Who’s Disrupting — and Funding — the AI Boom

Risk-averse investors have poured trillions into money-market funds since 2019. Our Chief Fixed Income Strategist explains why investors shouldn’t expect this money to pivot to equities and other risk assets as rates fall. ----- 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, today I'll be talking about money market funds. It's Tuesday, August 6th at 3pm in New York. Well over $6.5 trillion sit in US money market funds. A popular view in the financial media is that the assets under management in money market funds represent money on sidelines, waiting to be allocated to risk assets, especially stocks. The underlying thesis is that the current level of interest rates and the consequent high money market yields have resulted in accumulation of assets in money market funds; and, when policy easing gets under way and money market yields decline, these funds will be allocated towards risk assets, especially stocks. To that I would say, curb your enthusiasm. Recent history provides helpful context. Since the end of 2019, money market funds have seen net inflows of about $2.6 trillion, occurring broadly in three phases. The first phase followed the outbreak of COVID, as the global economy suddenly faced a wide array of uncertainties. The second leg mainly comprised retail inflows, starting when the Fed began raising rates in 2022.The third stage came during the regional bank crisis in March-April 2023, with both retail and institutional flows fleeing regional bank deposits into money market funds. Where do we go from here? We think money market funds are unlikely to return to their pre-COVID levels of about $4 trillion, even if policy easing begins in September as our economists expect. They see three 25 basis point rate cuts in 2024 and four in 2025 as the economy achieves a soft landing; and they anticipate a shallow rate-cutting cycle, with the Fed stopping around 3.75 per cent. This means money market yields will likely stabilize around that level, albeit with a lag – but still be attractive versus cash alternatives. In a hard landing scenario, the Fed will likely deliver significantly more cuts over a shorter period of time, but we think investors would be more inclined to seek liquidity and safety, allocating more assets to money market funds than to alternative assets. Further, money market funds can delay the decline in their yields by simply extending the weighted average maturities of their portfolios and locking in current yields in the run-up to the cutting cycle. This makes money market funds more attractive than both short-term CDs and Treasury bills, whose yields reprice lower in sync with rate cuts. This relative appeal explains much of the lag between rate cuts and the peak in assets under management in money market funds. These have lagged historically, but average lag is around 12 months. Finally, it is important to distinguish between institutional and retail flows into and out of money market funds, as their motivations are likely to be very different. Institutional funds account for 61 per cent of money market funds, while funds from retail sources amount to about 37 per cent. When they reallocate from money market funds, we think institutional investors are more likely to allocate to high-quality, short-duration fixed income assets rather than riskier assets such as stocks, motivated by safety rather than level of yield. Retail investors, the smaller segment, may have greater inclination to reallocate towards risk assets such as stocks. The bottom line: While money market fund assets under management have grown meaningfully in the last few years, it is likely to stay high even as policy easing takes hold. Allocation toward risk assets looks to be both lagged and limited. Thus, this 'money on the sidelines' may not be as positive and as imminent a technical for risk assets as some people expect. Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

6 Aug 20244min

Although Monday’s correction springs from multiple causes, the real questions may be what’s next and when will the correction become a buying opportunity?----- 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 the recent equity market correction and whether it’s time to step in.It's Monday, Aug 5th at 11:30am in New York.So let’s get after it.Over the past several weeks, global equity markets have taken on a completely different tone with most major averages definitively breaking strong uptrends from last fall. Many are blaming the Fed’s decision last week to hold interest rates steady in the face of weaker jobs data while others have highlighted the technical unwind of the Japanese yen carry trade.However, if we take a step back, this topping process began in April with the first meaningful sell off since last October’s lows. Even as many stocks and indices rallied back to new highs this summer, the leadership took on a more defensive posture with sectors like Utilities, Staples and even Real Estate doing better than they have in years. As I have been discussing on this podcast this shift in leadership has coincided with softer economic data during the second quarter. This softness has continued into the summer with the all-important labor market data joining in as already noted.This rotation was an early warning sign that stocks were likely vulnerable to a correction as we highlighted in early July. After all, the third quarter is when such corrections tend to happen seasonally for several reasons. This year has turned out to be no different. The real question now is what’s next and when will this correction become a buying opportunity?Lost in the blame game is the simple fact that valuations reached very rich levels this year, something we have consistently discussed in our research. In fact, this is the main reason we have no upside to our US major averages over the next year even assuming our economists’ soft landing base case outcome for the economy. In other words, stocks were priced for perfection.Now, with the deterioration in the growth data, and a Fed that is in no rush to cut rates proactively, markets have started to get nervous. Furthermore, the Fed tends to follow 2-year yields and over the last month 2-year treasury yields have fallen by 100 basis points and is almost 170 basis points below the Fed Funds rate. What this means is that the market is telling the Fed they are way too tight and they need to cut much more aggressively than what they have guided.The dilemma for the Fed is that the next meeting is six weeks away and that’s a lifetime when markets are trading like they are today. Markets tend to be impatient and so I expect they will continue to trade with high volatility until the Fed appeases the market’s wishes. The flip side, of course, is that the Fed does an intra meeting rate cut; but that may make the markets even more nervous about growth in my view.Bottom line, markets are likely to remain vulnerable in the near term until we get better growth data or more comfort from Fed on policy support, neither of which we think is forthcoming soon.Finally, support can also come from cheap valuations, but we don’t have that yet at current prices. As of this recording the S&P 500 is still trading 20x forward 12-month earnings estimates. Our fair value multiple assuming a soft-landing outcome on the economy is closer to 19x, which means things aren’t actually cheap until we reach 17-18x, which is more than 10 per cent away from where we are trading.In the meantime, we continue to recommend more defensive stocks in sectors like Utilities, Healthcare, Consumer Staples and some Real Estate. Conversely, we continue to dislike smaller cap cyclical stocks that are most vulnerable to the current growth slowdown and tight rate policy.Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

5 Aug 20244min

After a dizzying week of economic and market activity, our Head of Corporate Credit Research breaks down the three top stories.----- Transcript -----It’s been a whirlwind week of economic activity in the markets as we enter the dog days of summer. Our Head of Corporate Credits Research breaks down three top stories.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 discussing what we’ve taken away from this eventful week.It's Friday, August 2nd at 2pm in London.For all its sophistication, financial activity is still seasonal. This is a business driven by people, and people like to take time off in the summer to rest and recharge. There’s a reason that volumes in August tend to be low.And so this week felt like that pre-vacation rush to pack, find your keys, and remember your ticket before running out the door. Important earnings releases, central bank meetings and employment numbers all hit with quick succession. Some thoughts on all that whirlwind.The first story was earnings and continued equity rotation. Equity markets are seeing big shifts between which stocks are doing well and poorly, particularly in larger technology names. These shifts are a big deal for equity investors, but we think they remain much less material for credit.Technology is a much smaller sector of the bond market than the stock market, as these tech companies have generally issued relatively little debt – relative to their size. Credit actually tends to overlap much more with the average stock, which at the moment continues to do well. And while the Technology sector has been volatile, stocks in the US financial sector – the largest segment for credit – have been seeing much better, steadier gains.Next up this week was the Bank of Japan, which raised policy rates, a notable shift from many other central banks, which are starting to lower them. For credit, the worry from such a move was somewhat roundabout: that higher rates in Japan would strengthen its currency, the yen. That such strength would be painful for foreign exchange investors, who had positioned themselves the other way around – for yen weakness. And that losses from these investors in foreign exchange could lead them to lower exposure in other areas, potentially credit. But so far, things look manageable. While the yen did strengthen this week, it hasn’t had the sort of knock-on impact to other markets that some had feared. We think that might be evidence that investor positioning in credit was not nearly as concentrated, or as large, as in certain foreign exchange strategies, and we think that remains the case.But the biggest story this week was the Federal Reserve on Wednesday, followed by the US Jobs number today. These two events need to be taken together.On Wednesday, the Fed chose to maintain its high current policy rate, while also hinting it’s open to a cut. But with inflation falling rapidly in recent months, and already at the Fed’s target on market-based measures, the question is whether the Fed should already be cutting rates to even out that policy. After all, lowering rates too late has often been a problem for the Fed in the past.Today’s weak jobs report brings these fears front-and-center, as highly restrictive monetary policy may start to look out-of-line with labor market weakness. And not cutting this week makes it more awkward for the Fed to now adjust. If they move at the next meeting, later in September; well, that means waiting more than a month and a half. But acting before that time, in an unusual intra-bank meeting cut; well, that could look reactive. The market will understandably worry that the Fed, once again, may be reacting too late. That is a bad outcome for the balance of economic risks and for credit.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

2 Aug 20243min

Our Chief Global Cross-Asset Strategist, Serena Tang, explains where funds are moving across global markets currently, and why it matters to investors.----- Transcript -----Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll dig into the concept of fund flows, how they shape global markets and why they matter to investors. It’s Thursday, August 1, at 10am in New York. Finance industry professionals often use the term “flows” when looking at where investors are, in the aggregate, moving their money. It refers to net movements of cash in and out of investment vehicles such as mutual funds and exchange-traded funds, or in and out of whole markets. By looking at flows, investors can get a good sense of where market winds are blowing and, essentially, where demand is at any given moment. Now, whether you’re a retail or institutional investor, having a perspective on market sentiment and demand are powerful tools. So today I’m going to give you a snapshot of some key flows, which should give a sense of demand and the mood right now; and what it means for investors.First of all, despite the recent rally in global equities year-to-date, we've yet to see an investor rotation, or portfolio realignment, from bonds to stocks. Flows into bonds are still leading flows into stocks by a pretty large margin. And unless stocks cheapen materially, we don’t expect this trend to reverse anytime soon. In addition, fund flows into large-cap equities still dwarf those into small-caps year-to-date. Although we saw a brief reversal of this trend in June, large caps flows have swung back to prominence. We do see hints of sector rotation within equities, as investors shift to what they see as more promising stocks; but it’s not a clean or entirely unambiguous story. The Science & Tech sectors – which saw a notable drop-off in flows from the first to the second quarter of this year – still lead year-to-date; and flows represent nearly a third into all flows into equities. More cyclical sectors like Basic Materials and Financials attracted more capital than in the first and second quarter, while defensive sectors such as Consumer Goods saw a softening of outflows compared to the same period. From a global perspective, we also look at flows in and out of particular regions or markets. So, year-to-date, US stocks received about US$43 billion in net inflows while rest-of-world stocks saw about US$15 billion in net outflows. Now, there were some exceptions – with India, Korea, and Taiwan leading – seeing significant inflows year-to-date. We look at flows within categories too, so within fixed income, for example, we are seeing flows toward less risky assets; revealing what we call a risk-off preference. Higher quality, Investment Grade funds – raked in about US$92 billion in net inflows year-to-date, while US treasuries saw only at US$25 billion. That Treasury number is actually significantly higher than what we saw from the first quarter to the second quarter, while inflows to High Yield and low-quality Investment Grade corporates have slowed compared to the start of the year. Finally, money market funds – that is mutual funds that invest in short-term higher quality securities – have not yet really seen sustained outflows, as one would expect when investors believe shorter term yields would come down, as central banks start to ease. Rather there’s been some $70 billion in net inflows through the first half of this year. Although we’re sympathetic to the view that money market outflows should begin when the Fed starts cutting rates, there’s actually a considerable lag between first cut and those outflows, as we have seen in the last two rate cutting cycles. But what does all of this mean for investors? Well, it suggests they still have a defensive tilt, and they shouldn’t really be jumping on the rotational story. The current yield environment means rotation from fixed income and money market funds into riskier assets is still some way away. Investors also shouldn’t look at the dry powder/cash on the sidelines narrative as the big tailwind for riskier assets -- because it’s not coming any time soon. That said, we still like non-government bonds because this is where cash would go first if and when those flows begin. We also like global equities, but more so because the benign macro backdrop we are forecasting supports this. We’ll keep you up to date if there’s any change in the direction of market winds and fund flows.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

2 Aug 20245min

As Generative AI continues to accelerate, some agencies will be better positioned than others to reap the benefits. Our Europe Media & Entertainment analyst, Laura Metayer, explains.----- Transcript -----Welcome to Thoughts on the Market. I’m Laura Metayer, from the Morgan Stanley Europe Media & Entertainment team. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what the future may hold for advertising agencies amid fast-paced Generative AI developments.It’s Wednesday, July 31, at 2 PM in London. Right now we’re still in the early stages of GenAI’s impact on ad agency offerings; although the debate around technology removing the need for ad agencies is not new. Soon after the release of ChatGPT in early 2023, my colleagues in North America started mapping out the potential impact of GenAI on the ad agencies. They concluded that GenAI should represent an opportunity for the ad agencies, at least near-term. First, Gen AI would lead to productivity improvements from automatable tasks in creative, media, digital transformation consulting and central functions like HR and Finance. Second, GenAI would boost client demand for advice from agencies to help navigate the coming evolution in digital advertising. Fast-forward to now and the impact of GenAI on the ad agencies has become an active investor debate, with concerns centering around the Creative business. Many eyes are on the Gen AI-powered text to image/video tools, which could disrupt the ad agencies' Creative & Production business. We this has weighed on agency stock prices recently. Essentially, the bear case has been – and is – that technology would devalue agencies’ offerings and agency clients may rely more on tech platforms and in-house services. That bear case – twenty years into online advertising – has not played out. We think that in these early days of AI’s impact on marketing, there may be more upside to agency equities than risk over the next 12 to 18 months. On the one hand, the introduction of Gen AI tools may mean reduced pricing power and challenged top-line growth. At the same time, replacing creative personnel with software may increase earnings power, even with less revenue. We think it's likely that a key value-add of the ad agencies' Creative business would be campaign personalization at scale, powered by data and technology. Looking back, technology has been commoditizing certain areas of creative and production for years, well ahead of AI; and yet creativity and creative services remain core value propositions by agencies to brands. Overall, there is as much – if not more – opportunity than risk for ad agencies over time. So let me leave you with two key takeaways: First, we see the larger ad agencies as better positioned to remain relevant to customers in the GenAI era. However, we would caution that their large scale may also lower their ability to adapt quickly to evolving customer requirements when it comes to GenAI. Second, we expect GenAI to drive more consolidation in the industry. We think it’s likely that some of the large ad agencies take market share from other large ad agencies. As these trends play out over time, we’ll continue to keep you updated. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

31 Juli 20243min

A later cycle economy and continued uncertainty means that investors should be remain wary of cyclicals such as small caps, explains Mike Wilson, our CIO and Chief US Equity Strategist.----- 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 slowing growth in the context of high valuations.It's Tuesday, July 30th at 3pm in New York.So, let’s get after it.Over the past few weeks, the equity markets have taken on a different complexion with the mega cap stocks lagging and lower quality small caps doing better. What does this mean for investor portfolios? And is the market telling us something about future fundamentals? In our view, we think most of this rotation is due to the de-grossing that is occurring within portfolios that are overweight large cap quality growth and underweight lower quality and smaller cap names.We have long been in the camp that large cap quality has been the place to be – for equity investors – as opposed to diving down the quality and cap curves. That continues to be the case; though we are watching the fundamental and technical backdrop for small caps closely, and we’re respectful of the pace of the recent move in the space.For now, however, we continue to think the better risk/reward is to stay up the quality curve and avoid the more cyclical parts in the market like small caps. Our rationale for such positioning is simple — in a later cycle economy where growth is softening or not translating into earnings growth for most companies, large cap quality outperforms. Exacerbating the many imbalances across the economy is a bloated fiscal budget deficit. In our view, there are diminishing returns to fiscal spending when it starts to crowd out private companies and consumers. As I have been discussing for the past year, this crowding out has contributed to the bifurcation of performance in both the economy and equity markets, while potentially keeping the Fed's Interest rate policy tighter than it would have been otherwise.While the macro data has been mixed, there is a growing debate around the actual strength of the labor market with the household survey painting a weaker picture than the non-farm payroll data which is based on employer surveys. The bottom line is that we are in a stable, but decelerating late cycle economy from a macro data standpoint. However, on the micro front, the data has not been as stable and is showing a more meaningful deterioration in growth; particularly as it relates to the consumer.More specifically, earnings revision breadth has broken down recently for many of the cyclical parts of the market. Financials has been a bright spot here but that may be short-lived if the consumer continues to weaken. We continue to favor quality but with a greater focus on defensive sectors like utilities, staples and REITs as opposed to growthier ones like technology. The issue with the growth stocks is valuations and the quality of the earnings for some of the mega cap tech stocks.The other variable weighing on stocks at the moment is valuations which remain in the top decile of the past 20 years. It’s worth noting that valuations are very sensitive to earnings revisions breadth. The last time revision breadth rolled over into negative territory was last fall. Between July and October 2023, the market multiple declined from 20x to 17x. Two weeks ago, this multiple was 22x and is now 21x. If earnings revisions continue to fade as we expect, it’s likely these valuations have further to fall. With our 12-month base case target multiple at 19x, the risk reward for equities broadly remains quite unfavorable at the moment.Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.

30 Juli 20243min

Our sustainability strategists Stephen Byrd and Tim Chan discuss what’s driving new opportunities across the global nuclear power sector and some risks investors should keep in mind.----- Transcript -----Stephen Byrd: Welcome to Thoughts on the Market. I'm Steven Byrd, Morgan Stanley's Global Head of Sustainability Research.Tim Chan: And I'm Tim Chan, Asia Pacific Head of Sustainability Research.Stephen Byrd: And on this episode of the podcast, we'll discuss some significant developments in the nuclear power generation space with long term implications for global markets.It’s Monday, July 29th at 8am in New York.Tim Chan: And 8 pm in Hong Kong.Stephen Byrd: Nuclear power remains divisive, but it is making a comeback.So, Tim, let's set the scene here. What's really driving this resurgence of interest in nuclear power generation?Tim Chan: One key moment was the COP28 conference last year. Over 20 countries, including the US, Canada, and France, signed a joint declaration to triple nuclear capacity by 2050. Right now, the world has about 390 gigawatts of nuclear capacity providing 10 per cent of global electricity. It took 70 years to bring global nuclear capacity to 390 gigawatts. And now the COP28 target promises to build another 740 gigawatts in less than 30 years.And if this remarkable nuclear journey is going to be achieved, that will require financing and also shorter construction time.Stephen Byrd: So, Tim, how do you size the market opportunity on a global scale over the next five to ten years?Tim Chan: We estimate that nuclear renaissance will be worth $ 1.5 trillion (USD) through 2050, in the form of capital investment in new global nuclear capacity. And the growth globally will be led by China and the US. China will also lead in the investment in nuclear, followed by the US and the EU. In addition, this new capacity will need $128 billion (USD) annually to maintain.Stephen Byrd: Well, Tim, those are some gigantic numbers, $1.5 trillion (USD) and essentially a doubling of nuclear capacity by 2050. I want to dig into China a bit and if you could just speak to how big of a role China is going to play in this.Tim Chan: In China, by 2060, nuclear is likely to account for roughly 80 per cent of the total power generation, according to the China Nuclear Association. This figure represents half of the global nuclear capacity in similar stages, which amounts to 520 gigawatts.And Stephen, can you tell us more about the US?Stephen Byrd: Sure, during COP 28, the US joined a multinational declaration to triple nuclear power capacity by 2050. In this past year, the US has seen the completion of a new nuclear power plant in Georgia, which is the first new reactor built in the United States in over 30 years.Now, beyond this, we have not seen a strong pipeline in the US on large scale nuclear plants, according to the World Nuclear Association. And for the US to triple its nuclear capacity from about 100 gigawatts currently, the nation would need to build about 200 gigawatts more capacity to meet the target.In our nuclear renaissance scenario, we assume only 50 gigawatts will be built, considering a couple of factors. So, first, clean energy options, such as wind and solar are becoming more viable; they're dropping in cost. And also, for new nuclear in the United States, we've seen significant construction delays and cost overruns for the large-scale nuclear plants. Now that said, there is still upside if we're able to meet the target in the US.And I think that's going to depend heavily on the development of small modular reactors or SMRs. I am optimistic about SMRs in the longer term. They're modular, as the name says. They're easier to design, easier to construct, and easier to install. So, I do think we could see some upside surprises later this decade and into the next decade.Tim Chan: And nuclear offers a unique opportunity to power Generative AI, which is accounting for a growing share of energy needs.Stephen Byrd: So, Tim, I was wondering how long it was going to take before we began to talk about AI.Nuclear power generators do have a unique opportunity to provide power to data centers that are located on site, and those plants can provide consistent, uninterrupted power, potentially without external connections to the grid. In the US, we believe supercomputers, which are essentially extremely large data centers used primarily for GenAI training, will be built behind the fence at one or more nuclear power plants in the US. Now these supercomputers are absolutely massive. They could use the power, potentially, of multiple nuclear power plants.Now just let that sink in. These supercomputers could cost tens of billions of dollars, possibly even $100 billion plus. And they will bring to bear unprecedented compute power in developing future Large Language Models.So, Tim, where does regulation factor into the resurgence of nuclear power or the lack of resurgence?Tim Chan: So, for the regulation, we focus a lot on the framework to provide financing: subsidies, sustainable finance taxonomies and also from the bond investor; although we note that taxonomies are still developing to offer dedicated support to nuclear. We expect nuclear financing under green bonds will become increasingly common and accepted. However, exclusion on nuclear still exists.Stephen Byrd: So finally, Tim, what are some of the key risks and constraints for nuclear development?Tim Chan: I would highlight three risks. Construction time, shortage of labor, and uranium constraint. These remain the key risks for nuclear projects to bring value creation.US and Europe had high profile delay in the past, which led to massive cost overrun. We are also watching the impacts of shortage of skilled labor, which is more likely in the developed markets versus emerging markets. And the supply of enriched uranium, which is mainly dominated by Russia.Stephen Byrd: Well, that's interesting, Tim. There are clearly some risks that could derail or slow down this nuclear renaissance. Tim, thanks for taking the time to talk.Tim Chan: Great speaking with you, Stephen.Stephen Byrd: 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.

29 Juli 20246min

Our head of Corporate Credit Research, Andrew Sheets, notes areas of uncertainty in the credit, equity and macro landscapes that are worth tracking as we move into the fall.----- 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 three risks we’re focused on for the third quarter.It's Friday, July 26th at 2pm in London.We like credit. But there are certainly risks we’re watching. I’d like to discuss three that are top of mind. The first is probably the mildest. Looking back over the last 35 years, August and September have historically been tougher months for riskier assets like stocks and corporate bonds. US High Yield bonds, for example, lose about 1 per cent relative to safer government bonds over August-September. That’s hardly a cataclysm, but it still represents the worst two-month stretch of any point of the year. And so all-else-equal, treading a little more cautiously in credit over the next two months has, from a seasonal perspective, made sense. The second risk is probably the most topical. Equity markets, especially US equity markets, are seeing major shifts in which stocks are doing well. Since July 8th, the Nasdaq 100, an index dominated by larger high-quality, often Technology companies, is down over 7 per cent. The Russell 2000, a different index representing smaller, often lower quality companies, is up over 11 per cent. So ask somebody – ‘How is the market?’ – and their answer is probably going to differ based on which market they’re currently in. This so-called rotation in what’s outperforming in the equity market is a risk, as Technology and large-cap equities have outperformed for more than a decade, meaning that they tend to be more widely held. But for credit, we think this risk is pretty modest. The weakness in these Large, Technology companies is having such a large impact because they make up so much of the market – roughly 40 per cent of the S&P 500 index. But those same sectors are only 6 per cent of the Investment grade credit market, which is weighted differently by the amount of debt somebody is issued. Meanwhile, Banks have been one of the best performing sectors of the stock market. And would you believe it? They are one of the largest sectors of credit, representing over 20 per cent of the US Investment Grade index. Put a slightly different way, when thinking about the Credit market, the average stock is going to map much more closely to what’s in our indices than, say, a market-weighted index. The third risk on our minds is the most serious: that economic data ends up being much weaker than we at Morgan Stanley expect. Yes, weaker data could lead the Fed and the ECB to make more interest rate cuts. But history suggests this is usually a bad bargain. When the Fed needs to cut a lot as growth weakens, it is often acting too late. And Credit consistently underperforms.We do worry that the Fed is a bit too confident that it will be able to see softness coming, given the lag that exists between when it cuts rates and the impact on the economy. We also think interest rates are probably higher than they need to be, given that inflation is rapidly falling toward the Fed’s target. But for now, the US Economy is holding up, growing at an impressive 2.8 per cent rate in the second quarter in data announced this week. Good data is good news for credit, in our view. Weaker data would make us worried. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

26 Juli 20243min