Relief and Volatility Ahead for U.S. Stocks

As inflation continues to rise beyond expectations, the Fed is set to meet next week, leaving markets to wonder if an acceleration in rate hikes might be in store this summer.-----Transcript-----Welcome to Thoughts on the Market. I'm Robert Rosner, Senior U.S. Economist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about this morning's inflation data and how that may impact Fed discussions at next week's FOMC meeting. It's Friday, June 10th, at 2 p.m. in New York. This morning, we received the Consumer Price Index data for May that showed a faster than anticipated increase in both headline and core inflation. Inflation continues to be lifted by high food and energy prices, and the combination of the two have pushed inflation up to a new high on a year over year basis, to. 8.6%. That rise in inflation reflects not just gains in food and energy prices, but extremely broad based increases under the surface, with core goods prices continuing to reaccelerate and core services prices also remaining strong, reflecting continued upside in travel related airfares and hotels. While other factors like rents and owners' equivalent rents both jumped. Rents in particular posted their fastest sequential month on month pace of increase since 1987. That's really impo the Fed next week because this sets a tone of inflation that remains very elevated as the Fed sits down to discuss its policy. Moreover, many, including ourselves, had been expecting that the peak for inflation on a year over year basis would have been registered back in March. But today's data showed that CPI has reached a new high on a year over year basis. That raises uncertainty about the outlook for inflation. And Fed policymakers have expressed some concern about the possibility for some underlying reacceleration in inflation. We also saw at the same time that data from the University of Michigan Survey of Consumer Sentiment showed that both short and longer term household expectations for inflation have been on the rise. So the risks around inflation remain high, and as the Fed sits down next week policymakers are likely to see inflation as remaining a top of mind topic. We have been expecting the Fed to pursue a series of 50 basis point rate hikes as the FOMC seeks to tighten financial conditions in order to slow demand and eventually slow inflation. And markets after the inflation data moved very quickly to price in an even more hawkish path for Fed policy, with some risk that a 50 basis point rate hike might not be enough and that there might be some chance that the Fed could deliver a 75 basis point rate hike at some point over the summer. We'll hear from policymakers next week as to whether or not an acceleration in the pace of rate hikes is something that they see as an attractive option. But the bottom line here is the Fed's work is far from done. Inflation remains high, incoming data suggests that growth has moderated, but has not slowed enough to feel confident that inflation is likely to follow. It's going to be a tricky summer for Fed policymakers, and a tricky summer for data watchers as well, because each incremental inflation data point is likely to inform how Fed policymakers are likely to react and what that path for rate hikes is likely to look like over the summer and into the fall. Thank you for listening. If you enjoy the show, please leave us a review on Apple Podcasts, and share Thoughts on the Market with a friend or colleague today.

10 Jun 20223min

While many investors may be curious to know what other investors are thinking about current and future market trends, there’s a lot more to the calculation of investor sentiment than one might think.-----Transcript-----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, June 9th, at 6 p.m. in London. I've found that investors are almost always interested in what other types of investors are doing. Some of this is curiosity, but a lot of it is interest in sentiment and a desire to try to quantify market emotion to give a better indicator of when to buy or sell. One can find a variety of metrics that portend to reflect this investor mood. Many of them move in nice, big, oscillating waves between fear and greed. But as anyone trying to use them as encountered, investing based on sentiment is harder in theory than practice. The first challenge, of course, is that there is little agreement in professional circles on exactly the best way to capture market emotion. Is it different responses to a regular investor survey? Is it the level of implied volatility in the market? Is it the flow of money in and out of different funds? The potential list goes on. Next, once you have an indicator, what's the right threshold to establish if it's telling you something is extreme? If you poll a thousand investors every week, maybe 70% of those investors being negative tells you the mood is sufficiently sour. But maybe the magic number is 80%, or maybe it's 60%. Defining positive or negative sentiment isn't always straightforward. Finally, there's the simple but important point that sometimes the crowd is right. Think of a long bull market like the 1990s. People were often optimistic about the stock market and correct to think so as prices kept rising. Meanwhile, people are often bearish in a bear market. We remember the dour mood that persisted throughout 2008. It certainly didn't stop stocks from going down. With all of this in mind, our research is focused on finding some ways to use sentiment measures more effectively. We think it makes sense to use a composite of different indicators, as true extremes are likely to show up across multiple approaches to measurement. Valuing both the level and direction of sentiment can be helpful. Rather than trying to catch an absolute extreme or market bottom, the best risk reward is often when sentiment is negative but improving. And sentiment is more useful to identify market lows than market peaks, as negativity and despair tend to be stronger, sharper emotions. Identifying peak optimism, at least in our work, is much harder. So don't beat yourself up if you can't find a signal that consistently flags market tops. Those ideas underlie the tools that we've built to try to turn market sentiment into signals as the age old debate around the true state of fear and greed continues throughout this year. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.

9 Jun 20223min

Under the combined stresses of dry weather, COVID, and the Russian invasion of Ukraine, agricultural prices are spiking, and many countries are scrambling to combat the consequences to the global economy. Morgan Stanley Chief Global Economist Seth Carpenter explains.-----Transcript-----Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Chief Global Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about the surge in agricultural prices and some of the implications for the global economy. It's Wednesday, June 8th, at 1:30 p.m. in New York. Agricultural prices have jumped this year, and that surge has become one of the key topics of the moment, both on a domestic level and a global scale. The Russian invasion of Ukraine clearly contributed significantly to the runup in prices, but even before the war, dry weather and COVID-19 had already started to threaten the global food supply. Rising food prices pose many risks, particularly for lower income people and lower income countries. Even though I'm going to be talking mostly about cold economics today, the human toll of all of this is absolutely critical to keep in mind. In fact, we see the surge in food prices as a risk to the global economic recovery. When prices for necessities like food go up, lower income households just have to spend more on food. And that increased spending on food means they've got less money to spend on discretionary items. To put some numbers on how we got here, global food prices have surged about 66% since the start of COVID-19, and about 12% since the start of the Russian invasion of Ukraine. Dry weather had already affected crops, especially in Latin America and India. And remember, fertilizer is tightly linked to the petrochemical industry, and the Russian invasion of Ukraine has complicated that situation, leaving fertilizer prices at all time highs. So what's been the response? Governments across developed markets and emerging markets have started enacting measures to try to contain their domestic prices. In the developed market world, these measures include attempts to boost domestic production so as to relieve some of the pressures. While in EM, some governments have opted to cut food taxes or put in place price controls. In addition, some governments have also imposed bans on exports of certain agricultural products. The side effect, though, is getting more trade disruptions in already tight commodity markets. Against this backdrop, there are two key consequences. First, consumption spending is likely to be lower than it would have been. And second, inflation is likely to rise because of the rise in food prices. And if we look at it across the globe, emerging markets really look more vulnerable to these shocks than developed markets. First, in terms of consumption spending, our estimates suggest that the recent rise in food prices might decrease real consumption spending throughout this year by about 1% in the U.S. and about 3% in Mexico, all else equal. Now, that said, not every component of spending gets affected uniformly. Historical data analysis suggests that the drop is heavily focused in durable goods spending, like for motor vehicles. And EMs are more exposed because they've got a higher share of food consumption in their overall consumption basket. Now, when it comes to inflation, we think that the recent spike in food prices, if it lasts for the rest of this year, it's probably going to add about 1.2 percentage points to headline Consumer Price Index inflation in emerging markets, and about 6/10 of a percentage point increase to inflation in DM. These are really big increases. Now why should the inflationary push be higher in emerging markets? First, just arithmetically, food represents a larger share of CPI in emerging markets than it does in DM, something like 24% versus 17%. And second, in emerging markets, inflation expectations tend to be less well anchored, and so a rise in prices in a critical component like food tends to spread out to lots of other components in inflation as well. So what's the bottom line here? Growth is slowing globally. Inflation is high. The surge in food prices is going to increase the risks for both of those. Thanks for listening. If you enjoy this show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or a colleague today.

8 Jun 20224min

As some provisions of the Tax Cuts and Jobs Act start to kick in and others are set to expire, the future of U.S. tax rates may hinge on the results of the upcoming midterm elections. Head of U.S. Public Policy Research and Municipal Strategy Michael Zezas and Head of Global Valuation, Accounting and Tax Todd Castagno discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Head of U.S. Public Policy Research and Municipal Strategy for Morgan Stanley. Todd Castagno: And I'm Todd Castagno, Head of Global Valuation, Accounting and Tax for Morgan Stanley Research. Michael Zezas: And on this special edition of the podcast, we'll be talking about the 2022 U.S. midterm elections and the potential impact on individual and corporate taxes. It's Tuesday, June 7th, at 10:00 AM in New York. Michael Zezas: If you're a regular listener, you may have heard my conversation with our chief U.S. Economist, Ellen Zentner, last week about the economic implications of this year's midterm elections. This week, Todd Castagno and I are going to continue the midterm election topic because individual and corporate taxes could be set to increase starting this year. But the question is how high, when and what the impact from the election could be. So, Todd, you and I have talked about this and we agree that taxes are likely headed higher for both individuals and corporations. Maybe you can tell us why that is. Todd Castagno: Thanks, Michael. And it's really a driving function of how the Tax Cuts and Jobs Act was passed. And that's because Congress used the budget reconciliation legislation, which is primarily temporary. So, for instance, the individual provisions generally all expire at the end of 2025. And business tax increases have already started to phase in this year. So extension of the status quo for both businesses and individuals really is a function of the political landscape heading into midterms and then the next presidential election. Michael Zezas: Okay. So let's start with the individual taxes. Maybe you can name some provisions set to expire and what the changes would be. Todd Castagno: So Michael, let's first provide an overview of what the Tax Cuts and Jobs Act did for individuals. First, it reduced individual tax rates. Second, it almost doubled the standard deduction, meaning fewer taxpayers require itemized deductions. It provided a generous 20% deduction for small businesses, and pass-through businesses. It provided a much more generous child tax care credit, that's also refundable. And then the alternative minimum tax was reduced, so fewer taxpayers were caught in that tax. All these provisions are set to expire at the end of 2025 if Congress does not act. Michael Zezas: Let's shift over to corporate taxes. The Tax Cuts and Jobs Act lowered the corporate tax rate to 21% in 2017. Is there a chance we could see that climb? And to what level? Todd Castagno: That's true. One of the only permanent items of the Tax Cuts and Jobs Act was to reduce the corporate tax rate from 35% to 21%. However, starting this year, there are other tax increases within the corporate tax system. For instance, the requirement to amortize R&D costs over 5 years starts this year. That will primarily affect technology companies. And then there's elimination of favorable media expensing for capital expenditures, that starts to phase out next year, and that primarily would impact manufacturing and industrial companies. And then there's more restrictive deductibility of interest expense. So these in conjunction, will raise tax obligations. And it really depends on the political climate of how these get extended, and if that 21% corporate rate may nudge higher. Michael Zezas: Todd. Last October, you and I talked in the podcast about a two pillar tax overhaul which would come out of global tax reform. Nine months later, how do you see that playing out? Todd Castagno: So there's an ongoing effort to A, change the mix of which countries get to tax corporate income and B, the establishment of a global minimum corporate tax rate of 15%. The wheels are still in motion, but let's say the bus has slowed down. For instance, in the U.S., the required reforms are part of the build back better legislation, which has recently stalled. And then in Europe, nearly unanimous agreement, but they're still one or two states that are not fully on board. Todd Castagno: Michael, I want to turn it back to you. Investors and policymakers clearly have some worries about inflation risks. How will that factor into what kinds of effective tax increases would be palatable for lawmakers? Michael Zezas: Sure. Policymakers in Washington, D.C. have become really sensitive to inflation. And so tax increases now serve a purpose as a tool for Democrats to achieve some of their spending goals, like investing in clean energy, but doing so without contributing to inflation by increasing government deficits. So given that if Democrats manage to get a new spending bill focused on energy across the finish line, the tax increases will likely need to match that spending. So that keeps corporate tax increases and tax increases focused on high income earners on the table. Todd Castagno: Finally, before we close, I'm curious if you've heard anything from our economist or equity strategist on what the impact will be on growth, or corporate bottom lines, if some or all of these expirations occur? Michael Zezas: Well, tax increases mean higher costs for companies and households. So this becomes one of several factors that our equity strategists say will contribute to the crimping of the bottom line of U.S. companies. And they don't think that's in the price of the stock market quite yet. And so what that ultimately means is that the volatility we've been experiencing in markets is something they think is going to continue. Michael Zezas: Todd, thank you so much for talking. Todd Castagno: Great talking with you, Michael. Michael Zezas: And thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

7 Jun 20225min

While markets look forward to an acceleration in earnings growth and a subsequent rise in valuations over the next year, there are risks to this outlook that investors may want to consider before abandoning a defensive position.-----Transcript-----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, June 6th, at 11 a.m. in New York. So let's get after it. Over the past several months, we've been highlighting the declining trend in earnings revision breath. However, it's been a slow moving train and we're barely below zero at this point. This is why forward 12 month earnings estimates are still grinding higher for the S&P 500, and one reason why stocks have rallied over the past few weeks. But now valuations have risen back to 17.5x earnings, despite a rising 10 year Treasury yield. In order for this to make sense, however, one must take the view that earnings growth will reaccelerate later this year. Time will tell, but we think S&P 500 earnings growth will slow further rather than reaccelerate. Some have argued these revisions were fully priced, with the major averages down more than 20% year to date. In short, the earnings risk is now understood and the market is looking forward to better growth next year. In the absence of further revisions in the near term, that view can hold up for now. However, if earnings revisions don't reaccelerate, we think the price is too high. This is why we think it could be difficult for the equity market to make much upward progress this summer or fall from current levels. Either the price needs to come down to reflect the further earnings risk we foresee or the earnings need to fall. We think both will happen over the course of the second and third quarter earnings season as companies come to the confessional one by one. In the absence of a recession or a shock like the COVID lockdowns, negative earnings revisions typically take longer than they should, and this time is likely to be no different. Therefore, we remain open minded to the idea of stocks hanging around current levels and even rallying further in the near term, especially if there is some kind of pause or cease fire in the Russia Ukraine war. However, even if that were to happen, we don't think this reverses the fire and ice that is now well-established but incomplete. Bottom line, the bear market rally that began a few weeks ago can continue for a few more weeks until the Fed makes it crystal clear they remain hawkish and earnings revisions fall well into negative territory. That combination should ultimately take the S&P 500 down towards our 3400 target by mid to late August. As we've been highlighting all year, equity investors should be more focused on single stocks and relative opportunities across sectors. In that regard, real estate has seen the strongest earnings revisions over the past 4 weeks. Food, beverage and tobacco, commercial and professional services and materials have also seen a positive change in revisions. Finally, capital goods and the overall industrial sector have fared relatively well over the past 4 weeks, as their absolute revisions have remained flat. The weakest revisions have come from consumer and tech industry groups, two areas we remain underweight. Food and staples retailing revisions have collapsed over the past 4 weeks, as concerns over cost pressures on top of already thin margins hit the space. Consumer discretionary has also continued to see weakness in revisions over the past 4 weeks, despite some modest relief more recently over the past 2 weeks. Bottom line, U.S. stocks appear in the midst of a bear market rally that could run a few weeks longer. The Nasdaq and small cap indices will outperform under that view in the short term. However, we remain defensively positioned into the fall when a more durable low in equity markets is likely to coincide with a bottom in earnings growth. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.

6 Jun 20223min

Original Release on May 17th, 2022: As we forecast the remainder of an already uncertain 2022, new questions have emerged around economic data, inflation and the potential for a recession. Chief Cross Asset Strategist Andrew Sheets and Chief Global Economist Seth Carpenter discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets. Morgan Stanley's Chief Cross-Asset Strategist. Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley's Chief Global Economist. Andrew Sheets: And today on the podcast, we'll be talking about our outlook for strategy and markets and the challenges they may face over the coming months. It's Tuesday, May 17th, at 4 p.m. in London. Seth Carpenter: And it's 11 a.m. in New York. Andrew Sheets: So Seth, the global Morgan Stanley Economic and Strategy Team have just completed our mid-year outlook process. And, you know, this is a big collaborative effort where the economists think about what the global economy will look like over the next 12 months, and the strategists think about what that could mean for markets. So as we talk about that outlook, I think the economy is the right place to start. As you're looking across the global economy and thinking about the insights from across your team, how do you think the global economy will look over the next 12 months and how is that going to be different from what we've been seeing? Seth Carpenter: So I will say, Andrew, that we titled our piece, the economics piece, slowing or stopping with a question mark, because I think there is a great deal of uncertainty out there about where the economy is going to go over the next six months, over the next 12 months. So what are we looking at as a baseline? Sharp deceleration, but no recession. And I say that with a little bit of trepidation because we also try to put out alternative scenarios, the way things could be better, the way things could be worse. And I have to say, from where I'm sitting right now, I see more ways for the global economy to be worse than the global economy to be better than our baseline scenario. Andrew Sheets: So Seth, I want to dig into that a little bit more because we're seeing, you know, more and more people in the market talk about the risk of a slowdown and talk about the risk of a recession. And yet, you know, it's also hard to ignore the fact that a lot of the economic data looks very good. You know, we have one of the lowest unemployment rates that we've seen in the U.S. in some time. Wage growth is high, spending activity all looks quite high and robust. So, what would drive growth to slow enough where people could really start to think that a recession is getting more likely?Seth Carpenter: So here's how I think about it. We've been coming into this year with a fair amount of momentum, but not a perfectly pristine outlook on the economy. If you take the United States, Q1, GDP was actually negative quarter on quarter. Now, there are a lot of special exceptions there, inventories were a big drag, net exports were a big drag. Underlying domestic spending in the U.S. held up reasonably solidly. But the fact that we had a big drag in the U.S. from net exports tells you a little bit about what's going on around the rest of the world. If you think about what's going on in Europe, we feel that the economy in the eurozone is actually quite precarious. The Russian invasion of Ukraine presents a clear and critical risk to the European economy. I mean, already we've seen a huge jump in energy prices, we've seen a huge jump in food prices and all of that has got to weigh on consumer spending, especially for consumers at the bottom end of the income distribution. And what we see in China is these wave after wave of COVID against the policy of COVID zero means that we're going to have both a hit to demand from China and some disruption to supply. Now, for the moment, we think the disruption to supply is smaller than the hit to demand because there is this closed loop approach to manufacturing. But nevertheless, that shock to China is going to hurt the global economy. Andrew Sheets: So Seth, the other major economic question that's out there is inflation, and you know where it's headed and what's driving it. So I was hoping you could talk a little bit about what our forecasts for inflation look like going forward. Seth Carpenter: Our view right now is that inflation is peaking or will be peaking soon. I say that again with a fair amount of caution because that's been our view for quite some time, and then we get these additional surprises. It's clear that in many, many economies, a huge amount of the inflation that we are seeing is coming from energy and from food. Now energy prices and food prices are not likely to fall noticeably any time soon. But after prices peak, if they go sideways from there, the inflationary impulse ends up starting to fade away and so we think that's important. We also think, the COVID zero policy in China notwithstanding, that there will be some grudging easing of supply chain frictions globally, and that's going to help bring down goods inflation as well over time. So we think inflation is high, we think inflation will stay high, but we think that it's roughly peaked and over the balance of this year and into next year it should be coming down.Andrew Sheets: As you think about central bank policy going forward, what do you think it will look like and do you think it can get back to, quote, normal? Seth Carpenter: I will say, when it comes to monetary policy, that's a question we want to ask globally. Right now, central banks globally are generically either tight or tightening policy. What do I mean by that? Well, we had a lot of EM central banks in Latin America and Eastern Europe that had already started to hike policy a lot last year, got to restrictive territory. And for those central banks, we actually see them starting to ease policy perhaps sometimes next year. For the rest of EM Asia, they're on the steady grind higher because even though inflation had started out being lower in the rest of EM Asia than in the developed market world, we are starting to see those inflationary pressures now and they're starting to normalize policy. And then we get to the developed market economies. There's hiking going on, there's tightening of policy led by the Fed who's out front. What does that mean about getting back to an economy like we had before COVID? One of the charts that we put in the Outlook document has the path for the level of GDP globally. And you can clearly see the huge drop off in the COVID recession, the rapid rebound that got us most of the way, but not all the way back to where we were before COVID hit. And then the question is, how does that growth look as we get past the worst of the COVID cycle? Six months ago, when we did the same exercise, we thought growth would be able to be strong enough that we would get our way back to that pre-COVID trend. But now, because supply has clearly been constrained because of commodity prices, because of labor market frictions, monetary policy is trying to slow aggregate demand down to align itself with this restricted supply. And so what that means is, in our forecast at least, we just never get back to that pre-COVID trend line. Seth Carpenter: All right, Andrew, but I've got a question to throw back at you. So the interplay between economics and markets is really uncertain right now. Where do you think we could be wrong? Could it be that the 3%, ten-year rate that we forecast is too low, is too high? Where do you think the risks are to our asset price forecasts? Andrew Sheets: Yeah, let me try to answer your question directly and talk about the interest rate outlook, because we are counting on interest rates consolidating in the U.S. around current levels. And our thinking is partly based on that economic outlook. You know, I think where we could be wrong is there's a lot of uncertainty around, you know, what level of interest rate will slow the economy enough to balance demand and supply, as you just mentioned. And I think a path where U.S. interest rates for, say, ten year treasuries are 4% rather than 3% like they are today, I think that's an environment where actually the economy is a little bit stronger than we expect and the consumer is less impacted by that higher rate. And it's going to take a higher rate for people to keep more money in savings rather than spending it in the economy and potentially driving that inflation. So I think the path to higher rates and in our view does flow through a more resilient consumer. And those higher rates could mean the economy holds up for longer but markets still struggle somewhat, because those higher discount rates that you can get from safe government bonds mean people will expect, mean people will expect a higher interest rate on a lot of other asset classes. In short, we think the risk reward here for bonds is more balanced. But I think the yield move so far this year has been surprising, it's been historically extreme, and we have to watch out for scenarios where it continues. Seth Carpenter: Okay. That's super helpful. But another channel of transmission of monetary policy comes through exchange rates. So the Fed has clearly been hiking, they've already done 75 basis points, they've lined themselves up to do 50 basis points at at least the next two meetings. Whereas the ECB hasn't even finished their QE program, they haven't started to raise interest rates yet. The Bank of Japan, for example, still at a really accommodative level, and we've seen both of those currencies against the dollar move pretty dramatically. Are we in one of those normal cycles where the dollar starts to rally as the Fed begins to hike, but eventually peaks and starts to come off? Or could we be seeing a broader divergence here? Andrew Sheets: Yeah. So I think this is to your point about a really interesting interplay between markets and Federal Reserve policy, because what the Fed is trying to do is it's trying to slow demand to bring it back in line with what the supply of things in the economy can provide at at current prices rather than it at higher prices, which would mean more inflation. And there's certainly an important interest rate part to that slowing of demand story. There's a stock market part of the story where if somebody's stock portfolio is lower, maybe they're, again, a little bit less inclined to spend money and that could slow the economy. But the currency is also a really important element of it, because that's another way that financial markets can feed back into the real economy and slow growth. And if you know you're an American company that is an exporter and the dollar is stronger, you likely face tougher competition against overseas sellers. And that acts as another headwind to the economy. So we think the dollar strengthens a little bit, you know, over the next month or two, but ultimately does weaken as the market starts to think enough is priced into the Fed. We're not going to get more Federal Reserve interest rates than are already implied by the market, and that helps tamp down some of the dollar strength that we've been seeing. Andrew Sheets: And Seth thanks for taking the time to talk. Seth Carpenter: Andrew, it's been great talking to you. Andrew Sheets: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

3 Jun 202210min

In the years since the Global Financial Crisis, central bank policy has been supportive and predictable. But as the economic backdrop changes, shifts in policy will come with risks and rewards.-----Transcript-----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, June 2nd, at 2 p.m. in London. The period that followed the global financial crisis was filled with paradoxes. It was a period of serially disappointing economic growth, but exceptional asset class returns. Wealth exploded in relation to the economy, while capital investment withered. It was a period of such fragility that it demanded enormous policy support, yet produced remarkably consistent patterns of performance. For example, in 9 of the last 12 years, growth outperformed value, bonds outperformed cash and stocks outperformed commodities. That consistency in performance was mirrored by consistency in the economy. Generally speaking, 2010 through 2021 saw low inflation, weak growth and central bank policy that was both supportive and predictable. All of these trends are changing. Year to date, commodities have outperformed stocks, cash has outperformed bonds, and value has outperformed growth. The economic backdrop is also different; growth and inflation are high, capital investment is strong and global central bank policy has been more restrictive and less predictable. These shifts have risks, but consider the alternative. Over the last decade, it was common to hear investors worry about the bogged down state of the global economy, with weak growth that required large monetary policy support as far as the eye could see. Low growth and low rates clearly were not optimal. However, central banks are now adjusting their strategy. It's easy to argue that policy stayed too accommodative for too long. But hindsight is cheap and easy. What matters now is that policy is normalizing in a significant way. More importantly, these shifts are accomplishing central bank goals. Markets assume that central banks in the US, the eurozone and Australia can raise interest rates further without material economic declines. Inflation expectations are now falling, the housing market is cooling and credit risk premiums are back near the long run average, all the while labor markets in the US and Europe remain strong. In short, there is a lot of talk about whether central banks are making a mistake, especially given the recent market volatility. But looking at the results overall, we suspect central banks are reasonably happy with how things are going so far. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.

2 Jun 20222min

Looking back on the 2016 and 2020 elections, it is clear that elections can have a significant impact on the U.S. economic outlook. The question is whether the coming midterm elections have any meaningful implications. Head of U.S. Public Policy Research and Municipal Strategy Michael Zezas and Chief U.S. Economist Ellen Zentner discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Head of U.S. Public Policy Research and Municipal Strategy for Morgan Stanley. Ellen Zentner: And I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Michael Zezas: And on this special edition of the podcast, we'll be talking about the 2022 U.S. midterm elections and the potential impact on markets and the economy. It's Wednesday, June 1st, at 10 a.m. in New York. Ellen Zentner: Michael, I'm going to start us off here because 13 states have now completed their primaries ahead of the midterm elections. And as our key Beltway observer, I'd love to get your initial impressions. There's a fair amount of belief that Democrats will have a difficult time maintaining majorities in both houses of Congress and maybe some investor complacency around this sort of outcome. So what are you hearing from investors and how should they be thinking about the midterms? Michael Zezas: Yeah. I think the word complacency is the correct word to use here. I think in some ways this election hasn't gotten as much attention as it should because in prior elections there was a big macro issue at play, whether it be tax cuts and trade policy in 2016, or in 2020 whether or not another tranche of COVID stimulus aid could get approved based on the election outcome. This election, we think the outcomes will really drive more sectoral impacts. So whether or not tech regulation becomes possible or regulation around cryptocurrency, or could there be a path toward spending more money on renewables and traditional energy exploration. And then, of course, corporate taxes. And then when you couple that with polls and other items suggesting that Republicans are very likely to take control of one or more chambers of Congress, it's easy to put this issue aside and become complacent about it. But Ellen, this focus on the micro doesn't necessarily mean that the outcome doesn't matter for the macro, i.e., the U.S. economic outlook. Can we look back a bit to some prior elections and how they changed the trajectory of your economic outlook? Ellen Zentner: So, you know, I would start with 2016 where we had a Republican sweep and that led to the Tax Cut and Jobs Act being passed. It was a significant increase in the fiscal deficit and a good deal of stimulus to the economy. And so we really saw that bear out in 2017 where you already had a late cycle dynamic. At the time we called it ill timed policy, where you're throwing stimulus at the economy, when the economy doesn't really need it, you really want to do the majority of your fiscal stimulus when you're actually in a downturn. Trade policy then followed. And of course, late in 2018 started to really bite the global economy. And that's when we saw the Fed also move,v to the sidelines and start cutting rates because they saw a big slowdown in the global economy that was also hitting the U.S. economy. So fiscal policy there had both an uplifting effect and a depressing effect in the outlook. And then I would point to 2020 where the election outcome really opened the door for further fiscal stimulus related to COVID. So we had already done rounds of significant fiscal stimulus, but then in a Democratic sweep, you had two further rounds of fiscal stimulus related to COVID. And so that also had a very big effect on shaping the economy in terms of the excess savings that households were building up and the amount of excess money in the economy. And so I think those are the two best examples, of course, the two most recent examples. Michael Zezas: So a common thread between 2016 and 2020 was that the outcome had one party in control of both chambers of Congress as well as the White House. And it's long been part of our framework that one party control is a prerequisite for Congress providing proactive fiscal aid to the economy. So let's say the conventional thinking about this election is correct and the Republicans pick up control of one or both chambers of Congress. Then we'd expect that Congress would be more reactive to economic conditions than proactive, basically, that the economy would have to demonstrably worsen before you'd see Congress deliver aid. Would that shift in dynamic mean anything to your US economic outlook? Ellen Zentner: I mean, our baseline outlook fiscal policy is really not a big factor. The biggest factor coming from fiscal policy has already passed. So late last year we passed a significant infrastructure spending bill and while at the time that had a market impact, it doesn't really have an economic impact until about four quarters later when the bulk of those funds hit the economy. And so that's something that starts to lift growth in the fourth quarter of this year, we estimated by about 3/10 lift to GDP from those funds going out. Otherwise, in our baseline outlook, fiscal policy is just not a big factor. I think when we think about our bear case where we actually have a recession, that would be the first chance for fiscal policy to really kick in meaningfully. But even there, because we don't expect the downturn to be very deep, we expect nothing more than, say, the automatic stabilizers that typically go in to support the economy when jobless claims are rising, and the unemployment rate is rising and other economic factors are weakening. Finally, Michael, I want to ask you about election night and the days that follow. And I'm going to ask this because uncertainty around election outcomes also can impact the economy near term. So how likely is it we'll see the same sort of delays in vote tallies that we saw in 2020?. Michael Zezas: Yeah. I think investors should be on guard for a very similar time frame. The problem that drove this delayed tally in 2020 was the growth in use of vote by mail, and that really hasn't changed or is unlikely to change in our view. And of course, the problem is voting by mail, those ballots get tallied separately and sometimes later, as opposed to the machine votes which get tallied much quicker on election night. And like last time, it seems that Democrats tend to use vote by mail more than Republicans. So it creates this dynamic where on election night, initial leads could be misleading and you have to wait until the final votes are tallied in order to understand what the true margin is. So investors should prepare to wait a few days to fully understand, particularly if this is a close election, who is going to control the House of Representatives and who is going to control the Senate. That could create some volatile moments in the parts of the market that are most sensitive to these outcomes. Again, that's going to be sectors that are sensitive to corporate tax changes, tech regulation, crypto regulation and energy spending. Michael Zezas: Ellen, thanks so much for taking the time to talk with me. Ellen Zentner: As always, great talking with you, Michael. Michael Zezas: And thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

1 Jun 20227min