Europe in the Global AI Race

In the first of a special series, Morgan Stanley’s U.S. Thematic and Equity Strategist Michelle Weaver discusses new frontiers in artificial intelligence with Keith Weiss, Head of U.S. Software Research.----- Transcript -----Michelle: Welcome to Thoughts on the Market I'm Michelle Weaver, Morgan Stanley's U.S. Thematic and Equity Strategist.Keith: And I'm Keith Weiss, Head of U.S. Software Research.Michelle: This episode is the first episode of a special series we’re calling “Big Debates” – where we dig deeper into some of the many hot topics of conversation going on right now. Ideas that will shape global markets in 2025. First up in the series: Artificial Intelligence.It's Friday, January 10th at 10am in New York.When we look back at 2024, there were three major themes that Morgan Stanley Research followed. And AI and tech diffusion were among them. Throughout last year the market was largely focused on AI enablers – we’re talking semiconductors, data centers, and power companies. The companies that are really building out the infrastructure of AI.Now though, as we’re looking ahead, that story is starting to change.Keith, you cover enterprise software. Within your space, how will the AI story morph in 2025?Keith: I do think 2025 is going to be an exciting year for software [be]cause a lot of these fundamental capabilities that have come out from the training of these models, of putting a lot of compute into the Large Language Models, those capabilities are now being built into software functionality. And that software functionality has been in the market long enough that investors can expect to see more of it come into results. That the product is there for people to actually buy on a go forward basis.One of the avenues of that product that we're most excited about heading into 2025 is what we're calling agentic computing, where we're moving beyond chatbots to a more automated proactive type of interface into that software functionality that can handle more complex problems, handle it more accurately and really make use of that generative AI capability in a corporate or in an enterprise software setting as we head into 2025.Michelle: Could you give us an example of what agentic AI is and how might an end user interact with it?Keith: Sure. So, you and I have been interacting with chatbots a lot to gain access to this generative AI functionality. And if you think about the way you interact with that chatbot, right, you have a prompt, you have a question. You have to come up with the question. going to take that question and it's going to, try to contextually understand the nature of that question, and to the best of its ability it's going to give you back an answer.In agentic computing, what you're looking for is to add more agency into that chatbot; meaning that it can reason more over the overall question. It's not just one model that it's going to be using to compose the answer. And it's not just the composition of an answer where the functionality of that chatbot is going to end. There's actually an ability to execute what that answer is. So, it can handle more complex problems.And it could actually automate the execution of the answer to those problems.Michelle: It sounds like this tech is going to have a massive impact on the workplace. Have you estimated what this could do to productivity?Keith: Yeah, this is -- really aligns to the work that we did actually back in 2023, where we did our AI index, right. We came up with the conclusion that given the current capabilities of Large Language Models, 25 per cent of U.S. occupations are going to be impacted by these technologies. As the capabilities evolve, we think that could go as high as 45 per cent of U.S. labor touched by these productivity enhancing. Or, sort of, being replaced by these technologies. That equates to, at the high end, $4 trillion of labor that's being augmented or replaced on a go forward basis. The productivity gains still yet to be seen; how much of a productivity gain you could see on average. But the numbers are massive, right, in terms of the potential because it touches so much labor.Michelle: And finally on agentic, is the market missing anything and how does your view differ from the consensus?Keith: I think part of what the market is missing is that these agentic computing frameworks is not just one model, right? There's typically a reasoning engine of some sort that's organizing multiple models, multiple components of the system that enable you to -- one, handle more complex queries, more complex problems to be solved, lets you actually execute to the answer. So, there's execution capabilities that come along with that. And equally as important, put more error correction into the system as well. So, you could have agents that are actually ensuring you have a higher accuracy of the answer.It's the sugar that's going to make the medicine go down, if you will. It's going to make a lot easier to adopt in enterprise environments. I think that's why we're a little bit more optimistic about the pace of adoption and the adoption curves we could see with agentic computing despite the fact it's a relatively early-stage technology.Michelle: You just mentioned Large Language Models, or LLMs; and one barrier there has been training these models. It requires a ton of computing power, among other constraints. How are companies addressing this, and what's in the cards for next year?Keith: So, if you think about the demand for that compute in our mind comes from two fundamental sources. And as a software analyst, I break this down into research versus development, right? Research is investment that you make to find core fundamental capabilities.Development is when you take those capabilities and make the investment to create product out of it. Thus far, again, the primary focus has been on the training side of the equation.I think that part of the equation looks to be asymptotic to a certain extent. The – what people call the scaling laws, the amount of incremental capability that you're getting from putting more compute at the equation is starting to come down.What people are overlooking is the amount of improvement that you could see from the development side of the equation. So, whereas the demand for GPUs, the demand for data center for that pure training side of the equation might start to slow down a little bit, I think what we're going to see expand greatly is the demand for inference, the demand to utilize these models more fully to solve real business problems.In terms of where we're going to source this; there are constraints in terms of data center capacity. The companies that we cover, they've been thinking about these problems for the past decade, right? And they have these decade long planning cycles. They have good visibility in terms of being able to meet that demand in the immediate future. But these questions on how we are going to power these data centers is definitely top of mind for our companies, and they're looking for new sources of power and trying to get more creative there.The pace with which data centers can be built out is a fundamental constraint in terms of how quickly this demand can be realized. So those supply constraints I don't think are going to be a immediate limiter for any of our names when we're thinking about calendar [20]25. But definitely, part of the planning process and part of the longer-term forecasting for all of these companies in terms of where are they going to find all this fundamental resource – because whether it's training or inference, still a lot of GPUs are going to be needed. A lot of compute is going to be needed.Michelle: Recently we've been hearing about so called artificial general intelligence or AGI. What is it? And do you think we're going to see it in 2025?Keith: Yeah, so, AGI is the – it's basically the holy grail of all of these development efforts. Can we come up with models that can reason in the human world as well as we can, right? That can understand the inputs that we give it, understand the domains that we're trying to operate in as well or better than we can, so it can solve problems as effectively and as efficiently as we can.The easiest way to solve that systems integration problem of like, how can we get the software, how could we get the computers to interact with the world in the way that we do? Or get all the impact that we do is for it to replicate all those functionalities. For it to be able to reason over unstructured text the same way we do. To take visual stimuli the same way that we do. And then we don't have to take data and put into a format that's readable by the system anymore.2025 is probably too early to be thinking about AGI, to be honest. Most technologists think that there's more breakthroughs needed before the algorithms are going to be that good; before the models are going to be that good.There's very few people who think Large Language Models and the scaling of Large Language Models in themselves are going to get us to that AGI. You're probably talking 10 to 20 years before we truly see AGI emerge. So, 2025 is probably a little bit too early.Michelle: Well, great, Keith. Thank you for taking the time to talk and helping us kick off big debates. It looks like 2025 we'll see some major developments in AI.And to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

10 Jan 9min

Our Head of Corporate Credit Research, Andrew Sheets, offers up bull, bear and base cases for credit markets in the year ahead.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today, I’m going to revisit our story for 2025 – and what could make things better or worse.It's Thursday, January 9th at 2pm in London. Based on the number of out-of-office replies, I have a sneaking suspicion that many investors took advantage [of] the timing of holidays this year for a well deserved break. With this week marking the first full week back, I thought it would be a good opportunity to refresh listeners on what we expect in 2025, and realistic scenarios where things are better or worse.Our base case is that credit holds up well this year, doing somewhat better in the first half of 2025 than the second. Credit likes moderation, and while we think the shift in U.S. policy leadership generally means less moderation, and a wider range of economic outcomes, this shift doesn’t arrive immediately. On Morgan Stanley’s forecasts, the bulk of the disruptive impact from any changes to tariffs or immigration policy hits in 2026.Meanwhile, Credit is entering 2025 with some pretty decent tailwinds. The economy is good. The all-in yield – the total yield – on US investment grade corporate bonds, at above 5.4 per cent, is the highest to start any year since January of 2009 – which we think helps demand. And while we think corporate confidence and aggression will rise this year, normally a bad thing for credit; this is going to be coming off of a low, conservative starting point. We think that credit spreads will be modestly tighter by mid-year relative to where they finished 2024, and then start to widen modestly in the second half of the year – as the market attempts to price that greater policy uncertainty in 2026. We think that issuers in the Financial and Utilities sectors outperform, and we think bonds between five- and ten-year maturity will do the best.The bear case is that we exit the current period of moderation more quickly. At one end, a deregulatory push by a new administration could usher in an even faster rise in corporate confidence and aggression, leading to more borrowing and riskier dealmaking. At the other extreme, the strong current state of the economy and jobs market could make further gains harder to come by. If the rise in unemployment that our economists expect in 2026 is larger or arrives earlier, credit could start to weaken well ahead of this.So, how could things be better – especially given the relatively low, tight starting point for credit spreads? Well, we’d argue that the current mix of data for credit is border-line ideal: reasonable growth, falling inflation, still-low levels of corporate aggressiveness, and still-high yields that are attracting buyers. Recall that the tightest levels of credit in the modern era, which are still tighter than today, occurred during a period with similar characteristics – the mid-1990s.When thinking about the mid-90s as a bull case, there’s a further detail that’s relevant and topical, especially this week. At that time, interest rates stayed somewhat high and the Fed only lowered short-term rates modestly because the economy held up. In short, in the best environment that we’ve seen for credit, less action by the Federal Reserve was fine – so long as the economic data was good.This is a bull-case, rather than our base case, because there are also a number of key differences with the mid 1990s, not the least being a much worse trajectory – today – for the US government's budget. But in a scenario where things change less, and the status quo lasts longer, it could come into play.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.

10 Jan 3min

With the inauguration of President-elect Donald Trump approaching, our Global Head of Fixed Income and Public Policy Research weighs the impact for investors of his potential policy measures.----- Transcript -----Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income and Public Policy Research. Today on the podcast I'll be talking about what investors need to know about recent US policy developments.It’s Wednesday, Jan 8th, at 2:30pm in New York. In less than two weeks, Donald Trump will again become the sitting President of the United States. The economic and market consequences of the policies he might enact, either on his own or in concert with the Congress, continue to be an important debate for investors. Our view has been that the sequencing and severity of policy choices across tariffs, taxes, immigration, and regulation would be very meaningful to the market's outlook. So, have we learned anything from news around the policy discussions inside the incoming administration and congressional leaders? Let’s consider it here and level set. First, there‘s been news about Republicans debating their approach to legislating some of President Trump’s top policy priorities. That debate centers around whether to create one big bill around taxes, immigration, and a host of other issues or to break it into multiple bills. Leading with immigration reforms, where there may be more consensus within Republicans’ slim Congressional majority; and then following it up with tax cuts and extensions, which may take more time to negotiate given myriad interests. While investors have asked us about this debate quite a bit, the distinction between the approaches may not make much of a difference to investors. At the end of the day, what should matter most to markets is the timing and size of the fiscal impact driven by tax changes. Going with one big bill may seem faster, but we’re reminded of the saying ‘Nothing is agreed until everything is agreed.’ In other words, that one big bill would probably only pass as fast as Republicans could agree on its toughest negotiating points – so likely not very soon. As for the size of fiscal impact, we continue to see consensus around extending most of the tax cuts that expire at the end of 2025, with some new benefits, like a domestic manufacturing tax credit. So, there should be some fiscal expansion in 2026, a few hundred billion dollars in our view; but this is meaningfully different than the trillions of dollars that the media cites when discussing the whole of the tax policy wish list. There’s also been some news on the approach to tariffs, but again it seems more noise than signal. Recent media reports are that Trump might adopt a tariff plan focused on specific products as opposed to a blanket approach on all imports. Trump denied the report via social media. But even if he hadn’t, it's unclear that such a plan could be executed quickly through existing executive powers or through legislation, where it's far from clear that tariffs could be enacted given Democrats' opposition and procedural barriers from budget reconciliation. So, our view remains that new tariffs will likely be enacted but through executive authority – which means a phased-in focus on China and Europe in 2025; and any new authorities developed via existing laws might not be enactable until 2026. So said more simply, the impact of tariffs on the economy may be a late 2025 into 2026 story. Putting it together for investors: So far, the news flow hasn’t materially changed our view on the US policy path. Yes, important policy changes are coming, but their implementation may be slow. That should mean that, to start 2025, the healthy fundamentals of the US economy should help drive risk markets, namely U.S. equities and corporate credit, to outperform. If we’re wrong and, for example, tariffs are implemented in larger magnitude at a quicker pace, then it may be a year where less risky assets, like government bonds, outperform. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.

8 Jan 4min

Our Global Chief Economist Seth Carpenter weighs the myriad variables which could impact global markets in 2025, and why this year may be the most uncertain for economies since the start of the pandemic.----- Transcript -----Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, and today I'll be talking about 2025 and what we might expect in the global economy.It's Tuesday, January 7th at 10am in New York.Normally, our year ahead outlook is a roadmap for markets. But for 2025, it feels a bit more like a choose your own adventure book.uncertainty is a key theme that we highlighted in our year ahead outlook. The new U.S. administration, in particular, will choose its own adventure with tariffs, immigration, and fiscal policy.Some of the uncertainty is already visible in markets with the repricing of the Fed at the December meeting and the strengthening of the dollar. Our baseline has disinflation stalling on the back of tariffs and immigration policy, while growth moderates, but only late in the year as the policies are gradually phased in.But in reality, the sequencing, the magnitude and the timing of these policies remains unknown for now, but they're going to have big implications for the economies and central banks around the world. The U.S. economy comes into the year on solid footing with healthy payrolls and solid consumption spending.Disinflation is continuing, and the inflation data for November were in line with our forecast, but softer in terms of PCE than what the Fed expected. While the Fed did lower their policy rate 25 basis points at the December meeting, Chair Powell's tone was very cautious, and the Fed's projections had inflation risks skewed to the upside.The chair noted that the FOMC was only beginning to build in assumptions about policy changes from the new administration. Now, we have conviction that tariffs and immigration restriction will both slow the economy and boost inflation -- but we've assumed that these policies are phased in gradually over the entirety of the year. And consequently -- that materially Stagflationary impetus? Well, it's reserved for 2026, not this year.Similarly, we've assumed that effectively the entire year is consumed by the process of tax cut extensions. And so, we've penciled in no meaningful fiscal impetus for this year. And in fact, with the bulk of the process simply extending current tax policy, we have very little net fiscal impact, even in 2026.Now, in China, the deflationary pressure is set to continue with any policy reaction further complicated by U.S. policy uncertainty. The policymaker meeting in late December that they held provided only a modest upside surprise in terms of fiscal stimulus, so we're going to have to wait for any further details on that spending until March with the National People's Congress.Meanwhile, during our holiday break, the renminbi broke above 7.3, and that level matches roughly the peaks that we saw in 2022 and 2023. The strong dollar is clearly weighing on the fixing. The framework for policy will have to account for a potentially trade relationship with the U.S. So, again, in China, there's a great deal of uncertainty, a lot of it driven by policy.The euro area is arguably less exposed to U.S. trade risks than China. A weaker euro may help stabilize inflation that's trending lower there, but our growth forecasts suggest a tepid outlook. Private consumption spending should moderate, and maybe firm a bit, as inflation continues to fall, and continued policy easing from the ECB should support CapEx spending.Fiscal consolidation, though, is a key risk to growth, especially in France and Italy, and any postponement in investment from potential trade tensions could further weaken growth.Now, in Japan, the key debate is whether the Bank of Japan will raise rates in January or March. After the last Bank of Japan meeting, Governor Ueda indicated a desire for greater confidence on the inflation outlook.Nonetheless, we've retained our call that the hike will be in January because we believe the Bank of Japan's regional Branch manager meeting will give sufficient insight about a strong wage trend. And in combination with the currency weakness that we've been watching, we think that's gonna be enough for the BOJ to hike this month. Alternatively, the BOJ might wait until the Rengo negotiation results come out in March to decide if a hike is appropriate. So far, the data remains supportive and Japanese style core CPI inflation has gone to 2.7 per cent in November. The market's going to focus on Deputy Governor Himino's speech on January 14th for clues on the timing – January or March.Finally, as the Central Bank of Mexico highlighted in their most recent rate cut decision, caution is the word as we enter the new year. As economists, we could not agree more. The year ahead is the most uncertain since the start of the pandemic. Politics and policy are inherently difficult to forecast. We fully expect to revise our forecasts more -- and more often than usual.Thanks for listening, and 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.

7 Jan 5min

Our CIO and Chief U.S. Equity Strategist Mike Wilson considers the year-end slump in U.S. stocks, and whether more market-friendly policies can change the narrative.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Today on the podcast I’ll be discussing the weak finish to 2024 and what it means for 2025. It's Monday, Jan 6th at 11:30am in New York. So let’s get after it.While 2024 was another solid year for US equity markets, December was not. The weak finish to the year is likely attributable to several factors. First, from September to the end of November, equity markets had one of their better 3-month runs that also capped the historically strong 1- and 2-year advances. This rally was due to a combination of events including a reversal of recession fears this summer, an aggressive 50 basis points start to a new Fed cutting cycle, and an election that resulted in both a Republican sweep and an unchallenged outcome that led to covering of hedges into early December. This also lines up with my view in October that the S&P 500 could run to 6,100 on a decisive election outcome.Second, long-term interest rates have backed up considerably since the summer when recession fears peaked. Importantly, this 100 basis point back-up in the 10-year US Treasury yield occurred as the Fed cut interest rates by 100 basis points. In my view, the bond market may be calling into question the Fed’s decision to cut rates so aggressively in the context of stabilizing employment data. The fact that the term premium has risen by 77 basis points from the September lows is also significant and may be a by-product of this dynamic and uncertainty around fiscal sustainability. As we suggested two months ago, if the change in the term premium was to materially exceed 50 basis points, the equity market could start to take notice and hurt valuations. Indeed, Equity multiples peaked in early- to mid-December around the time when the term premium crossed this threshold. Finally, the rise in rates and the Trump election win has ushered in a stronger dollar which is now reaching a level that could also weigh on equities with significant international exposure. More specifically, the US dollar is quickly approaching the 10 per cent year-over-year rate of change threshold that has historically pressured S&P 500 earnings growth and guidance. All of these factors have combined to weigh on market breadth, something that still looks like a warning. The divergence between the S&P 500 Index as a ratio of its 200-day moving average and the percent of stocks trading above their 200-day moving average has rarely been wider. This divergence can close in two ways—either breadth improves or the S&P 500 trades closer to its own 200-day moving average, which is 10 per cent below current prices. The first scenario likely relies on a combination of lower rates, a weaker dollar, clarity on tariff policy and stronger earnings revisions. In the absence of those developments, we think 2025 could be a year of two halves with the first half being more challenged before the more market-friendly policy changes can have their desired effects.It's also worth pointing out that this gap between index pricing and breadth has been more persistent in recent years, something that we attribute to the generous liquidity provisions provided by the Treasury and the Fed. It's also been aided by interventions from other central banks. While not a perfect measure, we do find that the year-over-year change in global money supply in US Dollars is a good way to monitor key inflection points, and that measure has recently rolled over again. The recent moves in rates and US dollar is just another reason to stick with quality equities. Our quality bias is rooted in the notion that we remain in a later cycle environment which is typical of a backdrop that is consistent with outperformance of this cohort and the fact that the relative earnings revisions for this high quality factor are inflecting higher. As long as these dynamics persist, we think it also makes sense to stay selective within cyclicals and focused on areas of the market that are showing clear relative strength in earnings revisions. These groups include Software, Financials, and Media & Entertainment.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.

6 Jan 4min

With the start of the new year, our Head of Corporate Credit Research Andrew Sheets looks back to look ahead at trends for credit and other markets in 2025.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’ll be discussing the lessons we can learn from 2024 – a remarkable year that also may be easily forgotten. It's Friday January 3rd at 2pm in London. In 2024 I celebrated my 20th year with Morgan Stanley. Among my regrets over this time was not keeping a better journal. It’s notable how quickly events in the market that seemed large and remarkable at the time can fade in one’s memory as the years merge together. How markets that seem easy or obvious in hindsight were anything but. I say this because many years from now, 2024 may end up being one of those relatively forgettable years. Another year where – as usually happens – the stock market went up. Another year where stocks outperformed bonds, the US dollar strengthened, and US stocks beat those abroad. Yet what is significant about 2024 is the scale of all these trends. For anyone managing money, the question of “stocks versus bonds”, “US versus rest-of-world”, “large versus small” or “growth versus value” are some of the most fundamental strategic questions one faces. These calls don’t always matter. But last year, they did – to a very large degree. Global stocks outperformed bonds by about 20 percent. Growth outperformed Value by practically the same amount. US stocks beat their global peers by 13 per cent. In short, one’s experience in 2024 and relative performance could have varied significantly, based on just a few relatively simple decisions. Related to that is the second lesson. 2024 was the reminder that while Valuation is a powerful long-term force, it can be a much more frustrating 12-month guide. All of those relative relationships I just mentioned – stocks versus bonds, growth versus value, US versus International – all worked in favor of the market that was historically richer entering last year. For our third lesson from last year, we’ll focus on Credit, where investors earned a premium over safer government bonds by lending to riskier corporate borrowers. Notable for this asset class in 2024 was, for the most part, it did its own thing; showing some encouraging independence from other markets and highlighting the value of digging into a borrower’s details. Specifically, I think this independence showed up in a few different ways. Credit showed low correlation to government bonds, for example, delivering good excess returns despite very large swings in yields or central bank expectations. It also, even more impressively, bucked some of 2024’s biggest trends. For example, while the outperformance of the US economy and US assets was one of the biggest stories of 2024, that wasn’t the case in Credit – where Europe and Asia credit actually did marginally better. In contrast to the equity market, smaller companies and Credit outperformed, as spreads and higher yielded loans outperformed larger Investment Grade spreads, even after adjusting for risk. And this was true even at a more granular level. Rising corporate activity, alongside more aggressive strategies for companies to deal with their own borrowing created very dispersed outcomes driven by bond-level documentation; far removed from the macro machinations of politics and monetary policy. This somewhat weaker connection to the broader world is central to how we think about Credit looking ahead. While big economic and political questions certainly loom in 2025, we think that Credit, for now, will be driven more by more micro, company level trends, and show somewhat lower correlation to other assets – at least through the first half of this year. From all of us at Thoughts on the Market, we wish you a very Happy New Year, and all the best for 2025. 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.

3 Jan 4min

Our Head of Global Autos & Shared Mobility Adam Jonas discusses why the electric vehicle market may see a small reset in 2025, but ultimately accelerate under a Trump Administration.----- Transcript -----Adam Jonas: Welcome to Thoughts on the Market. I'm Adam Jonas, Morgan Stanley's Head of Global Autos and Shared Mobility. Today, I'll be talking about the outlook for U.S. automakers and electric vehicles.It's Thursday, January 2nd at 1pm in New York.With Trump's inauguration just around the corner, we've seen a resurgence in many auto stocks tied to Internal Combustion Engines, also known as ICE. While questions swirl around the outlook for electric vehicles. In the near term we do think it'll be a bumpy ride for the U.S. EV market. But looking toward the second half of this year and beyond, we think there's hidden value in the EV sector for a number of reasons.First, let's look at the big picture. In our 2025 outlook for U.S. auto sales, we anticipate demand of 16.3 million units, a modest increase from the previous year, underpinned by projected U.S. GDP growth of around 1.9 percent and lower policy interest rates for auto loans. Looking specifically at EVs, we think the trajectory will be first a dip, then a rip scenario. That is, we're lowering our 2025 forecasts for U.S. EV penetration to 8.5 percent, down slightly from 9 percent previously. However, our long-term outlook remains unchanged, and we continue to forecast significant growth for EVs by 2040.Now for the big question. What does a Trump administration mean for EVs? Following the U.S. election, investors hopped on the ‘ICE is Nice’ trade based on the expectation that a Trump administration will bring more relaxed U.S. emission standards, reduced EV incentives, and finally increased tariffs – which would drive up the costs of key EV components, such as batteries and semiconductors, predominantly manufactured in Asia.But the real story is more nuanced. You can't talk about EVs without talking about Elon Musk, who will be leading Trump's Department of Government Efficiency. And we struggle with the idea that the incoming Trump administration working in close partnership with Musk would structurally impede U.S. participation in two of the most important industrial transitions in over a century: electrification and embodied AI.If the U.S. wants to be a leader in autonomy, it must ultimately embrace EVs, which are the sockets of autonomous capability, and expand its EV infrastructure. How long will the U.S. cling to the soothing vibrations of its internal combustion fleet, while its rivals in China solidify their dominance in software defined electric mobility? Not for very long, in our opinion.While a rolling back of incentives under Trump may make 2025 a reset year for EV adoption, we view this mainly as a temporary action to help support a more capable and sustainable crop of domestic champions.That takes us to a resurgence in U.S. onshoring. Bringing manufacturing back to American soil has gained significant momentum and is another factor influencing the long-term outlook; not just for EV makers, but the entire supply chain. With the U.S. light vehicle market predominantly ICE-based at 92 percent of total sales, the real issue isn't the presence of gas powered combustion engines, but the glaring lack of advanced onshore EV production capabilities.Again, this puts the U.S. at a disadvantage compared to its global competitors and raises questions the Trump administration will need to address. Just what type of manufacturing does the U.S. want to prioritize? Are we looking to maintain the status quo with ICE, or are we aiming to be at the forefront of EV technology?No doubt, the U.S. auto industry stands at a crossroads between maintaining traditional technologies and embracing new, potentially disruptive advancements in EV and AV sectors. The decisions made in the next few years will likely dictate the pace and direction of the U.S.'s role in the global automotive landscape; and for investors, this brings new challenges – as well as opportunities.Thanks for listening. And if you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

2 Jan 4min

Original Release Date November 22, 2024: Our US Public Policy Strategist Ariana Salvatore and Chief Latin America Equity Strategist Nikolaj Lippmann discuss what Trump’s victory could mean for new trade relationships.----- Transcript -----Andrew Sheets: 2024 was a year of transition for economies and global markets. Central banks began easing interest rates, U.S. elections signaled significant policy change, and Generative AI made a quantum leap in adoption and development.Thank you for listening throughout 2024, as we navigated the issues and events that shaped financial markets, and society. We hope you'll join us next year as we continue to bring you the most up to date information on the financial world. This week, please enjoy some encores of episodes over the last few months and we'll be back with all new episodes in January. From all of us on Thoughts on the Market, Happy Holidays, and a very Happy New Year. Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US Public Policy Strategist.Nikolaj Lippmann: And I'm Nik Lippmann, Morgan Stanley's Chief Latin American Equity Strategist.Ariana Salvatore: Today, we're talking about the impact of the US election on Mexico's economy, financial markets, and its trade relationships with both the US and China.It's Friday, November 22nd at 10am in New York.The US election has generated a lot of debate around global trade, and now that Trump has won, all eyes are on tariffs. Nik, how much is this weighing on Mexico investors?Nikolaj Lippmann: It’s interesting because there's kind of no real consensus here. I'd say international and US investors are generally rather apprehensive about getting in front of the Trump risk in Mexico; while, interestingly enough, most Mexico-based investors and many Latin American investors think Trump is kind of good news for Mexico, and in many cases, even better news than Biden or Harris. Net, net, Mexican peso has sold off. Mexico's now down 25 per cent in dollar terms year to date, while it was flat to up three, four, 5 per cent around May. So, we've already seen a lot being priced then.Ariana, what are your expectations for Trump's trade policy with regards to Mexico?Ariana Salvatore: So, Mexico has been a big part of the trade debate, especially as we consider this question of whether or not Mexico represents a bridge or a buffer between the US and China. On the tariff front, we've been clear about our expectations that a wide range of outcomes is possible here, especially because the president can do so much without congressional approval.Specifically on Mexico, Trump has in the past threatened an increase in exchange for certain policy concessions. For example, back in 2019, he threatened a 5 per cent tariff if the Mexican government didn't send emergency authorities to the southern border. We think given the salience of immigration as a topic this election cycle, we can easily envision a scenario again in which those tariff threats re-emerge.However, there's really a balance to strike here because the US is Mexico's main trading partner. That means any changes to current policy will have a substantial impact.So, Nik, how are you thinking about these changes? Are all tariff plans necessarily a negative? Or do you see any potential opportunities for Mexico here?Nikolaj Lippmann: Look, I think there are clear risks, but here are my thoughts. It would be very hard for the United States to de-risk from China and de-risk from Mexico simultaneously. Here it becomes really important to double-click on the differences in the manufacturing ecosystems in North America versus Southeast Asia and China.The North American model is really very integrated. US companies are by a mile the biggest investor. In Mexico – and Mexican exports to the US kind of match the Mexican import categories – the products go back and forth. Mexico has evolved from a place of assembly to a manufacturing ecosystem. 25 years ago, it was more about sending products down, paint them blue, put a lid on it. Now there's much more value add.The link, however, is still alive. It's a play on enhancing US competitiveness. You can kind of, as you did, call it a China buffer; a fender that helps protect US competitiveness. But by the end of the day, I think integration and alignment is going to be the key here.Ariana Salvatore: But of course, it's not just the direct trade relationship between the US and Mexico. We need to also consider the global geopolitical landscape, and specifically this question of the role of China. What's Mexico's current trade policy like with China?Nikolaj Lippmann: Another great question, Ariana, and I think this is the key. There is growing evidence that China is trying to use Mexico as a China bridge.And I think this is an area where we will see the biggest adjustments or need for realignment. This is a debate we've been following. We saw, with interest, that Mexico introduced first a 25 per cent tariff and then a 35 per cent tariff on Chinese imports. And saw this as the initial signs of growing alignment between the two countries.However, Mexican import from China never really dropped. So, we started looking at like the complicated math saying 35 per cent times $115 billion of import. You know, best case scenario, Mexico should be collecting $40 billion from tariffs; that's huge and almost unrealistic number for Mexico. Even half of that would go a long way to solve fiscal challenges in that country.However, when we started looking at the actual tax collection from Chinese imports, it was closer to $3 billion, as we highlighted in a note with our Mexico economist just recently. There's just multiple discounts and exemptions to effective tariffs at neither 25 per cent nor 35 per cent, but actually closer to 2.5 [or] 3 per cent. I think there's a problem with Chinese content in Mexican exports, and I think it's likely to be an area that policymakers will examine more closely. Why not drive-up US or North American content?Ariana Salvatore: So, it sounds like what you're saying is that there is a political, or rhetorical at least, alignment between the US and Mexico when it comes to China. But the reality is that the policy implementation is not yet there.We know that there's currently nothing in the USMCA treaty that prevents Mexico from importing goods from China. But a lot has changed over the past four years, even since the pandemic. So, looking forward, do you expect Mexico's policy vis-a-vis China to change after Trump takes office?Nikolaj Lippmann: I think, I certainly think so, and I think this is again; this is going to be the key. As you mentioned, there's nothing in the USMCA treaty that prevents Mexico from buying the stuff from China. And it's not a customs union. Mexican consumers, much like American consumers, like to buy cheap stuff.However, the geopolitics that you refer to is important. And when I reflect, frankly, on the bilateral relationship between the two countries, I think Mexican policymakers need to perhaps pause and think a little bit about things like the spirit of the treaty and not just the letter of the treaty; and also about how to maintain public opinion support in the United States.By the end of the day, when we see what has happened with regards to China after the pandemic, it has been a significant change in political consensus and public opinion. When I think Americans are not necessarily interested in just using Mexico as a China bridge for Chinese products.During the first Trump administration, the NAFTA agreement was renegotiated as the US Mexico Canada agreement, the USMCA, that took effect or took force in mid 2020. This agreement will come under review in 2026.Ariana, what are the expectations for the future of this agreement under the Trump administration?Ariana Salvatore: So, I think this USMCA review that's coming up in 2026 is going to be a really critical litmus test of the US-Mexico relationship, and we're going to learn a lot about this China bridge or buffer question that you mentioned. Just for some very brief context, that agreement as you mentioned was signed in 2020, but it includes a clause that lets all parties evaluate the agreement six years into a 16-year time horizon.So, at that point, they can decide to extend the agreement for another 16 years. Or to conduct a joint review on an annual basis until that original 16 years lapses. So, although the agreement will stay in force until at least 2036, the review period, which is around June of [20]26, provides an opportunity for the signing parties to provide recommendations or propose changes to the agreement short of a full-scale renegotiation.We do see some overlapping objectives between the two parties. For example, things like updating the foundation for digital trade and AI, ensuring the endurance of labor protections, and addressing Mexico's energy sector. But Trump's approach likely will involve confronting the auto EV disputes and could possibly introduce an element of immigration policy within the revision. We also definitely expect this theme of Chinese investment in Mexico to feature heavily in the USMCA review discussions.Finally, Nik, keeping in mind everything that we've discussed today, with global supply chains getting rewired post the pandemic, Mexico has been a beneficiary of the nearshoring trend. Do you think this is going to change as we look ahead?Nikolaj Lippmann: So, look, we [are] still underweight Mexico, but I think risk ultimately biased with the upside over time with regards to trade.We need evidence to be able to lay it out, these scenarios; Mexico could end up doing quite well with Trump. But much work needs to be done south of the border with regards to all the areas that we just mentioned there, Ariana.When we reflect on this over the next couple of years, there's a couple of things that really stand out. Number one is that first wave of reshoring or nearshoring, which was really focused on brownfield. It was bringing our manufacturing ecosystems where we already had existing infrastructure.What is potentially next, and what we're going to be watching in terms of sort of policy maker incentives and so on, will be some of the greenfield manufacturing ecosystems. That could involve things like IT hardware, maybe EV batteries, and a couple of other really important sectors.Ariana Salvatore: And that's something we might get some insight into when we hear personnel appointments from President-elect Trump over the coming months. Nik, thanks so much for taking the time to talk.Nikolaj Lippmann: Thank you very much, Arianna.Ariana Salvatore: And thank you 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.

31 Des 20249min