US Elections: Weighing the Options

While venture capital is taking a more cautionary approach with crypto startups, the buzz around GenAI is only increasing.----- Transcript -----Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley’s Head of Thematic Research in Europe. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what private markets can tell us about the viability and investability of disruptive technologies. It’s Tuesday, the 3rd of September, at 2pm in London. For the past three years we have been tracking venture capital funding to help stay one step ahead of emerging technologies and the companies that are aiming to disrupt incumbent public leaders. Private growth equity markets are -- by their very definition – long-duration, and therefore highly susceptible to interest rate cycles. The easy-money bubble of 2021 and [20]22 saw venture funding reach nearly $1.2trillion dollars – more than the previous decade of funding combined. However, what goes up often comes down; and since their peak, venture growth equity capital deployment has fallen by over 60 percent, as interest rates have ratcheted ever higher beyond 5 percent. So as interest rates fall back towards 3.5 percent, which our economists expect to happen over the coming 12 months, we expect M&A and IPO exit bottlenecks to ease. And so too the capital deployment and fundraising environment to improve. However, the current funding market and its recovery over the coming months and years looks more imbalanced, in our view, than at any point since the Internet era. Having seen tens- and hundreds of billions of dollars poured into CleanTech and health innovations and battery start-ups when capital was free; that has all but turned to a trickle now. On the other end of the spectrum, AI start-ups are now receiving nearly half of all venture capital funding in 2024 year-to-date. Nowhere is that shift in investment priorities more pronounced than in the divergence between AI and crypto startups. Over the last decade, $79billion has been spent by venture capitalists trying to find the killer app in crypto – from NFTs to gaming; decentralized finance. As little as three years ago, start-ups building blockchain applications could depend on a near 1-for-1 correlation of funding for their projects with crypto prices. Now though, despite leading crypto prices only around 10 percent below their 2021 peak, funding for blockchain start-ups has fallen by 75 percent. Blockchain has a product-market-fit and a repeat-user problem. GenerativeAI, on the other hand, does not. Both consumer and enterprise adoption levels are high and rising. Generative AI has leap-frogged crypto in all user metrics we track and in a fraction of the time. And capital providers are responding accordingly. Investors have pivoted en-masse towards funding AI start-ups – and we see no reason why that would stop. The same effect is also happening in physical assets and in the publicly traded space. Our colleague Stephen Byrd, for example, has been advocating for some time that it makes increasing financial sense for crypto miners to repurpose their infrastructure into AI training facilities. Many of the publicly listed crypto miners are doing similar maths and coming to the same outcome. For now though, just as questions are being asked of the listed companies, and what the return on invested capital is for all this AI infrastructure spend; so too in private markets, one must ask the difficult question of whether this unprecedented concentration around finding and funding AI killer apps will be money well spent or simply a replay of recent crypto euphoria. It is still not clear where most value is likely to accrue to – across the 3000 odd GenerativeAI start-ups vying for funding. But history tells us the application layer should be the winner. For now though, from our work, we see three likely power-law candidates. The first is breakthroughs in semiconductors and data centre efficiency technologies. The second is in funding foundational model builders. And the third, specifically in that application layer, we think the greatest chance is in the healthcare application space. Thanks for listening. If you enjoy the show, please leave us a review and share Thoughts on the Market with a friend or colleague today.*****Digital assets, sometimes known as cryptocurrency, are a digital representation of a value that function as a medium of exchange, a unit of account, or a store of value, but generally do not have legal tender status. Digital assets have no intrinsic value and there is no investment underlying digital assets. The value of digital assets is derived by market forces of supply and demand, and is therefore more volatile than traditional currencies’ value. Investing in digital assets is risky, and transacting in digital assets carries various risks, including but not limited to fraud, theft, market volatility, market manipulation, and cybersecurity failures—such as the risk of hacking, theft, programming bugs, and accidental loss. Additionally, there is no guarantee that any entity that currently accepts digital assets as payment will do so in the future. The volatility and unpredictability of the price of digital assets may lead to significant and immediate losses. It may not be possible to liquidate a digital assets position in a timely manner at a reasonable price.Regulation of digital assets continues to develop globally and, as such, federal, state, or foreign governments may restrict the use and exchange of any or all digital assets, further contributing to their volatility. Digital assets stored online are not insured and do not have the same protections or safeguards of bank deposits in the US or other jurisdictions. Digital assets can be exchanged for US dollars or other currencies, but are not generally backed nor supported by any government or central bank.Before purchasing, investors should note that risks applicable to one digital asset may not be the same risks applicable to other forms of digital assets. Markets and exchanges for digital assets are not currently regulated in the same manner and do not provide the customer protections available in equities, fixed income, options, futures, commodities or foreign exchange markets. Morgan Stanley and its affiliates do business that may relate to some of the digital assets or other related products discussed in Morgan Stanley Research. These could include market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking.

3 Sep 20244min

Original Release Date August 8, 2024: Our Head of Europe Sustainability Research discusses how rising longevity is revolutionizing our fundamental approach from reactive to proactive treatment.----- Transcript -----Welcome to Thoughts on the Market. I’m Mike Canfield, Morgan Stanley’s European Head of Sustainability Research. Along with my colleagues, we’re bringing you a variety of perspectives; and today we’re focusing on a topic that affects everyone – how much does poor health cost us? And how are ageing populations and longer life expectancy driving a fundamental shift in healthcare? It’s Thursday, August the 8th, at 4pm in London. As populations age across the developed world, health systems need to help people live both longer and healthier. The current system is typically built around to focus on acute conditions and it’s more reactive; so it introduces clinical care or drugs to respond to a condition after it’s already arisen, rather than keeping people healthy in the first instance. So increasingly, with the burden of chronic disease becoming by far the greatest health and economic challenge we face, we need to change the structure of the healthcare system. Essentially, the key question is how much is poor health amongst the ageing population really costing society? To get a true sense of that, we need to keep in mind that workers over 50 already earn one out of every three dollars across the G20 regions. By 2035, they're projected to generate nearly 40 per cent of all household income. So with that in mind, preventable conditions amongst those people aged 50-64 at the moment, are already costing G20 economies over $1 trillion annually in productivity loss. And there’s one more key number: 19 per cent. That's how much age-diverse workforces can raise GDP per capita over the next thirty years, according to estimates from the Organization for Economic Co-operation and Development, or OECD. So clearly, keeping workers healthier for longer underpins a more productive, more efficient, and a profitable global economy. So it’s clear that [if] the current healthcare system were to shift from sick from care to prevention, the global gains would be substantial.The BioPharma sector is already contributing some targeted novel treatments in areas like smart chemotherapy and in CRISPR – which is a technology that allows for selective DNA modification. While we can credit BioPharma and MedTech for really powerful innovations in diagnostics, in AI deployment for areas like data science and material science, and in sophisticated telemedicine – all these breakthroughs together give a more personalized, targeted health system; which is a big step in the right direction, but honestly they alone can’t solve this much broader longevity challenge we face. Focus on health and prevention, ultimately, could address those underlying causes of ill-health, so that problems don’t arise even in the first instance. Governments around the world are obviously realizing the value of preventive care over sick care. And as a strategy, disease prevention fundamentally aims to promote wellness across the board, whether that’s in things like mental state, nutrition or even in things like sleep and stress. While it might be easy to kind of conflate that with wellness trends – things like green smoothies or meditation – the underlying benefits of boosting health at the cellular level have much broader and deeper implications. Things like Type 2 diabetes and heart disease, supporting better health across populations can significantly reduce the incidence of a wide range of chronic conditions. It can lower the burden on health systems overall, and actually increase healthy lifespan at the end of the day. BioPharma advances are significant, but addressing longevity will require a much broader alignment across a myriad of elements; everything really from the food system to sanitation to training healthcare professionals. And of course, all of that will require consistent policy support. Regulators and policymakers are paying very close attention to their ageing population – and so are we. We’ll continue to bring you updates on this topic, which is so important to all of us.Thanks for listening. If you enjoy the show, please do leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

30 Aug 20244min

As the US Federal Reserve mulls a forthcoming interest rate cut, our Head of Corporate Credit Research and Global Chief Economist discuss how it is balancing inflationary risks with risks to growth.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley’s Global Chief Economist.Andrew Sheets: And today on the podcast, we'll be discussing the Federal Reserve, whether its policy is behind the curve and what's next.It's Thursday, August 29th at 2pm in London.Seth Carpenter: And it's 9am in New York.Andrew Sheets: Seth, it's always great to talk to you. But that's especially true right now. The Federal Reserve has been front and center in the markets debate over the last month; and I think investors have honestly really gone back and forth about whether interest rates are in line or out of line with the economy. And I was hoping to cover a few big questions about Fed policy that have been coming up with our clients and how you think the Fed thinks about them.And I think this timing is also great because the Federal Reserve has recently had a major policy conference in Jackson Hole, Wyoming where you often see the Fed talking about some of its longer-term views and we can get your latest takeaways from that.Seth Carpenter: Yeah, that sounds great, Andrew. Clearly these are some of the key topics in markets right now.Andrew Sheets: Perfect. So, let's dive right into it. I think one of the debates investors have been having -- one of the uncertainties -- is that the Fed has been describing the risk to their outlook as balanced between the risk to growth and risk to inflation. And yet, I think for investors, the view over the last month or two is these risks aren't balanced; that inflation seems well under control and is coming down rapidly. And yet growth looks kind of weak and might be more of a risk going forward.So why do you think the Fed has had this framing? And do you think this framing is still correct in the aftermath of Jackson Hole?Seth Carpenter: My personal view is that what we got out of Jackson hole was not a watershed moment. It was not a change in view. It was an evolution, a continuation in how the Fed's been thinking about things. But let me unpack a few things here.First, markets tend to look at recent data and try to look forward, try to look around the corner, try to extrapolate what's going on. You know as well as I do that just a couple weeks ago, everyone in markets was wondering are we already in recession or not -- and now that view has come back. The Fed, in contrast, tends to be a bit more inertial in their thinking. Their thoughts evolve more slowly, they wait to collect more data before they have a view. So, part of the difference in mindset between the Fed and markets is that difference in frequency with which updates are made.I'd say the other point that's critical here is the starting point. So, the two risks: risks to inflation, risks to growth. We remember the inflation data we're getting in Q1. That surprised us, surprised the market, and it surprised the Fed to the upside. And the question really did have to come into the Fed's mind -- have we hit a patch where inflation is just stubbornly sticky to the upside, and it's going to take a lot more cost to bring that inflation down. So those risks were clearly much bigger in the Fed’s mind than what was going on with growth.Because coming out of last year and for the first half of this year, not only would the Fed have said that the US economy is doing just fine; they would have said growth is actually too fast to be consistent with the long run, potential growth of the US economy. Or reaching their 2 per cent inflation target on a sustained basis. So, as we got through this year, inflation data got better and better and better, and that risk diminished.Now, as you pointed out, the risk on growth started to rise a little bit. We went from clearly growing too fast by some metrics to now some questions -- are we softened so much that we're now in the sweet spot? Or is there a risk that we're slowing too much and going into recession?But that's the sense in which there's balance. We went from far higher risks on inflation. Those have come down to, you know, much more nuanced risks on inflation and some rising risk from a really strong starting point on growth.Andrew Sheets: So, Seth, that kind of leads to my second question that we've been getting from investors, which is, you know, some form of the following. Even if these risks between inflation and growth are balanced, isn't Fed policy very restrictive? The Fed funds rate is still relatively high, relative to where the Fed thinks the rate will average over the long run. How do you think the Fed thinks about the restrictiveness of current policy? And how does that relate to what you expect going forward?Seth Carpenter: So first, and we've heard this from some of the Fed speakers, there's a range of views on how restrictive policy is. But I think all of them would say policy is at least to some degree restrictive right now. Some thinking it's very restrictive. Some thinking only modestly.But when they talk about the restrictiveness of policy in the context of the balance of these risks, they're thinking about the risks -- not just where we are right now and where policy is right now; but given how they're thinking about the evolution of policy over the next year or two. And remember, they all think they're going to be cutting rates this year and all through next year.Then the question is, over that time horizon with policy easing, do we think the risks are still balanced? And I think that's the sense in which they're using the balance of risks. And so, they do think policy is restrictive.They would also say that if policy weren't restrictive, [there would] probably be higher risks to inflation because that's part of what's bringing inflation out of the system is the restrictive stance of policy. But as they ease policy over time, that is part of what is balancing the risks between the two.Andrew Sheets: And that actually leads nicely to the third question that we've been getting a lot of, which is again related to investor concerns -- that maybe policy is moving out of line with the economy. And that's some form of the following: that by even just staying on hold, by not doing anything, keeping the Fed funds rate constant, as inflation comes down, that rate becomes higher relative to inflation. The real policy rate rises. And so that represents more restrictive monetary policy at the very moment, when some of the growth data seems to be decelerating, which would seem to be suboptimal.So, do you think that's the Fed's intention? Do you think that's a fair framing of kind of the real policy rate and that it's getting more restrictive? And again, how do you think the Fed is thinking about those dynamics as they unfold?Seth Carpenter: I do think that's an important framing to think -- not just about the nominal level of interest rates; you know where the policy rate is itself, but that inflation adjusted rate. As you said, the real rate matters a lot. And inside the Fed as an institution there, that's basically how most of the people there think about it as well. And further, I would say that very framing you put out about -- as inflation falls, will policy become more restrictive if no adjustment is made? We've heard over the past couple of years, Federal Reserve policymakers make exactly that same framing.So, it's clearly a relevant question. It's clearly on point right now. My view though, as an economist, is that what's more important than realized inflation, what prices have done over the past 12 months. What really matters is inflation expectations, right? Because if what we're trying to think about is -- how are businesses thinking about their cost of capital relative to the revenues are going to get in the future; it's not about what policy, it's not about what inflation did in the past. It's what they expect in the future.And I have to say, from my perspective, inflation expectations have already fallen. So, all of this passive tightening that you're describing, it's already baked in. It's already part of why, in my view, you know, the economy is starting to slow down. So, it's a relevant question; but I'm personally less convinced that the fall in inflation we've seen over the past couple of months is really doing that much to tighten the stance of policy.Andrew Sheets: So, Seth, you know, bringing this all together, both your answers to these questions that are at the forefront of investors' minds, what we heard at the Jackson Hole Policy Conference and what we've heard from the latest FOMC minutes -- what does Morgan Stanley Economics think the Fed's policy path going forward is going to be?Seth Carpenter: Yeah. So, you know, it's funny. I always have to separate in my brain what I think should happen with policy -- and that used to be my job. But now we're talking about what I think will happen with policy. And our view is the Fed's about to start cutting interest rates.The market believes that now. The Fed seems from their communication to believe that. We've got written down a path of 25 basis point reduction in the policy rate in September, in November, in December. So, a string of these going all the way through to the middle of next year to really ease the stance of policy, to get away from being extremely restrictive, to being at best only moderately restrictive -- to try to extend this cycle.I will say though, that if we're wrong, and if the economy is a bit slower than we think, a 50 basis point cut has to be possible.And so let me turn the tables on you, Andrew, because we're expecting that string of 25 basis point cuts, but the market is pricing in about 100 basis points of cuts this year with only three meetings left. So that has to imply at least one of those meetings having a 50 basis point cut somewhere.So, is that a good thing? Would the market see a 50 basis point cut as the Fed catching up from being behind the curve? Or would the market worry that a bigger cut implies a greater recession risk that could spook risk assets?Andrew Sheets: Yeah, Seth, I think that's a great question because it's also one where I think views across investors in the market genuinely diverge. So, you know, I'll give you our view and others might have a different take.But I think what you have is a really interesting dynamic where kind of two things can be true. You know, on the one hand, I think if you talk to 50 investors and ask them, you know, would they rather for equities or credit have lower rates or higher rates, all else equal -- I think probably 50 would tell you they would rather have lower rates.And yet I think if you look back at history, and you look at the periods where the Federal Reserve has been cutting rates the most and cutting most aggressively, those have been some of the worst environments for credit and equities in the modern era. Things like 2001, 2008, you know, kind of February of 2020. And I think the reason for that is that the economic backdrop -- while the Fed is cutting -- matters enormously for how the market interprets it.And so, conditions where growth is weakening rapidly, and the Fed is cutting a lot to respond to that, are generally periods that the market does not like. Because they see the weaker data right now. They see the weakness that could affect earnings and credit quality immediately. And the help from those lower rates because policy works with lag may not arrive for six or nine or twelve months. It's a long time to wait for the cavalry.And so, you know, the way that we think about that is that it's really, I think the growth environment that’s going to determine how markets view this rate cutting balance. And I think if we see better growth and somewhat fewer rate cuts, the base case that you and your team at Morgan Stanley Economics have -- which is a bit fewer cuts than the market, but growth holding up -- which we think is a very good combination for credit. A scenario where growth is weaker than expected and the Fed cuts more aggressively, I think history would suggest, that's more unfriendly and something we should be more worried about.So, I do think the growth data remains extremely important here. I think that's what the market will focus most on and I think it's a very much good is good regime that I think is going to determine how the market views cuts. And fewer is fine as long as the data holds up.Seth Carpenter: That make a lot of sense, and thanks for letting me turn the tables on you and ask questions. And for the listeners, thank you for listening. If you enjoy this show, leave us a review wherever you listen to podcast. And share Thoughts on the Market with a friend or a colleague today.

29 Aug 202411min

While mortgage rates have come down, our Co-heads of Securitized Products Research say the US housing market still must solve its supply problem.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.Jay Bacow: And I’m Jay Bacow, the other co-head of Securitize Products Research.Jim Egan: Along with my colleagues bringing you a variety of perspectives, today Jay and I are here to talk about the US housing and mortgage markets.It's Wednesday, August 28th, at 10 am in New York.Now, Jay, mortgage rates declined pretty sharply in the beginning of August. And if I take a little bit of a step back here; while rates have been volatile, to say the least, we're about 50 basis points lower than we were at the beginning of July, 80 basis points lower than the 2024 peak in April, and 135 basis points below cycle peaks back in October of 2023.Big picture. Declining mortgage rates -- what does that mean for mortgages?Jay Bacow: It means that more people are going to have the ability to refinance given the rally in mortgage rates that you described. But we have to be careful when we think about how many more people. We track the percentage of homeowners that have at least 25 basis points of incentive to refinance after accounting for things like low level pricing adjustments. That number is still less than 10 percent of the outstanding homeowners. So broadly speaking, most people are not going to refinance.Now, however, because of the rally that we've seen from the highs, if we look at the percentage of borrowers that took out a mortgage between six and 24 months ago -- which is really where the peak refinance activity happens -- over 30 percent of those borrowers have incentive to refinance.So recent homeowners, if you took your mortgage out not that long ago, you should take a look. You might have an opportunity to refinance. But, for most of the universe of homeowners in America that have much lower mortgage rates, they're not going to be refinancing.Jim Egan: Okay, what about convexity hedging? That's a term that tends to get thrown around a lot in periods of quick and sizable rate moves. What is convexity hedging and should we be concerned?Jay Bacow: Sure. So, because the homeowner in America has the option to refinance their mortgage whenever they want, the investor that owns that security is effectively short that option to the homeowner. And so, as rates rally, the homeowner is more likely to refinance. And what that means is that the duration -- the average life of that mortgage is outstanding -- is going to shorten up. And so, what that means is that if the investor wants to have the same amount of duration, as rates rally, they're going to need to add duration -- which isn't necessarily a good thing because they're going to be buying duration at lower yields and higher prices. And often when rates rally a lot, you will get the explanation that this is happening because of mortgage convexity hedging.Now, convexity hedging will happen more into a rally. But because so much of the universe has mortgages that were taken out in 2020 and 2021, we think realistically the real convexity risks are likely 150 basis points or so lower in rates.But Jim, we have had this rally in rates. We do have lower mortgage rates than we saw over the summer. What does that mean for affordability?Jim Egan: So, affordability is improving. Let's put numbers around what we're talking about. Mortgage rates are at approximately 6.5 percent today at the peak in the fourth quarter of last year, they were closer to 8 percent.Now, over the past few years, we've gotten to use the word unprecedented in the housing market, what feels like an unprecedented number of times. Well, the improvement in affordability that we'd experience if mortgage rates were to hold at these current levels has only happened a handful of times over the past 35 to 40 years. This part of it is by no means unprecedented.Jay Bacow: Alright, now we talked about mortgage rates coming down and that means more refi[nance] activity. But what does the improvement in mortgage rates do to purchase activity?Jim Egan: So that's a question that's coming up a lot in our investor discussions recently. And to begin to answer that question, we looked at those past handful of episodes. In the past, existing home sales almost always climb in the subsequent year and the subsequent two years following an improvement in affordability at the scale that we're witnessing right now.Jay Bacow: So, there's precedent for this unprecedented experienceJim Egan: There is. But there are also a number of differences between our current predicament and these historical examples that I'd say warrant examination. The first is inventory. We simply have never had so few homes for sale as we do right now. Especially when we're looking at those other periods of affordability improvement.And on the affordability front itself, despite the improvement that we've seen, affordability remains significantly more challenged than almost every other historical episode of the past 40 years, with the exception of 1985. Both of these facts are apparent in the lock in effect that you and I have discussed several times on this podcast in the past.Jay Bacow: All right. So just like we think we are a 150 basis points away from convexity hedging being an issue, we're still pretty far away from rates unlocking significant inventory. What does that mean for home sales?Jim Egan: So, the US housing market has a supply problem, not a demand problem. I want to caveat that. Everything is related in the US housing market. For instance, high mortgage rates that put pressure on affordability -- but they've also contributed to this lock-in effect that has led to historically low inventory.This lack of supply has kept home prices climbing, despite high mortgage rates, which is keeping affordability under pressure. So, when we say that housing has a supply problem, we're not dismissing the demand side of the equation; just acknowledging that the binding constraint in the current environment is supply.Jay Bacow: Alright, so if supply is the binding constraint, then what does that mean for sales?Jim Egan: As rates come down, inventory has been increasing. When combined with improvements in affordability, this should catalyze increased sales volumes in the coming year. But the confluence of inputs in the housing market today render the current environment unique from anything that we've experienced over the past few decades.Sales volumes should climb, but the path is unlikely to be linear and the total increase should be limited to call it the mid-single digit percentage point of over the coming year.Jay Bacow: Alright, and now lastly, Jim, home prices continue to set an all time high but there's the absolute level of prices and the pace of home price appreciation. What do you think is going to happen?Jim Egan: We're on the record that this increased supply, even if it's only at the margins, and even if we're close to historic lows, should slow down the pace of home price appreciation. We've begun to see that year-over-year home price growth has come down from 6.5 percent to 5.9 percent over the past three months. We think it will continue to come down, finishing the year at +2 percent.Jay Bacow: Alright, Jim, thanks for those thoughts. And to our listeners, thank you for listening.If you enjoy the podcast, please leave a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

28 Aug 20247min

Our CIO and Chief US Equity Strategist explains why there’s pressure for the August jobs report to come in strong -- and what may happen to the market if it doesn’t. ----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the importance of economic data on asset prices in the near term.It's Tuesday, Aug 27th at 11:30am in New York.So let’s get after it. The stock rally off the August 5th lows has coincided with some better-than-expected economic data led by jobless claims and the ISM services purchasing manager survey. This price action supports the idea that risk assets should continue to trade with the high frequency growth data in the near term. Should the growth data continue to improve, the market can stay above the fair value range we had previously identified of 5,000-5,400 on the S&P 500. In my view, the true test for the market though will be the August jobs report on September 6th. A stronger than expected payroll number and lower unemployment rate will provide confidence to the market that growth risks have subsided for now. Another weak report that leads to a further rise in the unemployment rate would likely lead to growth concerns quickly resurfacing and another correction like last month. On a concerning note, last week we got a larger than expected negative revision to the payroll data for the 12 months ended in March of this year. These revisions put even more pressure on the jobs report to come in stronger. Meanwhile, the Bloomberg Economic Surprise Index has yet to reverse its downturn that began in April and cyclical stocks versus defensive ones remain in a downtrend. We think this supports the idea that until there is more evidence that growth is actually improving, it makes sense to favor defensive sectors in one's portfolio. Finally, while inflation data came in softer last week, we don't view that as a clear positive for lower quality cyclical stocks as it means pricing power is falling. However, the good news on inflation did effectively confirm the Fed is going to begin cutting interest rates in September. At this point, the only debate is how much?Over the last year, market expectations around the Fed's rate path have been volatile. At the beginning of the year, there were seven 25 basis points cuts priced into the curve for 2024 which were then almost completely priced out of the market by April. Currently, we have close to four cuts priced into the curve for the rest of this year followed by another five in 2025. There has been quite a bit of movement in bond market pricing this month as to whether it will be a 25 or 50 basis points cut when the Fed begins. More recently, the rates market has sided with a 25 basis points cut post the better-than-expected growth and inflation data points last week.As we learned a couple of weeks ago, a 50 basis points cut may not be viewed favorably by the equity market if it comes alongside labor market weakness. Under such a scenario, cuts may no longer be viewed as insurance, but necessary to stave off hard landing risks. As a result, a series of 25 basis points cuts from here may be the sweet spot for equity multiples if it comes alongside stable growth.The challenge is that at 21x earnings and consensus already expecting 10 percent earnings growth this year and 15 percent growth next year, a soft-landing outcome with very healthy earnings growth is priced. Furthermore, longer term rates have already been coming down since April in anticipation of this cutting cycle. Yet economic surprises have fallen and interest rate sensitive cyclical equities have underperformed. In my view this calls into question if rate cuts will change anything fundamentally.The other side of the coin is that defensive equities remain in an uptrend on a relative basis, a dynamic that has coincided with normalization in the equity risk premium. In our view, we continue to see more opportunities under the surface of the market. As such, we continue to favor quality and defensive equities until we get more evidence that growth is clearly reaccelerating in a way that earnings forecasts can once again rise and surpass the lofty expectations already priced into valuations.Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

27 Aug 20244min

Our US Thematic Strategist discusses surging confidence as the political landscape evolves, back-to-school spending starts strong and travel providers enjoy post-COVID demand. ----- Transcript -----Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's US thematic strategist. Along with my colleagues bringing you a variety of perspectives, today I'll give you an update on how recent market volatility and the upcoming US election are affecting the US consumer.It's Monday, August 26th at 10am in New York.A few weeks ago, we saw really sharp volatility. It was partially sparked by the unwind of the yen carry trade. But there are also renewed fears about a growth slowdown for the US or a possible US recession. Our economists do not think we are going into a recession though, and they have reaffirmed their longstanding view of a soft landing for the economy as a base case. And they think there's a slowdown, but not a slump.From the more company side, this earning season showed that the US consumer is softening incrementally; but they're not falling off a cliff. Spending is slowing this year, but it's on the heels of what was really high spending over the last couple of years.We did see some softness during second quarter results around the consumer. Consumer confidence is still intact, and our most recent survey in July showed a pretty strong improvement in sentiment. We think that this is partially a function of the political environment. We ran the survey from July 25th to 29th, shortly after President Joe Biden dropped out of the race and endorsed Vice President Kamala Harris. And we saw the biggest improvement in sentiment was for those who consider themselves middle of the road politically.Their net sentiment toward the economy improved from negative -23 percent to -1 percent. Net expectations are also really positive for those who identify as liberal. Net sentiment for very liberal respondents is +34 percent, while it's +20 percent for more somewhat liberal ones. Expectations for conservatives are still negative though, but they have improved since the prior wave of our survey.So, we do think that some of this increase in excitement and increase in confidence has been around the renewed political environment, renewed interest in the race.As we get close to the end of summer, we note two other key trends. Back to school shopping and travel. So, for back-to-school shopping, we're seeing pretty positive results from our survey. Consumers are reporting they're planning to spend more this back-to-school season versus last year. We saw an increase of 35 percent in spending intentions. And then when we think about the different back to school categories people are spending on, apparel saw the biggest net increase in spending plans versus last year. But we also saw an increase for school supplies and electronics. So, all things very important as the kids go back to school or people go off to college.Travel's been one part of the market that's held up super well post pandemic. People were very excited to get out there and go on vacations. And we saw, frankly, an unexpected positive level of demand for the past few years, and we didn't see that faster catch up in demand that a lot of people were expecting post pandemic. I know myself; I've been very excited to travel the last few summers. But this earning season we're starting to see more of a mixed bag within the travel space.Hotels across the board flag softening demand for leisure stays, but business travel has held up well. We saw a different story among the airlines though; several management teams were really emphasizing continued strong demands for air travel. And our survey is supportive of these comments and show that travel intentions remain stable and strong, and plans to follow through on travel that involve a flight also remain robust.The next three months leading up to the US election will certainly be interesting though, and we'll continue to bring you updates.Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

26 Aug 20244min

Although markets have recovered over the last few weeks after a sudden drop, our Head of Corporate Credit Research warns that investors are still skeptical about the growth outlook.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today we’ll discuss the big round trip for markets and why we’re not out of the woods.It's Friday, August 23rd at 2pm in London.The last few weeks have been a rollercoaster. July ended on a high with markets rallying as the Federal Reserve kept interest rates unchanged. Things turned almost immediately thereafter as weak data releases fanned fears that maybe the Fed was being just a little too nonchalant on the economy, making its patience withholding rates high look like a vice, rather than a virtue. A late summer period where many investors were out probably amplified the moves that followed. And so at the morning lows on August 5th, the S&P 500 had fallen more than 8 percent in just 3 trading days, and expected volatility had jumped to one of its highest readings in a decade. But since those volatile lows, markets have come back. Really come back. Stock prices, credit spreads, and those levels of expected volatility are all now more or less where they ended July. It was an almost complete round-trip. We have a colleague who got back from a two-week vacation on Monday. The prices on their screen had barely changed. The reason for that snapback was the data. Just as weak data in the aftermath of the Fed’s meeting drove fears of a policy mistake, better data in the days since have improved confidence. This has been especially true for data related to the US consumer, as both retail sales and the number of new jobless claims have been better than expected. This round-trip in markets has been welcome, especially for those, like ourselves, who are optimistic on credit, and see it well-positioned for the economic soft-landing that Morgan Stanley expects. But it is also a reminder that we’re not out of the woods. The last few weeks couldn’t be clearer about the importance of growth for the market outlook. This is a crucial moment for the economy, where U.S. growth is slowing, the Fed’s rates are still highly restrictive, and any help from cutting those rates may not be felt for several quarters. At Morgan Stanley we think that growth won’t slow too much, and so this will ultimately be fine for the credit market. But incoming data will remain important, and recent events show that the market’s confidence can be quickly shaken. Even with the sharp snapback, for example, cyclical stocks, which tend to be more economically sensitive, have badly lagged more defensive shares – a sign that healthy skepticism around growth from investors still remains. The quick recovery is welcome, but we’re not out of the woods, and investors should continue to hope for solid data. Good is good. Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

23 Aug 20243min

The Bank of Japan jolted global markets after its recent decision to raise interest rates. Our experts break down the effects the move could have on the country’s economy, currency and stock market.----- Transcript -----Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.Daniel Blake: And I'm Daniel Blake, from the Asia Pacific and Emerging Market Equity Strategy Team.Chetan Ahya: On this episode of the podcast, we will cover a topic that has been a big concern for global investors: Japan's rate hike and its effect on markets.It's Thursday, August 22nd at 6pm in Hong Kong.On July 31st, Japan's central bank made a bold move. For only the second time in 17 years, it raised interest rates. It lifted its benchmark rates to around 0.25 percent from its previous range of 0 to 0.1 percent. And at the press conference, BOJ Governor Ueda struck a more hawkish tone on the BOJ rate path than markets anticipated. Compounded with investors concern about US growth, this move jolted global equity markets and bond markets. The Japan equity market entered the quickest bear market in history. It lost 20 percent over three days.Well, a lot has happened since early August. So, I'm here with Daniel to give you an update.Daniel Blake: Chetan, before I can give you an update on what the market implications are of all this, let's make sense of what the macro-outlook is for Japan and what the Bank of Japan is really looking to achieve.I know that following that July monetary policy meeting, we heard from Deputy Governor Uchida san, who said that the bank would not raise its policy rates while financial and capital markets remain unstable.What is your view on the Bank of Japan policy outlook and the key macro-outlook for Japan more broadly?Chetan Ahya: Well, firstly, I think the governor's comments in the July policy meeting were more hawkish than expected and after the market's volatility, deputy governor did come out and explain the BOJ's thought process more clearly. The most important point explained there was that they will not hike policy rates in an environment where markets are volatile -- and that has given the comfort to market that BOJ will not be taking up successive rate hikes in an early manner.But ultimately when you're thinking about the outlook of BOJ's policy path, it will be determined by what happens to underlying wage growth and inflation trend. And on that front, wage growth has been accelerating. And we also think that inflation will be remaining at a moderate level and that will keep BOJ on the rate hike path, but those rate hikes will be taken up in a measured manner.In our base case, we are expecting the BOJ to hike by 25 basis points in January policy meeting next year, with a risk that they could possibly hike early in December of this year.Daniel Blake: And after an extended period of weakness, the Japanese yen appreciated sharply after the remarks. What drove this and what are the macro repercussions for the broader outlook?Chetan Ahya: We think that the US growth scare from the weaker July nonfarm payroll data, alongside a hawkish BOJ Governor Ueda's comments, led markets to begin pricing in more policy rate convergence between the US and Japan. This resulted in unwinding of the yen carry trade and a rapid appreciation of yen against the dollar.For now, our strategists believe that the near-term risk of further yen carry trade unwinding has lessened. We will closely watch the incoming US growth and labor market data for signs of the US slowdown and its impact on the yen. In the base case, our US Economics team continues to see a soft landing in the US and for the Fed to cut rates by three times this year from September, reaching a terminal of 3.625 by June 2025.Based on our US and BOJ rate path, our macro strategists see USD/JPY at 146 by year end. As it stands, our Japan inflation forecast already incorporates these yen forecasts, but if yen does appreciate beyond these levels on a sustainable basis, this would impart some further downside to our inflation forecast.Daniel Blake: And there's another key event to consider. Prime Minister Kishida san announced on August 14th that he will not seek re-election as President of The Liberal Democratic Party (LDP) in late September, and hence will have a new leader of Japan. Will this development have any impact on economic policy or the markets in your view?Chetan Ahya: The number of potential candidates means it's too early to tell. We think a major reversal in macro policies will be unlikely, though the timing of elections will likely have a bearing on BOJ.For example, after the September party leadership election, the new premier could then call for an early election in October; and in this scenario, we think likelihood of a BOJ move at its September and October policy meeting would be further diminished.So, Daniel, keeping in mind the macro backdrop that we just discussed, how are you interpreting the recent equity market volatility? And what do you expect for the rest of 2024 and into 2025?Daniel Blake: We do see that volatility in Japan, as extreme as it was, being primarily technically driven. It does reflect some crowding of various investor types into pockets of the equity market and levered strategies, as we see come through with high frequency trading, as well as carry trades that were exacerbated by dollar yen positions being unwound very quickly.But with the market resetting, and as we look into the rest of 2024 and 2025, we see the two key engines of nominal GDP reflation in Japan and corporate reform still firing. As you lay out, the BOJ is trying to find its way back towards neutral; it's not trying to end the cycle. And corporate governance is driving better capital allocation from the corporate sector.As a result, we see almost 10 percent earnings growth this year and next year, and the market stands cheap versus its historical valuation ranges.So, as we look ahead, we think into 2025, we should see the Japanese equity benchmark, the TOPIX index, setting fresh all-time highs. As a result, we continue to prefer Japan equities versus emerging markets. And we recommend that US dollar-based investors leave their foreign exchange exposure unhedged, which will position them to benefit from further strengthening in the Japanese yen.Chetan Ahya: So, which parts of the market look most attractive following the BOJ's rate hike and market disruptions to you?Daniel Blake: Yes, we do prefer domestic exposures relative to exporters. They'll be better protected from any further strengthening in the Japanese yen, and we also see a broad-based corporate governance reform agenda supporting shareholder returns coming out of these domestic sectors. They'll benefit from that stronger, price and wage outlook with an improved margin outlook.And we also see that capex beneficiaries with a corporate reform angle are likely to do well in this overall agenda of pursuing greater economic security and digitalization. So that includes key sectors like defense, real estate, and construction.And Chetan, what would you say are the key risks to your view?Chetan Ahya: We think the key risk would be if the US faces a deeper slowdown or an outright recession. While Japan is better placed today than in the past cycles, it would nonetheless be a setback for Japan's economy. In this scenario, Japan’s export growth would face downward pressures given weakening external demand.The Japanese corporate sector has also around 17 percent of its revenue coming from North America. Besides a deeper Fed rate cut cycle, will mean that the policy rate differentials between the US and Japan will narrow significantly. This will pose further appreciation pressures on the yen, which will weigh on inflation, corporate profits, and the growth outlook.And from your perspective, Daniel, what should investors watch closely?Daniel Blake: We would agree that the first order risk for Japan equities is if the US slips into a hard landing, and we do see that the dollar yen in that outlook is likely to fall even further. Now we shouldn't see any FX (foreign exchange) driven downgrades until we start bringing the yen down below 140, but we would also see the operating environment turning negative for Japan in that outlook.So, putting that aside, given our house view of the soft landing in the US economy, we think the second thing investors should watch is certainly the LDP leadership election contest, and the reform agenda of the incoming cabinet.Prime Minister Kishida san's tenure has been focused on economic security and has fostered further corporate governance reform alongside the Japan Stock Exchange. And this emphasis on getting household savings into investment has been another key pillar of the new capitalism strategy. So, these focus areas have been very positive for Japan equities, and we should trust -- but verify -- the commitment of a new leadership team to these policy initiatives.Chetan Ahya: Daniel, it was great to hear your perspective. This is an evolving story. We'll keep our eye on it. Thanks for taking the time to talk.Daniel Blake: Great speaking with you, Chetan.Chetan Ahya: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or a colleague today.

22 Aug 20249min