Is American Market Dominance Over?

In a generally positive environment for corporate credit, the recent performance of high-yield bonds in the telecom, media and technology (TMT) sector offers a market contrast. Our Lead Analyst for High-Yield TMT joins our Head of Corporate Credit Research to explain the divergence.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research for Morgan Stanley.David Hamburger: And I'm David Hamburger, Head of US Sector Corporate Credit Research and Lead Analyst for the high yield telecom, media, and technology sectors.Andrew Sheets: And today on the podcast we'll be discussing the contrast between strong overall markets in credit and a whole lot of volatility in the high yield TMT space.It's Friday, May 31st at 10am in New York.So, David, it's great to talk to you. You know, listeners have probably been hearing about our views on overall markets and credit markets for the 12 months ahead.We have US growth at 2 percent. We have inflation coming down. We had the Fed lowering interest rates. But there’s needless to say; there's some pretty notable contrast between that sort of backdrop and the backdrop we've had for credit year to date, which has been pretty calm, pretty strong -- and what's been going on in your sector.So maybe before we get into the why -- let's talk about the what and bring people up to speed on the saga that's been high yield TMT year.David Hamburger: Yeah. I'm here today to disavow you of any notion that everything is fine and dandy in the market today. So, if you look at the high yield communications sector, it's trading about 325 basis points wide of the overall high yield index. And just to give you that magnitude of that -- the high yield index trading around 300 basis points -- we're talking about 625 basis points over. Now, the high yield communication sector as well is trading about 275 basis points, wider than the next widest sector in the index.And so, it's pretty astounding today, given the market backdrop, how much underperformance we've seen in this sector.Andrew Sheets: What's been causing this just large divergence between high yield TMT and what seems like a lot of other things?David Hamburger: Yeah, I think there are two forces at work here. One's kind of a broader set of issues that I can outline for you. Really, I think it's a combination of one, the maturation of the communications marketplace. Coming out of COVID, we certainly had accelerated adoption of broadband and wireless services. That in and of itself has created a lot of intense competition.And as such, we've seen a lot of technological advances that have created some secular pressures on the space. As well, when you pair that up with elevated financial leverage, all coming together at a time when the marginal cost of capital for companies has increased due to higher interest rates. Those are really some of the underlying forces at work that have driven underperformance in this sector.But some companies have managed to navigate this environment. And I would say by and large, it's those with really strong balance sheets. But that has really cast a shadow on this sector -- is the fundamental and financing issues.When you think about the bloated balance sheets that some of the other companies have had, they've been exploring a whole new set of transactions and, evaluating different options for their balance sheets. And that's probably the more sinister thing that we've seen in the market of late.Andrew Sheets: So, so tell me a little bit more about this. You know, what are some of the types of things that companies can do that often leave the bond holder unhappy?David Hamburger: We all became all too aware of what private equity sponsors might do back in the heyday of LBOs, and we still live in that world today, and it's really fairly well known.You know, I've been in the credit markets for more than 20 years, but I can't recall a time we've seen so many management teams and controlling shareholders now that are at odds with their creditors because of elevated leverage and the business risks they face. So really, the prospect of real and expected liability management has created a lot of dislocation across companies’ capital structures.So, what have they done? We look and see companies that have been exploring liability manage, taking advantage of weak protections in certain credit documentation in their structure at the expense of other creditors in the same capital structure. So, we have one company where you see this dislocation in their term loans. They have the same pool of collateral between two different term loans with two different maturities. The later dated maturity is trading higher than the nearer dated maturity, strictly or solely because of the better protections in that documentation. And the premise being, you can negotiate with that class of creditors, give them an advantaged position in the capital structure at the expense of other creditors -- in order to somehow manage the balance sheet and manage those liabilities.Andrew Sheets: And David, is it fair to say that this is a direct outcrop of, you know -- a term some people might have heard of -- of covenant light debt, where, you know, usually debt has certain legal protections that mean that the bondholder is more assured of getting paid back or not being made a less well off than other lenders. But you know, we did see some of that change during different, stronger market conditions. Is that a partial explanation of what's going on?David Hamburger: That's exactly right, Andrew. We are seeing the result, if I might say, the hangover from some of these covenant light deals that came to market over the last few years; almost to the point of speak to some clients and they will just want to know what is the vintage of that secured debt issue that you're talking about because there were certain years where they were far more flexible documentation and protections. And now, given where the equity markets are trading and the financing environment, you see a lot of those securities trading at severe discounts to par, which is unusual because, again, in my 20-year career, I've not often seen companies with billion-dollar equity market caps and bonds trading in the 20, 30, or 40 cents on the dollar.You would think that if a company had a substantial market cap, that their bonds would be trading closer to par and would have value. But what really the market's, I think, pricing in is this transference of value from creditors to shareholders; and the opportunity cost associated with these shareholders; or controlling shareholders or management teams looking to capture those discounts that they now see in their bonds; or in their loans to the benefit of equity shareholders -- really puts all constituents in the company's balance sheet, if you will, at odds with one another.Andrew Sheets: So, David, this is so interesting because again, I think, you know, for a lot of listeners, you can read the newspaper, you see the headlines, the market looks very strong and stable. And yet, there's definitely a tempest that's been brewing, you know, in your sector. For people who are investing in high yield TMT, what are you think the most important things that you're looking out for in your credit coverage?David Hamburger: Well, look, we're forced to really dig in and scrutinize these credit docs and really understand what protections are there, understanding how companies might navigate through those protections in order to prolong or preserve their equity value or the equity options in their companies.It's not like we're trying to be alarmists in saying this is a canary in the coal mine, but it is certainly a cautionary tale for any high yield investor to be well versed in those credit documentation, understanding the protections in those debt securities.And we have seen bondholders and creditors, largely even in loans, you know, get together in co-op agreements to push back on some of these aggressive liability management transactions. And that, I think, is really important in an environment where yields have come back in and, you know, where people look at opportunities and maybe we could, once again, see two things. One, a reach for yield, where you're looking at sectors that have underperformed. And secondly, should we get back into an environment of covenant light docks once again? So, I don't want to be talking about this again in a few years’ time. And it's not something that the market has helped resolve rather than just perpetuate.Andrew Sheets: David, it's fascinating as always. Thanks for taking the time to talk.David Hamburger: Thank you Andrew. Glad to be here.Andrew Sheets: And thanks for listening. If you enjoy the show, please leave us a review wherever you get your podcast and share Thoughts on the Market with a friend or colleague today.

31 Touko 20248min

Our Chief Europe Economist explains why the region’s outlook over the next year is trending upward, including how higher growth will lead to lower interest rates this cycle.----- Transcript -----Welcome to Thoughts on the Market. I’m Jens Eisenschmidt, Morgan Stanley’s Chief Europe Economist. Along with my colleagues bringing you a variety of perspectives, today I will discuss our outlook for Europe’s economy in the second half of 2024 and into next year. It’s Thursday, May 30 at 10am in Frankfurt.So, over the last year, we have had a relatively downbeat outlook for Europe's economy, but as we head into the second half of this year our view is decidedly more optimistic. After bottoming last year, euro area growth should reach 0.7 per cent annualized terms in 2024 and 1.2 per cent in 2025 on the back of stronger consumption and exports. Inflation is on its way to the European Central Bank’s target, paving the way for the ECB to start cutting rates in June with three cuts in 2024, for a total of 75 basis points, and four more cuts in 2025, for a total of 100 basis points.What’s particularly notable, though, is the set-up of this growth rebound is highly unusual for several reasons.Let's start with inflation. In a normal environment, higher growth leads to higher inflation and vice versa. This time is different. The euro area needs to grow faster to get inflation down. The reason is that faster growth should lead to better resource utilization in sectors characterized by labor hoarding or keeping a surplus of employees. This should keep unit labor costs – or how much a business pays its workers to produce one unit of output – in check. We’re expecting further wage increases, mostly driven by the catch-up with past inflation, and so higher productivity is a way to cushion the pass-through to prices.So again, just to repeat, we are in a cycle where we need higher growth to get inflation down and not as usual, we have higher growth and that gets us more inflation. Of course, there is a limit to that. If we get too much growth, that would be an issue potentially for the ECB. And if you get too little growth, that is another issue because then we won't get the productivity rebound.In some sense, you could think of the growth we need as a landing strip and we need to come in at that landing strip precisely; and so far, the signs are there that is exactly the picture we are getting in 2024 and 2025 in Europe.Now the monetary and fiscal policy mix is another area where this cycle stands out. So normally, monetary policy would tighten into an upswing and ease into a downturn, while fiscal policy would be expansionary in a downturn and contractionary in an upswing. Euro area monetary policy is currently restrictive – but it’s set to get less restrictive over time. The likelihood of rates coming down is hardly bad news for growth. But policymakers will need to take care to not reignite inflation in the process. So all of that gives rise to the gradualism that the European Central Bank has been signaling it will use in its policy easing approach. And again, think about the landing strip metaphor. If we are not gradual enough and we reignite a growth too much, and with it inflation, we might be exiting the landing strip in one way or the other.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

30 Touko 20243min

Our Global Head of Fixed Income and Thematic Research reflects on Japanese investors’ interest in the outcome of the upcoming presidential vote in the US.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the upcoming US elections.It's Wednesday, May 29th at 10:30am in New York.I recently returned from Tokyo, having attended and presented at Morgan Stanley's inaugural Japan summit. And while I was asked to present on topics ranging from our fixed income markets outlook to the role of Japan in an increasingly multipolar world, my one-on-one conversations always tracked back to the same client question: who will win the US election.Of course this is a matter of great importance globally. But the investor in Japan is particularly interested in whether possible election outcomes could disrupt their rosy economic outlook – either through new tariffs or increased geopolitical tensions between the US and China, and also North Korea. To that end, many were focused on polls showing former President Trump with sufficient support to win the election, asking how predictive this would be of the ultimate outcome. Here our view remains, for all investors, that polls aren't giving a reliable signal yet. The election is still several months away. And Trump doesn't have leads beyond a normal polling error in sufficient states to win the presidency. So, investors still need to consider the potential impacts of a variety of US electoral outcomes. That's perhaps not the most settling answer for investors, who strive to limit uncertainties. But we think it's the most honest one. And as we've been doing in this space all year, we'll continue to walk you through the outcomes, policy impacts, and resulting market effects you need to be aware of. Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

29 Touko 20242min

Our Chief Europe Equity Strategist explains why she is forecasting a 23 percent total return for European equities over the next year.----- Transcript -----Welcome to Thoughts on the Market. I’m Marina Zavolock, Morgan Stanley’s Chief European Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why our mid-year outlook extends our bullish view on European equities. It’s Tuesday, May 28, at 10am in London. We have recently updated our outlook for the year ahead, maintaining our bullish view on European equities as we fully incorporate and roll forward our mid-1990s “soft landing” playbook. Like today, the mid-1990's was a period where markets focused on rates, inflation, and related data above anything else. The US and Europe saw soft and “softish” landings, the Fed’s cutting cycle was slower than investors initially expected, and there was an undercurrent of technological innovation. European equities, in particular, are following the mid-1990s path closely, and that means both a mid-cycle extension and a strong market set-up. We have high conviction in our constructive European equities view and have recently raised our one year forward MSCI Europe Index target to 2,500 – 18 percent potential upside. This brings potential total return upside – if we incorporate dividends and buybacks – to 23 percent. So why do we remain bullish? Over the second half of this year in particular we anticipate European equities ongoing re-rating is likely to combine with an emerging European equities earnings recovery. We’ve just come out of one of the strongest earnings seasons Europe has had in several quarters and we anticipate this is only the beginning. Our earnings model projects 7.5 percent earnings growth by year end for MSCI Europe, which is almost double consensus estimates. On top of this, we think the market underappreciates a number of significant thematic tailwinds that benefit European equities. These include rising corporate confidence, an M&A cycle recovery that is leading the global trend, an imminent start to rate cuts, high and rising capital distributions including buybacks, and underappreciated AI diffusion. In terms of our sector preferences, structurally, we continue to prefer Europe’s quality growth sectors. These include Software, Aerospace & Defense, Pharma, and Semiconductors, along with the Banks sector. Shorter-term, we also believe a recovery in bond yield-sensitive stocks has begun, which is expected at this stage in our mid-1990s playbook. We expect this rally to be tactical and bumpy but ultimately more powerful than a similar rotation that occurred around the Fed pivot late last year. We recently upgraded Building & Construction to overweight to play this rotation. Although we believe European equities are in the sweet spot over the second half of 2024, we expect the bar for continued performance to become tougher by the time we get into first half of 2025. Also, our bear case incorporates rising geopolitical risks and lower-than-expected economic growth – the latter in line with our economists' bear case. A US election scenario that would bring a change in the status quo is also a risk for European equities, albeit it’s far more idiosyncratic than broad-based according to our in-depth analysis. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

28 Touko 20243min

Our Head of Corporate Credit Research explains why moderate economic growth offers opportunities in credit markets – if investors choose carefully.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley, along with my colleagues, bring you a variety of perspectives Today, I'll be talking about our outlook for credit markets over the next 12 months.It's Friday, May 24th, at 9 a. m. in New York. Morgan Stanley's global economic and strategy teams have recently published our mid year outlook. Twice a year, all of us get together to take a step back, debating what we think the outlook could look like over the 12 months ahead. For credit, we think that backdrop still looks pretty good.Corporate credit, in representing lending to companies, is an asset class that loves moderation and hates extremes. An economy that's too weak raises the risk that companies fail, and has been consistently bad for returns. But an economy that's too strong also causes challenges, as companies take more risks, the rewards of which often go to stockholders, not their lenders.The good news for credit is that Morgan Stanley's latest economic forecasts are absolutely full of moderation for economic growth. We see the U.S. growing at about 2 percent this year and next and Europe growing at about 1%. Right in that temperate zone, the credit usually finds optimal.We see inflation falling, with core inflation back to 2 percent in the U. S. and Europe over the next 12 months. And monetary policy should also moderate, with the Federal Reserve, European Central Bank, and the Bank of England All lowering interest rates as this inflation comes down.For credit, forecasts that expect moderate growth, moderating inflation, and moderating interest rates are exactly that down the fairway outcome that we think markets generally like. The challenge, of course, is that spreads have narrowed and lower risk premiums are discounting a lot of good news. So how do investors navigate richer valuations within what we think is still a very supportive economic backdrop?One thing we continue to like is leveraged loans, where yields and spreads we think are more attractive. In the U. S., yields on loans are still north of 9%. We like short dated investment grade bonds, which we think offer a good mix of income and stability, and also happen to correspond to the maturity range that our interest rate colleagues expect yields to see the largest decline.That should help total returns. And in Europe, we don't think spreads are particularly tight. And that should be further supported by relatively upbeat views on the European stock market from our equity strategies. Morgan Stanley's macroeconomic backdrop, which is full of moderation, is supportive for credit.Tighter valuations are a challenge, but given this moderate backdrop, we think they can stay expensive. We still think there are good opportunities within credit, but investors will have to pick their spots. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen, and share thoughts on the market with a friend or colleague today.

24 Touko 20243min

With cooling inflation and an expected drop for mortgage rates, will more affordable housing lead to a big spike in sales? Our Co-Heads of Securitized Product Research take stock of the US housing market. ----- Transcript -----Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley.James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley.Jay Bacow: And on this episode of the podcast, we'll discuss our outlook for mortgage rates and the housing market over the next 12 months.It's Thursday, May 23rd, at 1pm in New York.James Egan: Jay, I want to talk about mortgage rates. From November through January, mortgage rates decreased over 120 basis points. But then from February to May, they've given back more than half of that decline. Where are mortgage rates headed from here?Jay Bacow: So, day to day, week to week, it's hard to have a lot of conviction, a lot of things can happen. But, over the next 12 months, we think mortgage rates are coming down. We estimate that by summer 2025, the 30-year fixed rate mortgage will be roughly 6.25 per cent.James Egan: Alright, that is a significant amount lower than about 7 per cent where we are right now. And that's good news for affordability in the US housing market. What gets us there?Jay Bacow: We think inflation is going to cool, and our economists are forecasting that the Fed is going to cut their policy rate by 75 basis points this year and 100 basis points next year. In fact, our economists are forecasting eight of the G10 central banks to cut rates next year.Now, mortgage rates are 30 year fixed rate products, so they're based more on where the longer end of the treasury curve is than the front end. But our rate strategists think ten year notes are going to rally to 375 by next summer.When you combine all of that with our expectation for secondary mortgage rates to tighten versus treasuries, that's how we end up with that forecast for the primary rate to rally.James Egan: All right, I want to dig in there. I really like how you highlighted the secondary mortgage rates tightening versus treasuries. One thing I know that we've both gotten a lot of questions on over the course of the past year plus is how wide mortgages are trading versus treasuries right now. So, what do you think drives that tightening basis?Jay Bacow: There’s a lot of factors -- but in end, two of them that are always going to drive things are supply and demand. One of the interesting things is that while housing activity has picked up, we're near the decade high in the percentage of homes that are bought with all cash, which means that the supply of mortgages to the market is actually not that high.On the demand front, we think you're going to get demand from a broad spread of investors. We think there's been some money manager supported inflows into the mortgage market. We think that as the Fed cuts rates and you get the Basel III endgame resolution, domestic banks are going to come back to the market as they get more regulatory clarity.And then also as the Fed cuts rates, that means that FX (foreign exchange) hedging costs for overseas investors will be improved and so you think Japanese life insurance companies can go back to the market and we think there's going to be continued demand from Chinese commercial banks. But, if you get all of this support, then as mortgage rates come down, that should be good news on the affordability front in the housing market, right Jim?James Egan: Exactly. When we combine that decrease in mortgage rates with what our US economics team is saying will be about mid-single digit growth in nominal incomes, we get an improvement in affordability over the next 12 months that we've only seen a handful of times over the past 30 years.Jay Bacow: Now this six and a quarter forecast is certainly good news versus spot rates. It's almost two per cent below the peaks we saw last year, but I don't really think it solves the lock-in effect that we've discussed on this podcast previously.Close to 80 per cent of homeowners have a mortgage rate below 5 per cent. So, they're still out of the money versus our expectations for our mortgage rates going next year.James Egan: Right, and we think that's a very important point. You made the point earlier about thinking about supply and demand with respect to mortgage rates versus treasuries, and we're going to talk about it here in the housing market. We have to think about affordability improvement in terms of both that supply and demand piece.If we look back towards the start of this year, I'd say that demand increased a little bit faster, a little bit stronger than we thought. Typically, when you see sharp improvements in affordability, it doesn't always lead to immediate increases in sales volumes. However, what we saw from November to January seemed to be a little bit quicker to stir animal spirits, perhaps because of how healthy this improvement in affordability was. Home prices were still climbing. Mortgage rates weren't even coming down because the Fed was cutting; it was because of market expectations for future fed cuts in a soft landing environment. But on the supply side, while we expect for sale listing volumes to increase as rates come down, they aren't going to race higher because of that lock-in dynamic that you just described.Jay Bacow: So, Jim, you think more people will list their homes; but what will actually happen to sales volumes? Will people buy them?James Egan: Right. So, I think we have to delineate between existing home sales and new home sales here. Yes, we think existing listings are going to increase on the margins. New home inventory has already increased.Historically, new homes make up about 10 to 20 per cent of the for-sale inventory on a monthly basis. Right now, they're between 30 and 35 per cent, and that's been the case for a little while. So, when we think about our forecasts for sales volumes, we're confident that new home sales will increase more than existing home sales. And that that growth in new home sales will spur single unit starts to increase more than both of them. Our specific spot forecasts, 10 per cent growth in new home sales, 5 per cent growth in existing home sales, with single unit starts edging out a double digit return of about 15 per cent growth. Jay Bacow: Do you have specific spot forecasts for home prices as well? James Egan: We do. As supply increases, the pace of home price growth should slow from where it is right now. It's been accelerating for the past several months, but the absolute level of supply is still pretty tight. We're at 3.8 months of supply as we're recording this podcast. Any reading below 6 is really associated with home price growth, not just today, but at least over the course of the next 6 months -- and we're well below 6 months of inventory.Right now, home prices are growing at about 6.5 per cent. We think they're growing to slow to about 2 per cent by the end of 2024, before accelerating to 3 per cent in 2025. So, while growing inventory leads to deceleration, tight inventory keeps home price appreciation positive.Jay Bacow: Alright so, home sale activity is going to pick up. It's going to be led by starts, which we think will be up 15 percent and more new home sales than existing home sales. There’s new home sales up 10 per cent. Home prices we now think will end the year positive; up 2 per cent in 2024 and up 3 per cent in 2025.Jim, always a pleasure talking.James Egan: Great speaking with you, Jay.Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

23 Touko 20246min

Why is the US economy poised for a strong second half of the year, despite slowing GDP growth? Our Chief US Economist points to population growth, housing demand and anticipated Fed rate cuts. ----- Transcript -----Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief US Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our mid-year outlook for the US economy. As we near the midpoint of this year, we refresh our outlook for the second half of the year. In our base case, the US economy remains strong, but US GDP growth is slowing, and slowing from 3.1 percent on a fourth quarter over fourth quarter basis last year, to 2.1 percent this year and in 2025.Okay, so what's behind the continued strength? Well, it's something we've been intensely following this year. Faster immigration and population growth will continue to expand the labor supply and support economic activity, and all without increasing inflationary pressures. So, whereas the mid-pandemic labor market was characterized by persistent shortage of labor, the supply of labor is now increasing, and we think will outstrip demand this year.This will drive the unemployment rate higher, which we expect will end this year half a point above 2023 at 4.2 per cent and rise further to 4.5 per cent in 2025. And wage gains should moderate further as the unemployment rate rises. We think consumer activity will continue to slow this year and into 2025 as that cooling labor market weighs on growth in real disposable income and elevated interest rates keep borrowing costs high.Tight lending standards also limit credit availability. That said, we do think lower rates are on the horizon, and this should spur a pickup in housing demand and goods spending around the middle of next year. In fact, after substantial reflation numbers in the first quarter of 2024, we expect lower inflation numbers ahead. We've already seen that in the April data, as rents, goods, and services prices decelerate. The Fed has held the policy rate steady at a range of 5.25 to 5.5 per cent since July 2023, and we expect it will deliver the first quarter point cut in September this year. In total, we expect three quarter point cuts this year, and four more by the middle of next year, which lowers the policy rate to around 4.5 per cent in the fourth quarter this year to about 3.5 per cent in the fourth quarter of 2025. But even before rate cuts, the Fed has announced it will start phasing out Quantitative Tightening, or QT, in June. We expect QT to end around March 2025, when the Fed's balance sheet is a little above 3 trillion.Finally, let's talk about housing. We expect continued growth in residential investment through 2025, with a rapid rise in housing starts, solid new home sales, and a bit more turnover in existing home sales as mortgage rates fall. Home building and increased brokerage commissions should keep residential investment on the boil, posting a 4.6 per cent rise on a 4th quarter over 4th quarter basis this year and 3.2 per cent in 2025. Our residential investment forecasts are a good deal stronger than we expected in the year ahead outlook we published last November. Booming first quarter growth probably reflected a combination of the warm winter and the temporary downswing in mortgage rates. We don't expect the same outperformance later in the year. But at the same time, housing demand is greater than we had anticipated amid that faster population growth. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

22 Touko 20243min

Our Global Cross-Asset Strategist and Global Chief Economist discuss the state of asset markets at the midway point of 2024, and why the current backdrop suggests positive directions for several key markets.----- Transcript -----Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.Serena Tang: And I'm Serena Tang, Morgan Stanley's Chief Global Cross Asset Strategist.Seth Carpenter: And yesterday, Serena, you and I discussed Morgan Stanley's global economic mid-year outlook. And today, I'm going to turn the tables on you, and we'll talk about asset markets.It's Tuesday, May 21st, at 10am in New York.Okay, so yesterday we talked about all sorts of different parts of the macro environment. Disinflation, inflation, central bank policy, growth. But when you think about all of that -- that macro backdrop -- what does it mean to you for markets across the world?Serena Tang: Right, I think the outlook laid out by your team of stable growth, disinflation, rate cuts. That is a great backdrop for risk assets, one of the reasons why we got overweight in global equities. Now, there will likely be low visibility and uncertainty beyond year end, and why we recommend investors should focus on the triple C's of cheap optionality, convexity, and carry.That very benign backdrop suggests more bullish possibilities. Your team has noted several times now that the patterns we're seeing now and what we expect have parallels to what happened in the mid 1990s -- when the Fed cut in small increments, US growth was sustained at high levels, and the labor market was strong. And now I'm not suggesting that this is 1990s and we should party like it. But just that the last time we found ourselves in this kind of benign macro environment, risk assets -- actually most markets did really well.Seth Carpenter: So, I will say the 1990s was a pretty good decade for me. However, you mentioned some uncertainty ahead, low visibility. We titled our macroeconomic outlook ‘Are we there yet?’ Because I agree, we do feel like we're on a path to something pretty good, but we're not out of the woods yet. So, when you say there's some low visibility about where asset markets are going, maybe beyond year end, what do you mean by that?Serena Tang: I think there's less visibility going into 2025. And specifically, I'm talking about the US elections. When I think about the range of possible outcomes, all I can confidently say is that it's wide, which I think you can see reflected in our strategist's latest forecast. Most teams actually have relatively constructive forecast returns for their assets in the base case, but there's an unusually wide gap between their bull and bear cases for bond and equity markets.Seth Carpenter: Let me narrow it down a little bit because equity markets have actually performed pretty well during the first half of the year. So what do you think is going to happen specifically with equities going forward? How should we be thinking about equity markets per se?Serena Tang: Equities have rallied a lot, but we've actually gotten more bullish. I talked about the three Cs of cheap optionality, convexity, and carry earlier, and I think European and Japanese equities really tick these boxes. Both of these markets also have above average dividend yields, especially for a dollar-based FX hedge investor.Serena Tang: Where we think there might be some underperformance is really in EM equities, but it's a bit nuanced. Our China equity strategy team thinks that consensus mid-teens earnings growth expectation for this year will still likely to disappoint given the Chinese growth forecast that you talked about yesterday.Seth Carpenter: Alright, in that case. Let me flip over to fixed income. A lot of that is often driven by central banks. Around the world, you just mentioned EM equities may be struggling a little bit. A lot of EM central banks are either cutting a little bit ahead of the Fed, but being cautious, worrying about not getting too far ahead of the Fed. So, if that's what's going on with policy rates at the very front end of the curve, what's happening in fixed income more broadly?Serena Tang: We generally see government bond yields lower over the forecast horizon for two reasons. On your team's forecast of central banks cutting rates and also in the US, an optical rise in the unemployment rate, our macro strategy team forecasts for the 10 year U.S. Treasury yields to fall to just above 4 per cent by the end of this year. And because government bond yields will be coming down, we also expect yields for spread products like agency MBS, investment grade, etc. to also come down. But I think for these spread products, returns can be positive beyond that duration piece.Serena Tang: So, credit loves moderation, and I think the mild growth backdrop your team is forecasting for is exactly that. US fixed income more generally should also see renewed flows from Japanese investors as FX hedging costs come down over the next six months. All of this supports tighter than average spreads.Seth Carpenter: Okay, so we talked about equities, we talked about fixed income. Big asset class that we haven't talked about yet are commodities. How bullish are you going into the summer? What do you think is going to go on and can that bullish view that you guys have last even longer?Serena Tang: So for crude oil, our strategists see market tightness over the summer, which could drive Brent to about $90 per barrel. You have demand coming in stronger than expected, and of course OPEC has extended its production agreement.But we also don't really expect prices to hold over the medium term. Non-OPEC supply should meet most of the global demand growth later this year and into 2025, which sort of leaves very little room for OPEC to unwind production cuts. We expect Brent to revert back steadily to its long-term anchor, which is probably somewhere around $80 per barrel.Serena Tang: For copper, it’s actually our metal strategist's top pick right now, and it's very much driven by, I think, tightening supply and demand balance. You've had significant mine supply disruptions, but also better than expected demand and new drivers such as -- we've talked about AI a lot, data centers and increasing participation.Serena Tang: And on gold, in our view, pricing is likely to remain pretty choppy as investors have to weigh inflation risk, incoming data, and the Fed path. But historically, that first rate cut tends to be a very positive catalyst for gold. And we see risks more skewed to our bull case at the moment.Seth Carpenter: Okay, so talked about equities, talked about fixed income, talked about commodities. These are global markets, and often when investors are looking around the world and thinking about what it means for them, currencies come into it, and everybody's always going to be looking at the dollar. So why don't you run us through the Morgan Stanley view on where the US dollar is going to go over the rest of this year, and maybe over the next 12 months.Serena Tang: The short answer is we see the dollar staying stronger for longer. Yes, we expect central banks to begin cutting this year. But the pace of cuts and ultimate destinations are likely to vary widely. Now another potential dollar tailwind is an increased risk premium being priced for the 2024 US elections. We think that investors may begin to price in material risks to dollar positive changes in US foreign and trade policy as the election approaches, which we assume will sort of begin ramping up in the third quarter.Seth Carpenter: All right, let's step back from the details. I want you to bring us home now. Give me some strategy. So where should people lean in, where should we be looking for the best returns and where do we need to be super cautious?Serena Tang: In our asset allocation recommendation, we recommend overweight in global equities, overweight in spread products, equal weight in commodities, and underweight in cash.We really like European and Japanese equities on the back of pretty strong earnings revision, attractive relative valuations, and good carry for a dollar based investor. We like spread products. Not so much that our strategists are not expecting duration to do well. We are still expecting yields to come down.Serena Tang: Where we are most cautious on, really, continues to be EM equities. From a very top down perspective, the outlook we have is constructive stable growth, continued disinflation, rate cuts. These make for a good environment for risk assets. But uncertainties beyond year end, that really argues for investors to look for assets which have those triple Cs, cheap optionality, convexity, and carry.And we think Japanese and European equities and spread products within fixed income take those boxes.Seth Carpenter: Alright, looking at the clock, I'm going to have to cut you off there. I could talk to you all day. Thank you for coming in and letting me turn the tables relative to yesterday when you were asking me all the questions.Serena Tang: Great speaking with you, Seth. And yes, I know we can go on forever.Seth Carpenter: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you get your podcasts. And share this episode with a friend or a colleague today.

21 Touko 20249min