Is American Market Dominance Over?

As the U.S. economy remains resilient in the face of continued rate hikes, investors may wonder if the Fed will re-accelerate their policy tightening or if cuts are on their way.----- Transcript -----Welcome to Thoughts on the Market. I'm Sarah Wolfe from the U.S. Economics Team. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about the economic response to the Fed's monetary tightening. It's Tuesday, February 28th, at 1 p.m. in New York. The Fed has been tightening monetary policy at the fastest rate in recent history. And yet the U.S. economy has been so remarkably resilient thus far that investors have begun to interpret this resilience as a sign that the economy has been less affected by monetary policy than initially expected. And so recession fears seem to have turned into fears of re acceleration. Of course, interest sensitive parts of the economy have largely reacted as expected to the Fed hiking interest rates. Housing activity responded immediately to higher interest rates, declining significantly more than in prior cycles and what our models would imply. Consumer spending on durable goods has dampened as well, which is also expected. And yet other factors have bolstered the economy, even in the face of higher rates. The labor market has shown more resilience since the start of the hiking cycle as companies caught up on significant staffing shortfalls. Households have spent out excess savings supporting spending, and consumers saw their spending power boosted by declining energy prices just as monetary tightening began. As these pillars of resilience fade over the coming months, an economic slowdown should become more apparent. Staffing levels are closing in on levels more consistent with the level of economic output, pointing to a weaker backdrop for job growth for the remainder of 2023 and 2024. Excess savings now look roughly normal for large parts of the population, and energy prices are unlikely to be a major boost for household spending in coming months. Residential investment and consumption growth should bottom in mid 2023, while business investment deteriorates throughout our forecast horizon. We expect growth will remain below potential until the end of 2024 as rates move back towards neutral. But even with more deceleration ahead, greater resilience so far is shifting out the policy path. We continue to expect the Fed to deliver a 25 basis point hike about its March and May meetings, bringing peak policy rates to 5 to 5.25%. However, with a less significant and delayed slowdown in the labor market, with a more moderate increase in the unemployment rate, the Fed's pace of monetary easing is likely to be slower, and the first rate cut is likely to occur later. We think the Fed will hold rates at these levels for a longer period rather than hike to a higher peak, as this carries less of a risk of over tightening. We now see the Fed delivering the first rate cut in March 2024 versus our previous estimate of December 2023, and cutting rates at a slower pace of 25 basis points each quarter next year. This brings the federal funds rate to 4.25% by the end of 2024. With rates well above neutral throughout the forecast horizon, growth remains below potential as well. As for the U.S. consumer, while excess savings boosted spending in 2022 despite rising interest rates, we expect consumers to return to saving more this year, which means a step down in spending. 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 Helmi 20233min

As we enter the final month of the first quarter, recalling the history of bear market trends could help predict whether earnings will fall again.----- 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, February 27th at 11am in New York. So let's get after it. Our equity strategy framework incorporates several key components. Overall earnings tend to determine price action the most. For example, if a company beats the current forecast on earnings and shows accelerating growth, the stock tends to go up, assuming it isn't egregiously priced. This dynamic is what drives most bull markets, earnings estimates are steadily rising with no end in sight to that trend. During bear markets, however, that is not the case. Instead, earnings forecasts are typically falling. Needless to say, falling earnings forecasts are a rarity for such a high quality diversified index like the S&P 500, and that's why bear markets are much more infrequent than bull markets. However, once they start, it's very hard to argue the bear markets over until those earnings forecasts stop falling. Stocks have bottomed both before, after and coincidentally with those troughs in earnings estimates. If this bear market turns out to have ended in October of last year, it will be the farthest in advance that stocks have discounted the trough in forward 12 month earnings. More importantly, this assumes earnings estimates have indeed troughed, which is unlikely in our view. In fact, our top down earnings models suggest that estimates aren't likely to trough until September, which would put the trough in stocks still in front of us. Finally, we would note that the Fed's reaction function is very different today given the inflationary backdrop. In fact, during every material earnings recession over the past 30 years, the Fed was already easing policy before we reached the trough in EPS forecasts. They are still tightening today. During such periods, there is usually a vigorous debate as to when the earnings estimates will trough. This uncertainty creates the very choppy price action we witness during bear markets, which can include very sharp rallies like the one we've experienced over the past year. Furthermore, earnings forecasts have started to flatten out, but we would caution that this is what typically happens during bear markets. The stock's fall in the last month of the calendar quarter as they discount upcoming results and then rally when the forward estimates actually come down. Over the past year, this pattern has been observed with stocks selling off the month leading up to the earnings season and then rallying on the relief that the worst may be behind us. We think that dynamic is at work again this quarter, with the stocks selling off in December in anticipation of bad news and then rallying on the relief it's the last cut. Given that we are about to enter the last calendar month of the first quarter later this week, we think the risk of stocks falling further is high. Bottom line, we don't believe the earnings forecasts are done and we think they're going to fall again in the next few months. This is a key debate in the market, and our take is that while the economic data appears to have stabilized and even turned up again in certain areas, our negative operating leverage cycle is alive and well and could overwhelm any economic scenario over the next six months. We remain defensive going into March with the worst of this earnings cycle still ahead of us. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.

27 Helmi 20233min

As short-term bond yields continue to rise, what impact does this comparatively high yield have on the broader market?----- 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, February 24th at 2 p.m. in London. One of the biggest stories brewing in the background of markets is the sharp rise in yields on safe, short-term bonds. A 6 month Treasury bill is a great example. In November of 2021, it yielded just 0.06%. Today, just 14 months later, it yields 5.1%, its highest yield since July of 2007. The rise in safe short-term yields is notable for its speed and severity, as the last 12 months have seen the fastest rise of these yields in over 40 years. But it also has broader investment implications. Higher yields on cash like instruments impact markets in three distinct ways, all of which reduce the incentive for investors to take market exposure. First and most simply, higher short term rates raise the bar for what a traditional investor needs to earn. If one can now get 5% yields holding short term government bonds over the next 12 months, how much more does the stock market, which is significantly more volatile, need to deliver in order to be relatively more appealing? Second, higher yields impact the carry for so-called leveraged investors. There is a significant amount of market activity that's done by investors who buy securities with borrowed money, the rate of which is often driven by short term yields. When short term yields are low, as they've been for much of the last 12 years, this borrowing to buy strategy is attractive. But with U.S. yields now elevated, this type of buyer is less incentivized to hold either U.S. stocks or bonds. Third, higher short term yields drive up the cost of buying assets in another market and hedging them back to your home currency. If you're an investor in, say, Japan, who wants to buy an asset in the U.S. but also wants to remove the risk of a large change in the exchange rate over the next year, the costs of removing that risk will be roughly the difference between 1 year yields in the US and 1 year yields in Japan. As 1 year yields in the U.S. have soared, the cost of this hedging has become a lot more expensive for these global investors, potentially reducing overseas demand for U.S. assets and driving this demand somewhere else. We think a market like Europe may be a relative beneficiary as hedging costs for U.S. assets rise. The fact that U.S. investors are being paid so well to hold cash-like exposure reduces the attractiveness of U.S. stocks and bonds. But this challenge isn't equal globally. Both inflation and the yield on short-term cash are much lower in Asia, which is one of several reasons why we think equities in Asia will outperform other global markets going forward. 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.

24 Helmi 20233min

Companies continue their attempts to mitigate their environmental impact. But are some merely buying their way out of the problem using carbon offsets? Global Head of Sustainability Research Stephen Byrd and Head of ESG Fixed-Income Research Carolyn Campbell discuss. ----- Transcript -----Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research. Carolyn Campbell: And I'm Carolyn Campbell, Head of Morgan Stanley's ESG Fixed-Income Research. Stephen Byrd: On this special episode of the podcast, we'll discuss the voluntary carbon offset market and the role carbon offsets play in achieving companies' decarbonization goals. It's Thursday, February 23rd at 10 a.m. in New York. Stephen Byrd: As extreme weather becomes the new normal, and sustainability rises in importance on investors' agendas, many companies are working towards mitigating their environmental impact. But even so, there's persistent public concern that some companies claiming to be carbon neutral may in fact be "greenwashing" by purchasing so-called carbon offsets. So, Carolyn, let's start with the basics. What exactly are carbon offsets and why should investors care? Carolyn Campbell: So a carbon offset represents one ton of carbon dioxide equivalent removed, reduced or avoided in the atmosphere. Companies are buying offsets to neutralize their own emissions. They essentially subtract the amount of carbon offsets purchased from their total emissions, from their operations and supply chain. These offsets are useful because it allows a company to take action against their emissions now, while implementing longer term decarbonization strategies. However, there's concern that these companies are just buying their way out of the problem and are using these offsets that do not actually do anything with respect to actually limiting global warming. So, Stephen, some of these offsets focus on reducing carbon dioxide emissions, while others aim to directly remove these emissions from the atmosphere. Between these so-called avoidance and removal offsets, how do you see the market evolving for each over the next 5 to 10 years, let's say? Stephen Byrd: Yeah, Carolyn, I think the balance is set to shift in favor of removal over the coming decade. So we developed an assessment of the potential mix shift from carbon avoidance to carbon removal projects, which shows the long term importance of removal projects as well as the near-term to medium term need for avoidance projects. We're bullish that over the long term removal projects, and think of these projects as projects that demonstrably and permanently take carbon dioxide out of the atmosphere, as generating enough carbon offset credits to reach company's net zero targets, again in the long term. However, over the near to medium term, call it the next 5 to 10 years, we expect the volume of removal projects to fall short. As a result, we think carbon avoidance projects, and these would be projects that avoid new atmospheric emissions of carbon dioxide. These will play an important role as offset purchasers shift their mix of carbon offsets towards removal over the course of this decade. Carolyn, one of the big debates in the market around voluntary carbon offsets involves nature based projects versus technology based projects. Could you give us some examples of each and just talk through, is one type significantly better than the other? And which one do you think will likely gain the most traction? Carolyn Campbell: Sure. So on the one side, we've got these nature based projects which include things like reforestation, afforestation and avoided deforestation projects. In essence planting trees and protecting forests that are already there. There's also other projects related to grasslands and coastal conservation. On the other side, we've got these tech based projects which are actually quite wide ranging. This includes things like deploying new renewable technology or capping oil wells to prevent methane leakage, substituting wood burning stove for clean cookstoves, everything up to direct air capture and carbon capture, so on and so forth. So in our view, these tech based offsets will eventually dominate the market, but they face some scaling and cost hurdles over in the near term. Tech based offsets have some key advantages. They're highly measurable and they have a high probability of permanence, both disadvantages on the nature based side. Nature based sides, like I said, have measurement hurdles, but we think they represent an important interim solution until either geographic limits are reached because there's no more area left to reforest, or legislative conservation takes over. Removal technologies, like direct air capture and carbon capture, yield highly quantifiable results. And that drives a value in a market where the lack of confidence is a major obstacle to growth. So we think that's where the market's heading, but we're not really there yet. Now, one thing we haven't discussed is why even buy carbon offsets at all? Should companies be spending their limited sustainability budgets on carbon offsets, or is that money better served on research and development that might get us closer to absolute zero in the long term? Stephen Byrd: Yeah, we are seeing signs that companies are increasingly looking to spend more of their sustainability budgets on research and development of long term decarbonization solutions, in lieu of buying carbon offsets. Now we support that trend, given the need for new technologies to really bend the curve on carbon emissions. And we do believe that offsets should not substitute for viable permanent decarbonization projects. Now, that said, offsets are a complimentary approach that enables action to be taken today against emissions that corporates currently cannot eliminate. We also believe the magnitude of consumer interest in carbon neutral products is underappreciated. Survey work from our alpha wise colleagues, really focused on consumer preferences and carbon neutral goods and services, shows that consumers are willing to pay about a 2% premium for carbon neutrality. Now, that may not sound like much, but it's actually a very significant number when you translate that into a price on carbon. Let's take sneakers as an example. Our math would indicate that consumers would be willing to price carbon offsets at a value above $150 a ton of carbon dioxide. That prices about 15 times the weighted average price of offsets in 2022. So consumer preferences may well play an important role in the evolution of the carbon offset market throughout the course of this decade and beyond. And we do think that this dynamic could provide the support needed to move the market towards higher quality offsets, and also drive companies to develop their own innovative decarbonization solutions. Carolyn, how big do you think the carbon offsets market could get over the next 5 to 10 years and even longer term? Carolyn Campbell: Okay, so right now the market's around 1 to 2 billion in size, but we think there is a sizable growth opportunity between now and 2030, which is when many of the interim targets are set. And also longer term out to 2050, by which point we're trying to be net zero. So we estimate that the market could grow to around 100 billion by the end of this decade, and that will swell to around 250 billion by mid-century. And we've done this analysis based on our median expectation for progress on a few different decarbonization technologies like decarbonizing cement, decarbonizing manufacturing, and increasing the zero carbon energy penetration in the grid. When we look at that technological progress versus where we need to be in terms of our ambition to keep warming to one and a half or two degrees Celsius, that's how we arrive at the shortfall to make up that size of the market. Stephen Byrd: Finally, Carolyn, one of the criticisms of carbon offsets is that they aren't regulated. So could you give us a quick glimpse into the policies and regulations around carbon offsets that potentially lie ahead? Carolyn Campbell: Yeah, so you're right. Right now the market is largely unregulated and that creates the risk of fraud and manipulation. However, we don't expect imminent action, and it's just not a priority in the U.S. for Congress. That being said, if regulation does occur, we have an idea of what it could look like. We would expect to be led by the CFTC, which regulates the commodities markets. And we think that it would be focused on ensuring integrity in the market, creating a registration framework for the offsets and pursuing individual cases of fraud. Now, without formal regulation, there are few voluntary initiatives that have continued to set the standards in the industry. These organizations focus on the integrity of the market, they set principles to ensure that offsets are high quality, and they're even looking at labeling to mark credits as high integrity. So there's a lot of guidance out there, and it's constantly adapting to this evolving landscape. Stephen Byrd: Carolyn, thanks for taking the time to talk. Carolyn Campbell: Great speaking with you today, Stephen. Stephen Byrd: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

24 Helmi 20238min

With housing affordability plateauing and inventory picking up, sales could be poised to rise again in the near future.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-Head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-Head of U.S. Securities Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing the U.S. housing and mortgage markets. It's Wednesday, February 22nd, at 11 a.m. in New York. Jay Bacow: All right. So, Jim, when we're looking at data on the housing market, it seems like it's all over the place. We've got home sale activity pointing one direction. We've got home prices doing other things. What's going on? You've had this bifurcation narrative. Is the bifurcation narrative still bifurcating? Jim Egan: So to remind our listeners, the bifurcation narrative for our housing forecasts is between home prices, which we thought were a lot more protected, and housing activity, so sales and housing starts where we thought you were going to see a lot more weakness. And I would say that bifurcation narrative still exists. But, as you're saying, the different data have been pointing to different things. For instance, purchase applications, they picked up sequentially in January from December. And after declining in every single month of 2022, the homebuilder confidence has increased in both January and February. Jay Bacow: All right. But when I think about what happened over that time period, mortgage rates fell almost 100 basis points from their highs in November, as you measure that purchase application pick up from December to January. Is that playing a role? Do you think that there are signs that maybe housing activity is going to pick back up? Jim Egan: So from a mortgage rate perspective, it'd be difficult for us to say it isn't. So we do think that that's playing a role, but we also think it's a little too early to say that housing activity is going to pick back up from here. For one thing, mortgage rates might have come down 100 basis points from mid-November into January, but they've also begun to move higher over the past few weeks. For another, the variables that we've been paying close attention to haven't really shown much improvement. Jay Bacow: Those variables, you mean affordability and supply. How are those looking now? Jim Egan: Exactly. Now let's think about what drove our bifurcation hypothesis in the first place. Because of the record growth in home prices that we saw in 2021 and 2022, combined with the sharp increase in mortgage rates in 2022. They were up almost 400 basis points before that 100 basis point decline that we talked about. Affordability deteriorated more than at any point in over three decades. In fact, the year over year deterioration was roughly three times what we experienced in the years leading up to the GFC. Jay Bacow: Now we want to remind our listeners that this affordability deterioration is really for first time homebuyers. Given the vast predominance of the fixed rate mortgage in the United States most homeowners have a low 30 year fixed rate mortgage with an average rate of about 3.5%. Obviously, their affordability didn't change. What did change was prospective homeowners that are looking to buy a house and now would have to take a mortgage at a higher rate. That does mean that those people with a low fixed rate mortgage, they've got low rates. Jim Egan: And that means that they simply have not been incentivized to list their homes for sale. The inventory of existing homes available for sale plummeted to over 40 year lows. And we only really have 40 years of data. More importantly for the drop in sales volumes that we've seen, if an existing homeowner is not selling their home, they're also not buying a home on the follow that further exaggerates the drop. But thinking about where we are today, affordability is no longer rapidly deteriorating. In fact, it's basically been unchanged over the past three months. And inventories, they remain near 40 year lows, but they're also no longer falling rapidly. If anything, they're actually kind of increasing on the margins. It is only on the margins because of that lock in effect that you mentioned Jay. Jay Bacow: Okay. But it is increasing slightly. So if you have a little bit of a pickup in inventory in basically unchanged affordability, what does that mean for home sales? Jim Egan: Affordability is challenged and supply is very tight, but both are no longer getting even more stretched. In other words, we don't see a catalyst for sales volumes to inflect higher from here, but we also don't think the ingredients are in place for large month over month declines to continue either. I wouldn't say that sales have bottomed, but I would lean more towards they are in the process of bottoming right now. We expect volumes to be weak in the first half of 2023, but perhaps not substantially weaker than they were in the fourth quarter of 2022, where volumes retraced all the way back to 2010 levels. We also want to emphasize that this will still result in significant year over year declines, given how strong the first half of 2022 was. The January purchase applications that I earlier stated were moving higher, they were down 40% year over year from January of 2022. And they also have started to come down a little bit in February. The existing home sales print that happened earlier this week for January, that was down 37% year over year. Jay Bacow: All right, so, home sale activity is in the process of bottoming, but it's down 37% to 40%, depending on what number that we're talking about. In order for things to bifurcate, we need another side. So what's happening with prices? Jim Egan: I would say that prices are still more protected. That doesn't mean the prices are going to continue to grow. When we think about year over year growth in prices, it continues to slow. We were down to 7.7% in the most recent print, which represents November home prices. We'll get the December print next week. We think it'll slow to roughly 6% when we get that. And month over month, home prices have been coming down. They're down about 3.5% from peak, which was June of 2022. We do think that year over year will still turn negative in 2023, the first time that's happened since 2012. But even if we get the 4% decline in home prices in 2023 that we're calling for, that would still only really bring us back to the end of 2021, which is up 30% from the onset of the pandemic in March of 2020. And as I mentioned earlier, sales volumes hit levels we hadn't seen since 2010. So, that bifurcation still exists. Jay Bacow: All right. So that bifurcation between home sales and home prices is still going to exist. Jim, always great talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app, and share the podcast with a friend or colleague today.

22 Helmi 20236min

While the causes of the European equity rally have become more clear over time, so have the caveats that warrant caution over optimism for cyclical stocks.----- Transcript -----Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the deflating safety cushion for European equities. It's Tuesday, February the 21st at 3 p.m. in London. With the benefit of hindsight, it's relatively easy to justify the European equity rally since the start of October, given that we've seen an improvement in the macro news flow against a backdrop of low valuation and depressed investor sentiment and positioning. While the macro outlook could continue to improve from here, we think the safety cushion that low valuation and depressed sentiment had previously provided has deflated considerably as investors have been drawn back into the market by rising price momentum. On valuation, the MSCI Europe Index still looks quite inexpensive on a next 12 month forward PE of 13, however the same ratio for Europe's median stock has risen to 16, which is at the upper end of its historic range. Admittedly, a less padded safety cushion is not necessarily a problem if the fundamental economic and earnings trends continue to improve. However, there is now considerably less margin for any disappointment going forward. This rebound in European equities has been led primarily by cyclical sectors who have outperformed their defensive peers by nearly 20% over the last six months. Historically, this pace of outperformance has tended to be a good sign, suggesting that we had started a new economic cycle with further upside for cyclical stocks ahead. However, while this sounds encouraging, we see three caveats that warrant caution rather than optimism at this point. First, we have seen no deterioration in cyclicals’ profitability yet, and the lack of any downturn now makes it harder to envisage an EPS upturn required to drive share prices higher going forward. Second, we get a very different message from the yield curve, which has consistently proved to be one of the best economic leading indicators over many cycles. Today's inverted yield curve is usually followed by a period of cyclical underperformance and not outperformance. And thirdly, cyclicals. Valuations look elevated, with the group trading in a similar price to book value as defensives. When this has happened previously, it usually signals cyclicals’ underperformance ahead. Given our cautious view on cyclicals, we prefer small and mid-cap stocks as a way to gain exposure to a European recovery. Having underperformed both large caps and cyclicals significantly over the last year, relative valuations for smaller stocks looks much more appealing, and relative performance looks like it is breaking out of its prior downtrend. In addition, we see two specific macro catalysts that should help smaller stocks in 2023, namely falling inflation and a rising euro. Historically, both these trends have tended to favor smaller companies over larger companies, and we expect the same to happen this year. At the country level we think the case for small and mid-cap stocks looks most compelling in Germany, where the relative index, the MDAX, has significantly lagged its larger equivalent, the DAX, such that relative valuations are close to a record low. 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.

21 Helmi 20233min

As our outlook for global equities becomes more cautious, what is influencing the move and what should investors watch as the story develops?----- 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, February 17th at 2 p.m. in London. We recently moved to an underweight stance in global equities as part of our cross-asset allocations. I want to talk a bit about why we did this, why we did it recently and what we're watching. The 'why' behind this move is straightforward, global equities now have low risk-adjusted returns in our framework. Our expected return for global stocks is now below what we see for bonds in the U.S., Europe or emerging markets, and it's also lower than what we expect for U.S. dollar cash. With lower expected returns and higher expected volatility, we think it makes sense to hold a lower than normal amount of global equities, hence our underweight stance. In terms of why we've made this change recently, a few things have shifted. Per Morgan Stanley's forecast, we entered the year expecting low returns for U.S. equities, but higher returns for non-U.S. stocks. But as prices have gone up in 2023, our expected returns outside the U.S. have also fallen, while in the U.S. they're now negative. We also think about expected returns based on longer-run valuations, and then adjusting these for economic conditions. We frame those economic expectations through something we call our cycle indicator, which is trying to look at economic data through the lens of being either stronger or weaker than average, and improving or softening. That indicator recently flipped, indicating a regime where the data is still strong but it's no longer improving, and historically that's often meant lower than average equity returns. And all of this has happened at a time when yields have risen, which is improving expected returns for a lot of other assets. The U.S. aggregate bond index now yields about 4.7%, while 12 month U.S. Treasury bills yield about the same amount. That is raising the bar for what global equities need to return to be relatively more attractive within one's portfolio. For a change like this, what are the risks? Well, one would be a stronger economy, which tends to be better for stocks relative to other assets. And some recent data has been strong, especially related to the U.S. labor market and retail sales. Our economists, however, think the growth story is still murky. Recent economic data is being impacted by large seasonal adjustments, which may be accurate, but which could also be flattering January data if economic patterns have changed versus their pre-COVID trends. Meanwhile, other economic indicators from PMIs to the yield curve to commodity prices suggest a softer growth backdrop ahead. Falling expected returns for stocks relative to other assets have led us to downgrade global equities to underweight. A surprising rebound in global growth is a risk to this change, but for now, we see better risk adjusted reward elsewhere in one's portfolio. 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.

17 Helmi 20233min

Next month the leadership of the Bank of Japan will change hands, so what policy shifts might be in store and what does this imply for markets?----- Transcript -----Welcome to Thoughts on the Market. I'm Daniel Blake from Morgan Stanley's Asia and Emerging Markets Equity Strategy team. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss Japanese equity markets and the changing of the guard at the Bank of Japan. It's Thursday, February 16th at 8 a.m. in Singapore. March the 10th will mark the end of an era for Japan, with Haruhiko Kuroda completing his final meeting at the helm of the Bank of Japan. Alongside the late Shinzo Abe, Kuroda-san has been instrumental in creating and implementing the famous Abenomics program over the last decade, and we think he's been successful in bringing Japan out of its long running deflationary stance. And just this week we've had the nomination of his replacement, Kazuo Ueda, a well-respected University of Tokyo professor and former Bank of Japan board member. He may not be a household name outside of the economics community, but his central bank and policy bloodlines run deep, having studied a Ph.D. at MIT alongside former Fed Chairman Ben Bernanke and under the tutelage of Stanley Fischer, former Bank of Israel governor and vice Fed chair. So as we see a generational handover at the BoJ, what do we expect next and what does it imply for equity markets? Firstly, Japan has made a lot of progress, but we don't think the mission has been fully accomplished on the Bank of Japan's 2% inflation target. Current inflation is being driven by cost pressures and while wage growth is picking up, we don't think wages will move up to the levels needed to see inflation at 2% being sustained. So we don't expect the BoJ under Ueda-san to embark on a tightening cycle the way we have seen for the Fed and the ECB. However, we can look for some change and in particular we think Ueda-san will look to resolve some of the market dysfunction associated with the policy of yield curve control. This is where the BoJ looks to cap bond yields at the ten year maturity, around a target of 0%. We expect he'll exit this policy of yield curve control by summer 2023, allowing the curve to steepen. And thirdly, we'll be watching closely his perspective on negative interest rate policy as we weigh up the costs and benefits and the transmission of negative rates into the real economy, albeit at the cost of profitability impacts for the banking sector. His testimony before the DIT on February 24th and his approach to negative interest rates under his governorship will be important to watch. We expect negative interest rate policy to be dropped, but not until 2024 in our base case, but this remains a key debate. So in terms of implications, this is more evolution than revolution for macro policy in Japan. And importantly, we see fiscal policy remaining supportive as the program of new capitalism and Ueda-san looks to strengthen social safety nets and double defense spending from 1% of GDP. Secondly, for equity markets, we see a resilient but still range bound outlook for the benchmark TOPIX Index. Our base case target of 2020 for December 2023 implies it doesn't quite break the top of its three year trading range, but remains well supported. Finally, at a sector level, banks and insurers may benefit from a tilting policy away from yield curve control. Again, especially if followed by a move back to zero rates from negative rate policy. In summary, we'll be watching for any shifts in the BoJ reaction function under the new leadership of Kazuo Ueda, but we do not expect a macro shock to asset markets. Instead, some micro adjustment in the yield curve control policy, and potentially negative interest rates, could help the sustainability of very low interest rates in Japan. Thanks for listening and if you enjoyed the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

16 Helmi 20233min