What Japan Can Teach the World About Longevity

Our CIO and Chief U.S. Equity Strategist explains why economic fluctuations have made it more difficult to project a possible soft or no landing outcome, and how investors can navigate this continuing market volatility.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the continued uncertainty in economic data and its impact on markets. It's Monday, June 10th at 11:30am in New York. So let’s get after it. Over the past few months, the economic growth data has surprised to the downside with more data releases coming in below expectations than usual. Meanwhile, inflation surprises have skewed more to the upside. This is a challenging combination because it means the Fed can't cut rates yet even though it may make sense to keep the economic expansion going. As we have been discussing for months, aggressive fiscal spending is keeping the headline economy looking good on the surface. The bad news is that inflation remains too high for the Fed which has to keep interest rate policy too tight for many economic participants. Some may disagree with that statement, but we think it's hard to argue with the yield curve which remains significantly inverted and a valid indicator of interest rate policy. When combined with high price levels for many goods and services, the end result is a crowding out of many parts of the economy and consumers. From our perspective, this is most evident in the persistent underperformance of small cap stocks. In fact, this past week, small cap equities relative performance fell to new cycle lows. Even more concerning is that while small caps are showing greater interest rate sensitivity than large caps, it’s also asymmetric. While higher rates are an obvious headwind for small caps, we're skeptical that lower rates offer a comparable benefit. Last week was a good example of this dynamic when small caps underperformed early in the week when rates rose and later in the week when rates fell. All of this argues for what we have been recommending — in an uncertain macro world, we think investors should stay up the quality curve with a barbell of both growth and cyclicals to participate in both the soft and no landing outcomes. We also think it makes sense to have some defensive exposure as a hedge against the above average risk of a recession that still looms. Given the more negative skew in the economic surprise data as noted, we think the defensive part of the portfolio should outweigh cyclicals at this point. We favor staples and utilities specifically in this regard. With markets sensitive to unpredictable inflation and labor data, it's very difficult to have an edge going into these releases, particularly on the labor front where the data itself has been subject to significant and ongoing revisions. While many market participants focus on the non-farm payroll data, these data have been subject to some of the larger revisions we’ve seen in recent history. Meanwhile, the household survey has been weaker than the non-farm payroll data and job openings have fallen persistently over the last 18 months. These diverging labor dynamics are classic late cycle phenomena based on our experience. For investors, it's just another reason to stay up the quality curve and to avoid positioning for a broadening out to lower quality areas. In our view, such a broadening is unlikely in any kind of sustainable way until the Fed cuts meaningfully — and by that we mean several hundred basis points rather than the one-to-two cuts that are now priced into the markets for this year. Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

10 Juni 20243min

Our Global Head of Emerging Markets Sovereign Credit reviews key insights and strategies for investors following the recent elections in Mexico, South Africa and India.----- Transcript -----Welcome to Thoughts on the Market. I’m Simon Waever, Morgan Stanley’s Global Head of EM Sovereign Credit and Latin America Fixed Income Strategy. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the far-reaching impact of emerging market elections on global markets. It’s Friday, June 7, at 10am in New York.Elections in 2024 will impact roughly 4 billion people around the globe – that’s the most in history. And within emerging markets, elections this year will impact nearly half the market cap of both hard and local currency debt indices and 60 percent of equities. With a dozen elections in the emerging markets sovereign credit universe already behind us, there are still almost another twenty more to go.We find that elections in emerging markets matter for both credit spreads and fiscal balances. And a frequent investor question is how to trade positive and negative election outcomes. This can be defined in many ways, of course, but we focus on whether credit spreads widen – which is a negative – or tighten – which is a positive – in the week post-elections. And history suggests that buying into negative election surprises has been a profitable strategy. But on the other hand, positive elections, they’re priced in beforehand and should not be chased post-outcome.So why is that, exactly? Well, for positive elections, markets tend to rally nearly continuously into the elections; but after the initial week of tightening, spreads then revert and end up trading only slightly tight to the levels prior to the elections. And then for negative elections, there’s actually no real trend ahead of the elections, with spreads largely flat. But then, after the initial sell-off, credit spreads end up reversing the initial move wider, and three months out the spreads are tighter than immediately post-elections. So, with this in mind, let’s consider the three most recent election outcomes in Mexico, India, and South Africa. And actually, all three had an element of surprise.In Mexico, they elected their first female president, Claudia Sheinbaum. That was expected – but the surprise was that she got a much larger majority than polls suggested, which means that it becomes easier to push through constitutional changes. So, I think it’s fair to say that uncertainty has increased, and markets are now in a wait-and-see mode looking for what policy she will prioritize.And from my side, I’m paying particularly close attention to the many reforms submitted by the executive to the Congress back in February, and then any signs of fiscal consolidation, which is needed.South Africa saw the ANC fall below 50 per cent for the first time, and they now need to form a coalition or at least agree on a confidence and supply model. Well, I would say that at this point, markets are already pricing a lot of that uncertainty.Finally, in India, the BJP led New Democratic Alliance is set to form a government for the third term, and we think the most important aspect of this is policy predictability. And in particular we see a number of critical structural reforms made in this third term; and then importantly for fixed income, we see a reduction in the primary budget deficit.We will continue to monitor closely the remaining emerging markets elections in this landmark election year, and we’ll come back with more investment updates.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

7 Juni 20243min

Our four-person panel explains Japan’s economic boom, from growing GDP to corporate sector vibrancy, and which upward trends will sustain.----- Transcript -----Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.Japan is undergoing a once in a generation transformation. A country once associated with its lost decades is now seeing multi-decade highs for nominal GDP growth and equity indices.On this special episode of the podcast, we will discuss why we are so optimistic on Japan's trajectory from here. I'm joined by our Chief Japan Economist Takeshi Yamaguchi, our Chief Asia and EM Strategist Jonathan Garner, and our Japan Equity Strategist Sho Nakazawa.This episode was recorded last Friday, May 31st at 9 am in Hong Kong.Jonathan Garner: And 9 am in Singapore. Takeshi Yamaguchi: And 10 am in Tokyo. Chetan Ahya: Japan's nominal GDP growth reached a 32 year high in 2023. Equity markets have reached multi decade highs, and ROE and productivity growth have been on an improving trend. Corporate sector vibrancy is returning, and animal spirits are reviving. A new, stronger equilibrium is one of robust nominal GDP growth and a sustainable moderate inflation.This new equilibrium of stronger normal GDP growth and low real interest rates will also be supportive of Japan's capex trends. With that backdrop, let me now turn to Yamaguchi san. Yamaguchi-san, what makes us confident that this virtuous cycle of rising wages and prices will continue to play out?Takeshi Yamaguchi: We think Japan's social norm of no price hike, no wage hike is changing, and a good feedback loop between wages and prices is emerging. Workers demand higher wages with higher inflation expectations and the corporate management accept their demand, as they also expect higher inflation. Japan's labor market remains structurally tight and aggregated corporate profits are now at a record high level. In addition to the pass-through from prices to wages, we are beginning to see the pass-through in the other direction from wages to prices, especially in service prices. The average wage hike in these spring wage negotiations was the highest in the last 33 years. So, we expect to see a gradual rise in service inflation going ahead with a rise in wages. Chetan Ahya: Could you elaborate a bit on the details of the capex outlook? Takeshi Yamaguchi: Yes. We expect Japan's private capex to exceed its previous 1991 peak this year. In the previous deflationary period, domestic nominal GDP remained in a flat range, and Japanese firms mainly invested abroad. That said, the trend of Japanese nominal GDP growth has shifted up, which will likely positively affect Japanese firms’ decision to increase domestic investment.Also, there are various other factors supporting domestic capex, such as real interest rates remaining low, the weak yen, the government's new industrial policy supporting onshoring and semiconductor investment, and the need for digitalization and labor-saving investment on the back of structural labor shortage driven by demographic shifts.Chetan Ahya: Thank you, Yamaguchi-san. And, you know, I can't let you go without answering this question, which is much of the focus of the markets right now. If yen depreciates to 160 again, how much upside risk to your rate path do you see?Takeshi Yamaguchi: Our FX team expects the yen to gradually appreciate to 146 by the end of 2024, and under the assumption, we expect one hike this year in July and another one in January next year. However, if sustained yen depreciation raises domestic underlying inflation trend, we think the BOJ will respond by raising the policy rate further to 0.75 per cent in 2025.Chetan Ahya: Thank you, Yamaguchi-san. Jonathan, let me come over to you now. You have led the debate on Japan's ROE improvement and have been bullish since 2018. How are we thinking about Japan equities from a broader Asia market allocation perspective now?Jonathan Garner: Back in 2018, we highlighted Japan equities as what we called the most underappreciated turnaround story in global equities. And at the heart of our thesis was the idea that monetary and fiscal policy dials were now set to exit deflation, driving an improved top-down environment for corporations from an asset utilization perspective.It's worth recalling that during the deflation era, Japan listed equities ROE averaged just 4.2 per cent for two decades, by far the lowest in global markets. That's now reached almost 10 per cent, and we're confident that by the end of next year we can be approaching 12 per cent, which would put Japan back in the middle of the pack in global equity markets.And we think further re-rating in line with the improved ROE is likely, over the medium term.Chetan Ahya: And how much upside do we see from here?Jonathan Garner: Well, in terms of the target price that we published in our midyear outlook, that now stands at 3,200 for June 2025 for TOPIX. And the way that we derive that is through an earnings forecast for TOPIX, which is around 5 per cent above current consensus levels.And in addition, a forward PE multiple assumption of 15 times, which is close to where the market is currently trading, and around about a 4 PE point discount to our target multiple for the S&P 500. So that gives us around 16 per cent upside versus current spot levels.Chetan Ahya: Thank you, Jonathan. And you mentioned about corporate governance changes helping Japan equity markets. Sho, let me bring you in here. How will corporate governance changes drive further improvement in Japan's ROE?Sho Nakazawa: I would say corporate governance reform, which is Tokyo Stock Exchange initiative will help fuel OE gains going forward. From the last year below 1x P/B has been a buzz word in the market, growing sense of shame and peer pressure to enhance capital efficiency for the corporate executives. And this is not just a psychological change. If we look at cumulative share buybacks amount, last fiscal year it hit a record high of ¥10 trillion, and we are seeing further record growth into this fiscal year as well.Chetan Ahya: And what are the key alpha generation themes still to pay for within Japan equities space?Sho Nakazawa: In terms of alpha generation, we explored three key themes within the Japanese equity landscape. So one, identifying companies with labor productivity and pricing power that can pay and absorb higher real wages; and two, finding the next cohort of corporate reform beneficiaries. Three, assessing the impact of NISA, Nippon Individual Saving Account, inflows.I think this will drive large cap, high-liquidity value and high dividend stock. Still plenty to play for in Japan.Chetan Ahya: Yamaguchi-san, Jonathan, Nakazawa-san, thank you all for taking the time to talk. And thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.

6 Juni 20247min

Original release date April 29, 2024: Our analysts find that despite the obvious differences between retail fashion and airlines, struggling brands in both industries can use a similar playbook for a turnaround.----- Transcript -----Ravi Shanker: Welcome to Thoughts on the Market. I'm Ravi Shanker, Morgan Stanley's North American Freight Transportation and Airlines Analyst.Alex Straton: And I'm Alex Straton, Morgan Stanley's North America Softlines, Retail and Brands Analyst.Ravi Shanker: On this episode of the podcast, we'll discuss some really surprising parallels between fashion, retail, and airlines.It's Monday, April 29th at 10am in New York.Now, you're probably wondering why we're talking about airlines and fashion retail in the same sentence. And that's because even though they may seem worlds apart, they actually have a lot in common. They're both highly cyclical industries driven by consumer spending, inventory pressure, and brand attrition over time.And so, we would argue that what applies to one industry actually has relevance to the other industry as well. So, Alex, you've been observing some remarkable turnaround stories in your space recently. Can you paint a picture of what some fashion retail businesses have done to engineer a successful turnaround? Maybe go over some of the fundamentals first?Alex Straton: What I'll lead with here is that in my North America apparel retail coverage, turnarounds are incredibly hard to come by, to the point where I'd argue I'm skeptical when any business tries to architect one. And part of that difficulty directly pertains to your question, Ravi -- the fundamental backdrop of the industry.So, what are we working with here? Apparel is a low single digit growing category here in North America, where the average retailer operates at a mid single digit plus margin level. This is super meager compared to other more profitable industries that Ravi and I don't necessarily have the joy of covering. But part of why my industry is characterized by such low operating performance is the fact that there are incredibly low barriers to entry in the space. And you can really see that in two dynamics.The first being how fragmented the competitive landscape is. That means that there are many players as opposed to consolidation across a select few. Just think of how many options you have out there as you shop for clothing and then how much that has changed over time. And then second, and somewhat due to that fragmentation, the category has historically been deflationary, meaning prices have actually fallen over time as retailers compete mostly on price to garner consumer attention and market share.So put differently, historically, retailers’ key tool for drawing in the consumer and driving sales has been based on being price competitive, often through promotions and discounting, which, along with other structural headwinds, like declining mall traffic, e-commerce growth and then rising wages, rent and product input costs has actually meant the average retailers’ margin was in a steady and unfortunately structural decline prior to the pandemic.So, this reliance on promotions and discounting in tandem with those other pressures I just mentioned, not only hurt many retailers’ earnings power but in many cases also degraded consumer brand perception, creating a super tough cycle to break out of and thus turnarounds very tough to come by -- bringing it full circle.So, in a nutshell, what you should hear is apparel is a low barrier to entry, fragmented market with subsequently thin margins and little to no precedent for successful turnarounds. That's not to say a retail turnaround isn't possible, though, Ravi.Ravi Shanker: Got it. So that's great background. And you've identified some very specific key levers that these fashion retail companies can pull in order to boost their profitability. What are some of these levers?Alex Straton: We do have a recent example in the space of a company that was able to break free of that rather vicious cycle I just went through, and it actually lifted its sales growth and profitability levels above industry average. From our standpoint, this super rare retail turnaround relied on five key levers, and the first was targeting a different customer demographic. Think going from a teens focused customer with limited brand loyalty to an older, wealthier and less fickle shopper; more reliable, but differently.Second, you know, evolving the product assortment. So, think mixing the assortment into higher priced, less seasonal items that come with better margins. To bring this to life, imagine a jeans and tees business widening its offering to include things like tailored pants and dresses that are often higher margin.Third, we saw that changing the pricing strategy was also key. You can retrain or reposition a brand as not only higher priced through the two levers I just mentioned, but also try and be less promotional overall. This is arguably, from my experience, one of the hardest things for a retailer to execute over time. So, this is the thing I would typically, you know, red flag if you hear it.Fourth, and this is very, very key, reducing the store footprint, re-examining your costs. So, as I mentioned in my coverage, cost inflation across the P&L (profit and loss) historically, consumers moving online over time, and what it means is retailers are sitting on a cost base that might not necessarily be right for the new demand or the new structure of the business. So, finding cost savings on that front can really do wonders for the margins.Fifth, and I list this last because it's a little bit more of a qualitative type of lever -- is that you can focus on digital. That really matters in this modern era. What we saw was a retailer use digital driven data to inform decision making across the business, aligning consumer experience across channels and doing this in a profitable way, which is no easy feat, to say the least.So, look, we identified five broad enablers of a turnaround. But there were, of course, little changes along the way that were also done.Ravi Shanker: Right.Alex Straton: So, Ravi, given what we've discussed, how do you think this turnaround model from fashion retail can apply to airlines?Ravi Shanker: Look, I mean, as we discussed, at the top here, we think there are significant similarities between the world of fashion retail and airlines; even though it may not seem obvious, at first glance. I mean, they're both very consumer discretionary type, demand environments. The vicious circle that you described, the price deflation, the competition, the brand attrition, all of that applies to retail and to airlines as well.And so, I think when you look at the five enablers of the turnaround or levers that you pull to make it happen, I think those can apply from retail to airlines as well. For instance, you target a different customer, one that likes to travel, one that is a premium customer and, and wants to sit in the front of the plane and spend more money.Second, you have a different product out there. Kind of you make your product better, and it's a better experience in the sky, and you give the customer an opportunity to subscribe to credit cards and loyalty program and have a full-service experience when they travel.Third, you change your distribution method. You kind of go more digital, as you said. We don't have inventory here, so it'd be more of -- you don't fly everywhere all the time and be everything to everyone. You are a more focused airline and give your customer a better experience. So, all of those things can drive better outcomes and better financial performance, both in the world of fashion retail as well as in the world of airlines.Alex Straton: So, Ravi, we've definitely identified some pretty startling similarities between fashion retail and airlines. Definitely more so than I appreciated when you called me a couple months ago to explore this topic. So, with that in mind, what are some of the differences and challenges to applying to airlines, a playbook taken from the world of fashion retail?Ravi Shanker: Right, so, look, I mean, they are obviously very different industries, right? For instance, clothing is a basic human staple; air travel and going on vacations is not. It's a lot more discretionary. The industry is a lot more consolidated in the airline space compared to the world of retail. Air travel is also a lot more premium compared to the entire retail industry. But when you look at premium retail and what some of those brands have done where brands really make a difference, the product really makes a difference. I think there are a lot more similarities than differences between those premium retail brands on the airline industry.So, Alex, going back to you, given the success of the turnaround model that you've discussed, do you think more retail businesses will adopt it? And are there any risks if that becomes a norm?Alex Straton: The reality is Ravi, I breezed through those five key enablers in a super clear manner. But, first, you know, the enablers of a turnaround in my view are only super clear in hindsight. And then secondly, one thing I want to just re-emphasize again is that a turnaround of the nature I described isn't something that happens overnight. Shifting something like your consumer base or changing investor perception of discounting activity is a multi year, incredibly difficult task; meaning turnarounds are also often multi year affairs, if ever successful at all.So, looking ahead, given how rare retail turnarounds have proven to be historically, I think while many businesses in my coverage area are super intrigued by some of this recent success; at the same time, I think they're eyes wide open that it's much easier said than done, with execution far from certain in any given turnaround.Ravi Shanker: Got it. I think the good news from my perspective is that hindsight and time both the best teachers, especially when put together. And so, I think the learnings of some of the success stories in your sector can not only be lessons for other companies in your space; they can also be lessons in my space. And like I said, I think some airlines have already started embarking on this turnaround, others are looking to see what they can do here. And I'm sure again, best practices and lessons can be shared from one sector to another. So, Alex, thanks so much for taking the time to talk to us today.Alex Straton: It was great to speak with you, Ravi.Ravi Shanker: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.

5 Juni 202410min

Our Chief Fixed Income Strategist takes listeners behind the curtain on Morgan Stanley’s expectations for markets over the next 12 months.----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupathur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the key debates we engaged in during the mid-year outlook process.It's Tuesday, June 4th at 1pm in New York.Over the last few episodes, you've been hearing a lot about Morgan Stanley's midyear outlook, where our economists have forecasted a sunny macro environment of decelerating growth and inflation, and policy easing in most developed market economies, leading to a positive backdrop for risk assets in the base case, especially in the second half of the year.But beyond the year end, many uncertainties -- uncertainties of outcomes and uncertainties of the consequences of those outcomes -- point to a wider range of outcomes, driving a wider than normal bull versus bear skew in our expectations for markets over the next 12 months.As always, these outlooks are the culmination of a process involving much deliberation and spirited debate among economists and strategists across all the regions and asset classes we cover. I thought it might be useful to detail some of these debates that we've had during the process to shed a better light on the forecast in our outlook.First, given the many changes to market pricing of Fed's rate cuts year to date, driven by higher-than-expected inflation, the path ahead for US inflation was heavily debated. Our economists argued that the acceleration in goods and financial services prices, which explains a substantial portion of the upside in the first quarter inflation data should decelerate from here. And also that leading indicators point to a weaker shelter inflation ahead. Their analysis also showed that residual seasonality contributed to the unexpected strength in first quarter [20]24 inflation data, suggesting a payback has to happen in the second half of 2024.The outlook for China economy and our cautious stance on the market was another point of debate, mainly because China's growth has surprised to the upside relative to our 2024 year ahead outlook. Our economists argued that while there are a few policy positives on housing and green products mitigating the debt deflation spiral, growth remains unbalanced and subpar. So, we discussed our cautious stance on China equity markets against this backdrop and concluded that the equity market recovery is still very challenging in China.Third, given the combination of favorable technicals, solid fundamentals, and a relatively benign economic outlook, we debated whether corporate credit, on which we are constructive, should we be even more constructive in our forecasts. After all, the setup for corporate credit has many elements similar to those during the mid 1990s, when, for example, US IG index spreads were about 30 basis points tighter versus the current spread targets. Our strategist highlighted the significant differences in the market structure, the composition of the index, and the duration of the underlying bonds that make up this index today, versus 1990s -- all of which put a higher floor on spreads, which explains our spread targets.The debates notwithstanding, we cannot argue with the benign macro backdrop and what that means for the second half of 2024. We turn overweight in global equities and overweight in a range of spread products within fixed income, most notably agency MBS, EM Sovereign credit, leveraged loans, securitized credit, especially CLO equity tranches.Thanks for listening. If you enjoyed the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

4 Juni 20243min

Our Chief Cross-Asset Strategist explains why the high correlation between stocks and bonds could work in investors’ favor throughout the second half of this year.----- Transcript -----Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why we believe bonds and equities can both rally this year, with the still-elevated correlations between the two assets a boon rather than a bane to investors. It’s Monday, June 3rd at 10am in New York. In our mid-year outlook two weeks ago, we expressed our bullish view on both global equities and parts of fixed income space like agency mortgage-backed securities and leveraged loans, on the back of the benign economic backdrop our economists are forecasting for in the second half of 2024. Now, this may be surprising to some. Received wisdom is that in an environment of rate cuts and falling yields, equities can't perform well because the former usually maps to growth slowdowns. When equities see double-digit upside – which is what we’re projecting for European equities – it’s unusual for bonds to also see strong and positive returns, which is what we’re projecting for German government bonds. And I want to push back on this received wisdom that we can’t have an ‘everything rally’. When we look at the annual performance of global stocks and 10-year US Treasuries every year going back to 1988, in the 13 times when the Fed cut rates over the course of the year, bond yields were lower and equities were up 43 per cent of the time. And in those periods, stock returns averaged 18 per cent while yields fell over 1 percentage points. ‘Everything rallies’ happen often in this very macro backdrop of benign growth and Fed cuts we’re expecting, And when they do happen, everything indeed rallies – strongly. Or to frame it another way – our expectations for both global equities and fixed income to see strong total returns this year is the flipside of what markets had experienced in 2022. Now back then, unlike in most other prior cycles, stock-bond return correlations were high because inflation was elevated even as growth was sluggish, meaning that bonds sold off on higher rates expectations, and equities on bad earnings. Today, with our view that global growth can be robust while disinflation continues, the opposite will likely be true; bonds should rally on lower rates expectations, and equities on strong earnings revisions. Stock-bond return correlations are still elevated, but it should work in an investor’s favor this year. Lean into it. Good macro, fair fundamentals, pockets of attractive valuations all make for a strong environment for risk assets, a reason for us to get more bullish on European and Japanese equities, but also in fixed income products like leveraged loans and Collateralized Loan Obligations. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

3 Juni 20243min

In a generally positive environment for corporate credit, the recent performance of high-yield bonds in the telecom, media and technology (TMT) sector offers a market contrast. Our Lead Analyst for High-Yield TMT joins our Head of Corporate Credit Research to explain the divergence.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research for Morgan Stanley.David Hamburger: And I'm David Hamburger, Head of US Sector Corporate Credit Research and Lead Analyst for the high yield telecom, media, and technology sectors.Andrew Sheets: And today on the podcast we'll be discussing the contrast between strong overall markets in credit and a whole lot of volatility in the high yield TMT space.It's Friday, May 31st at 10am in New York.So, David, it's great to talk to you. You know, listeners have probably been hearing about our views on overall markets and credit markets for the 12 months ahead.We have US growth at 2 percent. We have inflation coming down. We had the Fed lowering interest rates. But there’s needless to say; there's some pretty notable contrast between that sort of backdrop and the backdrop we've had for credit year to date, which has been pretty calm, pretty strong -- and what's been going on in your sector.So maybe before we get into the why -- let's talk about the what and bring people up to speed on the saga that's been high yield TMT year.David Hamburger: Yeah. I'm here today to disavow you of any notion that everything is fine and dandy in the market today. So, if you look at the high yield communications sector, it's trading about 325 basis points wide of the overall high yield index. And just to give you that magnitude of that -- the high yield index trading around 300 basis points -- we're talking about 625 basis points over. Now, the high yield communication sector as well is trading about 275 basis points, wider than the next widest sector in the index.And so, it's pretty astounding today, given the market backdrop, how much underperformance we've seen in this sector.Andrew Sheets: What's been causing this just large divergence between high yield TMT and what seems like a lot of other things?David Hamburger: Yeah, I think there are two forces at work here. One's kind of a broader set of issues that I can outline for you. Really, I think it's a combination of one, the maturation of the communications marketplace. Coming out of COVID, we certainly had accelerated adoption of broadband and wireless services. That in and of itself has created a lot of intense competition.And as such, we've seen a lot of technological advances that have created some secular pressures on the space. As well, when you pair that up with elevated financial leverage, all coming together at a time when the marginal cost of capital for companies has increased due to higher interest rates. Those are really some of the underlying forces at work that have driven underperformance in this sector.But some companies have managed to navigate this environment. And I would say by and large, it's those with really strong balance sheets. But that has really cast a shadow on this sector -- is the fundamental and financing issues.When you think about the bloated balance sheets that some of the other companies have had, they've been exploring a whole new set of transactions and, evaluating different options for their balance sheets. And that's probably the more sinister thing that we've seen in the market of late.Andrew Sheets: So, so tell me a little bit more about this. You know, what are some of the types of things that companies can do that often leave the bond holder unhappy?David Hamburger: We all became all too aware of what private equity sponsors might do back in the heyday of LBOs, and we still live in that world today, and it's really fairly well known.You know, I've been in the credit markets for more than 20 years, but I can't recall a time we've seen so many management teams and controlling shareholders now that are at odds with their creditors because of elevated leverage and the business risks they face. So really, the prospect of real and expected liability management has created a lot of dislocation across companies’ capital structures.So, what have they done? We look and see companies that have been exploring liability manage, taking advantage of weak protections in certain credit documentation in their structure at the expense of other creditors in the same capital structure. So, we have one company where you see this dislocation in their term loans. They have the same pool of collateral between two different term loans with two different maturities. The later dated maturity is trading higher than the nearer dated maturity, strictly or solely because of the better protections in that documentation. And the premise being, you can negotiate with that class of creditors, give them an advantaged position in the capital structure at the expense of other creditors -- in order to somehow manage the balance sheet and manage those liabilities.Andrew Sheets: And David, is it fair to say that this is a direct outcrop of, you know -- a term some people might have heard of -- of covenant light debt, where, you know, usually debt has certain legal protections that mean that the bondholder is more assured of getting paid back or not being made a less well off than other lenders. But you know, we did see some of that change during different, stronger market conditions. Is that a partial explanation of what's going on?David Hamburger: That's exactly right, Andrew. We are seeing the result, if I might say, the hangover from some of these covenant light deals that came to market over the last few years; almost to the point of speak to some clients and they will just want to know what is the vintage of that secured debt issue that you're talking about because there were certain years where they were far more flexible documentation and protections. And now, given where the equity markets are trading and the financing environment, you see a lot of those securities trading at severe discounts to par, which is unusual because, again, in my 20-year career, I've not often seen companies with billion-dollar equity market caps and bonds trading in the 20, 30, or 40 cents on the dollar.You would think that if a company had a substantial market cap, that their bonds would be trading closer to par and would have value. But what really the market's, I think, pricing in is this transference of value from creditors to shareholders; and the opportunity cost associated with these shareholders; or controlling shareholders or management teams looking to capture those discounts that they now see in their bonds; or in their loans to the benefit of equity shareholders -- really puts all constituents in the company's balance sheet, if you will, at odds with one another.Andrew Sheets: So, David, this is so interesting because again, I think, you know, for a lot of listeners, you can read the newspaper, you see the headlines, the market looks very strong and stable. And yet, there's definitely a tempest that's been brewing, you know, in your sector. For people who are investing in high yield TMT, what are you think the most important things that you're looking out for in your credit coverage?David Hamburger: Well, look, we're forced to really dig in and scrutinize these credit docs and really understand what protections are there, understanding how companies might navigate through those protections in order to prolong or preserve their equity value or the equity options in their companies.It's not like we're trying to be alarmists in saying this is a canary in the coal mine, but it is certainly a cautionary tale for any high yield investor to be well versed in those credit documentation, understanding the protections in those debt securities.And we have seen bondholders and creditors, largely even in loans, you know, get together in co-op agreements to push back on some of these aggressive liability management transactions. And that, I think, is really important in an environment where yields have come back in and, you know, where people look at opportunities and maybe we could, once again, see two things. One, a reach for yield, where you're looking at sectors that have underperformed. And secondly, should we get back into an environment of covenant light docks once again? So, I don't want to be talking about this again in a few years’ time. And it's not something that the market has helped resolve rather than just perpetuate.Andrew Sheets: David, it's fascinating as always. Thanks for taking the time to talk.David Hamburger: Thank you Andrew. Glad to be here.Andrew Sheets: And thanks for listening. If you enjoy the show, please leave us a review wherever you get your podcast and share Thoughts on the Market with a friend or colleague today.

31 Maj 20248min

Our Chief Europe Economist explains why the region’s outlook over the next year is trending upward, including how higher growth will lead to lower interest rates this cycle.----- Transcript -----Welcome to Thoughts on the Market. I’m Jens Eisenschmidt, Morgan Stanley’s Chief Europe Economist. Along with my colleagues bringing you a variety of perspectives, today I will discuss our outlook for Europe’s economy in the second half of 2024 and into next year. It’s Thursday, May 30 at 10am in Frankfurt.So, over the last year, we have had a relatively downbeat outlook for Europe's economy, but as we head into the second half of this year our view is decidedly more optimistic. After bottoming last year, euro area growth should reach 0.7 per cent annualized terms in 2024 and 1.2 per cent in 2025 on the back of stronger consumption and exports. Inflation is on its way to the European Central Bank’s target, paving the way for the ECB to start cutting rates in June with three cuts in 2024, for a total of 75 basis points, and four more cuts in 2025, for a total of 100 basis points.What’s particularly notable, though, is the set-up of this growth rebound is highly unusual for several reasons.Let's start with inflation. In a normal environment, higher growth leads to higher inflation and vice versa. This time is different. The euro area needs to grow faster to get inflation down. The reason is that faster growth should lead to better resource utilization in sectors characterized by labor hoarding or keeping a surplus of employees. This should keep unit labor costs – or how much a business pays its workers to produce one unit of output – in check. We’re expecting further wage increases, mostly driven by the catch-up with past inflation, and so higher productivity is a way to cushion the pass-through to prices.So again, just to repeat, we are in a cycle where we need higher growth to get inflation down and not as usual, we have higher growth and that gets us more inflation. Of course, there is a limit to that. If we get too much growth, that would be an issue potentially for the ECB. And if you get too little growth, that is another issue because then we won't get the productivity rebound.In some sense, you could think of the growth we need as a landing strip and we need to come in at that landing strip precisely; and so far, the signs are there that is exactly the picture we are getting in 2024 and 2025 in Europe.Now the monetary and fiscal policy mix is another area where this cycle stands out. So normally, monetary policy would tighten into an upswing and ease into a downturn, while fiscal policy would be expansionary in a downturn and contractionary in an upswing. Euro area monetary policy is currently restrictive – but it’s set to get less restrictive over time. The likelihood of rates coming down is hardly bad news for growth. But policymakers will need to take care to not reignite inflation in the process. So all of that gives rise to the gradualism that the European Central Bank has been signaling it will use in its policy easing approach. And again, think about the landing strip metaphor. If we are not gradual enough and we reignite a growth too much, and with it inflation, we might be exiting the landing strip in one way or the other.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

30 Maj 20243min