Japan Summit: Consumer Resilience and Trade Uncertainty

As the Fed continues to signal coming rate hikes this year, the housing market will face implications across home sales, mortgage rates, and fundamentals.-----Transcript-----Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of U.S. Securitized Products Research here at Morgan Stanley. Jim Egan: And I'm Jim Egan, the other Co-Head of U.S. Securitized Products Research. Jay Bacow: And on this edition of the podcast, we'll be talking about changes in the Fed policy and what the possible implications are for mortgages and the housing market more broadly. It's Thursday, March 3rd at 11:00 a.m. in New York. Jim Egan: Okay, Jay, we've talked about affordability pressures as mortgage rates have moved higher a couple of other times in the past on this podcast, and we would encourage listeners to go back and listen to those prior podcasts for a deeper dive on affordability. But Jay Powell just testified this week that he'll support a 25 basis point hike in March. Furthermore, if inflation pressures are persistent, then he's gonna raise Fed funds by more than 25 basis points at later meetings. The markets priced in six hikes this year. What does that mean for mortgage rates going forward? When I think about affordability, am I gonna have to think of another 150 basis point increase in mortgage rates? Jay Bacow: No. So you saying the market has priced in six hikes is really important, because mortgage rates are based on generally sort of the belly of the Treasury curve. And the belly of the Treasury curve is effectively a function of what the market's expecting the Fed to do, along with how much risk premium there is. And if the market's expecting the Fed to hike six times this year, then if the Fed hikes six times this year and there's no change in risk premium, then mortgage rates aren't really going to move very much from where they are right now. Now, Powell said that he's worried about inflation and so if inflation comes in higher than expected or the market changes their demand for risk premium, then mortgage rates are gonna move. Jay Bacow: But Jim, mortgage rates have already moved a lot, they've gone up 100 basis points this year in just two months. What does this mean for affordability? Jim Egan: From the affordability perspective, it's a problem. But that also really depends on how we define what a problem is. The housing market's been doing very, very well. But when we think about this kind of move in mortgage rates, existing home sales, transaction volumes, they're going to have to fall. Jay Bacow: But haven't existing home sales gone up a lot already? Jim Egan: Yes, and that's where we think it's important to really look at historical experiences during times like this. If we look back to mortgage rates to 1990 we have five other instances of this kind of increase in mortgage rates. Now, one of those was during the housing crisis, so we're going to remove the experience there, but if I look at the other four instances existing home sales climbed very sharply during that first 6 month period, while mortgage rates were climbing by 100 basis points. That's where we are right now, we're seeing that climb. The 12 months after, the subsequent year, which we're going to start to enter March of this year going forward, that's where existing home sales tend to plateau and in a lot of instances come down. And they tend to come down further if mortgage rates continue to climb during that year, which is what we just discussed. So we think it's very likely, and if historical precedent holds, then we've already seen the peak of existing home sales for at least the next 12 months. Jay Bacow: What about home prices? Powell was asked if he thinks that home prices are going to fall and go back to pre-COVID levels, and he said he thought that raising mortgage rates would just slow down home prices, and he doesn't want to see home prices fall. What do we think? Jim Egan: Well, I'd like to believe he's reading our research because that's very much in line with how we think about things right now. We think that home price appreciation at a 19% rate right now is going to have to slow. And as we've said on this podcast before, affordability pressures are really one of, if not the key reason that the rate of HPA has to come down. Simply put, potential homebuyers cannot continue to afford to buy homes, at prices that would allow HPA to continue to climb at almost 20% year over year levels. However, if we think about the other factors that would come into play to bring home prices from a positive level to a negative level, we just do not see those characteristics in the market right now. Supply conditions are very constrained. We think they'll be alleviated somewhat this year, but that's not enough for there to be an overhang of supply that would weigh on home prices. We think that the credit availability in the market has been very conservative. We don't think we're at a risk of increased defaults and foreclosures. What we think happens is that transaction volumes fall, as we've stated, as home buyers aren't willing to pay the prices that home sellers want to sell at. But those sellers are not forced. And so you end up with a market that kind of doesn't trade, home price growth slows and we see it bottoming out kind of in a positive 5-6% percent range from here. So, long story short, we agree with that assessment from Jay Powell. Jim Egan: Now, the other side of the equation, mortgages. With rates backing up by that much, Jay, what do we think about the mortgage market here? Jay Bacow: So rates backing up means that there's going to be less people refinancing. And you said that there's going to be a slowdown in existing home sales as well. But, we're still worried about the supply to the agency mortgage market. And that's because the supply that we care about the most is the new supply coming from new home sales. And the thing about new home sales is that it's about an 8-month period from the time that the homebuilder gets the permit to start building the house, to when it actually gets sold. So we're going to have about 6 more months of supply from people that started to build their house when mortgage rates were a lot lower. And that's going to weigh on the market, particularly given that Powell said during his testimony that they're going to start balance sheet normalization in the coming months. So, we've got supply coming and we've got the biggest buyer stepping away from the market. Now, mortgage rates have gone up and mortgage spreads have widened, but we think there's a little bit more room for mortgages to underperform given the supply that's coming, and the lack of demand coming from the Fed. Jim Egan: Certainly interesting times. Jay, thanks for taking the time to talk today. Jay Bacow: Always great speaking with you, Jim. Jim Egan: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

3 Mars 20226min

The recent crisis in Ukraine has caused a great deal of uncertainty in the economy and markets. To cut through the noise, we take a look at the three key questions we are hearing from investors.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 to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bring you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, March 2nd at 3pm in New York. As an analyst focusing on the interaction between geopolitical events and financial markets, I'm accustomed to dealing with uncertainties evolving at a rapid pace. But even by those standards, nothing in my career compares to the events of the past two weeks: the Russian invasion of Ukraine and the sanctions response by the US, the UK and Europe. To help cut through the noise, here's answers to the three most frequently asked questions by our investor clients. First, do sanctions mean higher energy costs? In the short term, the answer is likely yes. While sanctions on Russian banks currently permit payments for various energy commodities, there's still restrictions on, and disruptions to, their transportation. With Russia being a key producer of several commodities, including 10% of the world's oil, it's not surprising that global oil inventories have declined and the price of a barrel of oil is sitting above $100. This dovetails with the second question. Should we expect the Fed will shy away from hiking rates? In short, we don't think so, at least at the Fed's March meeting, but it certainly creates substantial uncertainty in the outlook. This conflict seems to be affecting both parts of the Fed's dual mandate in opposite directions. It risks dampening economic growth, but for the reasons we just described, it can also boost inflation. Accounting for both, our economists still expect the Fed to hike 0.25% in March but the conflict adds another layer to an already unprecedented level of complexity for the Fed. This is actually the key point for fixed income markets, in our view, where investors should prepare for ongoing volatility in Treasury and credit markets as the Fed may have to regularly tinker with their own assessment of growth and inflation. Finally, what are the long-term implications for investors? To answer this question, we refer you back to our framework for 'Slowbalization,' or the idea that companies will have to, in certain industries, spend more to adjust supply chains and exit certain businesses as governments create policies that prioritize economic and national security over short term profits. You can see how this trend may already be accelerating after the onset of the Ukraine crisis, with several multinational companies announcing they'll sell stakes in, exit joint projects with or pause sales to Russian companies. But some equity sectors may see upside. Defense and software, for example, could see bigger spending as governments reorient their budgets towards these efforts, most notably Germany announcing it will boost its defense spending to 2% of GDP. Of course, the situation remains fluid, and we'll continue to track it and keep you in the loop on what it means for the economy and markets. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

3 Mars 20223min

As the conflict between Russia and Ukraine continues to unfold, implications for the oil and gas sector in Europe are beginning to take shape.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 to Thoughts on the Market. I'm Martijn Rats, Global Commodity Strategist and Head of the European Energy Research Team for Morgan Stanley. Along with my colleagues bringing you a global perspective, I'll be talking about developments in the oil and gas sector amidst geopolitical tensions. It's Tuesday, March 1st at 2:00 p.m. in London. As the situation between Russia and the Ukraine continues to develop, implications for commodity markets are beginning to take shape. Russia is a major commodity producer, playing in an especially important role in providing energy for Europe through oil and natural gas imports. With a new round of sanctions announced over the weekend, the precise impact on prices remains to be seen, but we can begin to forecast the direction. First, there is no sign at this stage that, at least at the aggregate level, the flow of commodities has been impacted yet. All of the pipeline and tanker tracking data that we've seen suggests that they continue to be shipped. That shouldn't be too surprising, it's still early days and the sanctions that have been announced so far have been carefully crafted to reduce the impacts on energy flows from Russia. Second, trade patterns will nevertheless likely shift. We can already see this in the oil markets. European refiners are traditionally big buyers of Russian crudes, and even though technically they have continued to be able to buy these grades, they are increasingly reluctant to do so. There have been indications that ship owners are reluctant to send vessels to Russian ports, and that European buyers are uncertain about where sanctions will ultimately go. This is requiring increasingly large discounts. As many buyers already move away from Russian crudes, this also creates more demand for others, including North Sea crudes, which therefore drives up the price of Brent. Third, all of this is happening against the backdrop of tightness in both global oil markets and the European gas markets. We are seeing low and falling inventories, low and falling spare capacity and low levels of investment across both. At the same time, there is a healthy demand recovery ongoing as the world emerges from COVID. Given this tightness, even a modest disruption can have large price impacts. Now, with that in mind, risks to oil and gas prices are still firmly skewed higher, at least in the short term. Finally, I want to point at the growing tension in Europe between diversification and decarbonization. Several key politicians have said over the last several days that Europe should reduce its dependance on Russian oil and gas, and diversify its sources of supply. At the same time, Europe has set ambitious targets to decarbonize. Diversification requires investment in new supply, while decarbonization then requires that those supplies, in the end, will not be used. How that tension will be resolved is hard to know, but this is an issue that at some point will need to be addressed. Bottom line, there is still a lot of uncertainty for commodity markets in the coming weeks and months. We will keep you posted, of course, as new developments take shape. 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.

2 Mars 20223min

Like many markets, Corporate Credit has faced a rocky start to 2022. For investors, understanding the difference between default and duration risk will be key to positioning for the rest of the year.-----Transcript-----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Global Director of Fixed Income Research. Along with my colleagues bringing you a variety of perspectives, I'll be talking about corporate credit markets against the background of policy tightening and heightened geopolitical tensions. It's Monday, February 28th at 10 a.m. in New York. It's been a rough start for the year for the markets. Central banks' hawkish shift towards removing policy accommodation, the significant flattening of yield curves that followed, rising geopolitical tensions, fading prospects for fiscal support, and growing concerns about stretched valuations have all combined to spawn jitters in financial markets. Corporate credit has been no exception. After two years of abundant inflows, the narrative has turned outflows from credit funds in conjunction with negative total returns. These outflows conjure up painful memories of 2018, the last time the credit markets had to deal with substantial policy tightening. Let us focus on the source - sharply higher interest rates and duration versus credit quality and default concerns. Consider leverage loans, floating rate instruments that have credit ratings comparable to high yield bonds which are fixed rate instruments. Since the beginning of the year, high yield bond spreads have widened almost three and half times more than leverage loan spreads. If you limit the comparison just to fixed rate bonds, the longer duration investment grade bonds have significantly underperformed the lower quality high yield bonds. Clearly, it is duration and not a fear of a spike in defaults that is at the heart of credit investor angst. My credit strategy colleagues, Srikanth Sankaran and Taylor Twamley, have analyzed the impact of rate hikes on interest coverage ratios for leveraged loan borrowers. This ratio is a measure of a company's ability to make interest payments on its debt, calculated by dividing company earnings by interest on debt expenses during a given year. The key takeaway from their work is this - What matters more for interest coverage is the point at which higher rates become a headwind for earnings growth. Loan interest coverage ratios have historically improved early in the hiking cycle as interest expenses are offset by growth in earnings. I draw comfort from the evidence that as long as earnings growth holds up and does not turn negative, corporate credit fundamentals measured in interest coverage ratios are positioned well enough to withstand our economists base case of six 25 basis point rate hikes in this year. While credit fundamentals look fine, valuations are not. Since the beginning of the year, we have seen spread widening, the pace of which has picked up in the last couple of weeks. So, we still prefer taking default risk over duration and spread risk. The risk to this view has increased in the last few weeks. Specifically, if central bank reaction to the heightened geopolitical risk is to control inflation at the expense of growth, lower quality credit may be more exposed. 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.

28 Feb 20223min

As markets react to the conflict between Russia and Ukraine, price moves for corn, wheat, oil and metals may mean new inflationary pressures for central banks to contend with in the coming months.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. 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.This recording references actual or potential sanctions, which may prohibit U.S. persons from buying certain securities, making certain investments and/or engaging in other activities in or pertaining to Russia.The content of this recording is for informational purposes and does not represent Morgan Stanley’s view as to whether or not any of the Persons, instruments or investments discussed are or will become subject to sanctions. Any references in this presentation to entities, debt or equity instruments that may be covered by such sanctions should not be read as recommending or advising as to any investment activities in relation to such entities or instruments. Audience members are solely responsible for ensuring that their investment activities in relation to any sanctioned entities and/or securities are carried out in compliance with applicable sanctions.-----Transcript-----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together. It's Friday, February 25th at 3 p.m. in London. Russia's invasion of Ukraine has grabbed the headlines. There are other commentators and podcasts that are far more knowledgeable and better placed to comment on that conflict. Rather than offer assessment on geopolitics, I want to try to address one small tangent of these developments- the potential impact on prices and inflation. Russia and Ukraine are both major commodity producers. Russia produces about 10% of the world's oil, and Russia and Ukraine together account for 1/3 of the world's wheat and 1/5 of the world's corn production, according to the U.S. Department of Agriculture. So, if one is wondering why the price of wheat is up about 18% since the end of January, look no further. These commodities are traded around the world, but specific exposure can be even more acute. Morgan Stanley analysts estimate that Russia supplies roughly 1/3 of Europe's natural gas, while analysis by the Financial Times estimates that Ukraine supplies roughly 1/3 of China's corn. There are also second order linkages. Russia produces about 40% of the world's palladium, a key component for catalytic converters, and about 6% of the world's aluminum. But because Russia also provides the energy for a good portion of Europe's aluminum production, the impact could be even larger on aluminum prices than Russia's market share would indicate. Central banks will need to look at these changing prices and weigh how much they should factor into their medium term inflation outlook, which ultimately determines their monetary policy. For now, we think three elements will guide central bank thinking, especially at the U.S. Federal Reserve. First, higher policy rates are still necessary, despite international developments, given how low interest rates in the U.S. and Europe still are relative to the health of these economies. Slowing demand, which is the point of interest rate hikes, is still important to contain medium term inflationary pressures. Second, these developments may reduce the odds of an aggressive start to central bank action. A few weeks ago, markets implied that the Fed would begin with a large .5% interest rate increase. Our economists did not think that was likely, and continue to believe that the Fed will hike by a smaller .25% at its March meeting. Third and finally, the duration and scale of these commodity price impacts are uncertain. Indeed, I haven't even mentioned the prospect of further sanctions or other interventions that could further impact commodity prices. In the view of my colleagues who forecast interest rates, that should mean higher risk premiums, and therefore higher interest rates on government bonds in the U.S. and Europe. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.

26 Feb 20223min

Water scarcity brings unique challenges in the path to a more sustainable future. Solving for them will mean both risk and opportunity for governments, corporates, and investors.-----Transcript-----Jessica Alsford Obviously, everyone's minds today are rightly on news out of Europe. We will have an episode to cover this in the coming days, but today we are thinking more long term on sustainability. Jessica Alsford Welcome to Thoughts on the Market. I'm Jessica Alsford, Global Head of Sustainability Research at Morgan Stanley, Connor Lynagh And I'm Connor Lynagh, an equity analyst covering energy and industrials here at Morgan Stanley. Jessica Alsford And on this episode of the podcast, we'll be discussing one of the leading sustainability challenges of the near future, water scarcity, as well as potential solutions that are likely to emerge. It's Thursday, February, the 24th at 3 p.m. in London, Connor Lynagh and it's 10:00 am in New York. Connor Lynagh So Jess, we recently collaborated on the report, 'Changing Tides, Investing for Future Water Access.' Maybe the best place to start here is the big picture. Can you walk us through the demand picture and how challenges are expected to change in the industry? Jessica Alsford So the key issue really is that water is a critical but finite resource, and there's already huge inequality in access to water globally. So over the last century, we've seen water use rising about six fold, and yet there are still around 2 billion people without access to safely managed drinking water and around 3.6 billion without safely managed sanitation. Then add to this the fact that demand is likely to increase by around another 30% by 2050, about 70% of total demand comes from agriculture withdrawals, and clearly we need to increase the amount of food we're producing due to growing population, and there's also going to be incremental water needs from industry and municipalities. A third element to also think about is that this is all happening at the same time that climate change is going to alter the hydrological cycle. And so, this is going to increase the risk of floods in some areas and drought in others. Eight of the 10 largest economies actually have either the same or higher water risk scores than the global average. And so clearly what is already a challenge in terms of providing access to water is only going to become more complicated going forward. Connor Lynagh So Jess, water is pretty unique when you look at the different challenges that the sustainability community is facing. What do you think is particularly unique and noteworthy about the challenge we're facing here? Jessica Alsford So the three really big sustainability megatrends that we look at our climate, food and then water. They're all interrelated and they're all really tricky to solve for. But I think there are some unique characteristics about water that do add some complexities to it. First of all, it is finite. So, in theory, we can produce more food, but it's very difficult to make more water. In addition, it's incredibly difficult and costly to transport water around. So, if you think about energy and food, these can be moved over pretty large distances, but water is really a regionally specific commodity. And then the third element really is that water is underpriced if you compare to the actual cost of providing it. There aren't any free markets really to set prices according to supply and demand and because water is essential to life, it's really not straightforward when it comes to thinking about pricing. Jessica Alsford So Connor, from your perspective, covering some of the stocks exposed to the water theme, what are your thoughts on how water might be priced going forward? Connor Lynagh Yeah, I mean, I think you really hit on a lot of the big issues, which is that pricing is very heavily regulated relative to a lot of commodities out there. You know, a lot of utilities are not really able to cover their costs without subsidies from the government. And so, you know, I think as a base case, there does need to be an increase in pricing to solve for some of this shortfall that we see out there. But that has to be done delicately. We can't disadvantage members of society that are already struggling. And so, I think what we're going to need to see is some sort of market-based pricing, but in select instances. So, Australia already has a relatively well-developed water market. You're seeing some moves in that direction in California as well. But I think as a first step, I think there's going to be increased focus on larger industrial users paying more than their share and allowing consumers to have a relatively advantaged position on the cost structure. Jessica Alsford So pricing is clearly one issue, but we also need to see huge investment in global water infrastructure. What are your thoughts on how this develops over the next few years? Connor Lynagh It’s interesting if you look at a cross-section of countries globally, we tend to spend about 1% of GDP on our water resources. So, I think it's a fair starting point to say that water spending is going to grow in line with GDP. But, as we look at the world today and as you've covered previously, the spending is already not sufficient. It's probably hard to quantify exactly how much we, quote, 'should' spend. But I'll point out a couple of data points here. So globally, we spend about $300 billion per year on water capex. In order to get global water access to those that currently don't have it, this would cost an incremental $115 billion a year. And even in countries like the U.S., where our infrastructure is relatively well developed, we are currently facing a spending shortfall of about $40 billion per year. So, we do think this is going to need to rise significantly. Jessica Alsford So if we look at climate, for example, we have seen a really big step up in terms of regulation and policy support to really try to drive investment into green infrastructure. And so just picking up on that, for investors who are looking at this theme, where can capital be deployed to help solve this issue? Connor Lynagh I think that there's obviously just a major infrastructure investment need, but I think that absent major changes in policy, there's a few areas that we still think are relative areas of excess spending growth, if you will, within the sector. So, the first is emerging markets. As countries climb the wealth curve, we do think that their investment is going to increase significantly. I'd point to areas like India and China as areas of significant growth over the next few years. Wastewater management globally I really think that there is going to be increasing regulation and corporate-level focus on this. And then the final thing is applying digital technologies. So, as it stands right now, only about 70% of water globally is connected to a meter. So first and foremost, we need to get a better sense of how we're using our water, where we're using our water. But we can also use cellular technology, digital technologies to better monitor who's using this water in real time, and I think that's going to be a major area of investment, particularly in the US and Europe. Connor Lynagh So, Jess, obviously there's opportunities for companies that can offer solutions to the water industry, but water access is also a risk for many companies around the world. How should investors think about this? Jessica Alsford Absolutely. Energy and power generation are the most water intensive sectors. But actually, what's really critical with this theme is access to water on a local level. So actually, our analysis has shown that companies across a wide variety of sectors can really be impacted, whether that be datacenters, pharmaceuticals, apparel or beverages. One of the sectors most at risk is actually copper. So copper is a very water intensive commodity, and a lot of copper just happens to be mined in Chile, which is a country unfortunately already suffering from water scarcity. Now, desalination plants are becoming the norm in Chile as there are competing demands for water between copper mines and also the local population. If we look ahead, we actually think that demand for copper could increase by around 25% per annum. And this is due to the vital role that it's playing in the energy transition, whether it be for renewables or EVs, for example. And with this incremental demand for copper comes incremental demands for water. I'd also point to hydrogen, again, a key piece of the decarbonization puzzle. So, water is needed for hydrogen, whether for cooling, for gray or blue hydrogen, or for the electrolysis process with green hydrogen. And our analysis suggests that almost 60% of future hydrogen projects are located in countries with water stress. So again, this is going to require inventive solutions to ensure that there really is sufficient access to water for all users. Connor Lynagh Jess, thanks for taking the time to talk.Jessica Alsford Great speaking with you too Connor. Jessica Alsford And as a reminder, if you enjoy Thoughts on the Market, please do take a moment to rate and review on the Apple Podcasts app. It helps more people to find the show.

25 Feb 20228min

While geopolitical tensions currently weigh on markets, investors should look to the fundamentals in order to anticipate the depth and duration of the ongoing correction.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. 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 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 Wednesday, February 23rd at 11 a.m. in New York. So let's get after it. This past week tensions around Russia/Ukraine dominated the headlines. When unpredictable events like this occur, it's easy to simply throw up one's arms and blame all price action on it. However, we're not so sure that's a good idea, particularly in the current environment of Fed tightening and slowing growth. From here, though, the depth and duration of the ongoing correction will be determined primarily by the magnitude of the slowdown in the first half of 2022. While the Russia/Ukraine situation obviously can make this slowdown even worse, ultimately, we think that preexisting fundamental risks we've been focused on for months will be the primary drivers, particularly as geopolitical concerns are now very much priced. While most economic and earnings forecasts do reflect the slowdown from last year's torrid pace, we think there's a growing risk of greater disappointment in both. We've staked our case primarily on slowing consumer demand as confidence remains low thanks to the generationally high inflation in just about everything the consumer needs and wants. Many investors we speak with remain more convinced the consumer will hold up better than the confidence surveys suggest. After all, high frequency data like retail sales and credit card data remain robust, while many consumer facing companies continue to indicate no slowdown in demand, at least not yet. However, most of our leading indicators suggest that the risk of consumer slowdown remains higher than normal. Secondarily, but perhaps just as importantly, is the fact that supply is now rising. While this will alleviate some of the supply shortages, it could also lead to a return of price discounting for many goods where inflationary pressures have been the greatest. That's potentially a problem for margins. It's also a risk to demand, in our view, if the improved supply reveals a much greater level of double ordering than what is currently anticipated. In short, the order books - i.e. the demand picture - may not be as robust as people believe. Overall, the technical picture is mixed also within U.S. equities. Rarely have we witnessed such weak breath and havoc under the surface when the S&P 500 is down less than 10%. In our experience, when such a divergence like this happens, it typically ends with the primary index catching down to the average stock. In short, this correction looks incomplete to us. Nevertheless, we also appreciate that equity markets are very oversold and sentiment is bearish even if positioning is not. With the Russia Ukraine situation now weighing heavily on equity markets, relief would likely lead to a tactical rally, but we acknowledge that uncertainty remains extremely high. The bottom line for us is that we really don't have a strong view on the Russia/Ukraine situation as it relates to the equity markets. However, we think a lot of bad news is priced at this point. Therefore, we would look to sell strength into the end of the month if markets rally on the geopolitical risk failing to escalate further. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

24 Feb 20223min

The challenges of inflation can be felt around the world, but understanding the regional differences is key to an effective 2022 for both central banks and investors.----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.Seth Carpenter And I'm Seth Carpenter, Morgan Stanley's Chief Global Economist.Andrew Sheets And on part 2 of this special episode of Thoughts on the Market, we'll be continuing our discussion on central banks, inflation, and the outlook for markets. It's Tuesday, February 22nd at 1:00 p.m. in London.Seth Carpenter And 8:00 a.m. in New York.Andrew Sheets So Seth, you lay out the challenge that central banks face because they are being pulled in two directions. If they raise rates too quickly, the economy could slow too quickly. That means real people lose their jobs, real businesses have trouble getting loans. On the other hand, if they don't raise rates quickly enough, there's a risk that inflation would be higher and that has a real impact on the economy and people's lives. When it comes to, kind of, which side of caution to air on, how do you think central banks are thinking about that at the moment? And what would you be watching to indicate which side of that debate they're starting to come down on?Seth Carpenter I think if we're looking at the developed market, central banks, the Fed, the ECB, the Bank of England right now, I think they have a high conviction that the current stance of policy is just too accommodative given the state of the real economy and where inflation is. So I think right now all of them believe they need to get going, that starting now is fine. That mindset I don't think though will last too terribly long because over time we will start to see some outright tightening. So for the Fed, where does that point change? I think once they start to run off their balance sheet, probably sometime around the middle of this year, they're going to start to get much more cautious, they're going to look at markets and say how much of this tightening is being transmitted first through financial markets and then to the economy. So they'll be looking at credit spreads, they'll be looking at risk markets to ask, are we getting some traction? We think, especially if we're right and a bunch of the inflation that we're seeing now is this frictional inflation, that comes down in the latter half of the year. We think that hiking cycle is going to slow down over time. And so much like the Bank of England's forecast based on market pricing, we think there's probably a bit too much that's baked into markets in terms of how much hiking they do. They start off reasonably swiftly, knowing that they were too far away, knowing that they were being very accommodative. But in the latter half of the year, the pace of tightening starts to slow down.Andrew Sheets Seth, another question that I get quite a bit is at what point will market volatility cause the Fed or another central bank to change their policy? There's an idea in the market that if stocks drop or if credit spreads widen, or if there's higher volatility, then central banks would look at that and respond to that. From a central bank standpoint, how do you think central banks think about market volatility? And what are some important ways that you think investors either correctly or kind of incorrectly think about that reaction function?Seth Carpenter I can say over the 15 years that I spent at the Fed drafting policy documents, briefing the committee on policy options, thinking about how markets are affecting the economy, I can tell you the following. The market tends to have an overdeveloped sense of how sensitive central banks are to equity market reactions in particular. Equity market changes are important, it can be a very high frequency signal that there is cause to investigate what's going on in the economy. But they give many, many, many false signals as well, and so I would say that a sharp drop in equity prices would be the sort of thing that would get the attention of central bankers but would not force their hand to make a change. Instead, there would be further investigation. In addition, the whole point of tightening monetary policy is to tighten financial conditions and thereby slow the economy. So, it is not a question of are we getting credit spread widening? Are we getting softer asset prices? The answer to that is that's part of the plan. I think the real question is how large is the move in asset prices and how quick is the move in asset prices? If we have a very orderly tightening of financial conditions that plays out over several months, I don't think that's the sort of thing that causes the central bank to reverse course. If instead, over the course of a month you get a very sharp and disruptive widening and spreads, I think that really does cause a substantial reconsideration of the plan.Andrew Sheets So, Seth, I think it's fair to say one of the challenges of your job at Morgan Stanley is you only have the entire global economy to look after. This is an inflation story that does look similar in some ways around the world, but also looks different. Your global economics team has done some interesting research recently on Asia and how Asia, which is an enormous economy in its own right, is seeing quite different, you know, inflation dynamics and labor market dynamics. I was hoping you could touch a little bit on that and how the regional differences can actually be pretty significant.Seth Carpenter Absolutely. And I think Asia is very much the counterpoint to what we've seen in the rest of the globe in terms of the inflationary process. So inflation in Asia has been quite subdued, and I think there's some very clear reasons for that. First, when we think about food and energy inflation in Asia, many of the countries there have much more direct government intervention in those markets, and that has been helping to keep those inflation rates low. Second, when it comes to core consumer spending, there's been a bigger lag in consumer spending recovery in a lot of Asian economies than there have been in the developed market economies, which I think reflects two issues. One, aggressive COVID response, and second, much less fiscal transfers to the household sector, that is in the United States and in some other countries really helped to support consumer spending, especially on goods. And finally, in many Asian economies, there's been a bit less in the way of supply chain disruptions for the local market. So there really has been a big difference. I'll go you one further, when we think about the central bank's response, not only do we have the large developed market economy central bank starting to hike, the PBOC is going in exactly the opposite direction. The Chinese economy slowed aggressively for reasons that we can get into on another podcast, but the PBOC has eased. So, it is very much a differential outlook for both inflation and central banking in Asia versus the rest of the world.Seth Carpenter But I have to say, Andrew, let me turn it around to you because inflation is clearly the key story this year. The change in developed market, central banks towards hiking is huge this year. How is all of this debate affecting your views on strategy as it markets across assets across the globe?Andrew Sheets So I think there are a couple of important elements that are driving the way we're thinking about markets. The first is one key output of higher inflation is higher interest rates, or certainly investor concern around higher interest rates, if we look at how the market has historically performed as interest rates go up, what really matters, maybe simplistically, is how good the economy is. If interest rates are going up, but the underlying economy is still ultimately solid and strong, a lot of assets end up doing OK. And so if I think about, you know, the base case that you and the Morgan Stanley Global Economic Team have laid out where we have some maybe growth softness in the first quarter of this year, but overall 2022 is a pretty solid year for growth. I think that still means that overall, markets can avoid some of the more negative scenarios that would otherwise come with higher rates. But the second issue here that I think is important, and I think this dovetails nicely with your discussion on Asia relative to say the U.S., is that the challenges around inflation and rate hikes also have a lot of global differences. The more expensive your market is, the higher your rate of inflation, the less your central bank has done to this point. Which describes the U.S. pretty accurately, it's a more expensive market, the inflation rate is higher, the Fed has not made its first rate hike yet. I think that's a market where there's more uncertainty and where my colleague Mike Wilson, our Chief U.S. Equity Strategist, is forecasting a more difficult year for returns. You know, in contrast, in Europe the valuations aren't as expensive, the inflation rate isn't as high. I actually think it's OK for investors to kind of have different views on the impact of inflation, different views for 2022, because these trends are very different globally. And I think we're going to see a market that has much more diverse performance, it's going to be less one direction, it's going to be less unified. And I think that's OK, I think that would reflect a global backdrop for inflation and monetary policy and valuations that is quite different depending on where you look. Seth Carpenter Great. Well, you know, as the saying goes, forecasting is hard, especially about the future. But I have very high conviction in the following forecast: you and I are going to have a lot to talk about over the balance of this year. It's been great talking to you, Andrew.Andrew Sheets It's been great talking to you, Seth. As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

23 Feb 20228min