Thoughts on the Market
About the podcast Thoughts on the Market
Short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
Michael Zezas: New Restrictions in Light of Omicron?
The Omicron variant of COVID-19 has investors concerned about potential new restrictions, but the onus lies most on state and local governments who, for now, are awaiting more information on infection rates and severity. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, December 1st at 11:00 a.m. in New York. Not surprisingly, our client conversations this week have been all about Omicron, the new COVID 19 variant that our biotech team thinks may increase infection rates and reduce vaccine effectiveness. In particular, clients want to know if the new variant will lead to fresh government restrictions and crimp the U.S. economic outlook. While the federal government gets much of the attention here, we think the key to sizing up this variable lies in understanding how state and local governments will behave. These are the jurisdictions that have generally driven mask mandates, indoor dining restrictions and other activities. And while there's much to learn about Omicron, here our initial assessment is that the bar is quite high for states and locals to take action, and that should limit downside risk to the economy. What drives our view? In short, ever since states began lifting restrictions in late spring of 2020, their behavior has mostly been influenced by hospital capacity. Of course, some states lifted restrictions faster than others, but in most cases where restrictions were tightened, rising COVID hospitalizations and lack of bed capacity were cited as the culprits. With the availability of vaccinations in the U.S. and the high vaccination rate among vulnerable populations, risks to hospital capacity have lessened. That's because while COVID can infect the vaccinated, they are far less likely to get sick in a way that lands them in the hospital. So that means, when it comes to sizing up if Omicron will lead to government restrictions on economic activity, it's less about whether vaccines will prevent infection, but if they can limit hospitalizations. While there's still not a lot of information, and thus outlooks could easily change as data on the new variant is collected, our biotech research team's base case is that Omicron is not more virulent than the currently dominant Delta variant. Further, the U.S. government continues to express the view that vaccines will provide protection against severe disease. Taken together, this would suggest that as long as the U.S. can sustain its vaccine campaign, including the current push for boosters, the economy may only face manageable headwinds. For fixed income investors, that means Treasury yields should still trend higher. And for credit investors, particularly in COVID sensitive municipal bond sectors like airports and hospitals, we see fundamental risks as manageable. Yet investors should probably focus intently on what would change this view, as this ‘goldilocks outcome’ is mostly in the price of credit and equity markets already. And here again, we say focus on news about Omicron's severity, which is expected within the next few weeks. If data shows it to drive both more infection and more severe sickness, then hospital capacity could be challenged, leading state and local governments to reluctantly reimpose some restrictions. And of course, consumers could react to this signal and change their own behavior - thinking twice about that next flight, for example. Yet perspective is important here, and even this negative outcome is more likely an economic setback than a disaster, as our biotech team notes that pharmaceutical companies may be able to turn around new boosters to address the challenge within a few months. That in turn means there's likely to be opportunities in credit and equity markets if this riskier case is the one that plays out. We'll, of course, be tracking it all here and checking in with you as we learn more. 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.
Special Episode: COVID-19 - Omicron Variant Causes Concern
Last week’s news of the Omicron variant of COVID-19 has raised questions about transmissibility, vaccine efficacy, and virus mortality. Where does this variant leave us in the fight against COVID-19 and how are markets reacting? ----- Transcript ----- Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley Research. Matthew Harrison And I'm Matthew Harrison, Biotechnology Analyst Andrew Sheets And on this special edition of the podcast, we'll be talking about a new COVID variant and its impact on markets. It's Tuesday, November 30th at 2p.m. in London. Matthew Harrison And it's 9:00 a.m. in New York. Andrew Sheets So Matt, first things first, you know, we've seen a pretty major development over the American Thanksgiving holiday. We saw a new COVID variant, the omicron variant, kind of come into the market's attention. Can you talk just a little bit about why this variant has gotten so much focus and what do we know about it? Matthew Harrison Sure. I think there are probably three major factors that have driven the focus. The first thing is there was clear scientific concern because of the number of mutations in the variant. And specifically, there are over 50 mutations, 32 of which are in the spike protein region, which is where vaccines are targeted. And then a number in the receptor binding domain, which is where the antibodies typically tend to bind. So the antibodies that either vaccines or antibody therapies create. And what we know when we look at many of these mutations is they're present in other variants: gamma, delta, alpha, beta and we know that many of these mutations in a pair one or two have led to reduction in vaccine effectiveness. And so, when they're combined all together, from a scientific standpoint, people were very concerned about having all of those mutations together and what that would mean in terms of vaccine escape. Andrew Sheets So Matt, this is obviously a challenging situation because this is a new variant. It's just been discovered. And yet, you know, a lot of people are trying to figure out what the longer-term implications could be. So, you know, when you look at this with the kind of a limited amount of information, you know, what are the key characteristics that you're going to be watching that that you think we should care about? Matthew Harrison There are probably three things that I'm focused on and we can probably touch on in detail. So the first one is transmissibility, and the reason for that is if this variant overtakes Delta and becomes dominant globally, then we're going to care about the two other factors a lot more, which is vaccine escape and lethality. However, if it's not more transmissible than Delta and Delta remains the dominant variant, then this may be an issue in small pockets, but ultimately will fade and continue to be overtaken by Delta. And so that's why transmissibility is the primary focus. And so what do we know about transmissibility right now? We have a couple of pieces of information out of South Africa. The first is they have sequenced a number of recent COVID patients. And in those sequences, the vast majority or almost all of them have been Omicron. So that suggests that it is overtaking Delta. But again, sometimes sequence results can be biased because they're not a population sample and they're a selection of a certain subset of people. The second piece of information, which to me is more compelling, is I'm sure everybody's aware of the PCR tests. There's a certain kind of deletion here in this variant that that that you can pick up with a PCR test and so you can see the frequency of that deletion. And that that frequency has risen from about a background rate of about 5% in the last week and a half to about 50% of the PCR tests coming back suggestive of this variant in South Africa. And so that's a much bigger sample size than the sequencing sample size. And so that suggests at least in the small subset that you're seeing greater transmissibility compared to Delta. Now it's going to take time to confirm that. And now that we've seen cases globally in a lot of countries over the next week or two, everybody's going to be watching how quickly the Omicron cases rise compared to Delta to confirm whether or not it's more transmissible than Delta. Andrew Sheets This question of vaccine evasion. There's there has been some increased concern about this new variant that it might be able to evade vaccines. Why do people think that? And you know, how soon might we know? Matthew Harrison Why don't we start with the timeline, because that's the simpler part. The experiments to figure that out take about two weeks. And just so everybody has the background on this, you need to take the virus, you need to grow it up. And once you have a sample of it, then you take blood from people that have recovered from COVID and blood from people that have been vaccinated that are full of those antibodies. And you put them in the in the dish and you find out how much virus you kill. And that'll tell you how effective the serum from vaccinated or previously infected individuals are against the new variant. So that process typically takes about two weeks. So then why are people worried about vaccine evasion with this variant? Primarily because of the known mutations that it carries and the unknown mutations. And of the known mutations that it carries, it carries the same set of mutations as in beta, and the beta variant had significant vaccine evasion properties that never became dominant, but it did reduce vaccine effectiveness by about six-fold. And so, I think the concern is with those mutations, plus a range of other mutations known to have vaccine evasion properties, having them all together has really significantly increased concern about how much that may hurt the vaccine's ability to stop infection. Andrew Sheets And, Matt, so you talked about the importance of transmissibility, you know, you talked about some of the reasons why the concerns are higher around vaccine evasion with this variant. And the last thing you talked about was the lethality of this variant. And again, you know, what are you looking for there? Is there anything that concerns you with the information that we know and when might we know more? Matthew Harrison So this is the hardest question because as is typical, you get a lot of anecdotal reports about what's happening with recently infected patients, but it takes a while, on order of four to five weeks, to really understand if there is a significant difference in mortality or hospitalization. So we have very little information around those factors. You have seen in the capital region, in South Africa, where you've where you've seen these rising cases, a rise in hospitalizations, but we don't know if all those cases are Omicron cases or not. And we haven't seen mortality at all. But again, with recent infections, it usually takes four or five weeks to start to see the potential impact of those infections on mortality. Matthew Harrison And Andrew, I think one other thing which is important to mention is while we're while we're talking about severity of disease and lethality, we have to remember that in addition to vaccines, we do have now other effective treatments, including antibody therapies and oral therapies. And while some antibody therapies are likely not to work against Omicron, at least two or three of them are. And so you have you will have some effective antibody therapies. And then the oral therapies, given their mechanisms of action, should not be impacted. So we will have oral therapies in terms of treatment. So hopefully, even if we do get a scenario where there is significant impact on vaccine efficacy, this will not be like going back to the beginning of the pandemic, where we didn't have other effective treatments available. Matthew Harrison Andrew, unlike normal episodes, maybe it'll be my chance since the markets have been so volatile. How has this impacted your outlook on the markets in the near to medium term? Matthew Harrison I know inflation and the inflation debate and the impact of central banks on inflation has been a sort of key debate that I've heard you guys reflecting on. Andrew Sheets Yeah. So I think probably the thing I should say up front is at the moment, we don't think we have enough evidence around this variant to change our baseline economic forecast to change that optimistic view on growth. Now what it might change is some of the timing around it, and I think we saw a little bit of this with the Delta variant. Where, you know, that was a big development in 2021, you know, people didn't see that coming. And you know, if you step back and think about this year, the market was still good, yield still rose, there was a lot of market movement, very consistent with better economic growth if you take the year as a whole, even though you had this variant, but the variant did introduce some kind of twists and turns along the way. So you know, that's currently the way that we're thinking about this new omicron variant that it is not likely or we don't know enough yet to be confident that it would really change that economic outlook, especially because we think there are a lot of good reasons why growth could be solid, but it might introduce some near-term uncertainty. You know, the interesting thing about, as you mentioned, inflation is that it could affect inflation in both directions. It could cause inflation to be higher, for example, if it, you know, causes shutdowns in countries that are important for producing key goods. And you can't get the things that you want, and the price goes up. But it could also drive prices down. You know, on last Friday oil prices fell by over 10%. You know, that is a big part of inflation certainly as most people experience it. Gas prices will be lower based on what happened on Friday. So that can drive inflation down so it can cut both ways. Matthew Harrison Andrew, it's been great talking to you. Thanks for your thoughts. Andrew Sheets Matt, always a pleasure to talk to you. Matthew Harrison 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.
Mike Wilson: Markets React to Omicron
With last week’s news of the Omicron variant of COVID-19, markets sold-off sharply on Friday, but beyond the headlines, there may be other underlying factors at play. ----- 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, November 29th at 1:00 p.m. in New York. So let's get after it. Last week, the big news for markets was this new COVID variant named Omicron. While we don't yet know the characteristics of this variant with respect to its transmission and mortality rates, some nations are already acting with new restrictions on travel and other activities. These new restrictions is what markets were fearing the most on Friday, in our view. I'm also confident that markets were already expecting some seasonal increases in cases as we enter the winter months. This is why I'm not so sure Friday's sharp sell-off in equity markets was as much about Omicron as it was just a market looking for an excuse to go lower. In fact, equity markets had already been weak heading into Thanksgiving Day - a period that is almost always positive for stocks. This was before Omicron was a real concern, so why would that be the case? As we laid out in our year-ahead outlook, the combination of tightening financial conditions and decelerating growth is usually not bullish for stocks. When combined with one of the highest valuations on record, this is why we have a very unexciting 12-month price target for the S&P 500. Finally, as discussed on this podcast for the past 6 weeks, stocks typically do well from September to year end if they are already up until that point. However, we felt like that seasonal trade would be tougher after Thanksgiving, as the Fed began to taper its asset purchases and institutional investors moved to lock in profits rather than worrying about missing out on further upside. With retail a large buyer during Friday's sharp sell-off, it appears that the institutional investors were the ones selling. In short, it looks like that switch to locking in profits may have begun. Today's bounce back also makes sense in the context of a market that understands Omicron is probably not going to lead to a significant lockdown. In fact, we're already hearing reassuring words from the authorities making those decisions. The bottom line is that markets were already choppy, with many higher beta indices and stocks trending lower before this latest COVID variant. Breadth has also been weak, with erratic leadership. High dispersion between stocks is another market signal that suggests the rising tide may be going out. Our view remains consistent - the investment environment is no longer rich with opportunity, which means one must be more selective. In a world of supply shortages, we favor companies with high visibility on earnings due to superior pricing power or cost management. We also think it makes sense to be very attendant to valuation and not overpay for open ended growth stories with questionable profitability. From a sector standpoint, Healthcare, REITs and Financials all fit these characteristics. 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.
Michael Zezas: A Step Forward for Build Back Better
The Build Back Better Act took a key step towards becoming law last week, signaling implications for fiscal policy and taxation as the bill heads to the Senate. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 24th at 11:00 a.m. in New York. Last week, the Build Back Better Act took a step toward becoming law when the House of Representatives passed the bill along party lines. While the act now still needs to win Senate approval, likely with some substantive changes, there are two lessons that we learned from the House's actions. First, U.S. fiscal policy will continue to be expansionary in the near term. That's based on analysis from the Congressional Budget Office of the Build Back Better plan, adjusted for some key provisions that likely won't survive the Senate. When added to the analysis of the recently enacted Bipartisan Infrastructure Framework, it shows the combined plans could add around $200B to the deficit over 10 years - close to our base case of about $260B. But more importantly, the analysis suggests most of this deficit increase is front loaded, with around $800B of deficits in the first 5 years - toward the high end of the base case range we flagged earlier this year. This is the number we think matters to the economy and markets, as the durability of the policies that will reduce this deficit beyond 5 years is less certain, as elections can lead to future policy changes. And this number also helps drive some key views, namely our economists' call for above average GDP next year and our rates teams' view that bond yields will continue to move higher. Our second lesson is that the corporate minimum tax looks like it has legs. The provision, also called the Book Profits Tax, survived the house process largely unscathed. While Senate modifications are to be expected, we expect the provision will be enacted. That means investors will have to get smart on the sectoral impacts of this new, somewhat complex, corporate tax. Our base case is that this won't be a game changer for markets. Our equity strategy team calculates a 4% hit to S&P 500 earnings before accounting for any economic growth. And while some sectors, like financials, appear most likely to have a higher tax bill, our banks analyst team expects most of this new expense can be offset by tax credits. Still, this new tax is tricky and untested, so fresh risks can emerge as the bill goes through edits in the Senate. So, we'll be tracking it carefully into year end. 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.
Andrew Sheets: Twists and Turns In 2022
Our 500th episode! From all of us at Morgan Stanley, thanks to our listeners for all your support! An overview of our expectations for the year ahead across inflation, policy, asset classes and more. As with 2021, we expect many twists and turns along the way. ----- Transcript ----- Welcome to the 500th episode of Thoughts on the Market. I'm Andrew Sheets, and from all of us here at Morgan Stanley, thank you for your support. Today, as always, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Tuesday, November 23rd at 2:00 p.m. in London. At Morgan Stanley Research. We've just completed our outlook for 2022. This is a large, collaborative effort where all of the economists and strategists in Morgan Stanley Research get together and debate, discuss and forecast what we think holds for the year ahead. This is an inherently uncertain practice, and we expect a lot of twists and turns along the way, but what follows is a bit of what we think the next year might hold. So let's start with the global economy. My colleague Seth Carpenter and our Global Economics team are pretty optimistic. We think growth is strong in the U.S., the Euro area and China next year, with all three of those regions exceeding consensus expectations. A strong consumer, a restocking of low inventories and a strong capital expenditure cycle are all part of this strong, sustainable growth. And because we think consumers saved a lot of the stimulus from 2021, we're not forecasting a big drop off in growth as that stimulus fails to appear again in 2022. While growth remains strong, we think inflation will actually moderate. We forecast developed market inflation to peak in the coming months and then actually decline throughout next year as supply chains normalize and commodity price gains slow. Even though inflation is moderating, monetary policy is going to start to shift. Ultimately, we think moderating inflation and some improvement in labor force participation means that the Fed thinks it can wait a little bit longer to raise interest rates and doesn't ultimately raise rates until the start of 2023. For markets, shifting central bank policy means that the training wheels are coming off, so to speak. After 20 months of unprecedented support from both governments and central banks, this extraordinary aid is now winding down. Asset classes will need to rise and fall or, for lack of a better word, pedal under their own power. In some places, this should be fine. From a strategy perspective, we continue to believe that this is a surprisingly normal cycle, albeit one that's moving hotter and faster given the scale of the drawdown during the recession and then the scale of a subsequent response. As part of our cross-asset strategy framework, we run a cycle indicator that tries to quantify where we are in that economic cycle. We think markets are facing many normal mid-cycle conditions, not unlike 2004/2005. Better growth colliding with higher inflation, shifting central bank policy and more expensive valuations. Overall, we think that those valuations and this stage of the economic cycle supports stocks over corporate bonds or government bonds. We think the case for stocks is stronger in Europe and Japan than in emerging markets or the US, as these former markets enjoy more reasonable valuations, more limited central bank tightening and less risk from legislation or higher taxes. Those same issues drive a below consensus forecast here at Morgan Stanley for the S&P 500. We think that benchmark index will be at 4400 by the end of next year, lower than current levels. How do we get there? Well, we think earnings are actually pretty good, but that the market assigns a lower valuation multiple of those earnings - closer to 18x or around the average of the last 5 years as monetary policy normalizes. For interest rates and foreign exchange, my colleagues really see a year of two parts. As I mentioned before, we think that the Fed will ultimately wait until 2023 to make its first rate hike, but it might not be in any rush to signal that action right away, especially because inflation remains relatively high. As such, we remain positive on the U.S. dollar and think that U.S. interest rates will rise into the start of the year - two factors that mean we think investors should be patient before buying emerging market assets, which tend to do worse when both the U.S. dollar and yields are rising. We forecast the U.S. 10-year Treasury yield to be at 2.1% by the end of 2022 and think the Canadian dollar will appreciate against most currencies as the Bank of Canada moves to raise interest rates. That's a summary of just a few of the things that we think lie ahead in 2022. As with 2021, we're sure they're going to be many twists and turns along the way, and we hope you keep listening to Thoughts on the Market for updates on how we see these changes and how they impact our market views. 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.
Mike Wilson: 2022 Equity Outlook Feedback and Debates
With the release of our outlook for the coming year comes a cycle of feedback and debates from clients and investors. We look at those discussions around equity markets, valuations, and more in 2022. ----- 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, November 22nd at 11:30 a.m. in New York. So let's get after it. Last week, we published our outlook for 2022 and spent a lot of time discussing it with investors. This week, we share feedback from those conversations where there is agreement and pushback. Our first observation is that there wasn't as much engagement as usual. Part of this may be due to the fact that our general view hasn't changed all that much, leaving us with an unexciting overall price target for the main U.S. indices. We also sense there's a bit of macro fatigue setting in, with many investors struggling to generate alpha in what appears to be a runaway bull market for the S&P 500 - the primary U.S. equity benchmark for most asset managers. This lines up with one of our key messages for the upcoming year - focus on the micro and pick stocks if you want to outperform. As the economic recovery matures, more companies are struggling with the imbalances created by the pandemic. To us, this generally means focus on earnings stability and superior execution skills as key factors when identifying winning stocks from here. Going back to our conversations, there's a broad agreement with our more recent tactical view that U.S. equity markets are ahead of the fundamentals, but they can stay elevated in the near-term given incredibly strong flows from retail, systematic strategies and buybacks. Furthermore, pressure to keep up with the benchmarks is curtailing willingness to de-risk early. While there are signs of deterioration under the surface with many individual companies suffering from inflation pressures, supply bottlenecks and even demand destruction in some cases, the S&P 500 earnings forecasts are still moving higher, albeit at a slower pace. More specifically, we are witnessing weak breadth as the major averages make new highs. Most clients feel that in the absence of an outright decline in earnings forecasts, seasonal strength can maintain the market's elevated levels and there's no reason to fight it. Having said that, while there is agreement valuations are currently rich, the primary push back to our outlook for next year is that we are too bearish on valuation. While many investors we speak with think 2022 will be more challenging than this year, most still expect US equity indices to deliver 5-10% returns over the next year, while we project flat to slightly down returns in our base case. The primary difference of opinion is on valuation, which appears vulnerable, in our view, to tightening financial conditions and a more uncertain range of outcomes in the economy and earnings over the next 6 months, and that should lead to higher risk premiums or lower valuations. The other key debate with clients center on the strength of the US consumer. Recent macro data like retail sales, and micro data from strong consumer earnings in the third quarter, suggests that consumers remain ebullient into the holidays. This is very much in line with the survey that we published two weeks ago - the same survey that suggests this strength may not be sustainable into next year due to weakening personal financial conditions from higher inflation. Our analysis and comparison of the Conference Board and University of Michigan consumer confidence surveys appear to support a deterioration into next year - a key reason we are underway the consumer discretionary sector despite strength into the holidays. Bottom line, U.S. equity markets have delivered another stellar year of returns, which is typical in the second year of an economic recovery. However, given the speed of this recovery and record returns over the prior 18 months, we thought it was prudent to reduce our equity exposure back in early September. While our timing on that risk reduction was wrong, higher prices, driven mostly by higher valuations, only make the risk/reward for 2022 worse, not better. In short, stick with larger cap, higher quality stocks at reasonable valuations. 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.
2022 Global Economic Outlook, Pt. 2: Debates and Uncertainties
Andrew Sheets continues his discussion with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022, what’s misunderstood and where it could be wrong. ----- Transcript ----- Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research. Seth Carpenter And I'm Seth Carpenter. I'm Morgan Stanley's Chief Global Economist. Andrew Sheets And on part two of the special episode of Thoughts on the Market, Seth and I will be continuing our discussion on the 2022 outlook for the global economy and how that outlook could impact markets in the coming year. It's Friday, November 19th at 5:00 p.m. in London. Seth Carpenter And if it's five pm in London, it's noon in New York. Andrew Sheets Seth, you speak to a wide variety of clients, and this topic of the supply chain, you know, keeps coming up in a variety of formats. It comes up in our financial discussions. It comes up in the popular press. Is there a part of this story that you think is poorly understood or maybe misunderstood, you know, amidst all this focus of supply chain stress? Seth Carpenter I think I'd point to two key areas where maybe there could be a little bit more attention focused. The first one, and I was sort of talking in these terms before, is the difference between the price level and inflation. Now, if I am at the store and I'm looking at milk on the shelf, all I care about is the price level itself: is milk more expensive than it was before? Is the price high? When the central bank, when investors look at prices, they're actually measuring inflation, the rate of growth of those prices. And I think that key distinction is one of the big parts here. If supply chains stop getting worse, then it seems like in general, at some point the price level should stop going up. It'd still be a high price and it'd still be unpleasant for consumers. But the inflation on that would end up being zero. And I think that difference between growth rates and price levels is one thing that probably deserves a little bit more scrutiny. Seth Carpenter And I think the second part is-- I'm going to use an economics type term here-- how non-linear some of these effects are. And so what do I mean there? If you think about the auto industry, which has been in the news a lot for having a shortage of microchips, for example. But suppose you had a car that had 95% of the parts already assembled, 5% were missing. That's not a car. That's spare parts. Suppose you had a hundred cars that were 95% done. In a linear version of the world, 95% of one hundred is 95 cars. But you still really just have a pile of spare parts at that point. And so it's not as though you get proportional reduction in output. You can get all of the output disrupted for one of just a few parts. I'm curious to see how it resolves on the other side. Does it turn out then that all of a sudden, we're faced with a glut of extra products because those few missing parts are now delivered and so all of a sudden that final assembly can get done and we have a lot. I don't know what the answer is. We've assumed that it's much smoother than that when things unwind, but there really is a lot of uncertainty here. Andrew Sheets So, Seth, the last 18 months have been really hard. But you know, you could maybe argue that for the Fed, its decisions have been somewhat easy. And we've seen the Fed and other central banks take extraordinary action. But, you know, now the Fed, the European Central Bank, you know, a lot of these central banks are now coming under a lot more pressure on the one side to say, you know, inflation's now picking up, you're making a mistake to, you know, the economy still not normal. It still needs a lot of support. How do you see those debates playing out? And how do you think some of that ultimately resolves itself next year? Seth Carpenter I mean, debate is exactly the right word, and I love to note to clients that my job used to be to argue over what should happen with policy but now my job is just to think about what's likely to happen. And there I turn to the policymakers themselves, and so when I think about Chair Powell, I think about the fact that they announced a tapering of their asset purchases, and he said he expects that to run through the middle of next year. He also said that he expects inflation to come down, but he doesn't expect it to materially come down until Q2 or Q3 of next year. In that context, that to me says he's probably waiting for a while to see how the data resolve themselves. Seth Carpenter What I've also heard Chair Powell say is that their conditions for raising short term interest rates is both having inflation doing what they want it to do, but also full employment. And he's tried to give a few different measures of full employment means to them. It's not just the measured unemployment rate, but it's also people getting jobs. It's also people who have left the labor market coming back into the labor market. And so in the forecast that the US economics team has, inflation is coming down over the course of 2022, labor supply measured by the labor force participation rate in their forecast is going up. And so when the US economics team puts those two together and thinks about how Chair Powell has characterized the Fed's decision making process, they come to the conclusion that it seems natural to think that he's going to want them to wait at least through the end of 2022 and right at the beginning of 2023 before starting to raise short term interest rates. Now you're our cross asset strategist and so you know for a fact that markets have been pricing lots of other things. Andrew Sheets And Seth, it's fair to say that's probably one of our more controversial assumptions for next year, this idea that the Federal Reserve doesn't end up raising interest rates in 2022, even though that is, as you mentioned, what the market's currently expecting. Seth Carpenter Correct. It's definitely a place where we are out of consensus. And I think as we got the recent consumer price index report that showed still quite high inflation. And as markets start to look for, you know, the next couple of months where there's inflation prints go, I think the market is expecting inflation to stay high for sufficiently long that Chair Powell and the Fed change their minds. And that clearly could happen. Andrew Sheets Seth, the thing I wanted to close with was, you know, a real central part of our research process at Morgan Stanley-- and this is true in strategy and economics down to our stock analysts-- is to not just try to think about a likely base case, but also think about a bull and a bear case around it. Kind of realistic, good and bad scenarios that could happen over the next 12 months. So let's get the bad news out of the way. If you think about a realistic bad case for the global economy next year, what does it look like and what gets us there? Seth Carpenter Wow. So this is where I have to admit, being my first time in this outlook process, I may have tipped the apple cart over just a little bit because I threw the team a curveball and I said there are actually two key ways that I could be disappointed in the global economy. And the first one is a worse outcome for the supply side. That is our assumption that supply chains get better over time. That might not happen, right? That might stay bad for longer, we might have more frictions in the labor market than we expect. In that version of the world, we likely get both weaker economic growth than we think and higher inflation than we forecast because the supply disruptions would feed into sustained inflationary pressures that keep those price prices rising and rising and rising over time as supply chains get worse. And at the same time, we could easily see, under those circumstances, central banks globally shifting towards tighter monetary policy. If we get much higher inflationary outcomes than we currently forecast we're just going to see more tightening. And so you get that double whammy of less production, less economic activity because supply disruptions and also tighter financial conditions. And so that's an outcome that we can't rule out. And that's troubling. Seth Carpenter On the other hand, we could be wrong about the lack of a fiscal drag in the United States. We could be wrong about how much fiscal support there is going to be in Europe, for example. We could be wrong about how the Chinese economy recovers from the recent slowdown. And so we could have a demand side bear case, a demand side worse outcome. In that case, though, the world looks a little bit more normal the way, you know, markets and economists would have thought about these things pre-pandemic, i.e. slower growth, lower inflation. In that version of the world though central banks tend to sit back, I think, and wait to see how things turn out. But that, I think, is a really good illustration of just how much uncertainty there is right now. There's a version of the world where we have worse growth and higher inflation. There's a version of the world where we have worse growth and lower inflation. And I have to admit I spent some time wringing my hands, worrying about each of them. Andrew Sheets And finally, Seth, to end on a high note, what's the most realistic, positive case for the global economy next year and how could we get there? Seth Carpenter Andrew, you know, I'm an economist, which means that I'm uncomfortable being cheerful, but I'll give it a shot. So those global supply disruptions, the sort of inability of consumer goods to sort of flow to market as fast as people want to buy them, the restrictions on commodity production that have led to the really high prices. I have to believe there's a version of the world where that all gets resolved much more quickly. Right? Where all of those partially produced goods that only need one or two extra spare parts, that ship arrives, those spare parts come in, and then all of a sudden, we've got a glut of supply instead of a shortage of supply. I think in that version of the world, we have a really virtuous cycle. A couple of things happen. One, inflation starts to come down much more quickly because there's much more availability of all those goods that people are looking to buy. Second, there's a lot more availability of all those goods that people are willing to buy. And so as a result, you can have that economic activity picking up. I think at the same time, in the same spirit of a better supply outlook, the labor supply could fix itself more quickly. In which case wage pressures start to ease a little bit, people feel more comfortable coming back to the labor market. Maybe that's because of the increasing vaccinations, especially among children. Maybe it's because we get past the winter and we have a milder winter when it comes to the to the pandemic. All of those sort of supply things, both physical goods and greater supply and more labor supply-- if those happened together than we should have faster growth. But as it turns out, a bit less in the way of inflationary pressures. And so that really would be sort of a fantastic outcome. Andrew Sheets We'll have to stay tuned. Seth, thanks for taking the time to talk. Seth Carpenter I have to say, Andrew, it's always my pleasure to get to talk to you. Andrew Sheets 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 find the show.
2022 Global Economic Outlook, Pt. 1: Optimism in the New Year
Andrew Sheets speaks with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022 and how consumer spending, labor, and inflation contribute to that story. ----- Transcript ----- Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research. Seth Carpenter And I'm Seth Carpenter. I'm Morgan Stanley's Chief Global Economist. Andrew Sheets And on part one of this special episode of Thoughts on the market, we'll be discussing the 2022 outlook for the global economy and how that outlook could impact markets in the coming year. It's Thursday, November 18th at 5:00 p.m. in London. Seth Carpenter And that makes it noon in New York City. Andrew Sheets So, Seth, welcome to Thoughts on the Market. You are Morgan Stanley's new chief global economist and, while we've just sat down to work on our year ahead outlook and we're going to discuss that, I was hoping you could just give listeners a little background around yourself and what brings you to this role? Seth Carpenter Thanks, Andrew. This has been a great experience for me working on the outlook as my introduction to Morgan Stanley. I guess I've been here just a few months now. Before coming to Morgan Stanley, I was at another big sell-side bank for a few years, spent a little time on the buy-side. But most of my career, I have to say, I spent in Washington DC. I spent 15 years of my career at the Federal Reserve working on all sorts of aspects about monetary policy. And then I spent two and a half years at the U.S. Treasury Department. So, I'm really, really a product of Washington more than I am Wall Street. Andrew Sheets Well, that's great. And so well, let's get right into it because, you know, this is a big collaborative process that you and I and a lot of our colleagues work on. And so let's start with that global economic picture. You know, as you step back and you think about our expectations, how good is the global economy going to be next year? Seth Carpenter Yeah, I have to say our economics team around the world is actually fairly optimistic-- call it bullish-- relative to consensus. When I think about the global economy, clearly the two biggest economies are the U.S. and China. And so starting with the U.S., Ellen Zentner, our chief U.S. economist, has an outlook that the U.S. economy is going to slow down next year, but boy, still be going kind of fast. Right around four and a half percent, which is, you know, slower than the growth rate that we're getting this year, but still a really, really solid growth for the for the year as a whole. And I think in that there's a lot of things going on. We're still getting lots of job gains and the more job gains we have, the more consumer spending we get. And of course, consumer spending, that's 70% of US GDP. I think as well, we're looking forward to there being a big restocking of inventories. I think everyone has heard about the global supply chain issue and inventories in the United States in particular are very, very lean. And so we're looking for a bit of an extra boost to the economy coming from that inventory restocking. So it's a pretty optimistic case; slower than this year, to be sure, but still a pretty optimistic outlook. Andrew Sheets And Seth, what about that other big driver of the global economy, China? How do you think its economy looks next year? Seth Carpenter Robin Xing is our chief China economist, and he is also similarly a bit optimistic relative to consensus. Deceleration, to be sure, from where we were before COVID. But five and a half percent growth is still going to put our forecast, you know, higher than most other people making these sorts of forecasts. And there, when I talked to Robin, what he tells me is, you know, there was a slowdown in the Chinese economy this year in Q3, but a lot of that was policy induced as the policymakers in Beijing are trying to take another step in reorienting the Chinese economy. And because the slowdown was policy induced, we're going to get a recovery that's also policy induced. And so, he's actually pretty constructive about how growth for next year is going to turn out. Andrew Sheets So Seth, one question about the economy next year is, well, in 2021, we had all of this fiscal support, all this government support for growth and that's not going to be there in the same way. And you hear a lot about this concept of the fiscal cliff of the government support that was there falling away and even reversing and being a drag on growth. How do you square that with what seemed like pretty optimistic economic projections from our side? Seth Carpenter So here's how the US team would talk about it. When we think about what drove the fiscal policy this year, what drove the high deficit this year, a lot of it was income replacement. Many people had lost their jobs, many people were out of work and government transfers were replacing a fair amount of that income. And so as we move into next year, we're already seeing many of those jobs coming back, to be sure, not all of them yet. But in the forecast, jobs keep coming back and with it, labor income. And so what the government support had been doing, in part, was providing income to allow spending to go on in 2021. Next year in the forecast, it's labor income that allows the same type of spending to go on. And so as a result, there's no discrete step down that's coming from that removal of fiscal policy. And moreover, I think one thing that avid readers of economic data will know is that the saving rate i.e. how much of current income is being spent versus being saved. The saving rate is actually quite elevated. And part of that is this government transfer of income, not all of it being spent in the current period. Well, the US team says we're going to take some of that excess savings and assume that a portion of it actually gets spent in 2022. So that's another factor that's going to reduce the likelihood of us having a fiscal drag the way other forecasters probably have in their numbers. Andrew Sheets Seth, another concern that comes up a lot in these conversations is around the i-word: inflation. You know, you and I and some of our colleagues just did a large webcast for many of our investment clients. And I think without exaggeration, maybe 80% of the questions were in in some way related to inflationary risks and the inflationary backdrop. So, you know, we think growth is going to be good next year-- it might be better than expected-- but what does that imply for the inflation outlook and, how big of a risk is it that inflation is eating away at the spending power of the consumer and other parts of the economy? Seth Carpenter No question that inflation is sort of the key question in macro these days and into next year. And I think there is a real risk that high prices end up eating into purchasing power. It's clear that people who are on fixed income, people who are at the lower end of the income distribution, when the price of gasoline is going up, when the price is food is going up, that's very, very real for those people and it can affect how much extra discretionary spending they have. So I think that that clearly matters a lot. And I think one of the challenges between being an economist, thinking in terms of the technical data side of things, versus communicating to a broader audience is that inflation is about the rate of change of those prices, as opposed to what regular people see every day, which is the level of those prices. So in our-- in the forecast the US team has there are a lot of those prices that actually stay high, but the rate at which they go up in the forecast actually peaks at the beginning of 2022 and then starts to come down. It starts to come down for a few reasons. First: oil. If we look at the futures curve, looks as if oil prices should probably peak around December and then gradually come down over the course of next year. I think in addition to that, everyone has been talking about the global supply chain sort of bottlenecks in terms of consumer goods getting to consumers being a real challenge now takes time. It's proven to be quite durable so far. The maintained assumption that the economics team around the world had was the following: that those supply chain frictions-- be it the Port of Los Angeles and shipping containers, be it semiconductor production in East Asia, the whole kit and caboodle-- goes back to something that looks like normal at the end of 2022. But what that means in the forecast is things are about at their worst now, start to get better at the beginning of the year, and then take the whole year to get better. But if that's the case, then the easier access to the consumer goods should mean that prices on those consumer goods that have been going up so dramatically should probably stop going up sometime around the beginning of the year. And in fact, maybe start to go back towards more normal levels over time. So that's what's in the forecast. Andrew Sheets Seth, another thing I was hoping to ask you about as it relates to inflation is, you know, how much of this with your global hat on is a global phenomenon versus, you know, some more specific, idiosyncratic things related to the U.S. economy. You know, when you when you look across some different regions, some other major markets, are they having similar inflationary dynamics? Is it different? And importantly, could we see more divergence in the inflation picture going forward into next year? Seth Carpenter Oh, absolutely. So, looking across different countries, there's unquestionably a global component to this inflationary surge. I think what can differ, though, is how that inflationary impulse is transmitted to to different economies over time. So, you know, we've talked through our views on what happens in the United States. And in countries where you tend to have more of a history of high and variable inflation, it's easier for those sort of pricing pressures to spread to other components. Add to that in countries where if it's a small, open economy with a floating exchange rate, you can easily imagine that country's currency could decline a bit in value, which means all of their imported goods are more expensive as well, which then leads to more inflation. So clearly a common shock. The net effect across economies, though, can be quite different. I'd say one component that's a bit different in the United States than others is the structure of our of our labor market. In a lot of European countries, there was a mechanism put in place, a policy put in place to essentially try to freeze people in place attached to their employer; in the U.K. they call it 'the furlough scheme.' In the United States there was no similar specific plan that was covering the entire country. That friction in the labor market is quite difficult to overcome. And we're seeing some of that show through by, in some cases, businesses needing to pay more to attract new workers. And so, like I said, a clear common global shock, but the transmission varies by country. Andrew Sheets Thanks for listening. We'll be back in your feed soon for part two of my conversation with Seth Carpenter on the outlook for the global economy in 2022. Andrew Sheets And as a reminder, if you enjoy thoughts on the market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.
About the podcast Thoughts on the Market
Short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.