Thoughts on the Market
About 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.
Our Global Macro Strategist explains the complex nature of recent U.S. economic reports, and which figures should matter most to investors. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Matthew Hornbach, Morgan Stanley’s Global Head of Macro Strategy. Along with my colleagues bringing you a variety of perspectives, today I'll talk about what investors should take away from recent economic data. It's Thursday, February 29, at 4pm in New York. There’s been a string of confusing US inflation reports recently, and macro markets have reacted with vigor to the significant upside surprises in the data. Before these inflation reports, our economists thought that January Personal Consumption Expenditures inflation, or PCE inflation, would come at 0.23 per cent for the month. On the back of the Consumer Price Index inflation report for January, our economists increased their PCE inflation forecast to 0.29 per cent month-over-month. Then after the Producers’ Price Index, or PPI inflation report, they revised that forecast even higher – to 0.43 per cent month-over-month. Today, core PCE inflation actually printed at 0.42 per cent - very close to our economists’ revised forecast. That means the economy produced nearly twice as much inflation in January as our economists thought it would originally. The January CPI and PPI inflation reports seem to suggest that while inflation is off the record peaks it had reached, the path down is not going to be smooth and easy. Now, the question is: How much weight should investors put on this data? The answer depends on how much weight Federal Open Market Committee participants place on it. After all, the way in which FOMC participants reacted to activity data in the third quarter of 2023 – which was to hold rates steady despite encouraging inflation data – sent US Treasury yields sharply higher. Sometimes data is irrational. So we would take the recent inflation data with a grain of salt. Let me give you an example of the divergence in recent data that’s just that – an outlying number that investors should treat with some skepticism. The Bureau of Labor Statistics, or BLS, calculates two measures of rent for the CPI index: Owner’s equivalent rent, or OER, and rents for primary residences. Both measures use very similar underlying rent data. But the BLS weights different aspects of that rent data differently for OER than for rents. OER increased by 0.56 per cent month-over-month in January, while primary residence rents increased 0.36 per cent month-over-month. This is extremely rare. If the BLS were to release the inflation data every day of the year, this type of discrepancy would occur only twice in a lifetime – or every 43 years. The confusing nature of recent economic data suggests to us that investors should interpret the data as the Fed would. Our economists don't think that recent data changed the views of FOMC participants and they still expect a first rate cut at the June FOMC meeting. All in all, we suggest that investors move to a neutral stance on the US treasury market while the irrationality of the data passes by. 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.
As the deadline to fund the government rapidly approaches, Michael Zezas explains what economic effect a possible shutdown could have and whether investors should be concerned. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the market impacts of a potential US government shutdown. It's Wednesday, February 28th at 2pm in New York. Here we go again. The big effort in Washington D.C. this week is about avoiding a government shutdown. The deadline to pass funding bills to avoid this outcome is this weekend. And while many investors tell us they’re fatigued thinking about this issue, others still see the headlines and understandably have concerns about what this could mean for financial markets. Here’s our quick take on it, specifically why investors need not view this as a markets’ catalyst. At least not yet. In the short term, a shutdown is not a major economic catalyst. Our economists have previously estimated that a shutdown shaves only about .05 percentage points off GDP growth per week, and the current shutdown risk would only affect a part of the government. So, it's difficult to say that this shutdown would mean a heck of a lot for the US growth trajectory or perhaps put the Fed on a more dovish path – boosting performance of bonds relative to stocks. A longer-term shutdown could have that kind of impact as the effects of less government money being spent and government employees missing paychecks can compound over time. But shutdowns beyond a few days are uncommon. Another important distinction for investors is that a government shutdown is not the same as failing to raise the debt ceiling. So, it doesn’t create risk of missed payments on Treasuries. On the latter, the government is legally constrained as to raising money to pay its bills. But in the case of a shutdown, the government can still issue bonds to raise money and repay debt, it just has limited authority to spend money on typical government services. So then should investors just simply shrug and move on with their business if the government shuts down? Well, it's not quite that simple. The frequency of shutdown risks in recent years underscores the challenge of political polarization in the U.S. That theme continues to drive some important takeaways for investors, particularly when it comes to the upcoming US election. In short, unless one party takes control of both Congress and the White House, there’s little domestic policy change on the horizon that directly impacts investors. But one party taking control can put some meaningful policies into play. For example, a Republican sweep increases the chances of repealing the inflation reduction act – a challenge to the clean tech sector. It also increases the chances of extending tax cuts, which could benefit small caps and domestic-focused sectors. And it also increases the chances of foreign policies that might interfere with current trends in global trade through the levying of tariffs and rethinking geopolitical alliances. That in turn creates incentive for on and near-shoring…an incremental cost challenge to multinationals. So, we’ll keep watching and keep you in the loop if our thinking changes. 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.
As grocery and dining costs continue to increase, our analysts break down how this has affected consumers and when food prices may stabilize. ----- Transcript ----- Sarah Wolfe: Welcome to Thoughts on the Market. I'm Sarah Wolfe from the US economics team. Simeon Gutman: And I'm Simeon Gutman; Hardlines, Broadlines, and Food Retail Analyst. Sarah Wolfe: Today on the podcast, we'll discuss what's happening with food prices and how that's affecting the US consumer. It's Tuesday, February 27th at 10am in New York. It was almost exactly a year ago when I came on this podcast to talk about why eggs cost so much at the start of 2023. Here we are. It's a year later and food in the US still costs more. The overall inflation basket and personal consumption expenditures inflation was 2.6 per cent year over year in December; but dining out prices are still up 5.2 per cent. I'd like to admit that grocery prices are a little bit better. They're just a tad over 1 per cent. So we've seen a little bit more disinflation there. But overall food is still up and it's still expensive. Simeon, can you give us a little bit more color on what's actually going on here? Simeon Gutman: Yeah, so food prices measured by the CPI, as you mentioned, up about a per cent. The good news, Sarah, is that your eggs are actually deflating by about 30 per cent at the moment; so maybe you can buy a couple more eggs. But in general, we're following this descent that we started -- about almost two years ago where food prices were up double digits. A year ago, we were up mid single digits. And now we're down to this one per cent level. Looks like they're gonna hold. But so prices are coming in; but not necessarily deflating, but dis-inflating. Sarah Wolfe: Can you help me understand that a little bit better? You mentioned that some commodity prices are coming down, like food prices. So why is overall inflation for food still rising? And dining out, grocery stores, both of them are still seeing price increases. Simeon Gutman: Well, commodity prices, which is the most visible input to a lot of food items -- that's coming down in a lot of cases, and I'll mention some that haven't. But there's many other components into food pricing, besides the pure commodity. That's labor; you have freight; you have transportation. Those costs -- there's still some inflation running through the system -- and those costs make up a decent chunk of the total product costs. And that's why we're still seeing prices higher year over year on average for the entire group of products. Sarah Wolfe: How are grocery sales actually performing though? Are we seeing demand destruction from the higher pricing? Or has unit growth actually been holding up well? Simeon Gutman: First of all, total grocery sales are just slightly negative. We saw a little ray of hope in January, positive for the month; but likely driven by some stocking up ahead of weather events that happened in the country. So we were barely positive. It looked like we were getting out of the negative territory; but the first few weeks of February, we're back into the negative territory. Negative one, negative two per cent. Units are negative. Negative three to four per cent. If we look at CPI as sort of a proxy for the product categories that are doing better than others: dairy and fruit units, those are up mid to high single digits. And as I mentioned, we're seeing egg prices down significantly. We're also seeing a lot of deflation with fish and seafood as well as meat. So, and if you use that as a way to think about the various product categories that consumers are demanding, but overall industry sales are flat to slightly negative; and we think this negative cadence continues going forward. Sarah, let me turn it to you. You monitor the U. S. consumer closely. How big a bite of the US wallet is food right now? Groceries, eating out at restaurants, etc., and how does that compare to prior periods? Sarah Wolfe: Let's start high level with essential spending, which I consider to be groceries, energy and shelter. That typically averages about 40 per cent of household disposable income pre-COVID. And now if you add on all the price increases we've seen across all three categories, it's an additional 5 per cent of disposable income today. And this matters a lot when you're a lower income household and already over 90 per cent of your disposable income was going towards these essential categories pre-COVID. If I look at grocery prices alone, they're up 20 per cent on average since the start of the pandemic. And prior to COVID on a per household basis, they were spending $4,600 a year on groceries. And now that's $5,700 a year. More than a thousand dollars more each year on groceries. The last time we saw such extreme food inflation was the 1980s. Granted, I have to mention that we've also seen a really notable rise in disposable income too. So if you look at grocery spending as a share of disposable income, it's only marginally higher than it was pre-COVID. It was six and a half per cent, now it's seven per cent. What's really driving higher wallet share towards food is this dining out category -- and it's a price and unit story. On the pricing side, we have high labor costs, high food prices still. And on the unit side, there's still a much more notable preference to dine out to enjoy services. And so you mentioned that unit growth has been a lot weaker for groceries. That's not what we're seeing in the dining out space. And overall, it's been driving total food spend as a share of disposable income to high since the early 1990s. Simeon Gutman: So food spending is up a lot. But the situation is somewhat confusing. You have US inflation data and forecasts seem to be suggesting that food prices should be coming down. That doesn't seem to be happening. We're still looking for inflation. Can you talk about the macro factors behind these persistently high food prices? Sarah Wolfe: So as you mentioned, we have seen disinflation, right? So grocery prices are down from 12 per cent year over year in the summer of 2022 to about 1.5 per cent today. Dining out is down from 8 per cent to about 5 per cent. So there's a bit of progress on inflation growth. But price levels are not coming down. They're still rising and that definitely does not feel good to households. The reason we're still seeing a rise in prices, as you've mentioned, are supply chain disruptions, there was an avian flu, and we see very high labor costs. Some of the forward-looking indicators are pointing to more progress on inflation for food, so we know that labor costs are starting to moderate as supply demand imbalances in the labor market are getting a bit better. We know that supply chain disruptions have been unwinding. But all these things together are not pointing to price deflation. Only disinflation. So growth, but at a slower pace. Simeon Gutman: Yeah, so some of this backdrop continues. When can the US consumer expect some kind of relief, and then what data and indicators are you watching closely? Sarah Wolfe: Unfortunately, prices are still going up in our forecast, but they're going to stabilize around one to one and a half per cent year over year for grocery. So kind of where we are right now, that's what we expect for the next year and a half or so. But the price levels are going to remain elevated. As I mentioned in the last response. We know we're watching the supply chain indicators to see if commodity prices start to come up again. If freight costs start to come up again because of geopolitical tensions. We're not seeing any notable rise there yet but we're watching it very closely. And we're also watching what happens with the labor market. Do we continue to see slack in the labor market that'll bring down wages and bring down labor costs? Or do we continue to run a very tight labor market. Simeon, thanks for taking the time to talk. Simeon Gutman: Great speaking with you, Sarah. Sarah Wolfe: 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.
Our Chief U.S. Equity Strategist reviews how the unusual mix of loose fiscal policy and tight monetary policy has benefited a small number of companies – and why investors should still look beyond the top five stocks. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the investment implications of the unusual policy mix we face. It's Monday, February 26th at 12pm in New York. So let’s get after it. Four years ago, I wrote a note entitled, The Other 1 Percenters, in which I discussed the ever-growing divide between the haves and have-nots. This divide was not limited to consumers but also included corporates as well. Fast forward to today, and it appears this gap has only gotten wider. Real GDP growth is similar to back then, while nominal GDP growth is about 100 basis points higher due to inflation. Nevertheless, the earnings headwinds are just as strong despite higher nominal GDP – as many companies find it harder to pass along higher costs without damaging volumes. As a result, market performance is historically narrow. With the top five stocks accounting for a much higher percentage of the S&P 500 market cap than they did back in early 2020. In short, the equity market understands that this economy is not that great for the average company or consumer but is working very well for the top 1 per cent. In my view, the narrowness is also due to a very unusual mix of loose fiscal and tight monetary policy. Since the pandemic, the fiscal support for the economy has run very hot. Despite the fact we are operating in an extremely tight labor market, significant fiscal spending has continued. In many ways, this hefty government spending may be working against the Fed. And could explain why the economy has been slow to respond to generationally aggressive interest rate hikes. Most importantly, the government’s heavy hand appears to be crowding out the private economy and making it difficult for many companies and individuals. Hence the very narrow performance in stocks and the challenges facing the average consumer. The other policy variable at work is the massive liquidity being provided by various funding facilities – like the reverse repo to pay for these deficits. Since the end of 2022, the reverse repo has fallen by over $2 trillion. It’s another reason that financial conditions have loosened to levels not seen since the federal funds rate was closer to 1 per cent. This funding mechanism is part of the policy mix that may be making it challenging for the Fed’s rate hikes to do their intended work on the labor market and inflation. It may also help explain why the Fed continues to walk back market expectations about the timing of the first cut and perhaps the number of cuts that are likely to continue this year. Higher interest rates are having a dampening effect on interest-rate-sensitive businesses like housing and autos as well as low to middle income consumers. This is exacerbating the 1 percenter phenomena and helps explain why the market’s performance remains so stratified. For many businesses and consumers, rates remain too high. However, the recent hotter than expected inflation reports suggest the Fed may not be able to deliver the necessary rate cuts for the markets to broaden out – at least until the government curtails its deficits and stops crowding out the private economy. Parenthetically, the funding of fiscal deficits may be called into question by the bond market when the reverse repo runs out later this year. Bottom line: despite investors' desire for the equity market to broaden out, we continue to recommend investors focus on high-quality growth and operational efficiency factors when looking for stocks outside of the top five which appear to be fully priced. 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.
The valuations of stocks and corporate bonds, which have been driven largely by macroeconomic factors since 2020, are finally starting to reflect companies’ underlying performance. Our Head of Corporate Credit Research explains what that means for active investors. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about trends across the global investment landscape – and how we put those ideas together. It's Friday, February 23rd at 2pm in London. In theory, investing in corporate securities like stocks or corporate bonds should be about, well, the performance of those companies. But since the outbreak of COVID in 2020, financial markets have often felt driven by other, higher powers. The last several years have seen a number of big picture questions in focus: How fast could the economy recover? How much quantitative easing or quantitative tightening would we see? Would high inflation eventually moderate? And, more recently, when would central banks stop hiking rates, and start to cut. All of these are important, big picture questions. But you can see where a self-styled investor may feel a little frustrated. None of those debates, really, concerns the underlying performance of a company, and the factors that might distinguish a good operator from a bad one. If you’ve shared this frustration, we have some good news. While these big-picture debates may still dominate the headlines, underlying performance is starting to tell a different story. We’re seeing an unusual amount of dispersion between individual equities and credits. It is becoming a market of many. We see this in so-called pairwise correlation, or the average correlation between any two stocks in an equity index. Globally, that’s been unusually low relative to the last 15 years. Notably options markets are implying that this remains the case. We see this in credit, where solid overall performance has occurred along-side significant dispersion by sector, maturity, and individual issuer, especially in telecom, media and technology. We see this within equities, where my colleague Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist, notes that the S&P 500 and global stocks more broadly have decoupled from Federal Reserve rate expectations. And we see this in performance. More dispersion between stocks and credit would, in theory, create a better environment for Active Managers, who attempt to pick those winners and losers. And that’s what we’ve seen. Per my colleagues in Morgan Stanley Investment Management, January 2024 was the best month for active management since 2007. The post-COVID period has often felt dominated by large, macro debates. But more recently, things have been changing. Individual securities are diverging from one another, and moving with unusual independence. That creates its own challenges, of course. But it also suggests a market where picking the right names can be rewarded. And we think that will be music to many investors' ears. 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.
As traditional financial institutions tightened their lending standards last year, private credit stepped in to fill some of the gaps. But with rates now falling, public lenders are poised to compete again on the terrain that private credit has transformed. ----- Transcript ----- Vishy Tirupattur: Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today we’ll have a conversation with Joyce Jiang, our US leveraged finance strategist, on the topic of private credit. It's Thursday, February 22nd at noon in New York. Joyce, thank you for joining. Private credit is all over the news. Let’s first understand – what is private credit. Can you define it for us? Joyce Jiang: There isn't a consensus on the definition of private credit. But broadly speaking, private credit is a form of lending extended by non-bank lenders. It's negotiated privately on a bilateral basis or with a small number of lenders, bypassing the syndication process which is standard with public credit. This is a rather broad definition and various types of debt can fall under this umbrella term; such as infrastructure, real estate, or asset-backed financing. But what's most relevant to leveraged finance – is direct lending loans to corporate borrowers. Private credit lenders typically hold deals until maturity, and these loans aren't traded in the secondary market. So, funding costs in private credit tend to be higher as investors need to be compensated for the illiquidity risk. For example, between 2017 and now, the average spread premium of direct lending loans is 250 basis points higher compared to single B public loans. Vishy Tirupattur: That’s very helpful Joyce. The size of the private credit market has indeed attracted significant attention due to its rapid growth. You often see estimates in the media of [the] size being around $1.5 to $1.7 trillion. Some market participants expect the market to reach $2.7 trillion by 2027. Joyce, is this how we should think about the market? Especially in the context of public corporate credit market? Joyce Jiang: I've seen these numbers as well. But to be clear, they reflect assets under management of global private debt funds. So not directly comparable to the market size of high yield bonds or broadly syndicated loans. In our estimate, the total outstanding amount of US direct lending loans is in the range of $630-710 billion. So, we see the direct lending space as roughly half the size of the high yield bonds or broadly syndicated loan markets in the US. Vishy Tirupattur: Understood. Can you provide some color on the nature of private credit borrowers and their credit quality in the private credit space? Joyce Jiang: Traditionally, private credit targets small and medium-sized companies that do not have access to the public credit market. Their EBITDA is typically one-tenth the size of the companies with broadly syndicated loans. However, this is not representative of every direct lending fund because some funds may focus on upper middle-market companies, while others target smaller entities. Based on the data that’s available to us, total leverage and EBITDA coverage in private credit are comparable to a single B to CCC profile in the public space. Additionally, factors such as smaller size, less diversified business profiles, and limited funding access may also weigh on credit quality. Given this lower quality skew and smaller size, there have been concerns around how these companies can navigate the 500 basis point of rate hikes. However, based on available data, two years into the hiking cycle, coverage has deteriorated – mainly due to the floating-rate heavy nature of these capital structures. But on the bright side, leverage generally remained stable. Similar to what we’ve seen in public credit. Now let me turn it around to you, Vishy. What about defaults in private credit and how do they compare to public credit markets? Vishy Tirupattur: So when it comes to defaults, unlike in the public markets, data that cover the entire private credit market is not really there. We have to depend on the experience of sample portfolios from a variety of sources. These data tend to vary a lot, given the differences in defining what a default is and how to calculate default rates, and so on. So, all of this is a little bit tricky. We should also keep in mind that the data we do have on private credit is over the last few years only. So, we should be careful about generalizing too much. That said, based on available data we can say that the private credit defaults have remained broadly in the same range as the public credit. In other words, not substantially higher default rates in the private credit markets compared to the public credit defaults. A few things we should keep in mind as we consider this relatively benign default picture. What contributes to this? First, private credit deals have stronger lender protections. This is in contrast to the broadly syndicated loan market – which is, as you know, predominantly covenant-lite market. Maintenance covenants in private credit can really act as circuit breakers, reining in borrower behavior before things deteriorate a lot. Second, private credit deals usually involve only a very small number of lenders. So it’s easier to negotiate a restructuring or a workout plan. All of this contributes to the default experience we’ve observed in private credit markets. Joyce Jiang: And finally, what are your thoughts on the future of private credit? Vishy Tirupattur: The rapid growth of private credit is really reshaping the landscape of leveraged finance on the whole. Last year, as banks retreated, private credit stepped in and filled the gap – attracting many borrowers, especially those without access to the public market. Now, as rate cuts come into view, we see public credit regaining some of the lost ground. So how private credit adapts to this changing environment is something we’ll be monitoring closely. With substantial dry powder ready to be deployed, the competition between public and private credit is likely to intensify, potentially impacting the overall market. Joyce, let's wrap it up here, Thanks for coming on the podcast. Joyce Jiang: Thanks for having me. Vishy Tirupattur: Thank you all 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.
Central banks in the U.S. and Europe are looking to cut rates this year, but the path to those cuts differs greatly. Our Global Chief Economist explains this stark dichotomy. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Seth Carpenter, Morgan Stanley’s Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I’ll be talking about the challenges for monetary policy on both sides of the Atlantic. It’s Wednesday, Feb 21st at 10am in New York. The Fed, the Bank of England, and the ECB all hiked rates to fight inflation, and now we are looking for each of them to cut rates this year. For our call for a June Fed rate cut, both growth and inflation matter. But our call for a May and June start on the east side of the Atlantic depends only on inflation. “Data dependent” here has two different meanings. At the January Fed meeting, Chair Powell said continued disinflation like in prior months was needed to cut. But he also emphasized that disinflation needs to be sustainably on track; not simply touching 2 per cent. Until Thursday’s retail sales data, the market narrative began to flirt with a possible re-acceleration of the US economy, spoiling that latter condition of inflation going sustainably to target. January inflation data showed strength in services in particular, and payrolls showed a tight labor market that might pick up steam. The retail sales data pushed in the opposite direction, and we think that the slower growth will prevail over time. And for now, market pricing is more or less consistent with our call for 100 basis points of cuts this year, starting in June. Now the Fed’s situation is in stark contrast to that of the Bank of England. Last week’s UK data showed a technical recession in the second half of 2023. And while the UK economy is not collapsing, a strongly surging economy is not a risk either. But until the last print, inflation in the UK had been stubbornly sticky. The January print came in line with our UK economist’s call, but below consensus. But still, one swallow does not mean spring, and the recent inflation data do not guarantee our call for a May rate cut will happen. Rather, broader evidence that inflation will fall notably is needed; and for that reason, the risks to our call are clearly skewed to a later cut. For the ECB, the inflation focus is the same. And on Thursday, President Lagarde warned against cutting rates too soon – a particularly telling comment in light of the weak growth in the Euro area. Recent data releases suggest that not only did Germany’s GDP decline by three-tenths of a per cent in Q4 of 2023; the second largest economy, France, also experienced stagnation in the second half of the year. And with this weakness expected to persist – well, we forecast a weak half per cent growth this year and about only 1 per cent growth in 2025. So, why is this dichotomy so stark? The simple answer is the weak state of the economy in the UK and in Europe. More fundamentally, the drivers of inflation started with a jump in food and energy prices, and then surging consumer goods prices as disrupted supply chains met consumer spending shifting toward goods. That inflation has since abated but services inflation tends to be more tied to the real side of the economy. And for the US in particular, housing inflation is driven by the state of the labor market over time. The Bank of England and the ECB are waiting for services inflation to respond to the already weak economy, and there is little risk of a reacceleration of inflation if that happens. In contrast, the Fed cannot have conviction that inflation won’t reaccelerate because of the continued resilience on the real side of the economy. The retail sales data will help, but the pattern needs to continue. 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.
Our Head of Thematic Research in Europe previews the possible next phase of the AI revolution, and what investors should be monitoring as the technology gains adoption. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Edward Stanley, Morgan Stanley’s Head of Thematic Research in Europe. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the latest developments around AI Adopters. It’s Tuesday, February the 20th, at 2pm in London. The current technology shift driven by AI is progressing faster than any tech shift that came before it. I came on the show at the beginning of the year to present our thesis – while 2023 was the “Year of the Enablers,” those first line hardware and software companies; 2024 is going to be the “Year of the Adopters,” companies leveraging the Enablers’ hardware and software to better use and monetize their own data for this generative AI world. And the market is still sort of treating this as a “show me” story. Enablers are still driving returns. Around half of the S&P’s performance this year can be attributed to three Enabler stocks. Yet, be it Consumer or – more importantly – Enterprise adoption, monthly data we’re tracking suggests AI adoption is continuing at a rapid pace. So let me paint a picture of what we’re actually seeing so far this year. There has been a widening array of consumer-facing chatbots. Some better for general purpose questions; some better at dealing with maths or travel itineraries; others specialized for creating images or videos for influencers or content creators. But those proving to be the stickiest, or more importantly leading to major behavioral day-to-day changes, are coding assistants, where the productivity upside is now a well-documented greater than 50 per cent efficiency gain. From a more enterprise perspective, open-source models are interesting to track. And we do, almost daily, to see what’s going on. The people and companies downloading these models are likely to be using them as a starting point – for fine-tuning their own models. Within that, text models which form the backbone of most chatbots you will have interacted with, now account for less than 50 per cent of all models openly available for download. What’s gaining popularity in its place is multi-modal models. This is: models capable of ingesting and outputting a combination of text, image, audio or video. Their applications can range from disruption within the music industry, personalized beauty advice, applications in autonomous driving, or machine vision in healthcare. The list goes on and on. The speed of AI diffusion into non-tech sectors is really bewildering. Despite all these data points, suggesting consumer and enterprise adoption is progressing at a rapid clip, Adopter stocks continue to underperform those picks-and-shovels Enablers I mentioned. The Adopters have re-rated modestly in the first month and a half of the year – but not the whole group. Of course, this is a rapidly changing landscape. And many companies have yet to report their outlook for the year ahead. We’ll continue to keep you informed of the newest developments as the years progress. 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.
Our Fixed Income Strategist outlines commercial real estate’s post-pandemic challenges, which could make regional bank lenders vulnerable. ----- Transcript ----- Welcome to Thoughts on the Market, I’m Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the challenges of the commercial real estate markets. It's Friday, Feb 16th at 3 pm in New York. Commercial real estate – CRE in short – is back in the spotlight in the aftermath of the loan losses and dividend cuts announced by New York Community Bancorp. Lenders and investors in Japan, Germany, and Canada have also reported sizable credit losses or write-downs related to US commercial real estate. The challenges in CRE have been on a slow burn for several quarters. In our view, the CRE issues should be scrutinized through the lenses of both lenders and property types. We see meaningful challenges in both of them. From the lenders’ perspective, we now estimate that about a trillion and a half of commercial real estate debt matures by the end of 2025 and needs to be refinanced; about half of this sits on bank balance sheets. The regulatory landscape for regional banks is changing dramatically. While the timeline for implementing these changes is not finalized, the proposed changes could raise the cost of regional bank liabilities and limit their ability to deploy capital; thereby pressuring margins and profitability. This suggests that the largest commercial real estate lender – the regional banking sector – might be the most vulnerable. Office as a property type is confronting a secular challenge. The pandemic brought meaningful changes to workplace practice. Hybrid work has now evolved into the norm, with most workers coming into the office only a few days a week, even as other outdoor activities such as air travel or dining out have returned to their pre-Covid patterns. This means that property valuations, leasing arrangements, and financing structures must adjust to the post-pandemic realities of office work. This shift has already begun and there is more to come. It goes without saying, therefore, that regional banks with office predominant in their CRE exposures will face even more challenges. Where do we go from here? Property valuations will take time to adjust to shifts in demand, and repurposing office properties for other uses is far from straightforward. Upgrading older buildings turns out to be expensive, especially in the context of energy efficiency improvements that both tenants and authorities now demand. The bottom line is that the CRE challenges should persist, and a quick resolution is very unlikely. Is it systemic? We get this question a lot. Whether or not CRE challenge escalates to a broader system-wide stress depends really on one’s definition of what systemic risk is. In our view, this risk is unlikely to be systemic along the lines of the global financial crisis of 2008. That said, strong linkages between the regional banks and CRE may impair these banks’ ability to lend to households and small businesses. This, in turn, could lead to lower credit formation, with the potential to weigh on economic growth over the longer term. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
Michael Zezas, Global Head of Fixed Income and Thematic Research, gives his take on how the U.S. election may influence European policy on national security, with implications for the defense and cybersecurity sectors. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the impact of the US election on global security and markets. It's Thursday, February 15th at 3pm in New York. Last week I was in London, spending time with clients who – understandably – are starting to plan for the potential impacts of the US election. A common question was how much could change around current partnerships between the US and Europe on national security and trade ties, in the event that Republicans win the White House. The concern is fed by a raft of media attention to the statements of Republican candidate, Former President Trump, that are skeptical of some of the multinational institutions that the US is involved in – such as the North Atlantic Treaty Organization, or NATO. Investors are naturally concerned about whether a new Trump administration could meaningfully change the US-Europe relationship. In short, the answer is yes. But there’s some important context to keep in mind before jumping to major investment conclusions. For example, Congress passed a law last year requiring a two-thirds vote to affirm any exit from NATO, which we think is too high a hurdle to clear given the bipartisan consensus favoring NATO membership. So, a chaotic outcome for global security caused by the dissolution of NATO isn’t likely, in our view. That said, an outcome where Europe and other US allies increasingly feel as if they have to chart their own course on defense is plausible even if the US doesn’t leave NATO. A combination of President Trump’s rhetoric on NATO, a possible shift in the US’s approach to the Russia-Ukraine conflict, and the very real threat of levying tariffs could influence European policymakers to move in a more self-reliant direction. While it's not the chaotic shift that might have been caused by a dissolution of NATO, it still adds up over time to a more multipolar world. For investors, such an outcome could create more regular volatility across markets. But we could also see markets reflect this higher geopolitical uncertainty with outperformance of sectors most impacted by the need to spend on all types of security – that includes traditional suppliers of military equipment as well companies providing cyber security. 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.
Key developments in China and the U.S. will impact global trade and the growth outlook for Asia in 2024. ----- 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 discuss the risk of re-emerging trade tensions and how this might impact the growth outlook for Asia. It’s Thursday, Feb 15, at 9 AM in Hong Kong. Trade tensions took a back seat during the pandemic when supply-chain disruptions led to a mismatch in the supply-demand of goods and created inflationary pressures around the world. However, these inflationary pressures are now receding and, in addition, there are two developments that we think may cause trade tensions to emerge once again. First is China’s over-investment and excess capacity. China continues to expand manufacturing capacity at a time when domestic demand is weakening and its producers are continuing to push excess supply to the rest of the world. China’s role as a large end-market and sizeable competitor means it holds significant influence over pricing power in other parts of the world. This is especially the case in sectors where China’s exports represent significant market share. For instance, China is already a formidable competitor in traditional, lower value-added segments like household appliances, furniture, and clothing. But it has also emerged as a leading competitor in new strategic sectors where it is competing head-on with the Developed Market economies. Take sectors related to energy transition. China has already begun cutting prices for key manufactured goods, such as cars, solar cells, lithium batteries and older-generation semiconductors over the last two quarters. The second development is the upcoming US presidential election. The media is reporting that if reelected, former President Trump would consider trade policy options, such as imposing additional tariffs on imports from China, or taking 10 per cent across-the-board tariffs on imports from around the world, including China. Drawing on our previous work and experience from 2018, we believe the adverse impact on corporate confidence and capital expenditure will be more damaging than the direct effects of tariffs. The uncertainty around trade policy may reduce the incentive for the corporate sector to invest. Moreover, this time around, the starting point of growth is weaker than was the case in 2018, suggesting that there are fewer buffers to absorb the effects of this potential downside. Will supply chain diversification efforts help provide an offset? To some extent yes, in a scenario where the US imposes tariffs on just China. The acceleration of friend-shoring would help; but ultimately the lower demand from China would still be a net negative. However, in the event that the US imposes symmetric tariffs on all imports from all economies, the effects would likely be worse. Bottom line, if trade tensions do re-emerge, we think it will detract from Asia’s growth outlook. 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 a colleague today.
Our expert panel discusses how the Red Sea situation is affecting the global economy and equity markets, as well as key sectors and the shipping industry. ----- Transcript ----- Jens Eisenschmidt: Welcome to Thoughts on the Market. I am Jens Eisenschmidt, Morgan Stanley's Chief Europe Economist. Marina Zavolock: And I'm Marina Zavolock, Chief European Equity Strategist. Cedar Ekblom: And I'm Cedar Ekblom, Shipping and Logistics Analyst. Jens Eisenschmidt: And on this special episode of the podcast, we will discuss the ongoing Red Sea disruptions and the various markets and economic dislocations caused by it. It's Tuesday, February 13th, 6pm in Frankfurt. Marina Zavolock: And 5pm in London. Marina Zavolock: 12 per cent of global trade and 30 per cent of container trade passes through the Suez Canal in Egypt, which connects the Mediterranean Sea and the Red Sea. Safety concerns stemming from the recent attacks on commercial ships in the Red Sea have driven the majority of container liners to divert trade around the Cape of Good Hope, pushing up container freight rates more than 200 per cent versus December of last year on the Asia to Europe route. Last week, our colleague Michael Zezas touched briefly on the situation in the Red Sea. Now we'd like to dig deeper and examine this from three key lenses. The European economy, the impact on equity markets and industries, as well as on global container shipping in particular. Marina Zavolock: So Cedar, let's start with you. You’ve had a high conviction call since freight rates peaked in the middle of January – that container shipping rates overshot and were likely to decline. We've started to see the decline. How do you see this developing from here? Cedar Ekblom: Thanks, Marina. Well, if we take a step back and we think about how far container rates have come from the peak, we're about 15 per cent lower than where we were in the middle of January. But we're still nearly 200 per cent ahead of where we were on the 1st of December before the disruption started. Cedar Ekblom: The reason why we're so convicted that freight rates are heading lower from here really comes down to the supply demand backdrop in container shipping. We have an outlook of significant excess supply playing out in 24 and extending into 25. During the COVID boom, container companies enjoyed very high freight rates and generated a lot of cash as a result. And they've put that cash to use in ordering new ships. All of this supply is starting to hit the market. So ultimately, we have a situation of too much supply relative to container demand. Another thing that we've noticed is that ships are speeding up. We have great data on this. And since boats have been diverted around the Cape of Good Hope, we've seen an increase in sailing speeds, which ultimately blunts the supply impact from those ships being diverted. And then finally, if we look at the amount of containers actually moving through the Suez Canal, this is down nearly 80 per cent year over year. Sure, we're not at zero yet, and there is ultimately [a] downside to no ships moving through the canal. But we think we are pretty close to the point of maximum supply side tension. That gives us conviction that freight rates are going lower from here. Jens Eisenschmidt: Thank you, Cedar, for this clear overview of the outlook for the container shippers. Marina, let's widen our lens and talk about the broader impact of the Red Sea situation. What are the ripple effects to other sectors and industries and are they in any way comparable to supply chain disruptions we saw as a result of the COVID pandemic? Marina Zavolock: So what we've done in equity strategy is we've worked with over 10 different sector analyst teams where we've seen the most prominent impacts from the situation in the Red Sea. We've worked as well with our commodity strategy team. And what we were interested in is finding the dislocations in stock moves related to the Red Sea disruptions in light of Cedar's high conviction and differentiated view. And what we found is that if you take the stocks that are pricing in the most earnings upside, and you look at them on a ratio basis versus the stocks that have priced in the most earnings downside. That performance along with container freight rates peaked sometime in January and has been declining. But there's more to go in light of Cedar's view in that decline. We believe that these moves will continue to fade and the bottom group, the European retailers that are most exposed. They have fully priced in the bear case of Red Sea disruptions continuing and also that the freight rate levels more importantly stay at these recent peaks. So we believe that ratio will continue to fade on both sides. The second point is you have some sectors, like European Airlines, where there's also been an impact. Air freight yields have risen by 25 per cent in Europe. And we believe that there is the potential for more persistent spillover in demand for certain customers that look to speed up delivery times. The third point is that in case of an escalation scenario in the Red Sea, we believe that it's less the container shipping companies at this point that would be impacted and we actually see the European refiners as most exposed to any kind of escalation scenario. And lastly, and I think this is going to tie into Jens’ economics. We see a fairly idiosyncratic and broadly limited impact on Europe overall. Yes, Europe is the most exposed region of developed market regions globally – but this is nowhere near a COVID 2.0 style supply chain disruption in our view. Marina Zavolock: And Jens, if I could turn it back to you, how do you estimate the impact of these Red Sea disruptions on the European economy? Jens Eisenschmidt: That's indeed one thing we were sort of getting busy on and trying to find a way to get a handle on what has happened there and what would be the implications. And of course, the typical thing, what you do is you go back in time and look [at] what has happened last time. We were seeing changes to say delivery time. So basically disruptions in supply chains. And of course, the big COVID induced supply chain disruptions had [a] significant impact on both inflation and output. And so, it's of course a normal thing to ask yourself, could this be again happening and what would we need to see? And of course, we have to be careful here because that essentially is assuming that the underlying structure of the shock is similar to the one we have seen in the past, which of course it's not the case. But you know, again, it's instructive at least to see what the current level of supply chain disruptions as measurable in these PMI sub-indices. What they translate to in inflation? And so we get a very muted impact so far. We have 10 basis points for the EU area, 15 basis points for the UK. But again, that's probably an upper bound estimate because the situation is slightly different than it was back then. Back then under COVID, there was clearly a limit to demand. So demand was actually pushing hard against the limits of good supply. And so that has to be more inflationary than in the current situation where actually demand, if anything, is weakened by [the] central bank chasing inflation targets and also weak global backdrop. So, essentially we would say, yes, there could be some small uptick in inflation, but it's really limited. And that's talking about here, core goods inflation. The other point that you could sort of be worried about is commodity prices and here in particular energy commodities. But so far the price action here is very, very limited. If anything, so far, TTF prices are, you know, going in the other direction. So all, all in all, we don't really see a risk here for commodity prices, at least. If the tensions in the Red Sea are not persisting longer and intensify further – and here really, this chimes very well in the analysis of Cedar and also with Marina – what you just mentioned. That doesn't really look like any supply chain disruption we have seen on the COVID. And it also doesn't really look like that it would, sort of, last for so long. And we have the backdrop of a oversupply of containers. So all in all, we think the impact is pretty limited. But let's sort of play the devil's advocate and say, what would happen to inflation if this were to persist? And again, the backdrop would be similar to COVID. Then we could think of 70 basis points, both in the Euro area and the UK added to inflation. And of course that's sizable. And that's precisely why you have central bankers around the world, not particularly concerned about it – but certainly mentioning it in their public statements that this is a development to watch. Marina Zavolock: Thank you Jens, and thank you Cedar for taking the time to talk. Cedar Ekblom: Great speaking with you both. Jens Eisenschmidt: 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.
Despite a likely softening of the labor market, U.S. consumer spending should remain healthy for 2024. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Sarah Wolfe from the US Economics Team. Along with my colleagues bringing you a variety of perspectives; today I’ll give you an update on the US consumer. It’s Monday, February 12, at 10 AM in New York. Lately, there's been a lot of mixed data on the health of the US consumer. We saw a very strong holiday spending in November and December; very strong jobs reports in recent months. But we’re forecasting somewhat softer data in January for retail sales. And we know that delinquencies have been rising for households. When we look towards the rest of 2024, we're still expecting a healthy US consumer based on three key factors. The first is the labor market. Obviously, the labor market has been holding up very well and we’ve actually been seeing a reacceleration in payrolls in the last few months. What this means is that real disposable income has been stronger, and it’s going to remain solid in our forecast horizon. We do overall expect some cooling in disposable income though, as the labor market softens. Overall, this is the most important thing though for consumer spending. If people have jobs, they spend money. The second is interest rates. This has actually been one of the key calls for why we did not expect the US consumer to be in a recession two and half years ago, when the Fed started raising interest rates. There’s a substantial amount of fixed rate debt, and as a result less sensitivity to debt service obligations. We estimate that 90 per cent of household debt is locked in at a fixed rate. So over the last couple of years, as the Fed has been raising interest rates, we’ve seen just that: less sensitivity to higher interest rates. Right now, debt service costs are still below their 2019 levels. We’re expecting to see a little upward pressure here over the course of this year – as rates are higher for longer, as housing activity picks up a bit; but we expect there will be a cap on it. The last thing is what’s happening on the wealth side. We’ve seen a 50 percent accumulation in real estate wealth since the start of the pandemic. And we’re expecting to see very little deterioration in housing wealth this year. So people are still feeling pretty good; still have a lot of home equity in their homes. So overall, good for consumer spending. Good for household sentiment. So to sum it up, this year, we’re seeing a slowing in the US consumer, but still relatively strong. And the fundamentals are still looking good. 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.
Investors in credit markets pay close attention to the latest economic data. Our head of Corporate Credit Research explains why they should be less focused on the newest numbers and more focused on whether and how those numbers are changing. --------Transcript-------- Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together. It's Friday, February 9th at 2pm in London. Almost every week, investors are confronted with a host of economic data. A perennial question hovers over each release: should we focus more on the level of that particular economic indicator; or its rate of change. In many cases, we find that the rate of change is more important for credit. If so, recent data has brought some encouraging developments with surveys of US Manufacturing, as well as bank lending. I’m mindful that the concept of “economic data” is about as abstract as you can get. So let’s dig into those specific manufacturing and lending releases. Every quarter, the Federal Reserve conducts what is known as their Senior Loan Officer [Opinion] Survey, where they ask senior loan officers – at banks – about how they’re doing their lending. The most recent release showed that more officers are tightening their lending standards than easing them. But the balance between the two is actually getting a little better, or looser, than last quarter. So, should we care more about the fact that lending standards are tight? Or that they’re getting a little less tight than before? Or consider the Purchasing Managers Index, or PMI, from the Institute of Supply Management. This is a survey of purchasing managers at American manufacturers, asking them about business conditions. The latest readings show conditions are still weaker than normal. But things are getting better, and have improved over the last six months. In both cases, if we look back at history, the rate of change of the indicator has mattered more. As a credit investor, you’ve preferred tight credit conditions that are getting better versus easy credit that’s getting worse. You’ve preferred weaker manufacturing activity that’s inflecting higher instead of strong conditions that are softening. In that sense, at least for credit, recent readings of both of these indicators are a good thing – all else equal. But why do we get this result? Why, in many cases, does the rate of change matter more than the level? There are many different possibilities, and we’d stress this is far from an iron rule. But one explanation could be that markets tend to be quite aware of conditions and forward looking. In that sense, the level of the data at any given point in time is more widely expected; less of a surprise, and less likely to move the market. But the rate of change can – and we’d stress can – offer some insight into where the data might be headed. That future is less known. And thus anything that gives a hint of where things are headed is more likely to not already be reflected in current prices. No rule applies in all situations. But for credit, when in doubt, root for a positive rate of change. 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.
Our credit experts from Research and Investment Management give their overview of private and public credit markets, comparing their strengths and weaknesses following two years of rate hikes. ----- Transcript ----- Vishy Tirupattur: Welcome to Thoughts on the Market. I am Vishy Tirupattur, Chief Fixed Income Strategist in Morgan Stanley Research. David Miller: And I'm David Miller, Head of Global Private Credit and Equity for Morgan Stanley Investment Management. Vishy Tirupattur: And on this special edition of the podcast, we'll be taking a deep dive into the 2024 credit landscape, both from a private credit and public credit perspective. Vishy Tirupattur: So, David, you and I come at credit from two different avenues and roles. I cover credit, and other areas of fixed income, from a sell side research perspective. And you work for our investment management division, covering both private credit and private equity. Just to set the table for our listeners, maybe we could start off by you telling listeners how private credit investing differs from public credit. David Miller: Great. The main differences are: First, privately negotiated loans between lenders and borrowers. They're typically closely held versus widely distributed in public credit. The loans are typically held to maturity and those strategies are typically has that long duration, sort of look. Private credit -- really -- has three things of why their borrowers are valuing it. Certainty, that's committed capital; certainty of pricing. There's speed. There's no ratings -- fewer parties, working on deals. And then flexibility -- structures can be created to meet the needs of borrowers versus more highly standardized parts of the public credit spectrum. Lastly and importantly, you typically get an illiquidity premium in private credit for that holding to maturity and not being able to trade. Vishy Tirupattur: So, as we look forward to 2024, from your perspective, David, what would you say are some of the trends in private credit? David Miller: So private credit, broadly speaking, continues to grow -- because of bank regulations, volatility in capital markets. And it is taking some share over the past couple of years from the broadly syndicated markets. The deal structures are quite strong, with large equity contributions -- given rates have gone up and leverage has come down. Higher quality businesses typically are represented, simply as private equity is the main driver here and there tend to be selling their better businesses. And default rates remain reasonably low. Although we're clearly seeing some pressure, on interest coverage, overall. But volumes are starting to pick up and we're seeing pipelines grow into 24 here. Vishy Tirupattur: So obviously, it's interesting, David, that you brought up, interest rates. You know, it's a big conversation right now about the timing of the potential interest rate cuts. But then we also have to keep in mind that we have come through nearly two years of interest rate hikes. How have these 550 basis points of rate hikes impacted the private credit market? David Miller: The rate hikes have generally been positive. But there are some caveats to that. Obviously, the absolute return in the asset class has gone up significantly. So that's a strong positive, for the new deals. The flip side is -- transaction volumes have come down in the private credit market. Still okay but not at peak levels. Now older deals, right, particularly ones from 2021 when rates were very low -- you're seeing some pressure there, no doubt. The last thing I will say, what's noteworthy from the increase in rates is a much bigger demand for what I'll call capital solutions. And that's junior capital, any type of security that has pick or structure to alleviate some of that pressure. And we're quite excited about that opportunity. Vishy Tirupattur: David, what sectors and businesses do you particularly like for private credit? And conversely, what are the sectors and businesses you'd like to avoid? David Miller: Firstly, we really like recurring or re-occurring revenue businesses with stable and growing cash flows through the cycle, low capital intensity, and often in consolidating industries. That allows us to grow with our borrowers over time. You know, certain sectors we continue to like: insurance brokerage, residential services, high quality software businesses that have recurring contracts, and some parts of the healthcare spectrum that really focus on reducing costs and increasing efficiency. The flip side, cyclicals. Any type of retail, restaurants, energy, materials, that are deeply cyclical, capital intensive and have limited pricing power and high concentration of customers. So, now I get to ask some questions. So, Vishy, I'd love to turn it to you. How do returns, spreads, and yields in private credit compare to the public credit markets? Vishy Tirupattur: So, David, yields and spreads in private credit markets have been consistently higher relative to the broadly syndicated loan market for the last six or seven years -- for which we have decent data on. You know, likely reflecting, as you mentioned earlier, illiquidity premia and perhaps potentially investor perception of the underlying credit quality. The basis in yields and spreads between the two markets has narrowed somewhat over the last couple of years. Between 2014 and the first half of 2023, private credit, on average, generated higher returns and recorded less volatility relative to the broadly syndicated loan market. For example, since the third quarter of 2014, the private credit market realized negative total returns just in one quarter. And you compare that to eight quarters of negative returns on the broadly syndicated loan market. David Miller: Something we both encounter is the idea of covenants -- which simply put, are additional terms on lending agreements around cash flow, leverage, liquidity. How do covenants help investors of private credit? Vishy Tirupattur: Over the last several years, the one thing that stands out in the public credit markets -- especially in the leveraged loan market -- is the loosening of the covenant protection to lenders. Cov-Lite, which means, nearly no maintenance covenants, has effectively become the norm in the broadly syndicated loan market. This is one place that I think private credit markets really stand out. In our view, covenant quality is meaningfully better in private credit. This is mainly because given the much smaller number of lenders in typical private credit deals, private credit has demonstrably stronger loan documentation and creditor protections. Maintenance covenants are typically included. And to a great extent, these covenant breaches could act potentially as circuit breakers to better manage outcomes, you know, as credit gets weaker. David, we also hear a lot about the risk of defaults, in private credit markets. How much concern do you have around defaults? David Miller: We are watching, obviously stress on credits and the default rates overall, and they are at historically quite low levels. We do expect them to tick up over time. But there are some reasons why we clearly like private credit from that perspective. First, as mentioned, the covenant protections typically are a little better. If you look historically, depending on the data, private credit, default rates have been, somewhat lower than public leveraged credit and its been quite a resilient asset class, for a number of reasons. We like the amount of private equity dry powder that sits waiting to support some of the companies that are underperforming. And it's important to remember that private credit lenders typically have an easier time resolving some of these stresses and workouts given that they're quite bilateral or a very small group, to make decisions and reach those negotiated settlements. So overall, we feel like there will be a category of businesses that are underperforming and are in structural decline and that will default. But that number will be still very low relative to the universe of overall private credit. Vishy Tirupattur: So David, it’s been great speaking with you. David Miller: Thanks for having me on the podcast, Vishy. Vishy Tirupattur: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on Apple Podcasts app. It helps more people find the show.
With multiple, ongoing geopolitical conflicts, our analyst says investors should separate signals from noise in how these events can impact markets. Important note regarding economic sanctions. This research may reference jurisdiction(s) or person(s) which are the subject of sanctions administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the United Kingdom, the European Union and/or by other countries and multi-national bodies. Any references in this report to jurisdictions, persons (individuals or entities), debt or equity instruments, or projects that may be covered by such sanctions are strictly incidental to general coverage of the relevant economic sector as germane to its overall financial outlook, and should not be read as recommending or advising as to any investment activities in relation to such jurisdictions, persons, instruments, or projects. Users of this report are solely responsible for ensuring that their investment activities are carried out in compliance with applicable sanctions. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the impact of geopolitical events on markets. It's Wednesday, February 7 at 5 pm in London. Geopolitical conflicts around the globe seem to be escalating in recent weeks. Increased US military involvement in the Middle East, fresh uncertainty about Ukraine’s resources in its conflict with Russia, and lingering concerns about the US-China relationship are in focus. And since financial markets and economies around the world have become more interconnected, it's more important than ever for investors to separate signals from noise in how these events can impact markets. So here’s a few key takeaways that, in our view, do just that. First, fighting in the red sea may influence the supply chain, but the results are probably smaller than you’d think. Yes, there’s been a more than 200 per cent increase in the cost of freight containers moving through a channel that accounts for 12 per cent of global trade. But, the diversion of the freight traffic to longer routes around Africa really just represents a one-time lengthening of the delivery of goods to port. That’s because there’s an oversupply of containers that were built in response to bottlenecks created by increased demand for goods during the pandemic. So now that there’s a steady flow of containers with goods in them, even if they are avoiding the Red Sea, the impact on availability of goods to consumers is manageable, with only a modest effect on inflation expected by our economists. Second, ramifications on oil prices from the Middle East conflict should continue to be modest. While it might seem nonsensical that fighting in the Middle East hasn’t led to higher oil prices, that’s more or less what’s happened. But that’s because disruptions to the flow of oil don’t appear to be in the interest of any of the actors involved, as it would create political and economic risk on all sides. So, if you’re concerned about movements in the price of oil as a catalyst for growth or inflation, then our team recommends looking at the traditional supply and demand drivers for oil, which appear balanced around current prices. Finally, as the US election campaigns gear up, so does rhetoric around the US-China economic relationship. And here we see some things worth paying attention to. Simply put, higher tariffs imposed by the US are a real risk in the event that party control of the White House changes. That’s the stated position of Republicans’ likely candidate – former President Trump – and we see no reason to doubt that, based on how the former President levied tariffs last time he was in office. As our chief Asia economist Chetan Ahya recently noted, such an outcome creates downside risk for the China economy, at a time when downside risk is accumulating for other structural reasons. It's one reason our Asia equity strategy team continues to prefer other markets in Asia, in particular Japan. Of course, these situations and their market implications can obviously evolve quickly. We'll be paying close attention, and keeping you in the loop. 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.
Japan’s experience as one of the first countries to have an aging population offers a glimpse of what’s to come for other countries on the same path. See what an older population could mean in terms of social policy, productivity, immigration reform, medical costs and more. ----- Transcript ----- Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Robert Feldman: And I'm Robert Feldman, Senior Advisor at Morgan Stanley MUFG Securities. Seth Carpenter: And on this special episode of the podcast, we will talk about longevity, and what the rest of the world can learn from Japan. It’s Tuesday, February 6th, at 8 a. m. in New York. Robert Feldman: And it's 10 p. m. in Tokyo. Seth Carpenter: Over the past year, I am guessing that lots of listeners to this podcast have heard many, many stories about new anti obesity drugs, cutting edge cancer treatments. And so today, we're going to address what is perhaps a bigger theme at play here. Now, the micro human side of things is clearly huge, clearly important. But Robert and I are macroeconomists, and so we're going to think about what the potential for longer human lifespans is. For the economics. So as life spans increase, we're probably going to see micro and macro ramifications for demographics, consumer habits, the healthcare system, government spending, and long-term financial planning. And so, it follows that investors may want to consider these ramifications across a wide range of sectors. So, Robert, I wanted to talk to you in particular because you've been following this theme in your research on Japan -- which is perhaps at the earliest stage of this with the fastest aging population across developed economies. So, start us off. Perhaps share some more about the demographic challenges that Japan is facing and what's unique about their experience. Robert Feldman: Thanks, Seth. First, let me start by saying that Japan is not so much unique as it is early. For example, in the 1960s, Japan's total fertility rate averaged about two children per woman. But it hasn't been above two since 1975. Now it's about 1.34. Population as a whole peaked in 2010 and now is down by about 2.4 per cent. What about government spending on pensions and healthcare? Well, those went from about 16 per cent of GDP in 1994 to about 27 per cent now. So the speed of these increases is extremely fast. That said, Japan has one very unusual feature. Labor force participation rates have climbed quite sharply, especially for women. So, more people are working and they're working longer. But at the same time, Japan has actually been pretty successful in holding down costs of many longevity related spending categories. Japan has a nationalized healthcare system. So, the government has lots of power over drug prices, which it has held down. It’s shortened hospital stays. They're still too long -- but it has shortened them. It has also raised retirement ages and has a very clever pension indexing system. Seth Carpenter: All right, so if I can sum this up then, Robert. Japanese workers are working longer, the Japan economy is spending less on health care. So, does this mean that we can just say Japan has solved most or all of the challenges associated with longer lifespans? Robert Feldman: Well, it’s not exactly reduced spending on healthcare. It just hasn't gone up as much as it might have. Seth Carpenter: Okay, that's a good distinction. Robert Feldman: Yes. Anyway, Japan has not solved all the problems, not by a long shot. So, for example, productivity growth is very important for holding debt costs down. But productivity growth -- and I like the simplest measure, just real output per worker -- has been anemic in Japan. So, when productivity growth is low and aging is fast, it's kind of hard to pay the cost of longevity; even if labor force growth is high and Japan has been able to suppress ageing costs. That's the wrinkle here. Seth Carpenter: Okay. So then, if we shifted to think about the fiscal perspective on things. The debt side of things. Is the longer-lived nature of the population; is that going to end up being something like a debt time bomb? Robert Feldman: Well, I don’t think so. At least not yet. And there are two factors behind my view. One is the potential for productivity growth to accelerate a lot. And the other is some special things about Japan's debt dynamics. Let me start with growth. There is huge room here for productivity growth here in Japan. We still has a lot of labor that's underused. The labor force is very well educated, and it's very disciplined. Therefore, it can be re-skilled for more productive jobs. There's also a lot more room for cost reduction in social spending categories, especially by using IT and AI. In addition, healthier people are more productive workers. On the debt dynamic side, the national debt is about 250 percent of GDP. Very high. But Japan owns 1.23 trillion dollars of foreign exchange reserves. So, Japan is borrowing a lot at very, very low short-term rates, and very low long-term rates as well. They're below one per cent. That said it’s earning high foreign interest rates on its external assets. In addition, about half the national debt is owned by the central bank. And so when the central bank, the Bank of Japan, collects coupons from the government, it pays them right back to the government in its year end profit. Seth Carpenter: Okay, so that helps put things into perspective. So, if we're looking forward, do you have any concrete measures that you think Japan as a society, the Japanese government might undertake? And what some of those potential outcomes might be? Robert Feldman: Well, I'm expecting incremental change that Japan is very good at. Social policy is hard to make. There's a lot of politics involved. Even in the prime minister's policy speech the other day, he mentioned a number of things. There will be changes. For example, ways to keep costs down but also to improve productivity. There will some changes in retirement ages. There will be some flexible labor market rules. This is important because ideas move with people; and when people move more, then productivity should go up. There will be continued easing of the immigration rules for highly skilled workers. Japan now has about 2 million foreign workers and the number will probably keep going up. Medical costs reforms are also very important. For example, it’s important for Japan to allow non doctors to do some things that heretofore only doctors have been permitted to do. Faster deployment of new technologies in high import sectors like energy and agriculture -- this should save us a lot of money in terms of not buying imports that we don't need once technology is deployed domestically. Now, can I ask you some questions? Seth Carpenter: Of course. Robert Feldman: Okay. So. From where you sit as a global economist, what aspects of Japan's experience do you think are particularly relevant to other economies? Seth Carpenter: I would say the part where you were touching on the debt dynamics is particularly salient, right? We know that in the COVID era, lots of countries sort of ran up a really large increase in their national debt. And so, trying to figure out what sort of debt dynamics are sustainable over the long run I think are critical. And I think the factors that you point out in terms of an aging population, sort of, have to be considered in that context. I think more broadly, the idea of an aging population is pretty widespread. It is not universal, obviously. But we know, for example, that in China, the population growth is coming down. We know that for a long time in Europe, there has been this aging of the population and a fall in fertility rates. So, I think a lot of the same phenomena are relevant. And like you said at the beginning: it's not that Japan is unique, it's that Japan is early. Robert Feldman: I have another question for you is, and also on this longevity theme -- about the difference between developed and emerging markets. What are the notable differences between those two groups of countries? Seth Carpenter: Yeah, I mean, I think we can make some generalizations. It is more often the case that slowing population growth, falling fertility rates, aging population is more of a developed market economy than an emerging market economy phenomenon. So, I think in that regard, it's important. I will say, however, that there are some exceptions to every rule. And I mentioned China that, you know, maybe straddles those two worlds -- developed versus emerging market. And they’re also seeing this slowing in their population growth. But I think within that, what's also interesting is we are seeing more and more pressures on migration. Immigration could be part of the solution. I think you highlighted this about Japan. And therein lies, at times, some of the geopolitical tensions between developed market economies and emerging market economies. But I think, at the same time, it could be part of the solution to any of the challenges posed by longevity. Seth Carpenter: But, I have to say, we probably need to wrap it up there. Robert, for me, it is always a pleasure to get to talk to you and hear some of your wisdom. Robert Feldman: Thank you, Seth. This is great. Always happy to talk with you. And if you want to have me back, I'll be there. Seth Carpenter: That's fantastic. And for the listeners, thank you 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 positive economic data makes it less likely that the Fed will cut rates in March, our Chief US Equity Strategist explains what this could mean for small-cap stocks. ----- 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 a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, February 5th at 11 am in New York. So let's get after it. Going into the last week, investors had a number of factors to consider. The busiest week of earnings season that included several mega cap tech stocks, a Fed meeting, and some of the most relevant monthly economic data for markets. Around these data releases, we saw significant moves in many macro markets, as well as individual securities. We started the week with a soft Dallas Fed Manufacturing Index reading, which followed the weak New York Manufacturing Survey two weeks earlier. Meanwhile, the Conference Board Consumer Confidence Index and the University of Michigan Consumer Sentiment Survey both pushed higher. As the week progressed, we got more data that supported the view that the economy may not be slowing as much as many had started to believe, including perhaps the Fed. In contrast to the Dallas and New York Fed Manufacturing Surveys, The ISM manufacturing PMI ticked higher, and surprised to the upside by a few points. More importantly, the orders component ticked above 50 to 52, which tends to lead the headline index. The fact that the overall equity market responded favorably to these data makes sense in the context of still present growth uncertainty. However, the fact that cyclical stocks that are levered to manufacturing continue to underperform tells me the market is still very undecided about the macro outcome this year -- as am I. Finally, the headline non-farm payrolls number on Friday was extremely strong at 353, 000. Manufacturing jobs surprised to the upside, giving credence to the uptick in the ISM Manufacturing PMI cited earlier. However, the release also incorporated the annual revisions, which may be overstating the strength in labor markets. Employment trends from the Household Survey remain much softer, as do hours worked, quit rates, and layoff announcements. In short, the labor market is fine, but still weakening, as desired by the Fed. The one area of unequivocal strength remains government spending and hiring, which could be working against the Fed's goals. The bond market went with the stronger read of the data and traded sharply lower on Friday, as so this morning. It has also pushed out the timing of the first Fed interest rate cut, taking the odds of a March cut all the way down to just 20 per cent. Recall this probability was as high as 90 per cent around the end of last year. Perhaps the market is starting to take the Fed at its word. They aren't planning to cut rates in March. The equity market tried to look through this rate move on Friday driven by a historically narrow move in large cap quality growth stocks. This is very much in line with our recommendation since the beginning of the year to stick with large cap quality growth. For now, the internals of the stock market appear to agree with our view that a stickier rate backdrop is a disproportionate headwind for stocks with poor balance sheets and a lack of pricing power. In other words, lower quality cyclicals and many areas of small caps. Perhaps the most important data to support this conclusion is that earnings results and prospects for 2024 remain weak for these kinds of companies. On this front, we continue to get questions from investors on what it will take for small caps to work from here on a relative basis. The Russell 2000, the small cap index, has underperformed the S&P 500 by 7 per cent year to date and is still more than 20 per cent below all time highs reached over two years ago. While some think this is an opportunity, our view is that we need more confirmation that we're headed for a higher nominal growth regime driven more by the private economy rather than inefficient government spending. As we've discussed in the past, small caps are particularly economically sensitive and reliant on pricing power to offset their lack of scale. As they await more definitive confirmation on whether a higher nominal growth environment is coming, small caps are being weighed down by a weakening margin profile, higher leverage, and borrowing costs. In short, stick with what works in a late cycle environment where the macro remains uncertain. Large cap, high quality growth. 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.
Mortgage rates are down, sales volumes are rising and housing is gradually getting more affordable. Our analysts discuss why they think the U.S. housing market is on a healthy foundation. ----- Transcript ----- Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co Head of Securitized Products Research at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co Head of Securitized Products Research. Jim Egan: And on this episode of the podcast, we'll be talking about mortgage rates, home sales volumes and the U. S. housing market. Jay Bacow: Alright Jim. Mortgage rates are down. Sales volumes are up. [Is] the housing market back? Jim Egan: Sales volumes might finally be inflecting higher, or at least they might actually be finding that bottom. If we look at the seasonally adjusted annualized figures that came in in December, pending home sales increased 8 per cent to their highest level since July. Purchase applications, which -- little bit more high frequency, we have them through January -- they're up 23 percent from the lows that they put in in late October or early November. Jay Bacow: Alright, that sounds good, but seasonally adjusted annualized figure sounds like a mouthful. Can you lay that out a little easier for us? Jim Egan: I think that these numbers just need to be put [00:01:00] into a little bit more context. Yes, pending home sales were up 8 per cent month over month. But if I look at just the December print, it was the weakest pending home sales print for that month in the history of that index. Now, relative to 2022, it is improving. It was only down 1 per cent from December of 2022, and that's the lowest decrease we've had since 2021. But these numbers still aren't strong. Going around the horn to some of the other demand statistics, existing home sales finished 2023 down 19 per cent. But they also strengthened into year end only down 9 per cent in the fourth quarter. New home sales, as we've mentioned on this podcast before. That is the demand statistic that has actually been showing growth up 4 per cent in 2023 versus 2022. Up 15 per cent in the second half of 2023 versus the second half of 2022. Jay Bacow: Alright, so we’ve got a pickup or an inflection in housing activity, and we’ve had mortgage rates coming down. Affordability is also independent of home prices. So where does all this stand? Jim Egan: Right? [00:02:00] So because of those home price increases that you've mentioned, the monthly payment on the medium price home is still up almost $100 year over year. But the path of affordability, the deterioration that we've been talking about -- it's as small as it's been since February 2021. And if we're not looking at this on a year over year basis; if we're just looking at this on a month, over month, or every two-month basis. The two-month increase that we've seen in affordability is the steepest increase, or the steepest drop in unaffordability, if you will, since January of 2009. Suffice it to say, we think this is a much healthier housing market than 2009. Jay Bacow: Alright. Now what about the supply side? Because obviously, [there’s] a lot of ways we can get supply. One of the more straightforward methods is for someone just to build a new home. How’s that data looking? [00: 03:00] Jim Egan: We are building more homes. As new home sales have moved higher, single unit housing starts have moved higher as well. Now from cycle peak, which we estimate as April 2022, single unit starts fell about 23 per cent through the middle of 2023. And another thing that we've talked about on this podcast in the past is that build timelines have been elongating. And that was leading to a backlog in homes actually under construction. That decrease allowed that backlog to clear a little bit, and since the middle of 2023, June till the end of the year, single unit starts were actually up 7 per cent. We are building more homes. Jay Bacow: Alright. So new home sales are clearly, literally new homes. But people can also list their existing homes. What's that data look like? Jim Egan: Listing volumes are higher as well. In fact, as of this month, I can no longer say that we are at historic lows when it comes to for sale inventory. While inventory has also climbed throughout the second half of 2022 into the first half of 2023, [00:04:00] that historic low statement is something I could have made every month for the past 8 months. It's a statement I could have made for 41 of the past 54 months. Months of supply did retreat a little bit in December. But when we think about our models for housing activity and really for home prices, it's that growth in the absolute amount of for sale inventory that really plays a big role. Jay Bacow: Alright. I don’t have a PhD in economics. You’re the housing strategist. If we have more supply, does that mean prices are coming down? Jim Egan: That's what we think. We continue to think that these for sale inventory increases that are happening alongside what we do continue to believe will be sales growth in 2024 -- and we think we're seeing the first signs of now -- are going to be enough to bring home prices moderately negative in 2024. And alongside these recent activity prints, the most recent home price print was actually just a little bit softer than we thought it would be. We had forecasted about it a 15-basis point decrease in home prices in November. We saw an 18-basis point [00:05:00] decrease. It's not unusual for home prices to decrease month over month in November. But this is kind of from our perspective a little bit of validation from a home price forecast perspective. We're calling for them to fall 3 percent year over year in 2024. We think this is very moderate. We do not think this is a correction. We believe the housing market is on a very healthy foundation. Looks like we're moving towards sales increases. But we do still think you'll see a little bit of price weakness next year. Jay Bacow: Jim, thanks for taking the time to talk. Jim Egan: Great speaking with you, Jay. Jay Bacow: And thanks 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.
Our analyst explains what parts of the consumer staples sector could benefit from an aging global population. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Sarah Simon, Head of the European consumer staples team at Morgan Stanley, and today I’ll be talking the increasingly important longevity theme and its impact on consumers. It’s Thursday, the first of February, at 3 PM in London. It's no secret that global life expectancy is increasing. The rise of modern medicine, improved working conditions, urbanization, and greater access to food and water have all contributed to a greater life expectancy. According to the United Nations, global life expectancy has risen more than 54% since 1950, reaching about 71 years in 2021, with Asia improving the most. At the same time people are living longer, birth rates for most developed economies have dropped. Higher levels of education, the increasing proportion of women in the workforce, and modern medicine have all contributed to lower birth rates. In fact, over the last several decades, the global population has aged significantly, with the median global age increasing 8 years since 1950, hitting 30 years in 2021. Looking ahead, the United Nations expects the percentage of population aged 65+ will continue to increase at a faster rate than younger populations. An ageing population has far-reaching implications, but let’s consider the spending power of older adults. Real disposable income among older adults has increased throughout the years. In 2022, an older adult had about 50% more than in 2000. As a result, older adults today have more money to spend on consumer goods and services than in the last decades. Here are three categories within the Consumer Staples sector that could benefit from the rise in longevity. First, Consumer Health. As consumers skew older and their disposable income increases it bodes well for a wide range of consumer health products – think Vitamins, Minerals and Supplements (VMS), denture care, cold and flu remedies and more. Second, Active Nutrition, including protein supplements and probiotic-rich foods such as kimchi, kombucha, or yogurt, is a likely beneficiary of the longevity theme. This sub-category is currently growing mid- to high single digits on average (over 10% for protein-related categories), and we see room for further long-term growth. Finally, Medical Nutrition. With age comes increasing prevalence of chronic diseases, including cancers, and with malnutrition. Addressing malnutrition improves the cost, and effectiveness, of medical treatment and also allows for shorter hospital stays. To that end, healthcare providers are increasing turning to medical nutritional solutions--driving demand for these products. 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.