Europe in the Global AI Race

We discuss how the upcoming US elections could affect trade and tax policy, and which scenarios are most favorable to retailers and brands. ----- Transcript -----Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore from Morgan Stanley's US Public Policy Research Team.Alex Straton: And I'm Alex Straton, head of the North America Softlines Retail and Brands team.Ariana Salvatore: On this episode of the podcast, we'll discuss some key policy issues that may play into the U.S. presidential election and their potential impact on businesses and consumers.It's Tuesday, April 2nd, at 10 am in New York.Election season is fully underway here in the U.S. and as in past election cycles, trade policy and tax reform are once again a big concern.With that in mind, I wanted to discuss the potential implications on the retail space with my colleague Alex. So, let's start there. In general, Alex, how are retail stocks impacted leading up to the U.S. presidential elections?Alex Straton: So, look, this kind of surprised us when we had looked into some of this data. But if you look at the last six elections or so, on a full year basis, trading activity can be super volatile in my coverage; and it depends on what's at stake.But what we do broadly observe is back half underperformance to a bigger magnitude than is typical in a normal year. So, there is pressure on these stocks, in a way that you don't see in non-election years. Makes sense, right? Kind of a makes sense hypothesis that we confirmed. But I think the more interesting nugget about Softlines, Retail and Brand stocks leading into elections is that the higher frequency data can actually look worse than what actually comes to fruition in the top line or the sales numbers.So, by that I mean, you'll see surveys out of our economics team or out of, you know, big economics forums that say, ‘Oh, sentiment is getting worse.’ And then we'll see things like traffic is getting worse, these higher frequency indicators; and they actually end up almost exacerbating the impact than what we actually see when we get the true revenue results later on.So, my point being -- beware, as you see this degradation in the data; that doesn't necessarily mean that these businesses fundamentals are going to deteriorate to the same degree. In fact, it shows you that -- yes, maybe they're a little bit worse, but not to that extent.Alex Straton: So, Ariana, let's look at the policy side. More specifically, let's talk about some potential changes in tax policy that's been a hot topic for companies I cover. So, what's on the horizon, top down?Ariana Salvatore: Yeah, so, lots of changes to think about the horizon here.Just for some quick context, back in 2017, Republicans under former President Trump passed the Tax Cuts and Jobs Act, and that included a whole host of corporate and individual tax cuts. The way that law was structured was set to start rolling off around 2022, and most, if not all, of the bill is set to expire by the end of 2025.So that means that regardless of the election outcome, the next Congress will have to focus on tax policy, either by extending those cuts, or allowing some or all of them to roll off. So, in general, we think a Democratic sweep scenario would make it more likely that you would see the corporate rate, perhaps tick up a few points; while in a Republican sweep, we think you probably would maintain that 21 per cent corporate rate; and perhaps extend some of the other expiring corporate provisions.So, Alex, how do you expect these potential changes in the corporate tax side to impact the retailers and the brands that you cover?Alex Straton: Yeah. So, high level, I think about it on a sub-sector basis. And so, the headline you should hear is that my brand or wholesale coverage, which has more international revenue experience exposure, is better off than my retail coverage, which has more domestic or North America exposure.And it all just comes back to having more or less foreign exposure. The more North America exposure you have, the more subject you are to a change in tax rate. The more foreign exposure you have, the less subject you are to a change in tax rate. So that's the high-level way to think about it.We did run some analyses across our coverage, and if we do see the US corporate tax rate, let's say, lowered to 15 per cent hypothetically, we'll call that the Trump outcome, if you will. We calculate about a 5 per cent average benefit to 2025 earnings across our coverage. Now on the other hand, if we see something like a corporate tax rate that goes to 25 per cent, Biden outcome -- let's just label it that. We calculate 3 per cent average downside to the 2025 EPS estimates in our coverage.So that's how we sized it. It's not a huge swing, right? And the only reason why there's what I would call more of a benefit than a downside impact of that analysis is because of where the current tax rate sits and the relative magnitudes we took around it.Alex Straton: Now back over to you. You've highlighted trade policy as another key issue for the [20]24 election. Why is it so crucial in this election cycle compared to prior ones we've seen?Ariana Salvatore: Right. So, in contrast to some of the tax changes that we were just talking about, those would require full congressional agreement, right?So, you need either sweep scenario to make changes to tax policy in a really significant way. Trade policy is completely different because it is very much at the discretion of the president alone. So, to that end, we've envisioned a few different scenarios that can range from things like targeted tariffs on particular goods or trading partners, you know, something akin to the first Trump administration; to things like a universal baseline tariff scenario, and that's more similar to some of the more recent proposals that the former president has been talking about on the campaign trail.So, there are a whole host of different circumstances that can lead to each of those outcomes, but it's critically important, that level of discretion that I mentioned before. And we think for that reason, that investors really need to contemplate each of these different scenarios and what they could mean for, you know, macro markets and their individual stocks that they cover. Because, frankly, a lot can change.So, to that point, how do you think changes in trade policy are going to affect the side of the retail sector that you cover? Obviously, you mentioned North American exposure, so I imagine that's going to be critical again.But what kind of businesses will be most affected under the different scenarios that I just mentioned?Alex Straton: Yeah, so the way we examined this on our end, so from a Softlines, Retail, and Brands perspective, was looking at what a incremental China tariff means.I do think there's important background for people to understand in my space that differs this time around versus an election cycle, you know, four or eight years ago, whatever it may have been -- in that my companies have intentionally diversified out of China.The fact I love to give people is that US apparel imports from China has fallen from nearly 40 per cent to 20 per cent in the last, you know, decade or so; with 10 points of that in the last five years alone. So, the headline you should hear is there's not as much China exposure as there used to be. So that's good if there is a tariff put on for my companies. But with that backdrop, turning to the numbers, we have about 20 per cent cost of goods sold exposure to China on average across Softlines, Retail and Brands businesses.So, if that goes up by an incremental 10 per cent what we calculate is about a 15 per cent impact to 2025 earnings across my coverage. One final thing I would say is that it's very rare for businesses to have a North America based supply chain. But there are some companies -- very few, but select ones -- that do have a majority domestic supply chain. You can think about some of the favorite jeans you might wear on an everyday basis. Maybe more often than not, you don't realize they're actually made in America. And that's a benefit in a scenario like that.Ariana Salvatore: Makes sense. Alex, thanks for taking the time to talk.Alex Straton: It was great speaking with you, Ariana. Thanks for having me.Ariana Salvatore: And thank you 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.

2 Apr 20247min

Our Global Chief Economist surveys recent US and Australian census data to explain immigration’s impact on labor supply and demand, as well as the implications for monetary policy. ----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, along with my colleagues bringing you a variety of perspectives. And today, I'll be talking about immigration, economic growth, and the implications for monetary policy.It's Monday, April 1st, at 10am in New York.Global migration is emerging as an important macro trend. Some migration patterns change during and after COVID, and such changes can have first order effects on the population and labor force of an economy.That fact has meant that several central banks have discussed immigration in the context of their economic outlook; and we focus here on the Fed and the Reserve Bank of Australia, the RBA.In the US, recent population estimates from the CBO and the census suggests that immigration has been and is still driving faster growth in the population and labor supply, helping to explain some of last year's upside surprise in non-farm payrolls. In Australia, the issue is even longer standing, and accelerated migration in recent years has provided important support to consumption and inflation.From a macro perspective, immigration can boost both aggregate demand and aggregate supply. More specifically, more immigration can lead to stronger consumption spending, a larger labor force, and may drive investment spending.The permanence of the immigration, like some immigrants are temporary students or just visiting workers, the skill level of the migrants and the speed of labor force integration are consequential -- in determining whether supply side or demand side effects dominate. Demand side effects tend to be more inflationary and supply side effects more disinflationary.In Australia, the acceleration in immigration has played an important driver in population growth and aggregate demand. In the decade before COVID, net migration added about a percentage point to the population growth annually. In 2022 and 2023, the growth rate accelerated beyond two percent. The pace of growth and migration and the type of migration have supported consumption spending and made housing demand outpace housing supply.Our Australia economists note that net migration will likely remain a tailwind for spending in 2024 -- but with significant uncertainty about the magnitude. In stark contrast, recent evidence in the US suggests that the surge in immigration has had a relatively stronger impact on aggregate supply. Growth in 2023 surprised to the upside, even relative to our rosier than consensus outlook.Academic research on US states suggests that over the period from 1970 to 2006, immigration tended to increase capital about one for one with increases in labor -- because the capital labor ratio in states receiving more immigrants remained relatively constant. That is, the inflow of immigrants stimulated an increase in investment.Of course, the sector of the economy that attracts the immigrants matters a lot. Immigrants joining sectors with lesser capital intensiveness may show less of this capital boosting effect.So, what are the implications for monetary policy? Decidedly, mixed. In the short run, more demand from any of the above sources will tend to be inflationary, and that suggests a higher policy rate is needed. But, as any supply boosting effects manifest, easier policy is called for to allow the economy to grow into that higher potential. So, a little bit here, a little bit there. Over the long run, though, only a persistently faster growth rate in immigration, as opposed to a one-off surge, would be able to raise the equilibrium rate, the so-called R star, on a permanent basis.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or a colleague today.

1 Apr 20243min

A landmark settlement with the National Association of Realtors will change the way brokers are paid commissions. How would this affect people looking to buy or sell homes? Our co-heads of Securitized Products Research discuss.----- Transcript -----James Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.Jay Bacow: And I'm Jay Bacow, the other co-head of Securitized Products Research.James Egan: And on this episode of the podcast, we'll be discussing some proposed changes to the US housing market. It's Thursday, March 28th, at 1pm in New York.Jay Bacow: Jim, two weeks ago, the National Association of Realtors (NAR) settled a case that could fundamentally change how commissions are paid to brokers. Acknowledging that there's a few months until this is all going to get approved, it looks like sellers are no longer going to have to compensate buyers’ agents. Which means that the closing cost that sellers have to pay is going to come down from the current 5 to 6 per cent to brokers to something more in the context of 3.5 to 4 percent -- based on estimates from many economists. What does this mean for the housing market?James Egan: So, this is certainly a settlement worth paying attention to.There are a lot of moving pieces here, but some of our first thoughts. Look, if we're lowering the ultimate transaction costs when it comes to selling homes, we do think that -- all else equal and probably a little bit more into the future -- it's going to lead to a higher volume of transactions. Or a higher level of turnover in the housing market.Now sellers no longer having to compensate buyers’ agents. That becoming something that buyers will need to do -- that could, at least from a perception perspective, increase the cost for buyers at a place, where we're already at one of our least affordable points in several decades. So, when we think about an increased level of transaction volumes; if that means, especially in the near term, or especially where we are right now, a little bit of an increase in for-sale inventory, combined with some of the affordability issues -- maybe it weighs a little bit on home prices. But our bottom line here is we think from a home price perspective, largely unchanged here. From a transaction volume perspective, all else equal, you could see a little bit of a pickup.Jay Bacow: All right. But Jim, haven't you been calling for some of the story already with increased housing activity, causing home prices to end 2024 slightly below 2023. Does this then change the narrative at all?James Egan: No, I don't think this changes the narrative. If we go back into that call just a little bit, our call for the marginal decrease in year over year home price growth was driven by growth in for-sale inventory this year. We're seeing that steady growth in existing listings over the past couple of months.Now, the most recent housing start print was also positive from this perspective. Single unit housing starts were up for the eighth month in a row and have now increased 11 per cent from their local lows, which were in June of 2023. I think it's also worth pointing out over that same time frame, five plus unit starts, multi-unit housing, they're down in almost every single one of those months -- all but one of them. And they're down 19 per cent from that same month, June of 2023. But that's probably something for another podcast.Jay Bacow Alright. Well, I think there's two more things we should include in this podcast. First, this settlement isn't the only factor that could increase housing activity. Recently, around the State of the Union [address], President Biden announced a number of plans that could also contribute.Now, some of them require congressional approval, including a $10,000 middle-income first-time homebuyer tax credit. And then a separate $10,000 tax credit to middle class families that would sell their home below the median income in the county to help account for some of these lock-in effects that you mentioned.Jay Bacow: However, he also announced a pilot program that would eliminate total insurance fees for some low-risk refinance transactions. And that one doesn't require congressional approval; it's getting put in place as we speak, and that would save homeowners about $750 in closing costs on a refinance.James Egan: Interesting. So, if I'm hearing you correctly, the ones that would require congressional approval, they're more on the -- what we would call housing activity side: sales, purchase volumes. Whereas the one that didn't was on the refinance side. Now, presumably there's not much refinance activity going on right now.Jay Bacow: That's a correct presumption. Right now, we estimate that only about 3 per cent of homeowners have a critical incentive to refinance 25 basis points versus a prevailing mortgage rate. So, this is going to matter a lot more if we rally in rates. Realistically, we think we need a mortgage rate to get closer to 5 per cent than the current level for this to really matter.But I imagine that's probably a similar case with the NAR settlement as well.James Egan: Exactly. And that's why I made a point to say, all else equal, we think this is going to lead to a higher volume of transactions or a higher turnover rate in the housing market. It's because of that lock-in effect. Right now, so much of the homeowning distribution is well below the prevailing mortgage rate, that any real impacts of this we think are just going to be on the margins.Jay Bacow: Alright, so there's a lot of changes are coming to the housing market. They're likely to impact the market more if rates rally and are more of the back half of the year, next year event than this summer.Jim, thanks for taking the time to talk.James Egan: Great speaking with you, Jay.Jay Bacow: 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.

28 Mars 20245min

Consumer credit scores have ticked higher in the last two years – but so have the rate of delinquencies and defaults. Our Global Head of Fixed Income discusses “credit score migration” with the firm's Asset-Backed Security Strategist.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley.Heather Berger: And I'm Heather Berger, Asset-Backed Security Strategist.Michael Zezas: And today, we'll be talking about the trend of migrating US consumer credit scores and the potential effect on equities and fixed income. It's Wednesday, March 27th at 10am in New York.Heather, I really wanted to talk to you today because we've all seen some recent news reports about delinquencies and defaults in consumer credit ticking higher over the last two years. That means more people missing payments on their car loans and credit cards, suggesting the consumer is increasingly in a stressed position. But at the same time, that seems to be at odds with what's been an upward trend in consumers’ credit scores, which on its face should suggest the consumer is in a healthier position.So, it all begs the question: what's really going on here with the consumer, and what does it mean for markets? Now, you and your colleagues have been doing some really fascinating work showing that in order to get to the truth here, we have to understand that there's a measurement problem. There’s quirks in the data that, when you understand them, mean you have a more accurate picture of the health of the consumer. And that, in turn, can clarify some opportunities in the fixed income and equity markets.So, this measurement problem seems to center around the idea of credit score migration. Can you start by explaining what exactly is credit score migration?Heather Berger: Sure. So, credit scores are used as a way to estimate expected default risk on consumer loans. And these scores are really the most standardized and widespread way of evaluating consumer credit quality. Scores are meant to be relative metrics at any point in time. So, a 700 score today is meant to indicate less default risk than a 600 score today, but a 700 score today isn't necessarily the same as a 700 score a few years ago.Credit scores have been increasing throughout the past decade; most extremely from 2020 to 2021, largely due to COVID related factors such as stimulus checks. The average credit score is up 10 points in the past four years, and this trend has broadly been referred to as credit score migration.Michael Zezas: So, just so we can have a concrete example, can you talk about how this has affected one particular consumer credit category?Heather Berger: Well, as you mentioned earlier, delinquencies and defaults have been rising across consumer loan types, whether it's autos, credit cards, or personal loans. The macro backdrop has definitely contributed to this, as inflation has weighed on consumers real disposable income, but we do think that score migration has had an impact as well, considering the large changes over the past few years.Looking at auto loans, for example, with the same credit scores from 2022 versus loans from 2018, we see that delinquency rates on the 2022 loans are up to 60 per cent higher than on the 2018 loans. We estimate that 30 to 50 per cent of this increase can be due to effects of credit score migration.Michael Zezas: And is there anything we can assume here about the actual health of the US consumer? Do we see delinquencies improving or getting worse?Heather Berger: I think one of the main takeaways here is that since score migration impacts performance metrics, we shouldn't necessarily extrapolate delinquency data to broader consumer health. Despite the high delinquency rates, our economists do expect consumers to remain afloat.They're forecasting a modest slowdown in consumer spending this year as we move off a hot labor market and continue to face elevated interest rates.Michael Zezas: So, let's shift to the market impacts here. Maybe you could tell us what your colleagues in equity research saw as the impact on the banks and consumer finance sectors. And in your area of expertise, what are the impacts for asset-backed securities?Heather Berger: We think that across both of these spaces, taking into account changes in credit scores will be important to use in models moving forward; and this can help us to more accurately assess the risks of consumer loans and to predict performance. Movements in credit scores have actually been muted in the past year, which is a big change from the large increases we saw a few years ago.So, score migration should now have a smaller impact on consumer performance and delinquency rates. This means that performance will be driven by macro factors and lending standards. As inflation comes down and with lending standards tight, we view this as a positive for asset backed securities, and our colleagues view it as a positive for their coverage of consumer finance equities.Michael Zezas: Heather, this has been really insightful. Thanks for taking the time to talk.Heather Berger: Great speaking with you, Michael.Michael Zezas: And thanks for listening. If you enjoy thoughts on the market, please be sure to rate and review us on the Apple podcast app or wherever you listen. It helps more people find the show.

27 Mars 20244min

As investors look for clues on market durability, our Chief U.S. Equity Strategist highlights which sectors could show more widely distributed gains in the near term.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about an opportunity for energy stocks to keep working in the near term.It's Tuesday, March 26th at 9:30 am in New York. So let’s get after it.Over the past five months, global stocks are up about 25 percent while many other asset prices were up double digits or more. What’s driving this appreciation? Many factors are at work. But for stock indices, it’s been mostly about easier financial conditions and higher valuations rather than improving fundamentals. Granted, higher asset prices often beget even higher prices – as investors feel compelled to participate. From our perspective, it’s hard to justify the higher index level valuations based on fundamentals alone, given that 2024 and 2025 earnings forecasts have barely budged over this time period. We rolled out our “Boom-Bust” thesis in 2020 based on the shift to fiscally dominant policy in response to the pandemic. At that point, our positive view on stocks was based on the boom in earnings that we expected over the 2020-2021 period as the economy roared back from pandemic lows. Our outlook anticipated both accelerating top line growth and massive operating leverage as companies could reduce headcount and other costs while people were locked down at home. The result was the fastest earnings growth in 30 years and record high margins and profitability. In other words, the boom in stocks was justified by the earnings boom that followed. Stock valuations were also supported by arguably the most generous monetary policy in history. The Fed continued Quantitative Easing throughout 2021, a year when S&P earnings grew 48 percent to an all-time high.Today, stock valuations have reached similarly high levels achieved back in 2020 and [20]21 – in anticipation of improving growth after the earnings deterioration most companies saw last year. While the recent easing of financial conditions may foreshadow such an acceleration in earnings, bottom-up expectations for 2024 and [20]25 S&P 500 earnings remain flat post the Fed’s fourth quarter dovish shift. Meanwhile, small cap earnings estimates are down 10 percent and 7 percent for 2024 and [20]25, respectively since October. We think one reason for the muted earnings revisions since last fall, particularly in small caps, is the continued policy mix of heavy fiscal stimulus and tight front-end interest rates. We see this crowding out many companies and consumers. The question for investors at this stage is whether the market can finally broaden out in a more sustainable fashion. As we noted last week, we are starting to see breadth improve for several sectors. Looking forward, we believe a durable broadening comes down to whether other stocks and sectors can deliver on earnings growth. One sector showing strong breadth is Industrials, a classic late-cycle winner and a beneficiary of the major fiscal outlays for things like the Inflation Reduction and CHIPS Act, as well as the AI-driven data center buildout. A new sector displaying strong breadth is Energy, the best performer month-to-date but still lagging considerably since the October rally began. Taking the Fed’s recent messaging that they are less concerned about inflation or loosening financial conditions, commodity-oriented cyclicals and Energy in particular could be due for a catch-up. The sector’s relative performance versus the S&P 500 has lagged crude oil prices, and valuation still looks compelling. Relative earnings revisions appear to be inflecting as well. Some listeners may be surprised that Energy has contributed more to the change in S&P 500 earnings since the pandemic than any other sector. Yet it remains one of the cheapest and most under-owned areas of the market. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We’d love to hear from you.

26 Mars 20244min

Morgan Stanley’s Chief Fixed Income Strategist explains why private credit markets have expanded rapidly in recent years, and how they may fare if public credit makes an expected comeback.----- 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 implications of the rapid growth in private credit for the broader credit markets. It’s Monday, March 25th at 12 noon in New York.The evolution of private credit is reshaping the landscape of leveraged finance. Investors of all stripes and all around the world are taking notice. The rapid expansion of private credit in the last few years has come against a much different backdrop in the public credit markets – a contraction in the high yield bond market and lackluster growth in the broadly syndicated loan market. What the emergence of private credit means for the public credit and the broader credit markets is a topic of active debate.Just to be clear, let me define what we mean by private credit. Private credit is debt extended to corporate borrowers on a bilateral basis or involving very small number of lenders, typically non-banks. Lenders originate and negotiate terms directly with borrowers without the syndication process that is the norm in public markets for both bonds and loans. These private credit loans are typically not publicly rated; they’re not typically traded in secondary markets; tend to have stronger lender protections and offer a spread premium to public markets.Given the higher overall borrowing costs as well the need to provide stronger covenant protection to lenders, what motivates borrowers to tap private credit versus public credit? Three key factors explain the recent rapid growth in private credit and show how private credit both competes and complements the public credit markets.First, small and medium-sized companies that used to rely on banks had to find alternative sources of credit as banks curtailed lending in response to regulatory capital pressures. A majority of these borrowers have very limited access to syndicated bond and loan markets, given their modest size of borrowings.Second, because of the small number of lenders per deal – frequently just one – private credit offers both speed and certainty of execution along with flexibility of term. The last two years of monetary policy tightening has meant that there was a lot of uncertainty around how high policy rates would go and how long they will stay elevated – which has led investors to pull back. The speed and certainty of private credit ended up taking market share from public markets against this background, given this uncertainty in the public markets.Third, the pressure on interest coverage ratios from higher rates resulted in a substantial pick-up in rating agency downgrades into the B- and CCC rating categories. At these distressed ratings levels, public markets are not very active, and private credit became the only viable source of financing.Where do we go from here? With confidence growing that policy tightening is behind us and the next Fed move will be a cut, the conditions that contributed to deal execution uncertainty are certainly fading. Public markets, both broadly syndicated loan and high yield bond markets, are showing signs of strong revival. The competitive advantage of execution certainty that private credit lenders were offering has become somewhat less material. Further, given the amount of capital raised for private credit that is waiting to be deployed – the so-called dry powder – the spread premium in private credit may also need to come down to be competitive with the public markets.So private credit is both a competitor and a complement to the public markets. Its competitive attractiveness will ebb and flow, but we expect its complementary benefit as an avenue for credit where public markets are challenged to remain as well as grow.Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts or wherever you get this podcast – and share Thoughts on the Market with a friend or colleague today.

25 Mars 20244min

Our Head of Corporate Credit notes that while recent central bank meetings offered few surprises, there was still plenty to be gleaned that could affect credit valuations. ----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about this week’s central bank meetings, and why as expected outcomes can still mean new information for credit investors.It's Friday, March 22nd at 2pm in London.When a good friend was interviewing at Morgan Stanley, many years ago, he was asked a version of the ‘Monty Hall Problem.’ Imagine that you’re on a game show with a prize behind one of three doors. You make your guess of door 1, 2 or 3. And then the host opens one of the doors you didn’t pick, showing that it’s empty. Should you change your original guess?While it’s a bit of a paradox, you should. Your original odds of finding the prize were 1-in-3. But by showing you a door with a wrong answer, the odds have improved. The host gave you new information. And that’s what came to mind this week, after important meetings from the Federal Reserve and Bank of Japan. Both banks acted in-line with our economists’ expectations. But those meetings and what came after still provided some valuable new information. Information that, in our view, was helpful to credit.On Tuesday, the Bank of Japan raised interest rates for the first time since 2016, ended Yield Curve Control, and ended its purchases of equities. All of these measures had been previously used to help boost too-low inflation. But they have also resulted in a significant weakening of Japan’s currency, the Yen. And that, in turn, had made it attractive for Japanese investors to invest in overseas bonds in other currencies – which were gaining value as the Yen weakened.So, one risk heading into this week was that these big changes in the Bank of Japan would reverse these other trends. It would strengthen the currency and make buying corporate bonds from the US or Europe less attractive to Japanese investors. But this meeting has now come and gone, and the Yen saw little movement. That is helpful, new information. Before Tuesday, it was impossible to know how the currency would react.Then on Wednesday, the Fed confirmed its expectation from December that it was planning to cut interest rates three times this year. On the surface, that was another ‘as expected’ outcome. But it still contained new information. The Fed’s forecast suggested more confidence that stronger 2024 growth wouldn’t lead to higher inflation. And that endorsed the idea that the productive capacity of the US economy is improving. Solid growth and lower inflation co-existing, thanks to better productivity, will be closer to a 1990s style outcome. And that was a pretty good scenario for credit.This week’s central bank meetings have come and gone without big surprises. But sometimes ‘as expected’ can still deliver new information. We continue to expect credit valuations to hold at richer-than-average levels, and like US leveraged loans, as a high yielding market well-suited for a mid-90s scenario.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.

22 Mars 20243min

The perspective from our recent European Financials Conference looked positive for UK markets, loan demand and M&A activity. Our European heads of Diversified Financials and Banks Research discuss.----- Transcript -----Bruce Hamilton: Welcome to thoughts on the Market. I'm Bruce Hamilton, head of European Diversified Financials Research.Alvaro Serrano: And I'm Alvaro Serrano, head of European Banks Research.Bruce Hamilton: And on this episode of the podcast, we'll discuss some of the key takeaways from Morgan Stanley's just concluded 20th European Financials Conference. It's Thursday, March 21st at 3 pm in London.Alvaro, we were both at the European Financials Conference in London. More than 100 companies attended the event. 95 percent of the attendees were from CE level management. There was a lot to take in.Investor sentiment heading into the conference seemed noticeably more upbeat than last year's, thanks in part to stronger-for-longer net interest income (NII), an M&A cycle that is heating up, attractive capital returns, and increasing activity in private markets.Now you were the conference chair, Alvaro. And you have a unique overview of this event. What's, in your view, the single most important takeaway?Alvaro Serrano: Thanks, Bruce. Look, I think for me that if I had to summarize in two words is ‘risk on.’ I think the tone of the conference has been positive almost across the board. The lower rate outlook has increased market confidence. And corporates were pointing that out. They've seen stronger activity, so far this year, in many product lines. They've called out loan demand being stronger. They've called out debt capital market activity being stronger. They've announced M&A -- we know is up strongly and asset management inflows are up strong as well. So yes, a strong start to the year - confidence is back, and I would summarize it as risk on.Bruce Hamilton: Got it. And in terms of the other key themes and debates that emerged from company presentations at the conference.Alvaro Serrano: Yeah, look, I think the main themes following up from what I was saying earlier are: First of all, I would say leadership change. Within the sector, we've been calling for leadership change in our outlook. And I think what we heard at the conference supports this. So, given market activities coming back, I think a lot of investors were more keen to look for more resilient revenue models; maybe less peripheral banks, less NII retail-centric banks. And looking for more fee growth that could benefit from that market recovery.The second point I would point out is UK. There’s definitely a change in sentiment around the UK in the polling questions. It came out as a preferred region, and I think what's behind that preference is that we're seeing an inflection point in NII.And I think the third and final theme for me is investment banking and wealth recovery. Look, wealth may not recover already in Q1. But as this confidence builds up, we definitely expect inflows to pick up in the second half, both in quantity and margin.Bruce Hamilton: So, based on your own work and what you heard at the conference, what's your overall view on the financial sector and what drives that from here?Alvaro Serrano: We continue positive the sector. Look, the valuation is depressed. The multiples, the PE multiples on six times. Historically, it's been much closer to double-digit. We think, recovering PMIs should help re-rate that multiple. And while we do wait for those PMIs to recover, you're being paid 11 per cent yield between dividends and buybacks.I think the confidence build up that we're seeing in the tone of the conference suggests an early indicator of those PMIs recovering, if you ask me. And then in the panels, we've had plenty of discussions around asset quality. Obviously, commercial real estate exposure is a big theme. But we think it's a manageable problem. It's less than 5 per cent of the loan books, within that office is less than a third. And within that US office spaces is a fraction. So overall, we think it's a manageable problem and our highest single conviction in the sectors that the yields are sustainable and resilient.So, with a strong valuation underpin, we continue, positive of the sector.Bruce, why don't I turn it over to you? Given your focus on private markets, exchanges, and asset management sub-sectors within diversified financials, can you talk us through private markets and deal activity space?Bruce Hamilton: Yeah, our fireside chats with panels, and with private market management teams, saw more optimistic commentary on capital markets activity. And similarly fundraising improvements are expected to be closely linked to cash flows from exit activity flowing back to institutional clients, who can then reallocate to new funds.So there's a little delay. But overall, the direction of travel clearly feels positive and pointed to a reacceleration in the private markets’ flywheel in due course, which has been, of course, the rationale behind the more positive view we have taken on this subsector since our outlook piece in November last year.Alvaro Serrano: AI is obviously a dominant theme across sectors and industries globally. Also, by the way, a frequent topic in the discussion of this podcast. Can you give us an update on AI and its implications for wealth and asset management?Bruce Hamilton: Sure. I mean, our discussions with asset management CEOs highlighted the transformative potential of AI, as they see it as a source of significant efficiency potential across the value chain. From sales and marketing, through investments and research, to middle and back office -- in areas such as report writing, research synthesis and client servicing. The benefits of starting early, with leaders having been working on this for 12 months or more, seems clear given the need to manage risks, for example, ensuring data quality to avoid hallucinations.One asset management CEO indicated that his firm had identified 85 use cases, with 35 already in production. The initial opportunities for asset managers were seen as principally in driving cost efficiencies; though in wealth management a greater revenue potential we think exists given the scope to improve the effectiveness of wealth advisors in targeting and servicing clients.Exchanges also noted scope for AI to both support revenue momentum. For example, via chatbots, assisting clients in accessing data more effectively. And in driving efficiency in report writing, as well as in costs. So, think about scope to drive efficiencies in areas such as client servicing and data ingestion and organization where large language models (LLMs) are already driving efficiency gains for employees.Alvaro Serrano: Finally, let's talk about private credit, another big theme. What did you hear, at the conference around the growth of private credit? And what's your outlook from here?Bruce Hamilton: Sure. So, the players were positive on the potential for growth in private credit from here. In the near-term deployment opportunities probably look stronger in the private credit space relative to private equity, where some differences in buyer-seller expectations is still acting as a bit of a constraint. There are opportunities given bank retrenchments, even if the Basel III endgame is expected to be less negative than initial draft proposals. And the appetite from insurance -- institutional, as well as retail clients for the diversification benefits and attractive yields on offer -- remains pretty significant.Both private market specialists and traditional asset managers continue to explore ways to extend their capabilities in the space, with some adopting an organic approach and others looking to accelerate scaling via M&A.We expect that as we look forward, that some recovery in the bank's syndicated lending markets is likely to reduce the record market share enjoyed by private credit in private equity deals last year. However, we think a more vibrant overall deal environment is likely to drive opportunities for both bank syndicated and private credit looking forward.The democratization theme with wealth clients increasing allocations to private markets remains an additional powerful growth theme as we look forward; both for private credit providers, as well as players active in private equity infrastructure and real estate.I'm sure there'll be lots more to unpack from the conference in the near future. Let's wrap it up for this episode. Alvaro, thanks a lot for taking the time to talk.Alvaro Serrano: Great speaking with you, Bruce.Bruce Hamilton: 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.

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