Europe in the Global AI Race

While Japan's equities have continued to rally, a roster of sector leading companies and a weak Yen could signal this bullish story is only just beginning.----- Transcript -----Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Market Equity Strategist at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be sharing why Japan Equities could be a key part of the bullish story in Asia this year. It's Thursday, May the 25th at 10 a.m. in New York. Japan equities have rallied substantially during the current earnings season and we think further gains are increasingly likely. The theme of return on equity improvement, driven by productive CapEx and better balance sheet management, is clearly finding traction with a wide group of international investors. We first introduced this theme in our 2018 Blue Paper on Japan, where we described a journey from laggard to leader, which we felt was starting to take place due to a confluence of structural reforms such as the Corporate Governance Code and Institutional Investor Stewardship Code, as well as changes in company board composition and outside activist investor pressure. Japan has a formidable roster of world class firms, which we have identified as productivity and innovation leaders in areas such as semiconductor equipment, optical, healthcare, medtech, robotics and traditional heavy industrial automotive, agricultural and commodities trading, specialty chemicals. As well as more recent additions in Internet and E-commerce, many of which sell products far beyond Japan's borders. For the market overall, listed equities ROE has more than doubled in the last ten years, and it's now set to approach our medium term target of 11 to 12% by 2025. Company buybacks are analyzing at a record pace and total shareholder return, that is the sum of dividends and buybacks, is running at 3.6% of market capitalization. Yet Japan equities are still trading on only around 13 times forward price to earnings. And Japanese firms have a low cost of capital, given the country's status as a high income sovereign, with membership of the G7, as highlighted by Premier Kishida hosting its recent summit in his home town of Hiroshima. An additional near-term catalyst for Japan equities is that the yen is tracking significantly weaker year to date at around 135 to the U.S. dollar than company modeling, which was for around 125. Given the export earnings skew of the market, this is a positive.All in all, Japan equities are set, we think, to more than hold their own versus global peers and be a key part of a bullish story in Asian equities this year. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts and recommend Thoughts on the Market to a friend or colleague today.

25 Maj 20232min

Discussions at the recent Group of Seven Nations meeting point to the continued development of a multipolar world, as supply chains become less global and more local. Investors should watch for opportunities in this disruption.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the recent G7 meetings and its implications for markets. It's Wednesday, May 24th at 9 a.m. in New York. Over the weekend, President Biden traveled to Japan for a meeting of the Group of Seven Nations, or G7. G7 meetings typically involve countries discussing and seeking consensus on a wide range of economic and geopolitical issues. And the consensus they achieved on several principles underscores one of our big three secular investment themes for 2023, the transition to a multipolar world. Consider some of the following language from the G7 communique. First, there's discussion of efforts to make our supply chains more resilient, sustainable and reliable. Second, they discuss, quote, "Preventing the cutting edge technologies we develop from being used to further military capabilities that threaten international peace and security." Finally, there's also discussion of the, quote, "importance of cooperation on export controls, on critical and emerging technologies to address the misuse of such technologies by malicious actors and inappropriate transfers of such technologies."So that all may sound like the U.S. is drawing up hard barriers to commerce, particularly with places like China. But importantly, the communique also states an important nuance that's been core to our multipolar world thesis. They say, quote, "We are not decoupling or turning inwards. At the same time, we recognize that economic resilience requires de-risking and diversifying.". So to understand the practical implications of that nuance, we've been conducting a ton of research across different industries. My colleagues Ben Uglow and Shawn Kim have highlighted that the global manufacturing and tech sectors are very exposed to disruption from this theme. But their work also shows that capital equipment and automation companies will benefit from the global spend to set up more robust supply chains.So bottom line, the multipolar world theme continues to progress, but the disruption it creates should also create opportunities. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

24 Maj 20232min

As the confidence level of homebuilders building new homes is increasing, will home sales go along with it? Jim Egan and Jay Bacow, Co-Heads of U.S. Securitized Products Research discuss.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-Head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-Head of U.S. Securitized Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing the U.S. housing and mortgage markets. It's Tuesday, May 23rd at 2 p.m. in New York. Jay Bacow: It's been a while since we talked about the state of the U.S. housing market. And it seems like if I look at least some portions of the data, things are getting better. In particular, the NAHB confidence just showed for the fifth consecutive month that homebuilders are feeling better about building a house, and we're now finally at the point where they say it is a good time to build a house. When you take a step back and just look at the state of the housing market, do you agree? Jim Egan: I think it's a great question. Housing statistics are going in a whole number of different directions right now. So, yeah, let me take a step back. We've talked a lot about affordability on this podcast and it's still challenging. We've talked a lot about supply and it remains very tight, and all of this has really fueled that bifurcation narrative that we've talked about, protected home prices, weaker activity. But if we think about how the lock in effect and that's the fact that all of these current homeowners who have mortgages well below the prevailing mortgage rate just are not going to be incentivized to list their home for sale, then kind of a logical next step from a housing statistics perspective is that new home sales are probably going to increase as a percentage of total home sales. And that's exactly what we're seeing, new home sales in the first quarter of this year, they were roughly 20% of the total single unit sales volumes. That's the largest share of transactions in any quarter since 2006. And this dynamic was actually quoted by the National Association of Homebuilders when describing the increase in homebuilder confidence that you quoted Jay. Jay Bacow: Okay, but when I think about that percentage, aren't building volumes in aggregate coming down? Jim Egan: They are, though, as a caveat, I would say that if we look at that seasonally adjusted annualized rate, it did increase sequentially a little bit, month-over-month in April. What I would point to here is that from the peak in single unit housing starts, and we think the peak in the cycle was April of 2022, those starts are down 22%. Now, that's finally started to make a dent in the backlog of homes under construction. Now, as a reminder, again, this is something we've talked about here, there are a number of factors from supply chain issues to labor shortages, that we're really serving to elongate, build timelines in the months and years after the onset of COVID. And all of those things caused a real backlog in the number of homes under construction, so homes were getting started, but they weren't really getting finished. We see the number of single unit homes under construction is now down 130,000 units from that peak. Now, don't get me wrong, that number is still elevated versus where we'd expected to be, given the sheer number of housing starts that we've seen over the past year. But this is a first step towards turning more positive on housing starts. And again, homebuilder confidence Jay, as you said, it's climbed higher every single month this year. Jay Bacow: Okay, but you said this is a first step in turning more positive on housing starts. We get the start, we get the unit under construction, we get a completion and then eventually we get a home sale, so what does this mean for sales volumes? Jim Egan: We would think that it's probably likely for new home sales to continue making up a larger than normal share of monthly volumes, but we don't think that sales are about to really inflect materially higher here. Purchase applications so far in May, they're still down 26% year-over-year versus the same month in 2022. Now, that's the best year-over-year number since August of last year, but it's not exactly something that screams sales are about to inflect higher. Similarly, pending home sales just printed their weakest March in the history of the index, and it's the sixth consecutive month that they've printed their weakest month in index history. So it was their weakest February, their weakest January, and so on and so forth, so we think all of this is kind of emblematic of a housing market, specifically housing sales that are finding a bottom, but not necessarily about to move much higher. Jay Bacow: Okay. Now, Jim, in the past, when you've talked about your outlook for home prices, you mentioned your four pillars. There is supply, demand, affordability and credit availability. We've talked about the first three of these, we haven't really talked about credit availability yet. Jim Egan: Right. And that's another one of the reasons why we don't necessarily see a real move higher in sales volumes because of the whole new regime for bank assets that we've talked about a lot. Jay, you've talked about how much it's going to impact things like the mortgage market, so what do we mean when we talk about a new regime for bank assets? Jay Bacow: Fundamentally, when you think about the business model of a bank, if you're going to simplify it, it's they get deposits in and then they either make loans or buy securities with those deposits and they try to match up their assets to liabilities. Now, in a world where there's a lot more deposit outflows and happening more frequently, banks are going to have to have shorter assets to match that. And as they have shorter assets, that means they're going to have tighter lending conditions, and that tighter lending conditions is presumably going to play into the credit availability that you're looking for in your space. Jim Egan: And when we combine that with affordability that's no longer deteriorating, but still challenged, supply that's no longer setting record lows each month, but still very tight. All of that is a world in which we don't think you're going to see significant increases in transaction volumes. I will say one thing on the home price front month-over-month increases are back. We've seen some seasonality from a home price perspective, but we still think that that year over year number is going to soften going forward. It remains positive in the cycle, but we think it will turn negative in the next few months for the first time since the first quarter of 2012. We don't think those year-over-year drops will be too substantial. Our base case forecast for the end of the year is down 4%, we think it will be a little bit stronger than that down 4% number, but we think it will be negative. Jay Bacow: Okay. But I like things to be a little bit stronger. And with that, Jim, always great talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app and share the podcast with a friend or colleague today.

23 Maj 20236min

Though the current market narrative has turned bullish, it may not withstand a downturn in earnings.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, May 22nd at 11a.m in New York. So let's get after it. For the past six months, the S&P 500 has been trading in a narrow range with strong rotations under the surface. When we turned tactically bullish on the index last October at 3500, we did so because the price had reached an attractive level and we believed rates and the dollar were topping. When we exited that trade at 4100 in early December, the price was no longer attractive, given our view that 2023 earnings estimates were materially too high. Fast forward to today and the index is showing some signs that it wants to break higher, even though our concerns remain. The primary difference from the early December highs is that we now have dramatically different leadership. Back then the leaders were energy, materials, financials and industrials, while technology was the big laggard. Small caps were also doing much better and market breadth was strong. The bullish narrative centered around China's reopening, which would put a floor in for global growth. Today, breadth is very weak. Technology, communication services and consumer discretionary are the only sectors up on the year, and even those sectors are exhibiting narrow breadth. Yet investors are more bullish than in early December, or at least far less bearish. The bullish narrative today focuses on technology, specifically on artificial intelligence. While we believe artificial intelligence is for real and will likely lead to some great efficiency to help fight inflation, it's unlikely to prevent the deep earnings recession we forecast for this year. Last week's price action showed frenzied buying by investors who cannot afford to miss the next bull market. We believe this will prove to be a head fake, like last summer for many reasons. First, valuations are not attractive, and it's not just the top ten or 20 stocks that are expensive. The median price earnings multiple is 18 times, which is near the top decile the past 20 years. Second, a very healthy reacceleration is baked in the second half consensus earnings estimates. This flies directly in the face of our forecasts, which continue to point materially lower. We remain highly confident in our model, given how accurate it's been over time and recently. We first started talking about the oncoming earnings recession a year ago and received very strong pushback, just like today. However, our model proved to be quite prescient based on the results and is now projecting 20% lower estimates than consensus, for 2023. Third, the markets are pricing in 2 to 3 Fed cuts before year end without any material implications for growth. We think such an outcome is very unlikely. Instead, we think the Fed will only cut rates if we definitively enter into a recession or if credit markets deteriorate significantly.

22 Maj 20234min

While the U.S. economy looks to be on track for a soft landing in 2023, even the smallest of setbacks could spell trouble for the end of the year.----- Transcript -----Welcome to Thoughts on the Market. I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Along with my colleagues bringing you a variety of perspectives, today I'll discuss our view around the soft landing for the U.S. economy. It's Friday, May 19th, at 10 a.m. in New York. Last year, we presented our outlook that 2023 would see a soft landing for the U.S. economy. This out of consensus view continues to be our base case expectation. And we looked at several key data points as evidence to support it, including the U.S. housing cycle, income and spending dynamics, the labor market and inflation. To start, economists have long said, "As goes housing, so goes the business cycle." And housing is a very important factor in our outlook for a soft landing. While the decline in housing activity has been record breaking from a national perspective, Morgan Stanley's housing strategists believe the cycle is bottoming. In our forecast, the big drag on economic growth from the housing correction should turn neutral by the third quarter of 2023, providing some cushion against the growth slowdown elsewhere. Second, the incoming data on U.S. income and consumer spending also support our expectation that the economy is slowing but not falling off a cliff. On the one hand, discretionary consumer spending is softening. On the other hand, income is the predominant driver of consumer spending, and even as wage growth continues to slow, our forecasted path for inflation suggests that real wages will finally turn positive in the middle of this year. Third, we look to labor market dynamics, and the April U.S. employment report provides ample evidence that the labor market is slowing but is also not headed for a cliff. The steady decline in job postings with still low unemployment rates since the middle of last year supports our soft landing view. And finally, we closely monitor inflation. The most recent April data suggests that core inflation continues to slowly recede, tracking in line with our forecasts, as well as the Fed's March projections. We think the incoming data continue to support a Fed pause at the June meeting, and after June we can see a wide range of potential outcomes for the policy rate. We expect a gradual slowing in core inflation that keeps the Fed on hold until March 2024, when it begins to normalize policy with quarter percent rate cuts every three months. To be sure, the possibility of a recession remains a concern this year amid banking pressures with unknown spillovers to the economy from tighter credit. Should credit growth slow more than expected, it would bring larger spillovers to investment, consumption and labor. Against this backdrop, we expect the U.S. economy to experience a sharp slowdown in the middle two quarters of the year, so even small hiccups could push us into a recession. We'll continue to keep you abreast of any new developments. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

19 Maj 20232min

Although markets remain calm for now, incoming developments across the debt ceiling, inflation and monetary policy could quite quickly turn the tide.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, May 18th at 2 p.m. in London. A notable aspect of the current market is its serenity. Over the last 30 days, U.S. stocks have seen the least day-to-day volatility since December of 2021. It's a similar story for stocks in Europe or the movement of major currencies. Across key markets, things have been calm and investors have become more relaxed, with expectations of future volatility also in decline. But why is this happening? After all, major uncertainties around the path of inflation and central bank policy still exist. And the United States, the world's largest economy and most important borrower, still hasn't reached an agreement to keep borrowing by raising the debt ceiling, raising the risk, according to the U.S. Treasury secretary, of running out of money in less than a month. Well, we think a few things are going on. With the debt ceiling, we think this is a great example that real world investors genuinely struggle with pricing a binary, uncertain outcome. It's very challenging to put precise odds on what is ultimately a political decision and hard to quantify its impact. And further complicating matters, the conventional wisdom generally appears to be that any debt ceiling deal would only get done at the last possible moment. In short, investors are struggling, making big changes to their portfolio in the face of what is little better than a political guess and are finding it easier to wait, and hoping that more clarity emerges. I’d note we saw something very similar before the near-miss on the debt ceiling in 2011. Despite being extremely aware of the deadline back then, stocks moved sideways until the last possible moment in August of 2011, afraid of leaning too heavily in one direction before the event. Other factors are also in limbo. We're nearing the end of what was a reasonably solid first quarter earnings season and don't see larger disappointments arriving, potentially, until later in the year. And on our forecasts, the Federal Reserve just made its last rate hike of the cycle and is now on hold for the remainder of 2023. And volatility does have the tendency to be self-reinforcing. Low volatility often begets low volatility, and in turn drags down expectations of what future movements will look like. But importantly, this doesn't represent some form of clairvoyance, expectations about future levels of market volatility often deviate from what actually happens, in both directions. For now, markets remain calm. But don't assume that means investors have some special insight around the debt ceiling, inflation or monetary policy. Incoming developments across all of these areas can change the picture rather quickly. 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.

18 Maj 20233min

According to the Federal Reserve’s latest Senior Loan Officer Opinion Survey, small businesses may be the most vulnerable to banks tightening their lending standards.----- 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 takeaways from the Senior Loan Officer Opinion Survey. It's Wednesday, May 17th at 10 a.m. in New York. We've talked a lot about the effects of the turmoil in the regional banks on credit formation, on this podcast. We thought the ongoing liquidity pressures in the regional banking sector may lead to tighter lending standards, which will eventually translate into lower credit formation. The Senior Loan Officer Opinion Survey, conducted quarterly by the Federal Reserve, provides a window on bank lending practices, including the standards and terms for banks to make loans, as well as the demand for bank loans to businesses and households. The survey results published last week, reflect conditions during the first quarter of 2023 and provide a first glimpse on the effect of the regional banking turmoil on banks outlook for lending over the remainder of 2023. The survey showed that banks expect to tighten standards across all loan categories. Banks cited an expected deterioration in the credit quality of their loan portfolios, customer collateral values, a reduction in risk tolerance, concerns about bank funding costs, banks liquidity position and deposit outflows, as reasons for expecting to tighten lending standards over the rest of 2023. While standards for commercial and industrial, the so-called C&I loans, tightened only marginally, the demand for C&I loans fell to levels not seen since the great financial crisis. Even though lending standards only tightened marginally, the tightening came from some loan officers tightening standards considerably. Further, banks reported changes to their modalities of their lending quite substantially. For example, the spread on loans or their cost of funding broke above the pandemic period and entered levels last seen during the great financial crisis. Loan officers also changed credit lines to small businesses drastically, especially regarding the size and cost. They reduced the maximum size and maturity of credit lines, as well as increased collateral requirements and the cost of credit lines. For small businesses in the U.S., such credit tightening comes at a very difficult time. Small business optimism and the outlook for business conditions already deteriorated significantly over the past year, and small businesses acknowledge that the environment isn't conducive for expansion or CapEx. Why does this matter? As small businesses have continued to lower expectations of sales, there were also moderated plans to raise prices in the near term. We see this dynamic raising the risks of downside surprises to upcoming inflation data. Also worth noting that fewer small businesses describe inflation as their number one concern, in fact, more describe interest rates as the number one concern. One of the special questions in this quarter's survey pertained to commercial real estate, so-called CRE. Banks tightened lending standards across all categories of CRE loans. Action cited included, widening loan spreads, reducing loan to value, raising debt service covers ratios and reducing maximum loan sizes. These survey results are consistent with what we had been predicting. Volatility in the regional banking sector has resulted in lower credit formation, due to both lingering liquidity stress and regulatory changes to come. The former is already playing out and the latter is likely to weigh on economic growth over the long term. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

17 Maj 20233min

As investors attempt to find opportunities in an uncertain stock market, earnings disappointments and an ongoing debt ceiling debate loom overhead.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Tuesday, May 16th, at 1 p.m. in New York. So let's get after it. Having spent the last few weeks on the road engaging with clients from around the world, I figured it would be useful to share some thoughts from our meetings and to touch on the most often asked questions, concerns and pushback to our views. First, conviction levels are low, given broadly elevated valuations and a challenging macro backdrop. While many individual longs and shorts have worked well in the context of a buoyant S&P 500, the most favorite trades have largely played out and clients are having trouble finding the next opportunity. Small cap and low quality stocks have underperformed and we continue to see crowding into mega-cap tech and consumer staples stocks as safe havens in a deteriorating growth environment.Second, there isn't much interest in the S&P 500 as either a long or a short anymore. Most clients we speak with have given up on the idea of a big breakdown of the index level. Conversely, there are few who think the S&P 500 can trade much above 4200, which has proven to be a key resistance since the October lows. What has changed is that the floor has been raised, with the large majority of investors thinking 3800 is now unlikely to be broken to the downside. In short, the consensus believes the bear market ended in October, at least for the high quality S&P 500 and NASDAQ. Third, there is little appetite to dive back into the areas of the market that have significantly underperformed like regional banks, small caps and energy. Other deep cyclicals are also out of favor due to either extended valuation and high earnings expectations In the case of industrials, and recession risk in the case of materials. Instead, most clients we spoke with remained comfortably long, large cap tech stocks, especially given the group's recent outperformance. While consumer staples and other defensives have outperformed strongly since March, there's less confidence this outperformance can continue. Our take remains the same. The market is speaking loudly under the surface, with its classic late cycle leadership and extreme narrowness, it is bracing for further macro and earnings disappointments. However, it is not yet pricing these outcomes at the index level. Such is the typical pattern exhibited by equity markets until clearer evidence of an economic recession arrives, or the risks of one are fully extinguished. With our economist forecasting close to 0% growth this year for real GDP and just modest growth next year, valuations at full levels and several other risks in front of us, we suspect 4200 will hold to the upside as most clients suggest. However, we continue to hold a more bearish tactical view than most clients in terms of the downside risk given our earnings forecast. The majority of our fundamental debate with clients has been over earnings. More specifically, there is broad pushback to our view that margins have not yet bottomed. In addition, many clients do not think revenue growth can fall towards zero or go negative given the still elevated inflation across the economy. Our take is that while many companies have taken decisive cost action, including layoffs, they have not yet cut cost nearly enough for a zero-to-negative revenue growth backdrop. But the odds of such an outcome increasing, in our view, we find it notable that many investors are more sanguine today on the earnings backdrop than they were five months ago. Meanwhile, many clients are worried about the debt ceiling. Most believe it will get resolved, but not without some near-term volatility. However, the discussion has evolved, with many clients framing this event as a lose-lose for markets. Assuming the debt ceiling is not resolved before the Treasury runs out of money, market volatility is likely to pick up meaningfully. Conversely, if the debt ceiling is lifted before the Treasury runs out of money, it will likely come with some concessions on the spending front, which could be a headwind for growth. Secondarily, such an outcome will lead to significant, pent up issuance from the Treasury to pay its bills and rebuild its reserves. This issuance from Treasury, could approach $1 trillion in the six months immediately after the ceiling is lifted, and potentially present a materially tightening to liquidity that could tip the S&P 500 back to the downside. To summarize, clients are less bearish on earnings than we are, although most are still fundamentally cautious on growth in the economic backdrop. Given the resilience in the large cap indices and leadership from perennially favored companies this year, many investors are now convicted that the equity market can look through a mild economic or earnings recession at this point. We think this is a very challenging tactical setup should growth or liquidity deteriorate as we expect over the next few weeks and months. We maintain our well below consensus earnings estimates for this year and believe narrow breadth and defensive leadership support our view that this bear market is yet to be completed, especially at the index level. Defensively oriented companies with a focus on operational efficiency should continue to outperform, especially if they exhibit true pricing power. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate the review us on the Apple Podcasts app. It helps more people to find the show.

16 Maj 20234min