Relief and Volatility Ahead for U.S. Stocks

Original Release on December 2nd, 2022: While 2022 saw the fastest pace of policy tightening on record, has the Fed’s hiking cycle properly set the U.S. economy up for a soft landing in 2023?----- Transcript -----Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss our 2023 outlook for the U.S. economy. It's Friday, December 2nd, at 10 a.m. in New York. Let's start with the Fed and the role higher interest rates play in the overall growth outlook. The Fed has delivered the fastest pace of policy tightening on record and now feels comfortable to begin slowing the pace of interest rate increases. We expect it to step down the pace to 50 basis points at its meeting later this month and then deliver a final hike in January to a peak rate of between 4.5 and 4.75%. But in order to keep inflation on a downward trajectory, the Fed will likely keep rates at that peak level for most of next year. This shift to a more cautious stance from the Fed we think will help the U.S. economy narrowly miss recession in 2023. And we think only in the back half of 2024 will the pace of growth pick back up as the Fed gradually reduces the policy rate back toward neutral, which is around 2.5%. Altogether, we forecast 2023 GDP growth of just 0.3% before rebounding modestly to 1.4% in 2024. One bright spot in the outlook is that inflation seems to have reached a turning point. Mounting evidence points to a slowing in housing prices and rents, though they continue to drive above target inflation. Core goods inflation should turn to disinflation as supply chains normalize and demand shifts to services and away from goods. Used vehicle prices are a big contributor to lower overall inflation in our forecast, as our motor vehicle analysts believe that used car prices could be down as much as 10 to 20% next year. So overall, we expect core PCE - or personal consumption expenditures inflation - to slow from 5% this year, to 2.9% in 2023, and further to 2.4% in 2024. Throughout 2022, rising interest rates have raised borrowing costs, which has weighed on consumption. And we expect that to continue into 2023 as the cumulative effects of past policy hikes continue to flow through to households. On the income side, we expect a rebound in real disposable income growth in 23, because inflation pressures abate while job growth continues to be positive. So if I put those together, slower consumption and rising incomes should lift the savings rate from 3.2% this year, to 5.1% in 2023, and 6.2% in 2024. So households will start to rebuild that cushion. Now we're in the midst of a sharp housing correction, and we expect a double digit decline in residential investment to continue. But we don't expect a commensurate drop in home valuations. Our housing strategies predict just a 4% drop in national home prices in 2023, and further price declines are likely in the years ahead, but that's a much milder drop in home valuations compared with the magnitude of the drop off in housing activity. So we think that residential wealth, real estate wealth will continue to be a strong backdrop for household balance sheets. Now going forward, mortgage rates will start to fall again after reaching these peaks around 7%. And with healthy job gains, and that increase in real disposable income growth affordability should begin to ease somewhat, we think starting in the back half of 2024. Turning to the labor market, while signs of falling inflation is important to the Fed, so are signs that the labor market is softening and we expect softer demand for labor and further labor supply gains to create the slack in the labor market the Fed is looking for. So we expect job growth will likely fall below the replacement rate by the second quarter of 2023, pushing up the unemployment rate to 4.3% by the end of next year and 4.4% by the end of 2024. In sum, we think the U.S. economy is at a turning point, but not a turning point toward recession, a turning point toward what is likely to prove to be two sluggish years of growth in the economy. The Fed's hiking cycle is working as it should. The labor market is softening. The inflation rate is coming down. And we think that puts the U.S. economy on track for a soft landing in 2023. 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 Joulu 20224min

Original Release on November 22nd, 2022: The year ahead outlook is a process of collaboration between strategists and economists from across the firm, so what were analysts debating when thinking about 2023, and how were those debates resolved? Chief Cross-Asset Strategist Andrew Sheets and Head of Fixed Income Research Vishy Tirupattur discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's Chief Cross Asset Strategist. Vishy Tirupattur: And I am Vishy Tirupattur, Morgan Stanley's Head of Fixed Income Research. Andrew Sheets: And on this special episode of the podcast, we'll be discussing some of the key debates underpinning Morgan Stanley's 2023 year ahead outlook. It's Tuesday, November 22nd at 3 p.m. in London. Vishy Tirupattur: And 10 a.m. in New York. Andrew Sheets: So Vishy, within Morgan Stanley research we collaborate a lot, but I think it's not an exaggeration to say that when we sit down to write our year ahead outlooks for strategy and economics, it's probably one of the most collaborative exercises that we do. Part of that is some pretty intense debate. So that's what I was hoping to talk to you about, kind of give listeners some insight into what are the types of things that Morgan Stanley research analysts were debating when thinking about 2023 and how we resolved some of those issues. And I think maybe the best place to start is just this question of inflation, right? Inflation was the big surprise of 2022. We underestimated it. A lot of forecasters underestimated inflation. As we look into 2023, Morgan Stanley's economists are forecasting inflation to come down. So, how did that debate go? Why do we have conviction that this time inflation really is going to moderate? Vishy Tirupattur: Thanks, Andrew. And it is absolutely the case that challenging each other's view is critically important and not a surprise that we spent a lot of time on inflation. Given that we have many upside surprises to inflation throughout the year, you know, there was understandable skepticism about the forecasts that US inflation will show a steady decline over the course of 2023. Our economists, clearly, acknowledge the uncertainty associated with it, but they took some comfort in a few things. One in the base effect. Two, normalizing supply chains and weaker labor markets. They also saw that in certain goods, certain core goods, such as autos, for example, they expect to see deflation, not just disinflation. And there's also a factor of medical services, which has a reset in prices that will exert a steady drag on the core inflation. So all said and done, there is significant uncertainty, but there are still clearly some reasons why our economists expect to see inflation decline. Andrew Sheets: I think that's so interesting because even after we published this outlook, it's fair to say that a lot of investor skepticism has related to this idea that inflation can moderate. And another area where I think when we've been talking to investors there's some disagreement is around the growth outlook, especially for the U.S. economy. You know, we're forecasting what I would describe as a soft landing, i.e., U.S. growth slows but you do not see a U.S. recession next year. A lot of investors do expect a U.S. recession. So why did we take a different view? Why do we think the U.S. economy can kind of avoid this recessionary path? Vishy Tirupattur: I think the key point here is the U.S. economy slows down quite substantially. It barely skirts recession. So a 0.5% growth expectation for 2023 for the U.S. is not exactly robust growth. I think basically our economists think that the tighter monetary policy will stop tightening incrementally early in 2023, and that will play out in slowing the economy substantially without outright jumping into contraction mode. Although we all agree that there is a considerable uncertainty associated with it. Andrew Sheets: We've talked a bit about U.S. inflation and U.S. growth. These things have major implications for the U.S. dollar. Again, I think an area that was subject to a lot of debate was our forecast that the dollar's going to decline next year. And so, given that the U.S. is still this outperforming economy, that's avoiding a recession, given that it still offers higher interest rates, why don't we think the dollar does well in that environment? Vishy Tirupattur: I think the key to this out-of-consensus view on dollar is that the decline in inflation, as our economists forecast and as we just discussed, we think will limit the potential for US rates going much higher. And furthermore, given that the monetary policy is in restrictive territory, we think there is a greater chance that we will see more downside surprises in individual data points. And while this is happening, the outlook for China, right, even though it is still challenging, appears to be shifting in the positive direction. There's a decent chance that the authorities will take steps towards ending the the "zero covid" policy. This would help bring greater balance to the global economy, and that should put less upward pressure on the dollar. Andrew Sheets: So Vishy, another question that generated quite a bit of debate is that next year you continue to see quantitative tightening from the Fed, the balance sheet of the Federal Reserve is shrinking, it's owning fewer bonds and yet we're also forecasting U.S. bond yields to fall. So how do you square those things? How do you think it's consistent to be forecasting lower bond yields and yet less Federal Reserve support for the bond market? Vishy Tirupattur: Andrew, there are two important points here. The first one is that when QT ends, really, history is really not much of a guide here. You know, we really have one data point when QT ended, before rate cuts started happening. And the thinking behind our thoughts on QT is that the Fed sees these two policy tools as being independent. And stopping QT depends really on the money market conditions and the bank demand for reserves. And therefore, QT could end either before or after December 2023 when we anticipate normalization of interest rate policy to come into effect. So, the second point is that why we think that the interest rates are going to rally is really related to the expectation of significant slowing in the economic growth. Even though the U.S. economy does not go into a contraction mode, we expect a significant slowing of the U.S. economy to 0.5% GDP growth and the economy growing below potential even into 2024 as the effects of the tighter monetary policy conditions begin to play out in the real economy. So we think the rally in U.S. rates, especially in the longer end, is really a function of this. So I think we need to keep the two policy tools a bit separate as we think about this. Andrew Sheets: So Vishy, I wanted us to put our credit hats on and talk a little bit about our expectations for default rates. And I think here, ironically, when we've been talking to investors, there's been disagreement on both sides. So, you know, we're forecasting a default rate for the U.S. of around 4-4.5% Next year for high yield, which is about the historical average. And you get some investors who say, that expectation is too cautious and other investors who say, that's too benign. So why is 4-4.5% reasonable and why is it reasonable in the context of those, you know, investor concerns? Vishy Tirupattur: It's interesting, Andrew, when you expect that some some people will think that the our expectations are too tight and others think that they are too wide and we end up somewhat in the middle of the pack, I think we are getting it right. The key point here is that the the maturity walls really are pretty modest over the next two years. The fundamentals, in terms of coverage ratios, leverage ratio, cash on balance sheets, are certainly pretty decent, which will mitigate near-term default pressures. However, as the economy begins to slow down and the earnings pressures come into play, we will expect to see the market beginning to think about maturity walls in 2025 onwards. All that means is that we will see defaults rise from the extremely low levels that we are at right now to long-term average levels without spiking to the kinds of default rates we have seen in previous economic slowdowns or recessions. Andrew Sheets: You know, we've had this historic rise in mortgage rates and we're forecasting a really dramatic drop in housing activity. And yet we're not forecasting nearly as a dramatic drop in U.S. home prices. So Vishy, I wanted to put this question to you in two ways. First, how do we justify a much larger decrease in housing activity relative to a more modest decrease in housing prices? And then second, would you consider our housing forecast for prices bullish or bearish relative to the consensus? Vishy Tirupattur: So, Andrew, the first point is pretty straightforward. You know, as mortgage rates have risen in response to higher interest rates, affordability metrics have dramatically deteriorated. The consequence of this, we think, is a very significant slowing of housing activity in terms of new home sales, housing starts, housing permits, building permits and so on. The decline in those housing activity metrics would be comparable to the kind of decline we saw after the financial crisis. However, to get the prices down anywhere close to the levels we saw in the wake of the financial crisis, we need to see forced sales. Forced sales through foreclosures, etc. that we simply don't expect to see happen in the next few years because the mortgage lending standards after the financial crisis had been significantly tighter. There exists a substantial equity in many homes today. And there's also this lock-in effect, where a large number of current mortgage holders have low mortgage rates locked in. And remember, US mortgages are predominantly fixed rate mortgages. So the takeaway here is that housing activity will drop dramatically, but home prices will drop only modestly. So relative to the rest of the street, our home price forecast is less negative, but I think the key point is that we clearly distinguish between what drives home pricing activity and what drives housing activity in terms of builds and starts and sales, etc.. And that key distinction is the reason why I feel pretty confident about our housing activity forecast and home price forecast. Andrew Sheets: Vishy, thanks for taking the time to talk. Vishy Tirupattur: Always a pleasure talking to you, Andrew. Andrew Sheets: Happy Thanksgiving from all of us at Thoughts on the Market. We have passed yet another exciting milestone: over 1 million downloads in a single month. I wanted to say thank you for continuing to tune in and share the show with your friends and colleagues. It wouldn't be possible without you, our listeners. SummaryThe year ahead outlook is a process of collaboration between strategists and economists from across the firm, so what were analysts debating when thinking about 2023, and how were those debates resolved? Chief Cross-Asset Strategist Andrew Sheets and Head of Fixed Income Research Vishy Tirupattur discuss.

27 Joulu 202210min

Original Release on November 17th, 2022: With risks to both home sales and home prices continuing to challenge the housing market, investors will want to know what is keeping the U.S. housing market from a sharp fall mirroring the great financial crisis? Co-heads of U.S. Securitized Products Research Jim Egan and Jay Bacow discuss.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-head of U.S. Securities Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing our year ahead outlook for the U.S. housing market for 2023. It's Thursday, November 17th, at 1 p.m. in New York. Jay Bacow: So Jim, it's outlook season. And when we think about the outlook for the housing market, we’re not just looking in 2023, people live in their houses for their whole lives.Jim Egan: Exactly. We are contemplating what's going to happen to the housing market, not just in 23, but beyond in this year's version of the outlook. But just to remind the listeners, we have talked about this on this podcast in the past, but our view for 2023 hasn't changed all that much. What we think we're going to see is a bifurcation narrative in the housing market between activity, so home sales and housing starts, and home prices. The biggest driver of that bifurcation, affordability. Because of the increase in prices, because of the incredible increase in mortgage rates that we've seen this year, affordability has been deteriorating faster than we've ever seen it. That's going to bring sales down. But the affordability for current homeowners really hasn't changed all that much. We're talking about deterioration for first time homebuyers, for prospective homebuyers. Current homeowners in a lot of instances have locked in very low 30 year fixed rate mortgages. We think they're just incentivized to keep their homes off the market, they're locked into their current mortgage, if you will. That keeps supply down, that also means they're not buying a home on the follow, so it means that sales fall even faster. Sales have outpaced the drop during the great financial crisis. We think that continues through the middle of next year. We think sales ultimately fall 11% next year from an already double digit decrease in 2022 on a year over year basis. But we do think home prices are more protected. We think they only fall 4% year over year next year, but when we look out to 2024, it's that same affordability metric that we really want to be focused on. And, home prices plays a role, but so do mortgage rates. Jay, how are we thinking about the path for mortgage rates into 2024? Jay Bacow: Right. So obviously the biggest driver of mortgage rates are first where Treasury rates are and then the risk premium between Treasury rates and mortgages. The drive for Treasury rates, among other things, is expectations for Fed policy. And our economists are expecting the Fed to cut rates by 25 basis points in every single meeting in 2024, bringing the Fed rate 200 basis points lower. When you overlay the fact that the yield curve is inverted and our interest rate strategists are expecting the ten year note to fall further in 2023, and risk premia on mortgages is already pretty wide and we think that spread can narrow. We think the mortgage rate to the homeowner can go from a peak of a little over 7% this year to perhaps below 6% by 2024. Jim, that should help affordability right, at least on the margins. Jim Egan: It should. And that is already playing a role in our sales forecasts and our price forecasts. I mentioned that sales are falling faster than they did during the great financial crisis. We think that that pace of change really inflects in the second half of next year. Not that home sales will increase, we think they'll still fall, they're just going to fall on a more mild or more modest pace. Home prices, the trajectory there also could potentially be more protected in this improved affordability environment because I don't get the sense that inventories are really going to increase with that drop in mortgage rates. Jay Bacow: Right. And when we look at the distribution of mortgage rates in America right now, it's not uniformly distributed. The average mortgage rate is 3.5%, but right now when we think how many homeowners have at least 25 basis points of incentive to refinance, which is generally the minimum threshold, it rounds to 0.0%. If mortgage rates go down to 4%, about 2.5 points below where they are right now, we're still only at about 10% of the universe has incentive to refinance. So while rates coming down will help, you're not going to get a flood of supply. Jim Egan: We think that’s important when it comes to just how far home prices can fall here. The lock in effect will still be very prevalent. And we do think that that continues to support home prices, even if they are falling on a year over year basis as we look out beyond 2023 into 2024 and further than that. Now, the biggest pushback we get to this outlook when we talk to market participants is that we're too constructive. People think that home prices can fall further, they think that home prices can fall faster. And one of the reasons that tends to come up in these conversations is some anchoring to the great financial crisis. Home prices fell about 30% from peak to trough, but we think it's important to note that that took over five years to go from that peak to that trough. In this cycle home prices peaked in June 2022, so December of next year is only 18 months forward. The fastest home prices ever fell, or the furthest they ever fell over a 12 month period, 12.7% during the great financial crisis. And that took a lot of distress, forced sellers, defaults and foreclosures to get to that -12.7%. We think that without that distress, because of how robust lending standards have been, the down 4% is a lot more realistic for what we could be over the course of next year. Going further out the narrative that we'll hear pretty frequently is, well, home prices climbed 40% during the pandemic, they can reverse out the entirety of that 40%. And we think that that relies on kind of a faulty premise that in the absence of COVID, if we never had to deal with this pandemic for the past roughly three years, that home prices would have just been flat. If we had this conversation in 2019, we were talking about a lot of demand for shelter, we were talking about a lack of supply of shelter. Not clearly the imbalance that we saw in the aftermath of the pandemic, but those ingredients were still in place for home prices to climb. If we pull trend home price growth from 2015 to 2019, forward to the end of 2023, and compare that to where we expect home prices to be with the decrease that we're already forecasting, the gap between home prices and where that trend price growth implies they should have been, 9%. Till the end of 2024 that gap is only 5%. While home prices can certainly overcorrect to the other side of that trend line, we think that the lack of supply that we're talking about because of the lock in effect, we think that the lack of defaults and foreclosures because of how robust lending standards have been, we do think that that leaves home prices much more protected, doesn't allow for those very big year over year decreases. And we think peak to trough is a lot more control probably in the mid-teens in this cycle. Jay Bacow: So when we think about the outlook for the U.S. housing market in 2023 and beyond, home sale activity is going to fall. Home prices will come down some, but are protected from the types of falls that we saw during the great financial crisis by the lock in effect and the better outlook for the credit standards in the U.S. housing market now than they were beforehand. Jay Bacow: Jim, always greatv talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you all for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app, and share the podcast with a friend or colleague today.

23 Joulu 20227min

When attempting to determine what the global economy looks like, some economic indicators at an investors disposal may be more useful, while others lag behind.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, December 22nd at 2 p.m. in London. At the heart of investment strategy is trying to determine what the global economy will look like and what that could mean to markets. But this question has a catch. Market prices often move well ahead of the economic data, partly because markets are anticipatory and partly because it takes time to collect that economic data, creating lags. When thinking about all the economic indicators that an investor can look at, a consistent question is which of these are most and least useful in divining the future? One early indicator we think has relatively powerful forecasting properties is the yield curve, specifically the difference between short term and long term government borrowing costs. These differences can tell us quite a bit about what the bond market thinks the economy and monetary policy is going to do in the future, and can move before broader market pricing. One example of this, as we discussed on the program last week, is that an inverted yield curve like we see today tends to mean that the end of Fed rate hikes are less helpful to global stock markets than they would be otherwise. But at the other end of the spectrum is data on the labor market, which tends to be much more lagging. At first glance, that seems odd. After all, jobs and wages are very important to the economy, why aren't they more effective in forecasting cross-asset returns? But drill deeper and we think the logic becomes a little bit more clear. As the economy initially weakens, most businesses try to hang on to their workers for as long as possible, since firing people is expensive and disruptive. As such, labor markets often respond later as growth begins to slow down. And the reverse is also true, coming out of a recession corporate confidence is quite low, making companies hesitant to add new workers even as conditions are recovering. Indeed, with hindsight, one of the ironies of market strategy is it's often been best to sell stocks when the labor market is at its strongest, and buy them when the labor market is weakest. And then there's wages. Wage growth is currently quite high, and there's significant concern that high wage growth will lead to excess inflation, forcing the Federal Reserve to keep raising interest rates aggressively. While that's possible, history actually points in a different direction. In 2001, 2007, and 2019, the peak in U.S. wage growth occurred about the same time that the Federal Reserve was starting to cut interest rates. In other words, by the time that wage growth on a year over year basis hit its zenith, other parts of the economy were already showing signs of slowing, driving a shift towards easier central bank policy. Investors face a host of economic indicators to follow. Among all of these, we think the yield curve is one of the most useful leading indicators, and labor market data is often some of the most lagging. Happy holidays from all of us here at Thoughts on the Market. We'll be back in the new year with more new episodes. And 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.

22 Joulu 20223min

As congress wraps up for 2022, and we look towards a divided government in 2023, there are a few possible legislative moves on the horizon that investors will want to be prepared for.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between public policy and financial markets. It's Wednesday, December 21st at 11 a.m. in New York. As Congress wraps up its business for the year, it's a good time to level-set on what investors should watch out for out of D.C. in 2023. While it's not an election year, and a divided government means legislative achievements will be tough to come by, it's always a good idea to be prepared. So here's three things to watch for. First, cryptocurrency regulations. Turmoil in the crypto market seems to have accelerated lawmaker interest in tackling the thorny issue. And even if Democrats and Republicans can't come together on regulation, the Biden administration has been studying how regulators could use existing laws to roll out new rules. For investors, the most tangible takeaway from our colleagues is that crypto regulation could support large cap financials by evening the regulatory playing field with the crypto firms. Second, watch for permitting reform on oil and gas exploration. While a late year effort led by Democratic Senator Joe Manchin didn't muster enough votes for passage. It's possible Republicans may be willing to revisit the issue in 2023 when they control the House of Representatives. If this were to pass, watch the oil markets, which might be sensitive to perceptions of future increased supply, supporting the recent downtrend in prices. Lastly, keep an eye out for the U.S. to raise more non-tariff barriers with regard to China. While we're not aware of any specific deadlines in play, many of the laws passed in recent years that augment potential actions like export controls put the U.S. government on a sustained path toward drawing up more tariff barriers. Hence the continued momentum toward restricting many types of trade around semiconductors. We'll be particularly interested in 2023 if the U.S. takes actions that start to relate to other industries, which would reflect a broadening scope of U.S. intentions and the US-China trade conflict. That is potentially a challenge to our strategists' currently constructive view on China equities. Of course, these aren't the only three things out of D.C. that investors should watch for, and history tells us to expect the unexpected. We'll do just that and keep you in the loop here. In the meantime, happy holidays and have a safe and blessed new year. 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.

21 Joulu 20222min

With the recent breakthrough in fusion energy technology, the debate around the feasibility of nuclear fusion as a commercialized energy source may leave investors wondering, is it a holy grail or a pipe dream? Global Head of Sustainability Research and North American Clean Energy Research Stephen Byrd and Head of Thematic Research in Europe Ed Stanley discuss.----- Transcript -----Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research and North American Clean Energy Research. Ed Stanley: And I'm Ed Stanley, Morgan Stanley's Head of Thematic Research in Europe. Stephen Byrd: And on the special episode of Thoughts on the Market, we'll discuss the potential of nuclear fusion technology in light of a key recent breakthrough in the space. It's Tuesday, December 20th, at 10 a.m. in New York. Ed Stanley: And 2 p.m. in London. Stephen Byrd: Ed, you recently came to this podcast to discuss your team's work on "Earthshots", technologies that can accelerate the pace of decarbonization and mitigate some of the climate change that's occurring as a result of greenhouse gas emissions, trapping the sun's heat. In a sense, Earthshots can be defined as urgent solutions to an intensifying climate crisis and nuclear fusion as one of these potential radical decarbonization technologies. So, Ed, I wondered if you could just start by explaining how nuclear fusion fits into your excellent Earthshots framework. Ed Stanley: Absolutely. So in Earthshots we laid out six technologies we thought could be truly revolutionary and changed the course of decarbonization. Three of those were environmental and three were biological innovations. In order of investability, horizon carbon capture was first, smart grids were next, and then further out was nuclear fusion on the environmental side. In early December the U.S. Department of Energy announced the achievement of fusion ignition at the Lawrence Livermore National Laboratory. So Steve, passing back to you, can you give us a sense of why this was considered such an important moment? Stephen Byrd: Yeah Ed, you know, as you mentioned, ignition was achieved at the government lab. And this is very exciting because this shows the potential for fusion to create net energy as a result of achieving fusion. So essentially what happened was two megajoules of energy went into the process of creating the ignition, and three megajoules of energy were produced as a result. So a very exciting development. But as we'll discuss, a lot of additional milestones yet to achieve. Ed Stanley: And there's been significant debates around nuclear fusion in recent days caused by this. And from the perspective of a seasoned utilities analyst, but also with your ESG hat on, is fusion the Holy Grail it's often touted to be, or do you think it's more of a pipe dream? And compared to nuclear fission, how much of a step change would it be? Stephen Byrd: You know, that's a fascinating question in terms of the long term potential of fusion. I do see immense long term potential for fusion, but I do want to emphasize long term. I think, again, we have many steps to achieve, but let's talk fundamentally about what is so exciting about fusion energy. The first and foremost is abundant energy. As I mentioned, you know, small amount of energy in produces a greater amount of energy out, and this can be scaled up. And so this could create plentiful energy that's exciting. It's no carbon dioxide, that's also very exciting. No long live radioactive waste, add that to the list of exciting things. A very limited risk of proliferation, because fusion does not employ fissile materials like uranium, for example. So tremendous potential, but a long way to go likely until this is actually put into the field. So in the meantime, we have to be looking to other technologies to help with the energy transition. So Ed, just building on what we're going to really need to achieve the energy transition and thinking through the development of fusion, what are some of the upcoming milestones and technology advancements that you're thinking about for the development and deployment of fusion energy? Ed Stanley: The technology milestones to watch for, I think, are generally known and ironically, actually relatively simple for this topic. We need more power out than in, and we need more controlled energy output, and certain technology breakthroughs can help with that. But we also need more time, more money, more computation, more facilities with which to try this technology out. But importantly, I think the next ten years is going to look very different from the last ten years in terms of these milestones and breakthroughs. I think that's going to be formed by four different things: the frequency, geographically, disciplinary and privately. And by those I mean on frequency it took about 25 years for JET in 2020 to break its own output record that it set in 1995. And then all of a sudden in 2021, 22, we saw four more notable records broken. Geographically, two of those records broken were in China, which is incredibly interesting because it shows that international competition is clearly on the rise. Third, we're seeing interdisciplinary breakthroughs to your point on integrating new types of technology. And finally, the emergence of increasingly well-funded private facilities. And this public private competition can and should accelerate the breakthroughs occurring in unexpected locations. But Stephen, I suppose if we cut to the chase on the when, how long do you think commercial scale fusion will take to come to fruition? Stephen Byrd: You know, it's a great question Ed. I think the Department of Energy officials that gave the press release on this technology development highlighted some of the challenges ahead. Let me talk through three big technology challenges that will need to be overcome. The first is what I think of as sort of true net energy production. So I mentioned before that it just took two mega jewels to ignite the fuel and then the output was three megajoules. That's very exciting. However, the total energy needed to power the lasers was 300 megajoules, so a massive amount. So we need to see tremendous efficiency improvements, that's the first challenge. The second challenge would be what we think of as repeatable ignition. That relates to creating a consistent, stable set of fusion, which to date has not been possible. Lastly, for Tokamak Technologies, Tokamaks are essentially magnetic bottles. The crucial element for commercialization is making these high temperature superconducting magnets stronger. That would enable everything else to be smaller and that would lead to cost improvements. So I think we have a long way to go. So Ed, just building on that idea of commercialization, you know, with the economics of fusion technologies looking more attractive now than previously given this breakthrough that we've seen at the U.S. DOE lab, what's happening on the policy and regulatory side. Do you see support for nuclear fusion? And if you do, in which countries do you see that support? Ed Stanley: I mean, it's a great question. And governments and electorates around the world, particularly in Europe, where I'm sitting, have what can only be described as a complicated relationship with nuclear energy. But on support for fusion broadly, yes, I think there is tentative support. It depends on the news flow and I think excitement last week shows exactly that. But personally, I think we are still too early to worry too much about policy and regulation. In simple terms, you can't actually regulate and promote and subsidize something where the technology isn't actually ready yet, which is part of the point you've made throughout. But that question also reminds me of a time about 15 years ago when I received national security clearance to visit the U.K.'s Atomic Energy Authority in Europe. And at that time, they were the clear global leader in fusion research. Obviously, that was hugely exciting as a young teenager. But something that the lead scientist said to me at that point struck me and it remains true today, that no R&D project on the planet receives as much funding relative to its frequency of breakthroughs as Fusion does. Which tells you just how committed that governments and now corporates around the world are in trying to unlock carbon free nuclear waste, free energy. But as you have said, quite rightly, that has taken and it will continue to take patience. Stephen Byrd: That's great. Ed, thanks for taking the time to talk. Ed Stanley: It's great speaking with you, Stephen. Stephen Byrd: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

20 Joulu 20228min

As focus begins to shift from inflation and interest rates to a possible oncoming earnings recession, what has the market already priced in? And what should investors be looking at as risk premiums begin to rise?----- 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, December 19th, at 11 a.m. in New York. So let's get after it. While many commentators blame last week's selloff in stocks on the Fed, we think it was more about the equity market looking ahead to the oncoming earnings recession that we think is getting worse. The evidence for this conclusion is last week's drop in valuations, which was driven exclusively by a rising equity risk premium as 10 year yields remain flat. In fact, since mid-November, the equity risk premium has risen 50 basis points to 2.5%. While still very low relative to where we think it will eventually settle out next year, it's a good step in the right direction that tells us the equity market is at least contemplating the earnings risk. Until now, all of the bear market valuation compression has been about inflation, the Fed's reaction to it and the rise in interest rates. While we called for the end of the tactical rally two weeks ago, last week's price action provided the technical reversal to confirm it. Specifically, the softer than expected inflation report on Tuesday drove the equity markets up sharply in the morning, only to fail at the key resistance levels we highlighted two weeks ago. More importantly, the price action left a negative tactical pattern that looks like the mere image of the pattern back in October, when the September inflation report came in hotter than expected. We made our tactical rally call on the back of that positive technical action in October and last week provides the perfect bookend to our trade. Seasonally, the setup is now bearish too. At the end of every calendar quarter, many asset managers play a game of chasing markets higher or lower to protect or enhance their relative year to date performance. Most years, the equity markets tend to drift higher into year end, as liquidity dries up, asset managers are able to push prices higher of the stocks they own. However, in down years like 2022, the ability and/or willingness to do that is lower, which reduces the odds of a year end rally lasting all the way until December 31st. This is the other reason we pulled the plug on our tactical rally call. With last week's technical reversal so clear, we think the set up is now more bearish than bullish. Meanwhile, we are feeling more confident about our 2023 forecast for S&P 500 earnings per share of $195. This remains well below both the bottoms up consensus of $231 and the top down forecasts of $215. In fact, the leading macro survey data has continued to weaken. I bring this up because we often hear from clients that everyone knows earnings are too high next year, and therefore the market has priced it. However, we recall hearing similar things in August of 2008, the last time the spread between our earnings model and the street consensus was this wide. The good news is that we don't expect a balance sheet recession next year or systemic financial risk. Nevertheless, the earnings recession by itself could be similar to what transpired in 2008 and 09. The main message of today's podcast is don't assume the market prices this negative of an earnings outcome until it happens. Secondarily, if our earnings forecast proves to be correct, the price declines for equities will be much worse than what most investors are expecting. Based on our conversations, the consensus view on the buy side is now that we won't make new lows on the S&P 500 next year, but will instead defend the October levels or the 200 week moving average, approximately 3500 to 3600 on the S&P 500. We remain decidedly in the 3000 to 3300 camp with a bias toward the low end given our view on earnings. With the year end Santa Claus rally now fading, there is reason to believe the decline from last week is the beginning of the move lower into the first quarter for stocks that we've been expecting, and when a more sustainable low is likely to be made. 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.

19 Joulu 20223min

As cross-asset performance has continued to be weak, there is hope that the end of the Fed’s rate hiking cycle could give markets the boost they need, but does history agree with these investor’s hopes?----- 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, December 16th, at 3 p.m. in London. We expect the Federal Reserve to make its last rate hike in the first quarter of next year. What does that mean? Aggressive rate increases from the Fed this year have corresponded to weak cross-asset performance, leading to a lot of hope that the end of these rate hikes will provide a major boost to markets, especially to riskier, more volatile assets like stocks and high yield bonds. But the lessons of history are more complicated. While on average, both stocks and bonds do well once the Fed stops raising rates, there's an important catch. Stock performance is weaker in the handful of instances where the Fed has stopped while short term yields are higher than long term yields. That so-called inverted yield curve is exactly what we see today and suggests it's not so straightforward to say that the end of rate hikes means that stocks outperform. Specifically, we can identify 11 instances since 1980 when the Federal Reserve was raising rates and then stopped. In most of these instances, the yield curve was flat and slightly upward sloping, which means 2 year yields were a little bit lower than 10 year yields. That means the market thought that interest rates at the time of the last Fed rate hike could stay at those levels for some time, applying that they were in a somewhat stable equilibrium and that the economy wouldn't see major change. Unsurprisingly, the markets seemed to like that stability, with global equities up about 15% over the next year in these instances. But there's another, somewhat rare set of observations where the last Fed rate hike has occurred with short term interest rates higher than expected rates over the long term. That happened in 1980, 1981, 1989, and the year 2000, and suggests that the market at that time thought that interest rates were not in a stable equilibrium, would not stay at current levels, and might need to adjust down rather significantly. That's more consistent of bond markets being concerned about slower growth. And in these four instances, global equity markets did much worse, falling about 3% over the following 12 month period. We see a couple of important implications for that. First, as we sit today, the yield curve is inverted, suggesting that that rarer but more challenging set of scenarios could be at work. My colleague Mike Wilson, Morgan Stanley's Chief U.S. Equity Strategist and CIO, is forecasting S&P 500 to end 2023 at similar levels to where it is today, suggesting that the equity outlook isn't as simple as the market rallying after the Fed stops raising rates. Secondly, for bond markets, returns are more consistently strong after the last Fed rate hike, whether the yield curve is inverted or not. From a cross-asset perspective, we continue to prefer investment grade bonds over equities in both the U.S. and Europe. Questions of when the Fed stops raising rates and what this means remains a major debate for the year ahead. While an end to rate hikes is often a broad based positive, this impact isn't as strong when the yield curve is inverted like it is today. 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.

16 Joulu 20223min