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Investing is all about choices, so what should investors know when choosing between holding a financial asset or cash?----- 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, January 27th at 2 p.m. in London. Investing is about choices. In any market at any moment, an investor always has the option to hold a financial asset, like stocks or bonds, or hold cash. For much of the last decade, cash yielded next to nothing, or less than nothing if you were in the Eurozone. But cash rates have now risen substantially. 12-month Treasury bills now yield about 2.5% more than the S&P 500. When an asset yields less than what investors earn in cash, we say it has negative carry. For the S&P 500 that carry is now the worst since August of 2007. But this isn't only an equity story. A U.S. 30 year Treasury bond yields about 3.7%, much less than that 12 month Treasury bill at about 4.5%. Buying either U.S. stocks or bonds at current levels is asking investors to accept a historically low yield relative to short term cash. Just how low? For a 60/40 portfolio of the S&P 500 and 30 year Treasury bonds the yield, relative to those T-bills, is the lowest since January of 2001. To state the obvious low yields relative to what you can earn in cash isn't great for the story for either stocks or bonds. But we think bonds at least get an additional price boost if growth and inflation slow in line with our forecasts. It also suggests one may need to be more careful about picking one's spots within Treasury maturities. For example, we think 7 year treasuries look more appealing than the 30 year version. For stocks, we think carry is one of several factors that will support the outperformance of international over U.S. equities. Many non-U.S. stock markets still offer dividend yields much higher than the local cash rate, including indices in Europe, Japan, Taiwan, Hong Kong and Australia. This sort of positive carry has historically been a supportive factor for equity performance, and we think that applies again today. Investing is always about choices. For investors, rising yields on cash are raising the bar for what stocks and bonds need to deliver. 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.
European equities have been outperforming U.S. stocks. What’s driving the rally, and will it continue?----- Transcript -----Welcome to Thoughts on the Market. I'm Graham Sacker, Head of Morgan Stanley's European Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the recent outperformance of European equities and whether this could be the start of a longer upturn. It's Thursday, January the 26th at 4 p.m. in London. After a tricky period through last summer, the fourth quarter of 2022 saw European equities enjoy their best period of outperformance over U.S. stocks in over 30 years. Such was the size of this rally that MSCI Europe ended last year as the best performing region globally in dollar terms for the first time since 2000. In addition, the relative performance of Europe versus U.S. stocks has recently broken above its hundred week moving average for the first time since the global financial crisis. We do not think this latter event necessarily signals the start of a multi-year period of European outperformance going forward, however we do think it marks the end of Europe's structural underperformance that started in 2008. When we analyze the drivers behind Europe's recent rally, we can identify four main catalysts. Firstly, the economic news flow is holding up better in Europe than the U.S., with traditional leading indicators such as the purchasing managers surveys stabilizing in Europe over the last few months, but they continue to deteriorate in the U.S. Secondly, European gas prices continue to fall. After hitting nearly $300 last August, the price of gas is now down into the $60's and our commodity strategist Martin Rats, forecasts it falling further to around $20 later this year. Thirdly, Europe is more geared to China than the U.S., both economically and also in terms of corporate profits. For example, we calculate that European companies generate around 8% of their sales from China, versus just 4% for U.S. corporates. And then lastly, companies in Europe have enjoyed better earnings revisions trends than their peers in the U.S., and that does tend to correlate quite nicely with relative price performance too. The one factor that has not contributed to Europe's outperformance is fund flows, with EPFR data suggesting that European mutual fund and ETF flows were negative for each of the last 46 weeks of 2022. A consistency and duration of outflows we haven't seen in 20 years, a period that includes both the global financial crisis and the eurozone sovereign debt crisis. While the pace of recent European equity outperformance versus the U.S. is now tactically looking a bit stretched, improving investor sentiment towards China and still low investor positioning to Europe should continue to provide support. In addition, European equities remain very inexpensive versus their U.S. peers across a wide variety of metrics. For example, Europe trades at a 29% discount to the U.S. on a next 12 month price to earnings ratio of less than 13 versus over 17 for the S&P. European company attitudes to buybacks have also started to change over the last few years, such that we saw a record $220 billion of net buyback activity in 2022, nearly double the previous high from 2019. At 1.7%. Europe's net buyback yield does still remain below the U.S. at around 2.6%. However, when we combine dividends and net buybacks together, we find that Europe now offers a higher total yield than the U.S. for the first time in over 30 years. For those investors who are looking to add more Europe exposure to their portfolios, first we are positive on luxury goods and semis. Two sectors in Europe that should be beneficiaries of improving sentiment towards China, and our U.S. strategists forecast that U.S. Treasury yields are likely to move down towards 3%. A move lower in yields should favor the longer duration growth stocks, of which luxury and semis are two high profile ones in Europe. Secondly, we continue to like European banks, given a backdrop of attractive valuations, high cash returns and superior earnings revisions. Third, we prefer smaller mid-caps over large caps given that the former traditionally outperform post a peak in inflation and in periods of euro currency strength. Our FX strategists expect euro dollar to rise further to 115 later this year. The bottom line for us is that we think there is a good chance that the recent outperformance of Europe versus U.S. equities can continue as we move through the first half of 2023. 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. 
Last week, the U.S. Treasury hit the debt ceiling. How will markets respond as Congress decides how to move forward? Chief Cross-Asset Strategist Andrew Sheets and Head of Global Thematic and Public Policy Research Michael Zezas discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's Chief Cross-Asset Strategist. Michael Zezas: And I'm Michael Zezas, Head of Global Thematic and Public Policy Research. Andrew Sheets: And on this special episode of the podcast, we'll be discussing the U.S. debt ceiling. It's Wednesday, January 25th at 2 p.m. in London. Michael Zezas: And 9 a.m. in New York. Andrew Sheets: Mike, it's great to be here with you. I'm sure many listeners are familiar with the U.S. debt ceiling, but it's still probably worthwhile to spend 30 seconds on what it is and what hitting the debt ceiling really means. Michael Zezas: Well, in short, it means the government hit its legal limit, as set by Congress, to issue Treasury bonds. And when that happens, it can't access the cash it needs to make the payments it's mandated to make by Congress through appropriations. Hitting this limit isn't about the U.S. being unable to market its bonds, it's about Congress telling Treasury it can't do that until Congress authorizes it to have more bonds outstanding. Now, we hit the debt ceiling last week, but Treasury can buy time using cash management measures to avoid running out of money. And so what investors need to pay attention to is what's called the X date. So that's when there's actually not enough cash left on hand or coming in to pay all the obligations of the government. At that point, Treasury may need to prioritize some payments over others. That X date, it's a moving target and right now the estimates are that it will occur sometime this summer. Andrew Sheets: So I often see the debt ceiling and government shutdowns both used as reference points by investors, but the debt ceiling and government shutdowns are actually quite different things, right?Michael Zezas: That's right. So take a step back, the easiest way to think about it is this: Congress makes separate laws dictating how much revenue the government can collect, so taxes, how much money the government has to spend, and then how much debt it's allowed to incur. So within that dynamic, a debt ceiling problem is effectively a financing problem created by Congress. This problem eventually occurs if Congress' approve spending in excess of the tax revenue it's also approved, that makes a deficit. If, in that case, if Congress hasn't also approved a high enough level of debt to allow Treasury to meet its legal obligation to make sure Congress's approved spending gets done. And if then you also pass the X date, you're unable to fund the full operations of the government, potentially including principal and interest on Treasury bonds. But alternately a government shutdown, that's a problem if Congress doesn't authorize new spending. So if Congress says the government's authorized to spend X amount of dollars until a certain date, after that date, the government can't legally spend any more money with the exception of certain mandated items like principal and interest and entitlement programs. So in that case, the government shuts down until Congress can agree on a new spending plan.Andrew Sheets: So, Mike, let's bring this forward to where we are today in the current setup. How would you currently summarize the view of each camp when it comes to the debt ceiling? Michael Zezas: Well, Republicans say they won't raise the debt ceiling unless it comes with future spending cuts to reduce the budget deficit. Democrats say they just want a clean, no strings attached hike to the debt ceiling because the debate about how much money to spend is supposed to happen when Congress passes its budget, not afterwards, using the government's creditworthiness as a bargaining chip. But these positions aren't new. What's new here are two factors that we think means investors need to take the debt ceiling risk more seriously than at any point since the original debt ceiling crisis back in 2011. The first factor is that like in 2011, the debt ceiling negotiation is happening at a time when the U.S .economy is already flirting with recession. So any debt ceiling resolution that ends with reduced government spending could, at least in the near-term, cause some market concern that GDP growth could go negative. The second factor is the political dynamic, which is trickier than at any point since 2011. So Democrats control the White House and Senate, where Republicans have a slim majority in the House. And House Speaker Kevin McCarthy, he's in a tenuous position. So per the rules he agreed to with his caucus, any one member can call for a vote of no confidence to try and remove him from the speakership. And public reports are that he promised he wouldn't allow the debt ceiling to be raised without spending cuts. So the dynamic here is that both Republicans and Democrats are motivated to bring this negotiation to the brink. And because there's no obvious compromise, they'll have to improvise their way out. Andrew Sheets: So this idea of bringing things to the brink Mike, is I think a really nice segue to the next thing I wanted to discuss. There is a little bit of a catch 22 here where markets currently seem relatively relaxed about this risk. But the more relaxed markets are when it comes to the debt ceiling, the less urgency there might be to act, because one of the reasons to act is this risk that a default for the world's largest borrower would be a major financial disruption. So it's almost as if things might need to get worse in order to catalyze a resolution for things to get better. Michael Zezas: Yeah, I think that's right. And as you recall, that's pretty much what happened in 2011. The debt ceiling was a major story in May and June with extraordinary measures set to run out in early August. But markets remained near their highs until late July on continued hope that lawmakers would work something out. And this dynamic has been repeated around subsequent debt ceiling crisis over the last 11 or 12 years, and markets have almost become conditioned to sort of ignore this dynamic until it gets really close to being a problem. Andrew Sheets: And that's a great point, because I do think it's worth going back to 2011, as you mentioned, you know, there you had a situation by which you needed Congress and the White House to act by early August. And then it was only then, at kind of the last moment, that things got volatile in a hurry. You know, over the course of two weeks, starting in late July of 2011, the U.S. stock market dropped 17% and U.S. bond yields fell almost 1%. Michael Zezas: Right. And the fact that government bond yields fell, which meant government bond prices went up as the odds of default went up, it's a bit counterintuitive, right? Andrew Sheets: Yes. I think one would be forgiven for thinking that's an unusual result, given that the issue in question was a potential default by the issuer of those bonds, the U.S. government. But, you know, I actually think what the market was thinking was that the near-term nonpayment risk would be relatively short lived, that maybe there would be a near-term disruption, but Congress and the government would eventually reach a conclusion, especially as market volatility increased. But that the economic impact of that would be longer lasting, would lead to weaker growth over the long term, which generally supports lower bond yields. So, you know, I think that's something that's worth keeping in mind when thinking about the debt ceiling and what it means for portfolios. The most recent major example of the debt ceiling causing disruption was equities lower, but bond prices higher. Michael Zezas: So, Andrew, then, given that dynamic, is there really anything investors can do right now other than watch and wait and be prepared to see how this plays out? Andrew Sheets: Well, I do think 2011 carries some important lessons to it. One, it does say that the debt ceiling is an important issue. It really mattered for markets. It caused really large moves lower in stocks, in large moves higher in bond prices. But it also was one where the market didn't really have that reaction until almost the last minute, almost up until a couple of weeks before that final possible deadline. So I think that suggests that this is an important issue to keep an eye on. I think it suggests that if one is trying to invest over the very short term, other issues are very likely to overwhelm it. But I also think this generally is one more reason why we're approaching 2023, relatively cautious on U.S. assets. And we generally expect Bonds to do well now. Now, the debt ceiling is not the primary reason for that, but we do think that bonds are going to benefit from an environment of continued volatility and also slower growth over the course of this year. On a narrower level, this is an event that could cause disruption depending on what the maturity of the government bond in question is. And I think we've seen in prior instances where there's been some question over delays or payment, that delay matters a lot more for a 3 month bond that is expecting to get that money back quite quickly than a 10 year or a 30 year bond that is much more of an expression of where the market thinks interest rates will be over a longer period of time. So, again, you know, I think if we look back to 2011, 2011 turned out to be quite good for long term bonds of a lot of different stripes, but it certainly could pertain to some more disruption at the very front end of the bond market if that's where you happen to be to be investing. Andrew Sheets: Mike, thanks for taking the time to talk. Michael Zezas: Andrew, thanks so much for talking. Andrew Sheets: And thanks for listening. If you enjoy Thoughts on the Market, please leave
As economic pressures continue to drive consumption in the U.S., how will the health of the economy influence the soft lines industry? Head of Retail and Consumer Credit for Fixed Income Research Jenna Giannelli and U.S. Soft Lines Retail Equity Analyst Alex Straton discuss----- Transcript -----Jenna Giannelli: Welcome to Thoughts on the Market. I'm Jenna Giannelli, Head of Retail and Consumer Credit within Morgan Stanley's Fixed Income Research. Alex Straton: And I'm Alex Straton, Morgan Stanley's U.S. Soft Lines Retail Equity Analyst. Jenna Giannelli: And on this special episode of Thoughts on the Market we'll discuss soft lines from two different but complementary perspectives, equity and corporate credit. It's Tuesday, January 24th at 10 a.m. in New York. Jenna Giannelli: Our economists here at Morgan Stanley believe that tighter monetary policy and a slowing labor market will be the key drivers of consumption in the U.S. this year. Against this still uncertain backdrop where we're cautious on the health of the U.S. consumer, we're at an interesting moment to think about the soft lines industry. So let's start with the equity side. Alex, you recently said that you see 2023 as a 'tale of two halves' when it comes to soft lines. What do you mean by that and when do you see the inflection point? Alex Straton: So, Jenna, that's right, we are describing 2023 as a 'tale of two halves'. That's certainly one of the taglines we're using, the other being 'things are going to go down before they go up'. So let's start with a 'tale of two halves'. I say that because in the first half what retailers are facing are harder compares from a PNL perspective, an ongoing excess inventory overhang and likely recessionary conditions from a macro perspective. On top of that, what we've got is 2023 street EPS estimates sitting about 15% too high across our coverage. As we know, earnings revisions are the number one driver of stock prices in our space. So if we have negative revisions ahead, it's likely that we're also going to have our stocks move downwards, hence the bottom I'm calling for some time here in the first quarter, while that may seem like a pretty negative view to start the year, the story is actually very different when we move to the back half of the year. Hence, the 'tale of two halves' narrative and the 'down before up'. So what do I mean by that? In the back half, really, what we're facing is retailers with easier top line compares and returns that should enjoy year over year margin relief. That's on freight, cotton, promotions, there's a number of others there. On top of that, what we've got is inventory that should be mostly normalized. And then finally a recovering macro, I think with this improving backdrop and the fact that our stocks are the quintessential early cycle outperformers, they could quickly pivot off these bottoms and see some nice gains. Jenna Giannelli: Okay, Alex, that all makes a lot of sense. So what are the key factors that you're watching for to know when we've hit that bottom? Alex Straton: So on our end, it's really a few things. I think first it's where 2023 guidance comes in across our space. And, I think secondly, its inventory levels. Cleaner levels are essential for us to have a view on how long this margin risk we've seen in the back half of 2022 could potentially linger into this year. And then really finally, it's a few macro data points that will confirm that, you know, a recession is here, an early cycle is on the horizon. Jenna Giannelli: I mean, look, you touched on a bit just on inventory, but last year there was a lot of discussion around the inventory problem, right, which was seen as a key risk to earnings with oversupply, lagging demand weighing on margins. Where are we, in your view, on this issue now? And specifically, what is your outlook on inventory for the rest of the year? Alex Straton: So look, retailers and department stores, they made really nice progress in the third quarter. They worked levels down by about a little over ten points. But then from the preannouncements we had at ICR and using our work around our expectations for inventory normalization, it really seems like retailers might be able to bring that down by another ten points in the fourth quarter. But even though, you know, this rate of trend and clean up is good and people are getting a little bullish on that, I wouldn't say we're clean by any means. Inventory  to forward sales spreads are still nearly just as wide as they were at the peak of last year. And to give people a perspective there, what a retailer wants to be to assume that inventory levels are clean is that the inventory growth should be in line with forward sales growth. But I think looking ahead, you know, department stores could be in good shape as soon as this upcoming quarter, that's a fourth quarter, so really remarkable there. It'll then probably be followed by the specialty retailers in the first quarter. And then finally it'll be most of the brands in the second quarter or later. The one exception though, is the off price. And these businesses have suffered from arguably the opposite problem in the last couple of years, which is no inventory because of all the supply chain problems and the fact that it's just become this year when inventory’s been realized as a problem. So let me turn it over to you, Jenna, and shift our focus to high yield retail. The high yield retail market is often fertile ground for finding equity-like returns, and you believe there are a number of investment opportunities today. So tell me, what's your view on the high yield retail sector and what are the key factors that are informing that view? Jenna Giannelli: So, look, we have a very nuanced and very bottoms up company specific approach to the sector, we're looking at cash flow, we're looking at liquidity, we're looking at balance sheets and all in all in the whole for 23 things look okay. And so that's our starting point. So going into 2023, we're taking a slightly more constructive approach that there are some companies in certain categories, in certain channels up in quality that actually could provide nice returns for investors. So from a valuation standpoint, you know, look, I think that the primary drivers of what frame our view are very similar to yours, Alex. It really comes down to fundamentals and valuation. From the valuations and retail credit, levels are attractive versus historical standpoints. So to give some context, the high yield market was down 11% last year, high yield retail was down 21%. And this significant underperformance is still despite the fact that the overall balance sheet health of the average credit quality right now in this sector is better than in the five years leading up to COVID. So essentially, simply put, it means you're getting paid more to invest in this sector than you would have historically, despite balance sheets being in a generally better place. You know, from a fundamental standpoint, we fully incorporate caution on the consumer in 2023. We do take a slightly more constructive view on the higher end consumer. Taking that all together, you know, valuation’s more attractive, earnings outlook is actually neutral when we look at the full 2023 with pressure in the first half and expected improvement in the second half. Alex Straton: All right, Jenna, that's a helpful backdrop for how you're thinking about the year. I think maybe taking a step back, can you walk us through what the framework is that you use as you assess these companies more broadly? Jenna Giannelli: Sure. So we use a framework that we've dubbed our five C's, and this is really our assessment of the five key factors that allow us to rank order our preference from, you know, favorite to least favorite of all the companies in our coverage universe. So when we think about it, what are those five C's? What are these most important factors? They're content, they're category, channel, catalysts, and compensation. You know, in the case of content, this is probably the most intangible, but we're looking at brand value, brand trajectory and how that company's product really speaks to the consumer. Oftentimes when I talk to investors we're discussing: does it have an identity, what is the company and who do they and what do they represent? In the category bucket we're assessing whether the business is in a category that's growing or outperforming, like beauty is one that we've been very constructive on, or if it's heavily concentrated in mid-tier apparel, which has been, you know, underperforming. In the case of channel, look, we like diversification. That's the primary driver. So those that offer their products everywhere, similar to what the consumer would want. When we're thinking about catalysts for a company, as this is very important on the kind of the shorter term horizon, what are the events that are pending, whether with, you know, company management acquisition or restructuring related. And then of course, finally on compensation, this may be the more obvious, but are we getting paid appropriately versus the peer set? And in the context of the, you know, the risk of the company? And if you don't rank highly, at least in most or all of those boxes, we're probably not going to have a favorable outlook on the company. Alex Straton: Now, maybe using these five C's and applying them across your space, what are the biggest opportunities that you're seeing? Jenna Giannelli: So we definitely are more constructive on the categories, like a beauty or in casual footwear, right? Companies that fall in that arena. Or again, that have exposure to more luxury, luxury as a category. Look, there's been a lot of debate around the high end consumer and whether we're going to see, ya know, start to see softening there. Within our recommendations, we are less constructive on those names that are heavily apparel focused. Activewear is actually a negative, becaus
While there seemed to be a consensus that U.S. Equities will struggle through the first half of the year before finishing strong, views are now varying on the degree and timing of a potential recession.----- 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, January 23rd at 11am in New York. So let's get after it. Coming into this year, the number one investor concern was that everyone seemed to have the same outlook for U.S. equities - a tough first half followed by a strong finish. Views varied on the degree of the drawdown expected and magnitude of the rebound, but a majority expected a U.S. recession to begin sooner rather than later. Fast forward just a few weeks and the consensus view has shifted materially, particularly as it relates to the recession view. More specifically, while more investors are starting to entertain a soft landing for the economy, many others have pushed out the timing of a recession to the second half of the year. This change is due in part to China's reopening gaining steam and the sharp decline in European natural gas prices. While these are valid considerations for investors to modify their views, we think that price action has been the main influence. The rally this year has been led by low quality and heavily shorted stocks. It's also witnessed a strong move in cyclical stocks relative to defensive ones. This cyclical rotation in particular is convincing investors they are missing the bottom and they must reposition. Truth be told, it has been a powerful shift, but we also recognize that bear markets have a way of fooling everyone before they're done. The final stages of the bear are always the trickiest. In bear markets like last year, when just about everyone loses money, Investors lose confidence. They question their process as the price action and cross-currents in the data create a hall of mirrors. This hall of mirrors only increases the confusion. This is exactly the time one must trust their own work and ignore the noise. Suffice it to say we're not biting on this recent rally because our work in process is so convincingly bearish on earnings. Importantly, our call on earnings is not predicated on the timing of a recession or even if one occurs this year. Our work continues to show further erosion with the gap between our model and the forward estimates as wide as it's ever been. Could our model be wrong? Of course, but given its track record, we don't think it will be wrong directionally, particularly given the collection of leading series and models we published that point to a similar outcome. This is simply a matter of timing and magnitude, and we think the timing is imminent. We find the shift in investor tone helpful for our call for new lows in the S&P 500, which will finish this bear market later this quarter or early in the second quarter. Getting more specific, our forecasts are predicated on margin disappointment and the evidence in that regard is increasing. When costs are growing faster than sales, margins erode. This is very typical during any unexpected revenue slowdown. Recessions in particular lead to significant negative operating leverage for that very reason. In other words, sales fall off quickly and unexpectedly, while costs remain sticky in the short term. Inventory bloating, less productive headcount and other issues are the primary culprits. This is exactly what is happening in many industries already, and this is without a recession. It's also right in line with our forecast and the thesis that companies would regret adding costs so aggressively a year ago when sales and demand were running so far above trend. Bottom line, after a very challenging 2022, many investors are still bearish fundamentally, but are questioning whether negative fundamentals have already been priced into stocks. Our view has not changed as we expect the path and earnings in the U.S. to disappoint the consensus, expectations and current valuations. In fact, we welcome the change in sentiment positioning over the past few weeks as a necessary development for the last stage of this bear market to play out. Bear markets are like a hall of mirrors designed to confuse investors and take their money. We advise staying focused on the fundamentals and ignoring the false signals and misleading reflections. 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.
The financial landscape is filled with predictions about what comes next for markets, but how do investors use these forecasts to put a portfolio together?----- 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, January 20th at 2 p.m. in London. The financial landscape is filled with predictions about what markets will do. But how are these predictions used? Today, I want to take you through a quick journey through how Morgan Stanley research thinks about forecasting, and how those numbers can help put a portfolio together. Forecasting is difficult and as such it's always easier to be more vague when talking about the future. But when we think about market expectations, being specific is essential. That not only gives an expectation of which direction we think markets will go, but by how much and over a specific 12 month horizon. Details here can also really matter. For example, making sure you add dividends back to equity returns, adjusting bond forecasts for where the forwards are, and thinking about all asset classes in the same currency. In this case, U.S. dollars. Consistency in assumptions is another factor that is difficult but important. We try to set all of our forecasts to scenarios from our global economics team. That is more likely to produce asset class returns that are consistent with each other and to the economy we expect. With these returns in hand, we can then ask, "what's an optimal asset allocation based on our forecasts?" Now, everyone's investment objectives are different. So in this case we'll define optimal as a portfolio that will generate higher returns than a benchmark with a similar or better ratio of return to volatility. This type of analysis will consider expected return and historical risk, but also how well different asset classes diversify each other. As Morgan Stanley's forecasts currently stand this approach suggests U.S. equities are relatively unattractive. Sitting almost exactly at the year end price target of my colleague Mike Wilson, our U.S. Equity Strategist, expected returns are low, while volatility is high and U.S. stocks offer minimal benefits for diversification. Stocks in Japan and emerging markets look better by comparison. But the real winner of this approach continues to be fixed income. Morgan Stanley's rate strategists in the U.S. and Europe continue to think that moderating inflation in 2023 will help bond yields either hold around current levels, or push lower, resulting in returns that are better than equities with less volatility. Our expected returns for emerging market bonds are also higher, with less volatility than U.S. and European stocks. Forecasting the future is difficult, and it's very possible that either our market forecasts or the economic assumptions to back them will be off to some degree. Still, considering what is optimal based on these best estimates, is a useful anchor when thinking about strategy. And for the moment, this still favors bonds over stocks. 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.
With housing data from the last few months of 2022 coming in weaker than expected, what might be in store for mortgage investors? Co-Heads of U.S. Securitized Products Research Jim Egan and Jay Bacow 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 Thursday, January 19th at 11 a.m. in New York. Jay Bacow: So, Jim, the housing data hasn't been looking all that great recently. We've talked about this bifurcated outlook for the U.S. housing market, still holding that view? Jim Egan: So to catch people up, the bifurcated housing narrative was between housing activity. And by that we mean sales and housing starts and home prices. We thought there was going to be a lot more weakness in sales and starts at the end of 2022 and throughout 2023, then home prices, which we thought would be more protected. Since we came out with that outlook, it's safe to say that sales have been materially weaker than we thought they'd be. To put that into a little bit of context, existing home sales for the most recent month of data, which was November, showed the largest year over year decrease for that time series since the early 1980s. Pending home sales, we only have that data going back to 2001, but pending home sales just showed their weakest November in the entire history of that time series, so weaker than it was during the great financial crisis. Now, Jay, when we talk about those kind of weaker than anticipated sales volumes, what does that mean for your markets? Jay Bacow: Right. So while homeowners clearly are going to care about home prices, mortgage investors care more about the housing activity. And they care about that because that housing activity, those home sales, that results in supply to the market and it actually results in supply to the market from two different sides. There's the organic net supply from home sales. And then furthermore, because the Fed is doing QT, the faster the pace of home sales, the more the Fed balance sheet runoff is. And so as those home sales numbers come down, you get less supply to the market, which is inarguably good for mortgage investors. Now, the problem is mortgage spreads have repriced to reflect that at this point. Jim Egan: Now Jay, a lot of things have repriced. Jay Bacow: Right. And I think the question now is, is that going to keep up? But turning it over to you, what's causing this slowdown in home sales? And do we think that's going to continue? Jim Egan: I think in a word, it's affordability. A lot of the underlying premises behind our bifurcated narrative, we still see those there they're just impacting the market a little bit more than we thought they would. From an affordability perspective, and we've said this on this podcast before, the monthly mortgage payment as a percentage of household income has deteriorated more over the past year than really any year we have on record. From a numbers perspective, that payment's gone up over $700. That's a 58% increase. That's making it more difficult for first time buyers to buy homes and therefore pulling sales activity down. But where the bifurcation part of this narrative comes from, a lot of current homeowners have very low, call it maybe 3-3.5%, 30 year fixed rate mortgages. They're not incentivized to list their homes in this current environment and we're seeing that. Listing volumes are close to 40 year lows. In a month in which sales fall as sharply as they just did, we would expect months of supply at least to move higher and that roughly stayed flat. And so you have this lack of inventory, people aren't selling their homes, that means they're also not buying a home on the follow which pulls sales volumes down, leading to some of those numbers we talked about on top of just how long it's been since we've seen sales fall as sharply as they have. But on the other side of the equation, that's also keeping home prices a little bit more protected. Jay Bacow: Okay. So you mentioned affordability is impacting home sales, but then what's happening to actual home prices? Are they holding up then? Jim Egan: We think they will now. Don't hear what I'm not saying, that doesn't mean that home prices keep climbing. It just means that the pace with which they're going to slow down or the pace with which they're going to fall isn't as substantial as what we're going to see on the activity front. Now year over year HPA most recently up 9.2%. We think in the next month's print, that's going to slow to a little bit below 8% down to 7.9%. On a month over month basis from peak in June of 2022, home prices are off 3%. We think they'll fall a further 4% in 2023. But to kind of put some guardrails around that bifurcation narrative, that drop only brings us to the fourth quarter of 2021. That's 30% above where home prices were onset of the pandemic in March of 2020. On the sale side, our base case was that we were going to fall back to 2013 levels of transactions. And given how data has come in since then, it looks like we're heading lower than that. Jay Bacow: All right. So we think housing activity is going to continue to fall, but that slowdown in housing activity means that home prices, while seeing the first year on year decline since 2012, are going to be well supported. Jay Bacow [00:04:51] Jim, always a pleasure 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.
At a recent meeting of analysts from around the globe, we identified three central transitions for 2023 that may help investors shift towards a focus on long-term trends as opportunities.----- 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, January 18th at 10 a.m. in New York. What do you get when 45 global research analysts gather in a room for two days to debate secular market trends? A plan. In particular, a plan to deal with a world where key underpinnings of the global political economy are changing rapidly. For investors, we think that means concentrating on multi-year secular trends as an opportunity. In markets where short-term focus has become the norm, it stands to reason that there's less competition and more potential outperformance to be earned by analyzing the market impacts of longer-term trends. That's why we recently gathered analysts from around the globe to identify the key secular themes that Morgan Stanley research should focus on this year. The agenda for our meeting included over 30 topics, but the discussion gravitated around a smaller subset of themes whose potential market impact was substantial, but perhaps beyond what analysts could plausibly perceive or analyze individually. Understanding these three global transitions appeared central to the questions of inflation, interest rates and the structure of markets themselves. The first is rewiring global commerce for a multipolar world, one with more than one meaningful power base and commercial standard, where companies and countries can no longer seek efficiencies through global supply chains and market access without factoring in geopolitical risks. We've spoken much about that in this space, but our analysts believe the practical implications of this trend are not yet well understood. The second is decarbonization. While this isn't a new theme, we think investors need to shift from debating whether it will be meaningfully attempted to sizing up the impact of that attempt. After all, 2022 saw both U.S. and European policymakers putting the power of government behind decarbonization. Now we'll focus on helping investors grapple with both the positive and negative market impacts of this transition, which the International Energy Agency estimates could cost about $70 trillion over the next 30 years. Identifying the companies, sectors and macro markets that will benefit, or face fresh challenges, is thus essential work. Finally, we'll remain focused on tech diffusion. Once again, not a new theme, but what is new is the speed and breadth with which tech diffusion can impact sectors that were previously untouched. Fragmented industries or those with high regulatory barriers look poised for a multi-year transition via tech diffusion. Opportunities may appear in finance, health care and biopharma. We expect the next five years of tech diffusion to move meaningfully faster than the last five, and so we'll focus on delivering important market related insights. So, you'll be hearing more from us over the course of 2023 on these three transitions and their impacts on markets. 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.
At the start of each new year, we identify 10 overarching themes for the year and beyond. So what should investors be keeping an eye on in the coming months?----- Transcript -----Welcome to Thoughts on the Market. I'm Ed Stanley, Morgan Stanley's Head of Thematic Research in Europe. Along with my colleagues, bringing you a variety of perspectives, today I'll be discussing 10 key themes for 2023. It's Tuesday, January the 17th at 2 p.m. in London. At the start of the New Year, we identify 10 overarching, long-term themes that we believe will command investor attention throughout the year and beyond. If you're a regular listener to the show, you may have heard my colleagues and I discussing some of these topics over the past year. We will certainly revisit them in 2023 as we develop new insights, but let me offer you a roadmap to navigate these themes in the coming months. First, company earnings and margins are likely to come under pressure this year as pricing power declines and costs remain sticky. Both the U.S. and Europe look at risk from this theme. The S&P 500 earnings will likely face significant pressure and enter an earnings recession, and Europe earnings similarly will likely fall 10%. Second is inflation. Last year we flagged that inventory had grown sharply, while demand, especially demand for goods, is falling. In 2023, companies will need to decide how they want to handle that excess inventory, and we believe many will turn to aggressive discounting. Up next is China. We've talked a lot over the last few months about China's expected reopening, and we believe a V-shaped recovery in China's growth is now likely, given the sudden change in prior COVID zero policy. We expect a 5.4% GDP growth for China in 2023. Our fourth theme is ESG. We think that what we call ESG rate of change, i.e. companies that are leaders in improving environmental, social and governance metrics, will be a critical focus for investors looking to identify opportunities that can both generate alpha on the one hand and ESG impact on the other. Next, in Q4 last year, you may have heard us talk about Earthshots, which is our fifth theme. These are radical technological decarbonization accelerants or warming mitigants. Clean tech funding is one of the most resilient segments in venture, and breakthroughs are becoming more frequent. We're keeping a close eye on the key technologies that we think will hold the greatest decarbonization potential in 2023 and beyond. Sixth, we're in the upswing of unicorns, i.e. privately held startup companies with a valuation over $1 billion, needing to re raise capital to maintain operations and growth. In the absence of unicorn consolidation, we expect money to flow out of public equities to support or compensate for the weakness in private investments. This will be the year of the down round, in our view, where companies need to raise additional funds at lower valuations than prior rounds. But also we expect it to be a year of opportunity for crossover investors and a potential reopening of the IPO market. Next, I've already mentioned our China forecasts, but we are also in the early innings of the "India Decade", which is our seventh theme. India has the conditions in place for an economic boom fueled by offshoring, investment in manufacturing, the energy transition and the country's advanced digital infrastructure. This is an underappreciated multi-year theme, but importantly one that is gathering momentum right now. Our other regional theme to watch this year is Saudi Arabia, which is also undergoing an unprecedented transformation with sweeping social and economic reforms. With about $1 trillion in "gigaproject" commitments, and rapid demographic shifts, it's our eighth big theme. And one that we think could easily leave people behind given the blistering speed of change. Penultimately, with the emergence of ChatGPT, the future of work is set to be further disrupted. We believe that we are on a secular trajectory towards the workforce, particularly the younger Gen Z, entering what we call the "multi-earner era" - one where workers pursue multiple earning streams rather than a single job. There are a vast array of enabler stocks for this multi-year era, in our view.  And finally, last but not least, we believe obesity is the "new hypertension" and that investing in obesity medication is moving from a linear secular theme to an exponential one, with social media creating a virtuous feedback loop of education, word of mouth, and heightened demand for weight loss drugs. So that's it. Hopefully we've given you some thought provoking macro, micro, regional and ESG ideas for the year ahead. Thanks for listening. If you enjoy the show, please leave a review on Apple Podcasts and share Thoughts on the Market with a friend or a colleague today.
One of the frequent questions regarding Emerging Markets is whether outperformance will hold for the short term or the long term. So what factors should investors consider when evaluating the cross asset performance of EM?----- 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, January 13th at 2 p.m. in London. A common question when talking about almost any market is whether the view holds for the short term or the long term. Call it a question of whether to "rent" versus "own". Is this a strategy that could work over the next six months or is it geared to the next six years? This question comes up most frequently when we discuss emerging market or EM assets. We like EM on a cross-asset basis. We think equities in EM outperform those in the U.S. We think EM currencies outperform the U.S. dollar and the British pound. And we think EM sovereign bonds perform well on an outright basis and also relative to U.S. high yield. Several factors underlie this positive view. First, as we've discussed in this program before, a number of key themes for 2023 look like the mirror image of 2022. Last year saw U.S. growth outperform China, inflation rise sharply and central banks hike aggressively, a combination that was pretty tough in emerging market assets. But this year we see growth in China accelerating while the U.S. slows, inflation falling and central banks pausing, a reversal that would seem much better for EM. And this is all happening at a time when EM assets still enjoy a valuation advantage. Emerging market equities, currencies and sovereign bonds all still trade at larger than average discounts to their U.S. peers. All of that supports the near-term case for outperformance in emerging markets, in our view. But what about the longer term story? Here we admit there are still some uncertainties. On one hand, there are some countries where there's a quite positive long run outlook in the eyes of my research colleagues. I'd highlight Mexico here, a country that we think could be a major long term beneficiary of U.S. companies looking to shorten supply chains and bring more production back from Asia. But there are also major long term uncertainties, especially related to earnings power. The case for EM equities is often based around the idea that you get the higher growth of the developing world at lower valuations, an attractive combination that offsets the higher political and economic volatility. But as my colleague Jonathan Garner, Head of Asia and Emerging Market Equity Strategy, has noted, earnings for the EM market have been surprisingly weak over the long run and are still at levels similar to 2010. Growth so far has been elusive. Uncertainty around that long term earnings power is one of several reasons that it may be too early to say that EM will be a multiyear outperformer. But for the time being, we think those longer term concerns will be secondary to near-term support and continue to expect cross-asset outperformance from EM assets this year. 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.
At this week’s North American Leaders Summit, the U.S., Canada and Mexico committed to boosting the semiconductor industry in another key step on the path towards a multipolar world.----- 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 Thursday, January 12th at 10 a.m. in New York. This week, the presidents of the United States, Canada and Mexico gathered for the North American Leaders Summit. For investors, the key result was a commitment by the countries to work together to boost the semiconductor industry in North America. While the practical details of this commitment will matter greatly, the agreement in principle underscores a few key themes for investors. The first is that the trend toward a multipolar world is ongoing, one where geopolitics increase commercial barriers and create the need for multiple supply chains, product standards and economic ecosystems. So countries and companies must rewire their own approach to production in order to cope. This semiconductor commitment is the result of a determination by the U.S. that it's in its own interest to develop a substantial and secure semiconductor industry in its own backyard, in order to mitigate supply chain risks to key industries like automobile production. In this way, the country's economy is less susceptible to overseas disruptions. And the U.S. was likely able to achieve this commitment with its neighbors by enacting the CHIPS+ legislation with bipartisan support. You may recall that legislation appropriated money to attract the construction of semiconductor facilities in the U.S. This brings us to our second point, which is that this commitment underscores the opportunity for Mexico to benefit from U.S. led nearshoring. As we've discussed on this podcast with our Mexico strategist, Nik Lippman, Mexico has a sizable manufacturing labor force and proximity to the U.S. For semiconductors, that means Mexico could potentially be a supplier or at least a supplier of the goods materials that go into fabrication. It's one of the key reasons that Nik has upgraded Mexico stocks to overweight. So in short, this meeting was another step on the path toward a multipolar world, a key trend we're tracking in 2023. 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.
In 2022 it seemed like there was nowhere to hide from the negative returns in traditional investing. But if we look to quantitative strategies, we may find more flexibility for the year ahead.----- Transcript -----Vishy Tirupattur Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's head of fixed income research and director of Quantitative Research.Stephan Kessler And I'm Stephan Kessler, Morgan Stanley's global head of Quantitative Investment Strategies Research.Vishy Tirupattur And on this special episode of the podcast, we will discuss the return of quantitative investing. It's Wednesday, January 11th, at 10 a.m. in New York.Stephan Kessler And 3 p.m. in London.Vishy Tirupattur Stephan, 2022 was a pretty dismal year for traditional investment strategies across various asset classes. You know, equities, credit, government bonds—all of them had negative total returns for the year. And in fact, for traditional investment strategies, there really was nowhere to hide. That said, 2022 turned out to be a pretty decent year for systematic investing or factor investing or quantitative investing strategies. So can you start us off by giving us an overview of what systematic factor strategies are and how they performed in 2022 versus traditional investment strategies?Stephan Kessler Absolutely. So, if you look at quant strategies, or systematic strategies, key is 'systematic.' So we look at repetitive, persistent patterns in the markets which can be beneficial for investors. Usually they're data driven. So we look at data which can be price data, fundamental data like economic growth data and the like, which then gives us signals for our investment. Those strategies tend to have low long-term exposures to traditional markets such as equities and fixed income. So they work as diversifiers and the rationale for why they work comes from academic theory, by and large, where we look at risk premia, we look at structural or behavioral patterns that are well known in the academic world. So common strategies that investors apply can be carry investing, for example. So we benefit here from interest rate differentials where we borrow, for example, money in low yielding regions or currencies, and then we invest in high yielding currencies, clipping the difference in the interest rate between these regions. Value investing is another important style that investors implement, where they simply identify undervalued investments, undervalued assets by looking at price to book ratios, by looking at dividend yields, for example, to identify what appears to be cheap. Momentum investing is probably the third most important strategy here, which is where we benefit from the price trends in markets which we know to be persistent. So those are the, I think, the important styles—carry, value and momentum—but there are also more complex strategies where we model and identify very minute details in markets. We go really deep into the functionality of markets. Then the final point I would make is that these strategies tend to be long-short so they are not long biased as traditional investing is, but they can go really both directions in terms of their positioning.Vishy Tirupattur Investors often ask how quant strategies, that are typically predicated on historical data patterns, can handle volatile market environments with very few historical precedents. 2022 was anything but normal. Don't such market aberrations break quant strategies?Stephan Kessler That's a really good question. If you look at it from the higher level, it does seem like this was a unique market that actually should be challenging for systematic strategies which look at historical patterns. When you dig a little bit deeper, it becomes actually more nuanced. So the strong outperformance of quant in '22, we think is driven by the different catalysts that we saw in the markets. So for example, the tightening by central banks led to substantial and durable macro trends that can be captured by trend following. We saw a reemergence of interest rates across the globe through this monetary policy, which sparked the revival of carry investing. And then equity value investing reemerged as higher rates forced investors to focus more on fundamental valuations, and that led to an increase in efficiency of the value factor.Vishy Tirupattur Will any of the performance patterns that you saw in 2022 carry over into 2023? Or do you think the investment landscape for quant investors would be very different in this year?Stephan Kessler 2023 we think we'll look, of course, different from the past year. So, we'll move into an environment of low inflation where terminal rates are going to be reached by many central banks. And then equities will start the year in Q1 likely down to then end the year rather flat according to our equity strategists. Now, from a quant perspective, while this is different in terms of the actual dynamics, what remains is that we are likely to see market swings, which tend to favor short- to mid-term trend following strategies. The differences in central bank policies are also likely to remain so there's going to be a dispersion in rates and this dispersion in rates will help, in our expectation, carry strategies. It makes carry strategies attractive. Indeed, if you think about being exposed to, say, for example, carry in fixed income, where we go long bonds with high yields, we go short bonds with low yields and clip the difference, those bonds with particularly high interest rates are likely to also benefit from a normalization of rates. So, you could actually see an additional benefit where being invested in high yielding bonds will be then doubly positive because you earn the carry, but you also benefit from a normalization of rates and the increase in prices of those bonds. And finally, when we look at, you know, value investing, we think that is also likely to remain important because higher rates simply force investors to be focused on the valuations, to be focused on the financing of business activities, to be focused on healthy companies. And so we think that the market dynamics, while different, will continue to favor quant investing.Vishy Tirupattur So Stephan, you talked about a wide range of investment strategies within the quant world. Which of those strategies, what kinds of strategies do you think will drive outperformance in 2023?Stephan Kessler Yeah, I think it's specific forms of what I've mentioned is generally strategies which will do well. So, you know, if we start again with trend following, the market should be positive for it. There are though iterations of trend falling where we bias. And we think these types of biases—we have a long-bias or as we call it defensively-biased trend following strategies—those will be particularly positively performing because they will benefit from the higher rates that we see. We also think that some of the pricing out of inflation and then eventually in terms of the lower rates that we see, that should be beneficial for rates value strategies, where rates converge to longer term levels. And then something we haven't talked much about yet; volatility carry we feel is particularly interesting. Volatility carry means we are selling options in the markets. We sell a call option, a put option in the market, we earn the premium and then we hedge the beta that is embedded. So, we essentially try to earn the option premium without taking directional market risk, which works quite well in terms of harvesting a carry in calm market environments. But it tends to be causing negative returns, when you see spikes in volatility, when you see jumps in markets. We think that this is going to be an interesting investment opportunity, first on the Treasury side and then, once equity markets through this more difficult slowdown that we see at the moment, we also think volatility should get lower and that should benefit generally volatility carry in equities. So, selling equity options into the market. So those would be the particularly strong strategies. And then, as I already mentioned, there's this crossing of equity value and quality is a theme that we believe is particularly well-suited for the environment.Vishy Tirupattur If you're thinking about the outlook for 2023 for quant investors, what are the real risks? What can go wrong?Stephan Kessler So I think there's, of course, a range of things that can go wrong in such a dynamic and fluid market environment as we are at the moment. So one is that rates could continue to increase more than we expect at the moment, possibly driven by inflation being more resilient. That would not be good for rates carry strategies which tend to underperform in such environments because they are long. And so as those assets build up further, as the rates go up, the price of those assets would be hit. And on the back of that, the carry strategies would suffer. We also think that against all odds, growth is very resilient. There's a growth rally. That would, of course, hurt value type strategies, maybe through higher efficiency or resilience of tech stocks, for example. And then finally, if markets become to gap-y, i.e., if they don't trend but they really jump around through this market environment, that that might actually be negative for trend following strategies.Vishy Tirupattur Looks like 2023 will be a fascinating year ahead for quant investing strategies. So, Stephan, thanks for taking the time to talk to us.Stephan Kessler Great speaking with you, Vishy.Vishy Tirupattur And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.
As 2023 begins, most market participants agree the first half of the year could be challenging. But when we dig into the details, that's where the agreement ends.----- 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, January 10th at 10 a.m. in New York. So let's get after it.To start the year, we return to a busy week of client meetings and calls. While our conversations ranged across a wide swath of topics, the most consistently asked question was, "if everybody has the same view, how can that be right?" The view I'm referring to is that most sell-side strategists and buy-side investors believe the first half of the year will be a challenging one, but the second half will be much better. Wrapped into this view is the notion that we will experience a mild recession starting in the first half. The Fed will cut rates in response and a new bull market will begin. Truth be told, this is generally our view too. So, how do we reconcile this dilemma of how the consensus can be right? We think the answer is that the consensus can be right directionally, but it will be wrong in the magnitude and rationale which may inhibit its ability to monetize the swings we envision. More importantly, our biggest issue with the consensus view is how nonchalant many investors seem to be about the risk of a recession. When we ask investors how low they think the S&P 500 will trade in a mild recession, most suggest 35-3600 will suffice, and the October lows will hold. One rationale for this more constructive view is that we are closer to a Fed pause, and that pivot will put a floor under stock valuations.The other reason we hear is that everyone is already bearish and expects a recession. Therefore, it must already be priced. We would caution against those conclusions as recessions are never priced until they arrive and we're not so sure the Fed is going to be coming to the rescue as fast as usual, given the inflation dynamics unique to this cycle.The other way we think the consensus is likely to be wrong is on earnings. With or without an economic recession, the earnings forecasts for 2023 remain materially too high in our view. Our base case forecast for 2023 S&P 500 earnings per share is $195, and this assumes no recession, while our bear case forecast of a recession leads to $180. This compares to the bottoms up consensus forecast of $230, which nearly every institutional investor agrees is too high. However, most are in the camp that the S&P 500 earnings per share won't be as bad as we think, with the average client around $210-$215. Coincidentally, this is in line with the consensus sell-side strategists' forecast of $210 as well. In summary, even if we don't experience an economic recession, investor expectations for earnings remain too high based on our forecasts and conversations with clients. This leaves equity prices unattractive at current levels.Our well-below-consensus earnings forecast is centered around a theme of negative operating leverage driven by falling inflation. One of the most consistent pieces of pushback we have received to our negative earnings outlook centers around the idea that higher inflation means higher nominal GDP and therefore revenue growth that can remain positive even in the event of a mild real GDP recession. Therefore, earnings should hold up better than usual. While we agree with the premise of this view that revenue growth can remain positive this year, even if we have a mild recession, it ignores the fact that margins are likely to materially disappoint. This is because the rate of change on cost inflation exceeds the rate of change on sales. Indeed, margins have started to fall and the consensus forecasts for fourth quarter results currently assume negative operating leverage. But we think this dynamic is likely to get much worse before it gets better.The bottom line, equity markets still appear to be overly focused on inflation and the Fed, as evidenced by the still meaningfully negative correlation between real yields and equity returns. Last week, we saw expectations improve slightly for inflation and the Fed's reaction to it. And stocks rallied sharply into the end of the week. We think this ignores the ramifications of falling prices on profit margins, which is likely to outweigh any benefit from increased Fed dovishness.In short, we think we're quickly approaching the point where bad news on growth is bad. And we see 3900 on the S&P 500 as a good level to be selling into again in front of what is likely to be another weak earnings season led by poor profitability and the broader introduction of 2023 guidance.Thanks for listening. 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.
With an eventful year for the oil market behind us, what are the factors that might influence the supply, demand, and ultimately the pricing of oil and gas in 2023?----- Transcript -----Welcome to Thoughts on the Market. I'm Martijn Rats, Morgan Stanley's Global Commodity Strategist. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss some of the key uncertainties that the global oil market will likely face in 2023. It's Monday, January 9th at 3 p.m. in London. Looking back, 2022 was an eventful year for the oil market. The post-COVID demand recovery of 2021 continued during the first half and by June demand was back to 2019 levels. For a brief period the demand recovery appeared complete. Over the same period non-OPEC supply growth mostly disappointed, OPEC's spare capacity declined and inventories drew. Which eventually meant that oil markets had to start searching for the price level where demand destruction kicked in. Eventually, this forced prices of key oil products such as gasoline and diesel, to record levels of around $180-$290 a barrel in June. Clearly, those prices did the trick. Together with new mobility restrictions in China, aggressive rate hikes by central banks and rising risk of recession, particularly in Europe, they effectively stalled the oil demand recovery. And by September, global oil demand was once again below September 2019 levels. By late 2022, brent prices that retraced much of their earlier gains and other indicators, such as time spreads and refining margins, had softened too. Now, looking into 2023 we don't see this changing soon. Counting barrels of supply and demand suggest that the first quarter will still be modestly oversupplied. Also, declining GDP expectations, falling PMIs and central bank tightening are still weighing heavily on the oil market today. Eventually, however, we see a more constructive outlook emerging, say from the spring onwards. First, we expect to see a recovery in aviation. Global jet fuel consumption is still well below 2019 levels, and we think that a substantial share of that demand will return this year. Another key development will be China's reopening. At the end of 2022 China's oil demand was still well below 2020 and 2021 levels, held back by lockdowns and mobility restrictions. We expect China's oil demand to start recovering after the first quarter of this year. Shifting over to Europe and the EU embargo on Russian oil, as of last November, the EU still imported 2.2 million barrels a day of Russian crude oil and oil products. Now, especially after the EU's embargo on the import of oil product kicks in, which will be on February 5th, Russia will need to find other buyers and the EU will need to find other suppliers for much of this oil. Now, some of this has already been happening, but the full rearrangement of oil flows around the world as a result of this issue will probably not be full, smooth, fast and without price impact. As a result, we expect that some Russian oil will be lost in the process and Russian oil production is likely to decline in coming months. In the U.S., capital discipline and supply chain bottlenecks have already held back the growth in U.S. shale production. However, well performance and drilling inventory depth are emerging additional concerns putting further downward pressure on the production outlook. Eventually, the slowdown in U.S. shale will put OPEC in the driver's seat of the oil market. Also last year saw an unprecedented release of oil from the U.S. Strategic Petroleum Reserve. But this source of supply is now ended and the U.S. Energy Department will likely start buying back some of this oil in coming months. Finally, investment in new oil and gas production is rebounding, but it comes from a very low base and the recovery has so far been modest. Much of it is simply to absorb cost inflation that has also happened in the industry. In other words, the industry isn't investing heavily in new oil production, which has implications for the longer term outlook for oil supply. Eventually, we think these factors will combine in a set of tailwinds for oil prices. If we are wrong on those, the market would be left with the status quo, which would be neutral. But we believe that these risks will eventually skew positively later in 2023. We expect the oil market to return to balance in the second quarter, and be undersupplied in the second half of this year. With a limited supply buffer only, we think brent will return to over $100 a barrel by the middle of the year. 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.
Discover what 2022, a historic year for markets, can teach investors as they navigate the new year.----- 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, January 6th at 2 p.m. in London.For the year ahead, we think U.S. growth slows while China accelerates, inflation moderates and central banks pause their rate hikes while keeping policy restrictive enough to slow growth. We think that backdrop favors bonds over stocks, emerging over developed markets and international over U.S. equities.But there'll be plenty of time to discuss those views and more in the coming weeks. Today, I wanted to take a step back and talk a little about the year that was. 2022 was historic and within these unusual swings are some important lessons for the year ahead.First, for the avoidance of doubt, 2022 was not normal. It was likely the first year since at least the 1870s that both U.S. stocks and long-term bonds fell more than 10% in the same calendar year. We don't think that repeats and forecast small positive total returns for both U.S. stocks and bonds in the year ahead.Second, it was a year that challenged some conventional wisdom about what counts as a risky part of one's portfolio. So-called defensive stocks—those in consumer staples, health care and utilities—outperformed significantly, which isn't a surprise given the poor market environment. But other things were more unusual. Small cap stocks and value stocks, which are often seen as riskier, actually outperformed. Financial equities were the second-best performing sector in Europe, Japan and emerging markets despite being seen as a riskier sector. And both the stock market and currencies of Mexico and Brazil, markets that are seen as high beta, gained in dollar terms despite the historically difficult market environment.This is all a great reminder that the riskiness of an asset class is not set in stone. And it shows the importance of valuation. Small caps, value stocks and Mexico and Brazilian assets all entered 2022 with large historical valuation discounts, which may help explain why they were able to hold up so well. For this year, we think attractive relative valuation could mean international equities are actually less risky than U.S. equities, bucking some of the historical trends.Finally, 2022 was a great year for the so called 'momentum factor.' Factor investing is the idea that you favor a certain characteristic over and over. So, for example, always buying assets that are cheaper, the 'value factor,' buying assets that pay you more, the 'carry factor,' or always buying assets that are doing better, the 'momentum factor.'In 2022, buying what had been rising, both outright or relative to its peers, worked pretty well across assets despite the simplicity of this strategy. Our work has suggested that momentum has a lower return than these other factors but is often very helpful in more difficult market environments. It's a good reminder that it's not always best to be contrarian and sometimes going with the trend is a simple but effective strategy, especially in commodities and short-term interest rates.2022 is in the record books. It was an unusual year but one that still provides some useful and important lessons for the year that lies ahead.Happy New Year and thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us to review. We'd love to hear from you.
With the fight against inflation quieting down in many regions, Asia saw a relatively small step up in inflation. Will that leave 2023 open to the possibility of growth outperformance?----- Transcript -----Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be discussing our 2023 outlook for Asia economics. It's Thursday, January 5th at 9 a.m. in Hong Kong. If 2022 was all about inflation, we believe 2023 will be about the aftermath of this battle with inflation. All eyes are now on how the world's largest economies will stack up after this battle with inflation. While Asia, along with the rest of the world, face multiple stagflationary shocks in 2022, we think that Asia weathered these shocks better. Indeed, we believe Asia will enter a rapid phase of disinflation and is well-positioned for growth outperformance in 2023. The step up in Asia's inflation was smaller compared to other regions. Furthermore, Asia's inflation had more of a cost-push element, meaning it was driven to a large extent by increases in cost of raw materials. And we believe Asia's inflation already peaked in third quarter of 2022. Asia's inflation should be rapidly returning towards central bank's comfort zone. We expect this to be the case for 90% of Asian economies by mid 2023. Cost-push factors are fading, resulting in lower food and energy inflation. Core good prices are descending rapidly, given the deflation in goods demand. Moreover, labor markets were not that tight in Asia, and wage growth has remained below its pre-COVID rates. Because of this backdrop, we've argued that central banks in Asia do not need to take policy rates deeper into restrictive territory. In fact, all of the central banks in the region will likely stop tightening in first quarter of 2023. This pause in Asia's rate hiking cycle, coupled with an easing in U.S. 10 year bond yields and with the peak of USD behind us, should lead to easier financial conditions in 2023. While weak external demand will remain a drag at least through the first half of 2023, Asia's domestic demand is supported by three factors. First, the easing of financial conditions will lift the private sector sentiment. Second, we are witnessing a strong uplift in large economies like India and Indonesia, supported by healthy balance sheets. Finally, China's reopening will lift consumption growth and have a positive effect on economies in the region, principally via the trade channel, helping Asian economies to get onto the path of growth outperformance. We expect Asia's growth to improve from a trough of 2.8% in first quarter of 2023, to 4.9% in second half of 2023, while DM growth will slow from 0.9% in first quarter of 2023 to 0.3% in second half of 23. Growth differentials will likely swing back in Asia's favor, rising back towards the levels last seen in 2017 and 2018. There are, of course, risks to our optimistic outlook for Asia. If U.S. inflation stays elevated for longer, this would lead to more tightening by the Fed than is expected and could drive renewed strength in the USD. This in turn would prolong the rate hike cycle in Asia, keeping financial conditions tight and exert downward pressures on growth. A delayed reopening in China could impact China's growth trajectory with adverse spillover implications for the rest of the region. 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.
The House of Representatives continues its struggle to appoint a new Republican Speaker. What should investors consider as this discord sets the legislative tone for the year?----- 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, January 4th, at 10 a.m. in New York. The focus in D.C. this week has been on choosing the new speaker of the House of Representatives. Choosing this leader, who largely sets the House's voting and workflow agenda, is a necessary first step to opening a new Congress following an election. This process is usually uneventful, with the party in the majority typically having decided who they'll support long before any formal vote. But this week, something happened, which hasn't in 100 years. The House failed to choose a speaker on the first ballot. As of this recording, we're now three ballots in and the Republican majority has yet to agree on its choice. So is this just more DC noise? Or do investors need to be concerned? While it's too early to tell, and there don't appear to be any imminent risks, we think investors should at least take it seriously. The House of Representatives will eventually find a way to choose a speaker, but the Republicans' rare difficulty in doing so suggests it's worth tracking governance risk to the U.S. economic outlook that could manifest later in the year. To understand this, we must consider why Republicans have had difficulty choosing a speaker. In short, there's plenty of intraparty disagreement on policy priorities and governance style. And with a thin majority, that means small groups of Republican House members can create the kind of gridlock we're seeing in the speaker's race. This dynamic certainly isn't new, but the speaker's situation suggests it may be worse than in recent years. So whoever does become the next speaker of the House could have, even by recent standards, a higher degree of difficulty keeping their own position and holding the Republican coalition together. That's a tricky dynamic when it comes to negotiating on politically complex but economically impactful issues, such as raising the debt ceiling and keeping the government funded, two votes that will likely take place after the summer. On both counts, some conservatives have in the past been willing to say they will vote against those actions and in some cases have actually followed through. But aside from the debt ceiling situation in 2011, these votes have largely been protests and did not result in key policy changes. That's still the most likely outcome this year. And as listeners of this podcast are aware, we've typically dismissed debt ceiling and shutdown risks as noise that's not worth much investor attention. But we're not ready to say that today. Because while policymakers are likely to find a path to raising the debt ceiling, this negotiation could look and feel a lot more like the one in 2011 where party disagreements appeared intractable, even if they ultimately were not. That could remind investors that the compromise involved contractionary fiscal policy, which could weigh on markets if the U.S. economy is also slowing considerably per our expectations. This is a risk both our Chief Global Economist, Seth Carpenter, and I flagged in the run up to the recent U.S. midterm election. Of course, it's only January, and 6 to 9 months is a lifetime in politics. So, we don't think there's anything yet for investors to do but monitor this dynamic carefully. We'll be doing the same and we'll keep you in the loop. 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.
As new weight management medications are being developed, might the obesity market parallel the likes of hypertension or high blood pressure to become the next blockbuster Pharma category?----- Transcript -----Welcome to Thoughts on the Market. I'm Terence Flynn, Head of the U.S. Pharma Sector for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, today I'll talk about the global obesity challenge and some of the key developments we expect in 2023. It's Tuesday, January 3rd, at 4 p.m. in New York. If you're like most people, you're probably seeing a lot of post-holiday ads for gym memberships, diet apps and nutrition services. So this seems like a relevant time to provide an update on obesity. A few months ago, we hosted an episode on this show discussing the global obesity epidemic and how it's now reached an inflection point because of new weight management drugs that show a lot of promise and benefits. We continue to believe that obesity is the "new hypertension or high blood pressure", and that it looks set to become the next blockbuster pharma category. Obesity has been classified by the American Medical Association, and more recently the European Commission, as a chronic disease, and its treatment is on the cusp of moving into mainstream primary care management. Essentially, the obesity market is where the treatment of high blood pressure was in the mid to late 80's, before it transformed into a $30 Billion market by the end of the 90's. One of the main reasons the narrative around obesity is inflecting is because the focus is shifting to the upstream cause, as opposed to the downstream consequences of diabetes and cardiovascular disease. Now, given this change in focus, we expect excess weight to become a treatment target. The World Health Organization estimates that about 650 million people are living with obesity, and the associated personal, social and economic costs are significant. Over time, we're expecting about a quarter of obese individuals will engage with physicians, up from about 7% currently. Now, this compares to approximately 80% for high blood pressure and diabetes. Furthermore, well over 300 million of these people could potentially receive a new anti-obesity medicine. Looking back historically, previous medicines for obesity had minimal efficacy and were plagued by safety issues, which also contributed to limited reimbursement coverage. In our view, this is all poised to change as the more efficacious GLP-1 drugs are adopted and utilized and the companies begin to generate outcomes data to support the derivative benefits of these drugs beyond weight loss. Of course, as with biopharma, there are many de-risking clinical, regulatory and commercial steps in the development of the obesity market. This year, we're most focused on a key phase three outcomes trial called "SELECT", which we expect to read out this summer to conclude that "weight management saves lives". Furthermore, we think the innovation wave should continue as companies are working on a next generation of injectable combo drugs that could come to the market later this decade for obesity and Type two diabetes. And beyond the possibility of turning the tide on the obesity epidemic, it's also exciting to see room in the markets for multiple players and investment opportunities in a market that could reach over $50 billion by 2030. 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.
Original Release on November 15th, 2022: As we look ahead to 2023, we see a divergence away from the trends of 2022 in key areas across growth, inflation, and central bank policy. Chief Cross Asset Strategist Andrew Sheets and Global Chief Economist Seth Carpenter discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's chief cross-asset strategist. Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley's global chief economist. Andrew Sheets: And on the special two-part episode of the podcast, we'll be discussing Morgan Stanley's Global Year Ahead outlook for 2023. Today, we'll focus on economics, and tomorrow we'll turn our attention to strategy. It's Tuesday, November 15th at 3 p.m. in London. Seth Carpenter: And it's 10 a.m. in New York. Andrew Sheets: So, Seth I think the place to start is if we look ahead into 2023, the backdrop that you and your team are forecasting looks different in a number of important ways. You know, 2022 was a year of surprisingly resilient growth, stubbornly high inflation and aggressively tightening policy. And yet as we look ahead, all three of those elements are changing. I was hoping you could comment on that shift broadly and also dig deeper into what's changing the growth outlook for the global economy into next year. Seth Carpenter: You're right, Andrew, this year, in 2022, we've seen growth sort of hang in there. We came off of last year in 2021, a super strong year for growth recovering from COVID. But the theme this year really has been a great deal of inflation around the world, especially in developed markets. And with that, we've seen a lot of central banks everywhere start to raise interest rates a great deal. So what does that mean as we end this year and go into next year? Well, we think we'll start to see a bit of a divergence. In the developed market world where we've seen both a lot of inflation and a lot of central bank hiking, we think we get a great deal of slowing and in fact a bit of contraction. For the euro area and for the U.K, we're writing down a recession starting in the fourth quarter of this year and going into the beginning of next year. And then after that, any sort of recovery from the recession is going to be muted by still tight monetary policy. For the US, you know, we're writing down a forecast that just barely skirts a recession for next year with growth that's only slightly positive. That much slower growth is also the reflection of the Federal Reserve tightening policy, trying to wrench out of the system all the inflation we've seen so far. In sharp contrast, a lot of EM is going to outperform, especially EM Asia, where the inflationary pressures have been less so far this year, and central banks, instead of tightening aggressively to get restrictive and squeeze inflation out, they're actually just normalizing policy. And as a result, we think they'll be able to outperform. Andrew Sheets: And Seth, you know, you mentioned inflation coming in hot throughout a lot of 2022 being one of the big stories of the year that we've been in. You and your team are forecasting it to moderate across a number of major economies. What drives a change in this really important theme from 2022? Seth Carpenter: Absolutely. We do realize that inflation is going to continue to be a very central theme for all sorts of markets everywhere. And the fact that we have a forecast with inflation coming down across the world is a really important part of our thesis. So, how can we get any comfort on the idea that inflation is going to come down? I think if you break up inflation into different parts, it makes it easier to understand when we're thinking about headline inflation, clearly, we have food, commodity prices and we've got energy prices that have been really high in part of the story this year. Oil prices have generally peaked, but the main point is we're not going to see the massive month on month and year on year increases that we were seeing for a lot of this year. Now, when we think about core inflation, I like to separate things out between goods and services inflation. For goods, the story over the past year and a half has been global supply chains and we know looking at all sorts of data that global supply chains are not fixed yet, but they are getting better. The key exception there that remains to be seen is automobiles, where we have still seen supply chain issues. But by and large, we think consumer goods are going to come down in price and with it pull inflation down overall. I think the key then is what goes on in services and here the story is just different across different economies because it is very domestic. But the key here is if we see the kind of slowing down in economies, especially in developed market economies where monetary policy will be restrictive, we should see less aggregate demand, weaker labor markets and with it lower services inflation. Andrew Sheets: How do you think central banks respond to this backdrop? The Fed is going to have to balance what we see is some moderation of inflation and the ECB as well, with obvious concerns that because forecasting inflation was so hard this year and because central banks underestimated inflation, they don't want to back off too soon and usher in maybe more inflationary pressure down the road. So, how do you think central banks will think about that risk balance and managing that? Seth Carpenter: Absolutely. We have seen some surprises, the upside in terms of commodity market prices, but we've also been surprised at just the persistence of some of the components of inflation. And so central banks are very well advised to be super cautious with what's going on. As a result. What we think is going to happen is a few things. Policy rates are going to go into restrictive territory. We will see economies slowing down and then we think in general. Central banks are going to keep their policy in that restrictive territory basically over the balance of 2023, making sure that that deceleration in the real side of the economy goes along with a continued decline in inflation over the course of next year. If we get that, then that will give them scope at the end of next year to start to think about normalizing policy back down to something a little bit more, more neutral. But they really will be paying lots of attention to make sure that the forecast plays out as anticipated. However, where I want to stress things is in the euro area, for example, where we see a recession already starting about now, we don't think the ECB is going to start to cut rates just because they see the first indications of a recession. All of the indications from the ECB have been that they think some form of recession is probably necessary and they will wait for that to happen. They'll stay in restrictive territory while the economy's in recession to see how inflation evolves over time. Andrew Sheets: So I think one of the questions at the top of a lot of people's minds is something you alluded to earlier, this question of whether or not the US sees a recession next year. So why do you think a recession being avoided is a plausible scenario indeed might be more likely than a recession, in contrast maybe to some of that recent history? Seth Carpenter: Absolutely. Let's talk about this in a few parts. First, in the U.S. relative to, say, the euro area, most of the slowing that we are seeing now in the economy and that we expect to see over time is coming from monetary policy tightening in the euro area. A lot of the slowing in consumer spending is coming because food prices have gone up, energy prices have gone up and confidence has fallen and so it's an externally imposed constraint on the economy. What that means for the U.S. is because the Fed is causing the slowdown, they've at least got a fighting chance of backing off in time before they cause a recession. So that's one component. I think the other part to be made that's perhaps even more important is the difference between a recession or not at this point is almost semantic. We're looking at growth that's very, very close to zero. And if you're in the equity market, in fact, it's going to feel like a recession, even if it's not technically one for the economy. The U.S. economy is not the S&P 500. And so what does that mean? That means that the parts of the U.S. economy that are likely to be weakest, that are likely to be in contraction, are actually the ones that are most exposed to the equity market and so for the equity market, whether it's a recession or not, I think is a bit of a moot point. So where does that leave us? I think we can avoid a recession. From an economist perspective, I think we can end up with growth that's still positive, but it's not going to feel like we've completely escaped from this whole episode unscathed. Andrew Sheets: Thanks, Seth. So I maybe want to close with talking about risks around that outlook. I want to talk about maybe one risk to the upside and then two risks that might be more serious to the downside. So, one of the risks to the upside that investors are talking about is whether or not China relaxes zero COVID policy, while two risks to the downside would be that quantitative tightening continues to have much greater negative effects on market liquidity and market functioning. We're going through a much faster shrinking of central bank balance sheets than you know, at any point in history, and then also that maybe a divided US government leads to a more challenging fiscal situation next year. So, you know, as you think about these risks that you hear investors citing China, quantitative tightening, divided government, how do you think about those? How do you think they might change the base case view? Seth Carpenter: Absolutely. I think there are two-way risks as usual. I do think in the current circumstances, the upside risks are probably a little bit smaller than the d
Original Release on December 7th, 2022: As India enters a new era of growth, investors will want to know what’s driving this growth and how it may create once-in-a-generation opportunities. Head of Global Thematic and Public Policy Research Michael Zezas and Chief India Equity Strategist Ridham Desai discuss.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Global Thematic and Public Policy Research. Ridham Desai: And I'm Ridham Desai, Morgan Stanley's Chief India Equity Strategist. Michael Zezas: And on this special episode of Thoughts on the Market, we'll discuss India's growth story over the next decade and some key investment themes that global investors should pay attention to. It's Wednesday, December 7th, at 7 a.m. in New York. Michael Zezas: Our listeners are likely well aware that over the past 25 years or so, India's growth has lagged only China's among the world's largest economies. And here at Morgan Stanley, we believe India will continue to outperform. In fact, India is now entering a new era of growth, which creates a once in a generation shift in opportunities for investors. We estimate that India's GDP is poised to more than doubled to $7.5 trillion by 2031, and its market capitalization could grow 11% annually to reach $10 trillion. Essentially, we expect India to drive about a fifth of global growth in the coming decade. So Ridham, what in your view are the main drivers behind India's growth story? Ridham Desai: Mike, the full global trends of demographics, digitalization, decarbonization and deglobalization that we keep discussing about in our research files are favoring this new India. The new India, we argue, is benefiting from three idiosyncratic factors. The first one is India is likely to increase its share of global exports thanks to a surge in offshoring. Second, India is pursuing a distinct model for digitalization of its economy, supported by a public utility called India Stack. Operating at population scale India stack is a transaction led, low cost, high volume, small ticket size system with embedded lending. The digital revolution has already changed the way India handles documents, the way it invests and makes payments and it is now set to transform the way it lends, spends and ensures. With private credit to GDP at just 57%, a credit boom is in the offing, in our view. The third driver is India's energy consumption and energy sources, which are changing in a disruptive fashion with broad economic benefits. On the back of greater access to energy, we estimate per capita energy consumption is likely to rise by 60% to 1450 watts per day over the next decade. And with two thirds of this incremental supply coming from renewable sources, well in short, with this self-help story in play as you said, India could continue to outperform the world on GDP growth in the coming decade. Michael Zezas: So let's dig into some of the specifics here. You mentioned the big surge in offshoring, which has resulted in India's becoming "the office of the world". Will this continue long term? Ridham Desai: Yes, Mike. In the post-COVID environment, global CEOs appear more comfortable with work from home and also work from India. So the emergence of distributed delivery models, along with tighter labor markets globally, has accelerated outsourcing to India. In fact, the number of global in-house captive centers that opened in India over the past two years was double of that in the prior four years. During the pandemic years, the number of people employed in this industry in India rose by almost 800,000 to 5.1 million. And India's share in global services trade rose by 60 basis points to 4.3%. In the coming decade we think the number of people employed in India for jobs outside the country is likely to at least double to 11 million. And we think that global spending on outsourcing could rise from its current level of U.S. dollar 180 billion per year to about 1/2 trillion U.S. dollars by 2030. Michael Zezas: In addition to being "the office of the world", you see India as a "factory to the world" with manufacturing going up. What evidence are we seeing of India benefiting from China moving away from the global supply chain and shifting business activity away from China? Ridham Desai: We are anticipating a wave of manufacturing CapEx owing to government policies aimed at lifting corporate profits share and GDP via tax cuts, and some hard dollars on the table for investing in specific sectors. Multinationals are more optimistic than ever before about investing in India, and that's evident in the all-time high that our MNC sentiment index shows, and the government is encouraging investments by building both infrastructure as well as supplying land for factories. The trends outlined in Morgan Stanley's Multipolar World Thesis, a document that you have co authored, Mike, and the cheap labor that India is now able to offer relative to, say, China are adding to the mix. Indeed, the fact is that India is likely to also be a big consumption market, a hard thing for a lot of multinational corporations to ignore. We are forecasting India's per capita GDP to rise from $2,300 USD to about $5,200 USD in the next ten years. This implies that India's income pyramid offers a wide breadth of consumption, with the number of rich households likely to quintuple from 5 million to 25 million, and the middle class households more than doubling to 165 million. So all these are essentially aiding the story on India becoming a factory to the world. And the evidence is in the sharp jump in FDI that we are already seeing, the daily news flows of how companies are ramping up manufacturing in India, to both gain access to its market and to export to other countries. Michael Zezas: So given all these macro trends we've been discussing, what sectors within India's economy do you think are particularly well-positioned to benefit both short term and longer term? Ridham Desai: Three sectors are worth highlighting here. The coming credit boom favors financial services firms. The rise in per capita income and discretionary income implies that consumer discretionary companies should do well. And finally, a large CapEx cycle could lead to a boom for industrial businesses. So financials, consumer discretionary and industrials. Michael Zezas: Finally, what are the biggest potential impediments and risks to India's success? Ridham Desai: Of course, things could always go wrong. We would include a prolonged global recession or sluggish growth, adverse outcomes in geopolitics and/or domestic politics. India goes to the polls in 2024, so another election for the country to decide upon. Policy errors, shortages of skilled labor, I would note that as a key risk. And steep rises in energy and commodity prices in the interim as India tries to change its energy sources. So all these are risk factors that investors should pay attention to. That said, we think that the pieces are in place to make this India's decade.Michael Zezas: Ridham, thanks for taking the time to talk. Ridham Desai: Great speaking with you, Mike. Michael Zezas: As a reminder, 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 find the show.
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