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Thoughts on the Market

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Short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

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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.----- Transcript -----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. 
Rate Cut Uncertainty

Rate Cut Uncertainty

2024-03-1503:22

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.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I’ll be talking about 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.----- Transcript -----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. An
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.----- Transcript -----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.
Where AI Is Advancing

Where AI Is Advancing

2024-03-1207:32

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. ----- Transcript -----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.
AI, Scale and Privacy

AI, Scale and Privacy

2024-03-1103:11

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.  ----- Transcript -----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.
M&A Rebound Ahead?

M&A Rebound Ahead?

2024-03-0803:36

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.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.It's Friday, 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.---- Transcript -----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 EuropeSo 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 regulationSo 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.  ----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about 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.----- Transcript -----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.----- Transcript -----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 orsector 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.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.It's Friday, 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.----- Transcript -----Welcome to Thoughts on the Market. I’m Matthew Hornbach, Morgan Stanley’s Global Head of Macro Strategy. Along with my colleagues bringing you a variety of perspectives, today I'll talk about what investors should take away from recent economic data. It's Thursday, February 29, at 4pm in New York.There’s been a string of confusing US inflation reports recently, and macro markets have reacted with vigor to the significant upside surprises in the data. Before these inflation reports, our economists thought that January Personal Consumption Expenditures inflation, or PCE inflation, would come at 0.23 per cent for the month. On the back of the Consumer Price Index inflation report for January, our economists increased their PCE inflation forecast to 0.29 per cent month-over-month. Then after the Producers’ Price Index, or PPI inflation report, they revised that forecast even higher – to 0.43 per cent month-over-month. Today, core PCE inflation actually printed at 0.42 per cent - very close to our economists’ revised forecast.That means the economy produced nearly twice as much inflation in January as our economists thought it would originally. The January CPI and PPI inflation reports seem to suggest that while inflation is off the record peaks it had reached, the path down is not going to be smooth and easy. Now, the question is: How much weight should investors put on this data? The answer depends on how much weight Federal Open Market Committee participants place on it. After all, the way in which FOMC participants reacted to activity data in the third quarter of 2023 – which was to hold rates steady despite encouraging inflation data – sent US Treasury yields sharply higher.Sometimes data is irrational. So we would take the recent inflation data with a grain of salt. Let me give you an example of the divergence in recent data that’s just that – an outlying number that investors should treat with some skepticism. The Bureau of Labor Statistics, or BLS, calculates two measures of rent for the CPI index: Owner’s equivalent rent, or OER, and rents for primary residences. Both measures use very similar underlying rent data. But the BLS weights different aspects of that rent data differently for OER than for rents.OER increased by 0.56 per cent month-over-month in January, while primary residence rents increased 0.36 per cent month-over-month. This is extremely rare. If the BLS were to release the inflation data every day of the year, this type of discrepancy would occur only twice in a lifetime – or every 43 years.The confusing nature of recent economic data suggests to us that investors should interpret the data as the Fed would. Our economists don't think that recent data changed the views of FOMC participants and they still expect a first rate cut at the June FOMC meeting. All in all, we suggest that investors move to a neutral stance on the US treasury market while the irrationality of the data passes by.Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.
As the deadline to fund the government rapidly approaches, Michael Zezas explains what economic effect a possible shutdown could have and whether investors should be concerned. ----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the market impacts of a potential US government shutdown.It's Wednesday, February 28th at 2pm in New York.Here we go again. The big effort in Washington D.C. this week is about avoiding a government shutdown. The deadline to pass funding bills to avoid this outcome is this weekend. And while many investors tell us they’re fatigued thinking about this issue, others still see the headlines and understandably have concerns about what this could mean for financial markets. Here’s our quick take on it, specifically why investors need not view this as a markets’ catalyst. At least not yet.In the short term, a shutdown is not a major economic catalyst. Our economists have previously estimated that a shutdown shaves only about .05 percentage points off GDP growth per week, and the current shutdown risk would only affect a part of the government. So, it's difficult to say that this shutdown would mean a heck of a lot for the US growth trajectory or perhaps put the Fed on a more dovish path – boosting performance of bonds relative to stocks. A longer-term shutdown could have that kind of impact as the effects of less government money being spent and government employees missing paychecks can compound over time. But shutdowns beyond a few days are uncommon.Another important distinction for investors is that a government shutdown is not the same as failing to raise the debt ceiling. So, it doesn’t create risk of missed payments on Treasuries. On the latter, the government is legally constrained as to raising money to pay its bills. But in the case of a shutdown, the government can still issue bonds to raise money and repay debt, it just has limited authority to spend money on typical government services. So then should investors just simply shrug and move on with their business if the government shuts down? Well, it's not quite that simple. The frequency of shutdown risks in recent years underscores the challenge of political polarization in the U.S. That theme continues to drive some important takeaways for investors, particularly when it comes to the upcoming US election. In short, unless one party takes control of both Congress and the White House, there’s little domestic policy change on the horizon that directly impacts investors. But one party taking control can put some meaningful policies into play. For example, a Republican sweep increases the chances of repealing the inflation reduction act – a challenge to the clean tech sector. It also increases the chances of extending tax cuts, which could benefit small caps and domestic-focused sectors. And it also increases the chances of foreign policies that might interfere with current trends in global trade through the levying of tariffs and rethinking geopolitical alliances. That in turn creates incentive for on and near-shoring…an incremental cost challenge to multinationals.So, we’ll keep watching and keep you in the loop if our thinking changes.  Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.
As grocery and dining costs continue to increase, our analysts break down how this has affected consumers and when food prices may stabilize.----- Transcript -----Sarah Wolfe: Welcome to Thoughts on the Market. I'm Sarah Wolfe from the US economics team.Simeon Gutman: And I'm Simeon Gutman; Hardlines, Broadlines, and Food Retail Analyst.Sarah Wolfe: Today on the podcast, we'll discuss what's happening with food prices and how that's affecting the US consumer. It's Tuesday, February 27th at 10am in New York.It was almost exactly a year ago when I came on this podcast to talk about why eggs cost so much at the start of 2023. Here we are. It's a year later and food in the US still costs more. The overall inflation basket and personal consumption expenditures inflation was 2.6 per cent year over year in December; but dining out prices are still up 5.2 per cent. I'd like to admit that grocery prices are a little bit better. They're just a tad over 1 per cent. So we've seen a little bit more disinflation there. But overall food is still up and it's still expensive.Simeon, can you give us a little bit more color on what's actually going on here?Simeon Gutman: Yeah, so food prices measured by the CPI, as you mentioned, up about a per cent. The good news, Sarah, is that your eggs are actually deflating by about 30 per cent at the moment; so maybe you can buy a couple more eggs. But in general, we're following this descent that we started -- about almost two years ago where food prices were up double digits. A year ago, we were up mid single digits. And now we're down to this one per cent level. Looks like they're gonna hold. But so prices are coming in; but not necessarily deflating, but dis-inflating.Sarah Wolfe: Can you help me understand that a little bit better? You mentioned that some commodity prices are coming down, like food prices. So why is overall inflation for food still rising? And dining out, grocery stores, both of them are still seeing price increases.Simeon Gutman: Well, commodity prices, which is the most visible input to a lot of food items -- that's coming down in a lot of cases, and I'll mention some that haven't. But there's many other components into food pricing, besides the pure commodity. That's labor; you have freight; you have transportation. Those costs -- there's still some inflation running through the system -- and those costs make up a decent chunk of the total product costs. And that's why we're still seeing prices higher year over year on average for the entire group of products.Sarah Wolfe: How are grocery sales actually performing though? Are we seeing demand destruction from the higher pricing? Or has unit growth actually been holding up well?Simeon Gutman: First of all, total grocery sales are just slightly negative. We saw a little ray of hope in January, positive for the month; but likely driven by some stocking up ahead of weather events that happened in the country. So we were barely positive. It looked like we were getting out of the negative territory; but the first few weeks of February, we're back into the negative territory. Negative one, negative two per cent.Units are negative. Negative three to four per cent. If we look at CPI as sort of a proxy for the product categories that are doing better than others: dairy and fruit units, those are up mid to high single digits. And as I mentioned, we're seeing egg prices down significantly. We're also seeing a lot of deflation with fish and seafood as well as meat.So, and if you use that as a way to think about the various product categories that consumers are demanding, but overall industry sales are flat to slightly negative; and we think this negative cadence continues going forward.Sarah, let me turn it to you. You monitor the U. S. consumer closely. How big a bite of the US wallet is food right now? Groceries, eating out at restaurants, etc., and how does that compare to prior periods?Sarah Wolfe: Let's start high level with essential spending, which I consider to be groceries, energy and shelter. That typically averages about 40 per cent of household disposable income pre-COVID. And now if you add on all the price increases we've seen across all three categories, it's an additional 5 per cent of disposable income today.And this matters a lot when you're a lower income household and already over 90 per cent of your disposable income was going towards these essential categories pre-COVID. If I look at grocery prices alone, they're up 20 per cent on average since the start of the pandemic. And prior to COVID on a per household basis, they were spending $4,600 a year on groceries. And now that's $5,700 a year. More than a thousand dollars more each year on groceries.The last time we saw such extreme food inflation was the 1980s. Granted, I have to mention that we've also seen a really notable rise in disposable income too. So if you look at grocery spending as a share of disposable income, it's only marginally higher than it was pre-COVID. It was six and a half per cent, now it's seven per cent.What's really driving higher wallet share towards food is this dining out category -- and it's a price and unit story. On the pricing side, we have high labor costs, high food prices still. And on the unit side, there's still a much more notable preference to dine out to enjoy services.And so you mentioned that unit growth has been a lot weaker for groceries. That's not what we're seeing in the dining out space. And overall, it's been driving total food spend as a share of disposable income to high since the early 1990s.Simeon Gutman: So food spending is up a lot. But the situation is somewhat confusing. You have US inflation data and forecasts seem to be suggesting that food prices should be coming down. That doesn't seem to be happening. We're still looking for inflation. Can you talk about the macro factors behind these persistently high food prices?Sarah Wolfe: So as you mentioned, we have seen disinflation, right? So grocery prices are down from 12 per cent year over year in the summer of 2022 to about 1.5 per cent today. Dining out is down from 8 per cent to about 5 per cent. So there's a bit of progress on inflation growth. But price levels are not coming down. They're still rising and that definitely does not feel good to households.The reason we're still seeing a rise in prices, as you've mentioned, are supply chain disruptions, there was an avian flu, and we see very high labor costs. Some of the forward-looking indicators are pointing to more progress on inflation for food, so we know that labor costs are starting to moderate as supply demand imbalances in the labor market are getting a bit better. We know that supply chain disruptions have been unwinding. But all these things together are not pointing to price deflation. Only disinflation. So growth, but at a slower pace.Simeon Gutman: Yeah, so some of this backdrop continues. When can the US consumer expect some kind of relief, and then what data and indicators are you watching closely?Sarah Wolfe: Unfortunately, prices are still going up in our forecast, but they're going to stabilize around one to one and a half per cent year over year for grocery. So kind of where we are right now, that's what we expect for the next year and a half or so. But the price levels are going to remain elevated.As I mentioned in the last response. We know we're watching the supply chain indicators to see if commodity prices start to come up again. If freight costs start to come up again because of geopolitical tensions. We're not seeing any notable rise there yet but we're watching it very closely. And we're also watching what happens with the labor market. Do we continue to see slack in the labor market that'll bring down wages and bring down labor costs? Or do we continue to run a very tight labor market.Simeon, thanks for taking the time to talk.Simeon Gutman: Great speaking with you, Sarah.Sarah Wolfe: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple podcasts and share the podcast with a friend or colleague today.
Our Chief U.S. Equity Strategist reviews how the unusual mix of loose fiscal policy and tight monetary policy has benefited a small number of companies – and why investors should still look beyond the top five stocks.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the investment implications of the unusual policy mix we face.It's Monday, February 26th at 12pm in New York. So let’s get after it.Four years ago, I wrote a note entitled, The Other 1 Percenters, in which I discussed the ever-growing divide between the haves and have-nots. This divide was not limited to consumers but also included corporates as well. Fast forward to today, and it appears this gap has only gotten wider.Real GDP growth is similar to back then, while nominal GDP growth is about 100 basis points higher due to inflation. Nevertheless, the earnings headwinds are just as strong despite higher nominal GDP – as many companies find it harder to pass along higher costs without damaging volumes. As a result, market performance is historically narrow. With the top five stocks accounting for a much higher percentage of the S&P 500 market cap than they did back in early 2020. In short, the equity market understands that this economy is not that great for the average company or consumer but is working very well for the top 1 per cent.  In my view, the narrowness is also due to a very unusual mix of loose fiscal and tight monetary policy. Since the pandemic, the fiscal support for the economy has run very hot. Despite the fact we are operating in an extremely tight labor market, significant fiscal spending has continued.In many ways, this hefty government spending may be working against the Fed. And could explain why the economy has been slow to respond to generationally aggressive interest rate hikes. Most importantly, the government’s heavy hand appears to be crowding out the private economy and making it difficult for many companies and individuals. Hence the very narrow performance in stocks and the challenges facing the average consumer.  The other policy variable at work is the massive liquidity being provided by various funding facilities – like the reverse repo to pay for these deficits. Since the end of 2022, the reverse repo has fallen by over $2 trillion. It’s another reason that financial conditions have loosened to levels not seen since the federal funds rate was closer to 1 per cent. This funding mechanism is part of the policy mix that may be making it challenging for the Fed’s rate hikes to do their intended work on the labor market and inflation. It may also help explain why the Fed continues to walk back market expectations about the timing of the first cut and perhaps the number of cuts that are likely to continue this year.  Higher interest rates are having a dampening effect on interest-rate-sensitive businesses like housing and autos as well as low to middle income consumers. This is exacerbating the 1 percenter phenomena and helps explain why the market’s performance remains so stratified. For many businesses and consumers, rates remain too high. However, the recent hotter than expected inflation reports suggest the Fed may not be able to deliver the necessary rate cuts for the markets to broaden out – at least until the government curtails its deficits and stops crowding out the private economy. Parenthetically, the funding of fiscal deficits may be called into question by the bond market when the reverse repo runs out later this year. Bottom line: despite investors' desire for the equity market to broaden out, we continue to recommend investors focus on high-quality growth and operational efficiency factors when looking for stocks outside of the top five which appear to be fully priced. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you. 
The valuations of stocks and corporate bonds, which have been driven largely by macroeconomic factors since 2020, are finally starting to reflect companies’ underlying performance. Our Head of Corporate Credit Research explains what that means for active investors.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about trends across the global investment landscape – and how we put those ideas together.It's Friday, February 23rd at 2pm in London.In theory, investing in corporate securities like stocks or corporate bonds should be about, well, the performance of those companies. But since the outbreak of COVID in 2020, financial markets have often felt driven by other, higher powers. The last several years have seen a number of big picture questions in focus: How fast could the economy recover? How much quantitative easing or quantitative tightening would we see? Would high inflation eventually moderate? And, more recently, when would central banks stop hiking rates, and start to cut.All of these are important, big picture questions. But you can see where a self-styled investor may feel a little frustrated. None of those debates, really, concerns the underlying performance of a company, and the factors that might distinguish a good operator from a bad one.If you’ve shared this frustration, we have some good news. While these big-picture debates may still dominate the headlines, underlying performance is starting to tell a different story. We’re seeing an unusual amount of dispersion between individual equities and credits. It is becoming a market of many.We see this in so-called pairwise correlation, or the average correlation between any two stocks in an equity index. Globally, that’s been unusually low relative to the last 15 years. Notably options markets are implying that this remains the case. We see this in credit, where solid overall performance has occurred along-side significant dispersion by sector, maturity, and individual issuer, especially in telecom, media and technology.We see this within equities, where my colleague Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist, notes that the S&P 500 and global stocks more broadly have decoupled from Federal Reserve rate expectations.And we see this in performance. More dispersion between stocks and credit would, in theory, create a better environment for Active Managers, who attempt to pick those winners and losers. And that’s what we’ve seen. Per my colleagues in Morgan Stanley Investment Management, January 2024 was the best month for active management since 2007.The post-COVID period has often felt dominated by large, macro debates. But more recently, things have been changing. Individual securities are diverging from one another, and moving with unusual independence. That creates its own challenges, of course. But it also suggests a market where picking the right names can be rewarded. And we think that will be music to many investors' ears.Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We’d love to hear from you.
As traditional financial institutions tightened their lending standards last year, private credit stepped in to fill some of the gaps. But with rates now falling, public lenders are poised to compete again on the terrain that private credit has transformed.----- Transcript -----Vishy Tirupattur: Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today we’ll have a conversation with Joyce Jiang, our US leveraged finance strategist, on the topic of private credit.It's Thursday, February 22nd at noon in New York.Joyce, thank you for joining. Private credit is all over the news. Let’s first understand – what is private credit. Can you define it for us?Joyce Jiang: There isn't a consensus on the definition of private credit. But broadly speaking, private credit is a form of lending extended by non-bank lenders. It's negotiated privately on a bilateral basis or with a small number of lenders, bypassing the syndication process which is standard with public credit.This is a rather broad definition and various types of debt can fall under this umbrella term; such as infrastructure, real estate, or asset-backed financing. But what's most relevant to leveraged finance – is direct lending loans to corporate borrowers.Private credit lenders typically hold deals until maturity, and these loans aren't traded in the secondary market. So, funding costs in private credit tend to be higher as investors need to be compensated for the illiquidity risk. For example, between 2017 and now, the average spread premium of direct lending loans is 250 basis points higher compared to single B public loans.Vishy Tirupattur: That’s very helpful Joyce. The size of the private credit market has indeed attracted significant attention due to its rapid growth. You often see estimates in the media of [the] size being around $1.5 to $1.7 trillion. Some market participants expect the market to reach $2.7 trillion by 2027. Joyce, is this how we should think about the market? Especially in the context of public corporate credit market?Joyce Jiang: I've seen these numbers as well. But to be clear, they reflect assets under management of global private debt funds. So not directly comparable to the market size of high yield bonds or broadly syndicated loans.In our estimate, the total outstanding amount of US direct lending loans is in the range of $630-710 billion. So, we see the direct lending space as roughly half the size of the high yield bonds or broadly syndicated loan markets in the US.Vishy Tirupattur: Understood. Can you provide some color on the nature of private credit borrowers and their credit quality in the private credit space?Joyce Jiang: Traditionally, private credit targets small and medium-sized companies that do not have access to the public credit market. Their EBITDA is typically one-tenth the size of the companies with broadly syndicated loans. However, this is not representative of every direct lending fund because some funds may focus on upper middle-market companies, while others target smaller entities.Based on the data that’s available to us, total leverage and EBITDA coverage in private credit are comparable to a single B to CCC profile in the public space. Additionally, factors such as smaller size, less diversified business profiles, and limited funding access may also weigh on credit quality.Given this lower quality skew and smaller size, there have been concerns around how these companies can navigate the 500 basis point of rate hikes. However, based on available data, two years into the hiking cycle, coverage has deteriorated – mainly due to the floating-rate heavy nature of these capital structures. But on the bright side, leverage generally remained stable. Similar to what we’ve seen in public credit.Now let me turn it around to you, Vishy. What about defaults in private credit and how do they compare to public credit markets?Vishy Tirupattur: So when it comes to defaults, unlike in the public markets, data that cover the entire private credit market is not really there. We have to depend on the experience of sample portfolios from a variety of sources. These data tend to vary a lot, given the differences in defining what a default is and how to calculate default rates, and so on. So, all of this is a little bit tricky. We should also keep in mind that the data we do have on private credit is over the last few years only. So, we should be careful about generalizing too much.That said, based on available data we can say that the private credit defaults have remained broadly in the same range as the public credit. In other words, not substantially higher default rates in the private credit markets compared to the public credit defaults.A few things we should keep in mind as we consider this relatively benign default picture. What contributes to this?First, private credit deals have stronger lender protections. This is in contrast to the broadly syndicated loan market – which is, as you know, predominantly covenant-lite market. Maintenance covenants in private credit can really act as circuit breakers, reining in borrower behavior before things deteriorate a lot. Second, private credit deals usually involve only a very small number of lenders. So it’s easier to negotiate a restructuring or a workout plan. All of this contributes to the default experience we’ve observed in private credit markets.Joyce Jiang: And finally, what are your thoughts on the future of private credit?Vishy Tirupattur: The rapid growth of private credit is really reshaping the landscape of leveraged finance on the whole. Last year, as banks retreated, private credit stepped in and filled the gap – attracting many borrowers, especially those without access to the public market. Now, as rate cuts come into view, we see public credit regaining some of the lost ground. So how private credit adapts to this changing environment is something we’ll be monitoring closely. With substantial dry powder ready to be deployed, the competition between public and private credit is likely to intensify, potentially impacting the overall market.Joyce, let's wrap it up here, Thanks for coming on the podcast.Joyce Jiang: Thanks for having me.Vishy Tirupattur: Thank you all for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.
Central banks in the U.S. and Europe are looking to cut rates this year, but the path to those cuts differs greatly. Our Global Chief Economist explains this stark dichotomy.----- Transcript -----Welcome to Thoughts on the Market. I’m Seth Carpenter, Morgan Stanley’s Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I’ll be talking about the challenges for monetary policy on both sides of the Atlantic.It’s Wednesday, Feb 21st at 10am in New York.The Fed, the Bank of England, and the ECB all hiked rates to fight inflation, and now we are looking for each of them to cut rates this year. For our call for a June Fed rate cut, both growth and inflation matter. But our call for a May and June start on the east side of the Atlantic depends only on inflation. “Data dependent” here has two different meanings.At the January Fed meeting, Chair Powell said continued disinflation like in prior months was needed to cut. But he also emphasized that disinflation needs to be sustainably on track; not simply touching 2 per cent. Until Thursday’s retail sales data, the market narrative began to flirt with a possible re-acceleration of the US economy, spoiling that latter condition of inflation going sustainably to target. January inflation data showed strength in services in particular, and payrolls showed a tight labor market that might pick up steam.The retail sales data pushed in the opposite direction, and we think that the slower growth will prevail over time. And for now, market pricing is more or less consistent with our call for 100 basis points of cuts this year, starting in June.Now the Fed’s situation is in stark contrast to that of the Bank of England. Last week’s UK data showed a technical recession in the second half of 2023. And while the UK economy is not collapsing, a strongly surging economy is not a risk either. But until the last print, inflation in the UK had been stubbornly sticky. The January print came in line with our UK economist’s call, but below consensus. But still, one swallow does not mean spring, and the recent inflation data do not guarantee our call for a May rate cut will happen. Rather, broader evidence that inflation will fall notably is needed; and for that reason, the risks to our call are clearly skewed to a later cut.For the ECB, the inflation focus is the same. And on Thursday, President Lagarde warned against cutting rates too soon – a particularly telling comment in light of the weak growth in the Euro area. Recent data releases suggest that not only did Germany’s GDP decline by three-tenths of a per cent in Q4 of 2023; the second largest economy, France, also experienced stagnation in the second half of the year. And with this weakness expected to persist – well, we forecast a weak half per cent growth this year and about only 1 per cent growth in 2025.So, why is this dichotomy so stark? The simple answer is the weak state of the economy in the UK and in Europe. More fundamentally, the drivers of inflation started with a jump in food and energy prices, and then surging consumer goods prices as disrupted supply chains met consumer spending shifting toward goods. That inflation has since abated but services inflation tends to be more tied to the real side of the economy. And for the US in particular, housing inflation is driven by the state of the labor market over time.The Bank of England and the ECB are waiting for services inflation to respond to the already weak economy, and there is little risk of a reacceleration of inflation if that happens. In contrast, the Fed cannot have conviction that inflation won’t reaccelerate because of the continued resilience on the real side of the economy. The retail sales data will help, but the pattern needs to continue.Thanks for listening. If you enjoy the show, please leave us a review on Apple podcasts, and share Thoughts on the Market with a friend or colleague today.
Our Head of Thematic Research in Europe previews the possible next phase of the AI revolution, and what investors should be monitoring as the technology gains adoption.----- Transcript -----Welcome to Thoughts on the Market. I’m Edward Stanley, Morgan Stanley’s Head of Thematic Research in Europe. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the latest developments around AI Adopters. It’s Tuesday, February the 20th, at 2pm in London.The current technology shift driven by AI is progressing faster than any tech shift that came before it. I came on the show at the beginning of the year to present our thesis – while 2023 was the “Year of the Enablers,” those first line hardware and software companies; 2024 is going to be the “Year of the Adopters,” companies leveraging the Enablers’ hardware and software to better use and monetize their own data for this generative AI world.And the market is still sort of treating this as a “show me” story. Enablers are still driving returns. Around half of the S&P’s performance this year can be attributed to three Enabler stocks. Yet, be it Consumer or – more importantly – Enterprise adoption, monthly data we’re tracking suggests AI adoption is continuing at a rapid pace.So let me paint a picture of what we’re actually seeing so far this year.There has been a widening array of consumer-facing chatbots. Some better for general purpose questions; some better at dealing with maths or travel itineraries; others specialized for creating images or videos for influencers or content creators. But those proving to be the stickiest, or more importantly leading to major behavioral day-to-day changes, are coding assistants, where the productivity upside is now a well-documented greater than 50 per cent efficiency gain.From a more enterprise perspective, open-source models are interesting to track. And we do, almost daily, to see what’s going on. The people and companies downloading these models are likely to be using them as a starting point – for fine-tuning their own models.Within that, text models which form the backbone of most chatbots you will have interacted with, now account for less than 50 per cent of all models openly available for download. What’s gaining popularity in its place is multi-modal models. This is: models capable of ingesting and outputting a combination of text, image, audio or video.Their applications can range from disruption within the music industry, personalized beauty advice, applications in autonomous driving, or machine vision in healthcare. The list goes on and on. The speed of AI diffusion into non-tech sectors is really bewildering.Despite all these data points, suggesting consumer and enterprise adoption is progressing at a rapid clip, Adopter stocks continue to underperform those picks-and-shovels Enablers I mentioned. The Adopters have re-rated modestly in the first month and a half of the year – but not the whole group. Of course, this is a rapidly changing landscape. And many companies have yet to report their outlook for the year ahead. We’ll continue to keep you informed of the newest developments as the years progress.Thanks for listening. If you enjoy the show, please leave a review on Apple Podcasts and share Thoughts on the Market with a friend or a colleague today.
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