Episodes

  • Consumer credit scores have ticked higher in the last two years – but so have the rate of delinquencies and defaults. Our Global Head of Fixed Income discusses “credit score migration” with the firm's Asset-Backed Security Strategist.

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    Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley.

    Heather Berger: And I'm Heather Berger, Asset-Backed Security Strategist.

    Michael Zezas: And today, we'll be talking about the trend of migrating US consumer credit scores and the potential effect on equities and fixed income. It's Wednesday, March 27th at 10am in New York.

    Heather, I really wanted to talk to you today because we've all seen some recent news reports about delinquencies and defaults in consumer credit ticking higher over the last two years. That means more people missing payments on their car loans and credit cards, suggesting the consumer is increasingly in a stressed position. But at the same time, that seems to be at odds with what's been an upward trend in consumers’ credit scores, which on its face should suggest the consumer is in a healthier position.

    So, it all begs the question: what's really going on here with the consumer, and what does it mean for markets? Now, you and your colleagues have been doing some really fascinating work showing that in order to get to the truth here, we have to understand that there's a measurement problem. There’s quirks in the data that, when you understand them, mean you have a more accurate picture of the health of the consumer. And that, in turn, can clarify some opportunities in the fixed income and equity markets.

    So, this measurement problem seems to center around the idea of credit score migration. Can you start by explaining what exactly is credit score migration?

    Heather Berger: Sure. So, credit scores are used as a way to estimate expected default risk on consumer loans. And these scores are really the most standardized and widespread way of evaluating consumer credit quality. Scores are meant to be relative metrics at any point in time. So, a 700 score today is meant to indicate less default risk than a 600 score today, but a 700 score today isn't necessarily the same as a 700 score a few years ago.

    Credit scores have been increasing throughout the past decade; most extremely from 2020 to 2021, largely due to COVID related factors such as stimulus checks. The average credit score is up 10 points in the past four years, and this trend has broadly been referred to as credit score migration.

    Michael Zezas: So, just so we can have a concrete example, can you talk about how this has affected one particular consumer credit category?

    Heather Berger: Well, as you mentioned earlier, delinquencies and defaults have been rising across consumer loan types, whether it's autos, credit cards, or personal loans. The macro backdrop has definitely contributed to this, as inflation has weighed on consumers real disposable income, but we do think that score migration has had an impact as well, considering the large changes over the past few years.

    Looking at auto loans, for example, with the same credit scores from 2022 versus loans from 2018, we see that delinquency rates on the 2022 loans are up to 60 per cent higher than on the 2018 loans. We estimate that 30 to 50 per cent of this increase can be due to effects of credit score migration.

    Michael Zezas: And is there anything we can assume here about the actual health of the US consumer? Do we see delinquencies improving or getting worse?

    Heather Berger: I think one of the main takeaways here is that since score migration impacts performance metrics, we shouldn't necessarily extrapolate delinquency data to broader consumer health. Despite the high delinquency rates, our economists do expect consumers to remain afloat.

    They're forecasting a modest slowdown in consumer spending this year as we move off a hot labor market and continue to face elevated interest rates.

    Michael Zezas: So, let's shift to the market impacts here. Maybe you could tell us what your colleagues in equity research saw as the impact on the banks and consumer finance sectors. And in your area of expertise, what are the impacts for asset-backed securities?

    Heather Berger: We think that across both of these spaces, taking into account changes in credit scores will be important to use in models moving forward; and this can help us to more accurately assess the risks of consumer loans and to predict performance. Movements in credit scores have actually been muted in the past year, which is a big change from the large increases we saw a few years ago.

    So, score migration should now have a smaller impact on consumer performance and delinquency rates. This means that performance will be driven by macro factors and lending standards. As inflation comes down and with lending standards tight, we view this as a positive for asset backed securities, and our colleagues view it as a positive for their coverage of consumer finance equities.

    Michael Zezas: Heather, this has been really insightful. Thanks for taking the time to talk.

    Heather Berger: Great speaking with you, Michael.

    Michael Zezas: And thanks for listening. If you enjoy thoughts on the market, please be sure to rate and review us on the Apple podcast app or wherever you listen. It helps more people find the show.

  • As investors look for clues on market durability, our Chief U.S. Equity Strategist highlights which sectors could show more widely distributed gains in the near term.

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    Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about an opportunity for energy stocks to keep working in the near term.

    It's Tuesday, March 26th at 9:30 am in New York. 

    So let’s get after it.

    Over the past five months, global stocks are up about 25 percent while many other asset prices were up double digits or more. What’s driving this appreciation? Many factors are at work. But for stock indices, it’s been mostly about easier financial conditions and higher valuations rather than improving fundamentals. Granted, higher asset prices often beget even higher prices – as investors feel compelled to participate. From our perspective, it’s hard to justify the higher index level valuations based on fundamentals alone, given that 2024 and 2025 earnings forecasts have barely budged over this time period.  

    We rolled out our “Boom-Bust” thesis in 2020 based on the shift to fiscally dominant policy in response to the pandemic. At that point, our positive view on stocks was based on the boom in earnings that we expected over the 2020-2021 period as the economy roared back from pandemic lows. Our outlook anticipated both accelerating top line growth and massive operating leverage as companies could reduce headcount and other costs while people were locked down at home. The result was the fastest earnings growth in 30 years and record high margins and profitability. In other words, the boom in stocks was justified by the earnings boom that followed. Stock valuations were also supported by arguably the most generous monetary policy in history. The Fed continued Quantitative Easing throughout 2021, a year when S&P earnings grew 48 percent to an all-time high.

    Today, stock valuations have reached similarly high levels achieved back in 2020 and [20]21 – in anticipation of improving growth after the earnings deterioration most companies saw last year. While the recent easing of financial conditions may foreshadow such an acceleration in earnings, bottom-up expectations for 2024 and [20]25 S&P 500 earnings remain flat post the Fed’s fourth quarter dovish shift. Meanwhile, small cap earnings estimates are down 10 percent and 7 percent for 2024 and [20]25, respectively since October. We think one reason for the muted earnings revisions since last fall, particularly in small caps, is the continued policy mix of heavy fiscal stimulus and tight front-end interest rates. We see this crowding out many companies and consumers.  

    The question for investors at this stage is whether the market can finally broaden out in a more sustainable fashion. As we noted last week, we are starting to see breadth improve for several sectors. Looking forward, we believe a durable broadening comes down to whether other stocks and sectors can deliver on earnings growth. One sector showing strong breadth is Industrials, a classic late-cycle winner and a beneficiary of the major fiscal outlays for things like the Inflation Reduction and CHIPS Act, as well as the AI-driven data center buildout. 

    A new sector displaying strong breadth is Energy, the best performer month-to-date but still lagging considerably since the October rally began. Taking the Fed’s recent messaging that they are less concerned about inflation or loosening financial conditions, commodity-oriented cyclicals and Energy in particular could be due for a catch-up. The sector’s relative performance versus the S&P 500 has lagged crude oil prices, and valuation still looks compelling. Relative earnings revisions appear to be inflecting as well. Some listeners may be surprised that Energy has contributed more to the change in S&P 500 earnings since the pandemic than any other sector. Yet it remains one of the cheapest and most under-owned areas of the market.  

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We’d love to hear from you. 

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  • Morgan Stanley’s Chief Fixed Income Strategist explains why private credit markets have expanded rapidly in recent years, and how they may fare if public credit makes an expected comeback.

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    Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the implications of the rapid growth in private credit for the broader credit markets.  

    It’s Monday, March 25th at 12 noon in New York.

    The evolution of private credit is reshaping the landscape of leveraged finance. Investors of all stripes and all around the world are taking notice. The rapid expansion of private credit in the last few years has come against a much different backdrop in the public credit markets – a contraction in the high yield bond market and lackluster growth in the broadly syndicated loan market. What the emergence of private credit means for the public credit and the broader credit markets is a topic of active debate.

    Just to be clear, let me define what we mean by private credit. Private credit is debt extended to corporate borrowers on a bilateral basis or involving very small number of lenders, typically non-banks. Lenders originate and negotiate terms directly with borrowers without the syndication process that is the norm in public markets for both bonds and loans. These private credit loans are typically not publicly rated; they’re not typically traded in secondary markets; tend to have stronger lender protections and offer a spread premium to public markets.

    Given the higher overall borrowing costs as well the need to provide stronger covenant protection to lenders, what motivates borrowers to tap private credit versus public credit? Three key factors explain the recent rapid growth in private credit and show how private credit both competes and complements the public credit markets.

    First, small and medium-sized companies that used to rely on banks had to find alternative sources of credit as banks curtailed lending in response to regulatory capital pressures. A majority of these borrowers have very limited access to syndicated bond and loan markets, given their modest size of borrowings.

    Second, because of the small number of lenders per deal – frequently just one – private credit offers both speed and certainty of execution along with flexibility of term. The last two years of monetary policy tightening has meant that there was a lot of uncertainty around how high policy rates would go and how long they will stay elevated – which has led investors to pull back. The speed and certainty of private credit ended up taking market share from public markets against this background, given this uncertainty in the public markets.

    Third, the pressure on interest coverage ratios from higher rates resulted in a substantial pick-up in rating agency downgrades into the B- and CCC rating categories. At these distressed ratings levels, public markets are not very active, and private credit became the only viable source of financing.

    Where do we go from here? With confidence growing that policy tightening is behind us and the next Fed move will be a cut, the conditions that contributed to deal execution uncertainty are certainly fading. Public markets, both broadly syndicated loan and high yield bond markets, are showing signs of strong revival. The competitive advantage of execution certainty that private credit lenders were offering has become somewhat less material. Further, given the amount of capital raised for private credit that is waiting to be deployed – the so-called dry powder – the spread premium in private credit may also need to come down to be competitive with the public markets.

    So private credit is both a competitor and a complement to the public markets. Its competitive attractiveness will ebb and flow, but we expect its complementary benefit as an avenue for credit where public markets are challenged to remain as well as grow.

    Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts or wherever you get this podcast – and share Thoughts on the Market with a friend or colleague today.

  • Our Head of Corporate Credit notes that while recent central bank meetings offered few surprises, there was still plenty to be gleaned that could affect credit valuations.  

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    Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about this week’s central bank meetings, and why as expected outcomes can still mean new information for credit investors.

    It's Friday, March 22nd at 2pm in London.

    When a good friend was interviewing at Morgan Stanley, many years ago, he was asked a version of the ‘Monty Hall Problem.’ Imagine that you’re on a game show with a prize behind one of three doors. You make your guess of door 1, 2 or 3. And then the host opens one of the doors you didn’t pick, showing that it’s empty. Should you change your original guess?

    While it’s a bit of a paradox, you should. Your original odds of finding the prize were 1-in-3. But by showing you a door with a wrong answer, the odds have improved. The host gave you new information. 

    And that’s what came to mind this week, after important meetings from the Federal Reserve and Bank of Japan. Both banks acted in-line with our economists’ expectations. But those meetings and what came after still provided some valuable new information. Information that, in our view, was helpful to credit.

    On Tuesday, the Bank of Japan raised interest rates for the first time since 2016, ended Yield Curve Control, and ended its purchases of equities. All of these measures had been previously used to help boost too-low inflation. But they have also resulted in a significant weakening of Japan’s currency, the Yen. And that, in turn, had made it attractive for Japanese investors to invest in overseas bonds in other currencies – which were gaining value as the Yen weakened.

    So, one risk heading into this week was that these big changes in the Bank of Japan would reverse these other trends. It would strengthen the currency and make buying corporate bonds from the US or Europe less attractive to Japanese investors. But this meeting has now come and gone, and the Yen saw little movement. That is helpful, new information. Before Tuesday, it was impossible to know how the currency would react.

    Then on Wednesday, the Fed confirmed its expectation from December that it was planning to cut interest rates three times this year. On the surface, that was another ‘as expected’ outcome. But it still contained new information. The Fed’s forecast suggested more confidence that stronger 2024 growth wouldn’t lead to higher inflation. And that endorsed the idea that the productive capacity of the US economy is improving. Solid growth and lower inflation co-existing, thanks to better productivity, will be closer to a 1990s style outcome. And that was a pretty good scenario for credit.

    This week’s central bank meetings have come and gone without big surprises. But sometimes ‘as expected’ can still deliver new information. We continue to expect credit valuations to hold at richer-than-average levels, and like US leveraged loans, as a high yielding market well-suited for a mid-90s scenario.

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you. 

  • The perspective from our recent European Financials Conference looked positive for UK markets, loan demand and M&A activity. Our European heads of Diversified Financials and Banks Research discuss.

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    Bruce Hamilton: Welcome to thoughts on the Market. I'm Bruce Hamilton, head of European Diversified Financials Research.

    Alvaro Serrano: And I'm Alvaro Serrano, head of European Banks Research.

    Bruce Hamilton: And on this episode of the podcast, we'll discuss some of the key takeaways from Morgan Stanley's just concluded 20th European Financials Conference. It's Thursday, March 21st at 3 pm in London.

    Alvaro, we were both at the European Financials Conference in London. More than 100 companies attended the event. 95 percent of the attendees were from CE level management. There was a lot to take in.

    Investor sentiment heading into the conference seemed noticeably more upbeat than last year's, thanks in part to stronger-for-longer net interest income (NII), an M&A cycle that is heating up, attractive capital returns, and increasing activity in private markets.

    Now you were the conference chair, Alvaro. And you have a unique overview of this event. What's, in your view, the single most important takeaway?

    Alvaro Serrano: Thanks, Bruce. Look, I think for me that if I had to summarize in two words is ‘risk on.’ I think the tone of the conference has been positive almost across the board. The lower rate outlook has increased market confidence. And corporates were pointing that out. They've seen stronger activity, so far this year, in many product lines. They've called out loan demand being stronger. They've called out debt capital market activity being stronger. They've announced M&A -- we know is up strongly and asset management inflows are up strong as well. So yes, a strong start to the year - confidence is back, and I would summarize it as risk on.

    Bruce Hamilton: Got it. And in terms of the other key themes and debates that emerged from company presentations at the conference.

    Alvaro Serrano: Yeah, look, I think the main themes following up from what I was saying earlier are: First of all, I would say leadership change. Within the sector, we've been calling for leadership change in our outlook. And I think what we heard at the conference supports this. So, given market activities coming back, I think a lot of investors were more keen to look for more resilient revenue models; maybe less peripheral banks, less NII retail-centric banks. And looking for more fee growth that could benefit from that market recovery.

    The second point I would point out is UK. There’s definitely a change in sentiment around the UK in the polling questions. It came out as a preferred region, and I think what's behind that preference is that we're seeing an inflection point in NII.

    And I think the third and final theme for me is investment banking and wealth recovery. Look, wealth may not recover already in Q1. But as this confidence builds up, we definitely expect inflows to pick up in the second half, both in quantity and margin.

    Bruce Hamilton: So, based on your own work and what you heard at the conference, what's your overall view on the financial sector and what drives that from here?

    Alvaro Serrano: We continue positive the sector. Look, the valuation is depressed. The multiples, the PE multiples on six times. Historically, it's been much closer to double-digit. We think, recovering PMIs should help re-rate that multiple. And while we do wait for those PMIs to recover, you're being paid 11 per cent yield between dividends and buybacks.

    I think the confidence build up that we're seeing in the tone of the conference suggests an early indicator of those PMIs recovering, if you ask me. And then in the panels, we've had plenty of discussions around asset quality. Obviously, commercial real estate exposure is a big theme. But we think it's a manageable problem. It's less than 5 per cent of the loan books, within that office is less than a third. And within that US office spaces is a fraction. So overall, we think it's a manageable problem and our highest single conviction in the sectors that the yields are sustainable and resilient.

    So, with a strong valuation underpin, we continue, positive of the sector.

    Bruce, why don't I turn it over to you? Given your focus on private markets, exchanges, and asset management sub-sectors within diversified financials, can you talk us through private markets and deal activity space?

    Bruce Hamilton: Yeah, our fireside chats with panels, and with private market management teams, saw more optimistic commentary on capital markets activity. And similarly fundraising improvements are expected to be closely linked to cash flows from exit activity flowing back to institutional clients, who can then reallocate to new funds.

    So there's a little delay. But overall, the direction of travel clearly feels positive and pointed to a reacceleration in the private markets’ flywheel in due course, which has been, of course, the rationale behind the more positive view we have taken on this subsector since our outlook piece in November last year.

    Alvaro Serrano: AI is obviously a dominant theme across sectors and industries globally. Also, by the way, a frequent topic in the discussion of this podcast. Can you give us an update on AI and its implications for wealth and asset management?

    Bruce Hamilton: Sure. I mean, our discussions with asset management CEOs highlighted the transformative potential of AI, as they see it as a source of significant efficiency potential across the value chain. From sales and marketing, through investments and research, to middle and back office -- in areas such as report writing, research synthesis and client servicing. The benefits of starting early, with leaders having been working on this for 12 months or more, seems clear given the need to manage risks, for example, ensuring data quality to avoid hallucinations.

    One asset management CEO indicated that his firm had identified 85 use cases, with 35 already in production. The initial opportunities for asset managers were seen as principally in driving cost efficiencies; though in wealth management a greater revenue potential we think exists given the scope to improve the effectiveness of wealth advisors in targeting and servicing clients.

    Exchanges also noted scope for AI to both support revenue momentum. For example, via chatbots, assisting clients in accessing data more effectively. And in driving efficiency in report writing, as well as in costs. So, think about scope to drive efficiencies in areas such as client servicing and data ingestion and organization where large language models (LLMs) are already driving efficiency gains for employees.

    Alvaro Serrano: Finally, let's talk about private credit, another big theme. What did you hear, at the conference around the growth of private credit? And what's your outlook from here?

    Bruce Hamilton: Sure. So, the players were positive on the potential for growth in private credit from here. In the near-term deployment opportunities probably look stronger in the private credit space relative to private equity, where some differences in buyer-seller expectations is still acting as a bit of a constraint. There are opportunities given bank retrenchments, even if the Basel III endgame is expected to be less negative than initial draft proposals. And the appetite from insurance -- institutional, as well as retail clients for the diversification benefits and attractive yields on offer -- remains pretty significant.

    Both private market specialists and traditional asset managers continue to explore ways to extend their capabilities in the space, with some adopting an organic approach and others looking to accelerate scaling via M&A.

    We expect that as we look forward, that some recovery in the bank's syndicated lending markets is likely to reduce the record market share enjoyed by private credit in private equity deals last year. However, we think a more vibrant overall deal environment is likely to drive opportunities for both bank syndicated and private credit looking forward.

    The democratization theme with wealth clients increasing allocations to private markets remains an additional powerful growth theme as we look forward; both for private credit providers, as well as players active in private equity infrastructure and real estate.

    I'm sure there'll be lots more to unpack from the conference in the near future. Let's wrap it up for this episode. Alvaro, thanks a lot for taking the time to talk.

    Alvaro Serrano: Great speaking with you, Bruce.

    Bruce Hamilton: 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.

  • Our Global Head of Fixed Income and Thematic Research outlines the potential impact the upcoming U.S. elections could have on increasing treasury yields, US-China policy and Japan’s current trajectory.

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    Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about overseas investors' view on the US election.

     It's Wednesday, Mar 20th at 10:30 am in New York.

     I was in Japan last week. And as has been the case with other clients outside the US, the upcoming American elections were a key concern. To that end, we’re sharing the three most frequently asked questions, as well as our answers, about the impact of the U.S. election on markets coming from clients outside the US.

    First, clients are curious what the election could mean for what’s recently been a very rosy outlook for Japan. The central bank is taking steps toward normalizing monetary policy which, combined with corporate reforms, is driving renewed investment. And it doesn’t hurt that multinationals are finding it more challenging to do new business in China due to U.S. policy restrictions. In our view, regardless of the election outcome, these positive secular trends will continue. While its true that Republicans are voicing greater interest in tariffs on US friend and foe alike, in our view there are other geographies more likely to bear the impact of stricter trade policy from the US – such as Europe, Mexico, and China; areas where there’s clearer overlap between US trade interests and the geopolitical preferences of the Republican party.

    Second, clients wanted to know what the election would mean for US-China policy. The first thing to understand is that both parties are interested in policies that build barriers protecting technologies critical to US economic and national security. For Democrats, this has meant a focus on extending non-tariff barriers such as export and investment restrictions; many of which end up affecting the trade relationship between the US and China, and over time have resulted in US direct investment tilting away from China and toward the rest of the world.  Republicans support these policies too. But key party leaders, including former President and current candidate Trump, also want to use tariffs as a tool to negotiate better trade agreements; and, potentially as a fall back, to harmonize tariff levels between countries. So, the election is unlikely to yield an outcome that eases trade tension between the US and China. But an outcome where Republicans win could create more volatility for global trade flows and corporate confidence, creating more economic uncertainty in the near term. 

    Third and finally, clients wanted to know if there were any election outcomes that would reliably change the trajectory of US growth, inflation, and accordingly the trajectory for treasury yields. In particular there was interest in outcomes that could cause yields to move higher. Our take here is that there’s been no solidly reliable outcome that points in that direction -- at least not yet. While it's likely that a potential Trump presidency would favor tax cuts and tariffs, it’s not clear that either of these definitively lead to inflation. Cutting taxes for companies with healthy balance sheets doesn’t necessarily yield more investment. Tariffs increase the cost of the thing being tariffed, but that could lead to prices of other goods in the economy suffering from weaker demand. Relatedly, the idea that a more dovish Fed could enable inflation is not a foregone conclusion because – as we’ve discussed on prior episodes – the President's ability to influence monetary policy is more limited than you might think.

    Still, because of the pileup of these factors, it wouldn’t be surprising to see rates rise at some point this year on election risk perceptions. But it's not clear this would be a sustained move, and so it's not causing us yet to recommend clients’ position for it. For clients looking for more reliable market moves from the election, we’re still focused on key sectoral impacts: sectors like industrials and telecom which could benefit from tax cuts in a Republican win scenario; and sectors like clean tech which benefit in a Democratic win scenario, on greater certainty for the spend of energy transition money in the IRA.  

    Of course, as markets change and price in different outcomes, interesting macro markets opportunities will emerge -- and we’ll be here to tell you all about it.

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.

  • Our Chief Asia and Emerging Market Equity Strategist reviews an up-and-down first quarter for markets across the region, and gives an update on which sectors investors should be eyeing. 

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    Welcome to the Thoughts on the Market. I’m Jonathan Garner, Morgan Stanley’s Chief Asia and Emerging Market Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about our key investment views in Asia. It's Tuesday, Mar 19th at 9 am in Singapore.

    It's been quite a first quarter in Asian equities with a wide degree of dispersion in market returns. At one end of the spectrum Japan’s Nikkei index is up 16 percent. At the other end, despite a recent rally, the Hang Seng index in Hong Kong is down 2 percent for the year. Meanwhile, the AI thematic has helped Taiwan into second place regionally, with a 10 percent gain; but Korea has risen by a lot less.

    Our highest conviction views remains that we’re in the midst of multi-year secular bull markets in Japan and India, whilst at the same time China is in a secular bear market. So, let’s lay out the building blocks of those theses.

    Firstly, Japan’s Return on Equity Journey. We think that markets – like stocks – reward improvement in profitability or ROE. The drivers of the ROE improvement are numerous but include domestic reflation, a weaker Yen, a productive capex cycle and improved capital management by Japan’s leading firms. And these together have led to improving net income margins in two-thirds of industries versus a decade ago. 

    We forecast robust EPS growth of around 9 percent in 2024, with similar growth in 2025. Now that’s assuming our foreign exchange strategists’ USD/JPY forecast of 140 for the fourth quarter of this year is accurate. This week the BOJ – the Bank of Japan – is considering whether to exit its Negative Interest Rate Policy and abolish or flex yield curve control. If it does so, that will be a sign – along with recent strong wage gains – that Japan has definitively exited deflation.

    Secondly, India’s Decade. Multipolar world trends are supporting foreign direct investment (FDI) flows and portfolio flows to India, whilst positive demographics from a rapidly growing working age population are also supporting the equity market. India is holding national elections in May, and we will be watching the policy framework thereafter. But our base case is little change; success that India has achieved in macro-stability is underpinning a strong capex and profits outlook.

    Finally, China’s Deflationary Challenge. China continues to battle what we’ve termed its 3D challenge of Debt (now standing at 300 per cent of GDP), Demographics and Deflation. And profitability has fallen steadily in recent years – so going in the opposite direction from Japan; approximately halving since the middle of the last decade, whilst earnings have missed for nine straight quarters. We think more forceful countercyclical measures are needed to boost demand in China given incipient balance sheet recession due to headwinds from property and local government austerity.

    Finally, to summarize some of our sector and style views. We still like Korea and Taiwan’s semiconductors, into an expected 2024 recovery in traditional product areas such as smart phone, as well as the new theme of AI related demand. We are positive on Financials in India, Indonesia and Singapore; Industrials in India and Mexico; and Consumer Discretionary in India. On the quant and style side, we’re neutral on value versus growth as we expect the path to lower yields to be bumpy – as inflation risk remains. And we have recently recommended investors to reduce momentum exposure for risk management purposes given the strong outperformance year to date.

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen – and leave us a review. We’d love to hear from you.

  • Our CIO and Chief Equity Strategist discusses the continued uncertainty in the markets, and how investors are now looking at earnings growth and improving valuations.

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    Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the risk of higher interest rates and equity valuations. 

    It's Monday, March 18th at 11:30 am in New York. 

    So let’s get after it.

    Long term interest rates peaked in October of last year and coincided with the lows in equities. The rally began with the Treasury's guidance for less coupon issuance than expected. This surprise occurred at a time when many bond managers were short duration. When combined with the Fed’s fourth quarter policy shift, there was a major squeeze in bonds. As a result, 30-year Treasury bonds returned 19 per cent over the October-December 2023 period, beating the 14 per cent return in the S&P 500. Nearly all of the equity return over this period was attributable to higher valuations tied to the fall in interest rates.

    Fast forward to this year, and the story has been much different. Bond yields have risen considerably as investors took profits on longer term bonds, and the Fed walked back several of the cuts that had been priced in for this year. The flip side is that the growth data has been weaker in aggregate which argues for lower rates. Call it a tug of war between weaker growth and higher inflation than expected.

    There is also the question of supply which continues to grow with the expanded budget deficit. From an equity standpoint, the rise in interest rates this year has not had the typically negative effect on valuations.  In other words, equity investors appear to have moved past the Fed, inflation and rates – and are now squarely focused on earnings growth that the consensus expects to considerably improve.  

    As noted in prior podcasts, the consensus earnings per share (EPS) growth estimates for this year are high, and above our expectations – in the context of sticky cost structures and falling pricing power as fiscal spend crowds out both labor and capital for the average company. In our view, this crowding out is one reason why fundamentals and performance have remained relatively muted outside of the large cap, quality winners. We have been expecting a broadening out in leadership to other large cap/quality stocks away from tech and communication services; and recently that has started to happen. Strong breadth and improving fundamentals support our relative preference for Industrials within broader cyclicals.

    Other areas of relative strength more recently include Energy, Materials and Utilities. Some of this is tied to the excitement over Artificial Intelligence and the impact that will have on power consumption. The end result is lower valuations for the index overall as investors rotate from the expensive winners in technology to laggards that are cheaper and may do better in an environment with higher commodity prices.  

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen --and leave us a review. We’d love to hear from you. 

  • Our Head of Corporate Credit Research explains why leveraged loans would benefit if bumpy inflation data leads the Federal Reserve to delay interest rate cuts.

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    Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I’ll be talking about the ramifications of the fed rate cuts, and what it could mean for credit – and what would benefit if rates stay higher for longer. It's Friday, March 15th at 2pm in London.

    The big story in markets this week was inflation. U.S. Consumer Price inflation continues to moderate on a year-over-year basis, but the recent path has been bumpier than expected. 

    And as U.S. Economic growth in the first quarter continues to track above initial expectations, there’s growing debate around whether the U.S. economy is still too strong to justify the Federal Reserve lowering rates.

    Morgan Stanley’s economic base case is that these inflation readings will remain bumpy – but will trend lower over the course of the year. And if we couple that with our expectations that job growth will moderate, we think this still supports the idea that the Federal Reserve will start to lower interest rates starting in June.

    Yet the bumpiness of this recent data does raise questions. What if the Federal Reserve lowers rates later? Or what if they lower rates less than we expect?

    For credit, we think the biggest beneficiary of this scenario would be leveraged loans. For background, these represent lending to below-investment grade borrowers, similar to the universe for high yield bonds. But loans are floating rate; their yields to investors rise and fall with central bank policy rates.

    Coming into 2024, there were a number of concerns around the levered loan market. Worries around growth had led markets at the start of the year to imply significant rate cuts from the Fed. And that’s a double whammy, so to speak, for loans; as loans are both economically sensitive to that weaker growth scenario and would see their yields to investors decline faster if there are more rate cuts. Meanwhile, an important previous buyer of loans, so-called Collateralized Loan Obligations, or CLOs, had been relatively dormant.

    Yet today many of those factors are all looking better. Estimates for US 2024 GDP growth have been creeping up. CLO activity has been restarting. And some of this recent growth and inflation data means that markets are now expecting far fewer rate cuts – which means that the yield on loans would also remain higher for longer. And that’s all happening at a time when the spread on loans is relatively elevated, relative to similar fixed rate high yield bonds.

    A question of whether or not U.S. inflation will be sticky remains a key debate. While we think inflation resumes its improvement, we like leveraged loans as a high yielding, floating rate instrument that has a number of key advantages – if rates stay higher, for longer, than we expect.

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you. 

  • Morgan Stanley’s chief economists have their quarterly roundtable discussion, focusing on the state of inflation across global regions, the possible effect of the US election on the economy and more.

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    Seth Carpenter: Welcome to Thoughts On the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. On this episode, on this special episode of the podcast, we'll hold our second roundtable discussion covering Morgan Stanley's global economic outlook as we look into the second quarter of 2024.

    It's Thursday, March the 14th at 10 am in New York.

    Jens Eisenschmidt: And it's 2 pm in London.

    Chetan Ahya: And 10pm in Hong Kong.

    Seth Carpenter: Excellent. So, things around the world have changed significantly since our roundtable last quarter. US growth is notably stronger with few signs of a substantial slowdown. Inflation is falling, but giving some hints that things could stay -- maybe -- hotter for longer.

    In Europe, things are evolving mostly as anticipated, but energy prices are much lower, and some data suggest hope for a recovery. Meanwhile, in China, debt deflation risks are becoming a reality. And the last policy communication shows no sign of reflation. And finally, Japan continues to confirm the shift in equilibrium, and we are expecting the policy rate change imminently.

    So, let's dig into these developments. I am joined by the leaders of the economics team in key regions. Ellen Zentner is our Chief US Economist, and she's here with me in New York. Chetan Ahya is our Chief Asia Economist, and Jens Eisenschmidt is our Chief Europe Economist.

    Ellen, I'm going to start with you and the US. Have the stronger data fundamentally changed your view on the US economy or the Fed?

    Ellen Zentner: So, coming off of 2023, growth was just stronger than expected. And so, carrying that into 2024, we have revised upward our GDP forecast from 1.6 per cent Q4 over Q4 to 1.8 per cent. So already we've got stronger growth this year. We have not changed our inflation forecast though; because this could be another year of stronger data coming from supply side normalization, and in particular the labor market -- where it's come amid higher productivity and decelerating inflation. So, I think we're in store for another year like that. And I would say if I add risks, it would be risk to the upside on growth.

    Seth Carpenter: Okay, that makes sense. But if there's risk to the upside on growth -- surely there's some risk that the extra strength in growth, or even some of the slightly stronger inflation that we've seen, that all of that could persist; and the Fed could delay their first cut beyond the June meeting, which is what you've got penciled in for the first cut. So how do you think about the risks to the timing for the Fed?

    Ellen Zentner: So, I think you've got a strong backdrop for growth. You've got relatively easy financial conditions. And Fed policymakers have noted that that could pose upside risks to the economy and to inflation. And so, they're very carefully parsing every data point that comes in. Chair Powell said they need a bit more confidence on inflation coming down. And so that means that the year over year rate on core PCE -- their preferred measure of inflation -- needs to continue to take down.

    I think that the risk is more how long they stay on hold -- than if the next move is a hike, which investors have been very focused on. Do we get to that point? And so certainly if we don't see the next couple of months and further improvement, then I think it just does lead for a longer hold time for the Fed.

    Seth Carpenter: All right. A risk of a longer hold time. Chetan, how do you think about that risk?

    Chetan Ahya: That risk is important to consider. We recently published on the idea that Asian central banks will have to wait for the Fed. Even though inflation across Asia is settling back into target ranges, central banks appear to be concerned that real rate differentials versus US are negative and still widening, keeping Asian currencies relatively weak.

    This backdrop means that central banks are still concerned about future upside to inflation and that it may not durably stay within the target. Finally, growth momentum in Asia excluding China has been holding up despite the move in higher real rates -- allowing central banks more room to be patient before cutting rates.

    Seth Carpenter: I got it. Okay, so Jens, what about for the ECB? Does the same consideration apply if the Fed were to delay its cutting cycle?

    Jens Eisenschmidt: I'm glad you're asking that question, Seth, because that's sort of the single most asked question by our clients. And the answer is, well, yes and no. In our baseline, first of all, to stress this, the ECB cuts before the Fed, if only by a week. So, we think the ECB will go on June 6th to be precise. And what we have heard, last Thursday from the ECB meeting exactly confirms that point. The ECB is set to go in June, barring a major catastrophe on growth or disappointments on inflation.

    I think what is key if that effect cuts less than what Ellen expects currently; the ECB may also cut less later in the year than we expect.

    So just to be precise, we think about a hundred basis points. And of course, that may be subject to downward revision if the Fed decides to go later. So, it's not an idle or phenomenon. It's rather a rather a matter of degree.

    Seth Carpenter: Got it. Okay, so that's really helpful to put the, the Fed in the context of global central banks. But, Ellen, let me come back to you. If I'm going to look from here through the end of the year, I trip over the election. So, how are you thinking about what the US election means for the Fed and for the economy as a whole?

    Ellen Zentner: Sure. So, I think the important thing to remember is that the Fed has a domestic directive. And so, if there is something impacting the outlook -- regardless, election, geopolitics, anything -- then it comes under their purview to support the economy. And so, you know, best example I can give maybe is the Bush Gore election, when we didn't know who was going to be president for more than two months.

    And it had to go to the Supreme Court, and at that time, the uncertainty among households, among businesses on who will be the next president really created this air pocket in the economy. So that's sort of the best example I can give where an election was a bit disruptive, although the economy bounced back on the other side of that.

    Seth Carpenter: But can I push you there? So, it sounds like what you're saying is it's not the election per se that the Fed cares about. the Fed's not entering into the political fray. It's more what the ramification of the election is for the economy. Is that a fair statement?

    Ellen Zentner: Absolutely. Absolutely fair.

    Chetan Ahya: One issue the election does force us to confront is the prospect of geopolitical tension, and in particular the fact that President Trump has discussed further tariffs. For China, it is worth considering the implications, given the current weakness.

    Seth Carpenter:  That’s a really good point, Chetan, but before we even get there, maybe it's worth having you just give us a view on where things stand now in China. Is there hope of reflationary fiscal policy?

    Chetan Ahya: Unfortunately, doesn’t seem like a lot right now. We have been highlighting that China needs to stimulate domestic demand with expansionary fiscal policy targeted towards boosting consumption. And it is in this context that we were closely watching policy announcement during the National People's Congress a couple of weeks ago.

    Unfortunately, the announcement in NPC suggests that there are very limited reflationary policies being implemented right now. More importantly, the broad policy focus remains firmly on supporting investment and the supply side; and not enough on the consumption side. So, it does seem that we are far away from getting that required reflationary and rebalancing policies we think is needed to lift China back to moderate 2 to 3 per cent inflation trajectory.

    Jens Eisenschmidt: I would jump in here and say that part of the ongoing weakness we see in Europe and in particularly Germany is tied to the slowdown in global trade and the weakness Chetan is talking about for China.

    Seth Carpenter: Okay, Jens, if you're going to jump in, that's great. Could you just let us know where do you think things go in Europe then for the rest of this year and into next year?

    Jens Eisenschmidt: So, we see indeed a small rebound. So, things are not looking great on numbers. But, you know, where we are coming from is close to recessionary territory; so everything that's up looks will look better.

    So, we have 0. 5 on year and year growth rates; 1 percent next year; 0.5 for this year. In terms of quarterly profiles -- so, essentially we are hitting at some point later this year a velocity between 0.2 to 0.3, which is close to potential growth for the Euro area, which we estimate at 1.1.

    Seth Carpenter: Got it. Okay, so outside of the U. S. then. China's week. Europe's lackluster Chetan, I gotta come back to you. Give us some good news. Talk to us about the outlook for Japan. We were early adopters of the Japan reflation story. What does it look like now?

    Chetan Ahya: Well, the outlook in Japan is the exact opposite of China. We are constructive on Japan's macro-outlook, and we see Japan transitioning to a moderate but sustainable inflation and higher normal GDP growth environment.

    Japan has already experienced one round of inflation and one round of wage growth. But to get to sustained inflation, we need to see wage growth to stay strong and more evidence of wage passing through to inflation. In this context, we are closely watching the next round of wage negotiations between the trade unions and the corporate sector.

    We expect the outcome of first round of negotiations to be announced on March 15th, and we think that this will reflect a strong acceleration in wage growth in Japan. And that, we think, will allow Japan's core inflation to be sustained at 1.5 to 1.75 per cent going forward.

    This rise in inflation will mean higher normal GDP growth and lower real interest rates, reviving the animal spirits and revitalize the corporate sector. We do see BOJ moving from negative rates to positive rates in March 19th policy meeting and later follow up with another 15 bps (basis points) hike in July policy meeting. But we think overall policy environment will remain accommodative supporting Japan's reflation story.

    Seth Carpenter: All right, that does make me feel a little bit better about the global economy outside of the US. But I'm seeing the indication from the producers, we've got to wrap up. So, I'm going to go to each of you, rapid fire questions. Give me two quick risks to your forecast. Ellen for the US…

    Ellen Zentner: All right. If we're wrong and the economy keeps growing faster, I think I would peg it on something like fiscal impulse, which has been difficult to get a handle on. Maybe throw in easier than expected financial conditions there that fuel the economy, fuel inflation. I think if we slow a lot more then it's likely because of some stresses in the banking sector.

    Let's think about CRE; we say it's contained, maybe it's not contained. And then also if companies decide that they do need to reduce headcounts because economic growth is weaker, and so we lose that narrative of employee retention.

    Seth Carpenter: Got it. Okay, Jens, you're up. Two risks.

    Jens Eisenschmidt: The key upside risk is clearly consumption. We have a muted part for consumption; but consumption isn't really back to where it has been pre-COVID or just barely so. So, there's certainly more way up and we could be simply wrong because our outlook is too muted.

    Downside, think of intensification of supply chain disruptions. Think about Red Sea. The news flow from there is not really encouraging. We have modeled this. We think so far so good. But if persists for longer or intensified, it could well be a downside risk because either inflation goes up and/or growth actually slows down.

    Seth Carpenter: Perfect. All right, Chetan, let me end with you and specifically with China. If we are going to be wrong on China, what would that look like?

    Chetan Ahya: We think there are two upside risks to our cautious view on China's macro-outlook. Number one, if global trade booms, that helps China to use its excess capacity and enables it to de-lever and lift its inflation. And number two, if we see a shift in the reflationary and rebalancing policies, such that there is aggressive increase in social expenditure on things like healthcare, education, and public housing. This would help households to unlock precautionary saving, boost consumption demand, and get China out of current deflationary environment.

    Seth Carpenter: Got it. Ellen, Chetan, Jens, thank you each for joining us today. And to the listener, thank you for listening. If you enjoy the show, please leave us a review wherever you listen to the show and share thoughts on the market with a friend or a colleague today.

  • Our Freight Transportation & Airlines Analyst unboxes the latest trends around parcel transit times and systems in the U.S. and their impact on the future of e-commerce supply chains.

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    Welcome to Thoughts on the Market. I’m Ravi Shanker, Morgan Stanley’s Freight Transportation analyst. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss what’s happening in the eCommerce parcel delivery space. 

    It’s Wednesday, March 13, at 10 AM in New York.

    Most people love the convenience of online shopping. You click, you pay. Next thing you know, your doorbell rings. Turns out, we’ve become so used to this kind of instant gratification that many customers now abandon an online cart – if the delivery process takes too long. 

    eCommerce parcel delivery companies are taking notice of consumers' growing impatience and are putting a lot of effort into making parcel transit shorter, faster and tighter. A couple of factors drive this trend. First, we have the retailers’ desire to store inventory at more locations; closer to the end-consumer versus the centralized, nationalized distribution centers of the old model. Second, connecting those inventory locations quickly, easily and cheaply by truck rather than long-haul transportation modes like air or rail. As a result, companies can offer consumers one-day or same-day delivery in a highly cost-effective manner.

    This means a shift from long-distance transit via air towards ground transportation – be it express or non-express ground. Such a transition could be a drag on margins at major parcel companies. These players are fully aware of the risk; and they’re making their own structural changes and downsizing their air business. However, even as big parcel companies are trying to keep up with the times and evolving consumer pressures, the transition from long-haul air to short-haul truck makes parcel delivery a less complex operation to run – and that may attract more competitors over time.

    Another factor at play is the continued popularity of curbside pickup, also known as Click And Collect or even delivery from the store – these are options that became ubiquitous during the pandemic. Even post-pandemic, major retailers have been attempting to move inventory closer to customers and lowering the cost to ship to homes by treating their physical brick and mortar stores as last-mile fulfillment options.

    As inventories have been getting leaner over the last few quarters, Click & Collect, Ship from Store, and other similar services have seen their popularity rise. Indeed, several retailers have expanded their physical footprint to accommodate these options. Or they have leveraged their current stores to offer more of these capabilities.

    We think this could have a significant impact on eCommerce supply chains for incumbent parcel companies. In the current long-distance eCommerce supply chain model, the long-haul middle-mile portion accounts for the bulk of the profitability for a parcel carrier. By substituting that middle-mile parcel move with regular inventory channel fill, parcel companies could be effectively excluded from the process, in our view. Given their entrenched long-haul networks, it could be difficult for the parcel companies to be consistently profitable doing last-mile deliveries alone. Instead, this last mile delivery market could go to delivery companies, regional delivery providers, or even in-house delivery solutions.

    This is a rapidly evolving landscape, and we’ll continue to keep you updated on major new developments.

    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.

  • Our roundtable of experts recaps highlights from the 2024 Morgan Stanley Technology, Media & Telecom Conference, including AI innovation, trends in live entertainment and the need for operational efficiency.

     

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    Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley Research's US thematic strategist. I'm joined by Ben Swinburne, who leads coverage of the media and entertainment, advertising, and cable and satellite industries, and Kieran Kenny, who covers internet. Along with my colleagues, bringing you a variety of perspectives, today we'll discuss some key themes from Morgan Stanley's recently concluded Technology, Media, and Telecom Conference in San Francisco.

    It's Tuesday, March 12th, at 10am in New York.

    Ben, Kieran, we have to lead off on AI. It was a tech conference. As we've written about in the past, most companies want to either be AI enablers or AI adopters. And we believe that 2024 will be the year of the adopters. We scraped transcripts of the presentations at the conference and found that AI was mentioned 155 times.

    There was a particular focus on Generative AI or Gen AI. And one of the means of adopting AI that was repeatedly mentioned was using chatbots for customer service. And chatbots can easily handle commonly asked questions without needing a customer service person to speak live. Kieran, can we start by talking about some of the most interesting ways companies and internet are adopting AI?

    Kieran Kenny: So, there's a wide range of use cases so far. What we're seeing more recently is growing adoption for, to your point, AI assistance for customer support types of use cases. We're also seeing increased adoption from advertisers; for generative AI, for image and text creation for advertisements. And in the video game space, we're also seeing demand for generative AI based content creation tools -- to give you a sense of some of the use cases. The most common use case, though, is adoption of generative AI coding assistant tools, which we're seeing that pretty pervasively across the internet space.

    Michelle Weaver: Great. And I know you've done a bunch of work around AI. What are some of the areas you think we'll see the quickest AI driven efficiency gains?

    Kieran Kenny: I think most likely you'll see the efficiency gains come first in the code assistant use cases. That when we go through and scan company disclosures for efficiency gains related to generative AI and look through some of the empirical studies -- code assistant tools tend to show the most consistent productivity gains in the 20 to 50 per cent range. And because R&D expenses are such a large percent of revenue for internet. It's on average 25 percent. There's a really strong incentive for companies to adopt those tools to drive productivity amongst their software engineers. So, we think that's the area you're likely going to see the benefits first.

    Michelle Weaver: Great. Thanks, Kieran. Ben, what do you think some of the most interesting ways companies in your coverage are leveraging AI?

    Benjamin Swinburne: I would echo some of the points that Kieran made, particularly around content creation and dealing with customers.

    You know, in the content creation area, we're seeing AI leveraged in creative services. So, creating content for marketing purposes is an area we're seeing the ad agencies look for opportunities. In the audio industry, we've seen AI used to more efficiently and more effectively translate podcasts and audio books to different languages, which can be then distributed around the world.

    One leading streaming audio company has an AI DJ that they used to drive recommendations for listeners. And on the customer front, we're seeing a lot of companies in the cable industry, basically distribute AI tools into their call centers and into their network diagnostics -- so they can predict where network failures may happen before they happen. Or help call center agents better help customers with issues more effectively using, you know, AI and big data.

    Michelle Weaver: Great. Super interesting. I'm sure that's just the tip of the iceberg, too, in terms of what we'll see with AI adoption. Ben, I also noticed that there was a lot of discussion from media companies around live events and whether that's high demand for concert tickets, streaming services offering live events, or demand for theme parks. Can you tell us a little bit about consumer experiences in the media space?

    Benjamin Swinburne: Yeah, absolutely. I mean, we believe that there are secular drivers of consumer spending towards experiences, for a variety of reasons. And we're seeing that happen; show up in the results and outlook for a number of companies in our coverage. We had some really positive commentary from a number of companies in the theme park space around current trends, which are pacing better than expected from the conference. We've seen leading streaming companies increase their investment in live content, particularly live sports, which is uniquely powerful and driving customer acquisition and attracting advertising dollars.

    And probably no place is consumer spending continuing to grow and grow off record levels as quickly as they are in concerts. Where we really see -- while it's a minority of the population that drives the concert industry. Our survey work and what we heard at the conference last week is that consumers value that live communal experience more than ever. And we're seeing that show up in financial results.

    Michelle Weaver: The last theme I want to talk about is operational efficiency and profitable growth. Our research has shown that companies that demonstrate high operational efficiency have outperformed on a relative basis over the past two years; and operational efficiency and cost cutting came up repeatedly and fireside conversations with the phrase ‘do more with less’ being used quite a few times. And it was clear that at the conference companies are very aware of the importance of being the best operators, given the expectations for more tepid economic growth in 2024.

    Kieran, what did you hear about profitable growth or the importance of efficiency within internet?

    Kieran Kenny: For many of our companies, including one of the largest social media slash advertising companies in the space, 2023 was very much a year of efficiency. But that focus is persisting through 2024 and is likely to continue going forward. So, I think a lot of companies are pointing to that one social media company as the North Star of their ability to operate with a leaner cost structure, to be more disciplined in their investments. And ultimately do that in a way where hopefully it can reaccelerate revenue growth and not be detrimental to revenue growth. So, efficiency and AI, well they go hand in hand. Both of those are two of the biggest focus areas for internet companies broadly.

    Michelle Weaver: Ben, same question for you. What did you hear about the importance of efficiency in the media world?

    Benjamin Swinburne: Yeah, we’re seeing focus on efficiency, both in sort of an offensive and a defensive posture. I mean, there are companies who are seeing accelerating revenue growth, demonstrating real pricing power in their business who are also reducing headcount and focusing on operating leverage. So, there's no question that efficiency, particularly in the technology industries, has probably never been a bigger focus than it is right now.

    We're also seeing companies that are heavily driven by -- you know, service companies driven by labor costs looking at offshoring. That's a big theme in our space. Probably more on the defensive side, companies facing real secular challenges on the revenue front are looking for efficiencies, particularly around content spending. That typically shows up in a shift to more unscripted content, which is less expensive or producing more content offshore with lower cost of production.

    Michelle Weaver: Ben, Kieran, thank you for taking the time to talk. And 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.

  • Matt Cost of the firm’s U.S. Internet team shares his key takeaways from the 2024 Morgan Stanley Technology, Media & Telecom Conference, including the online ad market’s rebound and the future of property tech.  

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    Welcome to Thoughts on the Market. I’m Matt Cost, from the Morgan Stanley US Internet team.

    Along with my colleagues bringing you a variety of perspectives, today I’ll talk about some key trends that emerged in conversations with internet companies at Morgan Stanley’s 2024 Technology Media and Telecom Conference in San Francisco.

    It’s Monday, Mar 11th at 8am in New York.

    So, we had a busy four days at the conference last week. It was our biggest gathering yet for what’s really the marquee TMT event of the year. And we brought together companies and investors from all over the world for keynotes and meetings and a lot of moments in between to connect with industry insiders about the latest trends in their space.

    I want to start with talking about AI. It was a big topic for almost every company we saw. But I’d say that for me, the video game companies stood out the most. Some C-suite executives that we spoke to talked about how their companies could become up to 30 per cent more efficient, as they leverage new AI tools to build and operate their games. But they also talked about the need to reinvest those efficiencies to make sure their products are the biggest, the best, and the most competitive they can be.

    This is against a video game market backdrop that remains more mixed though we did hear about some green shoots in mobile games; since there are a number of newly launched games there that are getting good traction – which is actually something we haven’t seen in a few years at this point. On the M&A front, after a wave of game industry consolidation we’ve seen over the past few years, we did hear companies acknowledge that scale matters more than ever – if you want to compete in this space.

    When it comes to the advertising companies, it’s clear that we’ve seen a marked improvement in the health of the online ad markets since October and November of [20]23, but there are still pockets of strength and weakness, particularly for smaller players where competition is the most intense.

    We’re also seeing a major focus on privacy, which has been a long-term trend in the space. But in the near term, the industry does expect browser cookies to go away later this year. And investors are trying to decide who that might hurt – and in some cases who it might potentially help. And when it comes to AI in the ad space, we’ve heard a mostly positive story about the potential for more personalized and better targeted ads in the future.

    Finally on the property tech side. Despite the fact that the residential real estate market is still pretty subdued in the US, many players in the space feel that two years into higher mortgage rates, they have leaner business models that set them up well to benefit when the market does come back. We also heard greater confidence from companies that they don’t expect to see major disruption from the ongoing legal disputes around real estate broker commissions. But that does remain one of the uncertainties in the space that investors are the most focused on into 2024 and beyond.

    For more on the Morgan Stanley TMT conference, check out the episode tomorrow, where my colleagues will dive deeper into thematic takeaways from this year's event.

    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.

  • Our Head of Corporate Credit Research cites near-term and long-term factors indicating that investors should expect a major boost in merger and acquisition activity.

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    Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.

    It's Friday, March 8th at 2:00pm in London.

    Usually, company activity follows the broader trends in markets. But last year, it diverged. 2023 was generally a strong year for economic growth and the stock market. But Mergers and Acquisition activity was anemic. By our count, global M&A activity in 2023, adjusted for the size of the economy, was the lowest in 30 years. 

    We think that’s going to change. There are both near-term and longer-term reasons why we think the buying and selling of companies can pick up. We think we’re going to see the return of M&A.

    Near term, we think corporate confidence, which is essential to any large transaction, is improving. While stocks and the economy were ultimately strong last year, a lot of 2023 was still dominated by fears of rising yields, elevated inflation and persistent expectations of recession. Recall that as recently as October of 2023, the median stock in the S&P 500 was actually down about 5 per cent for the year.

    All of those factors that were hitting corporate confidence, today are looking better. And with Morgan Stanley’s expectation for 2024, and economic soft landing, we think that improvement will continue. But don’t just take our word for it. The companies that traffic directly in M&A were notably more upbeat about their pipelines when they reported earnings in January.

    Incidentally, this is also the message that we get from Morgan Stanley’s industry experts. We recently polled Morgan Stanley Equity Analysts across 150 industry groups around the world. Half of them saw M&A activity increasing in their industry over the next 12 months. Only 6 per cent expected it to decline.

    But there’s also a longer run story here.

    We think we can argue that depressed corporate activity has actually been a multi-year story. If we think about what factors historically explained M&A activity, such as stock market performance, overall valuations, volatility, Central Bank policy, and so on – the activity that we’ve seen over the last three years has undershot what these variables would usually expect by somewhere between $4-11 trillion. We think that speaks to a multi-year hit to corporate confidence and increased uncertainty from COVID and its aftermath; as that confidence returns, some of this gap might be made up.

    And there are other longer-term drivers. We believe Private Equity firms have been sitting on their holdings for an unusually long period of time, putting more pressure on them to do deals and return money to investors. Europe is just starting to emerge from an even longer-drought of activity, while reforms in Japan are encouraging more corporate action. We are positive on both European and Japanese equity markets. 

    And other multi-year secular trends – from rising demand in AI capabilities, to clean energy transition, to innovation in life sciences – should also structurally support more M&A over the next cycle.

    Mergers and Acquisition activity has been unusually low. We think that’s changing, and investors should expect much more of this activity going forward.

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.

  • Morgan Stanley’s Europe Telecom Analyst outlines three factors pointing to a boom, the obstacles to overcome and the associated industries most likely to benefit.

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    Welcome to Thoughts on the Market. I'm Emmet Kelly, head of Morgan Stanley's European Telecom team. Today, I'll be talking about the rise of data centers in Europe.

    The subject of data centers has, until now, largely been confined to the U.S. However, we believe that this is all about to change; and we also think the market significantly underestimates the size and scope of this potential growth in Europe.

    Why do we believe that the European data center market is set for such strong growth? Well, we've identified three reasons.

    The first reason is cloud computing. The primary driver of data center demand today is cloud and digitalization.

    Cloud represents the lion's share of data center growth in Europe on our numbers. Roughly 60 percent of growth by 2035. The second driver is AI. What's interesting is training AI models needs to be done within a single data center, and that's driving demand for large data center campuses across the globe.

    The third driver is data sovereignty. Data sovereignty is becoming increasingly important to both companies and also to consumers. Essentially, consumers want their data to be stored at home, and they want this to be subject to local law. A common parallel I've received is: would you want your bank account to be stored in a different country? The answer is probably no. And therefore, we believe that data will be increasingly near-shored across Europe

    So what's limiting European data center growth today? There are a number of hurdles in place and these bottlenecks include energy, capital, planning permission, and also regulation

    So how do we get around that? Well, having chatted with my colleagues in the utilities and renewables teams, it's been quite clear that Europe needs to invest a lot of money in renewable energy, up to 35 billion euros over the next decade in Europe. This will bring a lot of onshore wind, offshore wind, solar and hydro energy to the market.

    In terms of the big data center markets in Europe, we've identified five big data center markets, commonly referred to as FLAP-D.

    Now this acronym does not roll off the tongue, but it does stand for Frankfurt, London, Amsterdam, Paris, and Dublin. Today, there are constraints in three of those markets, in Ireland, in Frankfurt and also in Amsterdam. We therefore believe that London and Paris should see outsized growth in data centers over the next decade or so.

    We also believe we'll see the emergence of new secondary data center markets.

    So, who stands to benefit from the explosive growth of European data centers? Among the key beneficiaries, we would highlight the picks and shovels. I'm talking about electric engineering, construction. I'm talking capital goods. We've also got the hyperscalers, the large providers of cloud computing and storage services. And then there is the co-locators as well. Beyond this, it's also worth looking at private capital and private equity companies as being positively exposed too.

    Thanks for listening. If you do enjoy the show, please leave us a review on Apple Podcasts and share thoughts on the market with a friend or colleague today.

  • Our Global Head of Fixed Income shares some startling data on decarbonization, the widespread use of AI and longevity.  

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    Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about key secular themes impacting markets.

    It's Wednesday, Mar 6th at 10:30 am in New York.

    We kicked off 2024 by highlighting the three secular themes we think will make the difference between being ahead of or behind the curve in markets – longevity, AI tech diffusion, and decarbonization. 

    How’s it going so far? We’ve got some initial insights and opportunities at the sector level worth sharing, and here they are through the lens of three big numbers.

    The first number is €5 trillion – that’s how much our global economics and European utilities teams estimate will be spent in Europe by 2030 on efforts to decarbonize the energy system. These attempts will boost both growth and inflation, though by how much remains unclear. A more concrete investment takeaway is to focus on the sectors that will be on the receiving end of decarbonization spending: utilities and grid operators.

    The second set of numbers are US$140 billion and US$77 billion – these are our colleagues' total addressable market projections for smart-chemo, over the next 15 years, and obesity treatments, by 2030. In terms of our longevity theme, we see companies increasingly investing in and achieving breakthroughs that can extend life. While the theme will have myriad macro impacts that we’re still exploring, the tangible takeaway here is that there are clear beneficiaries in pharma to pursue.

    The last number we’re focusing on is US$500 billion. That’s the opportunity associated with a fivefold increase in the size of the European data center market out to 2035. That should be driven by the need to ramp up to deal with key tech trends, like Generative AI.

    So, while those numbers drive some pretty clear equity sector takeaways, the macro market implications are somewhat more complicated. For example, on longevity, a common client question is whether health breakthroughs will have a beneficial impact for bond investors by shrinking fiscal deficits. 

    Among US investors, for example, one theory is that breakthroughs in preventative care will reduce Medicare and Medicaid spending. But even if that proved true, we still have to consider potential offsetting effects, such as whether new healthcare costs will arise. After all, if people are living longer, more active lives, they might need more of other types of healthcare, like orthopedic treatments. 

    Simply put, the macro market impacts are complicated, but critical to understand. We remain on the case. In the meantime, there’s clearer opportunities from our big themes in utilities, pharma, and other key sectors.

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.

  • With tax season underway, our U.S. economist explains what the average refund will look like and how people are likely to spend it.

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    Welcome to Thoughts on the Market. I’m Sarah Wolfe, from the Morgan Stanley US Economics Team. Along with my colleagues bringing you a variety of perspectives, today I’ll talk about the US federal tax refunds season. It’s March 5, at 10 AM in New York. 

    The IRS began accepting tax returns for the 2023 tax year on January 29, 2024. This is about a week later than when they started accepting tax returns in 2023. As a result, the number of refunds and the total amount of refunds issued by the end of February is about 12 per cent below where they were at the same time last year. However, if we look at the average refund amount that households are getting in the third and fourth week of the tax refund season, they are about in line with the prior year. 

    As such, we expect that total refunds will ramp up to an average amount similar to last year; so that’s about $3100 per person. While data show that refunds can fluctuate notably on a weekly and daily basis, total tax refunds through the end of February ran about in line compared to the same period over the past five years. Let’s remember though that they’re not going to be as high as 2022 when refunds were much larger due to COVID-related stimulus programs. So, we can compare it to the past five years apart from 2022.

    February through April remains the period where most tax refunds are received and spent, with the greatest impact on consumer spending in March. Our own AlphaWise survey of household intentions around the refunds reveals that households typically spend about a third of their refunds on everyday purchases – such as grocery, gas, apparel. Another third goes toward paying off debt, and the remaining third into savings. 

    Last year, higher inflation pushed more households to use their refunds on everyday purchases. This year, it is likely that everyday purchases will remain a top priority, but we do think that more refunds will go in towards paying off debt than last year. There’s a couple of reasons why we think this. First, there was an expiration of the student loan moratorium at the end of 2023. This is affecting millions of student loan borrowers and putting more pressure on their debt service obligations. And then we’re also seeing rising credit card and consumer loan delinquencies, which reveal pressure to pay down debt. If we look at spending intentions by income group, upper income households are more likely to save any tax refund they may get or spend it on home improvement and vacations. So, a bit more on the discretionary side.

    When we think about tax liabilities instead of refunds, anomalous factors make this year’s tax season a poor comparison to last year – because last year several states got an extended deadline due to natural disasters. A delayed Tax Day largely impacts filers who have a tax liability or a complicated financial situation and prefer to file later. This has larger implications for the fiscal deficit since delayed tax remittances caused a larger deficit in the third quarter of 2023, and then it narrowed in the fourth quarter when remittances came in. But in terms of refunds and consumer spending, filers who expect refunds tend to file early and on time. An extension of the deadline has very little impact on this group of consumers.

    All in all, based on early data, we think that total tax refunds this year will be similar to last year, though higher than pre-COVID years due to inflation. Barring factors that can lead to a significant shift of the filing deadline, we should see a more normal timeline for tax remittances, but it is still important to track closely how the tax season evolves.

    Thank you for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

  • The U.S. stock market is rising to new highs, but investors should still try to minimize risk in their portfolios. Our analysts list a few key strategies to navigate this dynamic.

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    Stephan Kessler: Welcome to Thoughts on the Market. I'm Stefan Kessler, Morgan Stanley's Global Head of Quantitative Investment Strategies Research, QIS Research in short.

    Aris Tentes: And I am Aris Tentes, also from the QIS research team.

    Stephan Kessler: Along with our colleagues bringing you a variety of perspectives, today we'll discuss different strategies to hedge equity portfolios.

    It's Monday, the 4th of March at 10am in London.

    The US equity market has been climbing to record levels, and it seems that long only investors -- and especially investors with long time horizons -- are inclined to keep their positions. But even in the current market environment, it still makes sense to take some risk off the table. With this in mind, we took a closer look at some of the potential hedging strategies for high conviction calls with a quantitative lens. Long only portfolios of high conviction names of opportunities for excess returns, or alpha; but also of exposures to broad market risk, or beta, embedded in these names.

    While investors are keen to access the idiosyncratic excess return in individual stocks, they often overlook the systematic market and risk factors that come with owning stocks. Rather than treating these risks as uncontrolled noise, it makes sense to think about hedging such risks.

    Aris, let me pass over to you for some popular approaches to hedging such risk exposures.

    Aris Tentes: Yes, thank you, Stefan.

    Today, investors can use a range of approaches to remove systematic risk exposures. The first one, and maybe the most established approach, is to hedge out broad market risks by shorting equity index futures. Now, this has the benefit of being a low-cost implementation due to the high liquidity of a futures contract.

    Second, a more refined approach, is to hedge risks by focusing on specific characteristics of these stocks, or so-called factors, such as market capitalization, growth, or value. Now this strategy is a way to hedge a specific risk driver without affecting the other characteristics of the portfolio. However, a downside of both approaches is that the hedges might interfere with the long alpha names, some of which might end up being effectively shorted.

    Stephan Kessler: Okay, so, so these are two interesting approaches. Now you mentioned that there is a potential challenge in which shorting out specific parts of the portfolio and removing risks, we effectively end up shorting individual equities. Can you tell us some approaches which can be used to overcome this issue?

    Aris Tentes: Oh, yes. Actually, we suggest an approach based on quantitative tools, which may be the most refined way of overcoming the issues with the other approaches I talked about. Now, this one can hedge risk without interfering with the long alpha positions. And another benefit is that it provides the flexibility of customization.

    Stephan Kessler: Aris, maybe it's worth actually mentioning why better hedges are important.

    Aris Tentes: So actually, better hedges can make the portfolio more resilient to factor and sector rotations. With optimized hedges, a one percentile style or sector rotation shock leads to only minor losses of no more than a tenth of a percentage point. As a result, risk adjusted returns increase noticeably.

    Stephan Kessler: That makes sense. Overall, hedging with factor portfolios gives the most balanced results for diversified, high conviction portfolios. One exception would be portfolios with a small number of names, where the universe remaining for the optimized hedge portfolio is broad enough to construct a robust hedge. This can lead to returns that are stronger than for the other approaches.

    However, if the portfolio has many names, the task becomes harder and the factor hedging approach becomes the most attractive way to hedge. Having discussed the benefits of factor hedging, I think we also should talk about the implementation side. Shorting outright futures to remove market beta is rather straightforward. However, it leaves many other sectors and factor risks uncontrolled. To remove such risks, pure factor portfolios are readily available in the marketplace.

    Investors can buy or sell those pure factor portfolios to remove or target factor and sector risk exposures as they deem adequate. Pure factor portfolios are constructed in a way that investment in them does not affect other factor or

    sector exposures. Hence, we refer to them as “pure.” Running a tailored hedge rather than using factor hedging building blocks can be beneficial in some situations -- but comes, of course, at a substantially increased complexity.

    Those are some key considerations we have around performance enhancement through thoughtful hedging approaches.

    Aris, thank you so much for helping outline these ideas with me.

    Aris Tentes: Great speaking with you, Stefan.

    Stephan Kessler: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

  • Our head of Corporate Credit Research explains why the Purchasing Manager’s Index is a key indicator for investors to get a read on the economic outlook.

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    Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.

    It's Friday, March 1st at 2pm in London.

    A perennial problem investors face is the tendency of markets to lead the economic data. We’re always on the lookout for indicators that can be more useful, and especially more useful at identifying turning points. 

    And so today, I want to give special attention to one of our favorite economic indicators for doing this: the Purchasing Manager Indices, or PMIs. And how they help with the challenge that economic data can sometimes give us.

    PMIs works by surveying individuals working in the manufacturing and services sector – and asking them how they’re viewing current conditions across a variety of metrics: how much are they producing? How many orders are they seeing? Are prices going up or down? These sorts of surveys have been around for a while: the Institute of Supply Management has been running the most famous version of the manufacturing PMI since 1948.

    But these PMIs have some intriguing properties that are especially helpful for investors looking to get an edge on the economic outlook.

    First, the nature of manufacturing makes the sector cyclical and more sensitive to subtle turns of the economy. If we’re looking for something at the leading edge of the broader economic outlook, manufacturing PMI may just be that thing. And that’s a property that we think still applies -- even as manufacturing over time has become a much smaller part of the overall economic pie. 

    Second, the nature of the PMI survey and how it’s conducted – which asks questions whether conditions are improving or deteriorating – helps address that all important rate of change. In other words, PMIs can help give us insight into the overall strength of manufacturing activity, whether that activity is improving or deteriorating, and whether that improvement or deterioration is accelerating. For anyone getting flashbacks to calculus, yes, it potentially can show us both a first and a second derivative.

    Why should investors care so much about PMIs?

    For markets, historically, Manufacturing PMIs tend to be most supportive for credit when they have been recently weak but starting to improve. Our explanation for this is that recent weakness often means there is still some economic uncertainty out there; and investors aren’t as positive as they otherwise could be. And then improving means the conditions likely are headed to a better place. In both the US and Europe, currently, Manufacturings are in this “recently weak, but improving” regime – an otherwise supported backdrop for credit.

    If you’re wondering why I’m mentioning PMI now – the latest readings of PMI were released today; they tend to be released on the 1st of each month. In the Eurozone, they suggest activity remains weak-but-improving, and they were a little bit better than expected. In the US, recent data was weaker than expected, although still showing a trend of improvement since last summer.

    PMIs are one of many data points investors may be considering. But in Credit, where turning points are especially important, it’s one of our favorites. 

    Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you. 

  • Our Global Macro Strategist explains the complex nature of recent U.S. economic reports, and which figures should matter most to investors.

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    Welcome to Thoughts on the Market. I’m Matthew Hornbach, Morgan Stanley’s Global Head of Macro Strategy. Along with my colleagues bringing you a variety of perspectives, today I'll talk about what investors should take away from recent economic data. 

    It's Thursday, February 29, at 4pm in New York.

    There’s been a string of confusing US inflation reports recently, and macro markets have reacted with vigor to the significant upside surprises in the data. Before these inflation reports, our economists thought that January Personal Consumption Expenditures inflation, or PCE inflation, would come at 0.23 per cent for the month. 

    On the back of the Consumer Price Index inflation report for January, our economists increased their PCE inflation forecast to 0.29 per cent month-over-month. Then after the Producers’ Price Index, or PPI inflation report, they revised that forecast even higher – to 0.43 per cent month-over-month. Today, core PCE inflation actually printed at 0.42 per cent - very close to our economists’ revised forecast.

    That means the economy produced nearly twice as much inflation in January as our economists thought it would originally. The January CPI and PPI inflation reports seem to suggest that while inflation is off the record peaks it had reached, the path down is not going to be smooth and easy. 

    Now, the question is: How much weight should investors put on this data? The answer depends on how much weight Federal Open Market Committee participants place on it. After all, the way in which FOMC participants reacted to activity data in the third quarter of 2023 – which was to hold rates steady despite encouraging inflation data – sent US Treasury yields sharply higher.

    Sometimes data is irrational. So we would take the recent inflation data with a grain of salt. Let me give you an example of the divergence in recent data that’s just that – an outlying number that investors should treat with some skepticism. 

    The Bureau of Labor Statistics, or BLS, calculates two measures of rent for the CPI index: Owner’s equivalent rent, or OER, and rents for primary residences. Both measures use very similar underlying rent data. But the BLS weights different aspects of that rent data differently for OER than for rents.

    OER increased by 0.56 per cent month-over-month in January, while primary residence rents increased 0.36 per cent month-over-month. This is extremely rare. If the BLS were to release the inflation data every day of the year, this type of discrepancy would occur only twice in a lifetime – or every 43 years.

    The confusing nature of recent economic data suggests to us that investors should interpret the data as the Fed would. Our economists don't think that recent data changed the views of FOMC participants and they still expect a first rate cut at the June FOMC meeting. 

    All in all, we suggest that investors move to a neutral stance on the US treasury market while the irrationality of the data passes by.

    Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.