Big Debates: The State of the Energy Transition

The ultimate market outcomes of President Trump’s tactical tariff escalation may be months away. Our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas takes a look at implications for investors now.Read more insights from Morgan Stanley.----- Transcript -----Welcome to Thoughts on the Market. I’m Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy. Today: The latest on U.S. tariffs and their market impact. It’s Thursday, July 10th at 12:30pm in New York. It's been a newsy week for U.S. trade policy, with tariff increases announced across many nations. Here’s what we think investors need to know. First, we think the U.S. is in a period of tactical escalation for tariff policy; where tariffs rise as the U.S. explores its negotiating space, but levels remain in a range below what many investors feared earlier this year. We started this week expecting a slight increase in U.S. tariffs—nothing too dramatic, maybe from 13 percent to around 15 percent driven by hikes in places like Vietnam and Japan. But what we got was a bit more substantial. The U.S. announced several tariff hikes, set to take effect later, allowing time for negotiations. If these new measures go through, tariffs could reach 15 to 20 percent, significantly higher than at the beginning of the year, though far below the 25 to 30 percent levels that appeared possible back in April. It’s a good reminder that U.S. trade policy remains a moving target because the U.S. administration is still focused on reducing goods trade deficits and may not yet perceive there to be substantial political and economic risk of tariff escalation. Per our economists’ recent work on the lagged effects of tariffs, this reckoning could be months away. Second, the implications of this tactical escalation are consistent with our current cross-asset views. The higher tariffs announced on a variety of geographies, and products like copper, put further pressure on the U.S. growth story, even if they don’t tip the U.S. into recession, per the work done by our economists. That growth pressure is consistent with our views that both government and corporate bond yields will move lower, driving solid returns. It's also insufficient pressure to get in the way of an equity market rally, in the view of our U.S. equity strategy team. The fiscal package that just passed Congress might not be a major boon to the economy overall, but it does help margins for large cap companies, who by the way are more exposed to tariffs through China, Canada, Mexico, and the EU – rather than the countries on whom tariff increases were announced this week. Finally, How could we be wrong? Well, pay attention to negotiations with those geographies we just mentioned: Mexico, Canada, Europe, and China. These are much bigger trading partners not just for U.S. companies, but the U.S. overall. So meaningful escalation here can drive both top line and bottom line effects that could challenge equities and credit. In our view, tariffs with these partners are likely to land near current levels, but the path to get there could be volatile. For the U.S., Mexico and Canada, background reporting suggests there’s mutual interest in maintaining a low tariff bloc, including exceptions for the product-specific tariffs that the U.S. is imposing. But there are sticking points around harmonizing trade policy. The dynamic is similar with China. Tariffs are already steep—among the highest anywhere. While a recent narrow deal—around semiconductors for rare earths—led to a temporary reduction from triple-digit levels, the two sides remain far apart on fundamental issues. So when it comes to negotiations with the U.S.’ biggest trading partners, there’s sticking points. And where there’s sticking points there’s potential for escalation that we’ll need to be vigilant in monitoring. Thanks for listening. If you enjoy Thoughts on the Market please leave us a review. And tell your friends about the podcast. We want everyone to listen.

10 Jul 20253min

Our Chief Cross-Asset Strategist Serena Tang discusses whether demand for U.S. stocks has fallen and where fund flows are surging. Read more insights from Morgan Stanley.----- Transcript -----Serena Tang: Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist.Today – is the demand for U.S. assets declining? Let's look at the recent trends in global investment flows.It’s Wednesday, July 9th at 1pm in New York.The U.S. equity market has reached an all-time high, but at the same time lingering uncertainty about U.S. trade and tariff policies is forcing global investors to consider the riskiness of U.S. assets. And so the big question we need to ask is: are investors – particularly foreign investors – fleeing U.S. assets?This question comes from recent data around fund flows to global equities. And we have to acknowledge that demand for U.S. stocks overall has declined, going by high-frequency data. But at the same time, we think this idea is exaggerated. So why is that? As many listeners know, fund flows – which represent the net movement of money into and out of various investment vehicles like mutual funds and ETFs – are an important gauge of investor sentiment and market trends. So what are fund flows really telling us about investors’ sentiment towards U.S. equities? It would be nice to get an unequivocal answer, but of course, the devil is always in the details. And the problem is that different data sources and frequencies across different market segments don’t always lead to the same conclusions. Weekly data across global equity ETF and mutual funds from Lipper show that international investors were net buyers through most of April and May. But the pace of buying has slowed year-to-date versus 2024. Still, it remains much higher than during the same period in 2021 through 2023. Treasury TIC data point to something similar – a slowdown in foreign demand, but not significant net selling. So where are the flows going, if not to the U.S.? They are going to the rest of the world, but more particularly, Europe. Europe stocks, in fact, have been the biggest beneficiary of decreasing flows to the U.S. Nearly $37 billion U.S. has gone into Europe-focused equity funds year-to-date. This is significantly higher than the run-rates over the prior five years. What’s more notable here is that year-to-date, flows to European-focused ETFs and mutual funds dominated those targeting Japan and Emerging Markets. This suggests that Europe is now the premier destination for equity fund flows, with very little demand spillovers to other regions' equity markets.These shifts have yet to show up in the allocation data, which tracks how global asset managers invest in stocks regionally. Global equity funds' portfolio weights to Rest-of-the-World has gone up by roughly the same amount as allocation to the U.S. has come down. But allocation to the U.S. has actually gone down by roughly the same amount, as its share in global equity indices; which means that If allocation to the U.S. has changed, it's simply because the U.S. is now a smaller part of equity indices. Meanwhile, an estimated U.S.$9 billion from Rest-of-the World went into international equity funds, which excludes U.S. stocks altogether. Granted, it’s not a lot; but scaled for fund assets, it's the highest net flows international equities have seen. In other words, some investors are choosing to invest in equities excluding U.S. altogether. These trends are unlikely to reverse as long as lingering policy uncertainty dampens demand for U.S.-based assets. But as we've argued in our mid-year outlook, there are very few alternative markets to the U.S. dollar markets right now. U.S. stocks might start to see less marginal flows from foreign investors – to the benefit of Rest-of-the-World equities, especially Europe. But demand is unlikely to dry up completely over the next 12 months. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

9 Jul 20254min

Arushi Agarwal from the European Sustainability Strategy team and Aerospace & Defense Analyst Ross Law unpack what a reshaped defense industry means for sustainability, ethics and long-term investment strategy.Read more insights from Morgan Stanley.----- Transcript -----Ross Law: Welcome to Thoughts on the Market. I'm Ross Law from Morgan Stanley's European Aerospace and Defense team.Arushi Agarwal: And I'm Arushi Agarwal from the European Sustainability Research Team.Ross Law: Today, a topic that's rapidly defining the boundaries of sustainable investing and technological leadership – the use of AI in defense.It's Tuesday, July 8th at 3pm in London. At the recent NATO summit, member countries decided to boost their core defense spending target from 2 percent to 3.5 percent of GDP. This big jump is sure to spark a wave of innovation in defense, particularly in AI and military technology. It's clear that Europe is focusing on rearmament with AI playing a major role. In fact, AI is revolutionizing everything from unmanned systems and cyber defense to simulation training and precision targeting. It’s changing the game for how nations prepare for – and engage in – conflict. And with all these changes come serious challenges. Investors, policy makers and technologists are facing some tough questions that sit at the intersection of two of Morgan Stanley's four key themes: The Multipolar World and Tech Diffusion.So, Arushi, to set the stage, how is the concept of sustainability evolving to include national security and defense, particularly in Europe?Arushi Agarwal: You know, Ross, it's fascinating to see how much this space has evolved over the past year. Geopolitical tensions have really pushed national security much higher on the sustainability agenda. We're seeing a structural shift in sentiment towards defense investments. While historically defense companies were largely excluded by sustainability funds, we're now seeing asset managers revisiting these exclusions, especially around conventional and nuclear weapons. Some are even launching thematic funds, specifically focused on security and resilience.However, in the absence of standard methodologies to assess weapon related exposures, evaluate sector-specific ESG risks and determine transparency, there is no clear consensus on what sustainability focused managers can hold. Greater policy focus has created the need to identify a long-term approach to investing in this sector, one that is cognizant of ethical issues. Investors are now increasingly asking whether rapid technological integration might allow for a more forward-looking, risk aware approach to investing in national security.Ross Law: So, it's no news that Europe has historically underspent on defense. Now, the spending goal is moving to 3.5 percent of GDP to try and catch up. Our estimates suggest this could mean an additional $200 billion per year in additional spend – with a focus on equipment over personnel, at least for the time being. With this new focus, how is AI shaping the European rearmament strategy?Arushi Agarwal: Well, AI appears to be at the core of EU’s 800 billion euro rearmament plan. The commission has been quite clear that escalating tensions have not only led to a new arms race but also provoked a global technological race. Now to think about it, AI, quantum, biotech, robotics, and hypersonic are key inputs not only for long-term economic growth, but also for military pre-eminence.In our base case, we estimate that total NATO military spend into AI applications will potentially more than double to $112 billion by 2030. This is at a 4 percent AI investment allocation rate. If this allocation rate increases to 10 percent as anticipated by European deep tech firms, then NATOs AI military spend could grow sixfold to $306 billion by 2030 in our bull case.So, Ross, you were at the Paris Air Show recently where companies demonstrated their latest product capabilities. Which AI applications are leading the way in defense right now? Ross Law: Yeah, it was really quite eye-opening. We've identified nine key AI applications, reshaping defense, and our Application Readiness Radar shows that Cybersecurity followed by Unmanned Systems exhibit the highest level of preparedness from a public and private investment perspective.Cybersecurity is a major priority due to increased proliferation of cyber attacks and disinformation campaigns, and this technology can be used for both defensive and offensive measures. Unmanned systems are also really taking off, no pun intended, mainly driven by the rise in drone warfare that's reshaping the battlefield in Ukraine.At the Paris Airshow, we saw demonstrations of “Wingman” crewed and uncrewed aircraft. There have also been several public and private partnerships in this area within our coverage. Another area gaining traction is simulation and war gaming. As defense spending increases and potentially leads to more military personnel, we see this theme in high demand in the coming years.Arushi Agarwal: And how are European Aerospace and Defense companies positioning themselves in terms of AI readiness?Ross Law: Well, they're really making significant advancements. We've assessed AI technology readiness for our A&D companies across six different verticals: the number of applications; dual-use capabilities; AI pricing power; responsible AI policy; and partnerships on both external and internal product categories.What's really interesting is that European A&D companies have higher pricing power relative to the U.S. counterparts, and a higher percentage are both enablers and adopters of AI. To accelerate AI integration, these companies are increasingly partnering with government research arms, leading software firms, as well as peers and private players.Arushi Agarwal: And some of these same technologies can also be used for civilian purposes. Could you share some examples with us?Ross Law: The dual use potential is really significant. Various companies in our coverage are using their AI capabilities for civilian applications across multiple domains. For example, geospatial capabilities can also be used for wildfire management and tracking deforestation. Machine learning can be used for maritime shipping and port surveillance. But switching gears slightly, if we talk about the regulatory developments that are emerging in Europe to address defense modernization, what does this mean, Arushi, for society, the industry and investors?Arushi Agarwal: There's quite a lot happening on the regulatory front. The European Commission is working on a defense omnibus simplification proposal aimed at speeding up defense investments in the EU. It's planning to publish a guidance notice on how defense investment will fit within the sustainable finance framework. It’s also making changes to its sustainability reporting directive. If warranted, the commission will make additional adjustments to reflect the needs of the defense industry in its sustainability reporting obligations. The Sustainable Fund Reform is another important development. While the sustainability fund regulation doesn't prohibit investment into the defense sector, the commission is seeking to provide clarification on how defense investment goals sit within a sustainability framework.Additionally at the European Security Summit in June, the European Defense Commissioner indicated that a roadmap focusing on the modernization of European defense will be published in autumn. This will have a special focus on AI and quantum technologies. For investors, whilst exclusions easing has started to take place, pickup in individual positioning has been slow. As investors ramp up on the sector, we believe these regulatory developments can serve as catalysts, providing clear demand and trend signals for the sector.Ross Law: So finally, in this context, how can companies and investors navigate these ethical considerations responsibly?Arushi Agarwal: So, in the note we highlight that AI risk management requires the ability to tackle two types of challenges. First, technical challenges, which can be mitigated by embedding boundaries and success criteria directly into the design of the AI model. For example, training AI systems to refuse harmful requests. Second challenges are more open-ended and ambiguous set of challenges that relate to coordinating non-proliferation among countries and preventing misuse by bad actors. This set of challenges requires continuous interstate dialogue and cooperation rather than purely technical fixes.From an investor perspective, closer corporate engagement will be key to navigating these debates. Ensuring firms have clear documentation of their algorithms and decision-making processes, human in the loop systems, transparency around data sets used to train the AI models are some of the engagement points we mention in our note.Ultimately, I think the key is balance. On the one hand, we have to recognize the legitimate security needs that defense technologies address. And on the other hand, there's the need to ensure appropriate safeguards and oversight.Ross Law: Arushi, thanks for taking the time to talk.Arushi Agarwal: It was great speaking with you, Ross,Ross Law: And thank you all for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

8 Jul 20259min

The American consumer isn’t simply pulling back. They are changing the way they spend – and save. Our U.S. Thematic and Equity Strategist Michelle Weaver digs into the data. Read more insights from Morgan Stanley.----- Transcript -----Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's U.S. Thematic and Equity Strategist.Today, the U.S. consumer. What's changing about the ways Americans spend, save and feel about the future?It's Monday, July 7th at 10am in London.As markets digest mixed signals – whether that's easing inflation, changing politics, and persistent noise around tariffs – U.S. consumers are recalibrating. Under the surface of headline numbers, a more complex story is unfolding about the ways Americans are not just reacting but adapting to macro challenges.First, I want to start with a big picture. Data from our latest consumer survey shows that consumer sentiment has stabilized, even as uncertainty around tariffs persists, especially into these rolling July deadlines. Inflation remains the top concern for most. But the good news is that it's trending lower. This month more than half of respondents cited inflation as their primary concern, a slight decrease from last month and a year ago. Now, that's a subtle but a meaningful decline suggesting consumers may be adjusting their expectations rather than bracing for continued price shocks. At the same time though political concerns are on the rise. More than 40 percent of consumers now list the U.S. political environment as a major worry. That's slightly up from last month; and not surprisingly concern around geopolitical conflicts has also jumped from a month ago.Now, when we break this down by income levels, we see some interesting trends. Inflation is the top concern across all income groups, except for those earning more than $150,000. For them, politics takes the top spot. Lower income households, though, are more focused on paying rent and debts, while higher income groups are more concerned about their investments.As for tariffs, concern remains high but stable. About 40 percent of consumers are very worried about tariffs and another 25 percent are moderately so. But if we look under the surface, it's really showing us a political divide. 63 percent of liberals are very concerned, compared to just 23 percent of conservatives who say they're very concerned.Despite these worries, though, fewer people overall are planning to cut back on spending. Only about a third say they'll spend less due to tariffs, which is down quite a bit from earlier this year. Meanwhile, about a quarter plan to spend more, and roughly a third don't expect to change their plans at all.This resilience points to the notable behavioral trend I mentioned at the start. Consumers are not just reacting, they're adapting. Looking at the broader economy, consumer confidence is holding steady according to our survey, although it's slightly down from last month. But when it comes to household finances, the outlook is more positive with a significant number expecting their finances to improve and fewer expecting them to worsen – a net positive.Savings are also showing some resilience. The average consumer has several months of savings, slightly up from last year. Spending intentions are stable with nearly a third of consumers planning to spend more next month while fewer planned to spend less. And when it comes to big ticket items, more than half of U.S. consumers are planning a major purchase in the next three months, including vehicles, appliances, and vacations.Speaking of vacations, summer travel season is here and I'm looking forward to taking a trip soon. Around 60 percent of consumers are planning to travel in the next six months, with visiting friends and family being the top reason.So, what's the biggest takeaway for investors?Despite ongoing concerns about inflation, politics and tariffs, U.S. consumers are showing remarkable resilience. It's a nuanced picture, but one that overall suggests stability in the face of uncertainty.Thanks for listening. I hope you enjoyed the show, and if you did, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

7 Jul 20254min

For a special Independence Day episode, our Head of Corporate Credit Research considers a popular topic of debate, on holidays or otherwise – national debt.Read more insights from Morgan Stanley.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.Today on a special Independence Day episode of the podcast, we're going to talk a bit about the history of U.S. debt and the contrast between corporate and federal debt trajectories.It's Thursday, July 3rd at 9am in Seattle.The 4th of July, which represents the U.S. declaring independence from Great Britain, remains one of my favorite holidays. A time to gather with friends and family and celebrate what America is – and what it can still be.It is also, of course, a good excuse to talk about debt.Declaring independence is one thing, but fighting and beating the largest empire in the world at the time would take more than poetic words. The borrowing that made victory possible for the colonies also almost brought them down in the 1780s under a pile of unsustainable debt. It was a young treasury secretary Alexander Hamilton, who successfully lobbied to bring these debts under a federal umbrella – binding the nation together and securing a lower borrowing cost. As we'd say, it's a real fixed income win-win.Almost 250 years later, the benefits of that foresight are still going strong, with the United States of America enjoying the world's largest economy, and the largest and most liquid equity and bond markets. Yet lately there's been more focus on whether those bond markets are, well, too large.The U.S. currently runs a budget deficit of about 7 percent of GDP, and the current budget proposals in the house and the Senate could drive an additional 4 trillion of borrowing over the next decade above that already hefty baseline. Forecast even further out, well, they look even more challenging.We are not worried about the U.S. government's ability to pay its bills. And to be clear, in the near term, we are forecasting at Morgan Stanley, U.S. government yields to go down as growth slows and the Federal Reserve cuts rates more than expected in 2026. But all of this borrowing and all the uncertainty around it – it should increase risk premiums for longer term bonds and drive a steeper yield curve.So, it's notable then – as we celebrate America's birthday and discuss its borrowing – that it's really companies that are currently unwrapping the presents. Corporate balance sheets, in contrast, are in very good shape, as corporate borrowing trends have diverged from those of the government.Many factors are behind this. Corporate profitability is strong. Companies use the post-COVID period to refinance debt at attractive rates. And the ongoing uncertainty – well, it's kept management more conservative than they would otherwise be. Out of deference to the 4th of July, I've focused so far on the United States. But we see the same trend in Europe, where more conservative balance sheet trends and less relative issuance to governments is showing up on a year-over-year basis. With companies borrowing relatively less and governments borrowing relatively more, the difference between what companies and the government pay, that so-called spread that we talk so much about – well, we think it can stay lower and more compressed than it otherwise would.We don't think this necessarily applies to the low ratings such as single B or lower borrowers, where these better balance sheet trends simply aren't as clear. But overall, a divergent trend between corporate and government balance sheets is giving corporate bond investors something additional to celebrate over the weekend.Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

3 Jul 20254min

Our analysts Michael Zezas and Ariana Salvatore discuss the upcoming expiration of reciprocal tariffs and the potential impacts for U.S. trade.Read more insights from Morgan Stanley.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, global Head of Fixed Income Research and Public Policy Strategy.Ariana Salvatore: And I'm Ariana Salvatore, US Public Policy Strategist.Michael Zezas: Today we're talking about the outlook for US trade policy. It's Wednesday, July 2nd at 10:00 AM in New York.We have a big week ahead as next Wednesday marks the expiration of the 90 day pause on reciprocal tariffs. Ariana, what's the setup?Ariana Salvatore: So this is a really key inflection point. That pause that you mentioned was initiated back on April 9th, and unless it's extended, we could see a reposition of tariffs on several of our major trading partners. Our base case is that the administration, broadly speaking, tries to kick the can down the road, meaning that it extends the pause for most countries, though the reality might be closer to a few countries seeing their rates go up while others announce bilateral framework deals between now and next week.But before we get into the key assumptions underlying our base case. Let's talk about the bigger picture. Michael, what do we think the administration is actually trying to accomplish here?Michael Zezas: So when it comes to defining their objectives, we think multiple things can be true at the same time. So the administration's talked about the virtue of tariffs as a negotiating tactic. They've also floated the idea of a tiered framework for global trading partners. Think of it as a ranking system based on trade deficits, non tariff barriers, VAT levels, and any other characteristics that they think are important for the bilateral trade relationship. A lot of this is similar to the rhetoric we saw ahead of the April 2nd "Liberation Day" tariffs.Ariana Salvatore: Right, and around that time we started hearing about the potential, at least for bilateral trade deals, but have we seen any real progress in that area?Michael Zezas: Not much, at least not publicly, aside from the UK framework agreement. And here's an important detail, three of our four largest trading partners aren't even scoped for higher rates next week. Mexico and Canada were never subject to the reciprocal tariffs. And China's on a separate track with this Geneva framework that doesn't expire until August 12th. So we're not expecting a sweeping overhaul by Wednesday.Ariana Salvatore: Got it. So what are the scenarios that we're watching?Michael Zezas: So there's roughly three that we're looking at and let me break them down here.So our base case is that the administration extends the current pause, citing progress in bilateral talks, and maybe there's a few exceptions along the way in either direction, some higher and some lower. This broadly resets the countdown clock, but keeps the current tariff structure intact: 10% baseline for most trading partners, though some potentially higher if negotiations don't progress in the next week. That outcome would be most in line, we think, with the current messaging coming out of the administration.There's also a more aggressive path if there's no visible progress. For example, the administration could reimpose tariffs with staggered implementation dates. The EU might face a tougher stance due to the complexity of that relationship and Vietnam could see delayed threats as a negotiating tactic. A strong macro backdrop, resilient data for markets that could all give the administration cover to go this route.But there's also a more constructive outcome. The administration can announce regional or bilateral frameworks, not necessarily full trade deals, but enough to remove the near term threat of higher tariffs, reducing uncertainty, though maybe not to pre-2024 levels.Ariana Salvatore: So wide bands of uncertainty, and it sounds like the more constructive outcome is quite similar to our base case, which is what we have in place right now. But translating that more aggressive path into what that means for the economy, we think it would reinforce our house view that the risks here are skewed to the downside.Our economists estimate that tariffs begin to impact inflation about four months after implementation with the growth effects lagging by about eight months. That sets us up for weak but not quite recessionary growth. We're talking 1% GDP on an annual basis in 2025 and 2026, and the tariff passed through to prices and inflation data probably starting in August.Michael Zezas: So bottom line, watch carefully on Wednesday and be vigilant for changes to the status quo on tariff levels. There's a lot of optionality in how this plays out, as trade policy uncertainty in the aggregate is still high. Ariana, thanks for taking the time to talk.Ariana Salvatore: Great speaking with you, Michael.Michael Zezas: And if you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

2 Jul 20254min

Ron Kamdem, our U.S. Real Estate Investment Trusts & Commercial Real Estate Analyst, discusses how GenAI could save the real estate industry $34 billion and where the savings are most likely to be found.Read more insights from Morgan Stanley.----- Transcript -----Welcome to Thoughts on the Market. I’m Ron Kamdem, Head of Morgan Stanley’s U.S. Real Estate Investment Trusts and Commercial Real Estate research. Today I’ll talk about the ways GenAI is disrupting the real estate industry.It’s Tuesday, July 1st, at 10am in New York.What if the future of real estate isn’t about location, location, location – but automation, automation, automation?While it may be too soon to say exactly how AI will affect demand for real estate, what we can say is that it is transforming the business of real estate, namely by making operations more efficient. If you’re a customer dealing with a real estate company, you can now expect to interact with virtual leasing assistants. And when it comes to drafting your lease documents, AI can help you do this in minutes rather than hours – or even days.In fact, our recent work suggests that GenAI could automate nearly 40 percent of tasks across half a million occupations in the real estate investment trusts industry – or REITs. Indeed, across 162 public REITs and commercial real estate services companies or CRE with $92 billion of total labor costs, the financial impact may be $34 billion, or over 15 percent of operating cash flow. Our proprietary job posting database suggests the top four occupations with automation potential are management – so think about middle management – sales, office and administrative support, and installation maintenance and repairs.Certain sub-sectors within REITs and CRE services stand to gain more than others. For instance, lodging and resorts, along with brokers and services, and healthcare REITs could see more than 15 percent improvement in operating cash flow due to labor automation. On the other hand, sectors like gaming, triple net, self-storage, malls, even shopping centers might see less than a 5 percent benefit, which suggests a varied impact across the industry.Brokers and services, in particular, show the highest potential for automation gains, with nearly 34 percent increase in operating cash flow. These companies may be the furthest along in adopting GenAI tools at scale. In our view, they should benefit not only from the labor cost savings but also from enhanced revenue opportunities through productivity improvement and data center transactions facilitated by GenAI tools.Lodging and resorts have the second highest potential upside from automating occupations, with an estimated 23 percent boost in operating cash flow. The integration of AI in these businesses not only streamline operations but also opens new avenues for return on investments, and mergers and acquisitions.Some companies are already using AI in their operations. For example, some self-storage companies have integrated AI into their digital platforms, where 85 percent of customer interactions now occur through self-selected digital options. As a result, they have reduced on-property labor hours by about 30 percent through AI-powered staffing optimization. Similarly, some apartment companies have reduced their full-time staff by about 15 percent since 2021 through AI-driven customer interactions and operational efficiencies.Meanwhile, this increased application of AI is driving new revenue to AI-enablers. Businesses like data centers, specialty, CRE services could see significant upside from the infrastructure buildout from GenAI. Advanced revenue management systems, customer acquisition tools, predictive analytics are just a few areas where GenAI can add value, potentially enhancing the $290 billion of revenue stream in the REIT and CRE services space.However, the broader economic impact of GenAI on labor markets remains hotly debated. Job growth is the key driver of real estate demand and the impact of AI on the 164 million jobs in the U.S. economy remains to be determined. If significant job losses materialize and the labor force shrinks, then the real estate industry may face top-line pressure with potentially disproportionate impact on office and lodging. While AI-related job losses are legitimate concerns, our economists argue that the productivity effects of GenAI could ultimately lead to net positive job growth, albeit with a significant need for re-skilling.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

1 Jul 20255min

The U.S. housing market appears to be stuck. Our co-heads of Securitized Product research, Jay Bacow and James Egan, explain how supply and demand, as well as mortgage rates, play a role in the cooling market.Read more insights from Morgan Stanley.----- Transcript -----James 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 Securitized Products Research at Morgan Stanley. And after getting through last week's blistering hot temperatures, today we're going to talk about what may be a cooling housing market. It's Monday, June 30th at 2:30pm in New York. Now, Jim, home prices. We just got another index. They set another record high, but the pace of growth – the acceleration as a physicist in me wants to say – appears to be slowing. What's going on here?James Egan: The pace of home price growth reported this month was 2.7 percent. That is the lowest that it's been since August of 2023. And in our view, the reason's pretty simple. Supply is increasing, while demand has stalled.Jay Bacow: But Jim, this was a report for the spring selling season. I know we got it in June, but this is supposed to be the busiest time of the year. People are happy to go around. They're looking at moving over the summer when the kids aren't in school. We should be expecting the supply to increase. Are you saying that it's happening more than it's anticipated?James Egan: That is what we're saying. Now, we should be expecting inventories today to be higher than they were in, call it January or February. That's exactly the seasonality that you're referring to. But it's the year-over-year growth we're paying attention to here. Homes listed for sale are up year-over-year, 18 months in a row. And that pace, it's been accelerating. Over the past 40 years, the pace of growth from this past month was only eclipsed one time, the Great Financial Crisis.Jay Bacow: [sighs] I always get a little worried when the housing analyst brings up the Great Financial Crisis. Are you saying that this time the demand isn't responding?James Egan: That is what we're saying. So, through the first five months of this year, existing home sales are only down about 2 percent versus the first five months of 2024. So they've basically kind of plateaued at these levels. But that also means that we're seeing the fewest number of transactions through May in a calendar year since 2009. And that combination of easing inventory and lackluster demand, it's pushed months of supply back to levels that we haven't seen since the beginning of this pandemic. Call it the fourth quarter of 2019, first quarter of 2020, right before inventory has really plummeted to historic lows.Jay Bacow: All right, so 2009, another financial crisis reference. But you're also – you're speaking around a national level, and as a housing analyst, I feel like you haven't really spoken about the three most important factors when we think about things which are: Location. Location. And location.James Egan: Absolutely. And the deceleration that we're seeing in home price growth – and I would point out it is still growth – has been pervasive across the country. Year-over-year, HPA is now decelerating in 100 percent of the top 100 MSAs, for which we have data. In fact, a full quarter of them, 25 percent of these cities are now actually seeing prices decline on a year-over-year basis. And that's up from just 5 percent with declining home prices one year ago.Jay Bacow: As a homeowner, I do like the home price growth. And is it the same story when you look more narrowly around supply and demand?James Egan: So, there might be some geographical nuances, but we do think that it largely boils down to that. Local inventory growth has been a very good indicator of weaker home price performance, particularly the level of for-sale inventory today versus that fourth quarter of 2019. If we look at it on a geographic basis, of 14 MSAs that have the highest level of inventory today compared to 2019, 11 of them are in either Florida or Texas. On the other end of the spectrum, the cities where inventory remains furthest away from where it was four and a half years ago, they're in the Northeast, they're in the Midwest.Jay Bacow: As somebody who lives in the Northeast, I'd like to hear that again. But you're also; you're quoting existing prices, which that's been the outperformer in the housing market. Right?James Egan: Exactly. New home prices have actually been decreasing year-over-year for the past year and a half at this point. It's actually brought the basis between new home prices, which tend to trade at a little bit of a premium to existing sales; it's brought that basis to its tightest level that we've seen in at least 30 years. And that's before we take into account the fact that home builders have been buying down some of these mortgage rates. But Jay, you've recently done some work trying to size this.Jay Bacow: Yeah. First it might help to explain what a buydown is.A home builder might have a new home listed at say, $450,000. And with mortgage rates in the context of about 6.5 percent right now, the home buyer might not be able to afford that, so they offer to pay less. The home builder – often many of them also have an origination arm as well. They'll say, you know what? We'll sell it to you at that $450,000, but we'll give you a lower mortgage rate; instead of 6.5 percent, we'll sell it to you for $450,000 with a 5 percent mortgage rate. Then maybe the home buyer can afford that.James Egan: And so, new home prices are actually coming down. And by that we're specifically referring to the median price of new home transactions. They're falling despite the fact that these buy downs might be influencing prices a little bit higher.Jay Bacow: Right. And when we look at how often this is happening, it's a little actually hard to get it from the data because they don't have to report it. But when we look at the distribution of mortgage rates in a given month – prior to 2022, there were effectively no purchase loans that were originated less than one point below the prevailing mortgage rate for a given month.However, more recently we're up to about 12 percent of Ginnie Mae purchases, and those are the more credit constrained borrowers that might have a harder time buying a home. And about 5 percent of conventional purchase loans are getting originated with a rate 1 percent below the outstanding marketJames Egan: And so, this might be another sign that we're seeing a little bit of softening in home prices. But what are the implications on the agency mortgage side?Jay Bacow: I would say there's probably two things that we're keeping an eye out on. Because these are homeowners that are getting below market rate, the investors are getting a below market coupon. And because they're getting sold at a discount, they don't want that, but they're going to stay around for a while. So, investors are getting these rates that they don't want for longer.And then the other thing you think about from the home buyer perspective is, you know, maybe they – it's good for them right now. But if they want to sell that home, because they're getting a below market mortgage rate, they bought the home for maybe more than other people would've. So, unless they can sell it with that mortgage attached, which is very difficult to do, they probably have to sell it for a lower price than when they bought it.Now Jim, what does all this mean for home prices going forward?James Egan: Now, when we think about home prices, we're talking about the home price indices, right? And so those are going to be repeat sales. It’s going to, by definition, look at existing prices and not necessarily the dynamics we're talking in the new home price market.Jay Bacow: Okay, so all this builder buy down stuff is interesting for what it means for new home prices – but doesn't impact all the HPA indices that you reference.James Egan: Exactly, and at the national level, despite what we've been talking about on this podcast, we do think that home prices remain more supported than what we are seeing locally. Inventory is increasing, but it also remains near historically low levels. Months of supply that I mentioned at the top of this podcast, it's picked up to the highest level it's been since the beginning of this pandemic. We're also talking about four to four and a half months of supply. Anything below six is a tight environment that has been historically associated with home prices continuing to climb.That's why our base case is for positive HPA this year. We're at +2 percent. That's slower than where we are now. We think you're going to continue to see deceleration. And because of what we're seeing from a supply and demand perspective, we are a little bit more skewed to the downside in our bear case. Instead of that +2, we're at -3 percent than we are towards the upside in our bull case. Instead of that plus two, we’re at plus 5 percent in the bull case. So slower HPA from here, but still positive.Jay Bacow: Well, Jim, it's always a pleasure talking to you, particularly when you're highlighting that the home price growth is going to be stronger in the place where I own a home.James Egan: Pleasure talking to you too, Jay. And to all of you listening, thank you for listening to another episode of Thoughts on the Market. Please leave a review or a like wherever you get this podcast and share Thoughts on the Market with a friend or colleague today.Jay Bacow: Go smash that subscribe button.

30 Jun 20258min