One Rate Cut, Many Effects

Increasing ESG pervasiveness has led to increasing confusion, in particular around how investors might apply these criteria to the utility sector. Head of Sustainability Research and Clean Energy Stephen Byrd and Equity Analyst for the Power and Utilities Industry Dave Arcaro discuss. ----- Transcript -----Stephen Byrd Welcome to Thoughts on the Market. I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research and Clean Energy.Dave Arcaro And I'm Dave Arcaro, Equity Analyst for the Power and Utilities Industry.Stephen Byrd And on this special episode of the podcast, we'll be discussing a new framework for investors to approach ESG analysis within the utility space. It's Thursday, October 13th, at noon in New York.Stephen Byrd Our listeners are no doubt well aware that ESG criteria—that is environmental, social and governance criteria—have become an increasingly important part of the investment process. This growth has been spurred by a continual search for better long term financial returns, as well as a conscious pursuit of better alignment with values. Yet despite ESG's seeming pervasiveness within the financial ecosystem, there's been a genuine confusion and even controversy among investors about how to apply ESG metrics to the utility sector in particular. And so, in an effort to bring clarity to this key market debate, today we're going to share an innovative framework designed to drive both Alpha, which is the returns aspect, and impact, which is the societal benefit. So Dave, let's start with the problem. What causes this investor confusion and how does the new ESG framework address this problem?Dave Arcaro There are a few sources of confusion or debate that we're hearing from investors. The first seems to be centered on the lack of a clear distinction between ESG criteria that are likely to have a direct impact on stock performance, and then those that are more focused on achieving the maximum positive impact on ESG goals. Secondly, there is too much focus directly on carbon emissions, and there isn't enough focus on the social and governance criteria in the utility space. These can also have an impact on stocks and on key utility constituents, things like lobbying, operations, customer relationships. The new ESG framework that we've introduced here addresses these issues. It expands the environmental assessment, incorporates specific social and governance criteria that are most relevant for utilities, like customer and lobbying metrics, and it adds a new perspective. For each of these metrics, we assess which ones truly have an impact on alpha generation and which ones have the largest purely societal impact.Stephen Byrd And stepping back, Dave, we've seen that the utility sector is arguably the best positioned among the carbon heavy sectors in terms of its ESG potential. Can you walk us through that thought?Dave Arcaro Utilities are in a unique position because they can often create an outcome in which everybody wins when it comes to decarbonizing. This is because when utilities shut down coal and replace it with renewables, it often has three benefits; carbon emissions decline, customer bills are reduced because renewables have gotten so cheap and the utility also grows its earnings. So, it's a strong incentive for utilities to set ambitious plans to decarbonize their fleets.Stephen Byrd Now Dave, typically, when considering the E, that is environmental criteria, ESG analysis tends to focus solely or primarily at least on carbon dioxide. Is this a fair approach or should investors be considering other factors?Dave Arcaro We think other factors should come into play here, and we recommend investors consider the rate of change in carbon emissions, the CO2 intensity of the fleet, risks from climate change, and also impacts on biodiversity. Some of these are more readily available than others, but we think the environmental assessment should expand beyond a simple look at carbon emissions.Dave Arcaro So, Stephen, I want to turn it to you. The E part of ESG is always drawing attention when investors talk about utilities. But so far it seems that there's been little focus on the S, social, and G, governance, criteria when assessing U.S. utilities. What are some of the key areas that investors should concentrate on?Stephen Byrd The utility sector really is one of the most heavily regulated sectors, so both social and governance factors can impact the success of the utility business and drive stock performance as well. The short list of metrics that we found to have a clear linkage to share price performance would be one, corporate spending on lobbying activities, especially through 501c4 entities. Two, operational excellence, which for utilities really reflects safety and reliability. Three, risk of customer defection due to high bills and worsening grid reliability. And four, impacts to low-income communities. So, we use these metrics to round out a holistic ESG assessment of the industry.Dave Arcaro And last but not least, how does the new Inflation Reduction Act legislation figure within the kind of ESG framework Morgan Stanley is proposing here?Stephen Byrd Yeah, the Inflation Reduction Act really is a big deal for our sector. To be specific, the Inflation Reduction Act provides significant, wide-ranging support for decarbonization technologies really across the board, including wind, solar, storage and clean hydrogen. As a result, this legislation could accelerate progress for utility decarbonization strategies in a way that also drives earnings and alpha. For that reason, within our framework, we specifically consider whether a utility is a beneficiary of the Inflation Reduction Act, given the potentially very large positive impacts on both the business and the environment.Stephen Byrd David, thanks for taking the time to talk.Dave Arcaro Great speaking with 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.

13 Okt 20225min

As consumption of goods slows post COVID, companies are experiencing a build up in inventory that could have far reaching implications. Head of Global Thematic and Public Policy Research Michael Zezas and U.S. Equity Strategist Michelle Weaver discuss.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Global Thematic and Public Policy Research. Michelle Weaver: And I'm Michelle Weaver from the U.S. Equity Strategy Team. Michael Zezas: And on this special episode of Thoughts on the Market, we'll focus on what we see as an inventory problem with far reaching implications. It's Wednesday, October 12th, at 10 a.m. in New York. Michael Zezas: Michelle, can you start by taking us through some of the background on how we ended up with this problem of companies carrying high inventories, which could pressure them to discount prices leading to weaker earnings. Michelle Weaver: I'm sure listeners remember the COVID lockdowns when many of us overspent on a number of goods, especially things like furniture, tech products and leisure equipment. But now, with the recovery from COVID and supply chain bottlenecks easing, we're seeing a new challenge, inventory build coupled with slowing demand. Throughout 2022, we've been dealing with really high inflation, rising interest rates and declining consumer confidence. And while consumer confidence has rebounded from the all time lows that we saw this summer, it remains weak and we think consumers are still going to pare back spending in the face of macro concerns. We think inventory is one of the key problems that will weigh on S&P 500 earnings, and supports our negative call on earnings for the market. Michael Zezas: And how broad based is this problem? Which industries are most at risk? Michelle Weaver: This is a pretty broad problem for publicly traded companies. Inventory to sales for the median U.S. company have been on the rise since the financial crisis and are now at the highest level since 1990. And it's especially a problem for consumer staples, tech and industrials companies. We also looked at the difference between growth rates for inventory and sales. For the S&P 500 overall, there's an 8% mismatch between inventory growth and sales growth, meaning the median company is growing their inventory 8% faster than their growing sales. The median company within goods producing industries has a whopping 19% mismatch between inventory and sales growth. Consumer retailers face some of the biggest risks from these problems, and companies there are already seeing inventory pile up. They have already turned to discounting to try and move out some of this excess inventory. This is also a big problem for tech hardware companies, consumer markets and PCs have been the first to see excess inventory given how much overconsumption these goods saw during COVID. And the tech hardware team is expecting this to broaden out and start causing issues for enterprise hardware. Michael Zezas: And are there any beneficiaries from the current inventory situation? And if so, what drives the advantage for them? Michelle Weaver: Machinery is one industry where inventories remain tight and they're still seeing really strong demand. Inventories across machinery are still in line or below their longer term averages and there's especially big problems in agriculture equipment. Off price retailers who sell their excess inventory from other brands are another area that are expected to benefit from excess inventories. Michael Zezas: And Michelle, how do you expect companies to deal with the glut of inventory they're facing and how will this impact them in the final quarter of this year and into next year? Michelle Weaver: It's likely going to take several quarters for inventory to normalize, but it really varies by industry and we expect inventory to remain an issue for the market into 2023. Faced with a glut of inventory, companies are going to need to decide whether they want to accept high costs to keep holding inventory, destroy inventory, try and keep prices high and take a hit on the number of units sold, or slash prices to stimulate demand. And we think many are going to turn to aggressive discounting to solve their inventory issue. This could spark a race to the bottom as retailers try and cut prices faster than peers and move out as much inventory as possible. And this dynamic will weigh heavily on margins and fuel the earnings slowdown we are predicting. Michael Zezas: Well, Michelle, thanks for taking the time to talk. Michelle Weaver: Great speaking with you, Mike. Michael Zezas: As a reminder, if you enjoy Thoughts on the Market please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.

12 Okt 20224min

All over the world elections are taking place that will have profound effects on both local and global economies, so where are policy moves being made and how might investors use these moves to anticipate economic shifts? ----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Global Chief Economist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about political economy and how elections have consequences. It's Tuesday, October 11th, at 8 a.m. in New York. Economics is a relatively new field, born in 1776 after the publication of Adam Smith's 'Wealth of Nations'. But until the 1900s, everyone called it political economy. Politics and economics are still hard to separate. Fiscal policy is only sometimes the result of economic events, but almost always a driver of economic outcomes. And because of its power, uncertainty about policy can be a drag all by itself. Brazil has a second round ballot on October 30th between the incumbent Bolsonaro and former President Lula. Both candidates are likely to change or scrap an existing fiscal rule that caps government spending, but most observers think that Lula is likely to have a looser fiscal stance of the two. And so while our LatAm team questions not whether fiscal deficits will increase, but by how much, last week's congressional elections could lead to a split government which is taken to mean a smaller size of any deficit widening. So our LatAm team is pointing to a different risk that a possible President Lula, and he currently leads in most polls, that there might be an unwinding of recent reforms for state owned enterprises, the public sector and labor markets that were meant to enhance Brazil's competitiveness. As is often the case, politics here is more about the medium term than the immediate. In the U.K., it wasn't exactly the same thing. The newly appointed UK Prime Minister, Liz Truss, announced an ambitious fiscal package, including an energy price freeze and the biggest set of tax cuts since the 1970s. The echo to 1980s supply side economics was plain in terms of politics. In terms of economics, boosting productivity might allow more growth and lower inflation at a time where the opposite of each is at hand. But in a country with a 95% debt to GDP ratio and following on fiscal expansion that drove inflation through demand, the lack of details on how to pay for the tax cuts and the energy subsidies elicited a sharp, immediate market reaction. The gilt curve sold off sharply, and the pound reached an all time low of 103 against the dollar. The Bank of England intervened, buying gilts to contain volatility and to lower rates. And in the wake of that turmoil, Chancellor Kwarteng scrapped the tax cuts for the top bracket but kept the rest, leaving about £43 billion a year of additional cost. The outcome now seems to be a faster pace of hiking by the bank and an awareness that the U.K. will not have the fiscal space needed to avoid a recession. Barring unorthodox moves like scrapping the remuneration of bank reserves at the Bank of England, the Chancellor is going to need to find 30 to £40 billion in spending cuts to stabilize the debt to GDP ratio over the next five years. In Italy, elections brought a center right populist coalition led by Giorgia Meloni to a majority in both the lower house and the Senate. The Coalition's stated policy goals are expansionary. More social spending and labor tax cuts are top priorities, along with increasing pension benefits. Our economists estimate that the proposed measures would increase the deficit by roughly 2 to 4 percentage points of GDP, boosting the debt to GDP ratio next year. Such policies will prove difficult during a time of rising interest rates and heightened market scrutiny about debt dynamics. So, Maloney recently expressed her willingness to respect the EU budget rules, but reconciling that view with the policy priorities is going to be a challenge. Our main concern is less a repeat of the U.K. experience, but rather medium term debt sustainability. So let me finish up back home. For the U.S. midterm elections polls have been shifting but most point to at least one house of the Congress changing hands, thus a split government. Our base case from my colleague Mike Zezas as a result is gridlock, but divided governments do not always lead to such benign outcomes. I was a Treasury official during a government shutdown. It was not fun. And in fact, following the 2010 midterms, divided government led to a debt ceiling standoff, government shutdown, and ultimately contractionary policy in the form of the Budget Control Act. Such an outcome is easily conceivable after this midterm election, and with inflation high, even with weak growth, we could easily see another installment of contractionary policy. With growth only expected to be barely positive, that's a real risk. Policy always matters. 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.

11 Okt 20224min

Last week stocks rallied quickly but dropped just as fast as markets continue to hope for a more dovish Fed, but will this 2-way risk continue as evidence for a drop in earnings continues to accumulate?----- 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, October 10th, at 1:30 p.m. in New York. So let's get after it. Last week started with one of the biggest 2 day rallies in history, only to give most of it back by Friday's close. The culprit for this higher 2-way volatility is a combination of deteriorating fundamentals with oversold technicals. As noted last week, September was one of the worst months in what's been a difficult year, and the equity market was primed for a rally, especially with the S&P 500 closing right at its 200 week moving average on the prior Friday. Low quality stocks led the rally as further evidence the rebound was just bear market action rather than the beginning of a new bull. There is also still lingering hope for a Fed pivot, but the economic data that matters the most for such a pivot, jobs and inflation, continue to dash any hopes for a more dovish Fed. The sellout of momentum and retail, to some degree, does keep 2-way risk alive in the short term as it gets quiet for the next few weeks on the earnings front. Over the past month, there has been evidence that our call for lower earnings next year is coming to fruition. Large, important companies across a wide swath of industries have either reported or preannounced earnings and guided significantly lower for the fourth quarter. Some of these misses were as much as 30%, which is exactly what's needed for next year's estimates to finally take the step function lower, we think is necessary for the bear market to be over. The question is, will enough of this happen during third quarter earnings season, or will we need to wait for fourth quarter reporting in January and February when companies tend to formally guide for the next year? We think the evidence is already there and should be strong enough for this quarter for bottoms up consensus estimates have finally come down to reality, but we just don't know for sure. Therefore, over the next two weeks, stocks could continue to exhibit 2-way risk and defend that 200 week moving average at around 3600. One interesting development that supports our less optimistic view on 2023 earnings is in the dividend futures market. More specifically, we've noticed that dividend futures have traded materially lower, even as forward earnings per share forecasts have remained sticky to the upside. One reason this might be happening now is that cash flows are weakening. This is tied to the lower quality earnings per share we predicted earlier this year as companies struggled with the timing and costs versus revenues as the economy fully reopened. Things like inventory, labor costs and other latent expenses are wreaking havoc on cash flow. Accrual accounting earnings per share will likely follow 6 to 12 months later. In short, it's just another sign that our materially lower than consensus earnings per share forecasts next year are likely to be correct. If anything, we are now leaning more toward our bear case on S&P 500 earnings per share for next year, which is $190. The consensus is at $238. Bottom line, the valuation compression in equity markets this year is due to interest rates rising rather than concern about growth. This is evidenced by the very low equity risk premium, currently 260 basis points, that we still observe. The bear market will not be over until either earnings per share forecasts are more in line with our view, or the valuation better reflects the risk via the equity risk premium channel. Bear markets are about price and time, price takes your money, time takes your patience. Let the market wear everybody else out. When nobody is calling for the bottom, you will then know it's finally time to step in. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.

10 Okt 20223min

While China’s policy objectives strive for common prosperity, the country’s strict COVID management poses risks to employment and income, so when might Chinese policymakers start to reopen and recover?----- Transcript -----Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Asia Economist at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today I'll be focusing on the expected reopening of China's economy. It's Friday, October 7th, at 8:30 a.m. in Hong Kong. When my colleagues and I discuss Asia's growth outlook with investors, one of the top questions we get is, when will China reopen and what the roadmap will look like. We believe a reopening will happen not because the rest of the world is now living with COVID, but because the effects of China's strict COVID management are now increasingly at odds with its policy objective of achieving common prosperity. The challenges of a sharp rise in youth unemployment and significantly lower income growth, especially for the low income segments of the population, have become more pronounced this year ever since the onset of Omicron. To put this in context, the youth unemployment rate is at 19% and our wage growth proxy has decelerated from around 9% pre-COVID, to just about 2.2% year on year. These issues are further exacerbated by the intensifying spillover effects from weaker exports and a continued drag from property sector. Over the next five quarters, growth in developed markets will likely remain below 2% year on year. The continued shift in DM consumer spending towards services will mean global goods demand will deflate further. And as exports weaken, manufacturing CapEx will also follow suit, which will further weigh on employment creation. As for the property market, the pace of resolution of funding issues and uncompleted projects are still relatively sluggish. With the outlook for the drivers of GDP growth weakening, we think the only meaningful policy lever is a shift in COVID management aimed at reopening, reviving consumption and allowing services sector activity to lift aggregate demand towards a sustainable recovery. As things stand, several steps are necessary for a smooth reopening. They are, number one, renewed campaign to lift booster vaccination rates, especially amongst the elderly population. Number two, shaping the public perception on COVID. And number three, ensuring adequate medical facilities, equipment and treatment methods in the next 3 to 6 months. We therefore anticipate that policymakers will, in the spring of 2023, with the peak COVID and flu season behind us, be able to proceed with a broader reopening plan. Of course, we think that reopening in China will be gradual, as policymakers will remain mindful of the potential burden on the health care system. Against this backdrop, we see the recovery strengthening from second quarter of 2023 onwards. In the next two quarters, we estimate GDP growth will be subpar at around 3%. But as China reopens from the spring of 2023, we expect GDP growth will strengthen to 5.5% in the second half of the year. 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.

7 Okt 20223min

As month over month data begins to show a downturn in home prices, will overall price growth and sales begin to fall steeper than expected? Co-Heads of U.S. Securitized Products Research Jim Egan and Jay Bacow discuss.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-head of U.S. Securitized Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing why home prices could turn negative in 2023. It's Thursday, October 6th, at 3 p.m. in New York. Jay Bacow: Jim, it seems like every month the housing data is getting worse when we look at the sales activity. But, now I think I just saw something about home prices falling? What's going on there? I thought we call it home price appreciation, now we're seeing home price depreciation? Jim Egan: There is a lot going on out there. There's a lot of volatility, things are moving fast, and yes, there are home price indices that are showing negative numbers. I would caveat that a lot of those negative numbers are month over month, not the year over year that we've typically talked about here. But that doesn't mean it isn't important. Jay Bacow: In the past we've talked about this bifurcation narrative where we were going to get a big drop in home sales and housing starts, which we've seen, but home prices were more protected. Do you still believe that? Jim Egan: We do still believe in the bifurcation narrative, but the levels of the forecasts have changed, and they've changed for a couple of reasons. I think one reason is that there have been a number of forecast changes, expectations for 2023 are different. Our U.S. economics team has raised their hiking forecast 25 basis points in each of the next three meetings, and our interest rate team on the back of that forecast change has moved up their expectations for the 10 year Treasury. What that move means for us is that the incredible affordability deterioration that we've seen, probably isn't going to get a whole lot better next year. And that's happening in a world in which you mentioned some home prices turning negative. The home price deceleration that we were calling for, from plus 20% all the way down to plus 3% at the end of next year, that relied upon or I can say we expected home prices to fall month over month, but we thought that was going to start in September. It started in July. Sales volumes have been coming in weaker than we thought they would. When we take that weaker than expected housing data, we marry that with different expectations for affordability next year, the forecasts have to change. Jay Bacow: And so what exactly are we forecasting for this year and next year? Jim Egan: So in this world, we do think that sales are going to fall steeper than we thought. We think that starts are going to fall steeper than we thought, and that next year a single unit starts are going to be lower in 2023 than they were in 2022. We had originally been forecasting a return to growth in 2023, but the change to the forecast that's getting the most attention is that we went from plus 3% year over year growth in December of 2023 to -3% year over year growth by the end of next year. Jay Bacow: So if I buy a house today, it might be lower a year from now? That seems worrisome. Jim Egan: Yes. And I think there is a positive and a negative headline to that, right. The negative headline, the worrisome, if you will, that you mentioned is that not only is it down 3% next year, but that's down 7% from where we are right now. The positive headline is that even with that decrease in home prices from today, that only brings us back to January of 2022. That's 32% above where they were in March of 2020. Jay Bacow: All right, that doesn't seem so bad, given that stocks are a lot lower than where they were in January of 2022. So it's more stalling out than a real correction in home prices. But, why wouldn't home prices fall further from there? Jim Egan: We haven't seen anything in the data that changes kind of the underlying narrative that we've been discussing on this podcast in the past. In particular, two things. The first is how robust credit standards have been. If anything, lending standards, which were pretty tight to begin with in the first quarter of 2020, have tightened substantially since then. What that means, again, it constrains sales volumes. We think sales are going to fall more than home prices, but it also means that the likelihood of defaults and foreclosures is limited. And it is those distressed transactions, those forced sellers that we would need to see a leg down in prices. The other point is, away from defaults and foreclosures, actual inventory is still incredibly low. And because current homeowners sit on 30 year fixed rate mortgages, well below the current mortgage rate, when we talk about affordability deteriorating, we're not talking about it deteriorating for current homeowners. They're much more likely to stay in their home, much less likely to list their home for sale, they're not going to be selling into depressed bids. So that credit availability and those tight lending standards, we think that keeps home prices supported. Jay Bacow: So home prices are protected because we're not going to get the forced sellers that we saw during the financial crisis and the fundamentals of the housing market are in much stronger footing. What would actually get you, though, to forecast more of a real correction than just the stalling out? Jim Egan: I'm going to make this really complicated and say the supply and demand. If demand were to be weaker than we already think it is, and that could happen because the historic deterioration we've seen in affordability has a bigger impact than we think it will. Maybe because the unemployment rate picks up faster than we're expecting it to next year. If you have a much weaker demand environment than we're already envisioning, and you combine that with more supply, perhaps people who'd be a little bit more willing to part with their home at slightly lower prices than we expect them to, people who've owned their home for 10, 15, 20 years and might be looking to downsize. That's where you might have a little bit more of a marriage between uneconomic sellers and depressed demand that could bring home prices lower than we expect. Now, how does all of that, if we think about the implications to investors, what does all that mean for the MBS market? Jay Bacow: I'm going to make this really complicated, too. A lot of it comes down to supply and demand. The lack of housing activity and the lower home prices means that there's going to be less supply for mortgage investors to buy. That's good for the mortgage market. The rapid increase in unaffordability has been because of the rapid increase in implied volatility, which is bad for mortgage investors. This has brought nominal spread to the Treasury curve for agency mortgages to levels that are basically at the post GFC wides. And we think that move is a little bit overdone. And so for institutional investors we think this is an opportunity to own agency mortgages versus treasuries as a way to fade some of these moves, and take advantage of some of the more forward looking supply projections that we think will be coming as supply slows down. Jay Bacow: But Jim, it's always great talking to you. Jim Egan: Great talking to you too, Jay. Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcast app and share the podcast with a friend or colleague today.

6 Okt 20226min

As globalization slows and companies begin to nearshore their supply chains, investors may be wondering what the costs and benefits are of bringing manufacturing back home.Important note regarding economic sanctions. This research references country/ies which are generally the subject of comprehensive or selective sanctions programs administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries and multi-national bodies. Any references in this report to entities, debt or equity instruments, projects or persons that may be covered by such sanctions are strictly informational, and should not be read as recommending or advising as to any investment activities in relation to such entities, instruments or projects. Users of this report are solely responsible for ensuring that their investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.----- Transcript -----Welcome the Thoughts on the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, October 5th, at 10 a.m. in New York. We speak often here about the themes of slowing globalization, or slowbalization, and the shift to a multipolar world. It's important to understand these megatrends, as they will likely impact global commerce for decades to come and in many ways we cannot yet anticipate. But one impact we have anticipated is multinational companies spending money to shift their supply chains. Whereas globalization meant companies could focus on lowering their labor and transportation costs through 'just in time' logistics, 'just in case' logistics are the watchword of the multipolar world. Companies will have to invest money to nearshore or friend shore to protect their supply chains from seizing up due to geopolitical conflicts, be it war, such as Russia invading Ukraine leading to sanctions, or the proliferation of policies by Western governments, preventing companies from producing and/or sourcing sensitive technologies overseas. Now, we're increasingly seeing evidence that this dynamic is already at play. Take Apple, for example, which, according to the Wall Street Journal, recently released a supplier list showing that in September of 2021, 48 of its suppliers had manufacturing sites in the U.S., up from 25 just a year before. The article goes on to cite several semiconductor chip makers who have recently opened US based sites. One company recently agreed to invest as much as $100 billion in a semiconductor manufacturing facility in upstate New York. Another announced plans to invest $20 billion for chip factories in Ohio. So it's clear that companies are starting to respond to geopolitical incentives. The long term public policy benefits of these moves could prove to be quite sound, but in the short term they're a challenge to markets. These investments cost money and represent elevated costs relative to what these companies would have enjoyed had the geopolitical environment not become more challenging. That means investors have to price in yet another margin pressure on top of the ones our colleague Mike Wilson continues to highlight in U.S. equities, from labor costs and the fed hiking rates to engineer slower economic growth. So bottom line for investors, shifting to a new geopolitical world order may be necessary, but it will cost something along the way. And for the moment, that means extra pressure on a U.S. equity market that's already got its fair share. 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.

5 Okt 20222min

With investors becoming pervasively bearish on stocks and bonds in the face of a worsening growth outlook, can the U.S. investment grade credit market provide shelter from the storm?----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Global Director of Fixed Income Research. Along with my colleagues, bringing you a variety of perspectives, today I'll share why corporate credit markets may be a sheltering opportunity amid current turbulence. It's Tuesday, October 4th, at 11 a.m. in New York. At a September meeting, the Federal Open Market Committee delivered a third consecutive 75 basis point rate hike, just as consensus had expected. The markets took this to mean a higher peak and a longer hiking cycle, resulting in sharp spikes in bond yields and a sell off in equities. At the moment, both 2 and 10 year Treasury yields stand at decade highs, thanks to pervasively bearish sentiment among investors across both stocks and bonds. As regular listeners may have heard on this podcast, Morgan Stanley's Chief Global Economist, Seth Carpenter, has said that the worst of the global slowdown is still likely ahead. And our Chief U.S. Equity Strategist, Mike Wilson, recently revised down his earnings expectations for U.S. equities. Navigating this choppy waters is a challenge in both risk free and risky assets due to duration risk in the former, and growth or earnings risks in the latter. Against this backdrop, we think the U.S. investment grade corporate bonds, IG, particularly at the front end of the curve, which is to say 1 to 5 year segment, could provide a safer alternative with lower downside for investors looking for income, especially on the back of much higher yields. But investors may wonder, wont credit fundamentals deteriorate if economy slows, or worse, enters the recession and company earnings decline. Here is where the starting point matters. After inching higher in Q1, median investment grade leverage improved modestly in the second quarter and is well below its post-COVID peak in the second quarter of 2020. Gross leverage is roughly in line with pre-COVID levels. Notably, while median leverage is back to pre-COVID levels, the percentage of debt in the leverage tail has declined meaningfully. But if earnings were to decline, as our equity strategists expect, leverage ratios may pick back up. That said, interest coverage is the offsetting consideration. Given the amount of debt that investment grade companies have raised at very low coupons over the years, their ability to cover interest has been a bright spot for some time. Despite sharply higher rates, median interest coverage improved in the second quarter and is around the highest levels since early 1990. This modest improvement in interest coverage comes down to the fact that even though yields on new debt are higher than the average of all outstanding debt, the bonds that are maturing have relatively high coupons. Therefore, most companies have not had to refinance at substantially higher funding levels. In fact, absolute dollar level of interest expense paid out by IG companies actually declined in the quarter and is now well below the peaks of 2021. With limited near-term financing needs, higher rates are unlikely to dent these very healthy interest coverage ratios. The combination of strong in-place investment grade fundamentals, relatively low duration for the 1 to 5 year segment and yields at decade highs, suggests that this part of the credit market offers a relatively safe haven to weather the storms that are coming for the markets. History provides some validation as well. Looking back to the stagflationary periods of 1970s and 80's, while we saw multiple decisions and volatility in equity markets, IG credit was relatively stable with very modest defaults. And while history doesn't repeat, it does sometimes rhyme, so we look to the relative safety of IG credit once again in the current environment. 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.

4 Okt 20223min