US Economy: What Could Go Wrong

Global Head of Fixed Income and Public Policy Research Michael Zezas and Head of Global Evaluation, Accounting and Tax Todd Castagno discuss the market and economic implications of proposed tax extensions and tax cuts.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy.Todd Castagno: And I'm Todd Castagno, Head of Global Evaluation, Accounting and Tax.Michael Zezas: Today, we'll focus on taxes under the new Trump administration.It's Monday, February 10th, at 10am in New York.Recently, at the annual meeting of the World Economic Forum in Davos, President Trump stated his administration will pass the largest tax cut in American history, including substantial tax cuts for workers and families. He was short on the details, but tax policies were a significant focus of his election campaign.Todd, can you give us a better sense of the tax cuts that Trump's been vocal about so far?Todd Castagno: Well, there's tax cuts and tax extensions. So, I think that's an important place to set the baseline. The Tax Cuts and Jobs Act (TCJA), under his first administration, starts to expire in 2025. And so, what we view is, the most likelihood is, an extension of those policies going forward. However, there's some new ideas, some new contours as well. So, for instance, a lower corporate rate that gets you in the 15 per cent ballpark can be through domestic tax credits, new incentives.I think there's other items on the individual side of the code that could be explored as well. But we also have to kind of step back and creating new policy is very challenging. So again, that baseline is an extension of kind of the tax world we live in today.So, Michael, looking at the broader macro picture and from conversations with our economist, how would these tax cuts impact GDP and macro in general?Michael Zezas: Well, if you're talking about extension of current policy, which is most of our expectation about what happens with taxes at the end of the year, the way our economists have been looking at this is to say that there's no net new impulse for households or companies to behave differently.That might be true on a sector-by-sector basis, but in the aggregate for the economy, there's no reason to look at this policy and think that it is going to provide a definitive uplift to the growth forecast that they have for 2026. Now, there may be some other provisions that could add in there that are incremental that we'd have to consider.But still, they would probably take time to play out or their measurable impact would be very hard to define. Things like raising the cap on the state and local tax deduction, that tends to impact higher income households who already aren't constrained from a spending perspective. And things like a domestic manufacturing tax credit for companies, that could take several years to play out before it actually manifests into spending.Todd Castagno: And you’re kind of seeing that with the prior administration's tax law, the Inflation Reduction Act. A lot of this takes years in order to actually play through the economy. So that's something that investors should consider.Michael Zezas: Yeah, these things certainly take time; and you know back in 2018 it had been a long ambition, particularly of Republican lawmakers, to reduce the corporate tax rate. They succeeded in doing that, getting it down to 21 per cent in Trump's first term. Now, Trump's talked about getting corporate tax rates lower again here. If he's able to do that, how do you think he would do that? And would that affect how you're thinking about investment and hiring?Todd Castagno: So, there's the corporate rate itself, and it's at 21 per cent currently. There is a view to change that rate, lower it. However, there's other ways you can reduce that effective tax burden through what we've just discussed. So enhanced corporate deductions, timing differences, companies can benefit from a tax system that ultimately gets them a lower effective rate, even if the corporate rate doesn't move much.Michael Zezas: And so, what sorts of companies and what sorts of sectors of the market would benefit the most from that type of reduction in the corporate tax burden?Todd Castagno: So, if you think they're mosaic of all these items, it's going to accrue to domestic companies. That might sound kind of obvious, but if you look at our economy, we have large multinationals and we have domestic companies and we have small businesses. The policies that are being articulated, I think, mostly orient towards domestic companies, industrials, for instance, R&D incentives, again powering our AI plants, energy, et cetera.Michael Zezas: Got it. And is there any read through on if a company does better under this policy – if they're big relative to being small?Todd Castagno: There are a lot of small business elements as well. So, I mentioned that timing difference, being able to deduct a piece of machinery day one versus over seven years. So, there's a lot of benefits that are not in the rate itself that can accrue through smaller businesses.Michael Zezas: YAnd what about for individual taxpayers, particularly the middle class? What particular tax cuts are on the table there?Todd Castagno: So, first and foremost is the child tax care credit. So, it’s current policy, but after COVID, it was enhanced. A higher dollar amount, different mechanism for receiving funds. And so, there is bipartisan support and President Trump as well, bringing back a version of an enhanced credit. Now, the policy is a little bit tricky, but I would say there's very good odds that that comes back. You know, you mentioned the state and local tax deduction, right? The politics are also tricky, but there could be a rate of change where that reverts back to pre-TCJA.But one of the things, Michael, is all these policies are very expensive. So, I'm just curious, in your mind, how do we balance the price tag versus the outcome?Michael Zezas: Well, I think the main constraint here to consider is that Republicans have a very slim majority in the House of Representatives and the Senate, and they're unlikely to get Democratic representatives crossing the aisle to vote with them on a tax package this large. So, they'll really need complete consensus on whatever tax items they extend and the deficit impact that it causes this is the type of thing that ultimately will constrain the package to be smaller than perhaps some of the president's stated ambitions.So, for example, items like making the interest payments on auto loans tax deductible, we think there might not be sufficient support for that and the budget costs that it would create. So ultimately, we think you get back to a package that's mostly about extending current cuts, adding in a couple more items like that domestic manufacturing tax credit, which is also very closely tied to Republicans larger trade ambition. And you might also see Republicans do some things to reduce the price tag, like, for example, only extend the tax cuts for a few years, as opposed to five or 10 years.Todd Castagno: Right.Michael Zezas: Todd, thanks for taking the time to talk.Todd Castagno: Great speaking with you, Mike.Michael Zezas: Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

10 Feb 7min

Our Chief Fixed Income Strategist Vishy Tirupattur thinks that efficiency gains from Chinese AI startup DeepSeek may drive incremental demand for AI.----- Transcript -----Welcome to Thoughts on the Market. I’m Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Today I’ll be talking about the macro implications of the DeepSeek development.It's Friday February 7th at 9 am, and I’m on the road in Riyadh, Saudi Arabia.Recently we learned that DeepSeek, a Chinese AI startup, has developed two open-source large language models – LLMs – that can perform at levels comparable to models from American counterparts at a substantially lower cost. This news set off shockwaves in the equity markets that wiped out nearly a trillion dollars in the market cap of listed US technology companies on January 27. While the market has recouped some of these losses, their magnitude raises questions for investors about AI. My equity research colleagues have addressed a range of stock-specific issues in their work. Today we step back and consider the broader implications for the economy in terms of productivity growth and investment spending on AI infrastructure.First thing. While this is an important milestone and a significant development in the evolution of LLMs, it doesn’t come entirely as a shock. The history of computing is replete with examples of dramatic efficiency gains. The DeepSeek development is precisely that – a dramatic efficiency improvement which, in our view, drives incremental demand for AI. Rapid declines in the cost of computing during the 1990s provide a useful parallel to what we are seeing now. As Michael Gapen, our US chief economist, has noted, the investment boom during the 1990s was really driven by the pace at which firms replaced depreciated capital and a sharp and persistent decline in the price of computing capital relative to the price of output. If efficiency gains from DeepSeek reflect a similar phenomenon, we may be seeing early signs [that] the cost of AI capital is coming down – and coming down rapidly. In turn, that should support the outlook for business spending pertaining to AI.In the last few weeks, we have heard a lot of reference to the Jevons paradox – which really dates from 1865 – and it states that as technological advancements reduce the cost of using a resource, the overall demand for the resource increases, causing the total resource consumption to rise. In other words, cheaper and more ubiquitous technology will increase its consumption. This enables AI to transition from innovators to more generalized adoption and opens the door for faster LLM-enabled product innovation. That means wider and faster consumer and enterprise adoption. Over time, this should result in greater increases in productivity and faster realization of AI’s transformational promise.From a micro perspective, our equity research colleagues, who are experts in covering stocks in these sectors, come to a very similar conclusion. They think it’s unlikely that the DeepSeek development will meaningfully reduce CapEx related to AI infrastructure. From a macroeconomic perspective, there is a good case to be made for higher business spending related to AI, as well as productivity growth from AI.Obviously, it is still early days, and we will see leaders and laggards at the stock level. But the economy as a whole we think will emerge as a winner. DeepSeek illustrates the potential for efficiency gains, which in turn foster greater competition and drive wider adoption of AI. With that premise, we remain constructive on AI’s transformational promise.Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.DISCLAIMERIn the last few weeks… (Laughs) It’s almost like the birds are waiting for me to start speaking.

7 Feb 4min

Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explains why a resurgence in air travel is leading China’s emergence from deflation.----- Transcript -----Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Chinese airlines are at a once-in-a-decade inflection point, and today I’ll break down the elements of this turnaround story.It’s Thursday, Feb 6th at 10am in Hong Kong.Last week, hundreds of millions of people across Asia gathered to celebrate the lunar new year with their families. I was one of them and took a flight back to my hometown Nanjing. Airports were jam-packed for days, with air travel expected to exceed 90 million trips.It’s all indicative of Chinese airlines making a comeback after a seven-year run of underperformance. In fact, we believe Airlines will be one of the first industries to emerge from China's deflationary pressures this year. And this has implications for the country's broader economy.Although COVID impacted Airlines globally, other regions have since recovered. In China, the earnings recovery is just beginning. Since 2018, Chinese Airlines have experienced demand hits from the trade tension, currency depreciation, COVID-19, and post-COVID macro headwinds.It’s been two years since Chinese borders lifted restrictions and air travelers are returning in force. Excess capacity has now been digested. Slower deliveries of aircrafts continue to limit supply, and it is more difficult for airlines to get new aircraft and increase their available seats. Passenger load factors will continue to strengthen this year, which means the airlines are running close to full capacity. This will increase Airlines' pricing power within the next 6 to 12 months, feeding through to earnings.If we put that in a global context, China’s airlines industry handled around 700 million passengers in 2024, 8 per cent of global air passengers; but that 700 million passengers only account for half of China’s population. In the US, air passenger numbers can be three times its population.Chinese airlines have just reached break-even in the past year, while many of their global peers have already generated robust profits. Chinese Airlines’ earnings and valuations have lagged global peers in both absolute and relative terms. But now, with a turnaround coming into view, Chinese Airlines have a longer runway for stronger earnings growth and share price performance than global peers.What’s more, the August 2024 turnaround in US airlines offers several key takeaways for China. US Airlines’ share prices recovered last year, following a long period of underperformance post COVID. The wait before the inflection was long, but share prices moved up quickly once the turning point was reached, and valuation expanded ahead of earnings recovery. Big US airlines outperformed smaller players during the most recent rally. We think all these are relevant to the Chinese Airlines story.If we look at earnings – Chinese Big Three airlines reached breakeven in 2024, making a small profit in 2025, and that profit will double in 2026. But that’s not yet the peak of the cycle; peak cycle earnings could again double the 2026 level, probably in 2027 to 2028. That’s the reason why we think Chinese airlines are on the path to doubling share prices.To sum up, Chinese Airlines represent a once-in-a-decade opportunity for investors. With strengthened passenger load factors and a positive demand outlook, coupled with significant potential for earnings growth, this industry looks ready for takeoff.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. For those who celebrate – 新春快乐，恭喜发财！

6 Feb 4min

Our Global Head of Fixed Income Research & Public Policy Strategy Michael Zezas discusses the potential economic outcomes of a shifting North American trade policy.----- Transcript -----Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income Research and Public Policy Strategy. Today – the latest on tariffs and potential outcomes of a shifting North American trade policy. It’s Wednesday, February 5, at 10am in New York. In a series of last-minute phone calls on Monday, President Trump reached a deal with Mexican President Claudia Sheinbaum and Canadian Prime Minister Justin Trudeau. President Trump agreed to delay the announced 25 percent tariffs on Mexico and Canada for a month – citing their intention to do more on their borders against migration and drug trafficking. But President Trump’s 10 percent tariffs on all Chinese products went into effect yesterday morning. China responded promptly with its own countermeasures, which are not expected to take effect until Monday, February 10, leaving room for potential negotiations. These developments don’t come as a surprise. We had been assuming – one – that Canada and Mexico could avoid tariffs by making border concessions, which they did. And – two – that the US would craft a tariff policy related to China independent from its considerations around Mexico and Canada. If the underlying goal is to transform its trade relationship with China, then the US has an interest in preserving an alignment with Canada and Mexico. Given all of that, our base case of “fast announcements, slow implementation” looks intact. We expect tariffs on China and some products from Europe to ramp up through the end of the year, putting downward pressure on economic growth into 2026. If tariffs on Mexico and Canada are avoided or delayed further, there would be no change to our broader economic outlook. The U.S. dollar could weaken as it prices out some tariff risk. Within U.S. equities, consumer discretionary as well as broader cyclical stocks could lead. If, however, we're wrong and tariffs do go up on Mexico and Canada after this one-month pause, then we expect some rise in inflation, growth to slow, and the U.S. dollar and Treasuries to outperform equities; at least for a time as the U.S. gets to work rewiring its global trade relationships. Tariffs are likely to dominate news headlines in the days and months to come. We'll keep tracking the topic and bring you 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.

5 Feb 2min

Our analysts Ariana Salvatore, Stephen Byrd and Devin McDermott discuss President Trump’s four executive orders around energy policy and how they could reshape the sector.----- Transcript -----Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's U.S. Public Policy Strategist.Stephen Byrd: And I'm Stephen Byrd, Morgan Stanley's Head of Research Product for the Americas and Global Head of Sustainability Research.Devin McDermott: And I'm Devin McDermott, Head of North American Energy Research.Ariana Salvatore: Our topic today looms large in investors minds. We'll be digging into how the new policies proposed under President Trump's administration will fundamentally reshape energy markets.It's Tuesday, February 4th at 10am in New York.On his first day in office, President Trump declared a national energy emergency. He issued four key executive orders, setting out a sweeping plan to maximize oil and gas production. All of this on top of stepping back in tangible ways from the Biden administration's clean energy plans. We think these orders can have a significant impact on the future of energy, one of Morgan Stanley's four key themes for 2025.So, Stephen, let's start there. One of the biggest questions is which segments of the power and AI theme stand to benefit the most, and which ones will be the most challenged?Stephen Byrd: Yeah, Ariana, I'd say the two biggest beneficiaries will be natural gas and nuclear, probably in that order. And in terms of challenges, I do think, wind, especially offshore wind, will be quite challenged. So, when I think about natural gas, it's very clear that we have an administration that's very pro natural gas.And natural gas is also going to need to be part of the power mix for data centers. It's flexible. It could be built relatively quickly. There are a lot of locational options that are perfect here. So, I do think natural gas is a winner.On nuclear, we do think Republicans broadly, and also many Democrats, firmly support nuclear power. Nuclear is quite helpful, especially for larger data centers or supercomputers. They're large, there's a lot of land at these nuclear plants. And so, I would expect to see some very large data centers built at operational nuclear plants. And we do think the Trump administration will work hard to make that – from a regulatory point of view – make that happen.I also think we'll see a lot of support at the federal level for new nuclear power plant construction, as well as bringing the U.S. nuclear fuel cycle back to the U.S. So those are a few of the areas that I would expect to do well.Ariana Salvatore: Devin, same question for you on the energy sector. How are you thinking about the impacts?Devin McDermott: Yeah, it's a good question, and there's a lot in these executive orders. I mean, some of the key things that we're focused on as impacting the sector include encouraging federal lands development and leasing for oil and gas activity, with a specific focus on Alaska. Resuming LNG permit authorizations, which lifts the ban that's been in place for the last year. Eliminating EV targets, including pausing some IRA funds tied to EVs. Broad support for infrastructure permitting, including pipelines. And then a broader review of environmental regulations, including some recent headlines that point to rolling back fuel efficiency and emission standards for cars and trucks – something that the prior Trump administration did as well.The near-term financial impact to the industry of all this is fairly limited. But there are two key longer-term considerations. First, on the oil side, rolling back fuel efficiency standards and other environmental regulations doesn't stop the transition to lower carbon alternatives, but it does slow it. And in particular, it moderates the longer-term erosion of gasoline and diesel demand; and creates a backdrop where incumbent energy players have a longer runway to harvest cash from these legacy businesses and time to scale up profitable low carbon growth, which is still progressing, despite the policy changes.And then second, gas is the biggest winner, building on some of Stephen's comments. The policy initiatives that we're seeing here are likely to support more LNG exports and more gas power generation relative to the status quo.Ariana Salvatore: So, Devin, one of the things you mentioned there is regulation, and we think that's specifically reflected in this theme of unleashing American energy that Trump likes to talk about. It seems that this would set the stage for looser regulation and more supportive policy for oil and gas development.Do you expect any meaningful changes in near-term investment levels or production growth across the industry?Devin McDermott: It's an easy one, Ariana. No. The reality is the majority of U.S. oil and gas investment activity occurs on state or privately held lands. It's regulated at the state level. And the amount of investment that occurs across presidential election cycles really doesn't change all that much. And, in fact, some of the highest growth years ever for the U.S. oil and gas sector occurred under the Obama administration and also the most recent Biden term where production of both commodities actually hit all time highs.So, when your baseline is things really aren't that bad, it's tough to do much that really accelerates the throttle and causes companies to add more activity or add more oil or gas drilling rigs. And the last thing I just say on this point is the sector is not funding constrained. There's adequate free cash flow; there's adequate investment capacity. And that also is another limiting factor on doing anything that positively influences willingness to spend capital.In the end, it's really more about price – and where oil prices specifically goes as it relates to oil and gas investment – rather than policy.Stephen Byrd: So, Ariana, let me move from Devin's thoughts on price back to policy – and if you take a step back, a key question that we often get asked is: Will the President's executive orders be fully implemented? What do you think?Ariana Salvatore: Well, it's always necessary to frame these policy proposals in terms of their feasibility, right? So, we're still parsing through all of the details of these executive orders. But we already feel higher conviction in some areas over others, where we think the president has clear and present authority to make policy changes.For example, President Trump can pretty easily unilaterally decide to move away from Biden's clean energy targets, but he's going to have a much harder time rescinding money that has already been appropriated, dispersed, or obligated towards these ends. For example, through the Inflation Reduction Act. We think that process is going to be much longer and likely result in a very targeted repeal as opposed to a broad-based claw back of funds.Stephen Byrd: Just thinking about sequencing, can you talk more about, sort of, the potential specific sequencing of these policies?Ariana Salvatore: There are a few different balls in the air right now, so to speak, as we noted in the run up to the inauguration. We expected President Trump to focus first on the areas that are more within his unilateral control as president. So, that really comes down to tariffs and trade policy more broadly, as well as immigration.I would also put deregulation in that bucket, but more on a sector specific basis. So, as we've talked about, we think there's clear deregulatory tailwinds for the energy sector. It's also clear in financials. But across the board, these are going to have more limited success in the energy complex.But Stephen, back to you, given everything that we've been talking about, how do you see the future of clean energy, renewables, EVs – all these elements that make up the Inflation Reduction Act and the broader energy transition?Stephen Byrd: Yeah, as I think about the areas that are most at risk, I think it's very clearly electric vehicles as well as wind power. Both have been, the subject of direct criticism and we would expect a high risk of elimination or reduction of support there. So that will cause some issues. I would say especially offshore wind faces multiple issues and we think the growth outlook is now very challenged.Now that said, onshore wind is often, for example, done on private land rather than public land, and the economics in many locations for both wind and solar remain quite favorable. And I think a big area of underappreciated upside would be AI itself – in the sense that the hyperscalers have very significant zero carbon emissions goals. So, what we see happening is we think these hyperscalers over time as they build out more and more data centers, which do have very high carbon footprints, we do think these hyperscalers are going to engage in power contracts with new renewable projects. So that is a boost to demand that I think the market is really not well appreciating.Ariana Salvatore: And finally, let's consider the issue of powering data centers. Devin, you've spoken about your positive outlook for natural gas. Do you think natural gas is going to play a bigger role in powering large U.S. data centers?Devin McDermott: Yeah, we do, and there's been an uptick in natural gas related announcements as it relates to data center growth in the U.S. over the last few months. And more recently, we've actually seen some very large deals; plus carbon capture which addresses some of the emissions concerns that Stephen was mentioning before – that the hyperscalers have longer term.It's important to contextualize this, though, with the broader growth backdrop for natural gas. The market here domestically is on the cusp of what we see as a structural growth cycle driven really by two key pillars. The first of which is that rise in LNG exports that I was alluding to before, where we're on track to roughly double U.S. export capacity over the next five years. And the second pillar is power. And power has a lot of different subsets to it. It's onshore manufacturing, it's this broader trend of electrification, like more electric appliances, a little bit from EVs. Some underlying industrial activity growth and then data centers in AI.So that is meaningful. That's a lot of gas, but there's also a lot more in all the other buckets I talked about.Ariana Salvatore: Stephen, pivoting back to you, beyond natural gas, how do you see this theme of powering AI developing more broadly under the new Trump energy policies?Stephen Byrd: Yeah, you know, I think broadly what we see is that a number of debottlenecking technologies are going to become very important. We cannot get enough power for data centers that we need really over the next several years. So, we're going to need to be very creative.One option will be to build data centers at large nuclear power plants. I think we'll definitely see that. We will also, I think, see converting bitcoin sites into data centers. That's going to be quite popular. And then lastly, I do think electric transmission will see excellent growth. That is certainly one way to try to debottleneck the grid – is to increase the grid itself.That takes many years, but I do think there will be more and more willpower. Both at the federal and state level to provide incentives for electric transmission. So that's an asset class that's definitely a winner.Ariana Salvatore: Last question for both of you, Stephen. I know we're going to hear from you in an upcoming episode about the implications of DeepSeek, but just to get a little bit of a sneak peek here. I'd love a quick take on how you're thinking about DeepSeek.Stephen Byrd: It's really quite jarring in a week to go from a $500 billion U.S. AI plan to a LLM with a reported price tag of just $6 million. I come away bullish on power demand, and let me walk through why that is. You know, I think that as the cost of inference drops, and we're seeing many signs of that – not just DeepSeek, but many other developments. As that happens, the absolute demand for inference compute goes up, and that compute requires a lot of electricity, so I'm quite bullish there.Also on AI training, I think the market has gotten too negative. I think that what we'll see is continued LLM R&D to go to the next level of capability. And there are at least five U.S. companies who are going to spend in the tens of billions, possibly into the hundreds of billions of dollars each on training the next generation of Large Language Models, which could be much, much more capable than the current generation. So, I'm actually quite bullish on the outlook for power demand from AI.Ariana Salvatore: Devin?Devin McDermott: The news drove a big dislocation across the gas value chain and pullback in many exposed stocks. And we think those types of dips are a buying opportunity because the gas setup is constructive or compelling for many reasons. Power is one of them, but you're not paying for power in the stock prices today.Ariana Salvatore: Stephen, Devin, thanks for taking the time to talk. And to our listeners, thanks for tuning in. 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.

4 Feb 11min

Our CIO and Chief U.S. Equity Strategist Mike Wilson explains why U.S. stocks took a hit that is likely to sustain through the first half of 2025.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing tariffs, recent developments in AI and what it means for stocks.It's Monday, Feb 3rd at 11:30am in New York. So, let’s get after it.While 2024 was a strong year for many stocks, it was mostly a second half story. With recession fears peaking last summer and a Fed that remained on hold due to still elevated inflation, markets were essentially flat year-to-date in early August.But then everything changed. The Fed surprised markets with a 50 basis points cut to show its commitment to keeping the economy out of recession. This was followed by better labor data and two more 25 basis points cuts from the Fed. Investors took this as a green light to add more equity to portfolios—the riskier the better. It also became clear to markets and many observers that President Trump was likely going to win the election, with a rising chance of a Republican sweep in Congress. Given the more pro-growth agenda proposed by candidate Trump and his track record during his first term as President, he made investors even more bullish. Finally, given all the concern about a hung election, the fact that we got such definitive results on election night only added fuel to the equation. Hedges were swiftly removed and even reversed to long positions as both asset managers and retail investors chased performance for fear of falling behind, or missing out. In October, I suggested the S&P 500 would likely trade to 6100 on a clean election outcome. After promptly hitting that level in early December, stocks had a very weak month to finish the year with deteriorating breadth. The S&P 500 started the year soft before rallying sharply into inauguration day, essentially re-testing that 6100 level once again. The difference this time is that the re-test occurred on much lower breadth with high quality resuming its leadership role. Tariffs were always on the agenda, as was immigration enforcement, both of which are growth negative in the short-term.In my view, investors simply got complacent about these risks and are now dealing with them in real time. This also fits with our view that the first half of the year was likely to be tougher for stocks as equity negative policies would be implemented immediately before the equity positive policies like de-regulation, tax extensions and reduced government spending had time to play out in the form of less crowding out and lower interest rates. At the Index level, I expect the S&P 500 to trade in a range between 5500 to 6100 for the next 3 to 6 months, with our fourth quarter price target at 6500 remaining intact. Since we have been expecting tariffs to be implemented, this realization only furthers our preference for consumer services over goods. It also supports our preference for financials and other domestically geared businesses that have limited currency or trade exposures. In addition to rising political uncertainty, we also saw the release of DeepSeek’s latest AI chat bot last week. This added another level of uncertainty for investors that could have lasting implications at both the stock and index level given the importance of this investment theme. On one hand it could also accelerate the adoption of AI technologies if it truly lowers the cost – but many portfolios will need to adjust for this shift if that’s the case. We think it further supports our ongoing preference for software and media over semiconductors. Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

3 Feb 3min

Morgan Stanley Research analysts Michelle Weaver, Chris Snyder and Nik Lippmann discuss U.S.-Mexico trade and the future of reshoring and near-shoring under the Trump administration.----- Transcript -----Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity Strategist at Morgan Stanley.Christopher Snyder: I’m Chris Snyder, US Multi-Industry Analyst.Nikolaj Lippmann: And I'm Nik Lippmann, Chief Latin America Equity Strategist.Michelle Weaver: On this episode of our special mini-series covering Big Debates, we'll talk about the U.S.-Mexico trade relationship and the key issues around reshoring and nearshoring.It's Friday, January 31st at 10am in New York.The imposition of tariffs back in 2018 under the first Trump administration and the COVID pandemic put a severe strain on global supply chains and catalyzed reshoring and nearshoring in North America. But with inflation and supply chain concerns no longer front and center, investors are questioning whether the U.S. reshoring momentum can continue.Chris, what's your view here?Christopher Snyder: I think it's in the very early innings. You know, if you look at the history of U.S. manufacturing, the country really started ceding share in about 2000 when China joined the World Trade Organization. So, it's been going on for 25 years; we've been giving share back to the world. I think the process of taking share back is probably slower and ultimately is a multi-decade opportunity.But you're absolutely right. The supply chain concerns are no longer like they were three to four years ago. But what I think has persevered since the pandemic is this heightened focus on operational durability and resiliency; and really shortening supply chains and getting closer to the end user, which I'm sure we'll hear more from Nick about, on the Mexico side.But, you know, if you kind of look back at global supply chains and manufacturing, it's really been a chase to find low-cost labor for the last 45 years. And while that's always important, we think going forward, capital and proximity to end users will increasingly dictate that regional allocation of CapEx. I mean, those parameters are very supportive for the U. S.You know, one thing I would like to kind of, you know, make sure is known on our U.S. reshoring view is that, you know, oftentimes it's thought of that we're shutting down a factory in China and reopening the same factory in the United States, and that's really a very rare example.Our view is that the world, and very specific industries need to add capacity. And we just simply think that the U.S. is better positioned to get that incremental factory relative to any point in the last 45 years, due to the combination of structural tech diffusion, but also this focus on resiliency. And one thing that I really do think is underappreciated is that global manufacturing grows 4 to 5 per cent a year. In the U.S. it's been more in the 1 to 2 percent range because we're constantly ceding share. But even if the U.S. just stops giving back share, you could see the growth profile of U.S. industrials double.Michelle Weaver: How would you size the reshoring opportunity? Do you have a dollar amount on what that could be worth?Christopher Snyder: Yeah, we’ve sized it at $10 trillion. You know, and it's been a combination of the CapEx, the fixed asset investment that's needed to build these factories, then ultimately the production, you know, opportunity that will come to those factories thereafter.Michelle Weaver: And you've argued that the U.S. reshoring flame was really lit in 2018 with the first wave of the Trump tariffs. It seems clear that trade policies by the new administration will continue to support reshoring. What's your outlook there?Christopher Snyder: Yeah, you're absolutely right. Prior to 2018, there wasn't really a thought process. If you need an incremental factory, you most likely just put it in China. And I think the tariffs, back in 2018 or [20]19 really started, or kickstarted boardroom conversations around global supply chains. So, I think a Trump presidency absolutely adds duration to this theme via protectionism or tariffs that the administration will implement.If you go back to the Trump 1.0 tariffs, supply chains reacted to the change in cost structures very quickly. We didn't see a huge wave of investment back into the United States. We just saw production exit China and move to broader Asia, because the focus was tariff avoidance.Now, we think the focus is around building operational, resiliency and durability which better positions the U.S. to get that incremental factory. And one thing that I think is underappreciated here is just how much leverage U.S. politicians have. The U.S. is the best demand region in the world. The U.S. accounts for about 30 per cent of global goods consumption. That's equal to the E.U. and China combined. It's also the best margin region in the world, not only for U.S. companies; but most international companies do their best margins in the United States. So, you can raise the cost to serve the U.S. market, and no one is turning away from the region that has the best demand and the best margins.Michelle Weaver: So, of course, tariffs in the pandemic have been major catalysts for U.S. reshoring. Have there been any other drivers like tech diffusion?Christopher Snyder: Yeah. I view the pandemic as the catalyst, and I view tech diffusion as the structural tailwind for U.S. manufacturing. Over time, we will continue to figure out ways to squeeze labor out of the manufacturing cost profile. It's hard to kind of pinpoint it, but I think if we look out over any 5- or 10-year window, we will see that. That's a structural talent for the United States, given the high labor costs. And really what it will help do is just narrow the cost delta, between low cost producing regions. I also think as we kind of extend this tech diffusion into GenAI; I also think what's going on is, will fuel another round of protectionism. So, you know, kind of further keeping that cycle going.Michelle Weaver: Nick, of course the big question investors are asking is how will the Trump trade agenda impact Mexico? Contrary to the prevailing market view, you've argued that Mexico can actually win big with Trump. How's this possible?Nikolaj Lippmann: That's right, Michelle. Look, we recently upgraded Mexico to equal weight, from underweight. And while some of the news we see around the administration seems a bit like a sequel, there are other things that are just very different.We're not talking about ripping apart the USMCA but actually bringing forward renegotiations from [20]26 to [20]25. It's a much more constructive message. It's a very young deal, and yet I think the world we live in today is quite different from the world of 2018. When we look at what are some of the things where Mexico could actually end up winning big, we look at the regionalism that appears to be a number one agenda.We look at the – how difficult it would be for the United States to de-risk from China. And from Mexico simultaneously. And also, fundamentally at that integration across the border, the industrial integration. It's clear that there's a need for calibration. There's a need for calibration in terms of a lot of the trade policy. There's been talks about maybe a customs union and I think that's far out in the future. But there's a need to try to figure out how to calibrate trade. And also, you know, there are things that Mexican policy makers can do to deal with the non-trade related issues, such as immigration or the cartels. And I think frankly, it's in Mexico's interest to deal with some of these issues.Michelle Weaver: Where are we in the whole Mexico as a China bridge versus China buffer debate?Nikolaj Lippmann: Right. That's another good question, Michelle. And one thing that we've been writing a lot about. The key difference from where we were, in Trump 1.0 and now is just how different the relationship with China really is. And I think one area where we've been scratching our head a little bit with regards to the – how Mexican policymakers have reacted after signing the USMCA deal is really just around that. That relationship with China. Well, I think that might have – they might have misread or underestimated just how much times have changed.We've seen a big increase in import from China. There have been very specific manufacturing ecosystems. And we've also seen increased investments by China and Mexico. Now, this has caused Mexico's trade deficit with China to go up a lot – almost double. And we've also seen an increase in the trade deficit between Mexico and the United States, in Mexico's favor.Now, that could imply that it's all the China bridge, I think that's far from the truth. But, you know, Mexico is probably two-third or a little more above. It's really that integration that I think policy makers in Mexico need to understand. And then you need to manage that these emerging elements of being a bridge. This is not in Mexico's interest; it's not in the U.S. interest to simply just be a bridge.We have done a lot of surveys with corporates around the world; and the way the European, and American companies in particular view Mexico is completely different from the way Asian and in particular Chinese companies view Mexico. The Chinese companies view Mexico much more as a place of assembly – whereas Americans think of Mexico as an integrated part of the manufacturing value chain.Michelle Weaver: Finally, how will the Mexico nearshoring theme develop from here?Nikolaj Lippmann: This is a great debate, I think. And one that's going to be – I think we're going to be writing a lot with Chris about, and with you guys around, about. Also, with the U.S. policy team. We laid out in 2022 this hypothesis that onshoring, nearshoring was about to happen. In terms of Mexico, it would imply $150 billion over five years. And very importantly, it was going to be – it could happen so fast because it was brownfield.It was more to the same. Where you already had manufacturing ecosystems, you could add to that. We saw very little evidence that you could do greenfield. But now that the world has evolved, we're looking at some of these greenfield manufacturing ecosystems that are really not present in North America, not in the United States, not in Canada, not in Mexico, such as EV batteries or IT hardware, some of the things that are starting to emerge around the big chip investments.And we're wondering what are going to be the policy objectives pertaining to these very specific manufacturing ecosystems that in many cases are quite important for national security. If that is to happen, I think it's going to happen slower, much like what Chris laid out, but it's going to be much more impactful. So, I'm sure we're going to be working closely on these debates.Michelle Weaver: Nick, Chris, thank you for taking the time to talk. And to our listeners, 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.

31 Jan 10min

Our Global Head of Fixed Income and Public Policy Research, Michael Zezas, and Global Head of Macro Strategy, Matt Hornbach, discuss how the Trump administration’s fiscal policies could impact Treasuries markets.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.Matthew Hornbach: And I'm Matthew Hornbach, Global Head of Macro Strategy.Michael Zezas: Today, we'll talk about U.S. fiscal policy expectations under the new Trump administration and the path for U.S. Treasury yields.It's Thursday, January 30th at 10am in New York.Fiscal policy is one of the four key channels that have a major impact on markets. And I want to get into the outlook for the broader path for fiscal policy under the new administration. But Matt, let's start with your initial take on this week's FOMC meeting.Matthew Hornbach: So, investors came into the FOMC meeting this week with a view that they were going to hear a message from Chair Powell that sounded very similar to the message they heard from him in December. And I think that was largely the outcome. In other words, investors got what they expected out of this FOMC meeting. What did it say about the chance the Fed would lower interest rates again as soon as the March FOMC meeting? I think in that respect investors walked away with the message that the Fed’s baseline view for the path of monetary policy probably did not include a reduction of the policy rate at the March FOMC meeting. But that there was a lot of data to take on board between now and that meeting. And, of course, the Fed as ever remains data dependent.All of that said, the year ahead for markets will rely on more than just Fed policy. Fiscal policy may feature just as prominently. But during the first week of Trump's presidency, we didn't get much signaling around the president's fiscal policy intentions. There are plenty of key issues to discuss as we anticipate more details from the new administration.So, Mike, to set the scene here. What is the government's budget baseline at the start of Trump's second term? And what are the president's priorities in terms of fiscal policies?Michael Zezas: You know, I think the real big variable here is the set of tax cuts that expire at the end of 2025. These were tax cuts originally passed in President Trump's first term. And if they're allowed to expire, then the budget baseline would show that the deficit would be about $100 billion smaller next year.If instead the tax cuts are extended and then President Trump were able to get a couple more items on top of that – say, for example, lifting the cap on state and local tax deduction and creating a domestic manufacturing tax credit; two things that we think are well within the consensus of Republicans, even with their slim majority – then the deficit impact swings from a contraction to something like a couple hundred billion dollars of deficit expansion next year. So, there's meaningful variance there.And Matt, we've got 10-year Treasury yields hovering near highs that we haven't seen since before the global financial crisis around 10 years ago. And yields are up around a full percentage point since September. So, what's going on here and to what extent is the debate on the deficit influential?Matthew Hornbach: Well, I think we have to consider a couple of factors. The deficit certainly being one of them, but people have been discussing deficits for a long time now. It's certainly news to no one that the deficit has grown quite substantially over the past several years. And most investors expect that the deficit will continue to grow. So, concerns around the deficit are definitely a factor and in particular how those deficits create more government bonds supply. The U.S. Treasury, of course, is in charge of determining exactly how much government bond supply ends up hitting the marketplace.But it's important to note that the incoming U.S. Treasury secretary has been on the record as suggesting that lower deficits relative to the size of the economy are desired. Taking the deficit to GDP ratio from its current 7 per cent to 3 per cent over the next four years is desirable, according to the incoming Treasury secretary. So, I think it is far from conclusive that deficits are only heading in one direction. They may very well stabilize, and investors will eventually need to come to terms with that possibility.The other factor I think that's going on in the Treasury market today relates to the calendar. Effectively we have just gone through the end of the year. It's typically a time when investors pull back from active investment, but not every investor pulls back from actively investing in the market. And in particular, there is a consortium of investors that trade with more of a momentum bias that saw yields moving higher and invested in that direction; that, of course, exacerbated the move.And of course, this was all occurring ahead of a very important event, which was the inauguration of President Trump. There was a lot of concern amongst investors about exactly what the executive orders would entail for key issues like trade policy. And so there was, I think, a buyer's strike in the government bond market really until we got past the inauguration.So, Mike, with that background, can you help investors understand the process by which legislation and its deficit impact will be decided? Are there signposts to pay attention to? Perhaps people and processes to watch?Michael Zezas: Yeah, so the starting point here is Republicans have very slim majorities in the House of Representatives and the Senate. And extending these tax cuts in the way Republicans want to do it probably means they won't get enough Democratic votes to cross the aisle in the Senate to avoid a filibuster.So, you have to use this process called budget reconciliation to pass things with a simple majority. That's important because the first step here is determining how much of an expected deficit expansion that Republicans are willing to accept. So, procedurally then, what you can expect from here, is the House of Representatives take the first step – probably by the end of May. And then the Senate will decide what level of deficit expansion they're comfortable with – which then means really in the fall we'll find out what tax provisions are in, which ones are out, and then ultimately what the budget impact would be in 2026.But because of that, it means that between here and the fall, many different fiscal outcomes will seem very likely, even if ultimately our base case, which is an extension of the TCJA with a couple of extra provisions, is what actually comes true.And given that, Matt, would you say that this type of confusion in the near term might also translate into some variance in Treasury yields along the way to ultimately what you think the end point for the year is, which is lower yields from here?Matthew Hornbach: Absolutely. There's such a focus amongst investors on the fiscal policy outlook that any volatility in the negotiation process will almost certainly show up in Treasury yields over time.Michael Zezas: Got it.Matthew Hornbach: On that note, Mike, one more question, if I may. Could you walk me through the important upcoming dates for Congress that could shed light on the willingness or ability to expand the deficit further?Michael Zezas: Yeah, so I'd pay attention to this March 14th deadline for extending stopgap appropriations because there will likely be a lot of chatter amongst Congressional Republicans about fiscal expectations. And it's the type of thing that could feed into some of the volatility and perception that you talked about, which might move markets in the meantime.I still think most of the signal we have to wait for here is around the reconciliation process, around what the Senate might say over the summer. And then probably most importantly, the negotiation in the fall about ultimately what taxes will be passed, what that deficit impact will be. And then there's this other variable around tariffs, which can also create an offsetting impact on any deficit expansion.So still a lot to play for despite that near term deadline, which might give us a little bit of information and might influence markets on a near term basis.Matthew Hornbach: Great. Well Mike, thanks for taking the time to talk.Michael Zezas: Matt, great speaking with you. And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share Thoughts on the Market with a friend or colleague today.

30 Jan 9min