Europe in the Global AI Race

Although much will change before the elections, investors should watch for potential impacts on issues such as AI regulation, energy permitting, trade and tax policy.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Ariana Salvatore: And I'm Ariana Salvatore, from the U.S. Public Policy Research Team. Michael Zezas: On this special episode of Thoughts on the Market, we'll discuss our early views around the 2024 U.S. presidential election. It's Wednesday, December 6th at 10 a.m. in New York. Michael Zezas: With U.S. elections less than a year away now, it's likely much will change in terms of the drivers of the outcome and its market impact. Still, we believe early preparation will help investors navigate the campaign. And so starting now, we'll bring your updated views and forecasts until the U.S. elects its next president in November of 2024. Arianna, we've noted that this upcoming election will affect particular sectors rather than the broader macro market. What's driving this view? Ariana Salvatore: There are really two reasons that we've been pointing to. First, lawmakers have achieved a lot of their policy priorities that impact the deficit over the past few election cycles. If you think about the 2017 Tax Cuts and Jobs Act or the infrastructure bill back in 2021, for example. Now they're turning to policy that holds more sectoral impacts than macro. The second reason is that inflation is still a very high priority issue for voters. As we've noted, an elevated level of concern around inflation really disincentivizes politicians from pushing for legislation that could expand the deficit because it's seen as contrary to that mandate of fiscal austerity that comes in a high inflation environment. There is one exception to this. As we've noted before, lawmakers will have to deal with the expiring Tax Cuts and Jobs Act. We think the different configurations post 2024 each produce a unique outcome, but we expect in any scenario, that will only add modestly to the deficit. Michael Zezas: And digging into specific sectors. What policies are you watching and which sectors should investors keep an eye out for in the event these policies pass? Ariana Salvatore: Following the election, we think Congress will turn to legislative items like AI regulation, energy permitting, trade and tax policy. Obviously, each unique election outcome will facilitate its own level and type of policy transformation. But we think you could possibly see the biggest divergence from the status quo in a Republican sweep. In particular, in that case, we'd expect lawmakers to launch an effort to roll back, at least partially, the Inflation Reduction Act or the IRA, though we ultimately don't think a full scale repeal will be likely. We also expect to see something on AI regulation based on what's currently in party consensus, easing energy permitting requirements and probably extending the bulk of the expiring Tax Cuts and Jobs Act. That means sectors to watch out for would be clean tech, AI exposed stocks and sectors most sensitive to tax changes like tech and health care. Mike, as we mentioned, with this focus on legislation that impacts certain sectors, we don't expect this to be a macro election. So is there anything that would shift the balance toward greater macro concerns? Michael Zezas: Well, if it looks like a recession is getting more likely as the election gets close, it's going to be natural for investors to start thinking about whether or not the election outcome might catalyze a fiscal response to economic weakness. And in that situation, you'd expect that outcomes where one party doesn't control both Congress and the White House would lead to smaller and somewhat delayed responses. Whereas an outcome where one party controls both the White House and Congress, you would probably get a bigger fiscal response that comes faster. Those are two outcomes that would mean very different things to the interest rates market, for example, which would have to reflect differences in new bond supply to finance any fiscal response, and of course, the resulting difference in the growth trajectory. Ariana Salvatore: All right so, keeping with the macro theme for a moment. How do our expectations for geopolitics and foreign policy play into our assessment of the election outcomes? Michael Zezas: Yeah, this is a difficult one to answer, mostly because it's unclear how different election outcomes would net impact different geopolitical situations. So, for example, investors often ask us about what outcomes would matter for a place like Mexico, where they're concerned that some election outcomes might create economic challenges for Mexico around the US-Mexico border. However, those outcomes could also improve the prospects for near shoring, which improves foreign direct investment into Mexico. It's really unclear whether those cross-currents would be a net positive or a net negative. So we don't really think there's much specific to guide investors on, at least at the moment. Finally, Arianna, to sum up, how is the team tracking the presidential race and which indicators are particularly key, the focus on? Ariana Salvatore: Well, recent history suggests that it will be a close race. For context, the 2022 midterms marked the fourth time in four years that less than 1% of votes effectively determined which side would control the House, the Senate or the White House. That means that elections are nearly impossible to predict. But we think there are certain indicators that can tell us which outcomes are becoming more or less likely with time. For example, we think inflation could influence voters. As a top voter issue and a topic that the GOP is better perceived as equipped to handle, persistent concerns around inflation could signal potential upside for Republicans. Inflation also tracks very closely with the president's approval rating. So on the other hand, if you see decelerating inflation in conjunction with overall improving economic data, that might indicate some tailwinds for Democrats across the board. We're going to be tracking other indicators as well, like the generic ballot, President Biden's approval rating and prediction markets, which could signal that different outcomes are becoming more or less likely with time. Michael Zezas: Ariana, thanks for taking the time to talk. Ariana Salvatore: Great speaking with you, Mike. Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

6 Des 20235min

Asia’s economic recovery could continue to be out of step with the rest of the world. Hear which countries are positioned for growth and which might face challenges. ----- Transcript -----Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist. Along with my colleagues bringing you a variety of perspectives, today, I'll discuss 2024 Economics Outlook for Asia. It's Tuesday, December 5 at 9 a.m. in Hong Kong. It used to be the case that business cycles across Asian economies were in sync. But after the Covid shock, global trade and global growth have moved out of sync. Growth in Asia has diverged at times from global growth momentum. Moreover, in this cycle, the inflation picture is very different across Asian economies. So in contrast to previous cycles, we have to be more focused on nominal GDP growth. Real GDP growth, which is nominal GDP growth, adjusted for inflation, has been divergent across Asian economies during this cycle. And we think Asia's recovery will remain asynchronous vis a vis the rest of the world. Looking at the three largest economies in the region, we are more constructive on the outlook for nominal GDP growth for India and Japan, while we think China's nominal GDP growth will be constrained. Why is this? First, we think China is facing a challenge in managing aggregate demand and inflationary pressures from deleveraging of local government and property companies balance sheets. Policymakers have embarked on coordinated monetary and fiscal easing, which would help to bring about a modest recovery in 2024. But the deleveraging challenges are intense, and so the path ahead will still be bumpy. Moreover, we believe that inflation will remain low, which means corporate pricing power will be weak, and that could present a challenge for corporate profitability. Second, we are seeing a momentous shift in Japan's nominal GDP growth trajectory. Japan has exited deflation decisively, supported mainly by its accommodative policy and with some help from global factors. Against this backdrop, nominal GDP growth reached a 30 year high in the second quarter of 2023. Improving inflation dynamics mean that we see that Bank of Japan exiting negative rates and removing yield curve control in early 2024. But we believe the BOJ will not tighten macro policies aggressively, which should ensure a robust nominal GDP growth of 3.8% in 2024. Finally, we believe that India remains the best opportunity within the region. Nominal GDP growth is expanding rapidly and we think a pickup in private capital investment cycle will sustain productivity growth. Policymakers have been implementing supply side reform and that has already boosted public CapEx. A virtuous cycle is already underway in India and nominal GDP growth will be expanding at double digit growth rates. To sum up, Asia's recovery remains asynchronous relative to the rest of the world, and idiosyncratic drivers still matter more during the cycle. We are constructive on the outlook for India and Japan, however, structural challenges will constrain China's growth path. Thanks for listening. If you enjoy the show, please leave us a review and Apple podcast and share Thoughts on the Market with a friend or a colleague today.

5 Des 20233min

U.S. equities markets appear to be betting on an outdated playbook that worked when inflation was benign. But analysis of earnings and macro data suggests an updated playbook may be necessary. What investors should watch now.----- Transcript -----Welcome to thoughts of 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, December 4th at 11 a.m. in New York. So let's get after it. After a very challenging three month stretch for stocks ending in October, the S&P 500 recouped all its losses in November, while the small cap and S&P 500 equal weight indices only regained about half. This left the performance gap between the average stock and the market cap weighted index near its widest level of the year as equity market performance remains historically narrow. In other words, the market accurately reflects today's challenging operating environment for most companies. In many ways, it's a reflection of how most consumers are suffering amid high absolute prices in most spending categories. On Friday, the equity markets took on a different complexion, with small caps and lower quality stocks outperforming significantly. This occurred as rates continued to fall sharply, despite Jay Powell's comments that it was premature for markets to price in rate cuts early next year. With 130 basis points of cuts now priced into the Fed's fund futures market through the year end of 2024, investors have set a high bar for cuts to be delivered. Our analysis on equity returns post prior peaks in the Fed funds rate shows a strong disparity in performance between cycles where inflation was historically elevated versus those where inflation was relatively benign. The equity market appears to be betting on the playbook from the last four cycles when inflation was benign, suggesting we are early to mid-cycle for this particular economic expansion. However, our analysis of the earnings and macro data continue to suggest we are late cycle, which argues for continued outperformance of our defensive growth and late cycle cyclicals barbell strategy. The primary argument supporting our position relates to the labor market, which appears to be short on supply at a price companies can afford. This is why labor demand continues to soften and why consumer spending is slowing. Having said that, we can stay in the late cycle regime for long periods of time with 2023 representing one of those classic late cycle periods. This is why large-cap quality is outperform and why Friday's rally in small caps and lower quality stocks is unlikely to be sustained. Recently, we have received an increasing amount of client questions on the relative performance of industry groups and factors around the Fed's first interest rate cut of the cycle. Value stocks tend to outperform growth into the cut and underperform post the cut. Quality tends to outperform meaningfully into the cut and then sees more volatile performance after. Interestingly, defenses tend to outperform cyclicals and small caps fairly persistently, both before and after the initial cut. This helps to support the notion at the beginning of the Fed cutting cycle is not typically the catalyst for a meaningful broadening out of leadership. Another topic of interest from investors more recently has been industry group performance around presidential elections. On an equal weighted basis, performance shows a modest bias towards value, quality and defensive large caps. Post-election, we do tend to see a broadening out in leadership with small caps and cyclicals generally showing better performance. Value maintains its outperformance. Financials tend to show strong relative performance both before and after elections. And interestingly, health care's relative performance tends to hold up until three months prior to the election. Within the health care sector, equipment and services tends to outperform pharma and biotech post the election. 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.

4 Des 20233min

The market rally of the last few weeks is based on strong economic data, suggesting that the U.S. and Europe remain on track for a “soft landing.” ----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Corporate Credit Research 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 Friday, December 1st at 2 p.m. in London. November 2023 is now in the history books. It was outstanding. US bonds rose 4.5%, the best month since 1985. Global stocks rose 9%, the best month in three years. Spreads on an investment grade and high yield bonds tightened significantly. With the exception of commodities and Chinese stocks, which both struggled, November was an early holiday gift to investors of many stripes. While the size of the rally in November was unusual, the direction didn't just spring from thin air. Generally speaking, economic data in November strongly endorsed the idea of a soft landing. Soft landing, where inflation falls without a sharp drop in economic activity are historically rare. But they are Morgan Stanley's economic forecast for the year ahead. And in November, investors unwrapped data suggesting the story remains on track. In the US, core consumer price inflation declined more than expected. Core PCE inflation, a slightly different measure that the Federal Reserve prefers, has fallen down to an annualized pace of just 2.5% over the last six months. Gas prices are down 16% since the summer, rental inflation has stalled and the U.S. auto production is normalizing, improving the trend in three big drivers of the higher inflation we've seen over the last two years. Go back 12 months and most forecasts, including our own, assume that lower inflation would be the result of higher interest rates driving a slowdown in growth. But the economy has been good. Over the last 12 months, the U.S. economy has grown 3%, .5% better than the average since 1990. The story in Europe is a little different from the one in America, but it still rhymes. In Europe, recent inflation data has also come in lower than expected. While economic data has been somewhat weaker. Still, we see signs that the worst of Europe's economic growth will be confined to 2023 and continue to forecast the weakest growth right now, with somewhat better European growth in 2024. Why does this matter? While the returns of November were unusual and unlikely to repeat, it's a good reminder not to overcomplicate things. Good data, by which we mean lower inflation and reasonable growth, is a good outcome that markets will reward, and remains the Morgan Stanley economic base case. Deviating on either variable is a risk, especially for an asset class like credit. Following the data and keeping an open mind, remains important. 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.

1 Des 20232min

The growing popularity of medicines that curb appetite is having an impact on consumption of less-healthy foods. Here’s what that could mean for packaged snacks, soda, alcohol and fast food.----- Transcript -----Welcome to Thoughts on the Market. I'm Pamela Kaufman, Morgan Stanley's Tobacco and Packaged Food Analyst. Today I'll be talking about how obesity medicines are impacting food spending. It's Thursday, November 30th at 10 a.m. in New York. With Thanksgiving behind us, we've now entered the holiday season when many of us are focused on shopping, travel and, of course, food. The last 12 to 18 months have seen overwhelming growth in popularity for a glucagon-like peptide 1 or GLP-1 anti-obesity medications. These medications were first approved for the treatment of type two diabetes more than 15 years ago and for the treatment of obesity more than 8 years ago. But the inflection point came only recently when the formulation and delivery of GLP-1 drugs improved from once daily injections to once weekly injections, and even an oral formulation. There were also some key FDA approvals that opened the doors for widespread use. How effective are these new and improved GLP-1 drugs? Essentially, they target areas of the brain that regulate appetite and food consumption so that patients feel full longer, have a reduced appetite and consume less food. Studies show that patients taking the injectable GLP-1 medicines can lose approximately 10 to 20% of their body weight. One of the key debates in the market right now is how the growing use of GLP-1 drugs will affect various industries within the larger food ecosystem. The fact that patients on anti-obesity drugs experience a significant reduction in appetite impacts their food habits and consumption. The "Food Meets Pharma" debate is one we've been tracking closely, and our most recent work indicates that shoppers with obesity spend about 1% more on groceries compared to shoppers without obesity. But we see a larger difference across less healthy categories. Over the last year, obese shoppers spent more on candy, frozen meals and beverages, but less on produce, fish and beans and grains. In addition, shoppers with obesity spend more at large fast food chains. Our own survey data and various medical studies point to a drastic 60 to 70% reduction in consumption of less healthy categories in patients taking GLP-1 drugs, driven by the significant changes observed in their food consumption and preferences. As drug use grows, we can see an increasing impact across various food and beverage related industries in the U.S. For example, among our beverages coverage, U.S. shoppers with obesity spend more on carbonated soft drinks and salty snacks. Shoppers with obesity also spend more on fast food and on a relative basis, less at fast casual restaurants and casual diners. But obesity medicines are starting to change these habits. Furthermore, 62% of GLP-1 patients report consuming less alcohol since starting on the medications, with 56% of those consuming less reporting at least a 75% reduction in alcohol consumption. So what's our outlook for drug adoption? Morgan Stanley research estimates that the global obesity prescription market will reach $77 billion in the next decade, with $51 billion in the U.S. By 2035, my colleagues expect 7% of the U.S. population will be on anti-obesity medication. Given these projections, the "Food Meets Pharma" debate will remain relevant and something investors should watch closely. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

30 Nov 20234min

With a strong holiday season expected, and a rise in U.S. passport issuance, there’s good reason to believe the travel industry will see durable growth in the year ahead.----- Transcript -----Welcome to Thoughts on the Market. I'm Ravi Shanker, Morgan Stanley's Freight Transportation and Airlines Analyst. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our view on airline travel in 2024. It's Wednesday, November 29th at 10 a.m. in New York. Travel plans are in most people's minds over the holiday season, and many of us just experienced firsthand the hectic Thanksgiving holiday weekend. On the Sunday after Thanksgiving, the US Transportation Security Administration, or TSA, screened more than 2.9 million passengers, which was the most ever for a single day. Overall, the TSA's reported number of travelers last week was up 4.2% versus 2019 and has been tracking up nearly 6% versus 2019 for the month of November. This is impressive given that November is typically a slower leisure travel month. Furthermore, despite record travel over the last several weeks, airlines achieved record low cancellations over the Thanksgiving weekend as well. This all bodes well for the upcoming holidays. We continue to expect a strong holiday season ahead, as demand for air travel is showing no signs of slowing. And despite concerns around choppy macro conditions, we continue to see no signs of a cliff in demand. Meanwhile, our survey work indicates that holiday travel intentions remain robust among all consumers and not just high income households. At the same time, corporate travel budgets in 2024 are trending in line with expectations, and business travel is likely to mirror domestic leisure travel just on a delayed basis. Smaller enterprises continue to lead the way for corporate travel demand. Among companies with less than $1 billion in revenue, 41% are already back to pre 2020 travel volumes. Right now, the primary barriers to corporate travel appear to be cost concerns as well as the economic and market outlook. This suggests that constraints on corporate travel may be cyclical rather than structural. One final observation which relates to both international business and leisure travel is that US passport issuance is also up. According to US government data, as of early November, 2023 had already seen the issuance of over 24 million passports. That's 9% higher compared to 2022. This is a new record which demonstrates that people want to travel now more than ever, particularly internationally. Over the past 25 years, the number of US passports issued per year has noticeably increased after major economic events such as the dot-com bubble in the early 2000s, the global financial crisis in 2008-2009, with the latest being post-Covid in 2022. We continue to believe that this is not a one and done travel spike, but a durable growth trend. All told, it looks like we may be entering a new golden age of travel in the 2020s. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and shared Thoughts on the Market with a friend or colleague today.

29 Nov 20233min

Investors in the education sector have focused on threats from generative AI, but may be missing the potential for greater efficiency and new opportunities in workforce reskilling.----- Transcript -----Welcome to Thoughts on the Market. I'm Brenda Duverce from the Morgan Stanley Sustainability Research Team. Along with my colleagues bringing you a variety of perspectives. Today I'll discuss the potential impact of generative AI on the global education market. It's Tuesday, November 28th at 10 a.m. in New York. When ChatGPT was first introduced, it disrupted the education system with the threat of plagiarism and misinformation, and some school systems have banned it. Some companies in the educational technology space were initially affected by this, but have since recovered as the risks have become clearer. Still, investors appear to be overly focused on the risks GenAI poses to education companies, missing the potential upside GenAI can unlock. From a sustainability perspective, we view GenAI as an opportunity to drive improvements to society in general, with education being one core use case. We would highlight two areas where GenAI will be key. One, in improving the overall education experience and two, in helping to reskill or upskill an evolving workforce. Starting with the quality of the education experience, GenAI has the potential to transform learning and teaching, from automating tasks with chatbots to creating adaptive learning solutions. Applications such as auto grading, large language model based tutors and retention management can drive efficiencies and increase productivity. We see efficiencies driving $200 billion of value creation and education over the next three years. In the fragmented education market, we expect lower costs to flow through to prices as companies pass along cost savings to maximize volumes. The second key area that we highlight from a sustainability angle is the reskilling and upskilling of the workforce. We think the market may be under appreciating the role education companies can have in this respect. Many fear that GenAI would lead to substantial job losses in various areas of the economy, and the market sometimes assumes that job loss leads to permanent displacement of workers long term. But we argue this isn't necessarily true. Workers typically re-enter the labor force with an updated skill set. Take, for instance, the introduction of ATMs and the concerns that ATMs would replace bank tellers and lead to significant job loss. This didn't prove to be the case. Over time, there were fewer tellers per bank branch, but the overall number of tellers continued to rise. Furthermore, the bank teller role evolved as customers sought a better experience and bank tellers responded by reskilling. Another example of this type of disruption was the introduction of the spreadsheet in the accounting industry. Many argued that spreadsheets would replace accounting jobs. However, data from the Bureau of Labor Statistics indicates the opposite, the number of accountants and financial managers rose significantly. When it comes to reskilling or upskilling workers impacted by GenAI, we think this could cost somewhere around $16 billion within the next three years. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

28 Nov 20233min

Morgan Stanley published its 2024 macroeconomic and investment outlooks last week after spirited debates among our economists and strategists. Three topics animated much of this year’s discussion: lingering concerns about recession; China; and the challenging real estate market in the U.S.----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about some of the key debates we engaged in during our year ahead outlook process. It's Monday, November 27th at 10 a.m. in New York. We published our Year Ahead Global Economics and Strategy Outlook last Sunday and more detailed asset class and country specific outlooks have been streaming out since. At Morgan Stanley Research the outlooks are the culmination of a process involving much deliberation and spirited debate among economists and strategists across all regions and asset classes we cover. While we strive for cohesion and consistency in our outlook across economies and markets, we are convinced that in a highly interconnected world, facing numerous uncertainties, challenging each other's views makes the final product much stronger. In that spirit, here are some of the key debates we engaged in along the way. Slowdown but not recession? In their baseline scenario, our economists expect a significant slowdown in developed market economies while inflation is tamed and outright recession is avoided. Unsurprisingly, the prospect of a substantial slowdown that does not devolve into a recession was debated at length. Our economists maintain that while recessions remain a risk everywhere, they expect any recession, such as the one in the United Kingdom, to be shallow. Since inflation is falling with full employment, real incomes should hold up, leaving consumption resilient despite more volatile investment spending. Our economists call for policy easing to start across several DM economies in the middle of 2024 was also much discussed. For the U.S., our economists call for 100 basis points of rate cuts starting around the second half of the year and the cuts begin even before inflation target has been achieved and without a spike in the unemployment rate. The motivation here is not that the Fed will cut to stimulate the economy, but the cuts are a move towards a more normalized monetary policy. As the economy begins to slow and net new jobs created fall below replacement levels, we think that the Fed sees the need to normalize policy instead of maintaining policy at very restrictive levels. The China question. Relative to the expectations in our mid-year outlook, China growth surprised to the downside. We clearly overestimated the ability and willingness of China policymakers to restore vigor to the economy. Thus, as we debated China, we spent time on the policy measures needed to offset the drag from the looming 3D trap of debt, deflation and demographics. We look for subpar improvement in both growth and inflation in 2024, with real GDP growth reaching a below consensus 4.2%. More central government led stimulus will only cushion the economy against continued deleveraging in the housing sector and local government financial vehicles.Real estate challenges. U.S. residential and commercial real estate markets diverged dramatically over the course of 2023, and their trajectory in the year ahead was an important debate. The dramatic affordability challenges posed by higher mortgage rates caused a significant pullback in existing home sales, renewing decreases in inventory that provided near-term support for home prices. On the other hand, the combination of challenges for key lenders such as regional banks and secular challenges to select property types such as offers coupled with an imminent and persistent wall of maturities that need to be refinanced, drove commercial real estate prices and sales meaningfully lower. Looking ahead, as rates come down, we expect affordability to improve and for sale inventory of homes to increase. U.S. home prices should see modest declines, about 3% as the growth in inventory offsets the increased demand, with fundamental stressors still largely unresolved, we expect the outlook for commercial real estate to remain challenging. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

27 Nov 20234min