Europe in the Global AI Race

While the U.S is moving towards a soft landing and Japan is seeing nominal growth, the European economy continues to face restrictive policy.----- Transcript -----Welcome to Thoughts on the Market. I'm Matthew Hornbach, Morgan Stanley's Global Head of Macro Strategy. Along with my colleagues, bringing you a variety of perspectives, today, I'll talk about our mid-year outlook for macro markets. It's Tuesday, June 20th at 10 a.m. in New York. As we look ahead at macro markets for the next 12 months, central banks are front and center again. Our economists see them finding peak rates mid-year, while growth slows and inflation remains sticky. They also see the U.S. moving towards a soft landing, while the Euro area economy continues to face more restrictive policy. The U.K. continues to muddle through, while Japan delivers a year of nominal growth. Two global risk scenarios that our economists consider, a hard landing in the U.S. and then faster disinflation also in the U.S., should keep macro markets on the defensive. We think sovereign bond yields will end the year lower than in the first half, while the U.S. dollar will end the year stronger. We think macro markets already reflect the base case outlook for a soft landing and gradual adjustments in monetary policy. The view from our economists, which is mostly in the market price, aligns neatly with this consensus. So what will move markets into year end? Price action should, of course, evolve as surprises to this consensus view unfold. As usual, uncertainties around the outlook for monetary policy are murky, raising risks that the outcome will surprise currently held consensus views. One uncertainty involves the stance of monetary policy and the impact of the previous tightening that's been put in place. Have central banks tightened enough already to bring inflation back to target, in a suitable time frame? How long and variable are the lags of monetary policy today? We think rates market volatility, currently at its local lows, under appreciates the multitude of risks that lie ahead. For example, the lack of negative headlines around regional banks in the US have made investors complacent about bank stresses being behind us. However, key data points on bank balance sheets show that things have worsened on the margin since March. As for government bonds, we expect them to end the year with a rally for which investors have been waiting for, and we wouldn't be surprised if the positive returns accrued in line with historical seasonality. For example, strength in July and August, followed by a lull and then further strength in November and December. If you look at the US dollar, there's been a debate around the extent of the dollar's dominance in the global economy. As things stand, foreign investors continue to have a voracious appetite for US dollar denominated assets thanks to their strong returns and the U.S. economy's deep and liquid capital markets. So we forecast continued U.S. dollar strength into year end as tepid growth and asymmetric downside economic risk amplify investor demand for carry and defensive assets. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

21 Kesä 20233min

With investors anticipating earnings surprises for US stocks, the outlook for municipal bonds is looking brighter.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Mark Schmidt: And I'm Mark Schmidt, Head of Municipal Strategy. Michael Zezas: And today, we'll be talking about the core of many investors' fixed income portfolios, municipal bonds. It's Friday, June 16th at 9am in New York. Michael Zezas: As our equity strategists continue to highlight the risk of earnings surprises for U.S. stocks, the outlook for the bond market looks considerably better. A soft landing, so call it, slow growth and slowing inflation, would mean favorable total return prospects across fixed income. In fact, even as the Fed's been raising short term rates, longer term bond yields have been falling as investors anticipate both inflation and growth to decline. So, Mark, for the benefit of listeners, tell us why this is a sweet spot for munis. Mark Schmidt: Thanks, Michael. Municipal bonds, high credit quality and tax exempt income are an opportunity for investors in high tax brackets right now. Credit quality for municipals can seem confusing, but we like to think of it in a pretty simple way. What's the outlook for tax collections? Income tax collections were mixed in April, but sales and property taxes continue to grow. Also, most state and local governments still have plenty of cash on reserve in case the economy performs worse than our economists expect. That cash comes from all the aid that the federal government provided, several hundred billion dollars, in fact, to municipal issuers in response to COVID. That's created a balance sheet buffer that can still support issuers today, even as growth slows. Now, even though credit quality remains pretty good, the good news is we don't think you need to take a lot of risks to enjoy the benefits of tax free income in your portfolio. Michael Zezas: And Mark, investors ask a lot about what the right maturity of bond is for their portfolio. What do you think investors should favor right now? Shorter or longer maturity bonds? Mark Schmidt: Longer maturity bonds generally offer higher returns, but of course, with higher risk as well. Right now, we actually see superior risk adjusted returns in a 1 to 5 year or 1 to 10 year latter. We'd look for investment grade credits in those shorter maturities for investors seeking higher income with higher risk. We'd recommend a barbell approach, one that blends short 1 to 5 year maturities with select maturities between 15 and 20 years. On the long end of the curve, we prefer very high quality AA bonds. With credit spreads and risk free rates at multi-year highs, we just don't think you need to reach for yield in this environment, especially as the economy slows. But Michael, one question that always comes up with regards to municipal bonds is the risk of the tax exemption changing, given how important tax free income is for municipal investors. Congress does change the tax code from time to time, do you expect major legislation out of Washington anytime soon? Michael Zezas: In short, no. Major tax reforms tend to happen once in a generation, and they tend to need one party to control both the White House and both chambers of Congress. And even then, a big tax code change needs to be their priority. So, the earliest this could possibly happen again would be after the 2024 election, so call it 2025. And then again, even then, it's not clear that even if one party were to take control of Congress and the White House, that this would be a priority for them. So in short, it's not something I'd be particularly concerned about. But Mark, turning it back to you. Munis helped to build all kinds of infrastructures in states and cities, colleges, hospitals, airports and toll roads. They all issue municipal bonds. What sectors do you like right now? Mark Schmidt: We think the outlook for most transportation issuers remains pretty good. Summer vacations are right around the corner, and we all definitely want to pack our bags and hit the road. All those travelers going through airports and on toll roads is good news for credit quality. Now, as for one sector where credit quality is more mixed, health care providers are still recovering from all the disruptions related to COVID. You all know the story, of course, as more patients required more specialized care, the demand for nurses and frontline health care workers skyrocketed, leading to higher costs across the board. Those costs are now stabilizing, but we continue to think it will take some time for credit quality to fully recover. When it comes to some of these choices about sectors and credit quality, though, remember that volatility is relative. Compared to other asset classes, fundamentals for investment grade municipal bonds don't change very quickly or very often. They're the classic late cycle haven, as you've mentioned, Michael, in years before. Michael Zezas: Well, Mark, this has been really insightful. Thanks for taking the time to talk. Mark Schmidt: Great speaking with you today, Michael. Michael Zezas: And thanks for listening. If you enjoy thoughts on the Market, please be sure to rate and review us on the Apple Podcasts app. It helps more people find the show.

16 Kesä 20234min

With more Asian economies on pace to join the recovery path set by China, confidence in economic outperformance versus the rest of the world is rising. ----- Transcript -----Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Asia Economist at Morgan Stanley. Along with my colleagues bringing your variety of perspectives, today I'll be discussing our mid-year outlook for Asia's economy. It's Thursday, June 15 at 9 a.m. in Hong Kong. Asia's recovery is for real. We believe its growth outperformance has just started. We expect a full fledged recovery to build up over the next two quarters across two dimensions. First, we think more economies in the region will join the recovery path. Second, the recovery will broaden from services consumption to goods consumption and in the next six months to capital investments, or CapEx. We see Asia's growth accelerating to 5.1% by fourth quarter of this year. There are three main reasons why we expect this growth outperformance for Asia. First, Asia did not experience the interest rate shock that the U.S. and Europe did. Asian central banks did not have to take rates through restrictive territory because inflation in Asia has not been as intense. Plus, Asia's inflation has already declined and we expect 80% of region’s inflation will get back into central bank's comfort zone in the next 2 to 3 months. The second reason is China. While China's consumption recovery is largely on track, we have seen downside in the last two months, in investment spending and the manufacturing sector. We believe policy easing is imminent as policymakers are keen on preventing a deterioration in labor market conditions and on minimizing social stability risks. Easing should help stabilize investment spending and broaden out the recovery in back half of 2023. Beyond China, India, Indonesia and Japan will also contribute significantly to region's growth recovery. India is benefiting from cyclical and structural factors. Cyclically beating healthy corporate and banking system balance sheets mean India can have an independent business cycle driven by domestic demand, and we are seeing that appetite for expansion translating into stronger CapEx and loan growth. As for Japan, it is in a sweet spot, having decisively left the deflation environment behind, but not facing runaway inflation. Accommodative real interest rates are helping catalyze private CapEx growth, which has already risen to a seven year high. And, in another momentous shift, Japan's nominal GDP growth is now rising at a healthy pace after a long period of flatlining. Finally, we believe Indonesia will be able to sustain a 5% pace of growth. Indonesia runs the most prudent macro policy mix amongst emerging markets. In particular, the fiscal deficit has been maintained below 3%, since the adoption of the fiscal rule and has only exceeded that in 2020 during the worst of the pandemic. This has resulted in a consistent improvement in macro stability indicators and led to a structural decline in the cost of capital supporting private domestic demand. The risks to our next 12 month Asia outlook are hard landing in the U.S., which Morgan Stanley's U.S. economists think it's unlikely and a deeper slowdown in China. But we believe China's recovery will only broaden out in the second half of 2023. And given this, we feel confident about our outlook for Asia's outperformance in 2023 vis-à-vis rest of the world. Thanks for listening. 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.

15 Kesä 20233min

While investors are feeling optimistic with the strong performance in markets despite some predicted challenges, it may be too soon to tell if these possible hurdles have been completely avoided.----- 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 Wednesday, June 14th at 2 p.m. in London. It's hard to ignore a sense of relief and increased optimism that's starting to percolate among investors. After a hard 2022, there was widespread trepidation entering this year that slower growth, quantitative tightening and further rate hikes would continue to pressure markets. Yet year-to-date, performance has been pretty good. Is that evidence that these problems aren't really problems anymore? Markets have been strong. But in terms of that strength showing that markets have passed the test of slower growth or policy tightening, I think it's more accurate to say that it's too soon to tell. Let's start with the idea that markets have already weathered a period of weaker growth. While leading economic indicators of the economy are soft, so far, actual activity has held up pretty well. The U.S. economy grew 1.3% in the first quarter and has added 1.6 million new jobs year-to-date. It's the coming quarters, specifically the next 3 to 6 months, where our economists see the weakest stretch of economic activity. Next, how about market resilience suggesting that rate hikes don't matter, or at least don't matter very much? Here we think the question is to what extent rate increases hit with a lag. The optimistic case is that markets are forward looking, and thus have already discounted the full impact of very large recent rate increases by both the Fed and the European Central Bank. But there's also a school of thought that higher rates don't fully hit the economy for 12 months, or more. 12 months ago, the federal funds rate was still just 1%. Maybe the full effects of policy tightening haven't yet hit. Another part of the theme of tighter policy is the reduction of central bank balance sheets or quantitative tightening. Again, it's tempting to view recent market strength as evidence that this dynamic doesn't matter as much as expected, and that may be true. But I think the jury's still out. Year-to-date, the aggregate bond holdings of the world's central banks have actually risen, not fallen, thanks to continued easing from the Bank of Japan and support for the US banking sector from the Federal Reserve. That should now change going forward, with these balance sheets shrinking, giving us a better measure of the true impact. Third is the effect of tighter lending conditions. The optimistic case is that following quite a bit of banking sector volatility in March, recent market resiliency shows that this is just another test that the current market has passed. But lending, like monetary policy, could act with a lag. Morgan Stanley's banking analysts see tighter lending from the U.S. banking sector playing out over an extended period of time, rather than quickly, and all at once. Markets have been resilient year-to-date, a welcome respite from a poor 2022. We don't think, however, that this resilience is yet proof that markets have successfully answered the question of what the impact of lower growth, tighter policy or tighter bank credit will be. Rather, these questions are still sitting there, waiting to be answered over the next several months. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave a review. We'd love to hear from you.

14 Kesä 20233min

With the European economy losing momentum amidst a rally in growth stocks globally, the time of European equity outperformance may be in the past for now.----- 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 outlook for European equities in the second half of this year. It's Tuesday, June 13th at 2 p.m. in London. After a record burst of outperformance between October and March, European equities have started to underperform their international peers over the last couple of months, and we think this is likely to continue over the summer for two reasons. Firstly, the European economy seems to be losing some momentum, with many of the region's leading economic indicators turning back down over the last month or so. Now, while the magnitude of their reversal is small so far in absolute terms, the European Economic Surprise Index, which tracks how the data comes in relative to expectations, has fallen much more sharply and is now close to a ten year low. We think this is an important development, as this index is often a good lead indicator for future earnings and hence is now pointing to downside risks ahead for corporate profitability in Europe. The second factor starting to drag on Europe's relative performance, is the strong rally in growth stocks that we are seeing globally. While Europe has its own fair share of such companies, its tech weight overall remains considerably below that of most other regions. For example, tech is at about 7% of the European equity market versus 13% for Asia and over 30% for the U.S.. Quite simply, the size of this differential makes it difficult for Europe to keep pace with other regions when growth stocks are outperforming more broadly, such as now. While these two factors are likely to weigh on Europe's relative performance in the near term, we also see downside risks to broader global equity indices over the summer, given the potential for slowing growth and deteriorating liquidity dynamics in both the US and Europe. Taken together, we think these headwinds could see European equities fall by up to 10% over the next few months. Given this backdrop, we have further increased our preference for defensives over cyclicals, by upgrading pharmaceuticals to overweight, to sit alongside telecoms and utilities in our most preferred list. In contrast, we remain underweight cyclical sectors such as autos, capital goods, chemicals and energy. From a style perspective, we think it is too soon to take profits in the growth sectors and hence remain positive on the likes of luxury goods, medtech, semis and software. The biggest change to our view recently has become more downbeat on the outlook for European financials, which we think fits a, "right place but wrong time narrative". Specifically, while the sector looks attractive from a bottom up perspective in terms of low valuations, strong balance sheets and healthy earnings trends, we think the top down macro environment has become more challenging as we near the end of the current rate hiking cycle and with the prospect of slower economic growth and lower bond yields ahead. Notwithstanding our near-term caution, however, we are more positive on European stocks over the longer term, given the backdrop of what we think will ultimately be relatively resilient earnings and low equity valuations. For example, Europe's price to earnings ratio is now down to just 12.5 times versus the U.S. at close to 18 times. Looking out further on a 12 month view, our models suggest 8% price upside from here, which would rise closer to 12% if we include dividends and buybacks. So, when we put all of the above together, we think the outlook for European stocks is perhaps best described as one of short term pain, but for longer term gain. 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.

13 Kesä 20233min

With AI gaining momentum among investors and the Fed potentially pausing on rate hikes, signs are now pointing towards the end of the bear market rally.----- 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, June 12th at 11 a.m. in New York. So let's get after it. At the beginning of the year, we noted that our view is much more in line with the consensus and we discussed that it might take some time for that to change. Suffice it to say, it has taken longer than we expected. At the end of January, sentiment and positioning had improved enough to put stocks in a vulnerable state, and sure enough, we had a 10% correction in the S&P 500 over the following six weeks, with the average stock down about 13%. Since then, the average stock has lagged the overall index by about 10%. We think this is mostly due to increased liquidity from the depositor bailouts, at the same time artificial intelligence began to gain momentum with investors. The combination of perceived safety and of newfound open ended growth story was too much for investors to resist. Hence, we have one of the most concentrated markets in history. For most of the past two months, sentiment has remained somewhat pessimistic, which is part of the reason why the average stock hasn't done very well. But sentiment has turned outright bullish in the past week. Furthermore, it's not just sentiment, as both retail and institutional flows have returned to the equity markets with technology and artificial intelligence the dominant themes. This past week there were several other warning signs that this bear market rally may have finally exhausted itself after eight months. First, several sell side strategists and market commentators have publicly stated the bear market is now over at this point. Second, we don't find much value in the 20% threshold for declaring new bull markets. Instead, our conclusion is driven more by the fundamentals, valuations and expectations relative to our outlook. In short, our earnings view is much more pessimistic than the current consensus expectation, which is now assuming a second half reacceleration story. We can also find several instances of bear market rallies that exceeded the 20% threshold, only to eventually give way to new lows. One example is particularly relevant, given our 1940s and fifties boom bust framework that we discussed in last week's podcast. After the boom in 1946, following the end of the war, the S&P 500 corrected by 28%, followed by a 24% choppy bear market rally that lasted almost eighteen months before succumbing to new lows a year later. Thus far, it appears similar to the current bear market, which corrected 27 and a half percent last year and is now rallied 24% from its intraday lows, but is still 10% below the highs. Third, when we called for a bear market rally last October, it was predicated on two key assumptions. First, market concern around the Fed and terminal rate had likely peaked, and second, the US dollar was also peaking. Both of these developments occurred as long term interest rates and the U.S. dollar topped last October. Falling rates and the US dollar have combined to drive both valuations and earnings expectations higher. On the latter point, the U.S. dollar index is now flat on a year-over-year basis, which compares to up 21% at its peak last fall. The question is how much did a weaker dollar help the top line for multinational companies and the S&P 500 overall? Furthermore, will this dollar weakness continue or will it flatten out and or even reverse into a headwind? It's hard to know for sure, but our house view is for a stronger dollar, and it's important to acknowledge the S&P 500 has become very negatively correlated to the dollar over the last decade. Finally, we think the Fed's potential pause on rate hikes this week could serve as the perfect bookend to this bear market rally that began with a peak in the Fed's terminal rate last fall. In many ways, it's often easier to travel than arrive at the destination. The bottom line, sentiment and positioning are now 180 degrees from where they were on January 1st. This means stocks are no longer set up for the disappointment we think is coming in the form of much weaker than expected earnings this year. This reset can happen either slowly as companies miss expectations one by one, or quickly from another exogenous shock that is just too much for the market to absorb. In that latter case, the equity risk premium is likely to spike, price earnings multiples are likely to fall sharply and we may make a new bear market price low before estimates fall in earnest. We suspect the weaker liquidity backdrop from greater Treasury issuance discussed last week could serve as that exogenous shock. 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 for people to find the show.

12 Kesä 20234min

While the forecast for global bonds remains strong for the latter half of 2023, other asset classes could see bifurcated results across regions.----- Transcript -----Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Andrew Sheets: And I'm Andrew Sheets, Morgan Stanley's Chief Cross-Asset Strategist. Seth Carpenter: And on part two of the special two-part episodes of the podcast, we're going to focus on Morgan Stanley's year ahead strategy Outlook. It's Friday, June 9th at 10 a.m. in New York. Andrew Sheets: And 3 p.m. in London. Seth Carpenter: All right, Andrew, in the first part of this two part special, you were grilling me on the economic outlook. You were taking me to task on all of our views, pointing out the different ways in which our clients, investors around the world were pushing back at different parts of our story. And now, it's payback time. Let me ask you, basically, what are we thinking as a research house in terms of where the best trades are likely to be for markets? We're looking for a soft landing in the U.S., but that doesn't mean a good outcome. So very weak economic activity and policy rates that are still restrictive. So what is that type of backdrop going to mean for one of the most closely watched assets in the world, the U.S. dollar? Andrew Sheets: Sure. So we do think that this backdrop, despite the fact that on the surface it looks decent, you have the U.S. and Europe avoiding recession. You have stronger growth in Asia, but you have a lot of uncertainties that are front loaded, and you still have slowing growth, you still have tight monetary policy. And we think this is going to still lead to a somewhat more difficult backdrop for markets over the next three months. And so I think in that context, the U.S. dollar looks quite attractive. The US dollar pays investors to hold it, it's a so-called positive carry currency against most major currencies and it's a diversifying currency, so as an asset it helps protect your portfolio. And I also think kind of within this context, if any economy is going to be able to handle higher interest rates, well, it might be the U.S. where a large share of consumer debt is fixed in a long term mortgage, which is very different from what we see in Australia or the UK or Sweden. So, we think that the dollar will do better, we think the dollar will do better in large part because of this attractiveness in a portfolio context that it offers investors a positive yield, while at the same time offering portfolio protection. Seth Carpenter: All right. So, if you're feeling reasonably upbeat about the dollar, presumably that spills over to dollar denominated assets. At the end of last year, the strategy team published a piece that was called ‘The Year of Yield.’ Are you still feeling that good about bonds in the United States in particular? Is it really fixed income securities that are your strongest call? Andrew Sheets: So, we still feel good about bonds, but I would say that the start of the year has been a pretty mixed picture. I think kind of relative to what we were expecting at the start of the year, the Fed and the ECB have raised rates more. Growth has been somewhat stronger, inflation has been somewhat higher. I would say none of those things are good for the bond market and yields instead of falling have kind of trended sideways. So they've done okay, but they've not done as well as we on the strategy side initially thought. But, you know, looking ahead, we think that the case for high quality fixed income is still quite good. We still think we see slowing in the second half of the year, which we think will be supportive for bonds. We think, certainly based in large part on the forecasts from you and the economics team, that the Fed and the ECB are largely done with their rate hikes, which we think will be supportive for bonds, and we think that inflation will moderate over the course of the year, which could also be supportive. So, we still think that when we look across global assets, while we see positive returns from most bond and equity markets, we think it's high grade bonds that generally offer the best risk adjusted return on our forecasts. Seth Carpenter: Okay, So risk adjusted return on bonds seem attractive to you. The natural follow up question to that is what about equities? Equities have actually performed reasonably well this year. On our first part of this podcast, I said that we are looking for a soft landing. What's the call on equities in the United States? Is this going to be a great second half of the year for equities? Andrew Sheets: So we think the equity picture is quite bifurcated. In some ways, I think it ties quite nicely to the bifurcated global economic picture that you and the economics team are talking about. Where growth in Asia is accelerating, this year, it's accelerating in the second half of the year, while growth in the U.S. and Europe is slowing. And it's that bifurcation that we think is mirrored in the equity market where we see quite good returns for Japanese, in emerging market equities, we see double digit total returns over the next 12 months. But we see a U.S. equity market that's broadly flat in 12 months time to where it is today. Now, what's driving that is we do think that the slowing growth we have this year and tighter monetary policy that will hit profitability. We think it's already been hitting profitability, we think it will continue to. And more tactically, we think that a lot of the big questions for the market are somewhat unresolved, but will be tested very soon. It's the next two quarters, which is the weakest stretch of U.S. GDP growth. It's the next two or three quarters that we think is the bulk of the risks to U.S. earnings. It's this year, it's not next year. And we think the next two quarters is where monetary policy relative to inflation tightens more in our forecast horizon rather than tightening more in the future. So, when we think about the resilience of stocks, especially U.S. stocks year-to-date, it's been very impressive, it's been stronger than we expected. But also, I think year- to-date, growth has been pretty solid. The Federal Reserve's balance sheet has declined to less than initially expected. You haven't necessarily, I think, gone through some of the tests that investors, ourselves, thought might present more headwinds to the equity market, and those tests are going to present themselves, we think, rather soon. Seth Carpenter: Okay. So you highlighted a dichotomy there, especially for the second half of the year. That lines up, I would say, with some of our economic outlook, other parts of the world maybe doing a little bit better. I started off very narrowly with just the dollar. Are there other currencies in other parts of the world where based on, either what's going on with their central banks or what we think is going to be going on with their economic performance. Other currencies that you think would be really good for investors to take a look at. Andrew Sheets: So if I think about where we're forecasting currency strength, we do have the dollar appreciating against most currencies. So I'd say that's a dominant story. We do have the Japanese Yen doing modestly better, and that's largely a function of valuations that look to us very low versus history adjusted for inflation. And we do think that you could have a somewhat uncommon occurrence where Japanese equities and the currency both do well. We think that's the case because the currency is so inexpensive relative to other currencies and because Japanese corporates are already expecting their currency to strengthen some that, that wouldn't necessarily be an additional hit to profitability. The Brazilian Real is another currency that we're predicting to be stronger relative to regional peers. We think both the Indian Rupee and the Indonesian Rupiah can also do well as those economies are relatively strong in a regional context, and in a global context, looking out over the next 12 months. Seth Carpenter: All right. That's super helpful. I guess the last question will come back to you with, again, trying to take this global perspective on things, is commodities. Commodities are traded around the world. They are often a reflection of economic performance in different regions. We've got two big economies that we think will be growing fairly slowly, but we've got China and the rest of Asia that we think will be doing well. What is the outlook for commodities, and maybe especially oil, as we look forward the next six months, the next year? Andrew Sheets: Yeah so, we're underweight commodities. And here I want to talk about the market from a so-called factor perspective. When we think about markets, I think it can be helpful to think about them in terms of fundamentals, carry and momentum, as different things that can drive the market and especially for commodities where those things all matter. So, you know, what do we mean by fundamentals? Well, we think as growth slows, that's a negative for commodity demand relative to supply, and so a forecast where slowing growth is still ahead of us and it's really front loaded in our forecast is somewhat of a headwind to commodities. If I think about carry, that's another way of saying what does it pay you to hold the commodity or what does it cost to hold the commodity? And given how high short term U.S. interest rates are, it's quite expensive to hold copper or gold rather than hold a Treasury bill which pays you interest. The commodity does not. So, we think that works against commodities some. And then there's also momentum you tend to see in commodities more so than other asset classes that they tend to trend. They tend to stay in the same direction that they're traveling, rather than reverse, and commodity prices have been heading down. And if we look at the data, we think that tends to be more of a negative thing than a positive thing. So broadly, we think commodities produce lower risk adjusted returns than other assets. We do see oil prices modestly higher by the middle of 2024. We see Brent at about 78. So that's a little bit higher from current levels. But I think it's an asset class where after some very good returns in the recent past, is one where the risk reward looks less favorable relative to some other things. Seth Carpenter: All right, I'm going to call it there. Andrew, I really want to thank you for taking the time to talk, and let me throw a bunch of questions at you. Andrew Sheets: Seth, great speaking with you. Seth Carpenter: And thanks to everyone else 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 a colleague today.

9 Kesä 20239min

As we look toward the second half of 2023, the U.S. and Europe are likely to see very slow growth but avoid a recession, while Asia may be poised to become an engine of economic growth.----- Transcript -----Andrew Sheets: Welcome to Thoughts in the Market. I'm Andrew Sheets, Morgan Stanley's Chief Global Cross-Asset Strategist. Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Andrew Sheets: And on this special two part episode of the podcast, we'll be discussing Morgan Stanley's global mid-year outlook. Today we'll focus on economics, and tomorrow we'll turn our attention to strategy. It's Thursday, June 8th at 3 p.m. in London. Seth Carpenter: And it's 10 a.m. in New York. Andrew Sheets: Seth, it's great to sit down with you. We've been talking over the last several weeks as Morgan Stanley's gone through this outlook process. And this is a big joint collaborative forecasting process across Morgan Stanley research, where the economists and the strategists get together and think about what the next 12 to 18 months might look like. And, you know, we're sitting down at this really fascinating time for markets. The U.S. labor market is at some of its strongest levels since the late 1960s. Core inflation is at levels that we really haven't seen since the 1980s. The Federal Reserve and the European Central Bank have been raising rates at a pace that hasn't really been seen in 30 or 40 years. So, as you step back from all of these quite unusual occurrences, Seth, how do you frame where the global economy is at the moment and where is it headed? Seth Carpenter: I'd say there's one major dichotomy that I'll first start with in the global economy. On the one hand, Asia as a region really poised to have the strongest economic growth. And in very sharp contrast, when I think about the rest of the world, the United States and the Euro area, we see those as being actually quite weak. Second, China, you can't get out of a discussion of the global economy without talking about China. And there, the first quarter saw massive growth in China as all of the restrictions from COVID were removed, and as the government shifted the rest of its policies towards being supportive of growth. Now, there's been a little bit of a stumble in the second quarter, but we think that's temporary. And so you'll see a cyclical boost to Asia, coming out of China. Layer on top of this our structurally bullish views on economies like India and Indonesia, where there's a medium term, really positive note, you have all of these coming together, and it sets the stage for Asia really to be an engine of economic growth. The sharp contrast, the United States, the euro area. The inflation that you referenced has led central banks to raise interest rates for one reason and one reason alone. They want to slow those economies down, so the inflationary impulses start to fade away. Andrew Sheets: So Seth that's great context, and I'd like to drill down a little bit more detail on two economies in particular, the United States and China. For the United States, this idea of a soft landing, I think investors will point to the fact that given how strong the labor market is, given how high inflation is, given how inverted the yield curve is, given how much banks are tightening lending conditions, all those factors make it less likely historically that a recession is avoided. So, why do you think a soft landing is the most likely option here? Why do you think that that's our central scenario? Seth Carpenter: Yeah, I completely agree with you, Andrew. The discussion, the debate, the push back, the soft landing part of our thesis is definitely central to all of that discussion. Maybe I'll just start a little bit with the definition because I think the phrase soft landing can mean different things to different people. What I don't mean is that we just have great economic growth and inflation comes down on its own. Quite to the contrary, we are looking for economic growth in the United States to slow so much that it basically comes to a standstill. This year and next year are both likely to be years where economic growth is substantially below the long run productive capacity of the economy. Why? Because the Fed is raising interest rates, making the cost of borrowing, making the cost of extending credit higher, so that there is less spending in the economy so that those inflationary impulses go away. So that's what we're thinking is going to happen, is that we'll have really, really weak growth. But your question also gets into is if you're going to have that much slowing in the economy, why not a recession? And here, it's always fraught to say this time is different. But I think you highlighted what is really different about this cycle. It's the first time the Fed is pulling inflation down, instead of trying to limit its rise, in 40 years. But in addition to that, we're coming out of COVID. And I don't think anyone would argue that COVID is a normal part of an economic business cycle in the United States. Andrew Sheets: So we've just covered some of the reasons why we are more optimistic than those who expect a recession in the U.S. over the next 12 months. There are investors who say we're too pessimistic, and yet the economy in the first half of this year, the U.S. economy has been surprisingly solid and chugged along. So, what do you think is behind that? And why is it wrong to say that the last six months kind of disprove the idea that you need material slowing ahead? Seth Carpenter: Let's examine the facts. Housing activity actually did fall pretty substantially. If we compare where non-farm payrolls are and if you do any sort of averaging. Over months. Where we are now is actually much less hiring than what we saw six months ago, nine months ago, a year ago, the payrolls report for the month of May notwithstanding. We are seeing some slowing down there. And remember, I just said one of the reasons why we think we're going to get a soft landing is that the economy is still shorthanded. Some of the strength that we're seeing in hiring is making up for the fact that businesses were so cautious to hire in the past. I think the last thing to keep in mind is if we are wrong, if this slowing isn't in train, then the Federal Reserve is just going to have to raise interest rates even more because inflation, although it's coming down, there is a residual amount of inflation that really does need to be, in the Fed's mind, at least squeezed out of the economy by having subpar growth. Andrew Sheets: I'd like to turn now to the world's second largest economy, China, where there's also a great level of skepticism towards the economy generally, but also our view that the economy will recover in the second half of the year. If you look at commodity prices, Chinese equity prices, China's currency, there's been a lot of weakness across the board. So, what do you think has been going on? Why do you think the data has softened more recently and why is that not the right thing to extrapolate going forward for China growth? Seth Carpenter: Absolutely. All the asset prices that you point to, all of the market trades that people were looking to for a strong China recovery. Boy, they were a little bit disappointing. But the reason I think they were disappointing in general is because it was a different kind of expansion, so much domestic spending, so much on services. People were very much accustomed to looking at a Chinese surge coming from investment spending, infrastructure spending, housing spending, and most of the spending was elsewhere. So I think that's the first part of the puzzle. The second part of the puzzle, though, is Q2 legitimately has had a notable slowdown. Does that mean the whole China reopening story is derailed? I don't think so, and I don't think so for a few reasons. One, we are still seeing the spending on consumer services. So that's important. Second, we think what the government is planning on doing is topping up growth to make sure that the unemployment rate, especially among young people, continues to come down. And so it'll set us up for a strong second half of the year.Andrew Sheets: I'd like to ask you next about inflation. You know, I think something that's so fascinating about this year is if you were sitting there in early January, there was a real temptation, I think, by the market to think, 2023 was supposed to be the year where inflation is coming down. Yet inflation has been kind of surprisingly high this year. So if you think about our inflation forecasts, which do have inflation moderating throughout this year and into next year, what do you think is the more dominant part of that story that investors should be mindful of? Is it that inflation's falling? Is it that core inflation is still uncomfortably high? Is it a bit of both? Seth Carpenter: How about if I say absolutely all of the above? The inflation forecasting since COVID has been one of the most challenging parts of this job, I have to admit. So what is going on? Headline measures of inflation. So including food and energy prices that people like to strip out because it can be volatile, those are unquestionably off their peak and have come down a lot, not surprisingly, because oil prices, natural gas prices had spiked so much and those have backed off. But even looking at the core measures, as you say, we are seeing that core inflation has peaked in the U.S. and the euro area, sort of the major developed market economies where, you know, markets are focused and we are seeing things come down. And in particular, if you look in the United States, inflation on consumer goods, if you average over the past six months or so, has been about zero or negative. So went from very high inflation down to zero and for a few of those months, outright negative inflation. So I think it's impossible to say that we haven't seen a shift in terms of inflation. Andrew Sheets: And for monetary policy, what do you think that means? If we think about the big central banks, the Fed, the European Central Bank, the Bank of Japan, what do you think this inflation backdrop means for monetary policy, looking forward?Seth Carpenter: So for the Federal Reserve in the U.S. and the European Central Bank in the euro area, very, very similar. Different a little bit in terms of the specific numbers, the specific timing. But the strategy is the same, which is to raise policy rates to the point where they feel confident that they’re exerting restraint on the economy and allow inflation to come down over the course of another year or two years. In the United States, for example, you know, our baseline view is that the Fed did its last rate hike at the May meeting. The market is debating with itself as to whether or not the Fed is done. But, you know, the idea is make sure rates are in a way restrictive and then stay there for as long as needed to ensure that you get that downward trajectory in inflation and then only very gradually start to lower the policy rate as inflation comes down and looks like it's very clearly going back to target. In the euro area, same answer. Qualitatively, we're not convinced they're quite done raising rates. We think they probably have two more policy meetings where they raise their policy rate 25 basis points at each meeting. But then staying at that peak rate for an extended period of time and then gradually letting the policy rate come back down as the economy slows. Now, you mentioned Japan. And Japan, in our view, is really a bit different. When we think about the underlying, the trend inflation. We think that is about to peak now and come back down and in fact get below their 2% inflation target.Andrew Sheets: Very interesting. Seth, thanks for taking the time to talk. Seth Carpenter: Andrew, it is always a pleasure for me to get to talk to you. Andrew Sheets: And thanks for listening. Be sure to tune in for part two of this episode where Seth and I will discuss Morgan Stanley's mid-year strategy Outlook. 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.

8 Kesä 202310min