022 has been a year of extraordinary hawkishness from the Fed, and it continues to surprise on the upside with both its formal guidance and informal communications. This has led to almost weekly revisions for more Fed rate hikes from just about everyone, including our economists who now expect 50 basis point interest rate hikes in both May and June, and then 25 basis points in every meeting thereafter. The bond market has definitely gotten the message, too, with one of the sharpest rises in short term interest rates ever witnessed. Longer term rates have also adjusted as the expected terminal rate for this cycle has risen to 2.9%. The questions for equity investors now is whether they believe the Fed will actually tighten this much and what will be the impact on the economy from a growth standpoint. We have several takeaways from these recent moves. First, the Fed appears to be very committed to reducing inflation. Friday's University of Michigan Consumer Confidence Report for March confirmed that high prices are still the key reason this metric has plummeted to levels usually reserved for recessions. Second, 10 year yields are now at a level that takes the equity risk premium to its lowest level since the Great Financial Crisis. As a reminder, equity risk premium is the return and investor receives above and beyond the yield on a Treasury bond. The higher the risk, the greater the equity risk premium. In our view, it makes little sense for the equity risk premium to be so low right now, given the heightened risks to earnings growth from a rise in cost pressures, payback in demand, and a war that has structurally increased the price of food and energy. While stocks are a good hedge from higher inflation, keep in mind that inflation from food and energy is bad for most companies as it acts as a tax on consumers. Only energy and materials companies really benefit from this kind of inflation but they make up a very small slice of the index. Some may argue technology companies are less affected, but we're skeptical as they will feel it too in lower revenues if the consumer spending fades. Third, the risk from further exogenous shocks to growth are also elevated given the war in Ukraine, China's real estate stress, and ongoing battle with COVID, to name a few. This is one reason why market volatility remains so high. Importantly for investors, our work suggests the equity risk premium is also understated relative to this high market volatility. In short, equity investors are not being properly compensated for taking equity like risk at current prices. Finally, these high valuations are not isolated to just a few sectors. The lower equity risk premium is present across all sectors except energy and materials, and these are the two biggest beneficiaries of high commodity inflation. In some ways, the low equity risk premium for these sectors is simply saying the market does not believe the recent boost to earnings and cash flow is sustainable, due to either demand destruction or the eventual supply response. The bottom line is that we remain bearish on the S&P 500 index from a risk reward standpoint, particularly after the recent rally. Our year end base case target of 4400 is 4% below current levels. At the stock level, we continue to recommend investors look for stable cash flow generating companies in defensive sectors like utilities, health care, REITs and consumer staples. 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.

28 Maalis 20223min