Mike Wilson: Are We Ripe for a U.S. Equities Correction?

The asset management and wealth management sectors could see AI boost efficiency in the short term and drive alpha in the medium to long term.----- Transcript -----Mike Cyprys: Welcome to Thoughts on the Market. I'm Mike Cyprys, Morgan Stanley's Head of U.S. Brokers, Asset Managers and Exchanges Team. Bruce Hamilton: And I'm Bruce Hamilton, Head of European Asset Management and Diversified Financials Research. Mike Cyprys: And on this special episode of the podcast, we'll talk about what the Generative A.I Revolution might mean for asset and wealth managers. It's Tuesday, October 17th at 10 a.m. in New York. Bruce Hamilton: And 3 p.m. in London. Mike Cyprys: My colleagues and I believe that Generative A.I is a revolution rather than simply an evolution and one that is well underway. We think Gen A.I, which differs from traditional A.I in that it uses data to create new content, will fundamentally transform how we live and work. This is certainly the case for asset and wealth management, where leading firms have already started deploying it and extracting tangible benefits from Gen A.I across an array of use cases. Bruce, what has been the initial focus among firms that have successfully deployed Gen A.I so far? And, something that has been top of mind for most of us, is Gen A.I replacing human resources? Bruce Hamilton: So Mike, clearly it's early days, but from our conversations with more than 20 firms managing over $20 trillion in assets, it seems clear that the immediate opportunities are mainly around efficiency gains rather than top-line improvements. However over time, as these evolve, we expect that this can drive opportunity for top-line also. All firms we spoke with see the importance of humans in the loop given risks, so A.I as copilot and freeing up resource for more value added activities rather than replacing humans. Mike Cyprys: What are some of the top most priorities for firms already implementing Gen A.I? And in broad terms, how are they thinking about integrating Gen A.I within their business models? Bruce Hamilton: So opportunities are seen across the value chain in sales and client service, product development, investment in research and middle and back office. Initial efficiency use cases would include drafting customized pitch or RFP reports and sales, synthesis of research and extraction of data in research, and coding in I.T.. Now Mike, specifically within the asset management space, there are two primary ways Gen A.I is disrupting. One is through efficiencies and two revenue opportunities. Can you speak to the latter? How would Gen A.I change or improve asset management? And do you believe it will truly transform the industry? Mike Cyprys: Absolutely. I think it can transform the industry because what's going to change how we live, how we work, and that will have implications across business models and the competitive landscape. I believe we're now at a A.I tipping point, just in terms of its ability to be deployed on a widespread basis across asset managers. The initial focus is overwhelmingly on driving efficiency gains and at the moment there's skepticism if Gen A.I can drive product alpha, but it should help with some of the maintenance tax around collecting and summarizing information and cleaning data. This should help release PM's of time to focus more on higher value idea generation and testing their ideas, which should help performance generation. I don't think it hurts. All in, we think this could result in up to 30% productivity gains across the investment functions. Bruce Hamilton: We've talked about how Gen A.I affects asset management. Do you think it can transform how financial advisers do their job and what kind of productivity gains are you expecting to see? Mike Cyprys: Financial advisors stand to benefit the most from Gen A.I because it should help liberate advisors time spent on routine or administrative tasks and allow them to focus more of their time on building deeper connections with clients and allowing them to service more clients with the same resources. And so that's how you get the revenue opportunity, by serving more clients and more assets. It's more of a copilot or tool that enhances human capabilities as opposed to replacing the human advisor. So on the wealth side, we do see more of a revenue opportunity for Gen A.I than we do on the asset management side in the near-to-medium-term. Use cases include collecting client information and interactive ways and summarizing those insights as well as proposing the next best actions and drafting engagement plans and talking points. All in, Gen A.I should help drive productivity improvements between 30 to 40% in the wealth sleeve. Bruce Hamilton: So Mike, what's your outlook for the next 3 to 5 years when it comes to the impact of Gen A.I on asset management? Mike Cyprys: It's really an expense efficiency play in the near to medium term for asset managers. But as you look out over the next 3-to-5 years, we could see a situation where A.I is embedded in a broader range of activities, from product development to portfolio management and trading areas, including trade optimization strategies, as well as brainstorming new product ideas tailored to client needs. Now in terms of assessing firms that are best placed, our qualitative assessment considers four main areas. First, there's firm scale and resources to allocate to both profitability and balance sheet capacity. Secondly, we consider a firm's in-house data and technology resources to drive change. Thirdly, are firms’ access to proprietary datasets where it can leverage A.I capabilities. And finally, there's the strategic priority assigned to A.I. by management. Bruce Hamilton: But Mike, what are some of the risks and limitations of A.I technology when it comes to wealth management and specifically to financial advisors rather than to back office functions? Mike Cyprys: We see the risks falling into two categories. There's technological risks on one side that includes hallucinations that can result in poor decisions, as well as inability to trace underlying logic and the threat of cyber attack and fraud. Then on the other side, there's usage risks, which include data privacy, improperly trained models, as well as copyright concerns. We're seeing firms respond to these challenges by maintaining a ‘human in the loop’ approach to A.I. adoption. That is a human is involved in the decision making process such that A.I operates with human oversight and intervention. Mike Cyprys: Bruce, thanks so much for taking the time to talk. Bruce Hamilton: Great speaking with you, Mike. Mike Cyprys: 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 calling today.

17 Okt 20236min

The recent rise in long term yields and economic tightening raises the question of how restrictive U.S. financial conditions have become.----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Chief Global Economist, and along with my colleagues bringing you a variety of perspectives. Today, I'll be talking about the tightening of financial conditions. It's Monday, October 16th at 10 a.m. in New York. The net selloff in U.S. interest rates since May prompts the question of how restrictive financial conditions have become in the United States. Federal Reserve leaders highlighted the tightening in conditions in recent speeches, with emphasis on the recent rise in long term yields. One lens on this issue is the Financial Conditions index, and the Morgan Stanley version suggests that the recent rate move is the equivalent of just under two Fed hikes since the September FOMC meeting. Taken at face value, it sustained these tight conditions will restrain economic activity over time. Put differently, the market is doing additional tightening for the Fed. Before the rally in rates this week, the Morgan Stanley Financial Conditions Index reached the highest level since November 2022, and the move was the equivalent of more than 2 25 basis point hikes since the September FOMC meeting. Of course, the mapping to Fed funds equivalence is just one approximation among many. When Fed staff tried to map QE effects into Fed funds equivalence, they would have assessed the 50 basis point move in term premiums we have seen as a 200 basis point move in hiking the Fed funds rate. What does the FCI mean for inflation and growth? Well, Morgan Stanley forecasts have been fairly accurate on the inflation trend throughout 2023, although we have underestimated growth. We think that core PCE inflation gets below 3% by the first quarter of next year. For growth, the key question is whether the sell off is exogenous, that is if it's unrelated to the fundamentals of the economy and whether it persists. A persistent exogenous rise in rates should slow the economy, and over time the Fed would need to adjust the path of policy lower in order to offset that drag. The more drag that comes from markets, the less drag the Fed would do with policy. But if instead the sell off is endogenous, that is, the higher rates reflect just a fundamentally stronger economy, either because of more fiscal policy or higher productivity growth or both, the growth need not slow at all and rates can stay high forever. Well, what does the FCI mean then, for the Fed? Bond yields have contributed about 2/3's of the rise in the Financial conditions index, and the Fed seems to have taken note. In a panel moderated by our own Ellen Zentner last Monday, Vice Chair Jefferson was a key voice suggesting that the rate move could forestall another hike. The Fed, however, must confront the same two questions. Is the tightening endogenous or exogenous, and will it persist? If rates continued their rally over the next several weeks and offset the tightening, then there's no material effect. But the second question of exogeneity is also critical. If the selloff was exogenous, then the tightening should hurt growth and the Fed will have to adjust policy in response. If instead the higher rates are an endogenous reaction, then there may be more underlying strength in the economy than our models imply and the shift higher in rates could be permanent. Thanks for listening. If you enjoy the show, please leave a review on Apple Podcasts or share Thoughts on the Market with a friend or colleague today.

16 Okt 20233min

On the heels of a midsummer spike, long-end treasury yields have picked up further momentum, which has created complex implications for the Fed, the corporate credit market, and emerging market bonds.----- 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 our views on the back of moves higher in Treasury yields. It's Friday, October 13th at 3 pm. in New York. The midsummer move higher in long-end treasury yields picked up further momentum in September, spiking to levels last seen over 15 years ago. Market narratives explaining these moves have revolved largely around upside surprises to growth and concerns about large federal fiscal deficits. The September employment report was unequivocally strong, perhaps too strong for policymakers to relax their tightening bias. While inflation has been decelerating faster than the Fed forecasts, continued strength in job gains could fuel doubts about the sustainability of the pace of deceleration. On the other hand, the rise in long-end yields have led financial conditions tighter. By our economists’ measure, since the September FOMC meeting, financial conditions have tightened to the equivalent of about two 25 basis point hikes, bringing the degree of tightness more in line with the Fed's intent. Thus, our economists see no need for further hikes in the Fed's policy rates this year. In effect, the move higher in Treasury yields is doing the job of additional hikes. It's worth highlighting that there has been a subtle shift in the tone of Fed speak in the past two weeks, indicating that the appetite for additional hike this year is waning. Given the moves in Treasury yields, we felt the need to reassess our Treasury yield forecasts and move them higher relative to our previous forecasts. Our interest rate strategists now expect ten-year Treasury yields to end year 2023 at 4.3% and mid-2024 at 3.9%. The effects of higher treasury yields are different in the corporate credit market. Unlike the Treasury market, the concentration of yield buyers in investment grade corporate credit bonds is much higher, especially at the back end of the curve. These yield buyers offer an important counterbalance. In fact, for longer duration buyers, there are not that many competing alternatives to IG corporate credit. While spreads look low relative to Treasury yields, growth optimism is likely to keep demand skewed towards credit over government bonds. Insurance companies and pension funds may have room to add corporate credit exposure, although stability in yields is certainly important. Higher treasury yields have implications to other markets as well, notably on emerging market bonds. Considering the move in U.S. Treasury yields, we think EM credit bonds cannot absorb any further move higher. In a higher for longer scenario, we expect EM high yield bonds to struggle. Therefore, we no longer think that EM high-yield credit will outperform EM investment grade credit. 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.

13 Okt 20232min

Although inflation is largely under control in Asian economies, central banks could be pushed to respond if high U.S. yields meet rising oil prices.----- Transcript -----Welcome to Thoughts on the Market. Chetan Ahya, Morgan Stanley's Chief Economist. Along with my colleagues bringing you a variety of perspectives, today, I'll discuss how higher U.S. rates environment could affect Asia. It's Thursday, October 12th, at 9 a.m. in Hong Kong. Real rates in the U.S. have risen rapidly since mid-May and remain at elevated levels. Against this backdrop, investors are asking if Asian central banks will have to restart their rate hiking cycles. We think Asia should be less affected this time around, mainly because of the difference in inflation dynamics. As we've highlighted before on this show when compared to the U.S., Asia's inflation challenge is not as intense. In fact, for 80% of the economies in the region inflation is already back in the respective central bank's comfort zone. Real policy rates are already high and so against this backdrop, we believe central banks will not have to hike. However, we do think that the central banks will delay cutting rates. Previously, we had expected that the first rate cut in the region could come in the fourth quarter of 2023, but now we believe that cuts will be delayed and only start in first quarter of 2024. So what can trigger renewed rate hikes across Asia? We think that central banks will respond if high U.S. yields are accompanied by Brent crude oil prices rising in a sustained manner, above $110 per barrels versus $85 today. Under this scenario, the region's macro stability indicators of inflation and current account balances could become stretched and currencies may face further weakness. In thinking about which central banks might face more pressures to hike, we consider three key factors, economies with lower yields at the starting point, economies running a current account deficit or just about a mile surplus and the oil trade deficit. This suggests that economies like India, Korea, Philippines and Thailand, may be more exposed and so this means that the central banks in these countries may be prompted to begin raising rates. In contrast, the economies of China and Taiwan are less exposed, and so their central banks would be able to stay put. Thanks for listening, and 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.

12 Okt 20232min

With Congress still without a Speaker of the House, investors should keep an eye on the impact that another potential government shutdown would have on the markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the impact of Congress on financial markets. It's Wednesday, October 11th, at 10 a.m. in New York. As of this recording, the U.S. House of Representatives still does not have a speaker following Representative McCarthy's ouster a little over a week ago. Republicans are scheduled to meet today to attempt to nominate the speaker, but until one is chosen, it's unclear that Congress can do any other business. But does that actually matter for investors? Here's two signals from these events that we think are important. First, it signals that Congress is unlikely to deliver any substantial legislation between now and the 2024 election outside of funding bills. Republicans' difficulty choosing a speaker reflects their lack of consensus on many policy issues, including regulation, social spending and more. That further impedes the government's ability to legislate, which was already hampered by different parties controlling the White House and Congress. So for investors who have credited the rise in bond yields and stock prices to expanded fiscal support from the federal government in recent years, you shouldn't expect there to be more on the horizon. The exception to this could be an economic crisis that prompts a fiscal response. But for investors, that means you'd likely see bonds rally and stocks sell off before fiscal support would again become a stock market positive. The second signal, which also cuts against the narrative of government policy support for markets, is that a government shutdown is still a distinct possibility. Congress recently avoided the government shutdown at the beginning of the month by passing a temporary extension of funding into November. But that move only delayed the resolution of key policy disagreements within the House Republican caucus that nearly led to the shutdown in the first place. With the clock ticking toward another shutdown deadline, Republicans are spending precious time selecting a new speaker, and it's not clear they're any closer to resolving their disagreements on key issues such as funding aid to Ukraine. Without that resolution, the risk remains that the House could fail to consider funding bills in time to avoid another shutdown. Now, to put it in context, our economists expect that downward growth pressures from a shutdown event should be modest, and so there are more meaningful factors to consider for markets out there, but certainly this condition doesn't help investors' confidence in the U.S. growth trajectory. And generally speaking, a Congress stunted in its ability to legislate has the potential to become a bigger challenge, particularly if geopolitical events create greater global growth risks. So bottom line, this situation is worth keeping tabs on, but isn't yet something we think should principally drive investors decision making. 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.

11 Okt 20233min

As companies integrate generative AI into enterprise software, a wide variety of jobs that depend on requesting or distributing data could be automated.----- Transcript -----Welcome to Thoughts on the Market. I'm Keith Weiss, Head of Morgan Stanley's U.S. Software Team. Along with my colleagues bringing you a variety of perspectives, today I'll discuss the significant potential impact from generative A.I on enterprises. It's Tuesday, October 10th, at 10 a.m. in New York. You may remember the generative A.I powered chat app that reached 1 million users in only five days after its launch late last year. While much of the early discussion on the use of generative A.I focused on the consumer opportunity, we see perhaps an even bigger opportunity in enterprise software. The advantages from traditional A.I to generative A.I are rapidly broadening the scope of the types of work and business processes that enterprise software can automate, and this could ultimately have an impact on industries across the entire economy. Of course, one of the biggest questions everyone seems to have is how will generative A.I impact jobs? We forecast 25% of labor could be impacted by generative A.I capabilities available today, likely rising to 44% of labor in three years. Further, by looking at the wages associated with those jobs, our analysis suggests generative and A.I technologies can impact the $2.1 trillion of labor costs attached to those jobs today, expanding to $4.1 trillion in three years in the U.S. alone. This drives an approximately $150 billion revenue opportunity for software companies in our view. An important caveat here, we believe it's too early to make any definitive claims on the number of jobs that will be replaced by generative A.I. So we used the term impact to denote the potential for either an augmentation or further automation of these jobs on a go forward basis. So what are the jobs we think are most likely to be impacted? Based on the current capabilities of generative A.I technologies like large language models, we believe the common characteristics are skills amongst the jobs most impacted are the need to retrieve or distribute information. For example, billing clerks, proofreaders, switchboard operators, general office workers and brokerage clerks. On the other side of the equation, jobs that are least impacted today are those that require some aspect of physical labor, including ophthalmologists, extraction workers, choreographers, firefighters and manufactured building and mobile home installers. Over the next three years, as this more generalized A.I. technology focuses in on more specific use cases, we believe the impact of generative A.I will shift into more specialized jobs, such as general and operations managers, as well as registered nurses, software developers, accountants and auditors, and customer service reps. Of these, the General and Operations Manager jobs could experience the highest potential cumulative wage impact. In fact, our analysis suggests a $83 billion impact amongst general and operations managers today. The magnitude of the enterprise impact marks only one side of the equation, as the timing of the realizable opportunity becomes increasingly important for investors to navigate this evolving technology cycle. To be clear, the rapid adoption of these consumer technologies are not going to be indicative of the pace of adoption we're likely to see amongst the enterprise. There are several notable frictions to enterprise adoption related to items such as finding a good return on investment, enabling good data protection, the skill sets necessary to run and operate these new technologies and legal and regulatory considerations, all which necessitate significantly longer adoption cycles for the enterprise. For this reason, we think generative A.I remains in the early stages of the opportunity. 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 Okt 20233min

While U.S. consumer sentiment is on the decline, there are some categories that have remained stable as purse strings tighten.----- Transcript -----Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley U.S. Equity Strategy Team. Along with my colleagues bringing you a variety of perspectives, today I'll give you an update on the U.S. consumer. It's Monday, October 9th at 10 a.m. in New York. As we get into the fall season and close out the third quarter of this year, investors are paying attention to the state of the U.S. consumer. Our recent survey work reveals that inflation continues to be a primary concern for consumers and that the U.S. political environment is the second most significant concern. Furthermore, consumers continue to worry about their payment obligations, and 30% of people we surveyed expressed concern over their potential inability to repay debts. Low income consumers are generally more worried about their inability to pay rent, while upper income consumers are concerned about their investments, U.S. politics and geopolitics. Overall, consumer confidence in the U.S. economy and household finances worsened modestly in September. More than half of U.S. consumers are expecting the economy to get worse in the next six months, while less than a quarter of consumers are expecting the economy to get better. This worsening sentiment is also consistent across different income cohorts. Additionally, savings rates continue to trend lower versus earlier this year. Consumers report having an average savings reserve of 4.2 months, the average over the past few months has been trending lower compared to earlier in the year. Of course, savings reserves vary significantly by income though, with upper income consumers having on average around 6 to 7 months worth of expenses in savings compared to about 3 months for low income cohorts. Positively fewer consumers reported missing or being late on a loan or bill payment, with 34% missing a payment last month versus 38% in August. Low income consumers are more likely to have missed or been late on payments versus middle and high income consumers. Consumer spending intentions across income cohorts for the next month are similar to last month, with 31% of consumers expecting to spend more next month and 19% expecting to spend less. Consumers continue to prioritize essential categories like groceries and household items, but plan to spend less on more discretionary products like electronics, leisure and entertainment, small appliances and food away from home. Interesting to note, cell phone bills continue to be a clear priority for consumers. Travel intentions have also remained relatively stable. Over half of consumers are planning to travel over the next six months, mostly to visit friends and family, which is slightly up from last year. Not surprisingly, travel spending is higher for high income consumers than for low and middle income ones. However, we have seen plans for international travel start to decline. 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.

9 Okt 20232min

As bond yields continue to rise, credit has been more of a passenger than the driver of recent market volatility.-----Transcript -----Andrew Sheets: Welcome to Thoughts in the Market. I'm Andrew Sheets, Morgan Stanley's Head of Corporate Credit Research. Serena Tang: And I'm Serena Tang, Morgan Stanley's Chief Global Cross-Asset Strategist. Andrew Sheets: And on the special episode of the podcast, we'll discuss Morgan Stanley's updated cross-asset and corporate credit views. It's Friday, October 6th at 3 p.m. in London. Serena Tang: And 10 a.m. in New York. Andrew Sheets: Before we get into our discussion, let me introduce Serena Tang as Morgan Stanley's new Global Cross-Asset Strategist. Serena has been working with me for the last 15 years and together we initiated our cross-asset effort nearly a decade ago. Serena was responsible for building the team's investment framework, specializing in multi asset allocation, portfolio optimization, and long run capital market assumptions. So I can confidently say that Morgan Stanley's cross-asset effort is in very capable hands. As for me, I'm now Morgan Stanley's Head of Corporate Credit Research, but I'll continue to host my colleagues as we look forward to bringing you key debates from across asset classes and regions. So, Serena, welcome and let's jump right into what's going on in markets. Over the last several weeks, as everybody in the U.S. has returned from summer, the debate among Morgan Stanley's economists and strategists is centered on two main issues, the outperformance of the U.S. economy and the underperformance of China's economy, as well as the spike of government bond yields, especially at the longer end of the curve. So where has this left our views across asset classes? Serena Tang: Yeah, yields and real yields have indeed moved a lot higher in a very short amount of time, you know, on that narrative that rates will stay higher for longer. And I would say that, you know, while the market has been going against our current call for government bond yields to fall over the next 6 to 9 months or so, we’re steadfast on our preference for high quality fixed income over risk assets like global equities, like high yield corporate bonds. And the reason really comes down to how higher real yields mean the discount rate for equities is also higher, leading to lower stock prices. And we've kind of seen this over the past few weeks or so. I think this is especially true in today's environment where the rise in yields and the rise in real yields isn't really driven by a rise in growth expectations, which you know traditionally have been great for equities thinking about future growth. But rather today's move in yields is really much a function of what the markets think the Fed would do over the coming few months. And all this largely explains the nearly 9% selloff we've seen in global equities since the start of August. But Andrew, you know, such dynamics must also be very similar in the credit world. In your view, how do rising government bond yields affect your outlook for global credit? Andrew Sheets: So I think credit finds itself in a pretty interesting place as bond yields have risen. You know, I would safely say that I think credit as a passenger in recent market volatility, it's not the driver. And, you know, if I think very simply about why bond yields have been selling off and there are a lot of different theories of why that's been happening, maybe a simple explanation would be that bond yields offer pretty poor so-called carry, a government bond, a ten year government bond yields less than just holding cash. They offer poor momentum, they're moving in the wrong direction and they have difficult technicals, i.e., there's a lot of supply of government bonds forecast over the coming years. And across a lot of those metrics, I do think credit looks somewhat better. Credit yields are higher, that carry is better. Credit compensates you more for taking on a longer maturity corporate bond, which is the opposite of what you see in the government bond market. And as yields have risen, companies have looked at those higher yields and done, I think, a very understandable thing, they are borrowing less money because it's more expensive to borrow that money. So we've seen less supply of corporate bonds into the market, which means there's less supply that needs to be absorbed and bought by investors. So credit can't ignore what's going on in this environment and we're broadly forecasting this to be worse for weaker companies, as the effect of potentially slower growth and higher rates we think will weigh more heavily on the more levered type of capital structure. But overall, I think within this kind of challenging environment, I think credit has been an outperformer and I think it can remain an outperformer given it has some advantages on these key metrics. Serena Tang: So you touched on lower quality companies. One of the very interesting forecasts from your team is that we still think default rates can go higher over the next 12 months. Now, how do I square this with everything that you just said, but also our U.S. economics team’s continued forecast for a soft landing? Andrew Sheets: It's a great question. I'd say our default forecast, which is that US default rates rise to a little bit under 5% over the next 12 months, is quite divisive. I’d say there's a group of investors who say, well, it doesn't make a lot of sense that default rates would rise given that our base case does call for a soft landing of the US economy, no recession. And another group that says, well, that seems like too low of a default rate because interest rates have just risen at one of the fastest paces we've seen in 150 years. Of course, that's going to put stress on weaker companies. And I guess we see the markets splitting the difference a little bit between that. I think the fact that you are seeing a clearly outperforming US economy, I think that does really reduce the risk of an above average default rate. It would be very unusual to see an above average default rate with anything like what we're forecasting in our base case economically. And then at the same time, you do have, thanks to the low rates we're coming from, an unusually large share of borrowers who borrowed a lot relative to the amount of income that they generate because they could do that at lower interest rates, and now that's going to be a struggle at higher interest rates. So I think the combination of those two factors gets you something that's in the middle. I think you do have a more robust than expected US economy, but you do have this tail of more heavily indebted issuers that is just, I think, going to struggle with the math of how do you pay for that debt when the interest rate is effectively doubled from where it was just 18 months ago? Serena Tang: And you described just now our credit being in the middle, so to speak. And, you know, being in the middle is much better than what we're projecting for equity returns, and hence one of the reasons we like high quality credit and we like high quality bonds. But then my question to you is, what might the market be missing right now? But also importantly, what do you think we might be wrong? Andrew Sheets: So I think there are a couple of important things to follow. I think there has been over the last several years an advent of alternative forms of capital, some of this is kind of rolled up into the general classification of private credit. But, you know, there have been a lot of new entrants, new investors who are willing to lend to companies under nontraditional terms. And I think it's a big open question around, does that presence of additional investors actually make defaults a lot less likely because there's a new outlet for companies that need to raise funds from this new investor pool, or does that pool not have that effect? And if anything, maybe it is a source of some additional risk. It's a group of lending that's hard to observe by design, by its nature. I think another important thing to watch will be what do companies do? Part of our thinking on the research side is that companies will view current yields as expensive and they will react like any actor would act. When it's more expensive to borrow, they will borrow less. They will try to improve their balance sheet and maybe in the process they'll buy back less stock or do other types of things. That might be wrong. You know, we might see a different reaction from companies. Companies might view that debt cost as different. Maybe they view it as more reasonable than we think they will. So at the moment, we're thinking that companies will view that debt is expensive and respond accordingly and do more bondholder friendly things, so to speak. But we'll have to see. And we could be wrong about how corporate treasurers and management are thinking about those trade offs. Andrew Sheets: Serena, thanks for taking the time to talk. Serena Tang: As always, great. Speaking of you, Andrew. 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.

6 Okt 20238min