Wallets Wide Open For GenAI

While the Fed fights generationally high inflation, the U.S. economy continues to grow, supported by high levels of spending. This has affected both the bond and equity markets.----- 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, August 14, at 11 a.m. in New York. So let's get after it. At the trough of the pandemic recession in April 2020, we first introduced our thesis that the health care emergency would usher in a new era of fiscal policy. The result would be higher inflation than monetary policy was able to attain on its own over the prior decade. In the first phase of this new policy regime, we referred to it as helicopter money, as described by Milton Friedman in the early 1970s and then highlighted by Ben Bernanke after the tech bubble as a policy that could always be employed to avoid a deflationary bust. Handing out checks to people is a fairly radical policy, however, the COVID pandemic was the perfect emergency to try it. The policy shift worked so well to keep the economy afloat during the lockdowns that the government decided to double down on the strategy by doing an additional $3 trillion of direct fiscal spending in the first quarter of 2021. This excessive fiscal policy is why money supply growth increased to a record level at 25% year-over-year in early 2021, and why we finally got the inflation central banks had been trying so hard to achieve post the great financial crisis. After the financial crisis, the velocity of money collapsed, while the Fed's balance sheet ballooned to levels never seen before. The reason we didn't get inflation in that initial episode of quantitative easing is because the money created remained trapped in bank reserves rather than in a real economy where it could drive excess demand in higher prices, a dynamic that's been obviously very different this time. Fortunately, the Fed is responding to this generationally high inflation with the most aggressive tightening of monetary policy in 40 years. But this is the definition of fiscal dominance, monetary policy is beholden to the whims of fiscal policy. First, it had to be overly supportive and fund the record deficits in 2020 and 21, and then it had to react with historically tighter policy once inflation got out of control. Back in 2020, we turned very bullish on equities on this shift of fiscal dominance and also subsequently indicated it would lead to a period of hotter but shorter economic earning cycles, mainly because the Fed would not have the same flexibility to proactively try to extend economic expansions. We also argued that catching these cycles on both the upside and downside would be critical for equity investors to outperform. From 2020 to 2022, we found ourselves on the right side of that dynamic both up and down, this year, not so much. Part of the reason we found ourselves offsides this year is due to the very large fiscal impulse restarting last year and remaining quite strong in 2023. In fact, we have rarely ever seen such large deficits when the unemployment rate is so low and inflation well above target. If fiscal policy is showing little constraint in good times, what happens to the deficit when the next recession arrives? The main takeaway for the equity market this year is that fiscal policy has allowed the economy to grow faster than forecasted and has given rise to the consensus view that the risk of recession has faded considerably. Furthermore, with the recent lifting of the debt ceiling until 2025, this aggressive fiscal spending could continue. However, the sustainability of such fiscal policy is the primary reason why Fitch recently downgraded the U.S. Treasury debt. Combined with the substantial increase in the supply of Treasury notes and bonds expected to fund these government expenditures, bond markets have sold off considerably this past month. This should start to call into question the valuations of equities, which were already high even before this recent rise in yields. Furthermore, if fiscal spending must be curtailed due to either higher political or funding costs, the unfinished earnings decline that began last year is more likely to resume as our forecast is still predicting. Equity markets seem to have noticed, with many of the best performing stocks correcting by 10% or more. Even if one is bullish on stocks, such a correction was necessary to reset investor exuberance. The challenge will come this fall if growth fails to materialize as now expected. In that case, a healthy 5 to 10% pullback may turn into the much more significant correction we were expecting to occur in the first half of this year. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

14 Aug 20234min

While the Fed navigates a soft landing for the U.S. economy and stock valuations remain high, how can investors navigate the risks and rewards of a surprisingly strong equity market? Lisa Shalett is Morgan Stanley Wealth Management’s Chief Investment Officer. She is not a member of Morgan Stanley Research.----- Transcript -----Andrew Sheets: Welcome to Thoughts in the Market. I'm Andrew Sheets, Fixed Income Strategist at Morgan Stanley. Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management. Andrew Sheets: And today on the podcast, we'll be discussing what's been happening year to date in markets and what might lie ahead. It's Friday, August 11th at 1 p.m. in London. Lisa Shalett: And it's 8am here in New York City. Andrew Sheets: So, Lisa, it's great to have you here. I think it's safe to say that as a strategy group, we at Morgan Stanley have been cautious on this year. But I also think this is a pretty remarkable year. As you look back at your experience with investing, can you kind of help put 2023 in context of just how unusual and maybe surprising this year has been? Lisa Shalett: You know, I think one of the the key attributes of 2023 is, quite frankly, not only the extraordinarily low odds that history would put on the United States Federal Reserve being able to, quote unquote, thread the needle and deliver what appears to be an economic soft landing where the vast and most rapid increase in rates alongside quantitative tightening has exacted essentially no toll on the unemployment rate in the United States or, quite frankly, average economic vigor. United States GDP in the second quarter of this year looked to accelerate from the first quarter and came in at a real rate of 2.4%, which most folks would probably describe as average to slightly above average in terms of the long run real growth of the US economy over the last decade. So, you know, in many ways this was such a low odds event just from the jump. I think the second thing that has been perplexing is for folks that are deeply steeped in, kind of, traditional analytic frameworks and long run correlative and predictive variables, the degree to which the number of models have failed is, quite frankly, the most profound in my career. So we've seen some real differences between how the S&P 500 has been valued, the multiple expansion that we have seen and things like real rates, real rates have traditionally pushed overall valuation multiples down. And that has not been the case. And, you know, I think markets always do, quote unquote climb the wall of worry. But I think as we, you know, get some distance from this period, I think we're also going to understand the unique backdrop against which this cycle is playing out and, you know, perhaps gaining a little bit more of an understanding around how did the crisis and the economic shocks of COVID change the labor markets perhaps permanently. How did the degree to which stimulus came into the system create a sequencing, if you will, between the manufacturing side of the economy and the services side of the economy that has created what we might call rolling slowdowns or rolling recessions, that when mathematically summed together obscure some of those trends and absorb them and kind of create a flat, flattish, or soft landing as we've experienced. Andrew Sheets: How are you thinking about the valuation picture in the market right now? And then I kind of want to get your thoughts about how you think valuations should determine strategy going forward. Lisa Shalett: So this is a fantastic question because, you know, very often I'm sitting in front of clients who are, you know, very anxious about the next quarter, the next year. And while I think you and I can agree that there certainly are these anomalous periods where valuations do appear to be disconnecting from both interest rates and even earnings trends, they don't tend to be persistent states. And so when we look at current valuations just in the United States, if you said you're looking at a market that is trading at 20x earnings the implication is that the earnings yield or your earnings return from that investment is estimated at roughly 5%. In a world where fixed income instruments and credit instruments are delivering that plus at historic volatilities that are potentially half or even a third of what equities are, you can kind of make the argument that on a sharp ratio basis, stocks don't look great. Now, that's not all stocks. Clearly, all stocks are not selling at 20x forward multiples. But the point is we do have to think about valuation because in the long run, it does matter. Andrew Sheets: I guess looking ahead, as you think about the more highly valued parts of the market, where do you think that thinking might most likely apply, as in the current valuation, even if it looks expensive, might be more defendable? And where would you be most concerned? Lisa Shalett: I think we have to, you know, take a step back and think about where some of the richest valuations are sitting. And they're sitting in, you know, some of the megacap consumer tech companies that have really dominated the cycle over the last, you know, 14, 15 years. So we have to think about a couple of things. The first is we have to think about, you know, the law of large numbers and how hard it is, as companies get bigger and bigger, for them to sustain the growth rates that they have. There will never be companies as dominant as, you know, certain banks. There will never be companies that are as dominant as the industrials. There will never be companies that are as dominant as health care. I mean, there's always this view that winners who achieve this kind of incumbent status are incumbent forever. And yet history radically dispels that notion, right? I think the second thing that we need to understand is very often when you get these type of valuations on megacap companies, they become, you know, the increased subject of government and regulatory scrutiny, not only for their market power and their dominance, but quite frankly for things around their pricing power, etc. The last thing that I would say is that, you know, what's unique about some of the megacap consumer tech companies today that I don't hear anyone talking about, is this idea that increasingly they're bumping up against each other. It's one thing when, you know, you are an e-commerce innovator who is rolling up retail against smaller, fragmented operators. It's quite another when it's, you know, three companies own the cloud, seven companies own streaming. And I don't hear anyone really talking about it head on. It's as if these markets grow inexorably and there's, you know, room for everyone to gain share. And I push back on some of those notions.Andrew Sheets: So, Lisa, I'd like to ask you in closing about what we think investors should do going forward. And to start, within one's equity portfolio, where do you currently see the better risk reward? Lisa Shalett: So we're looking at where are the areas where earnings have the potential to surprise on the upside, and where perhaps the multiples are a little bit more forgiving. So where are we finding some of that? Number one, we're finding it in energy right now. I think while there's been a lot of high fiving and enthusiasm around the degree to which headline inflation has been tamed, I think that if you, you know, kind of look underneath the surface, dynamics for supply and demand in the energy complex are beginning to stabilize and may in fact be showing some strength, especially if the global economy is stronger in 2024. A second area is in some of the large cap financials. I think that some of the large cap financials are underestimated for not only their diversity, but their ability to actually have some leverage if in fact global growth is somewhat stronger. We also think that there may be opportunities in things like residential REITs. There's been, you know, concern about that area, but we also know that the supply demand dynamics in US housing are in fact quite different this cycle. And last but certainly not least, I think that there are a series of themes around fiscal spending, around infrastructure, around decarbonization, around some of the the reconfiguration of supply chains that involves some of the less glamorous parts of the market, like utilities, like, you know, some of the industrials companies that have some very interesting potential growth attributes to them that that may not be fully priced as well. Andrew Sheets: Lisa, thanks for taking the time to talk. Lisa Shalett: Absolutely, Andrew. Always a pleasure. Andrew Sheets: And thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on Apple Podcasts. It helps more people find the show.

11 Aug 20239min

A recent landmark study around weight-loss medicine could spark near-term growth opportunities in pharmaceuticals.----- Transcript -----Mark Purcell: Welcome to Thoughts on the Market. I'm Mark Purcell, Head of Morgan Stanley's European Pharmaceuticals Team. Terence Flynn: And I'm Terence Flynn, Head of the U.S. Biopharma Team. Mark Purcell: And on this special episode of Thoughts on the Market, we'll give you an update on the global obesity challenge. It's Thursday, the 10th of August, and it's 1 p.m. in London. Terence Flynn: And 8 a.m. in New York. Terence Flynn: Now, a year ago, we came on the show to discuss our views on the global obesity challenge, and the problem has since received significant media attention. We believe that the narrative around obesity has indeed changed, with a more empathetic media tone, exponential social media growth and increased recognition across health care professionals and policymakers. Mark, what exactly happened over the last year? Mark Purcell: Well, Terence I mean the uptake of obesity medicines in the US has been much stronger than we anticipated. In fact, obesity drug demand has outstripped supply, as you said, driven by social media activity, but also a rapid expansion in reimbursement. When we look back, about 12 million individuals suffering with obesity were covered by insurance and employee opt-ins for the first generation of these appetite suppressing medicines. For newer, higher efficacy GLP-1 medicines, about 40 million lives are covered, and that is more than the estimated number of individuals living with diabetes in the US, which is projected to be about 37 million. Terence Flynn: Great. Thanks, Mark. Now the greater focus on weight management has spilled over into an increasingly weight centric approach to treating diabetes. What changes are you seeing and how are they impacting the industry? Mark Purcell: Terence you're absolutely right. Look, for many years, treatment guidelines for diabetes focused on blood sugar control only. Just before the pandemic, there was an increasing focus on controlling cardiovascular risks as w ell, such as preventing heart attacks. In the past 12 months, there's been increased focus on weight management for diabetes, which can help prevent the progression of diabetes and potentially reverse the course of the disease if you catch it early enough. It's estimated about 40% of GLP-1 prescriptions in the US are for patients early in the course of their disease. These dynamics have driven a profound acceleration in the uptake of GLP-1 medicines in diabetes, and we now project GLP-1 sales in diabetes alone to exceed $56 billion in 2030. Terence Flynn: Mark, I know this SELECT trial has been a focus and this was the first large randomized trial to test whether long term treatment with a weight loss drug can meaningfully improve patients cardiovascular health. Now, this trial appears just to be the tip of the iceberg when it comes to market expansion. Maybe you could walk us through your thoughts on the recent data. Mark Purcell: Yeah, thanks Terence. I mean, SELECT is a really important obesity landmark study. It addresses the question does weight management save lives? The trial was designed to show a 17% reduction in the risk of heart attacks and strokes and cardiovascular deaths in non-diabetic individuals suffering from obesity who are treated with GLP-1 medicines. And we just got the data top line the other day, and in fact, these medicines are showing a 20% reduction in heart attacks, strokes and cardiovascular death. As you said, I mean, this is just the tip of the iceberg when it comes to new growth opportunities for weight loss medicines, with positive data to be presented at the American Heart Association meeting in November, the SELECT data and also data in heart failure, and then next year we get exciting data in obstructive sleep apnea, in chronic kidney disease and also in peripheral arterial disease. Back to you, Terence. What is your outlook for the size of the obesity market in the US and globally over the next 5 to 10 years? Terence Flynn: Thanks, Mark. As you mentioned earlier, the uptake of obesity medicines in the US over the last year has been stronger than we anticipated. There have been some supply chain shortages that have capped an acceleration uptake in the US, and delayed the rollout of these medicines outside of the US. But a number of companies are making significant manufacturing investments today which will help improve supply on a global basis, but also create barriers to entry in the future. We're projecting that sales of the new obesity medicines in the US would have exceeded $7 billion this year, if the supply challenges had not been an issue. But if we extrapolate these strong early dynamics in the US, we project the global obesity market could reach over $70 billion in 2030. Our prior estimate was over $50 billion. Mark Purcell: And Terence, are there any regional differences between Europe and the US and possibly other parts of the world? Terence Flynn: Now, the majority of the upgrade, Mark, to our forecasts really centered on our US assumption. And this reflects the limited rollout of these drugs in other countries, in part due to supply constraints I mentioned, but also lack of visibility with respect to demand and payer dynamics across different regions. In the future, we do expect this to change, as I mentioned, given improving supply dynamics, improving reimbursement and the rollout of newer oral options that could also help improve global access. Mark Purcell: So where are we in terms of GLP-1 obesity medicine prices, when it comes to the consumer and when it comes to insurance reimbursement? Terence Flynn: Yeah, thanks, Mark. I mean, the injectable GLP medicines right now for diabetes are priced at about $900 to $1000 per month here in the US, but net prices are more in the $500 per month range. Now, in obesity, these drugs do cost somewhat more, but over time prices could converge lower. Now, insurance coverage, as you mentioned, Mark, is still a work in progress with over 40 million people now covered. But in our view, the SELECT data, in conjunction with legislation, could really help to expand coverage further. Going back to you, Mark, what's next in the pipeline for these GLP-1 medicines? Mark Purcell: The key focus is if the industry's pipeline at the moment are combination approaches and new ways to deliver these medicines. We've previously drawn parallels between how the high blood pressure market evolved in the 1980s and how we expect the obesity market to develop in the future, where combining different mechanisms can lead to better and more consistent treatment approaches. In obesity, targeting liver fat and lean body mass, these are things that can improve the quality of weight loss. There are a number of oral treatment approaches in development as well now, which we expect to broaden the appeal of GLP-1 medicines to a new audience, so really, it's an exciting time in the obesity global challenge. Mark Purcell: Terence, thanks for taking the time to talk. Terence Flynn: Great speaking with you, Mark. Mark Purcell: 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.

10 Aug 20236min

Forthcoming U.S. restrictions on some tech investments in China may present new opportunities as companies adapt to these constraints.----- 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 developments in the US-China economic relationship. It's Wednesday, August 9th at 10 a.m. in New York. News this week broke that the U.S. government is close to finalizing rules that would limit U.S. investment into China related to cutting edge tech sectors, such as quantum computing and artificial intelligence. The long awaited move, which we've discussed many times on this podcast, is yet another sign that the rewiring of the global economic system continues, transitioning from one of globalization to that of a multipolar world. But when news breaks like this, it's helpful to remember that the headlines can sound worse than the reality. Yes, it's likely that the global economy, and therefore markets, would be better off if the U.S. and China could find a way to deepen their economic ties, but the fraying of those ties need not be a substantial negative either. And these new outbound investment restrictions are a great example of that point. The proposed rule will, reportedly, restrict investment in companies who derive more than half their revenue from the sensitive technologies in question. Effectively, that means the U.S. will mostly be concerned with U.S. investors not funding development of new technology through startups. It could potentially leave the door open for more traditional forms of U.S. investment into China, namely through working with larger companies on market access and supply chain solutions. So while many companies are still likely to seek diversification away from China for their supply chains, they still have the ability to do this over time, as opposed to an abrupt decoupling that investors would likely see as carrying much greater risk to the global economy and markets. So, this gives investors a better chance to identify the opportunities that emerge as companies and governments spend money to adopt to these new constraints. Security as an investment theme is something we see potential in, with the defense sector and many industrial subsectors as beneficiaries. Geographically, we see Mexico, India and broader Asia as best positioned to capture investment and jobs from supply chain realignment, given their labor costs and proximity to key end markets. 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.

9 Aug 20232min

The profound demographic changes underway in countries around the world will require innovative, socially focused solutions in sectors including health care, finance and infrastructure.----- Transcript -----Stephen Byrd: Welcome to Thoughts on the Market. I'm Stephen Bryd, Morgan Stanley's Global Head of Sustainability Research. Mike Canfield: And I'm Mike Camfield, Head of EMEA Sustainability Research. Stephen Byrd: On this special episode of the podcast, we'll discuss the social factors within the environmental, social and governance framework, or ESG, as a source of compelling opportunities for investors. It's Tuesday, August 8th, at 10 a.m. in New York. Mike Canfield: And 3 p.m. in London. Stephen Byrd: At Morgan Stanley Research. We believe that investing in social impact is critical to addressing some of the most pressing challenges facing our world today, such as inequality, poverty, lack of access to health care and education, and the repercussions of climate change. Traditional methods like philanthropy and government aid are a piece of the puzzle, but alone they can't address with the breadth and scale of these issues. So, Mike, looking back over the last couple of decades, investors have sometimes struggled with the social component of ESG investing. Some of the main challenges have been around data availability, the potential for social washing and the capacity to influence systemic change. How are market views on social investing changing right now, and what's driving this shift? Mike Canfield: It has historically been quite easy for investors to dismiss social, it's too subjective, too hard to measure, overly qualitative, and perhaps not even material in moving share prices. Increasingly, we do find investors recognize the vast and intractable social problems we face, whether that's structural shifts in workforces with countries like Korea, Japan and large parts of Europe projecting working age population decline by double digit percentage in the next 15 to 20 years, significant growth in urbanization or growing middle class populations in countries around the world. Investors also increasingly understand the interconnectivity of stakeholders across society, be that supranational organizations or governments or the corporate world, or even citizens themselves. Concurrently, it's becoming clear that corporate purpose and culture are critical considerations for prospective and current employees, as well as end customers themselves who are prepared to vote with both their wallets and their feet. All that said, we do note the overall impact at EM has garnered in 18% kagger over the last five years to nearly $213 billion with the Global Impact Investing Network pointing out that over 60% of impact investors are targeting some of the UN's socially focused SDGs. Notably goal eight around decent growth, goal five, around gender equality, goal ten around reduced inequalities broadly and goal three good health and well-being. In terms of drivers, we're seeing the realization rapidly dawning amongst investors that the profound changes underway in society and the climate will drive the need for innovative, socially focused solutions in a number of sectors, from health care to finance to infrastructure, as well as significant challenges to resilience and adaptation for industries around the world. With huge shifts in demographics coming whether through urbanization or migration, aging populations in some countries or declining fertility rates, the investing landscape is set to change dramatically across sectors, with change manifesting in anything from shifting consumer preferences to education access and outcomes to greater need for assistive technologies, to substantial food production issues, to financial system access and inclusion, or even simply addressing rapidly increasing demand for basic services and clean energy. Stephen Byrd: Thanks, Mike. So what are some of the core themes in social investing? Mike Canfield: Yeah in our recent social skills notes, we did identify five truly global, fast growing and compelling investment themes you can focus on under the broad umbrella of what we would call social investing. Firstly, access to health care, which includes but obviously not limited to pharmaceuticals, vaccines, orthopedics, medical devices, elderly care, sanitation and hygiene, women's health and sexual health. Secondly, nutrition and fitness, which encompasses things like infant nutrition, healthy or healthier food and beverage options, alternative proteins, food safety and food packaging. Thirdly, social infrastructure, which includes mobility, digital and communication systems, connectivity, health care and education facilities, community and affordable housing and access to clean energy. Fourthly, education and reskilling, which includes everything from pre-K, K-12, higher education, corporate and lifelong learning. Our colleague Brenda recently wrote on the potential $8 trillion opportunity in these markets. And finally, right inclusive finance, which encompasses microfinance, financial infrastructure, mobile digital banking, banking for underserved communities, fintech solutions and provision of financial services to SMEs. So Stephen, do you think any industries or regions stand out as leaders or laggards perhaps when it comes to social investing? Stephen Byrd: You know, Mike, when I think about industries leading, I do think education really stands out. And I think we all recognize that education is really one of the pillars of a productive, well-functioning society, but it does face an array of challenges. A quality education can promote democracy, help communities elevate their social and economic status, and drive innovation in the economy, and yet, over the past few years, multiple issues in education, which were really exacerbated by the COVID 19 pandemic, have hampered equitable progress in society across markets, regions and communities. In our note this past May on education innovators, we really focus on these issues as fields of opportunity for investment in innovation. An example would be improving the quality of the learning experience. The pandemic was an especially disruptive period for K-12 education, leaving a learning deficit that could linger for an entire generation, especially for groups that were already disadvantaged. The pandemic also highlighted the need for more robust lifelong learning opportunities beyond the traditional classroom. We expect to see players that are able to service these needs, best meet market demand. And Mike, in terms of reasons that stand out. A key issue that you highlighted before is data availability. And I would note that really Europe has led the way in terms of best in class disclosure. So Mike, social considerations have historically been viewed as overly qualitative rather than quantitative, but our research has shown a variety of ways in which the S-pillar can closely link to company fundamentals. Could you walk through some of these? Mike Canfield: Yeah, absolutely, Stephen, I think the starting point for our research was this notion that you can both do good and do well. The values in value based investing can be combined to deliver alpha and positive social impact at the same time. So one of the ways we think to approach this is to assess the corporate culture and its that that forms the first pillar of our forces social investing framework. At its heart, company culture pertains to the shared values, attitudes, practices and standards that shape a work environment and the strategy for business. In our analysis, we want to establish a holistic view of why a company exists, what it's doing to contribute positively towards society, how it's managed, and where its most material social related opportunities and risks lie. In doing that, we've established a data driven, objective process to evaluate culture using eight core components across five performance linked indicators, which are Glassdoor ratings, shareholder voting against management or proprietary, her school employee turnover and board gender diversity. And three engagement focus indicators. The trend in employee diversity, whether the company has a supplier code of conduct in place, and violations of the UN's Global Compact. These data sets are readily available and repeatable, giving a clear view of companies relationship with both its internal and its external stakeholders. Steven, How do you think investors can think about social investing more systematically, can you elaborate a little more on the 4 C's framework? Stephen Byrd: Yeah happy to Mike, I think you really touched on culture in a very comprehensive way. I really do think it's important that the performance related KPIs that you laid out really do show very clear performance differential between top and bottom quartiles. I want to move on to the second of the C's. This is Cultivate. And here we really focus on three so-called AIM lenses. The first is additionality. This is really the notion of generating positive social outcomes or impacts that otherwise would not have materialized. So finally, Mike, how does A.I play into social investing? Mike Canfield: Everyone's favorite acronym at the moment, clearly something that we can't ignore. We do believe there's a very real potential for us to be at the start of another economic revolution, driven by rapid technological evolution in AI. The so-called third industrial revolution, otherwise known as the digital revolution, brought with it transformational technologies in cell phones and the Internet, increased interconnectivity, greater industrial productivity and vastly greater accessibility of information. AI looks to play a central role in the fourth Industrial Revolution. Klaus Schwab, founder of the World Economic Forum, popularized that term back in 2015 when he suggested that AI and advanced robotics could herald a substantial shift in industrial capitalism and the so-called knowledge economy. This evolution could fundamentally change employment and geopolitical landscapes. Just as in the early 19th century, when Luddites found machines left weaving skills obsolete. AI could well prove just as disruptive, but technology on a grander scale, across everything from manufacturing to search engines to media content creation. We do see significant AI opportunities in areas like drug development, in education outcomes and access and significant benefits across efficiencies and resource management, whether that's in power grid optimization or in weather prediction, for example. We do suggest a three pronged approach to evaluating AI driven opportunities which focus on areas including reducing harm to the environment, enhancing people's lives through biotech, cybersecurity and life sciences, for example, and enabling technological advancements. Simultaneously, given a relative lack of regulation for the industry at the moment, we do think consistent investor engagement is key to driving responsible A.I practices. Stephen Byrd: Mike, thanks for taking the time to talk. Mike Canfield: Great to speak to you, Stephen. Stephen Byrd: 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.

8 Aug 20239min

The residential housing market continues to face limited inventory, low affordability and high mortgage rates, but the worst may have passed.----- Transcript -----Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley U.S. Equity Strategy Team. Jim Egan: And I'm Jim Egan, Co-Head of U.S. Securities Products Research. Michelle Weaver: On this special episode of the podcast, we'll discuss the state of the housing market. It's Monday, August 7th at 10 a.m. in New York. Michelle Weaver: We recently did a deep dive into the global housing market and found that cyclical housing headwinds are significant but approaching a peak globally. And there are a few important things to keep in mind when thinking about this housing cycle. First is that higher interest rates and high home prices have kept affordability low. Second, housing is undersupplied in most economies. And third, there is a big gap between new and existing mortgages. Jim, can you start by talking us through how the structure of U.S. mortgages are different from what's common in other parts of the world? Jim Egan: Absolutely. So the structure of various mortgage markets has important implications for the pass through of monetary policy changes. And average mortgage terms vary significantly across the globe, from roughly 70% adjustable rate in Australia on one end to nearly all 30 year fixed rate mortgages here in the United States. Though we would say the duration has generally lengthened post the great financial crisis for most economies. Longer duration mortgages lower the sensitivity of housing markets to the policy rate, both in terms of timing and cyclicality. But for the U.S., that 30 year fixed rate, fully amortizing mortgage that's freely repayable at any point in time with no penalty to the borrower, that's a unique feature for our mortgage market. And it's something that's made possible by the fact that roughly 2/3 of that $13 trillion mortgage market is guaranteed by the U.S. government. And that in turn contributes to the sizable and relatively liquid securitization market, which effectively democratizes the risk across a much broader range of investors than just the lenders themselves. Michelle Weaver: And how have high mortgage rates impacted home sales in the U.S.? If someone's looking to buy a home, are they able to even find listings? Jim Egan: I think that's an important question, and that's really contributed to our bifurcated housing narrative that we've discussed on this podcast in the past. Mortgage rates go up, affordability deteriorates, but not for current homeowners. They become very locked in at that lower rate and disincentivized to really list their home for sale, and that's why we've seen existing listings fall to 40 year lows. We say 40 year lows because that's just as far back as the data goes, this is the lowest we've seen that. If they're not listing their homes for sale, that means that they're also not buying homes on the follow, and that really brings sales volumes down. That's why in the cycle, existing home sales have fallen twice as fast as they did during the great financial crisis, despite the fact that home prices have remained incredibly protected at near those peaks. Now, let me turn it to you, Michelle. You cover U.S. equities and the housing market has many different links to the equity market. When someone buys a new home, they make a lot of associative purchases, like buying new furniture or making improvements around the house. How have home improvement companies fared? Michelle Weaver: Sure, so a lot of people made improvements to their houses during COVID to make staying indoors a little bit more comfortable. And post-COVID demand reversion has been a really important driver for the past few years. If you make home improvements one year, you're not going to need to make them again for, you know, several years. And so we think that the reversion of COVID driven overconsumption is largely complete now. Housing prices and housing turnover, these fundamental metrics governing the housing market are likely to resume being the core drivers for the home improvement space from here. Jim Egan: Now, banks also have a relationship with the housing market through mortgage lending. What've these higher mortgage rates meant for banks? Michelle Weaver: Interest rates are very high and consequently mortgage rates are also very high. And this has put a damper on demand for new mortgages at banks. There's also a large gap between existing mortgage rates and new mortgage rates, like we were discussing earlier. And in the U.S., homeowners refinanced and masked during COVID when mortgage rates were extremely, extremely low and locked in these rates. Now, less than 1% of American mortgages would be considered in the money to refinance or essentially make sense to refinance. So mortgage originations are expected to continue to stay very low. And this means that banks won't be getting this source of revenue from mortgages. Jim Egan: Now, that all makes sense on the homeownership side, the mortgage side, but let's think about the reciprocal here a little bit, the rental space. How have high mortgage rates and the lack of supply that we're describing impacted the rental market? Michelle Weaver: Definitely, high home prices and lack of availability have made it really tough for first time homebuyers. So people that are on the margin between buying their first house or staying in a rental have had to remain renters. And this has increased rents and been a big tailwind for rentership rates that are the owners of these rental properties. Jim, what do you think is going to happen with affordability in the United States, it's been very poor, are you expecting that to improve and what's going to go on with home prices? Jim Egan: Sure. So affordability remains very challenged, but it's not getting worse. On the margin that's probably going to improve a little bit from here, but remain challenged. Supply remains incredibly tight, but it's not getting tighter. We think that we're in a range bound environment here now, Case-Shiller just turned negative on a year-over-year basis for the first time since 2012. And while we expect that to persist for another couple of months, we expect home prices to basically be unchanged from these levels over the coming year. Michelle Weaver: Jim, thank you for taking the time to talk. Jim Egan: Great speaking with you, Michelle. Michelle Weaver: 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.

7 Aug 20235min

Moves by the Bank of Japan, the downgrade of the U.S. credit rating and new economic data may all have contributed to a spike in bond yields and fall in stock prices.----- Transcript -----Welcome to Thoughts in the Market. I'm Andrew Sheets, Fixed Income 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, August 4th at 2 p.m. in London. After a placid July, August has opened with a bout of volatility. In one sense, this isn't unusual. July is historically one of the best months of the year for global equity performance, August and September are two of the worst. But the way markets have weakened has been more striking. Long term bond yields rose sharply this week, with the U.S. 30 year bond yield rising 27 basis points over the course of the last five days. Long term rates in the UK and Germany also rose sharply. Equity markets fell. Those facts are clear and indisputable. But why interest rates rose so much, and whether they're responsible for equity weakness? That, ladies and gentlemen of the jury, is a lot less clear. Indeed, there's more than one driver of last week's events. Maybe it's the Bank of Japan, which late last week raised the effective cap on Japanese government bond yields, which went on to rise sharply over the course of this week. Maybe it's the Fitch rating agency, which on Tuesday downgraded the credit rating of the United States by one notch to AA+. And maybe it's the US economic data, which has been quite strong, something that usually corresponds to higher rates. There's also the way that yields have risen. While long term U.S. interest rates rose sharply, shorter two year yields barely budged over the last week and in the UK and Germany, those two year yields actually fell. The large move higher in U.S. rates has also occurred while the market's actually lowered its assumption about long run inflation, another unusual occurrence. In reality, the drivers of these recent events might be all of the above. The initial rise in U.S. yields matched the move higher in Japanese rates, almost one for one. But we do think that move in Japanese rates is now mostly complete. The timing of Fitch's downgrade, which was somewhat unusual, given that there hasn't been any recent legislation to change fiscal policy and the fact that it happened at the start of August, a month that often sees less liquidity, might have given it an outsized impact. And the economic data has been good, suggesting that the U.S. economy for now is handling higher rates, a development that would generally support higher yields and a steeper curve. And in terms of the global equity reaction, some perspective is probably helpful. While last week saw higher yields and lower prices, since early April, both nominal yields, real yields and global stock prices have all risen together and by quite a bit. Now, it's possible that this relationship between stocks and bonds shifted some this week based on simply how much equity valuations have appreciated, as my colleague Mike Wilson, Morgan Stanley's Chief Equity Strategist, has noted recently. Higher yields make a focus on valuation more important and also make it more essential that good data, the best version of that higher yield story, continues to come through. In bonds, meanwhile, the recent rise in yields is boosting expected returns going forward. On Morgan Stanley's base case forecast, the U.S. ten year Treasury through the middle of 2024 will return over 10%. Thanks for listening. Subscribe to Thoughts of the Market on Apple Podcasts or wherever you listen, and leave us a review. We'd love to hear from you.

4 Aug 20233min

While rate hikes and work from home are depressing office real estate in the U.S., the market is vast globally, and there are clear differences across regions and asset types, ranging from occupancy to design to financing.----- Transcript -----Welcome to Thoughts on the Market. I'm Ron Kamdem, Head of Morgan Stanley's U.S. Real Estate Investment Trust and Commercial Real Estate Research. Today, I'll be talking about our outlook for the future of the global office real estate market. It's Thursday, August 3rd at 10 a.m. in New York. There is more than 6 billion square feet of office space across the globe with value of more than 4 trillion U.S. dollars. Within this vast market, there are clear differences across the regions, ranging from occupancy to design to financing. In the U.S., office real estate fundamentals this cycle appear worse than they were during the great financial crisis of 2008 in terms of occupancy, subleasing activity and office utilization. In fact, overall, U.S. office utilization seems to be stalling at 20 to 55% compared to other regional markets in the 60 to 80% range. This trend will likely remain in place as key U.S. tenants are looking to reduce office space by about 10% over the next three years. Work from home and hybrid arrangements are the biggest drivers, particularly with business services and technology focused firms on the West Coast. In addition, sharp rate hikes and regional bank weakness have driven up loan-to-value ratios in the U.S. versus global peers. Looking at other countries, Australia and Mexico may be having similar problems as far as work from home is concerned, but average loan-to-value ratios are much lower, which lenders typically consider a good sign. Mainland China is unique among our coverage markets for having declining rates. Hong Kong seems to be the most undervalued and closer to bottoming, and we prefer it over Singapore, Japan and Australia. In Latin America, we remain on the sidelines. Despite the increase in net absorption growth, the office real estate market is still showing a slow paced recovery from pandemic levels, especially in Mexico. All in all, global office markets remain 10 to 15% oversupplied. While higher vacancy is an issue impacting all countries, an important emerging theme across the various region as a bias towards newer and greener buildings. Our channel checks with tenants and landlords suggests that as employees, especially the younger cohorts, choose to work for organizations with strong climate change values, employers will seek to establish offices and more energy efficient buildings. Also, in an effort to encourage office attendance and in-person collaboration, occupiers are gravitating toward younger buildings with more attractive amenities. Overall, as we look across regions and countries, one common thread is what we call "bifurcation", that is a widening gap between the class-A prime assets and the rest of the commodity B&C space, which is happening at an accelerating pace. We believe it would take 5 to 13 years for the global office market to return to pre-COVID occupancy levels. However, the class A prime assets can recover in half the time as the rest of the market and newer, greener buildings in particular are likely to be most favored. Bottom line for the U.S looking at fundamentals is that New York and Boston on the East Coast are showing the most resilient trends. Downtown L.A., downtown San Francisco, downtown Seattle and even Chicago are showing the most headwinds, sunbelt markets are somewhere in between but have been lowing. 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.

3 Aug 20233min