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Morgan Stanley Research analysts Michelle Weaver, Chris Snyder and Nik Lippmann discuss U.S.-Mexico trade and the future of reshoring and near-shoring under the Trump administration.
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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity Strategist at Morgan Stanley.
Christopher Snyder: I’m Chris Snyder, US Multi-Industry Analyst.
Nikolaj Lippmann: And I'm Nik Lippmann, Chief Latin America Equity Strategist.
Michelle Weaver: On this episode of our special mini-series covering Big Debates, we'll talk about the U.S.-Mexico trade relationship and the key issues around reshoring and nearshoring.
It's Friday, January 31st at 10am in New York.
The imposition of tariffs back in 2018 under the first Trump administration and the COVID pandemic put a severe strain on global supply chains and catalyzed reshoring and nearshoring in North America. But with inflation and supply chain concerns no longer front and center, investors are questioning whether the U.S. reshoring momentum can continue.
Chris, what's your view here?
Christopher Snyder: I think it's in the very early innings. You know, if you look at the history of U.S. manufacturing, the country really started ceding share in about 2000 when China joined the World Trade Organization. So, it's been going on for 25 years; we've been giving share back to the world. I think the process of taking share back is probably slower and ultimately is a multi-decade opportunity.
But you're absolutely right. The supply chain concerns are no longer like they were three to four years ago. But what I think has persevered since the pandemic is this heightened focus on operational durability and resiliency; and really shortening supply chains and getting closer to the end user, which I'm sure we'll hear more from Nick about, on the Mexico side.
But, you know, if you kind of look back at global supply chains and manufacturing, it's really been a chase to find low-cost labor for the last 45 years. And while that's always important, we think going forward, capital and proximity to end users will increasingly dictate that regional allocation of CapEx. I mean, those parameters are very supportive for the U. S.
You know, one thing I would like to kind of, you know, make sure is known on our U.S. reshoring view is that, you know, oftentimes it's thought of that we're shutting down a factory in China and reopening the same factory in the United States, and that's really a very rare example.
Our view is that the world, and very specific industries need to add capacity. And we just simply think that the U.S. is better positioned to get that incremental factory relative to any point in the last 45 years, due to the combination of structural tech diffusion, but also this focus on resiliency. And one thing that I really do think is underappreciated is that global manufacturing grows 4 to 5 per cent a year. In the U.S. it's been more in the 1 to 2 percent range because we're constantly ceding share. But even if the U.S. just stops giving back share, you could see the growth profile of U.S. industrials double.
Michelle Weaver: How would you size the reshoring opportunity? Do you have a dollar amount on what that could be worth?
Christopher Snyder: Yeah, we’ve sized it at $10 trillion. You know, and it's been a combination of the CapEx, the fixed asset investment that's needed to build these factories, then ultimately the production, you know, opportunity that will come to those factories thereafter.
Michelle Weaver: And you've argued that the U.S. reshoring flame was really lit in 2018 with the first wave of the Trump tariffs. It seems clear that trade policies by the new administration will continue to support reshoring. What's your outlook there?
Christopher Snyder: Yeah, you're absolutely right. Prior to 2018, there wasn't really a thought process. If you need an incremental factory, you most likely just put it in China. And I think the tariffs, back in 2018 or [20]19 really started, or kickstarted boardroom conversations around global supply chains. So, I think a Trump presidency absolutely adds duration to this theme via protectionism or tariffs that the administration will implement.
If you go back to the Trump 1.0 tariffs, supply chains reacted to the change in cost structures very quickly. We didn't see a huge wave of investment back into the United States. We just saw production exit China and move to broader Asia, because the focus was tariff avoidance.
Now, we think the focus is around building operational, resiliency and durability which better positions the U.S. to get that incremental factory. And one thing that I think is underappreciated here is just how much leverage U.S. politicians have. The U.S. is the best demand region in the world. The U.S. accounts for about 30 per cent of global goods consumption. That's equal to the E.U. and China combined. It's also the best margin region in the world, not only for U.S. companies; but most international companies do their best margins in the United States. So, you can raise the cost to serve the U.S. market, and no one is turning away from the region that has the best demand and the best margins.
Michelle Weaver: So, of course, tariffs in the pandemic have been major catalysts for U.S. reshoring. Have there been any other drivers like tech diffusion?
Christopher Snyder: Yeah. I view the pandemic as the catalyst, and I view tech diffusion as the structural tailwind for U.S. manufacturing. Over time, we will continue to figure out ways to squeeze labor out of the manufacturing cost profile. It's hard to kind of pinpoint it, but I think if we look out over any 5- or 10-year window, we will see that. That's a structural talent for the United States, given the high labor costs. And really what it will help do is just narrow the cost delta, between low cost producing regions. I also think as we kind of extend this tech diffusion into GenAI; I also think what's going on is, will fuel another round of protectionism. So, you know, kind of further keeping that cycle going.
Michelle Weaver: Nick, of course the big question investors are asking is how will the Trump trade agenda impact Mexico? Contrary to the prevailing market view, you've argued that Mexico can actually win big with Trump. How's this possible?
Nikolaj Lippmann: That's right, Michelle. Look, we recently upgraded Mexico to equal weight, from underweight. And while some of the news we see around the administration seems a bit like a sequel, there are other things that are just very different.
We're not talking about ripping apart the USMCA but actually bringing forward renegotiations from [20]26 to [20]25. It's a much more constructive message. It's a very young deal, and yet I think the world we live in today is quite different from the world of 2018. When we look at what are some of the things where Mexico could actually end up winning big, we look at the regionalism that appears to be a number one agenda.
We look at the – how difficult it would be for the United States to de-risk from China. And from Mexico simultaneously. And also, fundamentally at that integration across the border, the industrial integration. It's clear that there's a need for calibration. There's a need for calibration in terms of a lot of the trade policy. There's been talks about maybe a customs union and I think that's far out in the future. But there's a need to try to figure out how to calibrate trade. And also, you know, there are things that Mexican policy makers can do to deal with the non-trade related issues, such as immigration or the cartels. And I think frankly, it's in Mexico's interest to deal with some of these issues.
Michelle Weaver: Where are we in the whole Mexico as a China bridge versus China buffer debate?
Nikolaj Lippmann: Right. That's another good question, Michelle. And one thing that we've been writing a lot about. The key difference from where we were, in Trump 1.0 and now is just how different the relationship with China really is. And I think one area where we've been scratching our head a little bit with regards to the – how Mexican policymakers have reacted after signing the USMCA deal is really just around that. That relationship with China. Well, I think that might have – they might have misread or underestimated just how much times have changed.
We've seen a big increase in import from China. There have been very specific manufacturing ecosystems. And we've also seen increased investments by China and Mexico. Now, this has caused Mexico's trade deficit with China to go up a lot – almost double. And we've also seen an increase in the trade deficit between Mexico and the United States, in Mexico's favor.
Now, that could imply that it's all the China bridge, I think that's far from the truth. But, you know, Mexico is probably two-third or a little more above. It's really that integration that I think policy makers in Mexico need to understand. And then you need to manage that these emerging elements of being a bridge. This is not in Mexico's interest; it's not in the U.S. interest to simply just be a bridge.
We have done a lot of surveys with corporates around the world; and the way the European, and American companies in particular view Mexico is completely different from the way Asian and in particular Chinese companies view Mexico. The Chinese companies view Mexico much more as a place of assembly – whereas Americans think of Mexico as an integrated part of the manufacturing value chain.
Michelle Weaver: Finally, how will the Mexico nearshoring theme develop from here?
Nikolaj Lippmann: This is a great debate, I think. And one that's going to be – I think we're going to be writing a lot with Chris about, and with you guys around, about. Also, with the U.S. policy team. We laid out in 2022 this hypothesis that onshoring, nearshoring was about to happen. In terms of Mexico, it would imply $150 billion over five years. And very importantly, it was going to be – it could happen so fast because it was brownfield.
It was more to the same. Where you already had manufacturing ecosystems, you could add to that. We saw very little evidence that you could do greenfield. But now that the world has evolved, we're looking at some of these greenfield manufacturing ecosystems that are really not present in North America, not in the United States, not in Canada, not in Mexico, such as EV batteries or IT hardware, some of the things that are starting to emerge around the big chip investments.
And we're wondering what are going to be the policy objectives pertaining to these very specific manufacturing ecosystems that in many cases are quite important for national security. If that is to happen, I think it's going to happen slower, much like what Chris laid out, but it's going to be much more impactful. So, I'm sure we're going to be working closely on these debates.
Michelle Weaver: Nick, Chris, thank you for taking the time to talk. And to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.
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Our Global Head of Fixed Income and Public Policy Research, Michael Zezas, and Global Head of Macro Strategy, Matt Hornbach, discuss how the Trump administration’s fiscal policies could impact Treasuries markets.
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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.
Matthew Hornbach: And I'm Matthew Hornbach, Global Head of Macro Strategy.
Michael Zezas: Today, we'll talk about U.S. fiscal policy expectations under the new Trump administration and the path for U.S. Treasury yields.
It's Thursday, January 30th at 10am in New York.
Fiscal policy is one of the four key channels that have a major impact on markets. And I want to get into the outlook for the broader path for fiscal policy under the new administration. But Matt, let's start with your initial take on this week's FOMC meeting.
Matthew Hornbach: So, investors came into the FOMC meeting this week with a view that they were going to hear a message from Chair Powell that sounded very similar to the message they heard from him in December. And I think that was largely the outcome. In other words, investors got what they expected out of this FOMC meeting. What did it say about the chance the Fed would lower interest rates again as soon as the March FOMC meeting? I think in that respect investors walked away with the message that the Fed’s baseline view for the path of monetary policy probably did not include a reduction of the policy rate at the March FOMC meeting. But that there was a lot of data to take on board between now and that meeting. And, of course, the Fed as ever remains data dependent.
All of that said, the year ahead for markets will rely on more than just Fed policy. Fiscal policy may feature just as prominently. But during the first week of Trump's presidency, we didn't get much signaling around the president's fiscal policy intentions. There are plenty of key issues to discuss as we anticipate more details from the new administration.
So, Mike, to set the scene here. What is the government's budget baseline at the start of Trump's second term? And what are the president's priorities in terms of fiscal policies?
Michael Zezas: You know, I think the real big variable here is the set of tax cuts that expire at the end of 2025. These were tax cuts originally passed in President Trump's first term. And if they're allowed to expire, then the budget baseline would show that the deficit would be about $100 billion smaller next year.
If instead the tax cuts are extended and then President Trump were able to get a couple more items on top of that – say, for example, lifting the cap on state and local tax deduction and creating a domestic manufacturing tax credit; two things that we think are well within the consensus of Republicans, even with their slim majority – then the deficit impact swings from a contraction to something like a couple hundred billion dollars of deficit expansion next year. So, there's meaningful variance there.
And Matt, we've got 10-year Treasury yields hovering near highs that we haven't seen since before the global financial crisis around 10 years ago. And yields are up around a full percentage point since September. So, what's going on here and to what extent is the debate on the deficit influential?
Matthew Hornbach: Well, I think we have to consider a couple of factors. The deficit certainly being one of them, but people have been discussing deficits for a long time now. It's certainly news to no one that the deficit has grown quite substantially over the past several years. And most investors expect that the deficit will continue to grow. So, concerns around the deficit are definitely a factor and in particular how those deficits create more government bonds supply. The U.S. Treasury, of course, is in charge of determining exactly how much government bond supply ends up hitting the marketplace.
But it's important to note that the incoming U.S. Treasury secretary has been on the record as suggesting that lower deficits relative to the size of the economy are desired. Taking the deficit to GDP ratio from its current 7 per cent to 3 per cent over the next four years is desirable, according to the incoming Treasury secretary. So, I think it is far from conclusive that deficits are only heading in one direction. They may very well stabilize, and investors will eventually need to come to terms with that possibility.
The other factor I think that's going on in the Treasury market today relates to the calendar. Effectively we have just gone through the end of the year. It's typically a time when investors pull back from active investment, but not every investor pulls back from actively investing in the market. And in particular, there is a consortium of investors that trade with more of a momentum bias that saw yields moving higher and invested in that direction; that, of course, exacerbated the move.
And of course, this was all occurring ahead of a very important event, which was the inauguration of President Trump. There was a lot of concern amongst investors about exactly what the executive orders would entail for key issues like trade policy. And so there was, I think, a buyer's strike in the government bond market really until we got past the inauguration.
So, Mike, with that background, can you help investors understand the process by which legislation and its deficit impact will be decided? Are there signposts to pay attention to? Perhaps people and processes to watch?
Michael Zezas: Yeah, so the starting point here is Republicans have very slim majorities in the House of Representatives and the Senate. And extending these tax cuts in the way Republicans want to do it probably means they won't get enough Democratic votes to cross the aisle in the Senate to avoid a filibuster.
So, you have to use this process called budget reconciliation to pass things with a simple majority. That's important because the first step here is determining how much of an expected deficit expansion that Republicans are willing to accept. So, procedurally then, what you can expect from here, is the House of Representatives take the first step – probably by the end of May. And then the Senate will decide what level of deficit expansion they're comfortable with – which then means really in the fall we'll find out what tax provisions are in, which ones are out, and then ultimately what the budget impact would be in 2026.
But because of that, it means that between here and the fall, many different fiscal outcomes will seem very likely, even if ultimately our base case, which is an extension of the TCJA with a couple of extra provisions, is what actually comes true.
And given that, Matt, would you say that this type of confusion in the near term might also translate into some variance in Treasury yields along the way to ultimately what you think the end point for the year is, which is lower yields from here?
Matthew Hornbach: Absolutely. There's such a focus amongst investors on the fiscal policy outlook that any volatility in the negotiation process will almost certainly show up in Treasury yields over time.
Michael Zezas: Got it.
Matthew Hornbach: On that note, Mike, one more question, if I may. Could you walk me through the important upcoming dates for Congress that could shed light on the willingness or ability to expand the deficit further?
Michael Zezas: Yeah, so I'd pay attention to this March 14th deadline for extending stopgap appropriations because there will likely be a lot of chatter amongst Congressional Republicans about fiscal expectations. And it's the type of thing that could feed into some of the volatility and perception that you talked about, which might move markets in the meantime.
I still think most of the signal we have to wait for here is around the reconciliation process, around what the Senate might say over the summer. And then probably most importantly, the negotiation in the fall about ultimately what taxes will be passed, what that deficit impact will be. And then there's this other variable around tariffs, which can also create an offsetting impact on any deficit expansion.
So still a lot to play for despite that near term deadline, which might give us a little bit of information and might influence markets on a near term basis.
Matthew Hornbach: Great. Well Mike, thanks for taking the time to talk.
Michael Zezas: Matt, great speaking with you. And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Head of Corporate Credit Research and Head of Retail Consumer Credit discuss what choppy demand and tariff risk could mean for sectors that depend on consumer spending.
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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.
Jenna Gianelli: I’m Jenna Gianelli, Head of Retail Consumer Credit, here at Morgan Stanley.
Andrew Sheets: And today on this episode, we're going to discuss the outlook for the retail and consumer sectors.
It’s Wednesday, Jan 29th at 9 am in New York.
So, Jenna, it's great to talk with you, and it's really great to talk about the retail and consumer sectors heading into 2025, because it's such an important part of the investor debate. On the one hand, a lot of economic data in the U.S. seems strong, including a very low unemployment rate. And yet, we’re also hearing a lot about cost-of-living pressures on consumers, lower consumer confidence, and investor concern that the consumer is just not going to be able to hold up in this higher rate environment. And then you can layer on uncertainty from the new administration. Will we see tariffs? How large will they be? And how will retailers, which often import a lot of their goods, handle those changes?
So, maybe just kind of starting off at a 40, 000-foot view, how are you thinking about consumer dynamics going into 2025?
Jenna Gianelli: Of course. So, I think that that choppy consumer demand environment is actually one of the strongest pillars of our more cautious view, going into next year. How the sector, performed last year was not in tandem with kind of what the macro headlines suggested. The macro headlines were quite positive, and the consumer was, you know, seemingly strong. But there was a lot going on under the hood when you looked at different dichotomies, right? So, if you looked at the high-end versus the low-end, if you looked at goods versus services. And then within, you know, certain categories, there were categories that were, you know, really quite strong based on what the consumer was prioritizing – goods, essentials, personal care, beauty, right? And then there were others that they really shied away from.
So, I think what we're going to see in 2025 is quite a bit more of that. When we think that the high-end will continue to be resilient, that pressure on the low-income consumer will continue. But actually moderate potentially as into [20]25, as we think about lower interest rates, potentially, you know, lesser immigration and so less competition for jobs at the lower income level. So maybe even some tailwinds, but it's really an alleviation of pressure and easier compares. But we do expect overall some deceleration, right? Because we had a lot of pent-up demand, especially on the high-end.
So, we are expecting services, demand to slow, in 2025 and goods actually to hold up relatively well. So, we really are focused on what's going on at the individual category level and the different types of consumers that we're looking at.
Andrew Sheets: And as you think about some of those, you know, subcategories that you, you cover, maybe just a minute on a couple that you think will perform the best over this year and some that you think might face the biggest challenges.
Jenna Gianelli: There are some that have been under relative pressure, in [20]23 and [20]24 where we might actually see some, you know, relief. Now, depending on the direction of rates in the housing market, we could see and expect to see an uptick in bigger ticket spending, durables, home related, that have been under, you know, some pressure.
And also, you know, categories where, you know, the consumer, they're arguably discretionary. But maybe they pulled back because there was a big surge in demand just post-COVID. Pet in our universe is actually one example of those, where it's been a bit depressed and we actually expect to see, you know, some recovery into next year; also tied to housing right as new house formation starts.
So, but again, a lot of that is predicated on the, you know, housing direction of rates and some of these other macro factors. I'd say, irrespective of the more macro influences, we do still expect that essentials – grocery, and certain categories like a beauty, pockets of apparel and brands, right? It really comes down to the brands, the brand heat, the brand relevance. If it's relevant to the consumer, they're going to spend on it. And so, that's where we really focus on the micro level; our picks of which brands are resonating, which categories are resonating. Which is, those are some of the, you know, the few that we're expecting, either a recovery in or still, you know, relative, outperformance.
I'd say on the laggard side, which is probably the next piece of that question. I mean, look, there's still a lot of secular headwinds at play. And so, you know, from a department store perspective outside of event risk or idiosyncratic risk, we're still generally expecting department stores and kind of traditional specialty apparel, mall-based, with not a lot of channel diversification to still generally underperform and see similar trends they've seen the last few years.
Andrew Sheets: So, Jenna, your sector is sitting at the center of this kind of very interesting economic debate over how healthy the consumer really is. And, you know, it's also sitting at the center of the policy debate because tariffs are a dynamic that could dramatically affect retailers depending on how large they are and how they're implemented.
So how do you think about tariff risk? And can you give some sense of how you think about exposure of your sector to those dynamics?
Jenna Gianelli: So, tariffs and policy risk and the uncertainty, is one of the big reasons. And when we think about, you know, retail – and particularly discretionary retail – why we're more cautious on the space into [20]25. Tariffs is the biggest piece of that. The degrees of exposure across our universe, varying degrees to a very wide range, right? So, we have some that are minimal, you know, let's say 5 per cent out of, you know, China sourcing some up to 70 per cent out of China sourcing. And then you layer in, well, what about goods from Canada and Mexico and what if there's a universal tariff?
And so, the range of outcomes, is, you know, so significant. And so, what we are advocating to investors is that we go in with the expectation that tariffs are a – an uncertain, but certain threat, right? And not completely minimizing them within a portfolio but reducing the ones that do tend to have those higher, you know, exposures.
I'd say the range from when we stress tested the earnings headwinds potential. I mean, it was anything from call it down 10 per cent EBITDA to down 60-70 per cent EBITDA in the most draconian scenarios. And so, I think taking a very prudent approach, assuming that there will be some level of tariffs phased in, you know; if we look back to the 2018 timeframe – different sets of goods, different times, different rates and go from there.
Andrew Sheets: So, Jenna, we've talked about the economy. We've talked about some of the policy and tariff risk potentially impacting consumer and retail. You know, a third really key strategic theme for us is more corporate activity, more M&A. And again, I think this is where your sector is so interesting because you were already kind of in the center of some of these debates, last year with corporate activity.
So, can you talk a little bit about how you see that? And again, you also have this interesting dynamic that some of the targets of M&A activity in your sector were some of the businesses that were kind of struggling, that were kind of seen as some of these laggards. And so how does that just represent different investor views of their prospects? How do you think people should think about that going forward?
Jenna Gianelli: So, look, I think M&A could have positive risk for 2025 and also negative risk for some of our companies. And it really depends, at least from a credit perspective, how we think about some of their indentures and bond language and likelihood of pro forma capital structures.
But I think without getting, you know, too deep into that, our expectation is that M&A will increase. We know that there is private equity capital on the sidelines to the extent that rates, even if we're in a little bit of a higher for longer, if the expectation is that we do on the year [20]25 in a slightly lower regime, at least we have some stability or visibility on the rate front. Which should, you know, spur more corporate activity.
And then also, I think, look, just equity valuations, right? I mean, our universe, particularly when you think about – the size of the equity check that you need to come in at and the valuations are a bit cheaper because across our universe, we did see some underperformance last year.
So, I think those are the kind of main drivers of why we'll see the activity pick up on the underperforming pieces of the space. There are still pockets of value that I think private equity sponsors are seeing. The ones that have come up most notably are real estate, right? And, you know, we saw…
Andrew Sheets: Because these retailers often own a large…
Jenna Gianelli: Many of the department stores own a significant amount of their real estate. 20, 20, 40, 50 per cent depending on your, you know, assumptions and how you value this real estate. But even with conservative LTV assumptions, there is lending capability here. And I think so that's, you know, one piece of it, those that have multi-banner assets that appeal to different consumer cohorts, that have maybe a solid private label portfolio.
When you think about intellectual property, there are real assets, for certain retailers. And so, I think that's what, you know, private equity historically has seen as the play. Now, how that manifests throughout the space? You know, from an LBO perspective; I do still think that getting a really large LBO for a traditional, you know, mature type of retailer could be challenging, but there are creative ways to get these deals done.
And again, I think because of what we have is some legacy indentures, traditional, more investment grade style capital structures, there might be flexibility to approach, you know, LBOs in a more creative way – without having to access the capital markets in such a big way as maybe you would traditionally think.
Andrew Sheets: And so, this would be examples of private equity firms coming in, doing an LBO or a leveraged buyout where you can actually almost take advantage of the borrowing that company has already done in the market…
Jenna Gianelli: Yes. Keep the debt outstanding.
Andrew Sheets: ... at attractive levels.
Jenna Gianelli: Exactly. Exactly.
Andrew Sheets: So, Jenna, it's so great to talk to you. Well, it's always great to talk to you, but it's so great to talk to you now because I do think, you know, as we, we look into 2025, I think there's always a lot of focus on, you know, the direction of markets, you know. Will rates go up or down? Will equities go up or down? But I think what's so clear talking to you about your sector is that there are all these themes that are really about dispersion. That we see, you know, really different trends by the type of consumer segment and sub segment; that we see very different trends by how exposed companies are to tariffs, right? You mentioned anything from, your earnings could be down 10 per cent to 60 per cent. And, you know, very different dynamics, you know, winners and losers from M&A.
And so, I do think it just highlights that this is a year where, from the strategy side, we think spreads are kind of more range bound. But there does seem to be a lot of dispersion within the sector. And there seems like, well, there's going to be plenty that's going to keep you busy.
Jenna Gianelli: I hope so.
Andrew Sheets: Great. Jenna, thanks for taking the time to talk.
Jena Gianelli: Thank you, Andrew.
Andrew Sheets: Great. And thanks for listening. If you enjoyed the show, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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Our Global Head of Fixed Income and Public Policy Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss the potential impact of U.S. tariffs in China and beyond.
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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.
Chetan Ahya: And I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.
Michael Zezas: Today, we'll talk about what U.S. tariffs would mean for Asia's economy.
It's Tuesday, January 28th at 8am in New York.
Chetan Ahya: And 9pm in Hong Kong.
Michael Zezas: Chetan, a week into the new Trump administration, I'm eager to talk tariffs with you. You and I came on the show before the U.S. election to discuss the potential impact of new tariff policies on China's economy in particular. And now that President Trump has taken office, he's been vocal about levying tariffs in a lot of places, including on China. The policy underpinning all of that appears to be a tariff review under the America First Trade Policy. That suggests to us that he's developing options to impose tariffs with China as a focus, but there's still time before implementation -- as these legal options are developed. That's in line with our base case; but investors have been talking a lot about the idea that maybe these tariffs never go on.
What's your view here? And why do you think ultimately we are headed to a place where tariffs go higher?
Chetan Ahya: Well, I think if you just look at the press comments that the president has made at the same time, if you read through this America First document, we sort of think that there are five avenues under which tariffs can go up on China.
Number one is the recommendation from the America First policy document that the agencies in the U.S. will have to study how the large trade partners, which are running trade surpluses with the U.S. are managing their trade practices. Number two, a para in the America First document, which is suggesting that the trade agreements that US and China signed in 2018-19, how is China dealing with the commitments under that agreement?
And number three is the clause which is currently exempting imports into the U.S. under [the] de minimis rule of imports under U.S. $800 per bill being allowed to import without any tariffs being imposed. And what the document is suggesting is to assess what is the potential revenue loss occurring to the government, and how can they plug that. Number four is a potential tariff action with the sale of a social media company. And number five, a potential tariff action which is linked to the fentanyl issue.
So, as you can see, there are a number of avenues under which tariffs can go up on China and therefore we kind of keep that in our base case that tariffs will go up on China.
And Mike, some investors are also optimistic and thinking that there is a possibility of a new trade deal being taken up by U.S. and China. What do you think are the chances of that?
Michael Zezas: I think they're quite low. So, you mentioned five areas of potential dispute that the U.S. might want to use tariffs as a way of dealing with -- and I think that speaks to the idea that the bar is pretty high for China to avoid tariffs relative to some of the other negotiations the U.S. wants to engage in with other trade partners. Or maybe said differently, if the America First Trade Policy is pointing the U.S. at closing goods, trades, deficits, and improving security and making sure that it's not engaged with trade with other countries that are harming national security -- it seems that there are more of those activities going on between the U.S. and China than with other trade partners. Closing, for example, a $300 billion goods trades deficit would seem to be just really, really difficult within the structures of the economy.
So, if we're right, and the chance of tariff de escalation with China appears to be slim, do you think Beijing, for example, might use renminbi depreciation to mitigate some of those economic risks?
Chetan Ahya: Well, yes, we do think that China’s policymakers will allow depreciation in [renminbi] when tariffs are being imposed. However, we also think that the depreciation this time that they will allow will be less than what they did in 2018-19. And China has already been facing some capital outflows; and allowing a large depreciation could bring self fulfilling situation of more capital outflows and even sharper currency depreciation pressures.
Michael Zezas: Beijing also started introducing stimulus measures last fall to boost the Chinese economy. Would tariffs disrupt this policy?
Chetan Ahya: Certainly in our base case, despite the policy stimulus measures that China is taking, we think that overall growth in China will be lower in 2025 meaningfully. And more importantly in our view, China’s biggest challenge is deflation and tariffs will only exacerbate deflationary pressures.
Michael Zezas: And so, we're talking a lot about China here, but obviously there's a risk of tariffs being applied to a broader set of U.S. trading partners in Asia. Now that's not our base case. We think ultimately the focus will be on China because a lot of those trading partners will be able to come to agreements with the U.S. to limit potential future tariffs; but of course, there's a considerable risk that we're wrong. As we mentioned this America First Trade Policy is developing a wide range of options to levy tariffs across multiple geographies and multiple products. So, if that were to come to pass, Chetan, what is it that other Asian governments might be able to do to mitigate the impact from higher tariffs?
Chetan Ahya: First of all, this will be significantly negative for region's growth outlook. And there are two ways in which [the] region will get impacted. Firstly, because of the fact that China will be facing tariffs and China's growth will slow down, it will also have spillover effects for the rest of the region. At the same time, as you mentioned, there is a possibility that there are bilateral disputes opened up with other economies in the region. And so that will also add to the downside pressure for [the] region's growth.
In terms of what they can do to offset this downside; we think that region's central bank will take up monetary easing and at the same time the governments will expand their fiscal deficit. But both of those measures will not be enough to fully offset the downside from tariff increase.
Michael Zezas: Makes sense. Chetan, thanks for taking the time to talk.
Chetan Ahya: Great speaking with you Mike.
Michael Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Morgan Stanley Research looks at how the European defense industry might respond to military spending pressure from the Trump administration.
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Paul Walsh: Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's Head of Europe Product.
Ross Law: And I'm Ross Law, Head of the European Aerospace and Defense Team.
Paul Walsh: Today, we're discussing the outlook for European defense amid renewed pressure for more military spending from the Trump administration.
It's Monday, the 27th of January, at 9.30am in London.
Now Ross, the new Trump administration is now in place, and shifting NATO's defense burden to Europe is a top priority for President Trump. In fact, President Trump has made several comments throughout his campaign and after taking office. He has suggested that Europe should increase defense spending to 5 per cent of GDP. And just for reference, right now, many European countries are at or above NATO's target of spending 2 per cent of GDP on defense.
What's your reaction? Are President Trump's demands of 5 percent realistic?
Ross Law: In short, we don't think so. In a perfect world, yes, 5 per cent is exactly where Europe should be, to make up for the huge underspend that we've seen over the past three decades since the end of the Cold War, which we've calculated at around the $2 trillion mark. There's also a desire in Europe to reduce its reliance on the US, particularly under a Trump presidency. But we see the 5 per cent spending level as unrealistic on multiple fronts.
Firstly, from an economic perspective, given the lack of fiscal headroom in Europe; and for reference, 5 per cent would require an additional $600 billion of spend annually. Secondly, from a political perspective, given multiple pockets of uncertainty, and the fact that a rise in defense spending may mean a cut to spending elsewhere. And lastly, from an industry perspective, given the multi-decade underspend I mentioned, we don't think the industry could absorb anywhere close to such a strong increase in demand, at least near-term.
So, while we do see upside pressure to European defense spending, our base case is that 3 per cent could be a more reasonable target. Not only would this be a compromise between the current 2 per cent target and Trump's 5 per cent demands; it would also allow Europe to match the spending levels of the US, which is expected at around 3.1 per cent in 2024. Even still, this would represent a 50 per cent increase or around $200 billion per year in additional European spent. This would, of course, further improve industry fundamentals and why we remain very positive on the sector.
Paul Walsh: And as of now, Europe is heavily dependent on the U.S. for its defense. According to various data sources, more than 50 per cent of European arms imports came from the U.S. in 2019 through 2023, and that's up from 35 per cent in 2014. Given this, what steps would Europe need to take to reduce its dependence on the U.S.?
Ross Law: The first step is to invest in the defense industrial base. Europe buys equipment from the U.S. for several reasons. Firstly, because the U.S. develops some of the most advanced technologies in the world because it has consistently invested in its defense industry. Secondly, because the U.S. equipment is often cheaper due to the benefits of scale. And thirdly, because it supports the very unique relationship between Europe and the U.S., which has essentially provided a security umbrella for the past three decades.
So, Europe needs to invest, both to develop capabilities and technologies to rival U.S. peers, and also to expand capacity so that we can meet our own equipment needs. This, of course, all requires investment and also time. So, Europe will remain reliant on the U.S. for many years to come. But if Europe is serious about wanting to be more sovereign, we need a more capable defense industry.
Paul Walsh: So, you talked there, Ross, about investment and time. So now the big question, how would Europe fund this upward pressure on defense budgets?
Ross Law: Well, this is the million-dollar question, or the 200-billion-dollar question, you might say. Unfortunately, this is part of the equation that is, so far, most unclear – and the basis for an ongoing series of reports we've entitled the “European Defense Dilemma” – essentially the very clear need to spend more on defense, but no clear way to fund it. So far, we've seen some creative ways to fund near-term spending plans, from off balance sheet special funds like in Germany, to using the interest received on frozen Russian assets.
But these, in our view, all seem fairly temporary in nature. What we really need is structural change, and that requires political commitment. Clearly, there is a lot of political change happening right now in Europe. Germany is holding an election in a few weeks time. France doesn't yet have a budget. There's also fiscal issues here in the UK. But we're hoping that 2025 is the year in which we may get clearer political commitments to longer-term structural improvements in defense spending. The German election is a clear near-term catalyst for us, where the raising of the debt break may in part be used to fund higher defense spending. But we're also looking to the upcoming NATO summit in June as an opportunity to officially increase the NATO spending target, we think potentially to 3 per cent, to support a more structural increase in European defense spending.
Paul Walsh: In light of all of this, what's your outlook for the European defense industry?
Ross Law: We remain bullish. In fact, we turned even more bullish as part of our 2025 outlook published earlier this month. The pressure to raise spending even to 3 per cent of GDP should progressively benefit industry fundamentals.
So, we see upside to both forecasts. Given these are currently premised on a 2 per cent of GDP assumption, as well as devaluation multiples, which we view today as very attractive, with the sector trading in line with this long-term average – despite the improving fundamentals I've just described.
Paul Walsh: And finally, Ross, what developments if any might change your outlook?
Ross Law: The key for us this year is seeing clear political commitments from governments on more structural increases in spending. So, we're going to be watching the German election and the outcome of the French budgetary process very carefully. It's unlikely to be plain sailing. There was a media article published just this morning suggesting the UK government may be unwilling to raise spending beyond the current 2.3 per cent level. But we are hoping that as a whole 2025 sees Europe make a stronger commitment to defending itself.
Paul Walsh: Ross, fascinating as always. Thanks for taking the time to talk.
Ross Law: Great speaking with you Paul.
Paul Walsh: And thanks for listening. If you enjoy thoughts on the market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.
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Our Head of Corporate Credit Research Andrew Sheets argues that while investor hopes are running high, corporate confidence isn’t.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about optimism, how we measure it, whether it’s overly excessive and what lies ahead.
It's Friday January 24th at 2pm in London.
A central tenet of investing, including credit investing, is to be on the lookout for excessive optimism. By definition, the highest prices in a market cycle will happen when people are the most convinced that only great things lie ahead. The lowest prices, when you’d love to buy, happen when investors have given up all hope.
But identifying peak optimism, in real time, is tricky. It’s tricky because there is no generally agreed definition; and it's tricky because, sometimes, things just are good. Investors have been excited about the US Technology sector for more than a decade now. And yet this sector has managed to deliver extraordinary profit growth over this time – and extraordinarily good returns.
Yet this debate does feel relevant. The US equity market has soared over 50 per cent in the last two years. Equity valuations are historically high, both outright and relative to bonds. Credit risk premiums are near 20-year lows. Speculative investor activity is increasing. And so, have we finally hit peak optimism, a level from which we can go no further?
Our answer, for better or worse, is no. While we think investor optimism is elevated, corporate optimism is not. And corporations are really important in this debate, enjoying enormous financial resources that can invest in the economy or other companies. While we do think corporate confidence will pick up, it is going to take some time.
One of our favorite measures of corporate confidence is merger and acquisition activity. Buying another company is one of the riskiest things management can do, making it a great proxy for underlying corporate confidence. Volumes of this type of activity rose about 25 per cent last year, but they are still well below historical averages. And it would be really unusual for a major market cycle to end without this sort of activity being above-trend.
Another metric is the riskiness of new borrowing. Taking on new debt is another measure of corporate confidence, as you generally do something like this when you feel good about the future, and your ability to pay that debt off. But for the last three years the volume of low-rated debt in the US market has actually been shrinking, while the issuance of the riskiest grades of corporate borrowing is also down significantly from the 2017-2022 average. Again, these are not the types of trends you’d expect with excessive corporate optimism.
Uncertainties around tariffs, or the policies from the new US administration could still hold corporate confidence back. But the low starting point for corporate confidence, combined with what we expect to be a deregulatory push, mean we think it is more likely that corporate activity and aggressiveness have room to rise – and that this continues throughout 2025. Such an increase usually does present greater risk down the line; but for now, we think it is too early to position for those more negative consequences of increasing corporate aggression.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Morgan Stanley Research analysts Michelle Weaver, Michael Cyprys and Ryan Kenny discuss the resurgence in capital markets activity and how sponsors might deploy the $4 trillion that has been sitting on the sidelines.
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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity strategist at Morgan Stanley.
Michael Cyprys: I'm Mike Cyprys, Head of U.S. Brokers, Asset Managers and Exchanges Research.
Ryan Kenny: And I'm Ryan Kenney, U.S. Mid-Cap Advisors Analyst at Morgan Stanley.
Michelle Weaver: In this episode of our special miniseries covering Big Debates, we'll focus on the improving M&A and IPO landscape and whether retail investing can sustain in 2025.
It's Thursday, January 23rd at 10am in New York.
2023 saw the lowest level of global M&A activity in at least 30 years. But we've started to see activity pick up in 2024. Mike, what have been the key drivers behind this resurgence, and where are we now?
Michael Cyprys: Look, I think it's been a combination of factors in the context of a lot of pent-up activity and a growing urge to transact after a very subdued period of, you know, call it four- to six quarters of quite limited activity. Key drivers as we see it ranging from equity markets that have expanded across much of the world, low levels of equity volatility. broad financing, availability with meaningful issuance as you look across investment grade and high yield bond markets, tight credit spreads, interest rates stabilizing in [20]24, and then the Fed began to cut.
So, liquidity pretty robust, all of that helping reduce bid-ask spreads. In terms of where we are now, post election, think there's just a lot of excitement here around a new administration; where we could see some changes around the antitrust environment that can be helpful, as we think about unlocking greater M&A activity across sponsors as well as strategics, and helping improve corporate confidence.
But look, the recent rout of market could delay some of the transactional activity uplift. But we view that as more of a timing impact, and we are quite positive here in [20]25 as we think about scope for continued surge of activity.
Michelle Weaver: We've seen rates rising pretty substantially since December. Does that throw a wrench into this at all, or do you think we see more stabilization there?
Michael Cyprys: I think it could be a little bit of a slowdown, right? That would be the risk here, but as we think about the path for moving forward, I do think that there are a lot of factors that can be very helpful in terms of driving a continued pickup in activity, which we're going to talk about -- and why that will be the case.
Michelle Weaver: Great. And you mentioned financial sponsors earlier, I want to drill down there a little more. What do you think would get sponsor activity to pick up more meaningfully?
Michael Cyprys: Well, as I think about it, activity is already starting to pick up clearly across strategics as well as sponsors. On the sponsor side, it's been lagging a bit relative to strategics. We think both of which will build, and Ryan will get to that on the strategic side. As we think about the sponsors -- they're sitting with $4 trillion of capital to put to work that's been sitting on the sidelines where you just haven't seen as much activity over the past couple of years.
Overall activity in [20]24 was probably call it maybe around 20 per cent below peak levels, and this is burning a hole in the pockets of both sponsors as well as their clients. And so, we see a growing urge to transact here, which gets to some of your earlier questions there too.
So why is that? Well, the return clock is ticking; the lack of deployment is hurting returns within funds. Some of this dry powder also expires by the end of [20]25; and so if it's not yet deployed, then sponsors won't get some of the performance fee economics that come through to them on that capital. So that's all, all on the deployment side.
As we think about the realization or exit side, we think that's probably going to lag, but we'd still expect, a steady build through this year. Today sponsors are sitting on call it around $10 trillion of portfolio of investments that are in the ground, and they haven't really provided much in the way of liquidity back to their customers, the LPs and the funds. And so, this is putting a little bit of a strain not only on the client relationships that want more money back from their private investments that haven't received it, but it's also one of the causes of what has been a little bit of a challenging fundraising backdrop across private equity funds.
Hence if sponsors can return more capital to their clients, that can be helpful in terms of healing the overall fundraising backdrop. So, look, putting all that together, we expect an expanding pace of transactional deal activity across the sponsors from both the buy side as well as the sell side in terms of our activity.
Michelle Weaver: And Ryan, how about IPOs? Have they been part of a similar trend?
Ryan Kenny: Yes, definitely. So, with IPOs, we're also expecting a significant resurgence off of a low base. So just to put some numbers on it. In 2024, announced M&A volumes relative to nominal GDP, we're around 40 per cent below three-decade averages; equity capital markets [ECM] or ECM was even more muted, 50 per cent below three decade averages. And the leading indicators for ECM are very similar to the leading indicators for M&A. You want a strong equity market, relatively low volatility so that companies have the confidence to go public and so that deals can price well. And those conditions are really starting to materialize already in 2024; and we saw a few big IPOs price well last year, and launch well. The fourth quarter also looks strong. We saw a significant acceleration in industry ECM activity in October, November, December. 4Q volumes tracking up over 50 per cent year-over-year.
Michelle Weaver: Let's dig a little deeper into potential policies from the incoming Trump administration. What are your expectations around antitrust regulation and its impact on M&A?
Ryan Kenny: So, Trump has announced his appointments to the FTC and to the DOJ antitrust division. And our expectation is a return to normal. And that's coming off of what was a more onerous and not-clear environment under Biden. The Biden administration's approach was to disincentivize M&A; and they did that by defining M&A market concentration in novel ways -- looking at things like labor markets, and looking at how competitiveness is defined in new ways. And these new ways of defining concentration decrease the clarity of whether a specific deal would be challenged.
So, from a CEO and board perspective, you don't want to waste the time of your management team and your board going through a deal that might not go through; in addition to the risk of prolonging the deal, and the risk of higher legal expenses during the process. So now that we're returning more towards normal, that's our expectation. We expect there will still be some deals like a challenge, but it will operate under more historical norms and so that really checks the box of getting CEO confidence up to transact more.
Michelle Weaver: And I know that dynamic you’re talking about with market concentration created quite a big drag on large M&A deals and large-cap M& A. Do you think we could start to see that come back as well?
Ryan Kenny: Yeah, expect large-cap deals to rebound even more than small-cap deals. When we started to see the activity pick up in 2024, it was led by more mid-cap corporates. And now we expect to see large deals return in force at a time when financial sponsors, like what Mike was just talking about, coming back in force at the same time -- which drives up the animal spirits when all parts of the M&A market are returning at the same time.
Michelle Weaver: And what are some other catalysts beyond the political side that investors should watch in 2025 around capital markets developments?
Ryan Kenny: So, I categorize it as macro catalysts and structural catalysts The macro catalysts are clarity on tariff and immigration policies, how that will impact GDP. Clarity on the interest rate path. And look you don't need more rate cuts to get this market moving; you can still have a significant increase, even if there are no more rate cuts this year.
But narrowing the range of outcomes is important. And I think we're already there, where maybe we get no cuts this year. Maybe we get two cuts. It's a much tighter environment than where we were over the last few years. And so that helps narrow the bid-ask spread between buyers and sellers.
Structural catalysts that are really critical this cycle are the need for AI capabilities. Innovation in tech, innovation in biotech healthcare, the energy transition, reshoring and exploring your geographic footprint in a multipolar world -- are all really critical when you evaluate the types of companies that a board would want to acquire.
Michelle Weaver: What’s your outlook for 2025? And then even beyond that when it comes to both M&A and IPO activity?
Ryan Kenny: So, in 2025, we see a strong rebound in both ECM and M&A. ECM volumes in our base case, we expect to roughly double off of a low base. M&A announcements, we expect up over 50 per cent year-over-year in 2025. And importantly, that's our base case. Even in our bear case, we model an increase in both ECM and M& A volumes, given we're coming off of such low levels.
We've had three years of light activity and pent-up demand, and pipelines have already begun to build. When we look forward beyond 2025, we think this is the beginning of a multi-year capital markets growth cycle -- with bigger deal sizes and more deal count than average, driven by three years of pent-up demand and an economy that's a third larger than 2021, which was the last time we had a capital markets cycle.
Michelle Weaver: And then Mike, what does this rebound in capital markets activity, including M&A and IPOs means specifically for retail investing?
Michael Cyprys: Overall, a supportive macro backdrop with a rebound in capital markets activity, we think should be helpful in terms of bringing more investors into the markets, including retail investors. Whether it's from corporate actions and IPOs, it helps in terms of more stocks to trade; also helps in terms of revising animal spirits.
I think that's all helpful in terms of supporting engagement across both single stock volumes and equity markets as well as options. So, all of that together, we were expecting greater investor engagement here in [20]25. And confidence as well can help boost not just trading volumes but also margin lending and securities lending. And so, all of that can be helpful as we think about our forecast for our retail brokerage coverage group.
Michelle Weaver: Mike, Ryan, thank you for taking the time to talk. And to our listeners, thanks for listening. If you enjoyed the podcast, please share it with a friend or colleague today.
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On his first day in office, President Trump issued a series of executive orders, signaling his intent to deliver on campaign promises. Our Global Head of Fixed Income and Public Strategy Michael Zezas takes a closer look at economic impacts of Trump’s proposed policy path.
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Welcome to Thoughts on the Market. I’m Michael Zezas, Global Head of Fixed Income and Public Policy Strategy. On this episode of the podcast, we’ll discuss how trade policy uncertainty is creating volatility in markets.
It’s Wednesday, January 22nd, at 10am in New York.
Earlier this week, Donald Trump was again inaugurated as President of the United States. In the days that have followed, we’ve fielded tons of questions from investors, who are trying to parse the meaning of myriad executive orders and answers to press questions – looking through that noise for signals about the if, when, and how of policy changes around tariffs, taxes, and more. This effort is understandable because – as we’ve discussed here many times – the US public policy path will have substantial effects on the outlook for the global economy and markets.
And while we’ve spent some time here explaining our assumptions for the US policy path, it's important for investors to understand this. Even if you correctly forecast the timing and severity of changes to trade, tax, immigration, and other policies, you shouldn’t expect markets to consistently track this path along the way. That’s because there’s bound to be a fair amount of confusion among investors, as President Trump and his political allies publicly speculate on their policy tactics and make a wide variety of outcomes seem plausible.
Take tariff policy for example. On Monday, the President announced an America First Trade Policy, where the whole of government was instructed to come up with policy solutions to reduce goods trade deficits and related economic and national security concerns. Tariffs were cited as a tool to be used in furtherance of these goals, and instructions were given to develop authorities on a range of regional and product-specific tariff options. Said more simply, while new tariffs were not immediately implemented, the President appears to be maximizing his optionality to levy tariffs when and how he wants. That will mean that all public comments about tariffs and deadlines, including Trump’s comments to reporters on tariffs for Mexico, Canada, and China, must be taken seriously – even if they don’t ultimately come to fruition, which currently we don’t think they will for Mexico and Canada.
For markets, that max optionality can drive all sorts of short term outcomes. In the US Treasury market, for example, our economists believe these tariffs and a variety of other factors ultimately make for slower economic growth in 2026; and so we expect Treasury yields will ultimately end the year lower. But along the way they could certainly move higher first. As my colleague Matt Hornbach points out, tariff threats can drive investor concerns about temporary inflation leading markets to price in a slower pace of Fed interest rate cuts, which helps push short maturity yields higher.
So bottom line: investors should be carefully considering US public policy choices when thinking about the medium term direction of markets. But they should also expect considerable volatility along the way, because the short term path can look a lot different from the ultimate destination.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Chief Asia Economist Chetan Ahya discusses how tariffs, the power of the U.S. dollar, and the strength of domestic demand will determine Asia’s economic growth in 2025.
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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Today on the podcast: three critical themes that will shape Asia’s economy in 2025.
It’s Tuesday, January 21, at 2 PM in Hong Kong.
Let's start with the big picture: We foresee Asia's growth decelerating from 4.5 per cent last year to 4.1 per cent in 2025. The whole region faces a number of challenges and opportunities that could sway these numbers significantly. We highlight [the] following three key factors.
First up, tariffs. They are our single biggest concern this year. The pace, scale and affected geographies will determine the magnitude of the growth drag. In our base case, within Asia, we expect tariffs to be imposed on China in a phased manner from the first half of 2025. As Mike Zezas, our Head of US Public Policy states, this will be about fast announcements and slow implementation.
Given tariffs and trade tensions are not new, we think this means corporate confidence may not be as badly affected as it was in 2018-19. But the key risk is if trade tensions escalate. For instance, into more aggressive bilateral disputes outside of US-China or if [the] US imposes universal tariffs on all imports. Asia will be most affected, considering that seven out of [the] top ten economies that run large trade surpluses with the US are in Asia. If either of these risk scenarios materialize, it could bring a repeat of [the] 2018-19 growth shock.
Next, let's consider the Fed and the US dollar. Asian central banks find themselves in a bind with the US Federal Reserve's hawkish shift – which we think will result in only two rate cuts in 2025. The Fed is taking a cautious approach, driven by worries over inflation concerns, which could be exacerbated by changes in trade and fiscal policy. This has led to strength in the US dollar and on the flipside, weakness in Asian currencies. This constrains Asian central banks from making aggressive rate reductions -- even though Asia’s inflation is in a range that central banks are comfortable with.
Finally, with [the] external environment not likely to be supportive, domestic demand within key Asian economies will be an important anchor to [the[ region's growth outlook. We are constructive on the outlook for India and Japan but cautious on China.
China has a deflation challenge, driven by excessive investment and excess capacity. Solving it requires policy makers to rely more on consumption as a means to meet its 5 per cent growth target. While some measures have been implemented and we think more are coming, we remain skeptical that these measures will be enough for China to lift consumption growth meaningfully. We see investment remaining the key growth driver and the implementation of tariffs will only exacerbate the ongoing deflationary pressures.
In India and Japan, we think domestic demand tailwinds will be able to offset external headwinds. We expect a robust recovery in India fueled by government capital expenditure, monetary easing and acceleration in services exports. This should put GDP growth back on a 6.5 per cent trajectory. In Japan we expect real wage and consumption growth reacceleration, which will lead [the] Bank of Japan to be confident in the inflation outlook such that it hikes policy rates twice in 2025.
This week marks the start of the new Trump administration. And together with my colleagues, we are watching closely and will continue to bring you updates on the impact of new policies on Asia.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Government bond yields in the U.S. and Europe have risen sharply. Our Head of Corporate Credit Research Andrew Sheets explains why this surprising trend is not yet cause for concern.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley.
With bond yields rising substantially over the last month, I’m going to discuss why we’ve been somewhat more relaxed about this development and what could change our mind.
It's Friday January 17th at 2pm in London.
We thought credit would have a good first half of this year as growth held up, inflation came down, and the Federal Reserve, the European Central Bank and the Bank of England all cut rates. That mix looked appealing, even if corporate activity increased and the range of longer-term economic outcomes widened with a new U.S. administration. We forecast spreads across regions to stay near cycle tights through the first half of this year, before a modest softening in the second half.
Since publishing that outlook in November of last year, some of it still feels very much intact. Growth – especially in the U.S. – has been good. Core inflation in the U.S. and in Europe has continued to moderate. And the Federal Reserve and the European Central Bank did lower interest rates back in December.
But the move in government bond yields in the U.S. and Europe has been a surprise. They've risen sharply, meaning higher borrowing cost for governments, mortgages and companies. How much does our story change if yields are going to be higher for longer, and if the Fed is going to reduce interest rates less?
One way to address this debate, which we’re mindful is currently dominating financial market headlines, is what world do these new bond yields describe? Focusing on the U.S., we see the following pattern.
There’s been strong U.S. data, with Morgan Stanley tracking the U.S. economy to have grown to about 2.5 per cent in the fourth quarter of last year. Rates are rising, and they are rising faster than the expected inflation – a development that usually suggests more optimism on growth. We’re seeing a larger rise in long-term interest rates relative to shorter-term interest rates, which often suggests more confidence that the economy will stay stronger for longer. And we’ve seen expectations of fewer cuts from the Federal Reserve; but, and importantly, still expectations that they are more likely to cut rather than hike rates over the next 12 months.
Putting all of that together, we think it’s a pattern consistent with a bond market that thinks the U.S. economy is strong and will remain somewhat stronger for longer, with that strength justifying less Fed help. That interpretation could be wrong, of course; but if it's right, it seems – in our view – fine for credit.
What about the affordability of borrowing for companies at higher yields? Again, we’re somewhat more sanguine. While yields have risen a lot recently, they are still similar to their 24 month average, which has given corporate bond issuers a lot of time to adjust. And U.S. and European companies are also carrying historically high amounts of cash on their balance sheet, improving their resilience.
Finally, we think that higher yields could actually improve the supply-demand balance in corporate bond markets, as the roughly 5.5 per cent yield today on U.S. Investment Grade credit attracts buyers, while simultaneously making bond issuers a little bit more hesitant to borrow any more than they have to. We now prefer the longer-term part of the Investment Grade market, which we think could benefit most from these dynamics.
If interest rates are going to stay higher for longer, it isn’t a great story for everyone. We think some of the lowest-rated parts of the credit market, for example, CCC-rated issuers, are more vulnerable; and my colleagues in the U.S. continue to hold a cautious view on that segment from their year-ahead outlook. But overall, for corporate credit, we think that higher yields are manageable; and some relief this week on the back of better U.S. inflation data is a further support.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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The Federal Reserve’s shrinking balance sheet could have far-reaching implications for the banking sector, money markets and monetary policy. Global Head of Macro Strategy Matthew Hornbach and Martin Tobias from the U.S. Interest Rate Strategy Team discuss.
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Matthew Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy.
Martin Tobias: And I'm Martin Tobias from the U.S. Interest Rate Strategy Team.
Matthew Hornbach: Today, we're going to talk about the widespread concerns around the dip in reserve levels at the Fed and what it means for banking, money markets, and beyond.
It's Thursday, January 16th at 10am in New York.
The Fed has been shrinking its balance sheet since June 2022, when it embarked on quantitative tightening in order to combat inflation. Reserves held at the Fed recently dipped below [$]3 trillion at year end, their lowest level since 2020. This has raised a lot of questions among investors, and we want to address some of them.
Marty, you've been following these developments closely, so let's start with the basics. What are Fed reserves and why are they important?
Martin Tobias: Reserves are one of the key line items on the liability side of the Fed balance sheet. Like any balance sheet, even your household budget, you have liabilities, which are debts and financial obligations, and you have assets. For the Fed, its assets primarily consist of U.S. Treasury notes and bonds, and then you have liabilities like U.S. currency in circulation and bank reserves held at the Fed.
These reserves consist of electronic deposits that commercial banks, savings and loan institutions, and credit unions hold at Federal Reserve banks. And these depository institutions earn interest from the Fed on these reserve balances.
There are other Fed balance sheet liabilities like the Treasury General Account and the Overnight Reversed Repo Facility. But, to save us from some complexity, I won't go into those right now. Bottom line, these three liabilities are inversely linked to one another, and thus cannot be viewed in isolation.
Having said that, the reason this is important is because central bank reserves are the most liquid and ultimate form of money. They underpin nearly all other forms of money, such as the deposits individuals or businesses hold at commercial banks. In simplest terms, those reserves are a sort of security blanket.
Matthew Hornbach: Okay, so what led to this most recent dip in reserves?
Martin Tobias: Well, that's the good news. We think the recent dip in reserves below [$] 3 trillion was simply related to temporary dynamics in funding markets at the end of the year, as opposed to a permanent drain of cash from the banking system.
Matthew Hornbach: This kind of reduction in reserves has far reaching implications on several different levels. The banking sector, money markets, and monetary policy. So, let's take them one at a time. How does it affect the banking sector?
Martin Tobias: So individual banks maintain different levels of reserves to fit their specific business models; while differences in reserve management also appear across large compared to small banks. As macro strategists, we monitor reserve balances in the aggregate and have identified a few different regimes based on the supply of liquidity.
While reserves did fall below [$]3 trillion at the end of the year, we note the Fed Standing Repo Facility, which is an instrument that offers on demand access to liquidity for banks at a fixed cost, did not receive any usage. We interpret this to mean, even though reserves temporarily dipped below [$]3 trillion, it is a level that is still above scarcity in the aggregate.
Matthew Hornbach: How about potential stability and liquidity of money markets?
Martin Tobias: Occasional signs of volatility in money market rates over the past year have been clear signs that liquidity is transitioning from a super abundancy closer to an ample amount. The fact that there has become more volatility in money market rates – but being limited to identifiable dates – is really indicative of normal market functioning where liquidity is being redistributed from those who have it in excess to those in need of it.
Year- end was just the latest example of there being some more volatility in money market rates. But as has been the case over the past year, these temporary upward pressures quickly normalized as liquidity in funding markets still remains abundant. In fact, reserves rose by [$] 440 billion to [$] 3.3 trillion in the week ended January 8th.
Matthew Hornbach: Would this reduction in reserves that occurred over the end of the year influence the Fed's future monetary policy decisions?
Martin Tobias: Right. As you alluded to earlier, the Fed has been passively reducing the size of its balance sheet to complement its actions with its primary monetary policy tool, the Fed Funds Rate. And I think our listeners are all familiar with the Fed Funds Rate because in simplest terms it's the rate that banks charge each other when lending money overnight, and that in turn influences the interest you pay on your loans and credit cards. Now the goal of the Fed's quantitative tightening program is to bring the balance sheet to the smallest size consistent with efficient money market functioning.
So, we think the Fed is closely watching when declines in reserves occur and the sensitivity of changes in money market rates to those declines. Our house baseline view remains at quantitative tightening ends late in the first quarter of 2025.
Matthew Hornbach: So, bottom line, for people who invest in money market funds, what's the takeaway?
Martin Tobias: The bottom line is money markets continue to operate normally, and even though the Fed has lowered its policy rates, the yields on money markets do remain attractive for many types of retail and institutional investors.
Matthew Hornbach: Well, Marty, thanks for taking the time to talk.
Martin Tobias: Great speaking with you, Matt.
Matthew Hornbach: And thanks for listening. If you enjoy Thoughts on the Market, [00:06:00] please leave us a review wherever you listen and share the podcast with a friend or colleague today.
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Our Global Head of Fixed Income & Public Policy Research Michael Zezas discusses how Morgan Stanley’s key themes – deglobalization, longevity, the future of energy, and artificial intelligence – will evolve in 2025 and beyond.
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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income and Public Policy Research. Today I’ll discuss the key investment megatrends Morgan Stanley Research will be following closely in 2025.
It’s Wednesday, January 15th, at 10am in New York.
Short-term trends can offer investors valuable insights into immediate market dynamics. But it’s the long-term trends that truly shape the investment landscape. That’s why each year, Morgan Stanley Research identifies a short list of megatrends that we believe will provide long-term investment opportunities in an ever-changing world.
Three of Morgan Stanley’s megatrends—artificial intelligence, longevity, and the future of energy—carry over from last year. A fourth—the rewiring of the global economy—returns to our list after a hiatus in 2024. While none of these megatrends is new, each has evolved in terms of how it applies to investment strategies.
Let’s start with the rewiring of global commerce for a Multipolar World. As I mentioned, this theme rejoins our list of key megatrends after a year-long break. Why? In short, it’s clear that policymakers globally are poised to implement policies that will speed up the breakdown of the post-Cold War globalization trend. Simply put, policymakers are keen to promote their visions of national and economic security through less open commerce and more local control of supply chains and key technologies. Multinationals and sovereigns may have to accelerate their adaptation to this reality. Some will face tougher choices than others, while there are some who may still benefit from facilitating this transition. Knowing who fits into which category—and how this new reality may play out—will be critical for investors.
Our next theme—Longevity—remains an essential long-term secular trend, and this year the focus will be on measurable impacts for governments, economies, and corporates. The ripple effects of an aging population, the drive for healthy longevity, and challenging demographics across many geographies continue to impact markets. And in 2025, we see investors focusing on several specific longevity debates: First, innovation across healthcare – especially in an AI world, with obesity medications remaining front and center. Second, impacts on consumer behavior – including the drive for affordable nutrition. Third, the need to reskill aging workforces – especially if retirement ages move higher. And, finally, there’s implications for financial planning and retirement – with a bull market for financial advice just starting.
Our next theme centers around energy. When we think about the future of energy, our focus for 2025 shifts from decarbonization to the wide range of factors driving the supply, demand, and delivery of energy across geographies. And the common thread here is the potential for rapid evolution. We’ll be tracking four key dynamics: First, an increasing focus on energy security. Second, the massive growth in energy demand driven by trillions of dollars of AI infrastructure spend, to be met both by fossil fuel-powered plants and renewables. Third, innovative energy technologies such as carbon capture, energy storage, nuclear power, and power grid optimization. And fourth, increased electrification across many industries. We continue to believe that carbon emissions will likely exceed the targets in various nations’ climate pledges. So, we expect focus to shift toward climate adaptation and resilience technologies and business models.
Our last key theme is artificial intelligence and tech diffusion. Although it’s been two years since the launch of ChatGPT, we’re still in the early innings of AI's diffusion across sectors and geographies. However, while 2024 was driven by AI enablers and infrastructure companies, in 2025 we expect the market to focus on early AI downstream use cases that drive efficiency and market share. As you heard yesterday, our Global Head of Thematic Research Ed Stanley, explained that there’s alpha in understanding this rate of change. Agentic AI will be center stage, with robust enterprise adoption, stock outperformance for early adopters, positive surprises in model capabilities, greater breadth of monetization, and thus less attention to return-on-investment debates.
Before I close, it’s worth mentioning that you will likely see connections between these complex themes. As an example, the complexity of a multipolar world makes energy security all the more vital. The demand for energy connects with the enormous power requirements of AI. And AI is set to drive healthcare innovations which could help us lead longer healthier lives. We see these four themes not as static categories but as an interconnected roadmap for investing over the long-term – and we’ll be sharing more on specific debates throughout the year.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our Global Head of Thematic Research Ed Stanley discusses how artificial intelligence is changing and what could be in store for investors in 2025.
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Welcome to Thoughts on the Market. I’m Ed Stanley, Morgan Stanley’s Global Head of Thematic Research. Today I'll discuss how understanding AI’s rate of change can generate alpha in the year of AI agents.
It’s Tuesday, the 14th of January, at 2 PM in London.
Even if you haven't been using artificial intelligence in your work or home life yet – you’ll doubtless have heard about its capabilities by now. Tasked, for example, with drafting an elevator pitch for a 100-page report; it's a tedious task at the best of times. But using an AI model not only does it become a breeze, but these models can also generate you a podcast – if you so wish – through which to disseminate it, and almost in any language conceivable. But now imagine the algorithm begins thinking through multi-stage processes itself – planning, executing – to generate that 100-page report itself, in the first place. That … is an example of Agentic AI.
As the name implies, this next phase of AI development is where software programs gain agency, transitioning from reactive chatbots that we’ve been using into proactive task fulfillment agents. And this transition is happening now.
Over the past 36 months, we’ve gone from reliable output that can displace or supplement 5-second or 5-minute tasks, such as translation or quick summaries, to models that are providing reliable output for 15-minute tasks, 1-hour tasks – like the ones that I just mentioned. And each time the skeptics have claimed that model improvements are slowing down, and thus call into question the returns on hundreds of billions of dollars that have been spent on AI infrastructure, the AI research labs manage to take another leap forward, surprising even seasoned analysts.
That’s why we think this is such an important trend for 2025. AI Adopter companies that can leverage these agents will start to pull ahead of their peers. And as a result, tracking AI’s evolution in the materiality of companies’ investment cases, we think, has never been more important.
Since our first AI Adopter survey in January 2024 to our latest just published in January 2025, we've seen profound shifts in the thousands of stocks that we cover globally. This ongoing transformation not only underscores that AI’s diffusion is advancing rapidly, but that we’re still very much in its early innings.
To understand the breakneck speed of the AI evolution through the lens of its impact on the stock markets, we need to wrap our heads around the concept of “rate of change.” We just published the third iteration of our AI mapping survey of 3,700 global stocks under coverage. And it reveals that 585 of those stocks had their AI exposure or materiality to investment case changed by our analysts – and that is just versus 6 months ago. And it impacts around $14 trillion of global market cap.
And this rate of change in AI isn't just a buzzword; it's a tangible metric driving outperformance. So, if we look back in the second half of last year, 2024, stocks where our analysts previously increased both AI exposure and materiality in our last survey – went on to outperform broader equity markets by over 20 per cent in the second half of 2024. If we apply the same logic looking forward, where do we think most outperformance is going to come from? It’s in those same stocks where our analysts have just upgraded the exposure and materiality to the investment case.
Beyond this simple screen for AI outperformers we think there are three other key conclusions from our latest survey. The first is AI Enabler stocks with Rising Materiality, within which we believe that Semiconductors, which have outperformed well, might soon pass the baton to the Software layer in terms of equity market dominance. Second, Adopters with Pricing Power. These are companies that adopt AI early and use it to expand their margins but sustainably, without having to give it back to their customers. And the third is Financial stocks, in particular, where AI Rate of Change has been the fastest of any sector in our global coverage – in terms of the efficiency gains that we think it can manifest for the share prices.
So all in all, 2025 promises a slew of significant developments in AI, and, of course, we’ll be here to bring you all of the updates.
Thank you for listening. If you enjoy the show, please leave a review wherever you listen to your podcasts and share Thoughts on the Market with a friend or a colleague today.
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In the latest edition of our Big Debates miniseries, Morgan Stanley Research analysts discuss the factors that will shape the global energy market in 2025 and beyond, and where to look for investment opportunities.
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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. thematic and Equity strategist at Morgan Stanley.
Devin McDermott: I'm Devin McDermott, Head of Morgan Stanley's North America Energy Team.
Mike Canfield: And I'm Mike Canfield, Head of the Europe Sustainability Team,
Michelle Weaver: This is the second episode of our special miniseries, Big Debates, where we cover key investment debates for 2025. Today, we'll look at where we are in the energy transition and some key investment opportunities.
It's Monday, January 13th at 10am in New York.
Mike Canfield: And 3pm in London.
Michelle Weaver: Since 2005, U.S. carbon emissions have fallen by about 15 percent. Nearly all of this has been tied to the power sector. Natural gas has been displacing coal. Renewable resources have seen higher penetration. When you look outside the power sector, though, progress has been a lot more limited.
Let me come to you first, Devin. What is behind these trends, and where are we right now in terms of the energy transition in the U.S.?
Devin McDermott: Over the last 20 years now, it's actually been a pretty steady trend for overall U.S. emissions. There's been gradual annual declines, ratcheting lower through much of this period. [There’s] really two primary drivers.
The first is, the displacement of coal by natural gas, which is driven about 60 percent of this reduction over the period. And the remainder is higher penetration of renewable resources, which drive the remaining 40 percent. And this ratio between these two drivers -- net gas displacing coal, renewables adding to the power sector -- really hasn't changed all that much. It's been pretty consistent even in this post COVID recovery relative to the 15 years prior.
Outside of power, there's been almost no progress, and it doesn't vary much depending on which end market you're looking at. Industrial missions, manufacturing, PetChem -- all relatively stable. And then the transport sector, which for the U.S. in particular, relative to many other markets and the rest of the world, is a big driver transport, a big driver of emissions. And there it's a mix of different factors. The biggest of which, though, driving the slow uptick in alternatives is the lack of viable economic options to decarbonize outside of fossil fuels. And the fact that in the U.S. specifically, there is a very abundant, low-cost base of natural gas; which is a low carbon, the lowest carbon fossil fuel, but still does have carbon intensity tied to it.
Michelle Weaver: You've also argued that the domestic natural gas market is positioned for growth. What's your outlook for this year and beyond?
Devin McDermott: The natural gas market has been a story of growth for a while now, but these last few years have had a bit of a pause on major expansion.
From 2010 to 2020, that's when you saw the biggest uptick in natural gas penetration as a portion of primary energy in the U.S. The domestic market doubled in size over that 10-year period, and you saw growth in really every major end market power and decarbonization. There was a big piece of it. But the U.S. also transitioned from a major importer of LNG, which stands for liquefied natural gas, to one of the world's largest exporters by the end of last decade. And you had a lot of industrial and petrochemical growth, which uses natural gas as a feedstock.
Over the last several years, globally, gas markets have faced a series of shocks, the biggest of which is the Russia-Ukraine conflict and Europe's loss of a significant portion of their gas supply, which historically had come on pipelines from Russia. To replace that, Europe bought a lot more LNG, drove up global prices, and in response to higher global prices, you saw a wave of new project sanctioning activity around the world. The U.S. is a key driver of that expansion cycle.
The U.S. over the next five years will double; roughly double, I should say, its export capacity. And that is an unprecedented amount of volume growth domestically, as well as globally, and will drive a significant uptick in domestic consumption.
So that the additional exports is pillar number one; and pillar number two, which I'd say is more of an emerging trend, is the rise of incremental power consumption. For the last 15 years, U.S. electricity consumption on a weather adjusted basis has not grown. But if you look out at forecasts from utilities, from various market operators in the country, you're now seeing a trend of growth for the balance of this decade and beyond tied to three key things.
The first is onshore manufacturing. The second is power demand tied to data centers and AI. And the third is this broader trend of electrification. So, a little bit from EV's, more electric appliances, which fit into this decarbonization theme more broadly. We're looking at now an outlet, this is our base case of U.S. electricity demand growing at just shy of 2 percent per year over the next five years. That is a growth rate that we have not seen this century. And natural gas, which generates about 40 percent of U.S. power today, will continue to be a key player in meeting this incremental demand. And that becomes then a second pillar of consumption growth for the domestic market.
Michelle Weaver: And we're coming up on the inauguration here, and I think one really important question for investors is what's going to happen to the energy sector and to renewables when Trump takes office? What are you thinking here?
Devin McDermott: Yes. Well, the policy that supports renewable development in the U.S., wind and solar specifically, has survived many different administrations, both Republican and Democratic. And there's actually several examples over the last 10 to 15 years of Republican controlled Congress extending both the production tax credit and investment tax credit for wind and solar.
So, our base case is no major change on deployments, but also unlikely to see any incremental supportive policy for these technologies. Instead, I think the focus will be on some of the other major themes that we've been talking about here.
One, there's currently a pause on new LNG export permits under the Biden administration that should be lifted shortly post Trump's inauguration. Second, there are greenhouse gas intensity limits on new power plant and existing power plant construction in the U.S. that will likely be lifted, under the incoming Trump administration. So, gas takes a larger share of incremental power needs under Trump than it would have under the prior status quo. And then lastly. Consistently over the last few years, penetration of electric vehicles and low carbon vehicles in general in the United States have fallen short of expectations.
And interestingly, if you look at just the composition of new vehicles sold in the U.S. over the past years, nearly two-thirds were SUVs or heavier light duty vehicles that offset some of the other underlying trends of some uptick in EV penetration.
Under the prior Trump administration, there was a rollback of initiatives to improve the fuel economy of both light duty and heavy-duty transport. I would not be surprised if we see that same thing happen again, which means you have more longevity to gasoline, diesel, other fossil-based transport fuels. Which kind of put this all together -- significant growth for natural gas that could accelerate under Trump, more longevity to legacy businesses like gasoline and diesel for these incumbent energy companies is not a bad backdrop.
Trade's still at double its historical discount versus the broader market. So, not a bad setup when you put it all together.
Michelle Weaver: Great. Thank you, Devin. Mike, new policies under the second Trump administration will likely have an impact far beyond the U.S. And with a potential withdrawal of the U.S. from the Paris Agreement and increased greenhushing, many investors are starting to question whether companies may walk back or delay their sustainability ambitions.
Will decarbonization still be a corporate priority or will the pace of the energy transition in Europe slow in 2025?
Mike Canfield: Yeah, that's the big question. The core issues for EU policymakers at the moment include things like competitiveness, climate change, security, digitalization, migration and the cost of living.
At the same time, Mario Draghi highlighted in his report entitled “The Future of European Competitiveness” that there are three transformations Europe has to contend with: to become more innovative and competitive; to complete its energy transition; and to adapt to a backdrop of less stable geopolitics where dependencies are becoming vulnerabilities, to use his phrase.
We do still expect the EU's direction of travel on things like the Fit for 55 goals, its targets to address critical mineral supplies, and the overall net zero transition to remain consistent. And the UK's Labour Party has advocated for Clean Power 2030 goals of 95 percent clean generation sources.
At the same time, it's fair to say some commentators have pointed to the higher regulatory burden on EU corporates as a potentially damaging factor in competitiveness, suggesting that regulations are costly and can be overcomplicated, particularly for smaller companies. While we've already had a delay in the implementation of the EU's deforestation regulation, some questions do remain over other rules, including things like the corporate sustainability, due diligence directive, and the design of the carbon border adjustment mechanism or CBAM.
We're closely watching corporates themselves to see whether they'll reevaluate their investment plans or targets. One example we've actually already seen is in the metals and mining space where decarbonisation investment plans were adjusted because of inadequate green hydrogen infrastructure and policy concerns, such as the effectiveness of the CBAM.
It does remain committed to its long-term net zero goals. But the company has acknowledged that practical hurdles may delay achievement of its 2030 climate ambitions. We wouldn't be surprised to see other companies take an arguably more pragmatic, in inverted commas, approach to their goals, accepting that technology, infrastructure and policy might not really be ready in time to reach 2030 targets.
Michelle Weaver: Do you believe there are still areas where the end markets will grow significantly and where companies still offer compelling opportunities?
Mike Canfield: Yeah, absolutely. We think sustainable investing continues to evolve and that, as with last year, stock selection will be key to generating alpha from the energy transition. We do see really attractive opportunities in enabling technologies across decarbonisation, whether that's segments like grid transmission and distribution, or in things like Industry 4.0.
We'd recommend focusing on companies with clear competitive moats and avoiding the relatively commoditized areas, as well as looking for strong pricing power, and those entities offering mission critical products or services for the transition. We do anticipate a continued investment focus on data center power dynamics in 2025 with cooling technology increasingly a topic of investor interest.
Beyond the power generation component, the urgent need for investment in everything from electrical equipment to grid technologies, smart grid software and hardware solutions, and even cables is now increasingly apparent. We expect secular growth in these markets to continue apace in 2025.
Within Industry 4.0, we do think adoption of automation, robotics, machine learning, and the industrial Internet of Things is set to grow strongly this year as well. We also see further growth potential in other areas like energetic modernization in buildings, climate resilience, and the circular economy.
Michelle Weaver: And with the current level of policy uncertainty has enthusiasm for green investing or the ‘E’ environmental pillar of ESG declined
Mike Canfield: I think evolved might be a fairer expression to use than declined. Certainly, reasonable to say that performance in some of the segments of the E pillar has been very challenging in the last 12 to 24 months -- with the headwinds from geopolitics, from the higher interest rate backdrop and inflation. At the same time, we have seen a transition towards improver investment strategies, and they're continuing to gain in popularity around the world.
As investors recognize that often the most attractive alpha opportunities are in the momentum, or direction of travel rather than simple, so-called positive screening for existing leaders in various spaces. To this end, the investors that we speak to are often focused on things like Capex trends for businesses as a way to determine how companies might actually be investing to deliver on their sustainability ambitions.
Beyond those traditional E, areas like renewables or electric vehicles, we have therefore seen investors try to diversify exposures. So, broadening out to include things like the transition enablers, the grid technologies, HVAC -- that's heating, ventilation and cooling, products supporting energy efficiency in buildings, green construction and emerging technologies even, like small modular nuclear reactors alongside things like industrial automation.
Michelle Weaver: And, given this evolution of the e pillar, do you think that creates an opportunity for the S or G, the social or governance components of ESG?
Mike Canfield: We do think the backdrop for socially focused investing is very strong. We see compelling opportunities in longevity across a lot of elements, things like advanced diagnostics, healthier foods, as well as digitalization, responsible AI, personal mobility, and even parts of social infrastructure. So things as basic as access to water, sanitation, and hygiene.
One topic we as a team have written extensively on in the last few months It's preventative health care, for example. So, while current health systems are typically built to focus on acute conditions and react to complications with pharmaceuticals or clinical care, a focus on preventative care would, at its most fundamental, address the underlying causes of illnesses to avoid problems from arising in the first place.
We argue that the economic benefits of a more effective health system is self evident, whether that's in terms of reducing the overall burden on the system, boosting the workforce or increasing productivity. Within preventative healthcare, we point to fascinating investment opportunities across innovative biopharma, things like smart chemotherapy, for example, alongside solutions like integrated diagnostics, effective use of AI and sophisticated telemedicine advances -- all of which are emerging to support healthy longevity and a much more personalized targeted health system.
Michelle Weaver: Devin and Mike, thank you for taking the time to talk, and to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.
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In the first of a special series, Morgan Stanley’s U.S. Thematic and Equity Strategist Michelle Weaver discusses new frontiers in artificial intelligence with Keith Weiss, Head of U.S. Software Research.
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Michelle: Welcome to Thoughts on the Market I'm Michelle Weaver, Morgan Stanley's U.S. Thematic and Equity Strategist.
Keith: And I'm Keith Weiss, Head of U.S. Software Research.
Michelle: This episode is the first episode of a special series we’re calling “Big Debates” – where we dig deeper into some of the many hot topics of conversation going on right now. Ideas that will shape global markets in 2025. First up in the series: Artificial Intelligence.
It's Friday, January 10th at 10am in New York.
When we look back at 2024, there were three major themes that Morgan Stanley Research followed. And AI and tech diffusion were among them. Throughout last year the market was largely focused on AI enablers – we’re talking semiconductors, data centers, and power companies. The companies that are really building out the infrastructure of AI.
Now though, as we’re looking ahead, that story is starting to change.
Keith, you cover enterprise software. Within your space, how will the AI story morph in 2025?
Keith: I do think 2025 is going to be an exciting year for software [be]cause a lot of these fundamental capabilities that have come out from the training of these models, of putting a lot of compute into the Large Language Models, those capabilities are now being built into software functionality. And that software functionality has been in the market long enough that investors can expect to see more of it come into results. That the product is there for people to actually buy on a go forward basis.
One of the avenues of that product that we're most excited about heading into 2025 is what we're calling agentic computing, where we're moving beyond chatbots to a more automated proactive type of interface into that software functionality that can handle more complex problems, handle it more accurately and really make use of that generative AI capability in a corporate or in an enterprise software setting as we head into 2025.
Michelle: Could you give us an example of what agentic AI is and how might an end user interact with it?
Keith: Sure. So, you and I have been interacting with chatbots a lot to gain access to this generative AI functionality. And if you think about the way you interact with that chatbot, right, you have a prompt, you have a question. You have to come up with the question. going to take that question and it's going to, try to contextually understand the nature of that question, and to the best of its ability it's going to give you back an answer.
In agentic computing, what you're looking for is to add more agency into that chatbot; meaning that it can reason more over the overall question. It's not just one model that it's going to be using to compose the answer. And it's not just the composition of an answer where the functionality of that chatbot is going to end. There's actually an ability to execute what that answer is. So, it can handle more complex problems.
And it could actually automate the execution of the answer to those problems.
Michelle: It sounds like this tech is going to have a massive impact on the workplace. Have you estimated what this could do to productivity?
Keith: Yeah, this is -- really aligns to the work that we did actually back in 2023, where we did our AI index, right. We came up with the conclusion that given the current capabilities of Large Language Models, 25 per cent of U.S. occupations are going to be impacted by these technologies. As the capabilities evolve, we think that could go as high as 45 per cent of U.S. labor touched by these productivity enhancing. Or, sort of, being replaced by these technologies. That equates to, at the high end, $4 trillion of labor that's being augmented or replaced on a go forward basis. The productivity gains still yet to be seen; how much of a productivity gain you could see on average. But the numbers are massive, right, in terms of the potential because it touches so much labor.
Michelle: And finally on agentic, is the market missing anything and how does your view differ from the consensus?
Keith: I think part of what the market is missing is that these agentic computing frameworks is not just one model, right? There's typically a reasoning engine of some sort that's organizing multiple models, multiple components of the system that enable you to -- one, handle more complex queries, more complex problems to be solved, lets you actually execute to the answer. So, there's execution capabilities that come along with that. And equally as important, put more error correction into the system as well. So, you could have agents that are actually ensuring you have a higher accuracy of the answer.
It's the sugar that's going to make the medicine go down, if you will. It's going to make a lot easier to adopt in enterprise environments. I think that's why we're a little bit more optimistic about the pace of adoption and the adoption curves we could see with agentic computing despite the fact it's a relatively early-stage technology.
Michelle: You just mentioned Large Language Models, or LLMs; and one barrier there has been training these models. It requires a ton of computing power, among other constraints. How are companies addressing this, and what's in the cards for next year?
Keith: So, if you think about the demand for that compute in our mind comes from two fundamental sources. And as a software analyst, I break this down into research versus development, right? Research is investment that you make to find core fundamental capabilities.
Development is when you take those capabilities and make the investment to create product out of it. Thus far, again, the primary focus has been on the training side of the equation.
I think that part of the equation looks to be asymptotic to a certain extent. The – what people call the scaling laws, the amount of incremental capability that you're getting from putting more compute at the equation is starting to come down.
What people are overlooking is the amount of improvement that you could see from the development side of the equation. So, whereas the demand for GPUs, the demand for data center for that pure training side of the equation might start to slow down a little bit, I think what we're going to see expand greatly is the demand for inference, the demand to utilize these models more fully to solve real business problems.
In terms of where we're going to source this; there are constraints in terms of data center capacity. The companies that we cover, they've been thinking about these problems for the past decade, right? And they have these decade long planning cycles. They have good visibility in terms of being able to meet that demand in the immediate future. But these questions on how we are going to power these data centers is definitely top of mind for our companies, and they're looking for new sources of power and trying to get more creative there.
The pace with which data centers can be built out is a fundamental constraint in terms of how quickly this demand can be realized. So those supply constraints I don't think are going to be a immediate limiter for any of our names when we're thinking about calendar [20]25. But definitely, part of the planning process and part of the longer-term forecasting for all of these companies in terms of where are they going to find all this fundamental resource – because whether it's training or inference, still a lot of GPUs are going to be needed. A lot of compute is going to be needed.
Michelle: Recently we've been hearing about so called artificial general intelligence or AGI. What is it? And do you think we're going to see it in 2025?
Keith: Yeah, so, AGI is the – it's basically the holy grail of all of these development efforts. Can we come up with models that can reason in the human world as well as we can, right? That can understand the inputs that we give it, understand the domains that we're trying to operate in as well or better than we can, so it can solve problems as effectively and as efficiently as we can.
The easiest way to solve that systems integration problem of like, how can we get the software, how could we get the computers to interact with the world in the way that we do? Or get all the impact that we do is for it to replicate all those functionalities. For it to be able to reason over unstructured text the same way we do. To take visual stimuli the same way that we do. And then we don't have to take data and put into a format that's readable by the system anymore.
2025 is probably too early to be thinking about AGI, to be honest. Most technologists think that there's more breakthroughs needed before the algorithms are going to be that good; before the models are going to be that good.
There's very few people who think Large Language Models and the scaling of Large Language Models in themselves are going to get us to that AGI. You're probably talking 10 to 20 years before we truly see AGI emerge. So, 2025 is probably a little bit too early.
Michelle: Well, great, Keith. Thank you for taking the time to talk and helping us kick off big debates. It looks like 2025 we'll see some major developments in AI.
And to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.
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Our Head of Corporate Credit Research, Andrew Sheets, offers up bull, bear and base cases for credit markets in the year ahead.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today, I’m going to revisit our story for 2025 – and what could make things better or worse.
It's Thursday, January 9th at 2pm in London.
Based on the number of out-of-office replies, I have a sneaking suspicion that many investors took advantage [of] the timing of holidays this year for a well deserved break. With this week marking the first full week back, I thought it would be a good opportunity to refresh listeners on what we expect in 2025, and realistic scenarios where things are better or worse.
Our base case is that credit holds up well this year, doing somewhat better in the first half of 2025 than the second. Credit likes moderation, and while we think the shift in U.S. policy leadership generally means less moderation, and a wider range of economic outcomes, this shift doesn’t arrive immediately. On Morgan Stanley’s forecasts, the bulk of the disruptive impact from any changes to tariffs or immigration policy hits in 2026.
Meanwhile, Credit is entering 2025 with some pretty decent tailwinds. The economy is good. The all-in yield – the total yield – on US investment grade corporate bonds, at above 5.4 per cent, is the highest to start any year since January of 2009 – which we think helps demand. And while we think corporate confidence and aggression will rise this year, normally a bad thing for credit; this is going to be coming off of a low, conservative starting point.
We think that credit spreads will be modestly tighter by mid-year relative to where they finished 2024, and then start to widen modestly in the second half of the year – as the market attempts to price that greater policy uncertainty in 2026. We think that issuers in the Financial and Utilities sectors outperform, and we think bonds between five- and ten-year maturity will do the best.
The bear case is that we exit the current period of moderation more quickly. At one end, a deregulatory push by a new administration could usher in an even faster rise in corporate confidence and aggression, leading to more borrowing and riskier dealmaking. At the other extreme, the strong current state of the economy and jobs market could make further gains harder to come by. If the rise in unemployment that our economists expect in 2026 is larger or arrives earlier, credit could start to weaken well ahead of this.
So, how could things be better – especially given the relatively low, tight starting point for credit spreads? Well, we’d argue that the current mix of data for credit is border-line ideal: reasonable growth, falling inflation, still-low levels of corporate aggressiveness, and still-high yields that are attracting buyers. Recall that the tightest levels of credit in the modern era, which are still tighter than today, occurred during a period with similar characteristics – the mid-1990s.
When thinking about the mid-90s as a bull case, there’s a further detail that’s relevant and topical, especially this week. At that time, interest rates stayed somewhat high and the Fed only lowered short-term rates modestly because the economy held up. In short, in the best environment that we’ve seen for credit, less action by the Federal Reserve was fine – so long as the economic data was good.
This is a bull-case, rather than our base case, because there are also a number of key differences with the mid 1990s, not the least being a much worse trajectory – today – for the US government's budget. But in a scenario where things change less, and the status quo lasts longer, it could come into play.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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With the inauguration of President-elect Donald Trump approaching, our Global Head of Fixed Income and Public Policy Research weighs the impact for investors of his potential policy measures.
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Welcome to Thoughts on the Market. I’m Michael Zezas, Morgan Stanley’s Global Head of Fixed Income and Public Policy Research. Today on the podcast I'll be talking about what investors need to know about recent US policy developments.
It’s Wednesday, Jan 8th, at 2:30pm in New York.
In less than two weeks, Donald Trump will again become the sitting President of the United States. The economic and market consequences of the policies he might enact, either on his own or in concert with the Congress, continue to be an important debate for investors. Our view has been that the sequencing and severity of policy choices across tariffs, taxes, immigration, and regulation would be very meaningful to the market's outlook.
So, have we learned anything from news around the policy discussions inside the incoming administration and congressional leaders? Let’s consider it here and level set.
First, there‘s been news about Republicans debating their approach to legislating some of President Trump’s top policy priorities. That debate centers around whether to create one big bill around taxes, immigration, and a host of other issues or to break it into multiple bills. Leading with immigration reforms, where there may be more consensus within Republicans’ slim Congressional majority; and then following it up with tax cuts and extensions, which may take more time to negotiate given myriad interests. While investors have asked us about this debate quite a bit, the distinction between the approaches may not make much of a difference to investors.
At the end of the day, what should matter most to markets is the timing and size of the fiscal impact driven by tax changes. Going with one big bill may seem faster, but we’re reminded of the saying ‘Nothing is agreed until everything is agreed.’ In other words, that one big bill would probably only pass as fast as Republicans could agree on its toughest negotiating points – so likely not very soon.
As for the size of fiscal impact, we continue to see consensus around extending most of the tax cuts that expire at the end of 2025, with some new benefits, like a domestic manufacturing tax credit. So, there should be some fiscal expansion in 2026, a few hundred billion dollars in our view; but this is meaningfully different than the trillions of dollars that the media cites when discussing the whole of the tax policy wish list.
There’s also been some news on the approach to tariffs, but again it seems more noise than signal. Recent media reports are that Trump might adopt a tariff plan focused on specific products as opposed to a blanket approach on all imports. Trump denied the report via social media. But even if he hadn’t, it's unclear that such a plan could be executed quickly through existing executive powers or through legislation, where it's far from clear that tariffs could be enacted given Democrats' opposition and procedural barriers from budget reconciliation. So, our view remains that new tariffs will likely be enacted but through executive authority – which means a phased-in focus on China and Europe in 2025; and any new authorities developed via existing laws might not be enactable until 2026. So said more simply, the impact of tariffs on the economy may be a late 2025 into 2026 story.
Putting it together for investors: So far, the news flow hasn’t materially changed our view on the US policy path. Yes, important policy changes are coming, but their implementation may be slow. That should mean that, to start 2025, the healthy fundamentals of the US economy should help drive risk markets, namely U.S. equities and corporate credit, to outperform. If we’re wrong and, for example, tariffs are implemented in larger magnitude at a quicker pace, then it may be a year where less risky assets, like government bonds, outperform.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.
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Our Global Chief Economist Seth Carpenter weighs the myriad variables which could impact global markets in 2025, and why this year may be the most uncertain for economies since the start of the pandemic.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist, and today I'll be talking about 2025 and what we might expect in the global economy.
It's Tuesday, January 7th at 10am in New York.
Normally, our year ahead outlook is a roadmap for markets. But for 2025, it feels a bit more like a choose your own adventure book.
uncertainty is a key theme that we highlighted in our year ahead outlook. The new U.S. administration, in particular, will choose its own adventure with tariffs, immigration, and fiscal policy.
Some of the uncertainty is already visible in markets with the repricing of the Fed at the December meeting and the strengthening of the dollar. Our baseline has disinflation stalling on the back of tariffs and immigration policy, while growth moderates, but only late in the year as the policies are gradually phased in.
But in reality, the sequencing, the magnitude and the timing of these policies remains unknown for now, but they're going to have big implications for the economies and central banks around the world. The U.S. economy comes into the year on solid footing with healthy payrolls and solid consumption spending.
Disinflation is continuing, and the inflation data for November were in line with our forecast, but softer in terms of PCE than what the Fed expected. While the Fed did lower their policy rate 25 basis points at the December meeting, Chair Powell's tone was very cautious, and the Fed's projections had inflation risks skewed to the upside.
The chair noted that the FOMC was only beginning to build in assumptions about policy changes from the new administration. Now, we have conviction that tariffs and immigration restriction will both slow the economy and boost inflation -- but we've assumed that these policies are phased in gradually over the entirety of the year. And consequently -- that materially Stagflationary impetus? Well, it's reserved for 2026, not this year.
Similarly, we've assumed that effectively the entire year is consumed by the process of tax cut extensions. And so, we've penciled in no meaningful fiscal impetus for this year. And in fact, with the bulk of the process simply extending current tax policy, we have very little net fiscal impact, even in 2026.
Now, in China, the deflationary pressure is set to continue with any policy reaction further complicated by U.S. policy uncertainty. The policymaker meeting in late December that they held provided only a modest upside surprise in terms of fiscal stimulus, so we're going to have to wait for any further details on that spending until March with the National People's Congress.
Meanwhile, during our holiday break, the renminbi broke above 7.3, and that level matches roughly the peaks that we saw in 2022 and 2023. The strong dollar is clearly weighing on the fixing. The framework for policy will have to account for a potentially trade relationship with the U.S. So, again, in China, there's a great deal of uncertainty, a lot of it driven by policy.
The euro area is arguably less exposed to U.S. trade risks than China. A weaker euro may help stabilize inflation that's trending lower there, but our growth forecasts suggest a tepid outlook. Private consumption spending should moderate, and maybe firm a bit, as inflation continues to fall, and continued policy easing from the ECB should support CapEx spending.
Fiscal consolidation, though, is a key risk to growth, especially in France and Italy, and any postponement in investment from potential trade tensions could further weaken growth.
Now, in Japan, the key debate is whether the Bank of Japan will raise rates in January or March. After the last Bank of Japan meeting, Governor Ueda indicated a desire for greater confidence on the inflation outlook.
Nonetheless, we've retained our call that the hike will be in January because we believe the Bank of Japan's regional Branch manager meeting will give sufficient insight about a strong wage trend. And in combination with the currency weakness that we've been watching, we think that's gonna be enough for the BOJ to hike this month. Alternatively, the BOJ might wait until the Rengo negotiation results come out in March to decide if a hike is appropriate. So far, the data remains supportive and Japanese style core CPI inflation has gone to 2.7 per cent in November. The market's going to focus on Deputy Governor Himino's speech on January 14th for clues on the timing – January or March.
Finally, as the Central Bank of Mexico highlighted in their most recent rate cut decision, caution is the word as we enter the new year. As economists, we could not agree more. The year ahead is the most uncertain since the start of the pandemic. Politics and policy are inherently difficult to forecast. We fully expect to revise our forecasts more -- and more often than usual.
Thanks for listening, and if you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our CIO and Chief U.S. Equity Strategist Mike Wilson considers the year-end slump in U.S. stocks, and whether more market-friendly policies can change the narrative.
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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Today on the podcast I’ll be discussing the weak finish to 2024 and what it means for 2025.
It's Monday, Jan 6th at 11:30am in New York.
So let’s get after it.
While 2024 was another solid year for US equity markets, December was not. The weak finish to the year is likely attributable to several factors. First, from September to the end of November, equity markets had one of their better 3-month runs that also capped the historically strong 1- and 2-year advances. This rally was due to a combination of events including a reversal of recession fears this summer, an aggressive 50 basis points start to a new Fed cutting cycle, and an election that resulted in both a Republican sweep and an unchallenged outcome that led to covering of hedges into early December. This also lines up with my view in October that the S&P 500 could run to 6,100 on a decisive election outcome.
Second, long-term interest rates have backed up considerably since the summer when recession fears peaked. Importantly, this 100 basis point back-up in the 10-year US Treasury yield occurred as the Fed cut interest rates by 100 basis points. In my view, the bond market may be calling into question the Fed’s decision to cut rates so aggressively in the context of stabilizing employment data. The fact that the term premium has risen by 77 basis points from the September lows is also significant and may be a by-product of this dynamic and uncertainty around fiscal sustainability. As we suggested two months ago, if the change in the term premium was to materially exceed 50 basis points, the equity market could start to take notice and hurt valuations. Indeed, Equity multiples peaked in early- to mid-December around the time when the term premium crossed this threshold.
Finally, the rise in rates and the Trump election win has ushered in a stronger dollar which is now reaching a level that could also weigh on equities with significant international exposure. More specifically, the US dollar is quickly approaching the 10 per cent year-over-year rate of change threshold that has historically pressured S&P 500 earnings growth and guidance.
All of these factors have combined to weigh on market breadth, something that still looks like a warning. The divergence between the S&P 500 Index as a ratio of its 200-day moving average and the percent of stocks trading above their 200-day moving average has rarely been wider. This divergence can close in two ways—either breadth improves or the S&P 500 trades closer to its own 200-day moving average, which is 10 per cent below current prices. The first scenario likely relies on a combination of lower rates, a weaker dollar, clarity on tariff policy and stronger earnings revisions. In the absence of those developments, we think 2025 could be a year of two halves with the first half being more challenged before the more market-friendly policy changes can have their desired effects.
It's also worth pointing out that this gap between index pricing and breadth has been more persistent in recent years, something that we attribute to the generous liquidity provisions provided by the Treasury and the Fed. It's also been aided by interventions from other central banks. While not a perfect measure, we do find that the year-over-year change in global money supply in US Dollars is a good way to monitor key inflection points, and that measure has recently rolled over again.
The recent moves in rates and US dollar is just another reason to stick with quality equities. Our quality bias is rooted in the notion that we remain in a later cycle environment which is typical of a backdrop that is consistent with outperformance of this cohort and the fact that the relative earnings revisions for this high quality factor are inflecting higher. As long as these dynamics persist, we think it also makes sense to stay selective within cyclicals and focused on areas of the market that are showing clear relative strength in earnings revisions. These groups include Software, Financials, and Media & Entertainment.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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With the start of the new year, our Head of Corporate Credit Research Andrew Sheets looks back to look ahead at trends for credit and other markets in 2025.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’ll be discussing the lessons we can learn from 2024 – a remarkable year that also may be easily forgotten.
It's Friday January 3rd at 2pm in London.
In 2024 I celebrated my 20th year with Morgan Stanley. Among my regrets over this time was not keeping a better journal. It’s notable how quickly events in the market that seemed large and remarkable at the time can fade in one’s memory as the years merge together. How markets that seem easy or obvious in hindsight were anything but.
I say this because many years from now, 2024 may end up being one of those relatively forgettable years. Another year where – as usually happens – the stock market went up. Another year where stocks outperformed bonds, the US dollar strengthened, and US stocks beat those abroad.
Yet what is significant about 2024 is the scale of all these trends. For anyone managing money, the question of “stocks versus bonds”, “US versus rest-of-world”, “large versus small” or “growth versus value” are some of the most fundamental strategic questions one faces.
These calls don’t always matter. But last year, they did – to a very large degree. Global stocks outperformed bonds by about 20 percent. Growth outperformed Value by practically the same amount. US stocks beat their global peers by 13 per cent. In short, one’s experience in 2024 and relative performance could have varied significantly, based on just a few relatively simple decisions.
Related to that is the second lesson. 2024 was the reminder that while Valuation is a powerful long-term force, it can be a much more frustrating 12-month guide. All of those relative relationships I just mentioned – stocks versus bonds, growth versus value, US versus International – all worked in favor of the market that was historically richer entering last year.
For our third lesson from last year, we’ll focus on Credit, where investors earned a premium over safer government bonds by lending to riskier corporate borrowers. Notable for this asset class in 2024 was, for the most part, it did its own thing; showing some encouraging independence from other markets and highlighting the value of digging into a borrower’s details.
Specifically, I think this independence showed up in a few different ways. Credit showed low correlation to government bonds, for example, delivering good excess returns despite very large swings in yields or central bank expectations. It also, even more impressively, bucked some of 2024’s biggest trends.
For example, while the outperformance of the US economy and US assets was one of the biggest stories of 2024, that wasn’t the case in Credit – where Europe and Asia credit actually did marginally better. In contrast to the equity market, smaller companies and Credit outperformed, as spreads and higher yielded loans outperformed larger Investment Grade spreads, even after adjusting for risk.
And this was true even at a more granular level. Rising corporate activity, alongside more aggressive strategies for companies to deal with their own borrowing created very dispersed outcomes driven by bond-level documentation; far removed from the macro machinations of politics and monetary policy.
This somewhat weaker connection to the broader world is central to how we think about Credit looking ahead. While big economic and political questions certainly loom in 2025, we think that Credit, for now, will be driven more by more micro, company level trends, and show somewhat lower correlation to other assets – at least through the first half of this year.
From all of us at Thoughts on the Market, we wish you a very Happy New Year, and all the best for 2025.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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