Andrew Sheets: The Uncertainty of the Fed’s New Certainty

The past few weeks have seen weak valuations across equity markets. While many look to the Omicron variant as the main culprit, the correction may have more to do with the recent Fed pivot.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bring you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, December 6th at 2:30 p.m. in New York. So let's get after it. While there's evidence the past few weeks have been rough for equity investors, there's a lot of debate around why stocks have been so weak. To us, it seemed like too much attention had been put on the new COVID variant, Omicron, as the primary culprit. Our focus has been much more on the Fed's more aggressive pivot on tapering asset purchases. Last Tuesday, Fed Chair Jay Powell told Congress that it was time to retire the word 'transient' when talking about inflation. This was a significant change for a Fed that had been arguing inflation would likely settle back down next year as supply chains adjusted to the increased demand. As a result, the Fed is now likely to reduce its asset purchase program - known as quantitative easing, or QE - twice as fast as it had previously told us. In short, we now expect the Fed to be completely done with its QE program by the end of March. That is quite a speedy exit in our view and is likely to leave a mark on asset prices. Hence, the sharp correction in stocks last week, especially the most expensive ones. Importantly, this move by the Fed is very much in line with our mid-cycle transition narrative that regular listeners should recognize. From an investment standpoint, the most important thing one needs to know about the mid-cycle transition is that valuations typically come down. In S&P 500 terms, it's typically 20%. So far, we've seen valuations come down by only 10%, making this normalization process only about halfway done, at least at the index level. The good news is many individual stocks have gone through a derating of much greater than 20% already. The bad news is that while some of the most expensive stocks have been hit the hardest, they still look expensive when normalizing for the period of over-earning these companies enjoyed in 2021. Sectors we think look particularly vulnerable include consumer discretionary and technology stocks. Sectors that look cheap are health care and financials. Another consideration for investors is the fact that this White House appears to be more focused on getting inflation under control, rather than keeping the stock market propped up. This might give the Fed cover to stay the course on its plans to withdraw policy accommodation more aggressively. In other words, investors should not be so confident the Fed will reverse course quickly if stocks continue to wobble into year end. Finally, the new variant can't be completely ignored and does pose a risk to demand. However, we always expected another big wave of COVID this winter as the cold weather set in. In fact, the recent spike in cases in the US are almost exclusively the Delta variant. In other words, we would be seeing this spike with or without Omicron's arrival. This is one of the reasons we've been expecting demand to disappoint in the first quarter and another thing that markets will have to deal with as we go into next year. Bottom line, expect markets to remain volatile into year-end as investors are forced to chase and de-risk depending on the price action. In short, moves up and down will be accentuated by asset managers trying to keep up with their benchmarks. In such an environment, we recommend investors continue to keep their risk lower than normal with a focus on large cap quality stocks trading at a reasonable valuation. We expect that over the next three to four months, markets will give us a much fatter pitch to swing at as the Fed completes its exit from QE and growth bottoms. 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.

6 Dec 20213min

One of our most controversial calls for 2022, that the Fed won’t hike interest rates next year, faces renewed scrutiny amidst high inflation, signals on tapering, and today's employment report.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, December 3rd at 2:00 p.m. in London. We recently published our year ahead outlook for 2022 and right there on the cover, near the top, is one of Morgan Stanley Research's most controversial calls: that the U.S. Federal Reserve will not raise interest rates next year. Over the last week, more than one investor has pointed to this report and asked if it still applies. After all, inflation has been high, a situation that tends to call for higher interest rates to cool the economy. And Federal Reserve officials have been increasingly vocal about the merits of slowing their bond buying, accelerating the so-called tapering, even more quickly than they originally intended. Seeing the economy is strong and in less need of that additional support. If the Fed is going to slow down and then stop its bond buying more quickly, the argument goes, surely higher interest rates must be right around the corner. But there's an interesting phenomenon here. When you talk to most investors, they view both higher interest rates and fewer bond purchases as pretty similar things. Both actions, at their core, signal less central bank support for the economy and for markets. But maybe, just maybe, central banks view the world a little differently. For them, buying any bond, even fewer of them, still represents additional support for the economy. But in contrast, increasing interest rates... well, that's different. That's not additional support, that's actively tightening monetary policy. At the end of the day, this question is up to the central bankers. But if they do see a genuine distinction between these two actions - a difference that isn't necessarily as apparent to many investors - a faster taper may be able to coexist with a later first interest rate hike. That, at least, is how we see it at Morgan Stanley Research where our forecast is for exactly that - the Fed to accelerate the pace of its taper but not raise interest rates next year. But there's one more wrinkle in this story. While we think the Federal Reserve will ultimately wait longer than most people expect to raise interest rates next year, there's little reason for them to make that clear now. Inflation is still high and probably won't start to fall for several months. Economic data has been strong and today's employment report showed yet another decline in the unemployment rate. We see little reason why the Fed would want to commit not to take action right now, even if we think that's what they ultimately might do. Why does that matter? It will mean that in the near term, the Federal Reserve will appear to be taking support away from the economy and for markets. After extraordinary intervention to support markets and the economy, the central bank training wheels are coming off, so to speak, and this impact may be uneven. We think this creates the greatest challenge for highly valued growth stocks in the U.S. and emerging market assets and suggests that investors be patient before trying to buy both. 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.

3 Dec 20213min

Chief Asia and Emerging Markets Strategist Jonathan Garner highlights the key debates around his team’s outlook on the region’s growth, policy changes and more in the coming year.----- Transcript -----Welcome to Thoughts on the Market. I'm Jonathan Gardner, Chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the 2022 outlook for Asia equities and some of the key debates for next year. It's Thursday, December the 2nd at 7:30am in Hong Kong. Since we published our year ahead outlook in mid-November, we've had the opportunity to debate the contents with clients in a number of formats, including presentations at our 20th Annual Asia Summit. So today I'd like to share that feedback and focus on some key debates. Our first debate is, why aren't we more bullish on Asia equities given our economics team's constructive view on 2022 global growth? The answer is that mapping GDP growth forecasts into company earnings growth forecasts is problematic since headline revenue growth is only one driver of earnings per share growth. Margins and leverage are also crucial, and even then, the sector breakdown of earnings growth in listed equities does not always match that of the economy as a whole. That said, broadly speaking, we are more constructive on Japan earnings growth than Emerging Markets and Asia earnings growth, given stronger relative gearing to the US, Europe and developed markets GDP growth, and the broad sector mix of export earnings and global cyclicals in Japan. We are anticipating earnings growth to continue next year and beyond consistent with continued global economic expansion. We expect 13% earnings per share growth from Tokyo's Stock Price Index “TOPIX" - in Yen - but only 8% for the MSCI Emerging Markets Index - in dollar terms. But it's fair to say that whilst we’re in line with bottom-up consensus for TOPIX, we're around 500 basis points below consensus for emerging markets. And in aggregate, this has a lot to do with the macro headwinds of our house forecast of dollar strength for Emerging Markets, but also specific sectoral headwinds which we anticipate in areas like China Internet and Asia Semis and Tech hardware in Korea and Taiwan. Another key factor to consider is clearly what's in the price, and we think emerging markets, which are trading around 13x consensus forward P/E - or around the 60th percentile of the 5-year range - still have some downside to valuations over the next year as a whole, whilst we are comfortable with Japan valuations. Our second debate was, why we're not enthusiastic about buying back China equities. Here, we think risk/reward has not yet tilted definitively to the positive, particularly for offshore China growth stocks. We think earnings estimates still need to come down significantly further and similarly to Asia and emerging markets overall, valuations are not particularly cheap - at around 13x consensus forward price to earnings multiple for MSCI China. For sure, China's monetary policy is gradually changing to be more accommodative, and some measures have been taken to re-stimulate property sector demand. However, the Chinese economy has developed downward momentum over the summer and autumn and still faces significant downside risk this winter as a result of prior policy tightening and factors such as COVID Zero lockdowns on the consumer and the impact of regulatory reset on private sector capital spending. Our proprietary indicator of Global Multinational Corporations' sentiment, vis-a-vis their Chinese operations, has just reported its biggest ever quarterly decline and is now at the second lowest since we began our regular quarterly survey. The third debate was, why are we constructive on emerging markets energy? Our answer is that the energy sector and energy sensitive markets are typically later cycle performers, and early next year will mark the second anniversary of the short but intense COVID-driven recession, which at one point marked the first time ever that oil prices went negative. We've come a long way since then in terms of demand recovery, but more is likely still to come if our commodities team is right that Brent can trade over $90 a barrel in 2022. This is the payback for underinvestment in conventional energy supply in recent years, mainly due to ESG concerns. So, it's an example of where our house view on strong global growth in 2022 and 2023 does lead directly to an investment conclusion for a particular sector. And MSCI EM Energy is trading at book value versus 1.9x price to book for the index, and with a free cash flow yield of almost 9%. Before I close, there is a lot of discussion around the new COVID 19 variant, Omicron, and whether it changes our views. At present, we're in early days on this variant and as such, it doesn't change our already cautious view on the outlook for Asia equities. 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.

2 Dec 20214min

The Omicron variant of COVID-19 has investors concerned about potential new restrictions, but the onus lies most on state and local governments who, for now, are awaiting more information on infection rates and severity.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, December 1st at 11:00 a.m. in New York. Not surprisingly, our client conversations this week have been all about Omicron, the new COVID 19 variant that our biotech team thinks may increase infection rates and reduce vaccine effectiveness. In particular, clients want to know if the new variant will lead to fresh government restrictions and crimp the U.S. economic outlook. While the federal government gets much of the attention here, we think the key to sizing up this variable lies in understanding how state and local governments will behave. These are the jurisdictions that have generally driven mask mandates, indoor dining restrictions and other activities. And while there's much to learn about Omicron, here our initial assessment is that the bar is quite high for states and locals to take action, and that should limit downside risk to the economy. What drives our view? In short, ever since states began lifting restrictions in late spring of 2020, their behavior has mostly been influenced by hospital capacity. Of course, some states lifted restrictions faster than others, but in most cases where restrictions were tightened, rising COVID hospitalizations and lack of bed capacity were cited as the culprits. With the availability of vaccinations in the U.S. and the high vaccination rate among vulnerable populations, risks to hospital capacity have lessened. That's because while COVID can infect the vaccinated, they are far less likely to get sick in a way that lands them in the hospital. So that means, when it comes to sizing up if Omicron will lead to government restrictions on economic activity, it's less about whether vaccines will prevent infection, but if they can limit hospitalizations. While there's still not a lot of information, and thus outlooks could easily change as data on the new variant is collected, our biotech research team's base case is that Omicron is not more virulent than the currently dominant Delta variant. Further, the U.S. government continues to express the view that vaccines will provide protection against severe disease. Taken together, this would suggest that as long as the U.S. can sustain its vaccine campaign, including the current push for boosters, the economy may only face manageable headwinds. For fixed income investors, that means Treasury yields should still trend higher. And for credit investors, particularly in COVID sensitive municipal bond sectors like airports and hospitals, we see fundamental risks as manageable. Yet investors should probably focus intently on what would change this view, as this ‘goldilocks outcome’ is mostly in the price of credit and equity markets already. And here again, we say focus on news about Omicron's severity, which is expected within the next few weeks. If data shows it to drive both more infection and more severe sickness, then hospital capacity could be challenged, leading state and local governments to reluctantly reimpose some restrictions. And of course, consumers could react to this signal and change their own behavior - thinking twice about that next flight, for example. Yet perspective is important here, and even this negative outcome is more likely an economic setback than a disaster, as our biotech team notes that pharmaceutical companies may be able to turn around new boosters to address the challenge within a few months. That in turn means there's likely to be opportunities in credit and equity markets if this riskier case is the one that plays out. We'll, of course, be tracking it all here and checking in with you as we learn more. Thanks for listening! If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

1 Dec 20213min

Last week’s news of the Omicron variant of COVID-19 has raised questions about transmissibility, vaccine efficacy, and virus mortality. Where does this variant leave us in the fight against COVID-19 and how are markets reacting?----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley Research.Matthew Harrison And I'm Matthew Harrison, Biotechnology AnalystAndrew Sheets And on this special edition of the podcast, we'll be talking about a new COVID variant and its impact on markets. It's Tuesday, November 30th at 2p.m. in London.Matthew Harrison And it's 9:00 a.m. in New York.Andrew Sheets So Matt, first things first, you know, we've seen a pretty major development over the American Thanksgiving holiday. We saw a new COVID variant, the omicron variant, kind of come into the market's attention. Can you talk just a little bit about why this variant has gotten so much focus and what do we know about it?Matthew Harrison Sure. I think there are probably three major factors that have driven the focus. The first thing is there was clear scientific concern because of the number of mutations in the variant. And specifically, there are over 50 mutations, 32 of which are in the spike protein region, which is where vaccines are targeted. And then a number in the receptor binding domain, which is where the antibodies typically tend to bind. So the antibodies that either vaccines or antibody therapies create. And what we know when we look at many of these mutations is they're present in other variants: gamma, delta, alpha, beta and we know that many of these mutations in a pair one or two have led to reduction in vaccine effectiveness. And so, when they're combined all together, from a scientific standpoint, people were very concerned about having all of those mutations together and what that would mean in terms of vaccine escape.Andrew Sheets So Matt, this is obviously a challenging situation because this is a new variant. It's just been discovered. And yet, you know, a lot of people are trying to figure out what the longer-term implications could be. So, you know, when you look at this with the kind of a limited amount of information, you know, what are the key characteristics that you're going to be watching that that you think we should care about?Matthew Harrison There are probably three things that I'm focused on and we can probably touch on in detail. So the first one is transmissibility, and the reason for that is if this variant overtakes Delta and becomes dominant globally, then we're going to care about the two other factors a lot more, which is vaccine escape and lethality. However, if it's not more transmissible than Delta and Delta remains the dominant variant, then this may be an issue in small pockets, but ultimately will fade and continue to be overtaken by Delta. And so that's why transmissibility is the primary focus. And so what do we know about transmissibility right now? We have a couple of pieces of information out of South Africa. The first is they have sequenced a number of recent COVID patients. And in those sequences, the vast majority or almost all of them have been Omicron. So that suggests that it is overtaking Delta. But again, sometimes sequence results can be biased because they're not a population sample and they're a selection of a certain subset of people. The second piece of information, which to me is more compelling, is I'm sure everybody's aware of the PCR tests. There's a certain kind of deletion here in this variant that that that you can pick up with a PCR test and so you can see the frequency of that deletion. And that that frequency has risen from about a background rate of about 5% in the last week and a half to about 50% of the PCR tests coming back suggestive of this variant in South Africa. And so that's a much bigger sample size than the sequencing sample size. And so that suggests at least in the small subset that you're seeing greater transmissibility compared to Delta. Now it's going to take time to confirm that. And now that we've seen cases globally in a lot of countries over the next week or two, everybody's going to be watching how quickly the Omicron cases rise compared to Delta to confirm whether or not it's more transmissible than Delta.Andrew Sheets This question of vaccine evasion. There's there has been some increased concern about this new variant that it might be able to evade vaccines. Why do people think that? And you know, how soon might we know?Matthew Harrison Why don't we start with the timeline, because that's the simpler part. The experiments to figure that out take about two weeks. And just so everybody has the background on this, you need to take the virus, you need to grow it up. And once you have a sample of it, then you take blood from people that have recovered from COVID and blood from people that have been vaccinated that are full of those antibodies. And you put them in the in the dish and you find out how much virus you kill. And that'll tell you how effective the serum from vaccinated or previously infected individuals are against the new variant. So that process typically takes about two weeks. So then why are people worried about vaccine evasion with this variant? Primarily because of the known mutations that it carries and the unknown mutations. And of the known mutations that it carries, it carries the same set of mutations as in beta, and the beta variant had significant vaccine evasion properties that never became dominant, but it did reduce vaccine effectiveness by about six-fold. And so, I think the concern is with those mutations, plus a range of other mutations known to have vaccine evasion properties, having them all together has really significantly increased concern about how much that may hurt the vaccine's ability to stop infection.Andrew Sheets And, Matt, so you talked about the importance of transmissibility, you know, you talked about some of the reasons why the concerns are higher around vaccine evasion with this variant. And the last thing you talked about was the lethality of this variant. And again, you know, what are you looking for there? Is there anything that concerns you with the information that we know and when might we know more?Matthew Harrison So this is the hardest question because as is typical, you get a lot of anecdotal reports about what's happening with recently infected patients, but it takes a while, on order of four to five weeks, to really understand if there is a significant difference in mortality or hospitalization. So we have very little information around those factors. You have seen in the capital region, in South Africa, where you've where you've seen these rising cases, a rise in hospitalizations, but we don't know if all those cases are Omicron cases or not. And we haven't seen mortality at all. But again, with recent infections, it usually takes four or five weeks to start to see the potential impact of those infections on mortality.Matthew Harrison And Andrew, I think one other thing which is important to mention is while we're while we're talking about severity of disease and lethality, we have to remember that in addition to vaccines, we do have now other effective treatments, including antibody therapies and oral therapies. And while some antibody therapies are likely not to work against Omicron, at least two or three of them are. And so you have you will have some effective antibody therapies. And then the oral therapies, given their mechanisms of action, should not be impacted. So we will have oral therapies in terms of treatment. So hopefully, even if we do get a scenario where there is significant impact on vaccine efficacy, this will not be like going back to the beginning of the pandemic, where we didn't have other effective treatments available.Matthew Harrison Andrew, unlike normal episodes, maybe it'll be my chance since the markets have been so volatile. How has this impacted your outlook on the markets in the near to medium term?Matthew Harrison I know inflation and the inflation debate and the impact of central banks on inflation has been a sort of key debate that I've heard you guys reflecting on.Andrew Sheets Yeah. So I think probably the thing I should say up front is at the moment, we don't think we have enough evidence around this variant to change our baseline economic forecast to change that optimistic view on growth. Now what it might change is some of the timing around it, and I think we saw a little bit of this with the Delta variant. Where, you know, that was a big development in 2021, you know, people didn't see that coming. And you know, if you step back and think about this year, the market was still good, yield still rose, there was a lot of market movement, very consistent with better economic growth if you take the year as a whole, even though you had this variant, but the variant did introduce some kind of twists and turns along the way. So you know, that's currently the way that we're thinking about this new omicron variant that it is not likely or we don't know enough yet to be confident that it would really change that economic outlook, especially because we think there are a lot of good reasons why growth could be solid, but it might introduce some near-term uncertainty. You know, the interesting thing about, as you mentioned, inflation is that it could affect inflation in both directions. It could cause inflation to be higher, for example, if it, you know, causes shutdowns in countries that are important for producing key goods. And you can't get the things that you want, and the price goes up. But it could also drive prices down. You know, on last Friday oil prices fell by over 10%. You know, that is a big part of inflation certainly as most people experience it. Gas prices will be lower based on what happened on Friday. So that can drive inflation down so it can cut both ways.Matthew Harrison Andrew, it's been great talking to you. Thanks for your thoughts.Andrew Sheets Matt, always a pleasure to talk to you.Matthew Harrison As a reminder, 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 find the show.

1 Dec 20219min

With last week’s news of the Omicron variant of COVID-19, markets sold-off sharply on Friday, but beyond the headlines, there may be other underlying factors at play.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, November 29th at 1:00 p.m. in New York. So let's get after it. Last week, the big news for markets was this new COVID variant named Omicron. While we don't yet know the characteristics of this variant with respect to its transmission and mortality rates, some nations are already acting with new restrictions on travel and other activities. These new restrictions is what markets were fearing the most on Friday, in our view. I'm also confident that markets were already expecting some seasonal increases in cases as we enter the winter months. This is why I'm not so sure Friday's sharp sell-off in equity markets was as much about Omicron as it was just a market looking for an excuse to go lower. In fact, equity markets had already been weak heading into Thanksgiving Day - a period that is almost always positive for stocks. This was before Omicron was a real concern, so why would that be the case? As we laid out in our year-ahead outlook, the combination of tightening financial conditions and decelerating growth is usually not bullish for stocks. When combined with one of the highest valuations on record, this is why we have a very unexciting 12-month price target for the S&P 500. Finally, as discussed on this podcast for the past 6 weeks, stocks typically do well from September to year end if they are already up until that point. However, we felt like that seasonal trade would be tougher after Thanksgiving, as the Fed began to taper its asset purchases and institutional investors moved to lock in profits rather than worrying about missing out on further upside. With retail a large buyer during Friday's sharp sell-off, it appears that the institutional investors were the ones selling. In short, it looks like that switch to locking in profits may have begun. Today's bounce back also makes sense in the context of a market that understands Omicron is probably not going to lead to a significant lockdown. In fact, we're already hearing reassuring words from the authorities making those decisions. The bottom line is that markets were already choppy, with many higher beta indices and stocks trending lower before this latest COVID variant. Breadth has also been weak, with erratic leadership. High dispersion between stocks is another market signal that suggests the rising tide may be going out. Our view remains consistent - the investment environment is no longer rich with opportunity, which means one must be more selective. In a world of supply shortages, we favor companies with high visibility on earnings due to superior pricing power or cost management. We also think it makes sense to be very attendant to valuation and not overpay for open ended growth stories with questionable profitability. From a sector standpoint, Healthcare, REITs and Financials all fit these characteristics. 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.

29 Nov 20213min

The Build Back Better Act took a key step towards becoming law last week, signaling implications for fiscal policy and taxation as the bill heads to the Senate.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 24th at 11:00 a.m. in New York. Last week, the Build Back Better Act took a step toward becoming law when the House of Representatives passed the bill along party lines. While the act now still needs to win Senate approval, likely with some substantive changes, there are two lessons that we learned from the House's actions. First, U.S. fiscal policy will continue to be expansionary in the near term. That's based on analysis from the Congressional Budget Office of the Build Back Better plan, adjusted for some key provisions that likely won't survive the Senate. When added to the analysis of the recently enacted Bipartisan Infrastructure Framework, it shows the combined plans could add around $200B to the deficit over 10 years - close to our base case of about $260B. But more importantly, the analysis suggests most of this deficit increase is front loaded, with around $800B of deficits in the first 5 years - toward the high end of the base case range we flagged earlier this year. This is the number we think matters to the economy and markets, as the durability of the policies that will reduce this deficit beyond 5 years is less certain, as elections can lead to future policy changes. And this number also helps drive some key views, namely our economists' call for above average GDP next year and our rates teams' view that bond yields will continue to move higher. Our second lesson is that the corporate minimum tax looks like it has legs. The provision, also called the Book Profits Tax, survived the house process largely unscathed. While Senate modifications are to be expected, we expect the provision will be enacted. That means investors will have to get smart on the sectoral impacts of this new, somewhat complex, corporate tax. Our base case is that this won't be a game changer for markets. Our equity strategy team calculates a 4% hit to S&P 500 earnings before accounting for any economic growth. And while some sectors, like financials, appear most likely to have a higher tax bill, our banks analyst team expects most of this new expense can be offset by tax credits. Still, this new tax is tricky and untested, so fresh risks can emerge as the bill goes through edits in the Senate. So, we'll be tracking it carefully into year end. 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.

24 Nov 20212min

Our 500th episode! From all of us at Morgan Stanley, thanks to our listeners for all your support!An overview of our expectations for the year ahead across inflation, policy, asset classes and more. As with 2021, we expect many twists and turns along the way.----- Transcript -----Welcome to the 500th episode of Thoughts on the Market. I'm Andrew Sheets, and from all of us here at Morgan Stanley, thank you for your support. Today, as always, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Tuesday, November 23rd at 2:00 p.m. in London. At Morgan Stanley Research. We've just completed our outlook for 2022. This is a large, collaborative effort where all of the economists and strategists in Morgan Stanley Research get together and debate, discuss and forecast what we think holds for the year ahead. This is an inherently uncertain practice, and we expect a lot of twists and turns along the way, but what follows is a bit of what we think the next year might hold. So let's start with the global economy. My colleague Seth Carpenter and our Global Economics team are pretty optimistic. We think growth is strong in the U.S., the Euro area and China next year, with all three of those regions exceeding consensus expectations. A strong consumer, a restocking of low inventories and a strong capital expenditure cycle are all part of this strong, sustainable growth. And because we think consumers saved a lot of the stimulus from 2021, we're not forecasting a big drop off in growth as that stimulus fails to appear again in 2022. While growth remains strong, we think inflation will actually moderate. We forecast developed market inflation to peak in the coming months and then actually decline throughout next year as supply chains normalize and commodity price gains slow. Even though inflation is moderating, monetary policy is going to start to shift. Ultimately, we think moderating inflation and some improvement in labor force participation means that the Fed thinks it can wait a little bit longer to raise interest rates and doesn't ultimately raise rates until the start of 2023. For markets, shifting central bank policy means that the training wheels are coming off, so to speak. After 20 months of unprecedented support from both governments and central banks, this extraordinary aid is now winding down. Asset classes will need to rise and fall or, for lack of a better word, pedal under their own power. In some places, this should be fine. From a strategy perspective, we continue to believe that this is a surprisingly normal cycle, albeit one that's moving hotter and faster given the scale of the drawdown during the recession and then the scale of a subsequent response. As part of our cross-asset strategy framework, we run a cycle indicator that tries to quantify where we are in that economic cycle. We think markets are facing many normal mid-cycle conditions, not unlike 2004/2005. Better growth colliding with higher inflation, shifting central bank policy and more expensive valuations. Overall, we think that those valuations and this stage of the economic cycle supports stocks over corporate bonds or government bonds. We think the case for stocks is stronger in Europe and Japan than in emerging markets or the US, as these former markets enjoy more reasonable valuations, more limited central bank tightening and less risk from legislation or higher taxes. Those same issues drive a below consensus forecast here at Morgan Stanley for the S&P 500. We think that benchmark index will be at 4400 by the end of next year, lower than current levels. How do we get there? Well, we think earnings are actually pretty good, but that the market assigns a lower valuation multiple of those earnings - closer to 18x or around the average of the last 5 years as monetary policy normalizes. For interest rates and foreign exchange, my colleagues really see a year of two parts. As I mentioned before, we think that the Fed will ultimately wait until 2023 to make its first rate hike, but it might not be in any rush to signal that action right away, especially because inflation remains relatively high. As such, we remain positive on the U.S. dollar and think that U.S. interest rates will rise into the start of the year - two factors that mean we think investors should be patient before buying emerging market assets, which tend to do worse when both the U.S. dollar and yields are rising. We forecast the U.S. 10-year Treasury yield to be at 2.1% by the end of 2022 and think the Canadian dollar will appreciate against most currencies as the Bank of Canada moves to raise interest rates. That's a summary of just a few of the things that we think lie ahead in 2022. As with 2021, we're sure they're going to be many twists and turns along the way, and we hope you keep listening to Thoughts on the Market for updates on how we see these changes and how they impact our market views. 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.

23 Nov 20214min