Europe in the Global AI Race

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

Our Head of Corporate Credit Research and Head of Retail Consumer Credit discuss what choppy demand and tariff risk could mean for sectors that depend on consumer spending.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.Jenna Gianelli: I’m Jenna Gianelli, Head of Retail Consumer Credit, here at Morgan Stanley.Andrew Sheets: And today on this episode, we're going to discuss the outlook for the retail and consumer sectors.It’s Wednesday, Jan 29th at 9 am in New York.So, Jenna, it's great to talk with you, and it's really great to talk about the retail and consumer sectors heading into 2025, because it's such an important part of the investor debate. On the one hand, a lot of economic data in the U.S. seems strong, including a very low unemployment rate. And yet, we’re also hearing a lot about cost-of-living pressures on consumers, lower consumer confidence, and investor concern that the consumer is just not going to be able to hold up in this higher rate environment. And then you can layer on uncertainty from the new administration. Will we see tariffs? How large will they be? And how will retailers, which often import a lot of their goods, handle those changes?So, maybe just kind of starting off at a 40, 000-foot view, how are you thinking about consumer dynamics going into 2025?Jenna Gianelli: Of course. So, I think that that choppy consumer demand environment is actually one of the strongest pillars of our more cautious view, going into next year. How the sector, performed last year was not in tandem with kind of what the macro headlines suggested. The macro headlines were quite positive, and the consumer was, you know, seemingly strong. But there was a lot going on under the hood when you looked at different dichotomies, right? So, if you looked at the high-end versus the low-end, if you looked at goods versus services. And then within, you know, certain categories, there were categories that were, you know, really quite strong based on what the consumer was prioritizing – goods, essentials, personal care, beauty, right? And then there were others that they really shied away from.So, I think what we're going to see in 2025 is quite a bit more of that. When we think that the high-end will continue to be resilient, that pressure on the low-income consumer will continue. But actually moderate potentially as into [20]25, as we think about lower interest rates, potentially, you know, lesser immigration and so less competition for jobs at the lower income level. So maybe even some tailwinds, but it's really an alleviation of pressure and easier compares. But we do expect overall some deceleration, right? Because we had a lot of pent-up demand, especially on the high-end.So, we are expecting services, demand to slow, in 2025 and goods actually to hold up relatively well. So, we really are focused on what's going on at the individual category level and the different types of consumers that we're looking at.Andrew Sheets: And as you think about some of those, you know, subcategories that you, you cover, maybe just a minute on a couple that you think will perform the best over this year and some that you think might face the biggest challenges.Jenna Gianelli: There are some that have been under relative pressure, in [20]23 and [20]24 where we might actually see some, you know, relief. Now, depending on the direction of rates in the housing market, we could see and expect to see an uptick in bigger ticket spending, durables, home related, that have been under, you know, some pressure.And also, you know, categories where, you know, the consumer, they're arguably discretionary. But maybe they pulled back because there was a big surge in demand just post-COVID. Pet in our universe is actually one example of those, where it's been a bit depressed and we actually expect to see, you know, some recovery into next year; also tied to housing right as new house formation starts.So, but again, a lot of that is predicated on the, you know, housing direction of rates and some of these other macro factors. I'd say, irrespective of the more macro influences, we do still expect that essentials – grocery, and certain categories like a beauty, pockets of apparel and brands, right? It really comes down to the brands, the brand heat, the brand relevance. If it's relevant to the consumer, they're going to spend on it. And so, that's where we really focus on the micro level; our picks of which brands are resonating, which categories are resonating. Which is, those are some of the, you know, the few that we're expecting, either a recovery in or still, you know, relative, outperformance.I'd say on the laggard side, which is probably the next piece of that question. I mean, look, there's still a lot of secular headwinds at play. And so, you know, from a department store perspective outside of event risk or idiosyncratic risk, we're still generally expecting department stores and kind of traditional specialty apparel, mall-based, with not a lot of channel diversification to still generally underperform and see similar trends they've seen the last few years.Andrew Sheets: So, Jenna, your sector is sitting at the center of this kind of very interesting economic debate over how healthy the consumer really is. And, you know, it's also sitting at the center of the policy debate because tariffs are a dynamic that could dramatically affect retailers depending on how large they are and how they're implemented.So how do you think about tariff risk? And can you give some sense of how you think about exposure of your sector to those dynamics?Jenna Gianelli: So, tariffs and policy risk and the uncertainty, is one of the big reasons. And when we think about, you know, retail – and particularly discretionary retail – why we're more cautious on the space into [20]25. Tariffs is the biggest piece of that. The degrees of exposure across our universe, varying degrees to a very wide range, right? So, we have some that are minimal, you know, let's say 5 per cent out of, you know, China sourcing some up to 70 per cent out of China sourcing. And then you layer in, well, what about goods from Canada and Mexico and what if there's a universal tariff?And so, the range of outcomes, is, you know, so significant. And so, what we are advocating to investors is that we go in with the expectation that tariffs are a – an uncertain, but certain threat, right? And not completely minimizing them within a portfolio but reducing the ones that do tend to have those higher, you know, exposures.I'd say the range from when we stress tested the earnings headwinds potential. I mean, it was anything from call it down 10 per cent EBITDA to down 60-70 per cent EBITDA in the most draconian scenarios. And so, I think taking a very prudent approach, assuming that there will be some level of tariffs phased in, you know; if we look back to the 2018 timeframe – different sets of goods, different times, different rates and go from there.Andrew Sheets: So, Jenna, we've talked about the economy. We've talked about some of the policy and tariff risk potentially impacting consumer and retail. You know, a third really key strategic theme for us is more corporate activity, more M&A. And again, I think this is where your sector is so interesting because you were already kind of in the center of some of these debates, last year with corporate activity.So, can you talk a little bit about how you see that? And again, you also have this interesting dynamic that some of the targets of M&A activity in your sector were some of the businesses that were kind of struggling, that were kind of seen as some of these laggards. And so how does that just represent different investor views of their prospects? How do you think people should think about that going forward?Jenna Gianelli: So, look, I think M&A could have positive risk for 2025 and also negative risk for some of our companies. And it really depends, at least from a credit perspective, how we think about some of their indentures and bond language and likelihood of pro forma capital structures.But I think without getting, you know, too deep into that, our expectation is that M&A will increase. We know that there is private equity capital on the sidelines to the extent that rates, even if we're in a little bit of a higher for longer, if the expectation is that we do on the year [20]25 in a slightly lower regime, at least we have some stability or visibility on the rate front. Which should, you know, spur more corporate activity.And then also, I think, look, just equity valuations, right? I mean, our universe, particularly when you think about – the size of the equity check that you need to come in at and the valuations are a bit cheaper because across our universe, we did see some underperformance last year.So, I think those are the kind of main drivers of why we'll see the activity pick up on the underperforming pieces of the space. There are still pockets of value that I think private equity sponsors are seeing. The ones that have come up most notably are real estate, right? And, you know, we saw…Andrew Sheets: Because these retailers often own a large…Jenna Gianelli: Many of the department stores own a significant amount of their real estate. 20, 20, 40, 50 per cent depending on your, you know, assumptions and how you value this real estate. But even with conservative LTV assumptions, there is lending capability here. And I think so that's, you know, one piece of it, those that have multi-banner assets that appeal to different consumer cohorts, that have maybe a solid private label portfolio.When you think about intellectual property, there are real assets, for certain retailers. And so, I think that's what, you know, private equity historically has seen as the play. Now, how that manifests throughout the space? You know, from an LBO perspective; I do still think that getting a really large LBO for a traditional, you know, mature type of retailer could be challenging, but there are creative ways to get these deals done.And again, I think because of what we have is some legacy indentures, traditional, more investment grade style capital structures, there might be flexibility to approach, you know, LBOs in a more creative way – without having to access the capital markets in such a big way as maybe you would traditionally think.Andrew Sheets: And so, this would be examples of private equity firms coming in, doing an LBO or a leveraged buyout where you can actually almost take advantage of the borrowing that company has already done in the market…Jenna Gianelli: Yes. Keep the debt outstanding.Andrew Sheets: ... at attractive levels.Jenna Gianelli: Exactly. Exactly.Andrew Sheets: So, Jenna, it's so great to talk to you. Well, it's always great to talk to you, but it's so great to talk to you now because I do think, you know, as we, we look into 2025, I think there's always a lot of focus on, you know, the direction of markets, you know. Will rates go up or down? Will equities go up or down? But I think what's so clear talking to you about your sector is that there are all these themes that are really about dispersion. That we see, you know, really different trends by the type of consumer segment and sub segment; that we see very different trends by how exposed companies are to tariffs, right? You mentioned anything from, your earnings could be down 10 per cent to 60 per cent. And, you know, very different dynamics, you know, winners and losers from M&A.And so, I do think it just highlights that this is a year where, from the strategy side, we think spreads are kind of more range bound. But there does seem to be a lot of dispersion within the sector. And there seems like, well, there's going to be plenty that's going to keep you busy.Jenna Gianelli: I hope so.Andrew Sheets: Great. Jenna, thanks for taking the time to talk.Jena Gianelli: Thank you, Andrew.Andrew Sheets: Great. And thanks for listening. If you enjoyed the show, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

29 Jan 11min

Our Global Head of Fixed Income and Public Policy Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss the potential impact of U.S. tariffs in China and beyond.----- 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.Chetan Ahya: And I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.Michael Zezas: Today, we'll talk about what U.S. tariffs would mean for Asia's economy.It's Tuesday, January 28th at 8am in New York.Chetan Ahya: And 9pm in Hong Kong.Michael Zezas: Chetan, a week into the new Trump administration, I'm eager to talk tariffs with you. You and I came on the show before the U.S. election to discuss the potential impact of new tariff policies on China's economy in particular. And now that President Trump has taken office, he's been vocal about levying tariffs in a lot of places, including on China. The policy underpinning all of that appears to be a tariff review under the America First Trade Policy. That suggests to us that he's developing options to impose tariffs with China as a focus, but there's still time before implementation -- as these legal options are developed. That's in line with our base case; but investors have been talking a lot about the idea that maybe these tariffs never go on.What's your view here? And why do you think ultimately we are headed to a place where tariffs go higher?Chetan Ahya: Well, I think if you just look at the press comments that the president has made at the same time, if you read through this America First document, we sort of think that there are five avenues under which tariffs can go up on China.Number one is the recommendation from the America First policy document that the agencies in the U.S. will have to study how the large trade partners, which are running trade surpluses with the U.S. are managing their trade practices. Number two, a para in the America First document, which is suggesting that the trade agreements that US and China signed in 2018-19, how is China dealing with the commitments under that agreement?And number three is the clause which is currently exempting imports into the U.S. under [the] de minimis rule of imports under U.S. $800 per bill being allowed to import without any tariffs being imposed. And what the document is suggesting is to assess what is the potential revenue loss occurring to the government, and how can they plug that. Number four is a potential tariff action with the sale of a social media company. And number five, a potential tariff action which is linked to the fentanyl issue.So, as you can see, there are a number of avenues under which tariffs can go up on China and therefore we kind of keep that in our base case that tariffs will go up on China.And Mike, some investors are also optimistic and thinking that there is a possibility of a new trade deal being taken up by U.S. and China. What do you think are the chances of that?Michael Zezas: I think they're quite low. So, you mentioned five areas of potential dispute that the U.S. might want to use tariffs as a way of dealing with -- and I think that speaks to the idea that the bar is pretty high for China to avoid tariffs relative to some of the other negotiations the U.S. wants to engage in with other trade partners. Or maybe said differently, if the America First Trade Policy is pointing the U.S. at closing goods, trades, deficits, and improving security and making sure that it's not engaged with trade with other countries that are harming national security -- it seems that there are more of those activities going on between the U.S. and China than with other trade partners. Closing, for example, a $300 billion goods trades deficit would seem to be just really, really difficult within the structures of the economy.So, if we're right, and the chance of tariff de escalation with China appears to be slim, do you think Beijing, for example, might use renminbi depreciation to mitigate some of those economic risks?Chetan Ahya: Well, yes, we do think that China’s policymakers will allow depreciation in [renminbi] when tariffs are being imposed. However, we also think that the depreciation this time that they will allow will be less than what they did in 2018-19. And China has already been facing some capital outflows; and allowing a large depreciation could bring self fulfilling situation of more capital outflows and even sharper currency depreciation pressures.Michael Zezas: Beijing also started introducing stimulus measures last fall to boost the Chinese economy. Would tariffs disrupt this policy?Chetan Ahya: Certainly in our base case, despite the policy stimulus measures that China is taking, we think that overall growth in China will be lower in 2025 meaningfully. And more importantly in our view, China’s biggest challenge is deflation and tariffs will only exacerbate deflationary pressures.Michael Zezas: And so, we're talking a lot about China here, but obviously there's a risk of tariffs being applied to a broader set of U.S. trading partners in Asia. Now that's not our base case. We think ultimately the focus will be on China because a lot of those trading partners will be able to come to agreements with the U.S. to limit potential future tariffs; but of course, there's a considerable risk that we're wrong. As we mentioned this America First Trade Policy is developing a wide range of options to levy tariffs across multiple geographies and multiple products. So, if that were to come to pass, Chetan, what is it that other Asian governments might be able to do to mitigate the impact from higher tariffs?Chetan Ahya: First of all, this will be significantly negative for region's growth outlook. And there are two ways in which [the] region will get impacted. Firstly, because of the fact that China will be facing tariffs and China's growth will slow down, it will also have spillover effects for the rest of the region. At the same time, as you mentioned, there is a possibility that there are bilateral disputes opened up with other economies in the region. And so that will also add to the downside pressure for [the] region's growth.In terms of what they can do to offset this downside; we think that region's central bank will take up monetary easing and at the same time the governments will expand their fiscal deficit. But both of those measures will not be enough to fully offset the downside from tariff increase.Michael Zezas: Makes sense. Chetan, thanks for taking the time to talk.Chetan Ahya: Great speaking with you Mike.Michael Zezas: 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.

28 Jan 6min

Morgan Stanley Research looks at how the European defense industry might respond to military spending pressure from the Trump administration.----- Transcript -----Paul Walsh: Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's Head of Europe Product.Ross Law: And I'm Ross Law, Head of the European Aerospace and Defense Team.Paul Walsh: Today, we're discussing the outlook for European defense amid renewed pressure for more military spending from the Trump administration.It's Monday, the 27th of January, at 9.30am in London.Now Ross, the new Trump administration is now in place, and shifting NATO's defense burden to Europe is a top priority for President Trump. In fact, President Trump has made several comments throughout his campaign and after taking office. He has suggested that Europe should increase defense spending to 5 per cent of GDP. And just for reference, right now, many European countries are at or above NATO's target of spending 2 per cent of GDP on defense.What's your reaction? Are President Trump's demands of 5 percent realistic?Ross Law: In short, we don't think so. In a perfect world, yes, 5 per cent is exactly where Europe should be, to make up for the huge underspend that we've seen over the past three decades since the end of the Cold War, which we've calculated at around the $2 trillion mark. There's also a desire in Europe to reduce its reliance on the US, particularly under a Trump presidency. But we see the 5 per cent spending level as unrealistic on multiple fronts.Firstly, from an economic perspective, given the lack of fiscal headroom in Europe; and for reference, 5 per cent would require an additional $600 billion of spend annually. Secondly, from a political perspective, given multiple pockets of uncertainty, and the fact that a rise in defense spending may mean a cut to spending elsewhere. And lastly, from an industry perspective, given the multi-decade underspend I mentioned, we don't think the industry could absorb anywhere close to such a strong increase in demand, at least near-term.So, while we do see upside pressure to European defense spending, our base case is that 3 per cent could be a more reasonable target. Not only would this be a compromise between the current 2 per cent target and Trump's 5 per cent demands; it would also allow Europe to match the spending levels of the US, which is expected at around 3.1 per cent in 2024. Even still, this would represent a 50 per cent increase or around $200 billion per year in additional European spent. This would, of course, further improve industry fundamentals and why we remain very positive on the sector.Paul Walsh: And as of now, Europe is heavily dependent on the U.S. for its defense. According to various data sources, more than 50 per cent of European arms imports came from the U.S. in 2019 through 2023, and that's up from 35 per cent in 2014. Given this, what steps would Europe need to take to reduce its dependence on the U.S.?Ross Law: The first step is to invest in the defense industrial base. Europe buys equipment from the U.S. for several reasons. Firstly, because the U.S. develops some of the most advanced technologies in the world because it has consistently invested in its defense industry. Secondly, because the U.S. equipment is often cheaper due to the benefits of scale. And thirdly, because it supports the very unique relationship between Europe and the U.S., which has essentially provided a security umbrella for the past three decades.So, Europe needs to invest, both to develop capabilities and technologies to rival U.S. peers, and also to expand capacity so that we can meet our own equipment needs. This, of course, all requires investment and also time. So, Europe will remain reliant on the U.S. for many years to come. But if Europe is serious about wanting to be more sovereign, we need a more capable defense industry.Paul Walsh: So, you talked there, Ross, about investment and time. So now the big question, how would Europe fund this upward pressure on defense budgets?Ross Law: Well, this is the million-dollar question, or the 200-billion-dollar question, you might say. Unfortunately, this is part of the equation that is, so far, most unclear – and the basis for an ongoing series of reports we've entitled the “European Defense Dilemma” – essentially the very clear need to spend more on defense, but no clear way to fund it. So far, we've seen some creative ways to fund near-term spending plans, from off balance sheet special funds like in Germany, to using the interest received on frozen Russian assets.But these, in our view, all seem fairly temporary in nature. What we really need is structural change, and that requires political commitment. Clearly, there is a lot of political change happening right now in Europe. Germany is holding an election in a few weeks time. France doesn't yet have a budget. There's also fiscal issues here in the UK. But we're hoping that 2025 is the year in which we may get clearer political commitments to longer-term structural improvements in defense spending. The German election is a clear near-term catalyst for us, where the raising of the debt break may in part be used to fund higher defense spending. But we're also looking to the upcoming NATO summit in June as an opportunity to officially increase the NATO spending target, we think potentially to 3 per cent, to support a more structural increase in European defense spending.Paul Walsh: In light of all of this, what's your outlook for the European defense industry?Ross Law: We remain bullish. In fact, we turned even more bullish as part of our 2025 outlook published earlier this month. The pressure to raise spending even to 3 per cent of GDP should progressively benefit industry fundamentals.So, we see upside to both forecasts. Given these are currently premised on a 2 per cent of GDP assumption, as well as devaluation multiples, which we view today as very attractive, with the sector trading in line with this long-term average – despite the improving fundamentals I've just described.Paul Walsh: And finally, Ross, what developments if any might change your outlook?Ross Law: The key for us this year is seeing clear political commitments from governments on more structural increases in spending. So, we're going to be watching the German election and the outcome of the French budgetary process very carefully. It's unlikely to be plain sailing. There was a media article published just this morning suggesting the UK government may be unwilling to raise spending beyond the current 2.3 per cent level. But we are hoping that as a whole 2025 sees Europe make a stronger commitment to defending itself.Paul Walsh: Ross, fascinating as always. Thanks for taking the time to talk.Ross Law: Great speaking with you Paul.Paul Walsh: And thanks for listening. 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.

27 Jan 7min

Our Head of Corporate Credit Research Andrew Sheets argues that while investor hopes are running high, corporate confidence isn’t.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about optimism, how we measure it, whether it’s overly excessive and what lies ahead. It's Friday January 24th at 2pm in London. A central tenet of investing, including credit investing, is to be on the lookout for excessive optimism. By definition, the highest prices in a market cycle will happen when people are the most convinced that only great things lie ahead. The lowest prices, when you’d love to buy, happen when investors have given up all hope. But identifying peak optimism, in real time, is tricky. It’s tricky because there is no generally agreed definition; and it's tricky because, sometimes, things just are good. Investors have been excited about the US Technology sector for more than a decade now. And yet this sector has managed to deliver extraordinary profit growth over this time – and extraordinarily good returns. Yet this debate does feel relevant. The US equity market has soared over 50 per cent in the last two years. Equity valuations are historically high, both outright and relative to bonds. Credit risk premiums are near 20-year lows. Speculative investor activity is increasing. And so, have we finally hit peak optimism, a level from which we can go no further? Our answer, for better or worse, is no. While we think investor optimism is elevated, corporate optimism is not. And corporations are really important in this debate, enjoying enormous financial resources that can invest in the economy or other companies. While we do think corporate confidence will pick up, it is going to take some time. One of our favorite measures of corporate confidence is merger and acquisition activity. Buying another company is one of the riskiest things management can do, making it a great proxy for underlying corporate confidence. Volumes of this type of activity rose about 25 per cent last year, but they are still well below historical averages. And it would be really unusual for a major market cycle to end without this sort of activity being above-trend. Another metric is the riskiness of new borrowing. Taking on new debt is another measure of corporate confidence, as you generally do something like this when you feel good about the future, and your ability to pay that debt off. But for the last three years the volume of low-rated debt in the US market has actually been shrinking, while the issuance of the riskiest grades of corporate borrowing is also down significantly from the 2017-2022 average. Again, these are not the types of trends you’d expect with excessive corporate optimism. Uncertainties around tariffs, or the policies from the new US administration could still hold corporate confidence back. But the low starting point for corporate confidence, combined with what we expect to be a deregulatory push, mean we think it is more likely that corporate activity and aggressiveness have room to rise – and that this continues throughout 2025. Such an increase usually does present greater risk down the line; but for now, we think it is too early to position for those more negative consequences of increasing corporate aggression. Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

24 Jan 3min

Morgan Stanley Research analysts Michelle Weaver, Michael Cyprys and Ryan Kenny discuss the resurgence in capital markets activity and how sponsors might deploy the $4 trillion that has been sitting on the sidelines. ----- Transcript -----Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity strategist at Morgan Stanley.Michael Cyprys: I'm Mike Cyprys, Head of U.S. Brokers, Asset Managers and Exchanges Research.Ryan Kenny: And I'm Ryan Kenney, U.S. Mid-Cap Advisors Analyst at Morgan Stanley.Michelle Weaver: In this episode of our special miniseries covering Big Debates, we'll focus on the improving M&A and IPO landscape and whether retail investing can sustain in 2025.It's Thursday, January 23rd at 10am in New York.2023 saw the lowest level of global M&A activity in at least 30 years. But we've started to see activity pick up in 2024. Mike, what have been the key drivers behind this resurgence, and where are we now?Michael Cyprys: Look, I think it's been a combination of factors in the context of a lot of pent-up activity and a growing urge to transact after a very subdued period of, you know, call it four- to six quarters of quite limited activity. Key drivers as we see it ranging from equity markets that have expanded across much of the world, low levels of equity volatility. broad financing, availability with meaningful issuance as you look across investment grade and high yield bond markets, tight credit spreads, interest rates stabilizing in [20]24, and then the Fed began to cut.So, liquidity pretty robust, all of that helping reduce bid-ask spreads. In terms of where we are now, post election, think there's just a lot of excitement here around a new administration; where we could see some changes around the antitrust environment that can be helpful, as we think about unlocking greater M&A activity across sponsors as well as strategics, and helping improve corporate confidence.But look, the recent rout of market could delay some of the transactional activity uplift. But we view that as more of a timing impact, and we are quite positive here in [20]25 as we think about scope for continued surge of activity.Michelle Weaver: We've seen rates rising pretty substantially since December. Does that throw a wrench into this at all, or do you think we see more stabilization there?Michael Cyprys: I think it could be a little bit of a slowdown, right? That would be the risk here, but as we think about the path for moving forward, I do think that there are a lot of factors that can be very helpful in terms of driving a continued pickup in activity, which we're going to talk about -- and why that will be the case.Michelle Weaver: Great. And you mentioned financial sponsors earlier, I want to drill down there a little more. What do you think would get sponsor activity to pick up more meaningfully?Michael Cyprys: Well, as I think about it, activity is already starting to pick up clearly across strategics as well as sponsors. On the sponsor side, it's been lagging a bit relative to strategics. We think both of which will build, and Ryan will get to that on the strategic side. As we think about the sponsors -- they're sitting with $4 trillion of capital to put to work that's been sitting on the sidelines where you just haven't seen as much activity over the past couple of years.Overall activity in [20]24 was probably call it maybe around 20 per cent below peak levels, and this is burning a hole in the pockets of both sponsors as well as their clients. And so, we see a growing urge to transact here, which gets to some of your earlier questions there too.So why is that? Well, the return clock is ticking; the lack of deployment is hurting returns within funds. Some of this dry powder also expires by the end of [20]25; and so if it's not yet deployed, then sponsors won't get some of the performance fee economics that come through to them on that capital. So that's all, all on the deployment side.As we think about the realization or exit side, we think that's probably going to lag, but we'd still expect, a steady build through this year. Today sponsors are sitting on call it around $10 trillion of portfolio of investments that are in the ground, and they haven't really provided much in the way of liquidity back to their customers, the LPs and the funds. And so, this is putting a little bit of a strain not only on the client relationships that want more money back from their private investments that haven't received it, but it's also one of the causes of what has been a little bit of a challenging fundraising backdrop across private equity funds.Hence if sponsors can return more capital to their clients, that can be helpful in terms of healing the overall fundraising backdrop. So, look, putting all that together, we expect an expanding pace of transactional deal activity across the sponsors from both the buy side as well as the sell side in terms of our activity.Michelle Weaver: And Ryan, how about IPOs? Have they been part of a similar trend?Ryan Kenny: Yes, definitely. So, with IPOs, we're also expecting a significant resurgence off of a low base. So just to put some numbers on it. In 2024, announced M&A volumes relative to nominal GDP, we're around 40 per cent below three-decade averages; equity capital markets [ECM] or ECM was even more muted, 50 per cent below three decade averages. And the leading indicators for ECM are very similar to the leading indicators for M&A. You want a strong equity market, relatively low volatility so that companies have the confidence to go public and so that deals can price well. And those conditions are really starting to materialize already in 2024; and we saw a few big IPOs price well last year, and launch well. The fourth quarter also looks strong. We saw a significant acceleration in industry ECM activity in October, November, December. 4Q volumes tracking up over 50 per cent year-over-year.Michelle Weaver: Let's dig a little deeper into potential policies from the incoming Trump administration. What are your expectations around antitrust regulation and its impact on M&A?Ryan Kenny: So, Trump has announced his appointments to the FTC and to the DOJ antitrust division. And our expectation is a return to normal. And that's coming off of what was a more onerous and not-clear environment under Biden. The Biden administration's approach was to disincentivize M&A; and they did that by defining M&A market concentration in novel ways -- looking at things like labor markets, and looking at how competitiveness is defined in new ways. And these new ways of defining concentration decrease the clarity of whether a specific deal would be challenged.So, from a CEO and board perspective, you don't want to waste the time of your management team and your board going through a deal that might not go through; in addition to the risk of prolonging the deal, and the risk of higher legal expenses during the process. So now that we're returning more towards normal, that's our expectation. We expect there will still be some deals like a challenge, but it will operate under more historical norms and so that really checks the box of getting CEO confidence up to transact more.Michelle Weaver: And I know that dynamic you’re talking about with market concentration created quite a big drag on large M&A deals and large-cap M& A. Do you think we could start to see that come back as well?Ryan Kenny: Yeah, expect large-cap deals to rebound even more than small-cap deals. When we started to see the activity pick up in 2024, it was led by more mid-cap corporates. And now we expect to see large deals return in force at a time when financial sponsors, like what Mike was just talking about, coming back in force at the same time -- which drives up the animal spirits when all parts of the M&A market are returning at the same time.Michelle Weaver: And what are some other catalysts beyond the political side that investors should watch in 2025 around capital markets developments?Ryan Kenny: So, I categorize it as macro catalysts and structural catalysts The macro catalysts are clarity on tariff and immigration policies, how that will impact GDP. Clarity on the interest rate path. And look you don't need more rate cuts to get this market moving; you can still have a significant increase, even if there are no more rate cuts this year.But narrowing the range of outcomes is important. And I think we're already there, where maybe we get no cuts this year. Maybe we get two cuts. It's a much tighter environment than where we were over the last few years. And so that helps narrow the bid-ask spread between buyers and sellers.Structural catalysts that are really critical this cycle are the need for AI capabilities. Innovation in tech, innovation in biotech healthcare, the energy transition, reshoring and exploring your geographic footprint in a multipolar world -- are all really critical when you evaluate the types of companies that a board would want to acquire.Michelle Weaver: What’s your outlook for 2025? And then even beyond that when it comes to both M&A and IPO activity?Ryan Kenny: So, in 2025, we see a strong rebound in both ECM and M&A. ECM volumes in our base case, we expect to roughly double off of a low base. M&A announcements, we expect up over 50 per cent year-over-year in 2025. And importantly, that's our base case. Even in our bear case, we model an increase in both ECM and M& A volumes, given we're coming off of such low levels.We've had three years of light activity and pent-up demand, and pipelines have already begun to build. When we look forward beyond 2025, we think this is the beginning of a multi-year capital markets growth cycle -- with bigger deal sizes and more deal count than average, driven by three years of pent-up demand and an economy that's a third larger than 2021, which was the last time we had a capital markets cycle.Michelle Weaver: And then Mike, what does this rebound in capital markets activity, including M&A and IPOs means specifically for retail investing?Michael Cyprys: Overall, a supportive macro backdrop with a rebound in capital markets activity, we think should be helpful in terms of bringing more investors into the markets, including retail investors. Whether it's from corporate actions and IPOs, it helps in terms of more stocks to trade; also helps in terms of revising animal spirits.I think that's all helpful in terms of supporting engagement across both single stock volumes and equity markets as well as options. So, all of that together, we were expecting greater investor engagement here in [20]25. And confidence as well can help boost not just trading volumes but also margin lending and securities lending. And so, all of that can be helpful as we think about our forecast for our retail brokerage coverage group.Michelle Weaver: Mike, Ryan, thank you for taking the time to talk. And to our listeners, thanks for listening. If you enjoyed the podcast, please share it with a friend or colleague today.

23 Jan 10min