Is American Market Dominance Over?

Although Europe has been the global leader when it comes to greening its economy, recent challenges may be a cause for concern.----- Transcript -----Rob Pulleyn: Welcome to Thoughts on the Market. I'm Rob Pulleyn, Morgan Stanley's Head of Utilities of Clean Energy Research in Europe. Jens Eisenschmidt: And I'm Jens Eisenschmidt, Morgan Stanley's Chief Europe Economist. Rob Pulleyn: On this special episode of this podcast, we'll be discussing the future of Europe's energy transition, including whether its clean energy goals are realistic and the implications for investors and Europe's broader economy. It's the 30th of August, 10 a.m. in London. Rob Pulleyn: Europe has long been a global leader when it comes to greening its economy. Strong societal and political support has bolstered the region's transition to clean sources of energy, with a European Green Deal and climate target plan aiming to reduce CO2 emissions by at least 55% by 2030 and achieve net zero by 2050. While substantial progress has been made over the previous decades, the region is now facing several challenges. Jens, can you give us the backdrop to Europe's energy transition and some of what's changed recently? Jens Eisenschmidt: Yes Rob, I mean, you have explained it already. There are big change targets, climate change related targets to the energy transition that Europe has subscribed to. These targets were in place already before the 24th of February in 22, when we saw the Russian invasion in Ukraine that changed the European energy set up profoundly. Now, why is this important? It's important because these targets were done in sort of a plan that relied on a certain energy source that is no longer existing. So let me give you an example. Let's take Germany, which was anyway already quite progressed in its journey onto increasing the share of renewables in electricity production. If you take Germany, they have been turning their back on nuclear power generation, which is another source of emission free power generation, and have embraced as a flex load provider, so as a provider of electricity when renewables are unavailable to natural gas. Now this natural gas supply from Russia is no longer available, as we all know, and of course, that implies that the Germans and other member states of the European Union as well have to change the plan by which they transit to a carbon free economy. And, you know, this is very complicated because it's not only switching one energy source for the other or exchanging one for the other. You also have to look about the infrastructure, you have to see what is essentially giving your energy mix the stability, as I said before, when we don't have sun shining and wind blowing, you need to have a source that's about the question about storage technologies, that's not entirely independent of the energy sources that you have available. And so the last year provided a profound challenge to the way Europe had planned its energy transition, so they have to replan it, and the complexity of that is huge. Essentially, it's something you want to ideally plan at the European level in order to harness all the comparative advantages all the countries have, given example, you have a lot of sun hours in Spain, less so in Germany, so ideally you want to put solar for Europe somewhere south and not so much somewhere north. But that of course means something for the grid, you have to deploy around it. So all that complexity is huge, all the coordination needs are huge and so this is the new situation we are in. Rob Pulleyn: Yeah, that new situation clearly puts increased pressure on Europe, if electricity prices remain elevated, Europe's large industrial base and you mentioned Germany would continue to shoulder this burden. You know margins, pricing, competitiveness would all suffer and the region's place in the global value chain might be at risk. Now, renewables are increasingly cost competitive, but even when the solar power is still very intermittent and that requires either a stable baseload or at least flexible generation. And as you mentioned, this previously was facilitated partly by Russian gas. Now, with all that in mind Jens, how much investment is needed to fund the transition and is there economic risk associated with this? Jens Eisenschmidt: So the numbers are huge. We have said that number could be around $5 trillion, other sources estimate this to be slightly higher, but more or less the ballpark is the same. We also know that already $1.4 trillion is earmarked from public funds, so EU budget, meaning that $3.6 are left for the private sector to deploy or for member states to come up from national budgets. So the figure itself boiling down to somewhere between $5 to $600 billion a year until at least 2030 and maybe beyond, these figures are not in itself the problem. The problem is how do you, according to which plan, do you deploy this and what is the sort of economic backdrop in which this investment happens? So ideally, from an economist perspective, this is a productivity increasing undertaking, and if it's done in that way, it won't be necessarily inflationary, it would be mildly growth enhancing. But of course there is a risk that all that investment in particularly being driven by the public sector, crowds out other productive investment. And in that case, it would be less productivity enhancing and more inflationary, which we think is the more realistic case here for Europe. We don't think that this is the end of the world in terms of inflation, but we do estimate a sizable impact of around 20 basis points per year that inflation could turn out to be higher. That all being said, if electricity prices can be reliably and durably lowered, that would have the potential to generate more innovation. Rob, you have your finger on the pulse of new technology, what do you see emerging that may advance the progress of Europe's transition? Rob Pulleyn: Yeah, thanks Jens. So historically, we've been positively surprised by the pace of levelized cost of energy coming down, particularly in renewables. And we've also been positively surprised by technological developments elsewhere. As we think about the key challenge of this new wind and solar capacity ambitions, the key is intermittency, and therefore industrial scale batteries are going to be key, fuel cells should also be, green gas, which is also needed for industrial abatement, could also be part of that solution. I also think we need to talk about behind the meter, which is really rooftop solar, whether it's solar panels but more crucially one of the parts of the value chain is the inverters. More efficient inverters are one of the most key components for reducing the cost of solar. As we think about electrification of the home in terms of heat pumps, you know, there's another technology which will develop and also passenger vehicles moving to electric, this behind the meter rooftop solar generation will be important combined with batteries and as I said, the inverters are a key part of that. Also will be software, how to manage all of this demand side response, I think is something you're going to hear much more from many of the retail companies we cover and innovating in the space. Now, as we think about the sequence and the steps of decarbonization here, step one, decarbonize the existing power system, step two electrify as much as possible, step three move to green gasses. We will eventually reach an area whereby we cannot decarbonize any further, and that's where carbon capture and storage comes in, for which we're already seeing significant improvement. So, there's many technologies which I think will play a significant role in this. And I suspect despite the current pressures we're seeing at the moment, we will continue to see significant positive surprises over the coming decade and thereafter, notwithstanding that the cost of capital is, of course, higher than it was over the last decade. Jens Eisenschmidt: So which sectors are likely to benefit the near-term and in the longer term? Rob Pulleyn: So the obvious answer, and somewhat self-serving, is utilities. To that number you mentioned earlier of $5 billion spent, we also think that the utilities could probably contribute around a European utility in Europe around $1.5 to $2 trillion of this. That still leaves a sizable gap versus what you were talking and perhaps there is upside risk to these investment spends. But within utilities, the obvious route is renewables. Having a tough time, I would say in 2023, trapped within higher costs and capital costs, but also, you know, policy impasse. But if we separate the wood for the trees under the vast majority of scenarios out to 2030 and 2050, the increase in green electricity is going to be substantial and utilities are the natural developers of those assets as they migrate away from coal and some degree gas, into clean energy. But it's not the only area. There's also networks. We need to invest in distribution and transmission, in electricity to actually accommodate these renewables and connect the new areas of upstream electricity generation to the areas of demand, which is primarily the cities and industry. Speaking about industry, there's also a need for green gas, and I actually think other sectors are going to contribute here, most notably oil and gas, which has the technical expertise and of course the industrial plant for industrial gasses. As we look into the supply chains, another area that's been in focus this year, both the OEMs in terms of turbines and solar manufacturers, the cabling, the software, the heat pumps, I think there are many aspects within equity stories which are ancillary to utilities but could create different risk rewards and different opportunities to what you may find in my sector. I think we can both agree that while significant progress has been made, Europe still has a long way to go for the next step of this journey. Jens Eisenschmidt: I fully agree. I would say that not all hope is lost that current targets will be met, but there are headwinds that cannot be denied. Rob Pulleyn: Jens, thank you very much for taking the time to talk today. Jens Eisenschmidt: Thanks, Rob. It was great to speak with you. Rob Pulleyn: And thank you all for listening. Subscribe to Thoughts on the Market, on Apple Podcasts or wherever you listen, and please leave us a review. We'd love to hear from you.

30 Aug 20239min

If China economic woes become a true debt deflation cycle, it could export some of that disinflation to the global economy.----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Global Chief Economist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today, I'll be talking about the global implications of China's economic slowdown. It's Tuesday, August 29th, at 10 a.m. in New York. China's economic woes continue to be center stage. Our Asia team has outlined the risks of a debt deflation cycle there and how policy is needed to avert the possibility of a lost decade. As always, big economic news from China will get global attention. That said, when we turned bullish on China's economic growth last year, we flagged that the typical positive spillovers from China were likely to be smaller this cycle than in the past. We expected growth to be heavily skewed towards domestic consumption, especially of services, and thus the pull into China from the rest of the world would be smaller than usual. We also published empirical analysis on the importance of the manufacturing sector to these global spillovers, and the very strong Chinese growth and yet modest global effects that we saw in the first quarter of this year vindicated that view. Now the world has changed and Chinese growth has slumped, with no recovery apparent so far. The global implications, however, are somewhat asymmetric here. Because we are seeing the weakness now show through to the industrial sector and especially CapEx spending, we cannot assume that the rest of the world will be as insulated as it was in the first quarter. Although we have recently marked down our view for Chinese economic growth, we still think a lost decade can be avoided. Nevertheless, with Chinese inflation turning negative, the prospect of China exporting disinflation is now getting discussed in markets. Much of the discussion about China exporting this inflation started when China's CPI went into deflation in the past couple of months. Although the connection is intuitive, it is not obvious that domestic consumer price numbers translate into the pricing that, say, U.S. consumers will eventually see. Indeed, even before China's prices turned negative, U.S. goods inflation had already turned to deflation because supply chains had healed and consumer spending patterns were starting to normalize. For China to export meaningful disinflation, they will likely have to come through one of three channels. Reduced Chinese demand for commodities that leads to a retreat in global commodities prices, currency depreciation or exporters cutting their prices. On the first, oil prices are actually at the same levels roughly that they were in the first quarter after Chinese goods surged. And they're well off the lows for this year. And despite the slump in economic activity, transportation metrics for China remain healthy, so to date, that first channel is far from clear. The renminbi is much weaker than it was at the beginning of the year. But recent policy announcements from the People's Bank of China imply that they are not eager to see a substantial further depreciation from here, limiting the extent of further disinflation through that channel. So that leaves exporters cutting prices, which could happen, but again, it need not be directly connected to the broader domestic prices within China coming down. So all of that said, the direction of the effect on the rest of the world is clear. Even if the magnitude is not huge, there is a disinflationary force from China to the rest of the world. For the Fed and ECB, other developed market central bankers, such an impulse may be almost welcome. Central banks have tightened policy intentionally to slow their economies and pulled down inflation. Despite progress to date, we are nowhere near done with this hiking cycle. If we're wrong about China, however, should we start to worry about a global slump? Probably not. The Fed is currently trying to restrain growth in the US with high interest rates. If the drag comes more from China, well then the Fed will make less of the drag come from monetary policy. Thanks for listening and 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.

29 Aug 20233min

Proposed regulations for smaller banks show that turmoil in the banking sector may still have an impact on the broader economy.----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the links between regulations and the real economy. It's Monday, August 28, at 11 a.m. in New York. In the euphoria of buoyant equity markets over the last few months, the many challenges facing regional banks have receded into the background. While it certainly has not been our view, a narrative has clearly emerged that the issues in the sector that erupted in March are largely behind us. The ratings downgrades by both Moody's and Standard & Poor's of multiple U.S. banks in the last few weeks provide a reminder that the headwinds of increasing capital requirements, higher cost of funding and rising loan losses continue to challenge the business models of the regional banking sector. The rating agency actions come on the heels of proposed rules to modify capital requirements for banks with total assets of 100 billion or more. Separately, the Fed has proposed a capital rule on implementing capital surcharge for the eight U.S. global systemically important banks. Further proposed regulations on new long term debt requirements for banks with assets of $100-700 billion are due to be announced tomorrow. It is early in the rulemaking process for all of these proposals. They may change after the comment period and the rules will be phased in over several years once they are finalized. Nevertheless, they outline the framework of the regulatory regime ahead of us. While we won't go into the detailed discussion of thousands of pages of proposals here, suffice to say that the documents envisage significantly higher capital requirement for much of the U.S. banking sector, and extends several large bank requirements to much smaller banks. One such requirement pertains to the impact on capital of unrealized losses in available for sale securities. Currently, this provision applies only to Category one and Category two banks, that is banks with greater than $700 billion in total assets. But the proposal now expands it to Category three and Category four banks, that is banks with greater than $100 billion in total assets. A recent paper from the San Francisco Fed shows how the regulatory framework of the banking system affects the real economy. Specifically, the paper demonstrates that banks, which experienced larger market value losses on their securities during the 2022 monetary tightening cycle extended less credit to firms. Given the experience of the last 18 months across fixed income markets, extending the impact of such mark-to-market losses to smaller banks, as is being proposed now, would exasperate the potential challenges to credit formation. Against this background, we look at the near term prospects for bank lending. In the latest Senior Loan Officer Opinion survey, reflecting 2Q23 lending conditions, lending standards tightened across nearly all categories for the fourth consecutive quarter. Banks expect to tighten lending standards further across all categories through the year end, with the most tightening coming in commercial real estate, followed by credit card and commercial and industrial loans to small firms. The survey also asked banks to describe current lending standards relative to the midpoint of the standards since 2005. Most banks indicated the lending standards are tighter than the historical midpoint for all categories of commercial real estate and commercial and industrial loans to small firms. The bottom line is that more tightening lies ahead for the broader economy. This survey shows how the evolution of regulatory policy can weigh on credit formation and overall economic growth. Given the disproportionate exposure of the regional banks to commercial real estate debt that needs to be refinanced, commercial real estate is likely to be the arena where pressure has become most evident, another reason why we are skeptical that the turmoil in the regional banking sector is behind us. While the proposed regulatory changes can open doors for non-bank lenders, such as private credit, it is important to note that such lending will likely come at higher cost. 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 Aug 20234min

As the Fed meets this weekend for their annual summit at Jackson Hole, investors are most focused on whether rate hikes will continue and the state of the neutral interest rate.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, August 25th at 2 p.m. in London. The eyes of the market will be on Wyoming this weekend, where the Federal Reserve is holding its annual summit at Jackson Hole. While many topics will be discussed, investors are particularly focused on two: is the Fed done raising interest rates? And is the so-called neutral rate of interest higher than initially thought? The Federal Reserve has been raising interest rates at the fastest pace in 40 years to try to get rates to a level where economic activity starts to slow, easing inflationary pressure. But the level of interest rate that achieves this is genuinely uncertain, even to the experts at the Fed. We believe that they'll feel increasingly comfortable that rates have now hit this level. And in turn, Morgan Stanley's economists do not expect further rate hikes in this cycle. A few things drive our thinking. First, those inflationary pressures are easing. Two key measures of underlying inflation, core PCE and core CPI, slowed sharply in the most recent reading. Leading indicators for car prices and rental costs, which have been big drivers of high inflation last year, now point in the opposite direction. Bank loan growth is slowing and the torrid pace of U.S. job growth is also moderating, two other signs that interest rates are already restrictive. Historically, the Fed being done raising interest rates has been supportive for markets. But the relationship with high grade bonds is especially notable. Since 1984, there have been five times where the Fed has ended interest rate hiking cycles after multiple increases. Each time the yield on the U.S. aggregate bond index peaked within a month of this last hike. In short, the Fed being done has been good for the U.S. Agg Bond Index. And we can see the logic to this. If the Fed has stopped raising interest rates, one of two things may very well be true. First, it stopped at the correct level to support growth while also reducing inflation, and that stability with less inflation is liked by the bond market. Or it has stopped because rates are actually too high and set to slow growth and inflation much more sharply. In the second scenario, investors like the safety of bonds. But behind this question of whether the Fed will pause is another, larger issue. What is the so-called neutral rate of interest that neither slows nor boosts the U.S. economy? During the decade of stagnation that followed the global financial crisis, weak growth led people to believe that this balancing interest rate was extremely low. There are signs this thinking persists, when the Fed surveys its members about where they see the Fed funds rate over the long run, which is a proxy for where this neutral interest rate might be, the median is just 2.5%. In 2012, the Fed thought this same rate was over 4%. So that will be another focus at Jackson Hole, and beyond. The strength of the U.S. economy in the face of higher rates has been a surprising story. Does that mean that the balancing interest rate is much higher, and will the Fed raise their long run estimates of this rate to reflect this? Or is recent U.S. strength still temporary and not yet fully reflecting the effect of higher interest rates? Expect this debate to continue in the months ahead. 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.

25 Aug 20233min

Inspiring change through informed and inclusive innovation. On Access & Opportunity, host Carla Harris, Senior Client Advisor at Morgan Stanley, explores the lived experiences of the people who face systemic inequities and sits down with founders, investors, developers, activists, and educators who are building a more equitable future today.

24 Aug 20232min

As debate season begins among Republican presidential candidates, can investors hope to glean market insights for 2025 and beyond?----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the impact of presidential debates on markets. It's Wednesday, August 23rd at 10 a.m. in New York. Several candidates seeking the Republican Party's nomination for president take the stage in the debate tonight. Coverage of the event in traditional and financial media has escalated in anticipation of the debate. And while it's a good idea for voters looking to understand the candidates better and make an informed choice to tune in to the debate, for those tuning in looking for something that might guide their perception of how the 2024 election might impact financial markets, our guidance is this: lower your expectations. This debate, the first among many, is likely to tell us a lot less about who the nominee will be than traditional polls. Those polls show former President Trump with solid support that surpasses his main rivals. And while, of course, there's plenty of time for that to change, debates this early in the process haven't historically been reliable indicators of changes in support that may follow. This may be even more true this time around, since President Trump is not attending this debate. And so it will be more difficult to get a read as to which candidates might be better suited than others to make a more persuasive argument to Republican voters than the former president. Additionally, debates this early in the process generally tell us little about potential policy changes that could result from any one of these candidates ultimately being elected in 2024. Stock and corporate bond investors, in theory, might be very interested in what these candidates have to say about a variety of pending corporate tax code changes starting in 2025. But one shouldn't expect candidates to get into that level of detail on the debate stage. General comments about making sure the tax code doesn't work against the economy are far more likely. Further, the ability of any candidate to execute on their policy vision is going to be a function of the makeup of Congress, which again, this debate is unlikely to give us much information about. Bottom line, the 2024 election will be consequential to the markets, but tune in to the debate to inform yourself as a voter. As we've said in previous podcasts, it's too early to expect to learn anything that will help you as an investor.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.

23 Aug 20232min

Original Release on August, 1st 2023: While the U.S. economy appears on track to avoid a recession, investors should still consider the implications of an upcoming wave of maturities in corporate credit.----- Transcript -----Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I will be talking about potential risk to the economy. It's Tuesday, August 1st at 10 a.m. in New York. Another FOMC meeting came and went. To nobody's surprise the Fed hiked the target Fed funds rate by 25 basis points. Beyond the hike, the July FOMC statement had nearly no changes. While data on inflation and jobs are moving in the right direction, the Fed remains far from its 2% inflation goal. That said, Fed Chair Powell stressed that the Fed is closer to its destination, that monetary policies is in restrictive territory and is likely to stay there for some time. Broadly, the outcome of the market was in line with our economists expectation that the federal funds rate has peaked, will remain unchanged for an extended period, and the first 25 basis point cut will be delivered in March 2024. Powell sounded more confident in a soft landing, citing the gradual adjustment in the labor market and noting that despite 525 basis point policy tightening, the unemployment rate remains at the same level it was pre-COVID. The fact that the Fed has been able to bring inflation down without a meaningful rise in unemployment, he described as quote unquote "blessing". He noted that the Fed staff are no longer forecasting a recession, given the resilience in the economy. This specter of soft landing, meaning a recession is not imminent, is something our economists have been calling for some time. This has now become more broadly accepted across market participants, albeit somewhat reluctantly. The obvious question, therefore, is what are the risks ahead and what are the paths for such risks to materialize? One such potential risk emanates from the rising wave of credit maturities from the corporate credit markets. While company balance sheets, by and large, are in a good shape now, given how far interest rates have risen and how quickly they have done so, as that debt begins to mature and needs to be refinanced, it will happen at sharply higher rates. From now through the end of 2024, almost a trillion of corporate debt will mature. Sim ply by holding rates constant, that refinancing will represent a tightening of financial conditions. Fortunately, a high proportion of the debt comes from investment grade borrowers and does not appear to be particularly challenging. However, below investment grade debt has a tougher path ahead for refinancing. As we continue through 2024 and get into 2025, more and more high yield bonds and leveraged loans will need to be refinanced. All else equal, the default rates in high yield bonds and leveraged loans currently hovering around 2.5% may double to over 5% in the next 12 months. The forecasts of our economists point to a further slowdown in the economy from here, as the rest of the standard lags of policy are felt. We continue to think that such a slowing could necessitate a re-examination of the lower end of the credit spectrum. The ongoing challenges in the regional banking sector only add to this problem. In our view, in the list of risks to the U.S. economy, the rising wave of maturities in the corporate debt markets is notable. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts, and share Thoughts on the Market with a friend or colleague today.

22 Aug 20233min

Original Release on July, 27th 2023: With higher quality and lower costs, China’s electric vehicles could lead a shift in the global auto industry.----- Transcript -----Adam Jonas: Welcome to Thoughts on the Market. I'm Adam Jonas, Head of Morgan Stanley's Global Autos and Share Mobility Team. Tim Hsaio: And Tim Hsaio Greater China Auto Analyst. Adam Jonas: And on this special episode of Thoughts on the Market, we're going to discuss how China Electric vehicles are reshaping the global auto market. It's Thursday, July 27th at 8 a.m. in New York. Tim Hsaio: And 8 p.m in Hong Kong. Adam Jonas: For decades, global autos have been dominated by established, developed market brands with little focus on electric vehicles or EVs, particularly for the mass market. As things stand today, affordable EVs are few and far between, and this undersupply presents a major global challenge. At Morgan Stanley Equity Research, we think the auto industry will undergo a major reshuffling in the next decade as affordable EVs from emerging markets capture significant global market share. Tim, you believe China made EVs will be at the center of this upcoming shakeup of the global auto industry, are we at an inflection point and how did we get here? Tim Hsaio: Thanks, Adam. Yeah, we are definitely at a very critical inflection point at the moment. Firstly, since last year, as you may notice that China has outsized Germany car export and soon surpassed Japan in the first half of this year as the world's largest auto exporter. So now we believe China made EVs infiltrating the West, challenging their global peers, backed by not just cheaper prices but the improving variety and quality. And separately, we believe that affordability remains the key mitigating factors to global EV adoption, as Rastan brands have been slow to advance their EV strategy for their mass market. A lack of affordable models actually challenged global adoption, but we believe that that creates a great opportunity to EV from China where a lot of affordable EVs will soon fill in the vacuum and effectively meet the need for cheaper EV. So we believe that we are definitely at an inflection point. Adam Jonas: So Tim, it's safe to say that the expansionary strategy of China EVs is not just a fad, but real solid trend here? Tim Hsaio: Totally agree. We think it's going to be a long lasting trend because you think about what's happened over the past ten years. China has been a major growth engine to curb auto demands, contributing more than 300% of a sales increment. And now we believe China will transport itself into the key supply driver to the world, they initially by exporting cheaper EV and over time shifting course to transplant and foreign production just similar to Japan and Korea autos back to 1970 to 1990. And we believe China EVs are making inroads into more than 40 countries globally. Just a few years ago, the products made by China were poorly designed, but today they surpass rival foreign models on affordability, quality and even detector event user experience. So Adam, essentially, we are trying to forecast the future of EVs in China and the rest of the world, and this topic sits right at the heart of all three big things Morgan Stanley Research is exploring this year, the multipolar world, decarbonization and technology diffusion. So if we take a step back to look at the broader picture of what happens to supply chain, what potential scenarios for an auto industry realignment do you foresee? And which regions other than China stand to benefit or be negatively impacted? Adam Jonas: So, Tim, look, I think there's certainly room to diversify and rebalance at the margin away from China, which has such a dominant position in electric vehicles today, and it was their strategy to fulfill that. But you also got to make room for them. Okay. And there's precedent here because, you know, we saw with the Japanese auto manufacturers in the 1970s and 1980s, a lot of people doubted them and they became dominant in foreign markets. Then you had the Korean auto companies in the 1990s and 2000s. So, again, China's lead is going to be long lasting, but room for on-shoring and near-shoring, friend shoring. And we would look to regions like ASEAN, Vietnam, Thailand, Indonesia, Malaysia, also the Middle East, such as Morocco, which has an FTA agreement with the U.S. and Saudi, parts of Scandinavia and Central Europe, and of course our trade partners in North America, Mexico and Canada. So, we’ re witnessing an historic re-industrialization of some parts of the world that where we thought we lost some of our heavy industry. Tim Hsaio: So in a context of a multipolar trends, we are discussing Adam, how do you think a global original equipment manufacturers or OEM or the car makers and the policymakers will react to China's growing importance in the auto industry? Adam Jonas: So I think the challenge is how do you re-architect supply chains and still have skin in the game and still be relevant in these markets? It's going to take time. We think you're going to see the established auto companies, the so-called legacy car companies, seek partnerships in areas where they would otherwise struggle to bring scale. Look to diversify and de-risk their supply chains by having a dual source both on-shore and near-shore, in addition to their established China exposed supply chains. Some might choose to vertically integrate, and we've seen some striking partners upstream with mining companies and direct investments. Others might find that futile and work with battery firms and other structures without necessarily owning the technology. But we think most importantly, the theme is you're not going to be cutting out the world's second largest GDP, which already has such a dominant position in this important market, so the Western firms are going to work with the Chinese players. And the ones that can do that we think will be successful. And I'd bring our listeners attention to a recent precedent of a large German OEM and a state sponsored Chinese car company that are working together on electric vehicle architecture, which is predominantly the Chinese architecture. We think that's quite telling and you're going to see more of that kind of thing. Tim Hsaio: So Adam, is there anything the market is missing right now? Adam Jonas: A few things, Tim, but I think the most obvious one to me is just how good these Chinese EVs are. We think the market's really underestimating that, in terms of quality safety features, design. You know, you're seeing Chinese car companies hiring the best engineers from the German automakers coming, making these beautiful, beautiful vehicles, high quality. Another thing that we think is underestimated are the environmental externalities from battery manufacturing, batteries are an important technology for decarbonization. But the supply chain itself has some very inconvenient ESG externalities, labor to emissions and others. And I would say, final thing that we think the market is missing is there's an assumption that just because the electric vehicle and the supporting battery business, because it's a large and fast growing, that it has to be a high return business. And we are skeptical of that. Precedents from the solar polysilicon and LED TVs and others where when you get capital working and you've got state governments all around the world providing incentives that you get the growth, but you don't necessarily get great returns for shareholders, so it's a bit of a warning to investors to be cautious, be opportunistic, but growth doesn't necessarily mean great returns. Tim, let's return to China for a minute and as I ask you one final question, where will growing China's EV exports go and what is your outlook for the next one or two years as well as the next decade? Tim Hsaio: Eventually, I think China EVs will definitely want to grow their presence worldwide. But initially, we believe that there are two major markets they want to focus on. First one would be Europe. I think the China's export or the local brands there will want to leverage their BEV portfolio, battery EV, to grow their presence in Europe. And the other key market would be ASEAN country, Southeast Asia. I think the Chinese brands where the China EV can leverage their plug-in hybrid models to grow their presence in ASEAN. The major reason is that we noticed that in Southeast Asia the charging infrastructure is still underdeveloped, so the plug-in hybrid would be the more ideal solution to that market. And for the next 1 to 2 years, we are currently looking for the China the EV export to grow by like 50 to 60% every year. And in that long-terms, as you may notice that currently China made vehicles account for only 3% of cars sold outside China. But in the next decade we are looking for one third of EVs sold in overseas would be China made, so they are going to be the leader of the EV sold globally. Adam Jonas: Tim, thanks for taking the time to talk. Tim Hsaio: Great speaking with you Adam.Adam Jonas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.

21 Aug 20239min