Europe in the Global AI Race

As the advancement of generative AI takes off, how might this inflection point in technology impact markets, companies, and investors alike? Equity Analyst and Head of U.S. Internet Research Brian Nowak and Head of the U.S. Software Research Team Keith Weiss discuss.----- Transcript -----Brian Nowak: Welcome to Thoughts on the Market. I'm Brian Nowak, Equity Analyst and Head of U.S. Internet Research for Morgan Stanley. Keith Weiss: And I'm Keith Weiss, Head of the U.S. Software Research Team. Brian Nowak: Today, we're at Morgan Stanley's annual Tech, Media, and Telecom conference in downtown San Francisco. We've been here most of the week talking with industry leaders and emerging companies across the spectrum, and the topic on everyone's mind is clearly A.I. So today, we're going to share some of what we're hearing and our views on the rise of artificial intelligence tools. It's Thursday, March 9th at 2 p.m. here on the West Coast. Brian Nowak: All week, Keith and I have been meeting with companies and speaking with new companies that are developing technologies in artificial intelligence. We've written research about how we think that artificial intelligence is reaching somewhat of an iPhone inflection moment with new people using new tools, and businesses starting to realize artificial intelligence is here to stay and can drive real change. Keith, talk to us about how we reached this moment of inflection and how do you think about some of the big picture changes across technology? Keith Weiss: Well, thank you for having me, Brian. So we've been talking about artificial intelligence for some time now. Software companies have been infusing their solutions with machine learning driven type algorithms that optimize outcomes for quite some time. But I do think the iPhone analogy is apt, for two reasons. One, what we're talking about today with generative AI is more foundational technologies. You can almost think about that as the operating system on the mobile phone like the iOS operating system. And what we've heard all week long is companies are really seeing opportunity to create new apps on top of that operating system, new use cases for this generative AI. The other reason why this is such an apt analogy is, like the iPhone, this is really capturing the imagination of not just technology executives, not just investors like you and I, but everyday people. This is something that our kids are coming home from high school and saying, "Hey, dad, look at what I'm able to do or with chatGPT, isn't this incredible?" So you have that marketing moment of everybody realizes that this new capability, this new powerful technology is really available to everybody. Keith Weiss: So, Brian, what do you think are going to be the impacts of this technology on the consumer internet companies that you cover? Brian Nowak: We expect significant change. There is approximately $6 trillion of U.S. consumer expenditure that we think is going to be addressed by change. We see changes across search. We see more personalized search, more complete search. We see increasing uses of chatbots that can drive more accurate, personalized and complete answers in a faster manner across all types of categories. Think about improved e-commerce search helping you find products you would like to buy faster. Think about travel itinerary AI chatbots that create entire travel itineraries for your family. We see the capability for social media to change, better rank ordering and algorithms that determine what paid and organic content to show people at each moment. We see new creator tools, generative AI is going to enable people to make not only static images but more video based images across the entire economy. So people will be able to express themselves in more ways across social media, which will drive more engagement and ultimately more monetization for those social media platforms. We see e-commerce companies being able to better match inventory to people. Long tail inventory that previously perhaps could not find the right person or the right potential buyer will now better be able to be matched to buyers and to wallets. We see the shared economy across rideshare and food delivery also benefiting from this. Again, you're going to have more information to better match drivers to potential riders, restaurants to potential eaters. And down the line we go where we ultimately see artificial intelligence leading to an acceleration in digitization of consumers time, digitization of consumers wallets and all of that was going to bring more dollars online to the consumer internet companies. Brian Nowak: Now that's the consumer side, how do you think about artificial intelligence impacting enterprise in the B2B side? Keith Weiss: Yeah, I think there's a lot of commonalities into what you went through. On one level you talked about search, and what these generative AI technologies are able to do is put the questions that we're asking in context, and that enables a much better search functionality. And it's not just searching the Internet. Think about the searches that you do of your email inbox, and they're not very effective today and it's going to become a lot more effective. But that search can now extend across all the information within your organization that can be pretty powerful. When you talk about the generative capabilities in terms of writing content, we write content all day long, whether it's in emails, whether it's in text messages, and that can be automated and made more efficient and more effective. But also, the Excel formulas that we write in our Excel sheets, the reports that you and I write every day could be really augmented by this generative AI capability. And then there's a whole nother kind of class of capabilities that come in doing jobs better. So if we think about how this changes the landscape for software developers, one of the initial use cases we've seen of generative AI is making software developers much more productive by the models handling a lot of the rote software development, doing the easy stuff. So that software developer could focus his time on the hard problems to be solved in overall software development. So if you think about it holistically, what we've seen in technology trends really over the last two decades, we've seen the cost of computing coming way down, stuff like Public Cloud and the Hyperscalers have taken that compute cost down and that curve continues to come down. The cost of data is coming down, it's more accessible, there's more out of it because we've digitized so much of the economy. And then thirdly, now you're going to see the cost of software development come down as the software developers become more productive and the AI is doing more of that development. So those are all of your input cost in terms of what you do to automate business processes. And at the same time, the capabilities of the software is expanding. Fundamentally, that's what this AI is doing, is expanding the classes and types of work that can be automated with software. So if your input costs are coming way down and your capabilities are coming up, I think the amount of software that's being developed and where it's applied is really going to inflate a lot. It's going to accelerate and you're going to see an explosion of software development. I'm as bullish about the software industry right now as I've been over the past 20 years. Keith Weiss: So one of the things that investors ask me a lot about is the cost side of the equation. These new capabilities are a lot more compute intensive, and is this going to impact the gross margins and the operating margins of the companies that need to deploy this. So, how do you think about that part of the equation, Brian? Brian Nowak: There's likely to be some near-term impact, but we think the impacts are near-term in nature. It is true that the compute intensity and the capital intensity of a lot of these new models is higher than some of the current models that we're using across tech. The compute intensity of the large language models is higher than it is for search, it is higher than it is for a lot of the existing e-commerce or social media platforms that are used. So as we do think that the companies are going to need to invest more in capital expenditure, more in GPUs, which are some of the chips that enable a lot of these new large language models and capabilities to come. But these are more near-term cost headwinds because over the long term, as the companies work with the models, tune the models and train the models, we would expect these leading tech companies to put their efficiency teams in place and actually find ways to optimize the models to get the costs down over time. And when you layer that in with the new revenue opportunities, whether we're talking about incremental search revenue dollars, incremental e-commerce transactions, incremental B2B, SAS like revenue streams from some companies that will be paying more for these services that you spoke about, we think the ROI is going to be positive. So while there is going to likely be some near-term cost pressure across the space, we think it's near-term and to your point, this is a very exciting time within tech because these new capabilities are going to just expand the runway for top line growth for a lot of the companies across the space. Brian Nowak: And this is all very exciting on the consumer side and the business side, but Keith talk to us about sort of some of the uncertainties and sort of some of the factors that need to be ironed out as we continue to push more AI tools across the economy. Keith Weiss: Yeah, there's definitely uncertainties and definitely a risk out there when it comes to these technologies. So if we think about some of the broader risks that we see, these models are trained on the internet. So you have to think about all the data that's out there. Some of that data is good, some of that data is bad, some of that data could introduce biases into the search engines. And then the people using these search engines that are imbued with the AI, depending on how hard they're pushing on the search engines on the prompts, and that's the questions that they're asking the search engines, you could elicit some really strange behavior. And some of that behavior has elicited fears and scared some people, frankly, by what these search engines are bringing back to them. But there's also business model risk. From a software perspective, this is going to be the new user interface of how individual users access software functionality. If you're a software company that's not integrating this soon enough, you're going to be at a real disadvantage. So there's business has to be taken into account. And then there's broader economic risk. We're talking about all the capabilities that this generative AI can now do that these models can now take over. So for the software developer, does this mean there's job risk for software developers? For creative professionals who used to come up with the content on their own, does this mean less jobs for creative professionals? Or you and I? Are these models going to start writing our research reports on a go forward basis? So those are all kind of potential risks that we're thinking about on a go forward basis. Keith Weiss: So, Brian, maybe to wrap up, how do you think about the milestones and sort of the key indicators that you're keeping an eye on for who are going to be the winners and losers as this AI technology pervades everything more fully? Brian Nowak: It's a great question. I would break it into a couple different answers. First, because of the high compute intensity and costs of a lot of these models, we only see a handful of large tech companies likely being able to build these large language models and train them and fully deploy them. So the first thing I would say is look for new large language model applications from big tech being integrated into search, being integrated into e-commerce platforms, being integrated into social media platforms, being integrated into online video platforms. Watch for new large language tools to roll across all of big tech. Secondly, pay attention to your app stores because we expect developers to build a lot of new applications for both businesses and consumers using these large language models. And that is what we think is ultimately going to lead to a lot of these consumer behavior changes and spur a lot of the productivity that you talked about on the business side. Keith Weiss: Outstanding. Brian Nowak: Keith, thanks for taking the time. Keith Weiss: Great speaking with you, Brian. Brian Nowak: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

10 Mars 202311min

While the U.S. has surprised investors with its economic resilience, new labor market and retail sales data could challenge this continued strength.----- 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, March 9th at 2 p.m. in London. One of the biggest surprises this year has been the resilience of the U.S. economy. This story faces a key test over the next week, with a large bearing on how investors may think about where we are in the cycle. Investors entered this year downbeat on U.S. growth, with widespread expectations of a recession. A payback in high levels of consumption over the pandemic, and the lagged impact of higher interest rates, were both big drivers of this view. And indeed many traditionally leading indicators of economic activity did, and still do, point to elevated economic risk. Yet the story so far has been different. The U.S. economy is still seeing robust consumption and jobs growth and more economically sensitive stocks have been major outperformers. Last month the U.S. economy added half a million jobs and saw very robust retail sales, data points that were taken by the market as a sign that the economy may not be slowing at all. That might be the case, but what's interesting is that this story is about to get a key update. Over the next week, we'll get the next release of data on the U.S. labor market and retail sales. And that data comes with a big uncertainty. The uncertainty is how much of the strength in January's data was flattered by so-called seasonal adjustments. For obvious reasons, a lot of things are sold in December and a lot of people are hired to sell them. In January, activity and jobs usually drop off, and so seasonal adjustments are important to help look through all this noise. To be more specific, retail sales usually drop 20% between December and January. This time around, they only dropped 16%, and since they dropped less than normal this was reported as a healthy gain. The U.S. usually loses 3 million jobs in January as seasonal workers are let go. This time the U.S. lost two and a half million jobs. December holidays are real and we should adjust for them. But if consumption patterns have changed since 2020, historical seasonal adjustments could be misleading. This month's data may give us a much cleaner picture of where that activity really is. If activity is once again strong, it could help further fuel the idea that U.S. growth this year will be better than feared. But if it's weak, investors may start to think that January's strength was something of a statistical quirk, especially in the face of other forward indicators that look much softer. Because of this, we think weak data over the next couple of days could be especially good for bonds. But either way, this data has a major bearing on the market narrative. 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.

9 Mars 20233min

While there is some skepticism that Asia’s growth will outperform this year, there are a few promising indicators that investors may want to keep in mind.----- Transcript -----Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Asia Economist at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, today I'll be discussing how Asia's growth is bouncing back. It's Wednesday, March 8th at 9 a.m. in Hong Kong. The last time I came on this podcast, I spoke about why we expect Asia's growth to outperform in 2023. To briefly recap, we expect Asia's growth to be five percentage points higher than the developed markets by the end of the year. One of the key debates we have with investors is precisely about how the growth outlook is tracking relative to our bullish forecasts. Investors are generally skeptical on two counts. First, for China, investors believe that consumption growth will not be sustained after the initial reopening boost. Second, for region excluding China, investors saw that there was a soft patch in the consumption data for some of the economies, and so they are questioning if this will persist over time and across geographies. For China, we have already seen a sharp rebound in services spending in areas like dining out, domestic travel and hotels. We expect consumption growth to continue to recover towards the pre-COVID strength in a broad-based manner. Crucially, this consumption growth is being supported by the sustainable drivers of job growth and income growth rather than a drawdown in excess savings. Private sector confidence is being revived by the alignment of policies towards a pro-growth stance. This shift in stance also means that policymakers will likely be taking quick and concerted policy action to address any remaining or fresh impediments to growth. In other words, this policy stance is likely to persist at least until we get clear signs of a sustainable recovery. Moreover, the property sector, which some investors fear might be a drag on household sentiment, appears to be recovering faster than our expectations. For region excluding China, we focus on the next largest economies in purchasing power parity terms, which is India and Japan. For India, growth indicators did slow post the festive season in October, but have reaccelerated in early 2023. Cyclically strong trailing demand has only lifted capacity utilization, and structurally government policies are still very much geared towards reviving private investment. We see private CapEx cycle unfolding, which will sustain gains in employment and allow consumption growth to stay strong in the coming quarters. For Japan, we see three reasons why growth should improve in 2023. Monetary policy will remain accommodative, private CapEx is now on the mend and Japan will benefit from the full reopening of China this spring, in form of increased tourism and goods exports. Overall, we think we are still on track for our base case narrative of growth acceleration and outperformance. In fact, we see marginal upside risk to our above consensus growth forecasts, which will be driven predominantly by China and its spillover impact to the rest of the region. For China, the upside to growth forecasts stems from the possibility that pro-growth pragmatism may set in motion a much stronger recovery than currently expected. Thanks for listening. If you enjoyed the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or a colleague today.

8 Mars 20233min

Original Release on February 24th, 2023: As short-term bond yields continue to rise, what impact does this comparatively high yield have on the broader market?----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, February 24th at 2 p.m. in London. One of the biggest stories brewing in the background of markets is the sharp rise in yields on safe, short-term bonds. A 6 month Treasury bill is a great example. In November of 2021, it yielded just 0.06%. Today, just 14 months later, it yields 5.1%, its highest yield since July of 2007. The rise in safe short-term yields is notable for its speed and severity, as the last 12 months have seen the fastest rise of these yields in over 40 years. But it also has broader investment implications. Higher yields on cash like instruments impact markets in three distinct ways, all of which reduce the incentive for investors to take market exposure. First and most simply, higher short term rates raise the bar for what a traditional investor needs to earn. If one can now get 5% yields holding short term government bonds over the next 12 months, how much more does the stock market, which is significantly more volatile, need to deliver in order to be relatively more appealing? Second, higher yields impact the carry for so-called leveraged investors. There is a significant amount of market activity that's done by investors who buy securities with borrowed money, the rate of which is often driven by short term yields. When short term yields are low, as they've been for much of the last 12 years, this borrowing to buy strategy is attractive. But with U.S. yields now elevated, this type of buyer is less incentivized to hold either U.S. stocks or bonds. Third, higher short term yields drive up the cost of buying assets in another market and hedging them back to your home currency. If you're an investor in, say, Japan, who wants to buy an asset in the U.S. but also wants to remove the risk of a large change in the exchange rate over the next year, the costs of removing that risk will be roughly the difference between 1 year yields in the US and 1 year yields in Japan. As 1 year yields in the U.S. have soared, the cost of this hedging has become a lot more expensive for these global investors, potentially reducing overseas demand for U.S. assets and driving this demand somewhere else. We think a market like Europe may be a relative beneficiary as hedging costs for U.S. assets rise. The fact that U.S. investors are being paid so well to hold cash-like exposure reduces the attractiveness of U.S. stocks and bonds. But this challenge isn't equal globally. Both inflation and the yield on short-term cash are much lower in Asia, which is one of several reasons why we think equities in Asia will outperform other global markets going forward. 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.

7 Mars 20233min

While equity markets continue to rally, the key to the end of the bear market may be in the fundamentals.----- 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, March 6th at 2 p.m. in New York. So let's get after it. Given our focus on the technicals in the short term, I'm going to provide an update on that view today, which contrasts with our intermediate term view that the bear market is not over. In short, equity markets traded right to technical support levels on Thursday last week and held. More importantly, they reacted strongly from those levels, which suggests this will not be a one day wonder, meaning the bear market rally may not be over yet. While my comments will focus on the S&P 500, these observations apply to most of the other major indices as well: the Nasdaq, Russell 2000 and the Dow Industrials, which remains the weakest of the bunch. First, as already mentioned, the key support levels were tested twice over the past few weeks, but on Thursday equity prices reacted strongly around the second test. As a strategist, I respect the price action and need to incorporate it into our fundamental view, which remains bearish. In addition to the strong rebound, the S&P 500 was able to recapture its uptrend from the rally that began in October. However, we did not observe any positive divergence on the second retest, and that leaves the door open that this rally may still be on borrowed time. We would point out that one of the reasons we called the rally in October had to do with the fact that we did get a very strong positive divergence on that secondary low in mid-October. For listeners who don't use technical analysis, a positive divergence is when markets make new price lows on less momentum. We measure momentum through price oscillators like relative strength or moving average convergence divergence. The other thing we're watching closely from a tactical standpoint is the longer term uptrend that began after the financial crisis in 2009. We continue to think it is critical that the S&P 500 get back above it to confirm the cyclical bear market is over. This trend line has provided critical resistance and support over the past 14 years during the secular bull market. More recently, it has been more of a resistance line and that level comes in today at around 4150 on the S&P 500. While we think the S&P 500 could make another attempt at this key resistance, it will require two things to surmount it- lower 10 year U.S. Treasury yields and a weaker dollar. In fact, we think Friday's sharp fall in 10 year yields was an important driver of the bounce in stocks. The dollar, too, showed some signs of exhaustion and it would be helpful if it can decline more meaningfully. As we suggested last week, in the absence of a weaker dollar and lower yields, this bear market rally will likely fail once again. The bottom line, there is plenty of bullish and bearish fodder in the technicals in our view, and one will need to take a view on the fundamentals to decide this bear market for stocks is over. Our view remains the same, the bear market is not over, but we acknowledge that Friday's price action may push out the next leg lower for a few more weeks. As we've been discussing on prior podcasts, the main reason we believe the bear market is not over is because the earnings recession has much further to go. Rather than repeating our case once again, we would like to highlight an important note published last week by Todd Castagno, our Global Valuation, Accounting and Tax team, appropriately entitled Exhausted Earnings. In this note, the team discusses their analysis of accruals and to what extent net income is diverging from cash flows. In short, the gap between reported earnings and cash flow is the widest in 25 years. This analysis supports our negative operating leverage thesis and means earnings estimates have a long way to fall over the next several quarters. Unfortunately, most stock valuations do not reflect this risk and why we think the risk reward for U.S. equities remains poor despite the positive price action last week. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.

6 Mars 20233min

The way companies and individuals spend their money has changed in the wake of the COVID pandemic. How might market leadership shift as a result and will new market winners come into focus? Chief Cross-Asset Strategist Andrew Sheets and Chief Investment Officer for Wealth Management Lisa Shalett discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research. Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management. Andrew Sheets: And on part two of this special episode, we'll be continuing our discussion of the "Next American Productivity Renaissance". It's Friday, March 3rd at 2 p.m. in London. Lisa Shalett: And it's 9 a.m. in New York. Andrew Sheets: So Lisa, let's take this to markets, how do you think this impacts equity market leadership, given that we've been in a market that's really been defined by the age of secular stagnation. What do you think happens now and who will be those new leaders? Lisa Shalett: This is one of the most important, I think, outcomes of our thesis. And that is that pendulums swing and market leadership shifts all the time, but when it's at that moment of inflection there's huge amounts of pushback, typically. Our sense is that the wealth creation ahead of us may not be in the current leadership in consumer tech, but rather in enterprise tech and the technology providers who are the leaders in new automation technologies that are going to allow us potentially to automate parts of our economy that have heretofore resisted. So it's a lot of the services side of the economy. Think of financial services, consumer services, government services, education services, how manual some of those industries are. And yet when we think about these triads or four or five level combinations of things like artificial intelligence, and machine learning, and optical scanning, and natural language processing and voice recognition. These are things that could really transform service-oriented businesses in terms of their margins and the economics of them. And so we envision a leadership that is potentially bimodal, that includes the tech enterprise enablers. Some of the software or software-as-a-service, some of the technology consultants who will help implement these automation programs and some of the beneficiaries, the tech takers, right. Think about some of those banks, those insurance companies, those healthcare companies, educational-oriented institutions that are just so heavy in manual service support infrastructures that could be rationalized. Andrew Sheets: So I'd like to dive into two of those threads and in just a little bit more detail. Just in terms of, kind of, the decade we've just been in. And, you know, I think it was pretty unique that it was a decade with some of the lowest cost of capital we've ever seen in economic history, and yet, you know, it's kind of left us with an economy where it's very easy to order food and very hard to take a train to the airport. We've had a lot of investment in consumer-led technology and a lot less in infrastructure. Do you think that equation has finally changed in a bigger way? And what do you think that means for maybe winners and losers of the changes that might be happening? Lisa Shalett: Our perspective is that I don't know that it's a permanent change. I think pendulums swing and there are waves when technology is more consumer-oriented. The issue with consumer technology, as we know and certainly with the smartphone, has been there's 2 billion people implementing that technology in 2 billion different ways. So it's very hard to scale those productivity benefits, if there are any, across an economy. When you go through periods of enterprise or economy-wide or infrastructure deepening-based technology spends, that's when economies can transform. And so I think it's a phase in the market. But I think one that is really important, you know, when we think about the advancement of overall return on assets in the economy. Andrew Sheets: And so, Lisa, digging into that technology piece, is there an example that stands out to you of a type of technology consumption that you think could be more fleeting as a result of the post-COVID period? And to your point about the more tangible, long lasting shifts in technology investment, the types of things that will be a lot more permanent and could really surprise people in their permanence over the longer run? Lisa Shalett: I'm not a technology visionary, but I do think that so many of the consumer technologies that we see over time end up being cannibalizing and substitutive as opposed to truly revolutionary. So, think about the consumption of media. We're still consuming media, it's just on what mode. Are we consuming it through a radio broadcast, a television broadcast, now streaming services on demand and etc, but it's content nonetheless. I think that there are other technologies when we think about what's going on with things like A.I., when we think about some of the things that are going on in genomics and in health care in particular, that really are transformative and take us to places we truly have never been before. And I think that that's one of the things that's super exciting right now is that we've never seen this before in many industries, right? Whether we're talking about things like transport and things in terms of human robotics and artificial intelligence and machine learning. These are places that we really haven't been before. And so to me, this is an extraordinarily exciting time vis a vis the innovation path. Andrew Sheets: Lisa, you've been talking about some of these big secular drivers of this productivity shift and capital investment shifting to deglobalization, decarbonization. And so I guess the next question is there might be demand for these things, but is there the supply to address these issues? Can we actually build these plants and re-orient these supply chains? How do you think about the supply side of this? And do you think supply is going to be able to rise to the challenge of the potential demand for this capital expenditure? Lisa Shalett: So I think that that's the piece of this thesis that was most exciting to us because very often one of the things that constrains investment is that you don't have the supply side enablement. One of the things that we can't take for granted is how good, particularly in the United States, private sector balance sheets are today. And so whether we're talking about the degree to which the United States banking system has healed and recapitalized, or we're talking about corporations who are still reasonably cash-rich and have locked in almost historically low costs of capital, or we talk about the household sector, which has moved away and locked in to fixed rate mortgages. That's a huge enablement that says we have the capacity to fund new technology. Then one of the other things that we've been talking about that enable the supply side are demographics. We've gone through this period where there was a bit of an air pocket in terms of overall working age population growth because Gen X was just not all that big relative to the boom. And we're talking about a working age population that is rapidly going to be dominated by a humongous millennial and Gen Z wave. And these are digital natives, right? These are folks who were born with technology in their hands. And so having a workforce that is flexible and tech savvy, that helps implement. So I think those are some of the supply side factors that are different than perhaps what we saw 10-15 years ago, you know, in 2007 when Apple launched the iPhone. Andrew Sheets: Lisa, thanks for taking the time to talk. Lisa Shalett: It's my pleasure, Andrew. Andrew Sheets: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

3 Mars 20238min

The COVID pandemic changed the way the U.S. engages with work, but how will these shifts impact structural changes to capital investment? Chief Cross-Asset Strategist Andrew Sheets and Chief Investment Officer for Wealth Management Lisa Shalett discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research. Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management. Andrew Sheets: And on this special two-part episode, we'll be discussing what we see as the "Next American Productivity Renaissance". It's Thursday, March 2nd at 2 p.m. in London. Lisa Shalett: And it's 9 a.m. in New York. Andrew Sheets: So while everybody has been paying close attention, and rightly so, to 40 year highs of inflation that we've been having recently, there's another legacy from this pandemic that we want to dig into more deeply. We believe that the COVID crisis catalyzed an incredibly powerful regime shift, a once-in-a-generation shock to the labor markets which transformed the nature of work and is accelerating structural changes to capital investment. Lisa, you believe we're on the cusp of what you call the "Next American Productivity Renaissance", and this renaissance is underpinned by an upcoming capital spending supercycle. So, I guess the place to start is what does that mean and what's driving it? Lisa Shalett: I mean, I think that some of these trends were already beginning to take form before COVID struck, but COVID was really an accelerant. And so if we think about first the detachment from the labor force and the way COVID really transformed the way we think about work, and those jobs that maybe were not flexible to convert to a remote setting, or a work from home setting, and carried with them in-person high risk attributes. I think that was really one of the first dimensions of it, but then it was really about companies having to fundamentally rethink and re-engineer business models towards digitization, right? The removal of human contact. And then you overlay those two major pillars with things like decarbonization and the issues that emerged around how we make this transition to a cleaner energy mix around the world. Obviously COVID accelerated some of the issues around supply chain and deglobalization and how do we secure supply chains. And last but not least, I think it has really become clear we're talking about a world where incentives to invest either to substitute for labor, to strengthen our infrastructure, to commit to some of these climate change initiatives, to re-engineer supply chains or to deal with this new multipolar world. The incentives and the argument for capital spending has really changed. Andrew Sheets: So Lisa actually it's that last point on labor market tightness that I'd like to dive into a little bit more. Because I mean, it's fair to say that this would actually be a pretty normal cyclical phenomenon that as labor markets get tighter, as workers are harder to find, that companies decide that now it's worth investing more to make their existing workers more productive. Do you think that's a fair characterization of some past capital spending cycles that we've seen? And how do you think this one could fit into that pattern? Lisa Shalett [00:04:19] Yes, I think very often, you know, we've gone through these periods where the capital for labor substitution has been at the forefront. Now, one of the things that very often we have to wait for are what I call the supply side enablers of that. There have been eras where there's more automation-oriented technology that is available, and then there's eras where perhaps there's been less. And I think that one of the things that we're positing is that after the golden age of private equity that we're entering one of those periods of technology J-curve explosion, right, where the availability of automation-orienting technologies is there. So it enables part of the dialog around capital for labor arithmetic. Andrew Sheets: I also want to ask you about decarbonization as a theme, which you cited as one of these drivers of the productivity renaissance and capital deepening because I think you do encounter a view out there in the world that decarbonization and environmental regulation is negative for productivity. What do you think the market might be missing about decarbonization as a theme? And how does it drive higher productivity in the future rather than lower productivity? Lisa Shalett: I think fundamentally that there is no doubt that as we make this transition, there are going to be bumps and bruises along the road. And part of the issue is that as we move away from what is perhaps the lowest cost, but most dirty technologies that there may be pressures on inflation. But the flip side of that is that it creates huge incentives to drive productivity improvement in some of those cleaner technologies so that we can accelerate adoption through more compelling economics. So our sense is hydro and wind and some of these technologies are going to see material productivity improvements. Andrew Sheets: Well, Lisa, I think that's a great point, because also what we've certainly seen in Europe is a dramatic fall of consumption of natural gas and a dramatic increase in efficiency. As energy prices spiked in Europe in the aftermath of Russia's invasion of Ukraine, you did see an increased focus on energy-efficient investment, on the cost of energy. And I think it surprised a lot of people about how much more production they were able to squeeze out of the same kilowatt hour of electricity. So it's, I think, a really interesting and important point that might go against some of the conventional wisdom around decarbonization. But I think we have some real hard evidence in the last couple of quarters of how that could play out. And Lisa, the final piece that I think your thesis probably gets a little bit of debate on is deglobalization. Because, again this has been a macro and micro topic, you know, macro in the sense that you're seeing companies look to shorten supply chains after some of the major supply chain issues around COVID. They're looking to shorten supply chains, given heightened geopolitical risk. And, you know, this has often been cited as something that's going to reduce profitability of companies, is they're going to have to double up on inventory and make their supply chain somewhat less efficient. So again, how does that fit into a productivity story or how do you see the winners and losers of that potentially playing out? Lisa Shalett: I don't know that the deglobalization itself drives productivity per se, but what it does do is it creates a lot of incentives for us to rethink the infrastructure that underlies supply chains. So, for example, as companies maybe think about shortening supply chains, maybe it's that American companies don't want to simply be motivated by the lowest net cost of production. But perhaps to your point, the proximity and security of production. So suddenly, does that mean we will be investing in infrastructure across the NAFTA region, for example, as opposed to over oceans and through air freight? And as those infrastructures are strengthened, be those through highway infrastructure, rail infrastructure or new port infrastructure, there's productivity benefits to the aggregate economy as companies rethink those linkages and flows. Andrew Sheets: That's interesting. So when we're talking about deglobalization, maybe you run the risk of focusing very narrowly on some higher near-term costs, but thinking bigger picture, thinking out over the next decade, maybe you are ending up with a more robust, more resilient economy and supply chain that over the long run over cycles does deliver better, more productive output. Lisa Shalett: Absolutely. Andrew Sheets: Lisa, thanks for taking the time to talk. Lisa Shalett: It's my pleasure, Andrew. Andrew Sheets: Thanks for listening, and be sure to tune in for part two of this special episode. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.

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After the passing of the Inflation Reduction Act in the U.S., other countries may be looking to invest more in their own energy transitions.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between public policy and financial markets. It's Wednesday, March 1st at 10 a.m. in New York. When Congress passed and the president signed into law the Inflation Reduction Act last year, they may have started a race among global governments to spend new money in an attempt to cut carbon output dramatically. Consider the European Union, where our economists and strategists are flagging that they expect, later this month, there will be an announcement of a major allocation of government funds to mirror the nearly $370 billion allocated by the U.S. toward its own energy transition. In the U.S., we've already flagged that much of the investment opportunity lies in the domestic clean tech space. As Stephen Byrd, our Global Head of Sustainability Research, has flagged the IRA's monetary allocation and rules creating preferences for materials sourced domestically or in friendly national confines, means that the U.S. clean tech space is seeing a substantial growth in demand for its products and services. In the EU, the story is more nuanced as we await details on what a final version of the European Commission's Green Deal Industrial Plan is, a process that could take us into the summer or beyond. Streamlining regulations to encourage private funding and expand the network for trade partners on green tech equipment is expected to be in focus. So the near term macro impacts are murky, but at a sector level, such a policy should present opportunities in utilities, capital goods, materials and construction. In short, this policy would mean the EU is finding ways to accelerate demand for these green enabler companies. So, in line with the transition to decarbonization as one of our big three investment themes for 2023, investors would do well to follow the money and see where there may be 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.

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