Avsnitt
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Our Chief China Economist Robin Xing and Chief China Equity Strategist Laura Wang discuss how markets have responded to rate cuts and commitments to government spending, and what they could mean over the long term.
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Laura Wang: Welcome to Thoughts on the Market. I'm Laura Wang, Morgan Stanley's Chief China Equity Strategist.
Robin Xing: And I'm Robin Xing, Morgan Stanley's Chief China Economist.
Laura Wang: All eyes have been on China this past week, and today we'll discuss why recent news from China's policymakers have commanded the attention of global markets.
It's Thursday, October the 3rd, at 4pm in Hong Kong.
So, Robin, China has been wrestling with the triple macro challenge of debt deflation and demographics -- what we call the three Ds -- for some time now. Last week, China's central bank, PBOC, announced a stimulus package that exceeded market expectations. And then later in the week, top China Communist Party officials, known as the Politburo, focused their monthly meeting on economics, which is not their usual practice.
This meeting was a positive surprise to both us and the market. Let's start with the PBOCs easing package. For listeners who haven't been following China's economy closely, what's our current view on China's economy and can you walk us through the policy measures that the central bank introduced?
Robin Xing: China's economy has been struggling lately and that's pushed the Beijing to pivot approach. Over the last 18 months, they have tried smaller, reactive measures. But now, they are doing something much bigger. On September 24, the People's Bank of China, PBOC, made a bold move, cutting interest rates and introducing new tools to support the stock market.
Now, these cuts might sound small, just 20 basis points, but they are pretty rare in China. They also cut the reserve requirement ratio, which is a fancy way of saying banks can lend more money by 50 basis points. And for the first time, the central bank gave forward guidance, signaling even more cuts could come by year end.
On top of that, the PBOC launched two big programs, a 500 billion yuan fund to help investors buy stocks, and a 300 billion yuan program to help companies buy back their own shares. These moves gave a much-needed boost to both the markets and consumer confidence.
Laura Wang: And how about the Politburo meeting that came on the heels of the PBOC announcement? What exactly did it focus on?
Robin Xing: The Politburo meeting was a rather critical moment. Normally, they don't even talk about the economy in September. But this year was different. It really signaled how urgent things have become.
They made it clear they are ready to spend more. The government is pledging to increase public spending because other parts of the economy, like corporates and consumers, are holding back. There is also a big focus on the housing market, which has been in decline since 2021. They are promising to stop that slide, and it's the strongest commitment we have seen so far.
Laura Wang: So, given everything we've seen from the PBOC and the Politburo, do you think this is a ‘whatever it takes moment’ to address the macro challenges facing China's economy?
Robin Xing: Not quite, but it's close. We are seeing the start of what's going to be a bumpy recovery. The deflation problem, where prices are falling and people are not spending, is complicated.
Beijing seems open to trying different approaches, but fixing the deeper issues -- like the struggling housing market and the local government debt -- it’s going to take a lot. In fact, we think China might need to spend about 1-1.5 trillion dollars over the next two years to really turn things around.
Right now, the measures they have announced are smaller than that. That's because these are new policies. And they still need to build consensus and work out the details. So, while this isn't a ‘whatever it takes moment’ yet the mindset has definitely shifted in that direction.
Laura Wang: In this case, what are the next steps you are monitoring for China's policymaker and how long will the various measures take to implement?
Robin Xing: We expect to see a supplementary budget of 1-2 trillion yuan announced at the upcoming NPC Standing Committee meeting in late October. This budget should focus on boosting consumer spending, increasing social welfare, and helping local governments managing their debt. We will likely see more monetary easing too.
As well as tweaks to the Housing Inventory Buy Back program. These steps should help the economy grow slightly faster, possibly hitting a 5 per cent quarter on quarter growth over the next two quarters, compared to the 3 per cent we have seen recently.
Looking ahead, we will get more clues at the December Central Economic Work Conference. That's when we might see the first signs of plans to use central government funds to tackle housing and local government debt issues. The full details could come in March 2025. If things don't improve quickly, and especially if social unrest starts to rise, Beijing may have to act even more aggressively.
We are keeping an eye on our social dynamics indicator, which tracks how people feel about jobs, welfare and income. If that dips further, it could push the government to ramp up stimulus measures.
Laura, turning it over to you. How are stock markets reacting to all this policy signaling from China?
Laura Wang: I would say to say that the market has responded very enthusiastically is an understatement. I'll give you some numbers.
On the first day of the PBOC announcement, the Shanghai Composite Index, as well as the Hong Kong Market Hang Seng Index, were both up by more than 4 per cent in one single day. Then with the further boost from the surprise Politburo meeting -- by now, both the Shanghai Composite Index and the Hang Seng Index have already been up by more than 21 per cent in just one week's time.
Robin Xing: Within the China stock market, which sectors and industries do you think will most benefit from the shift in policy?
Laura Wang: There are a few ways to position to benefit from this major market condition change. We have a list of companies that we believe will directly benefit from the PBOC market stabilization funding, given the funding's low cost compared to these companies implied re-rating opportunity, just by tapping into the funding and enhancing their shareholder returns.
For the potential reflationary fiscal efforts suggested by the Politburo meeting, as more details come out, I think sectors with good exposure to reflation, particularly the private consumption, will benefit the most -- given their still relatively low valuation, large market cap and high liquidity.
Robin Xing: Finally, Laura, what are your expectations for the markets in China and outside of China for the next few weeks and months?
Laura Wang: Clearly this rally so far is reflecting significant sentiment improvement and capitals that are willing to take a leap of faith and preposition for physical reflationary efforts ramp up. If the government can deliver these measures in a timely fashion, and more importantly, on top of that, communicate their commitment to winning this uphill battle against deflation, I think further valuation re-rating is quite possible for both the Asia market and the Hong Kong market by another 10 to 20 per cent.
To go beyond that level, we need to see clear signs of a corporate earnings growth reacceleration, which would require incrementally more easing to come along in the next few months. We should also monitor the housing market inventory level very closely because any earlier completion of this inventory digestion could suggest less drag on demand investment.
Obviously, there are still a lot of moving parts and it's still a very much evolving story from here. Robin, thanks for taking the time to talk.
Robin Xing: Great speaking with you, Laura.
Laura Wang: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.
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Thousands of U.S. dockworkers have gone on strike along the East Coast and Gulf Coast. Our Global Head of Fixed Income and Thematic Research Michael Zezas joins U.S. economist Diego Anzoategui to discuss the potential consequences of a drawn-out work stoppage.
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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.
Diego Anzoategui: And I'm Diego Anzoategui from the US Economics team.
Michael Zezas: And today, we'll be talking about the implications of this week's US dockworker strike on the US economy.
It's Wednesday, October 2nd, at 11am in New York.
Diego, as most of our listeners likely know, yesterday roughly 45,000 US dockworkers went on strike for the first time in perhaps decades at 36 US ports from Maine to Texas. And so, I wanted to get your initial read on the situation because we're obviously getting a lot of questions from clients concerned about what this could mean for growth and inflation.
Diego Anzoategui: Yeah, of course, there's a lot of uncertainty about this situation because we don't know how long the strike is going to last. But the strike can in principle hit economic growth and boost inflation -- but only if it is long lasting, right. Local producers and retailers, they typically have inventories of final and intermediate goods, so the disruption needs to be long enough so that those inventories go down to critical levels in order to see a meaningful macroeconomic impact.
But if the strike is long enough, we might see an important impact on economic activity and inflation. If we look at trade flows data, roughly 30 per cent of all goods imports and exports are handled by the East and Gulf ports.
Michael Zezas: So then let's drill down on that a bit. If the strike continues long enough and inventories decline, what are the shocks to economic growth that you're considering?
Diego Anzoategui: Yeah, I would think that there are two main channels through which the strike might hit economic activity. The first one is a hit to local production because of disruptions in the supply of capital goods and intermediate goods used for domestic production. We not only use the ports to bring final goods, but also intermediate and capital goods like machinery, basic metals, plastic, to name a few.
And the second channel is directly through exports. The East Coast and Gulf ports channel 84 per cent of exports by water. Industries producing energy, chemicals, machinery, cars, might be affected by these bottlenecks.
Michael Zezas: Right, so fewer potential imports of goods, and fewer potential productive capacity as a consequence. Does that have an impact on inflation from your perspective?
Diego Anzoategui: Yes, it can have an impact on inflation. Again, assuming that the strike is long lasting, right? I would expect acceleration in goods prices, in particular key inputs coming from the Eastern Gulf ports. And these are cars, electronics, clothes, furniture and apparel. All these categories roughly represent 13 per cent of the core PCE basket, the price index.
Also, you know, a meaningful share of food and beverages imports come through water. So, I would also expect an impact there in those prices. And in terms of what prices might react faster, I think the main candidate is food and beverages -- and especially perishable food that typically have lower inventory to sales ratios.
And if we start seeing an increase in those prices, I think that would be a good early signal that the disruptions are starting to bite.
Michael Zezas: That makes sense. And last question, what about the impact to the US workforce? What would be the impact, if any, on payroll data and unemployment data, reflecting workforce impact -- the types of data that investors really pay close attention to.
Diego Anzoategui: Yeah. So, we will likely see an impact on nonfarm payrolls, NFP, and the unemployment rate if the strike is long lasting. But even if there are not important disruptions, the strike itself can mechanically affect October's nonfarm payrolls print. They want to be released in November. Remember that strikers don't get paid, and they are not on the payroll; so they are not be[ing] counted by the establishment survey.
But a necessary condition to see this downward bias in the NFP reading is that the strike needs to continue next week, that is the second week of October, right. But know that The Fed tends to look through these short run fluctuations in NFP due to strikes -- because any drag we see in the October sprint will likely be followed by payback in November if the strike is short lived.
Michael Zezas: Got it. That makes a lot of sense. Diego, thanks for making the time to talk with us as this unfolds. Let's hope for a quick resolution here.
Diego Anzoategui: Thanks, Michael. Great speaking with you.
Michael Zezas: And thanks for listening. If you enjoy Thoughts on the Market, please be sure to rate and review us on the Apple Podcasts app. It helps more people find the show.
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Saknas det avsnitt?
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Our US public policy and global economics experts discuss how an escalation of US tariffs could have major domestic and international economic implications.
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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's US Public Policy Strategist.
Arunima Sinha: And I’m Arunima Sinha, from the Global Economics team.
Ariana Salvatore: Today we're talking tariffs, a major policy issue at stake in the US presidential election. We'll dig into the domestic and international implications of these proposed policies.
It's Tuesday, October 1st at 10am in New York.
In a little over four weeks, Americans will be going to the polls. And as we've noted on this podcast, it's still a close race between the two presidential candidates. Former president Donald Trump's main pitch to voters has to do with the economy. And tariffs and tax cuts are central to many of his campaign speeches.
Arunima Sinha: You're right, Ariana. In fact, I would say that tariffs have been the key theme he keeps on coming back to. You've recently written a note about why we should take the Republicans proposed policies on tariffs seriously. What's your broad outlook in a Trump win scenario?
Ariana Salvatore: Well, first and foremost, I think it's important to note that the President has quite a bit of discretion when it comes to trade policy. That's why we recommend that investors should take seriously a number of these proposals. Many of the authorities are already in place and could be easily leveraged if Trump were to win in November and follow through on those campaign promises. He did it with China in 2018 to 2019, leveraging Section 301 Authority, and many of that could be done easily if he were to win again.
Arunima Sinha: And could you just walk us through some of the specifics of Trump's tariff proposals? What are the options at the President's disposal?
Ariana Salvatore: Sure. So, he's floated a number of tariff proposals -- whether it be 10 per cent tariffs across the board on all of our imports, 60 per cent specifically on China or targeted tariffs on certain goods coming from partners like Mexico, for example. Targeted tariffs are likely the easiest place to start, especially if we see an incrementalist approach like we saw during the first Trump term over the course of 2018 to 2019.
Arunima Sinha: And how quickly would these tariffs be implemented if Trump were to win?
Ariana Salvatore: The answer to that really depends on the type of authorities being leveraged here. There are a few different procedures associated with each of the tariffs that I mentioned just now. For example, if the president is using Section 301 authorities, that usually requires a period of investigation by the USTR -- or the US Trade Representative --before the formal recommendation for tariffs.
However, given that many of these authorities are already in place, to the extent that the former president wants to levy tariffs on China, for example, it can be done pretty seamlessly. Conversely, if you were to ask his cabinet to initiate a new tariff investigation, depending on the authority used, that could take anywhere from weeks to months. Section 232 investigations have a maximum timeline of 270 days.
There's also a chance that he uses something called IEEPA, the International Emergency Economic Powers Act, to justify quicker tariff imposition, though the legality of that authority hasn't been fully tested yet. Back in 2019, when Trump said he would use IEEPA to impose 5 per cent tariffs on all Mexican imports, he called off those plans before the tariffs actually came into effect.
Arunima Sinha: And could you give us a little more specific[s] about which countries would be impacted in this potential next round of tariffs -- and to what extent?
Ariana Salvatore: Yeah, in our analysis, which you'll get into in a moment, we focus on the potential for a 10 per cent across the board tariff that I mentioned, in conjunction with the 60 per cent tariff on Chinese goods. Obviously, when you map that to who our largest trading partners are, it's clear that Mexico and China would be impacted most directly, followed by Canada and the EU.
Specifically on the EU, we have those section 232 steel and aluminum tariffs coming up for review in early 2025, and the US-MCA or the agreement that replaced NAFTA is set for review later in 2026. So, we see plenty of trade catalysts on the horizon. We also see an underappreciated risk of tariffs on Mexico using precedent from Trump's first term, especially if immigration continues to be such a politically salient issue for voters.
Given all of this, it seems that tariffs will create a lot of friction in global trade. What's your outlook, Arunima?
Arunima Sinha: Well, Arianna, we do expect a hit to growth, and a near term rise in inflation in the US. In the EU, our economists also expect a negative impact on growth. And in other economies, there are several considerations. How would tariffs impact the ongoing supply chain diversification? The extent of foreign exchange moves? Are bilateral negotiations being pursued by the other countries? And so on.
Ariana Salvatore: So, a natural follow up question here is not only the impact to the countries that would be affected by US tariffs, but how they might respond. What do you see happening there?
Arunima Sinha: In the note, we talked with our China economists, and they expect that if the US were to impose 60 per cent tariffs on Chinese goods, Beijing may impose retaliatory tariffs and some non-tariff measures like it did back in 2018-19. But they don't expect meaningful sanctions or restrictions on US enterprises that are already well embedded in China's supply chain.
On the policy side, Beijing would likely resort less to Chinese currency depreciation but focus more on supply chain diversifications to mitigate the tariff shock this time round. Our economists think that the risk of more entrenched deflationary pressures from potential tariff disruptions may increase the urgency for Beijing to shift its policy framework towards economic rebalancing to consumption.
In Europe, our economists expect that targeted tariffs will be met with challenges at the WTO and retaliatory tariffs on American exports to Europe, following the pattern from 2018-19, along with bilateral trade negotiations. In Mexico, our economists think that there could be a response with tariffs on agricultural products, mainly corn and soybeans.
Ariana Salvatore: So, bringing it back to the US, what do you see the macro impact from tariffs being in terms of economic growth or inflation?
Arunima Sinha: We did a fairly extensive analysis where we both looked at the aggregate impacts on the US as well as sectoral impacts that we'll get into. We think that a pretty reasonable estimate of the effect of both a 60 per cent tariff on China and a 10 per cent blanket tariff on the rest of the world is an increase of 0.9 per cent in the headline PCE prices that takes into effect over 2025, and a decline of 1.4 percentage points in real GDP growth that plays out over a longer period going into 2026.
Ariana Salvatore: So, your team is expecting two more Fed cuts this year and four by the first half of 2025. Thinking about how tariffs might play into that dynamic, do you see them influencing Fed policy at all?
Arunima Sinha: Well, under the tariff scenario, we think that it's possible that the Fed decides to delay cuts first and then speed up the pace of easing. So, in theory, the effect of a tariff shock is really just a level shift in prices. And in other words, it's a transitory boost to inflation that should fade over time.
Because it's a temporary shock. The Fed can, in principle look through it as long as inflation expectations remain anchored. And this is what we saw in the FOMC minutes from the 2018 meetings. In a scenario of increased tariffs, we think that the uncertainty about the length of the inflationary push may slow down the pace of cuts in the first half of 2025. And then once GDP deceleration becomes more pronounced, the Fed might then cut faster in the second half of [20]25 to avoid that big, outsized deceleration and economic activity.
Ariana Salvatore: And what about second order effects on things like business investment or employment? We talked about agriculture as a potential target for retaliatory tariffs, but what other US sectors and industries would be most affected by these type of plans?
Arunima Sinha: That's something that we have leaned in on, and we do expect some important second round effects. So, if you have lower economic activity, that would lower employment, that lowers income, that lowers consumption further -- so that standard multiplier effect.
So overall, in that scenario, with the 60 per cent tariffs on China, 10 per cent on the rest of the world that are imposed fully and swiftly, we model that real consumption would decline by 3 per cent, business investment would fall by 3.1 per cent, and monthly job gains would fall by between 50- and 70, 000.
At the sectoral level, this combination of tariffs have potential to increase average tariffs to the 25 to 35 per cent range for almost 50 per cent of the NAICS industries in the United States when first put into place. And we expect the biggest impacts on computers and electronics, apparel, and the furniture sectors; but this does not take into account any potential exclusion lists that might be put into place.
Ariana Salvatore: Finally, what does all this boil down to in terms of a direct impact to the US consumer wallet?
Arunima Sinha: So, the impact of higher tariffs on consumer spending would depend on many factors, and one of the most important ones is the price elasticity of demand. So how willing would consumers be to take on those higher prices from tariffs, or do we see a pullback in real demand? What we think will happen is that higher prices could reduce real consumption by as much as 2. 5 per cent. The impact on goods consumption is much more meaningful because imported goods are directly affected by tariffs, and we would expect to see a drag on real goods consumption of 5 per cent. But then you have lower labor income and higher production costs and services prices that is also going to bring down services consumption by 1.3 per cent.
Ariana Salvatore: So, it's important to keep in mind here that US tariff policy would undoubtedly have far reaching consequences. That means it's something that we're going to continue to follow very closely. Arunima, thanks so much for taking the time to talk.
Arunima Sinha: Great speaking with you, Ariana. Thank you,
Ariana Salvatore: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.
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Our CIO and Chief US Equity Strategist Mike Wilson takes a closer look at the potential ramifications of the sharp central bank policy shifts in the U.S., Japan and China.
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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 what to expect from the sharp pivot in global monetary and fiscal policy.
It's Monday, Sept 30th at 11:30am in New York.
So let’s get after it.
Over the past few months, Fed policy has taken on a more dovish turn. To be fair, bond markets have been telling the Fed that they are too tight and in many respects this pivot was simply the Fed getting more in line with market pricing. However, in addition to the 50 basis point cut from the Fed, budget deficits are providing heavy support; with August’s deficit nearly $90b higher than expected. Meanwhile, financial conditions continue to loosen and are now at some of the most stimulative levels seen over the past 25 years.
Other central banks are also cutting interest rates and even the Bank of Japan, which recently raised rates for the first time in years, has backed off that stance – and indicated they are in no hurry to raise rates again. Finally, this past week the People’s Bank of China announced new programs specifically targeting equity and housing prices. After a muted response from markets and commentators, the Chinese government then followed up with an aggressive fiscal policy stimulus. Why now?
Like the US, China is highly indebted but it has entered full blown deflation with both credit and equity markets trading terribly for the past several years. There is an old adage that markets stop panicking when policy makers start panicking. On that score, it makes perfect sense why China equity and credit markets have responded the most favorably to the changes made last week. European equity markets were also stronger than the US given European economies and companies have greater exposure to China demand. On the other hand, Japan and India traded poorly which also makes sense in my view since they were the two largest beneficiaries of investor outflows from China over the past several years. Such trends are likely to continue in the near term.
For US equity investors, the real question is whether China’s pivot on policy will have a material impact on US growth. We think it’s fairly limited to areas like Industrial spending and Materials pricing and it’s unlikely to have any impact on US consumers or corporate investment demand. In fact, if commodities rally due to greater China demand, it may hurt US consumer spending.
As usual, oil prices will be the most important commodity to watch in this regard. The good news is that oil prices were down last week due to an unrelated move by Saudi Arabia to no longer cap production in its efforts to get oil prices back to its $100 target. If prices reverse higher again and move toward $80/bbl due to either China stimulus or the escalation of tensions in the Middle East, it would be viewed as a net negative in my view for US equities.
As discussed last week the most important variables for the direction of US equities is the upcoming labor market data and third quarter earnings season. Weaker than expected data is likely to be viewed negatively by stocks at this point and good news will be taken positively. In other words, investors should not be hoping for worse news so the Fed can cut more aggressively.
At this point, steady 25 basis point cuts for the next several quarters in the context of growth holding up is the best outcome for stocks broadly. Meanwhile individual stocks will likely trade as much on idiosyncratic earnings and company news rather than macro data in the absence of either a hard landing or a large growth acceleration; both of which look unlikely in the near term. In such a scenario, we think large cap quality growth is likely to perform the best while there could be some pockets of cyclical strength in companies that can benefit from greater China demand. The best areas for cyclical outperformance in that regard remain in the Industrial and materials sectors.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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Credit likes moderation, and the Fed’s rate cut indicates its belief that the economy is heading for a soft landing. Our Chief Fixed Income Strategist warns that markets still need to keep an eye on incoming data.
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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, today I'll be talking about the implications of the Fed’s 50 basis points interest rate cut for corporate credit markets.
It's Friday, Sep 27th at 10 am in New York.
For credit markets, understanding why the Fed is cutting is actually very critical. Unlike typical rate cutting cycles, these cuts are coming when the economic growth is still decelerating but not falling off the cliff. Typically, rate cuts have come in when the economy is already in a recession or approaching recession. Neither is the case this time. So the US expanded by 3 per cent in the second quarter; and the third quarter, it is tracking well over 2 per cent.
So, these cuts do not aim to stimulate the economy but really to acknowledge that there’s been significant progress on inflation, and move the policy towards a much more normalized policy stance. In some way, this really reflects the Fed’s confidence in the inflation path. So that means, not cutting now would mean restraining the economy further through high real interest rates. So, this cut really reflects a growing faith by the Fed in achieving a soft landing. Also, the size of the cut, the 50 basis point cut as opposed to 25 basis points, shows the Fed’s willingness to go big in response to weaker data, especially in labor markets.
So since the beginning of the year, we have been pretty constructive on spread products across the board, particularly corporate credit and securitized credit, even though valuations have been tightening. Our stance is based on the idea that credit fundamentals will stay reasonably healthy even if economic growth decelerates, as long as it doesn’t fall off the cliff. Further, we also believe that credit fundamentals will improve with rate cuts because stress in this cycle has mainly come from higher interest expenses weighing on both corporations and households. This is in stark contrast to other recent periods of stress in credit markets – such as 2008/09 when we had the financial crisis, 2015/16 we had the challenges in the energy sector and then 2020, of course, we faced COVID.
So the best point of illustrating this would be through leveraged loans, which are floating-rate instruments. As the Fed started tightening in 2022, we saw increasing pressures on interest coverage ratios for leveraged loan borrowers. That led to a pick-up in downgrades and defaults in loans. As rate hikes ended, we started seeing stabilization of these coverage ratios, and the pace of downgrades and defaults slowed. And now, with rate cutting ahead of us and the dot plot implying 150 basis points more of cuts for the rest of this year and the next year to come, the pressure on interest coverage ratios are going to be easing, especially if the economy stays in soft landing mode.
This suggests that while spreads are today tight, the fundamentals could even improve with rate cuts – that means the spreads could remain around these levels, or even tighten a bit further. After all, if you remember the mid-1990s, which was the the last time that the Fed achieved a soft landing, investment grade corporate credit spreads were about 30 basis points tighter relative to where we are today.
That 'if' is a big if. If we are wrong on the soft landing thesis, our conviction about the spread products being valuable will prove to have been misplaced. Really the challenge with any landing is that we can’t be certain of the prospect until we actually land. Till then, we are really looking at incoming data and hypothesizing: are we heading into a soft or hard landing?
So this means incoming data pose two-sided risks to the path ahead for credit spreads. If incoming data are weak – particularly employment data are weak – it is likely that faith in this soft landing construct will dim and spreads could widen. But if they are robust, we can see spreads tightening even further from the current tight levels.
Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our US Consumer Economist Sarah Wolfe lays out the impact of the Federal Reserve’s rate cut on labor market and consumers, including which goods could see a rise in spending over the next year.
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Welcome to Thoughts on the Market. I’m Sarah Wolfe, from the Morgan Stanley US Economics Team.
Today, a look at what the Fed cut means for US consumers.
It’s Thursday, September 26, at 2 PM in Slovenia.
Earlier this week, you heard Mike Wilson and Seth Carpenter talk about the Fed cut and its impact on markets and central banks around the world. But what does it actually mean for US consumers and their wallets? Will it make it easier to pay off credit card debt and secure mortgages? We explore these questions in this episode.
Looking back to last week, the FOMC cut rates by a larger chunk than many anticipated as risks from inflation have come down significantly while labor market risks have risen. Now, with inflation wrangled in, it’s time to start reducing the restrictiveness of policy to prevent a rise in the unemployment rate and a slump in economic growth. In fact, my colleague Mike Wilson believes the US labor data will be the most important factor driving US equities for the next three to six months.
Despite potential risks, the current state of the U.S. labor market is still solid and that’s where the Fed wants it to stay. The health of the labor market, in my opinion, is best reflected in the health of consumer spending. If we look at this quarter, we’re tracking over 3 per cent growth in real consumption, which is a strong run rate for consumption by all measures. And if we look at how the whole year has been tracking, we’ve only seen a very modest slowdown in real consumer spending from 2.7 per cent last year to 2.5 per cent today.
For a bit of perspective, if we go back to 2018 and 2019, when rates were much lower than they are today, and we had a tight labor market, consumption was running closer to 2 to 2.3 per cent. So we can definitively say, consumption is pretty solid today.
What is most notable, however, is the slowdown in nominal consumption which takes into account unit growth and pricing. This has slowed much more notably this year from 5.6 per cent last year to 4.9 per cent today. It’s reflected by the significant progress we’ve seen in inflation this year across goods and services, despite solid unit growth – as reflected by stronger real consumer spending.
Our US Economics team has been stressing that the fundamentals that drive consumption – which are labor income, wealth, and credit – would be cooler this year but still support healthy spending. When it comes to consumption, in my opinion, I think what matters most is labor income. A slowdown in job growth has stoked fears of slower consumer spending, but if you look at aggregate labor income growth and household wealth, across both equities and real estate, those factors remain solid. So, then we ask ourselves, what has driven more of the slowdown in consumer spending this past year?
And with that, let’s go back to interest rates.
Rates have been high, and credit conditions have been tight – undeniably restraining consumer spending. Elevated interest rates have pushed banks to pull back on lending and have curbed household demand for credit. As a result, if you look at consumer loan growth from banks, it’s fallen from about 12 per cent in 2022 to 7 per cent last year, and just 3 per cent in the first half of this year.
Tight credit is dampening consumption. When interest rates are high, people buy less -- especially on credit. And this is a key principle of monetary policy and it's used to lower inflation. But it can have adverse effects. The brunt of the pain has been borne by the lowest-income households which rely heavily on revolving credit for basic spending needs and more easily max out on their credit limits and fall delinquent.
As such, as the Fed begins to lower interest rates, the rates charged on consumer loan products have started to moderate. And with a lag, we expect credit conditions to ease up as well, allowing households across the income distribution to begin to access more credit. We should first see a rebound in durable goods spending – like home furnishing, electronics, appliances, and autos. And then that should all be further supported by more activity in the housing market.
While interest rates are on their way down, they are still relatively elevated, which means the rebound in consumption will take time. The good news, however, is that we do think we are moving through the bottom for durable goods consumption – with pricing for goods likely to stabilize next year and unit growth to pick back up.
Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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With the US presidential race being as closely contested as it is, Michael Zezas explains why patience may be a virtue for investors following Election Day.
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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 why investors should prepare to wait to get clarity on the US election result.
It's Wednesday, September 25th at 10:30am in New York.
As we all know, markets dislike uncertainty; and one of the biggest potential catalysts between now and the end of the year is the results of the US presidential election. So it’s important for investors to know that the timing of knowing the outcome may not be what you expect.
On most U.S. presidential election days, the outcome is known within hours of polls closing in the evening. That’s because while all votes may not yet have been counted, enough have to make a reasonable projection about the winner.
But that’s not what happened in 2020. Vote counts were tight across many states. A condition that was compounded by the slowness of counting mail in ballots, which was a style of voting more widely adopted during the pandemic. As a result, news networks didn’t make a formal outcome projection until about four days after election day.
Rather than a reversion to the norm of quickly knowing the result for the 2024 election, we expect an outcome similar to 2020. It could be days before we reliably know a result.
The same dynamics as 2020 are in play. Polls show a very close race. And while more voters are likely to show up in person this year, voting by mail is still expected to represent a substantial chunk of ballots cast this cycle. That’s because many states' rules automatically send mail-in ballots to those who voted by that method in the last election. And some recent news out of Georgia underscores the potential for a slower result. The state just adopted a rule requiring all its votes to be hand-counted.
Now, this may not matter if either candidate has enough votes without Georgia to win the electoral college. But if Georgia is the deciding or tipping point state then a longer wait becomes possible. Per the 538 election forecast model, there’s about an 11 per cent chance that Georgia plays this role.
So, bottom line, investors may have to be patient this November. It could take days, or weeks, to reliably project an election outcome, and therefore start seeing its market effects.
Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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From stock price fluctuations to concerns about deflation, the reactions to the Fed rate cut have been varied. But we still need to keep an eye on labor data, says Mike Wilson, our CIO and Chief US Equity Strategist.
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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 the Fed’s 50 basis point rate cut last week, and the impact on markets.
It's Tuesday, Sept 24th at 11:30am in New York.
So let’s get after it.
As discussed last week, I thought that the best short-term case for equities was that the Fed could deliver a 50 basis point cut without prompting growth concerns. Chair Powell was able to thread the needle in this respect, and equities ultimately responded favorably.
However, I also believe the labor data will be the most important factor in terms of how equities trade over the next three to six months.
On that score, the next round of data will be forthcoming at the end of next week. In my view, that data will need to surprise on the upside to keep equity valuations at their currently elevated level. More specifically, the unemployment rate will need to decline and the payrolls above 140,000 with no negative revisions to prior months.
Meanwhile, I am also watching several other variables closely to determine the trajectory of growth. Earnings revision breadth, the best proxy for company guidance, continues to trend sideways for the overall S&P 500 and negatively for the Russell 2000 small cap index. Due to seasonal patterns, this variable is likely to face negative headwinds over the next month.
Second, the ISM Purchasing Managers Index has yet to reaccelerate after almost two years of languishing. And finally, the Conference Board Leading Economic Indicator and Employment Trends remain in downward trends; this is typical of a later cycle environment.
Bottom line, the Fed's larger than expected rate cut can buy more time for high quality stocks to remain expensive and even help lower quality cyclical stocks to find some support. The labor and other data now need to improve in order to justify these conditions though, through year end.
It's also important to point out that the August budget deficit came in nearly $90 billion above forecasts, bringing the year-to-date deficit above $1.8 trillion. We think this fiscal policy has been positive for growth but has resulted in a crowding out within the private economy and financial markets.
This is another reason why a recession is the worst-case scenario even though some argue a recession is better than high price levels or inflation for 80-90 per cent of Americans. A recession will undoubtedly bring debt deflation concerns to light, and once those begin, they are hard to reverse. The Fed understands this dynamic better than anyone as first illustrated in Ben Bernanke's famous speech in 2002 entitled “Deflation, Making Sure It Doesn’t Happen Here.” In that speech, he highlighted the tools the Fed could use to avoid deflation including coordinated monetary and fiscal policy.
We note that gold continues to outperform most stocks including the high-quality S&P 500. Specifically, gold has rallied from just $300 at the time of Bernanke’s speech in 2002 to $2600 today. The purchasing power of US dollars has fallen much more than what conventional measures of inflation would suggest.
As a result, gold, high-quality real estate, stocks and other inflation hedges have done very well. In fact, the newest fiat currency hedge, crypto, has done the best over the past decade. Meanwhile, lower quality cyclical assets like commodities, small cap stocks and commercial real estate have done poorly in both absolute and relative terms; and are losing serious value when adjusted for purchasing power.
The bottom line, we expect this to continue in the short term until something happens to change investors' view about the sustainability of these policies. In order to reverse these trends, either organic growth in the private economy needs to reaccelerate and we’ll see a rotation back to the lower quality cyclical assets; or recession arrives, and we finish the cycle and reset all asset prices to levels from which a true broadening out can occur.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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Our Global Chief Economist, Seth Carpenter, explains why, despite last week’s big Fed move, there’s still plenty of uncertainty in global markets and questions about how other central banks will respond.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.
Today, I'll be talking about the Fed meeting, where they cut rates for the first time in this cycle, and what it means for the economy around the world.
It's Monday, September 23rd at 10am in New York.
The Fed cut rates by 50 basis points; but we did not see a huge shift in its reaction function. Rather, the 50 basis points was to show a commitment to not falling behind the curve -- to use Chair Powell's words. From here, the most likely path, from my perspective, is a string of 25 basis point cuts. Powell has again demonstrated that the Fed can move gradually, or quickly, depending on perceptions of risk.
But for now, judging from Powell, or other policy makers comments, the Fed still sees the economy as healthy in the labor market; as solid. But another payroll print of 100, 000 or softening in consumer spending, well, that would tip the balance. So, the market debate will continue to focus on the pace of rate cuts and the ultimate landing zone.
Our baseline is a touch more front loaded than the dot plot would imply; with us expecting the funds rate to reach just below 3.5 per cent in the middle of next year, rather than the end of next year. The Fed's projections have declines in the target rate into 2026 and beyond, but I have to say the dispersion in the dots that they put up shows just how much consensus is yet to be built within the committee. And, as a result, the phrase data dependency, well, that's not a term that we want to drop from the lexicon anytime soon.
The magnitudes of the changes differ, but a comparison that we have made often here is to the 1990s, and that cutting cycle eventually it paused as the economy stabilized and continued to grow. So, there are lots of options for where we go next.
Globally, central banks will be adapting and reacting both to global financial conditions like this Fed rate cut, as well as their domestic outlook. Among emerging market economies, Brazil and Indonesia make for useful case studies. With an eye on defending its policy credibility and on market expectations, the central bank in Brazil hiked rates to 10-and-three-quarters per cent this week after a cutting cycle and then a long pause. A weaker currency is the external push, but strong domestic growth is the internal consideration and both of those imply some inflation risks.
The Bank of Indonesia cut rates after a strong appreciation in the currency, which lowered the risk from inflations, and it really enabled them to change their footing.
Now, for DM central banks, the 50 basis point cut really doesn't materially shift our expectations for what's going to happen. If we are right, and ultimately we get a string of 25 basis point cuts, there's little reason for other developed market central banks to really adjust what they're doing. In Europe, we're waiting for inflation data to confirm the slowdown after the softening of wages that we've seen. So, we have high conviction that there's a cut in September, and we expect another cut in December.
Now, more cutting by the Fed might lead to a stronger Euro, which would reinforce that inflation trend, but I don't think it would be enough to really change the path and prompt more aggressive cutting from the ECB. After skipping a rate move in September, given all the question marks they still see about inflation in the UK, we think the Bank of England restarts their cuts in November.
The split decision at this most recent meeting shows that the MPC is not making frequent adjustments to its plan based on small tweaks to the incoming data. And finally, for the Bank of Japan, we expect them to stay on hold until January. The meeting for the Bank of Japan was primarily about communication, and indeed, Governor Ueda's comments did not prompt the type of reaction that we saw at the July meeting. So, if we're right, and the Fed's path is mostly, like we think it will be, these other developed market central banks don't have to make big changes.
So, the Fed didn't really fully recalibrate its outlook. Instead, what it did was signal a willingness, but just a willingness, to make large shifts; with no clear indication that the fundamental strategy has changed.
The market implications seem like they could be clear. With the Fed easing, amid economic conditions that remain resilient, that should be positive for risk assets. But the Fed is also trying to prevent complacency, and I have to say, uncertainty is plentiful. If for no other reason, we've got an election coming up, and that makes forecasting what happens in 2025 very difficult.
Thanks for listening. And if you enjoy this show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.
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Our Chief Latin American Equity Strategist explains how potential changes in Mexico’s regulatory approach could have implications for the country’s equity markets.
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Welcome to Thoughts on the Market. I’m Nikolaj Lippmann, Morgan Stanley’s Chief Latin American Equity Strategist. Today I’ll talk about Mexico’s recent judicial reform and its potential impact on equities market.
It’s Friday, September 20, at 10am in Mexico City.
Mexico has made significant changes to its judicial system. After winning two-thirds majority in both houses – enough to allow for constitutional changes – Mexico policymakers have embarked on a robust reform agenda. Their first stop is a comprehensive reform of the judicial branch, which aims at replacing roughly 2,000 senior judges including the entire Supreme Court.
New judges will no longer be appointed but will now be elected by popular vote. This is practically unprecedented in a global context, and while the executive branch might still try to filter future candidates, this new system will likely create a real risk to checks and balances on the judicial branch as well as to expertise and procedure. Additional reforms, including the elimination of independent regulatory bodies, would likely compound these risks.
The judicial reform could have a material impact on Mexican equities. So much so, that we think Mexico goes from being an investor favorite to a ‘show me’ story where investors are less likely to give the market the benefit of the doubt. This is likely to result in a derailing or lower set of multiples being paid by investors in Mexican equities or higher risk premium required to invest.
Essentially, the judicial reforms could add fiscal, labor and concession/regulatory risk for Mexican companies, even though Mexico has deep manufacturing ecosystems, and has been well-positioned from the transition to [a] multipolar world. Just to give you a sense. Mexico has already sailed past China in terms of manufacturing exports to the United States, and are now approaching the levels of the entire European Union in terms of manufacturing export to the US.
These new reforms will raise significant investor concerns, so much so that we’ve downgraded Mexican equities to underweight, a second downgrade since June. Mexican equities have sold off roughly 20 per cent in the past three months, in dollar terms. And we think the judicial reform may contribute to further decline. All in, we see significantly greater potential for negative outcomes than positive outcomes going forward.
Looking ahead, we see three key challenges for Mexico:
First, the new judicial structure would raise concerns about the independence of the judicial branch.
Second, the United States-Mexico-Canada Agreement, the USMCA, is up for review in 2026, and Mexico's judicial reform could mean a much deeper revision. Mexico has committed to maintaining independent regulatory bodies for a number of areas, such as telecom, electricity, in competition. The judicial reform could complicate this commitment.
Electricity is a key challenge for Mexico, and it requires immediate investments. Our nearshoring investment thesis stands, but the electricity-related challenges are becoming more pronounced, and they won’t be helped by investor concerns around the judicial reform.
So all in, some businesses will be at greater risk from these developments. We expect technology, digitalization, real estate companies to be at the least level of risk, or the lowest level of risk. Domestic concessions could be at more risk.
We will continue to bring you relevant updates as Mexico reforms unfold.
Thank you for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. It helps more people find the show.
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Investors came away from Morgan Stanley’s recent Industrials Conference with a more optimistic outlook than they expected, based on perspectives including freight transportation’s momentum and AI’s impact on the growth of data centers.
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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley Research's U.S. Thematic Strategist.
Ravi Shanker: I'm Ravi Shanker, Morgan Stanley's Freight Transportation and Airlines Analyst.
Chris Snyder: And I'm Chris Snyder, the U.S. Industrial Analyst.
Michelle Weaver: Today, we'll talk about key themes for Morgan Stanley's recently concluded industrials conference in Laguna Beach.
It's Thursday, September 19th at 10am in New York.
Last week, we were all out in Laguna Beach at the industrials conference. There were about 500 different industrials investors, along with 156 corporates, which gave us a pretty comprehensive read on what's going on in the industrial sector.Investor sentiment around industrials was pretty poor heading into the conference, and the overall tone of management, though, seemed better than feared in presentations.
Chris, your coverage includes companies with exposure to a wide range of end markets. What did you learn about the cycle from your discussions with company management?
Chris Snyder: Yeah, I think you categorized it well: consistent, largely unchanged, but better than feared. Morgan Stanley did a poll ahead of the conference. And only 5 percent of investors thought that the conference would be bullish for industrial risk sentiment. Coming out of the conference, 60 percent of industrial investors are bullish on risk sentiment into the end of the year. So, I think it kind of shows that sentiment was in a very bad place and ‘better than feared’ is the right way to categorize it.
We've generally been surprised at the lack of optimism around the industrial cycle in the market. The industrial economy has been in contraction for almost two years now, and it seems like we're on the verge of a rate cut cycle, which has historically been a tailwind for the cycle.
You know, in our coverage, business is driven by a combination of investments and then production of goods; and the companies we’re seeing real bifurcation on that. On the investment side -- and that's things like data center, new manufacturing facilities with all the US reshoring momentum -- that business remains strong. And on the production side of the house, that business remains soft. And that's generally in line with our call. We prefer CapEx exposure, particularly those that are tied into energy efficiency.
Michelle Weaver: Great. That's really positive to hear that the investment side is still doing well. Ravi, your freight coverage is very macro as well -- in that the freight companies move all the stuff that other companies are making. How does demand from shippers look? And what are freight companies saying about the cycle?
Ravi Shanker: Yeah, from a freight transportation perspective, I guess, no news was good news out in Laguna; largely because we have already started to see an improvement in the freight cycle, at the end of 1Q going into 2Q. And I think the market was just waiting to see if that would sustain through 3Q. The data has been supportive so far, and the good news was most of the trucking companies did validate the fact that we have seen a continuation of seasonality from 2Q into 3Q.
And looking forward, they're also anticipating a fairly decent peak season, probably the most robust peak season we have had in two or three years. And I use the word robust on a relative basis because it's not going to be the greatest peak season ever. But certainly, better than we've had the last couple of years. But that momentum should continue into 2025.
So, nobody really was high fiving out there. But certainly, noted the fact that we are seeing a continued improvement in the cycle; and that momentum should continue into next year.
Michelle Weaver: One of Morgan Stanley Research's three key themes for the year is technology, diffusion and AI; and this theme came up repeatedly throughout the conference.
Chris, some of your companies have significant exposure to data centers, which have seen a huge boost in demand from AI. What does the growth opportunity look like for Multi's names with exposure to data centers?
Chris Snyder: Yeah, data center is a growth opportunity for my industrials’ coverage. And they primarily are driven by the investment side. How much data centers are we building? And they sell a lot of the equipment that goes into the data centers. And what we're seeing now is that there's a huge focus on energy efficiency within the data center. You know, obviously it helps improve their cost profile, but also as there's growing concerns around load growth and electricity allotment.
And what that's doing is it's driving demand towards the high end of the spectrum, which is where our big public companies compete. You know, they're the ones that are always spending R&D and innovating and driving energy efficiency for the customer. So, we think there's a mix up opportunity behind it.
In terms of growth rates, you know, most of the companies are talking to about 15 percent kind of plus as the growth rate going forward or where they are exposed. And the conference brought, you know, really positive updates. There was no talk of slowdown. And generally, it sounds like momentum remains firm and growth will continue.
Michelle, what were some of the other ways companies discussed AI or how they're leveraging the technology?
Michelle Weaver: Yeah. So, when I think about how companies have been adopting AI so far, not just within industrials, but within the broader market, it's largely been about things that are plug and play solutions; something like taking a chat bot, putting that on your website, and then you don't need as many customer service representatives.
So, when I'm at these kind of events, I always like to listen for more unique or differentiated ways of adopting AI. And I heard about a really interesting case from a company that holds about half of the global market for luxury seating. Processing leather is a super important part of manufacturing seats and has typically been really labor intensive and skilled labor at that. But this company is using AI to scan cow hides to determine what the optimal use for them is, and then inventory them.
Before that, a worker had to individually mark the leather for imperfections and then determine how to cut around that. So, I thought that was a pretty interesting use of AI.
But now I want to turn over to the consumer exposed pockets of industrials. Discretionary spending has been slowing as multiple years of high prices have been weighing on consumers. But overall, I thought the commentary around the consumer at the conference seemed pretty mixed, and we saw a big divide between the high-end and low-end consumers.
Ravi, what did you hear from the airlines around travel demand?
Ravi Shanker: Unlike the transportation side where what we heard was fairly consistent with expectations, I think things were much better than expected on the airline side largely because the airlines came out and validated the fact that demand continues to remain very robust -- pretty much across the board. But as you mentioned, definitely at the high end, the premium traveler continues to travel.
International is rebounding post Olympics. Corporate is normalizing as well, and some of the low-cost carriers did mention that they were seeing some weakness on the low-end consumer side. Although it was unclear to them if that was actual demand weakness or a function of too much capacity in the marketplace.
But they did come out and validate that demand continues to remain very robust; and with capacity continuing to come out of the marketplace and be more balanced with demand, you have seen pricing inflect positive for all the airlines for the first time in several quarters. So definitely, a pretty supportive backdrop for airline demand. And that is going to show up in airline numbers in the third and fourth quarters as well, we think.
Michelle Weaver: As someone who's been in the airports a lot recently, I can definitely feel that demand has held up well. Chris, some of your companies also sell consumer products. What does consumer demand look like in your space?
Chris Snyder: I would say stable, but at soft levels. And I think a lot of the tailwinds that Ravi is seeing on the service side of the house in airlines is actually coming at the expense of my companies who sell consumer goods. You know, if you look at the consumer wallet share, service mix has not gotten back to the levels that we saw in 2019 and we think that will remain a headwind for goods purchasing going forward.
Michelle Weaver: Ravi, Chris, thank you for taking the time to talk.
Ravi Shanker: Thanks so much for having me.
Chris Snyder: Thank you.
Michelle Weaver: And to our listeners, thanks for tuning in. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.
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While the electoral impact of last week’s US presidential debate is unclear, our Global Head of Fixed Income and Thematic Research offers two guiding principles to navigate the markets during the election cycle.
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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 takeaways from the US presidential campaign debate.
It's Wednesday, September 18th at 10:30am in New York.
Last week, Vice President Harris and Former President Trump met in Philadelphia for debate. Investor interest was high, and understandably so. As our Chief Economist Seth Carpenter has previously highlighted in his research, visibility remains low when it comes to the outlook for the US in 2025.
That’s because the election could put the country on policy paths that take economic growth in different directions. And of course, the last presidential debate in June led to President Biden’s withdrawal, changing the race dramatically. So, any election-related event that could provide new information about the probability of different outcomes and the resulting policies is worth watching.
But, as investors well know from tracking data releases, earnings, Fedspeak, and more, potential catalysts often remain just that – potential. For the moment, we’re putting last week’s debate in that category.
Take its impact on outcome probabilities. It could move polls, but perhaps not enough for investors to view one candidate as the clear favorite. For weeks, the polls have been signaling an extremely tight race, with only a small pool of undecided voters. While debates in past campaigns have modestly strengthened a candidate’s standing in the polls, in this race any lead would likely remain within the margin of error.
On policy, again we don’t think the debate taught us anything new. Candidates typically use these widely watched events to influence voters’ perceptions. The details of policies and their impact tend to take a back seat to assertions of principles and critiques of their opponents. This is what we saw last week.
So if the debate provided little new information about the impact of the election on markets, what guidance can we offer? Here again we repeat two of our guiding principles for this election cycle.
First, between now and Election Day, expect the economic cycle to drive markets. The high level of uncertainty and the lack of precedent for market behavior in the run-up to past elections suggest sticking to the cross-asset playbook in our mid-year outlook. In general, we prefer bonds to equities. While our economists continue to expect the US to avoid a recession, growth is slowing. That bodes better for bonds, where yields may track lower as the Fed eases, as opposed to equities, where earnings may be challenged as growth slows.
Second, lean into market moves that election outcomes could accelerate. For several months, Matt Hornbach and our interest rate strategy team have been calling for a steeper yield curve, driven by lower yields in shorter-maturity bonds. They have been guided by our economists’ steadfast view that the Fed would start cutting rates this year as inflation eases. We doubt that policies in Democratic win scenarios would change this trend, and a Republican win could accelerate it in the near term, as higher tariffs would imply pressure on growth and possibly further Fed dovishness. Pricing that path could steepen the yield curve further.
And of course, there’s still several weeks before the election to get smart on the economic and market impacts of a range of election outcomes. We’ll keep you updated here.
Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Our US Public Policy Strategist explains the potential impact of the upcoming presidential election on the healthcare sector, including whether the outcome is likely to drive a major policy shift.
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Welcome to Thoughts on the Market. I’m Ariana Salvatore, Morgan Stanley’s US Public Policy Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll focus on what the US election means for healthcare.
It’s Tuesday, September 17th at 10am in New York.
Around elections what we tend to see is voters rank healthcare pretty high among their priority list. And for that reason it’s not surprising that it generates significant debate as well as investor concern – about everything from drug pricing to potential sweeping reforms. We think that the 2024 election is unlikely to transform the US healthcare system. But there are still policies to watch that could change depending on the outcome. We outlined these in a recent note led by our equity research colleagues Erin Wright and Terence Flynn.
To start, we think bipartisan policies should continue uninterrupted, regardless of the election outcome. Certain regulations requiring drug price and procedural transparency, for example, which affect hospitals and health plans, are unlikely to change if there is a shift of power next year. We’ve seen some regulations from the Trump era kept in place by the Biden administration; and similarly during the former president’s term there were attempts at bipartisan legislation to modify the Pharmacy Benefit Management model.
There are some healthcare policies that could be changed through the tax code, including the extension of the COVID-era ACA subsidies. In President Biden’s fiscal year [20]25 budget request, he called for an extension of those enhanced subsidies; and Vice President Kamala Harris has proposed a similar measure. As we’ve said before on this podcast, we think tax policy will feature heavily in the next Congress as lawmakers contend with the expiring Tax Cuts and Jobs Act. So many of these policies could come into the fold in negotiations.
Aside from these smaller potential policy changes, we think material differences to the healthcare system as we know it right now are a lower probability outcome. That’s because the creation of a new system - like Medicare for All or a Public Option - would require unified Democratic control of Congress, as well as party unanimity on these topics. Right now we see a dispersion among Democrats in terms of their views on this topic, and the presence of other more motivating issues for voters; mean[ing] that an overhaul of the current system is probably less likely. Similarly, in a Republican sweep scenario, we don't expect a successful repeal of the Affordable Care Act as was attempted in Trump’s first administration.
The makeup of Congress certainly is important, but there are some actions that the President can leverage unilaterally to affect policy here. For example, former President Trump issued several executive orders addressing transparency and the PBM model.
If we look at some key industries within Healthcare, our equity colleagues think Managed Care is well positioned heading into this relatively more benign election cycle. Businesses and investors are focusing on candidates' approaches to the Medicare Advantage program and the ACA Exchange, which has subsidies set to expire at the end of 2025.
Relative to prior elections, Biopharma should see a lower level of uncertainty from a policy perspective given that the Inflation Reduction Act, or the IRA, in 2022 included meaningful drug pricing provisions. We also think a full-scale repeal of the IRA is unlikely, even in a Republican sweep scenario. So, expect some policy continuity there.
Within Biotech, the path to rate cuts is likely a more significant driver of near-term Small and Mid-Cap sentiment rather than the 2024 election cycle. Our colleagues think that investors should keep an eye on two election-related factors that could possibly impact Biotech including potential changes to the IRA that may impact the sector and changes at the FTC, or the Federal Trade Commission, that could make the M&A environment more challenging.
As always, we will continue to keep you abreast of new developments as the election gets closer.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.
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With the Federal Reserve poised to make its long-awaited rate cut this week, our CIO and Chief US Equity Strategist tells us why investors have pivoted their concerns from high inflation to slowing growth.
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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 what to expect as the Fed likely begins its long-awaited rate cutting cycle this week.
It's Monday, Sept 16th at 10:30am in New York.
So let’s get after it.
After nearly 12 months of great anticipation, the Fed is very likely to start its rate cutting cycle this week. The old adage that it is often easier to travel than arrive may apply as markets appear to have priced an aggressive Fed cutting cycle into the middle of next year while assuming a soft-landing outcome for the economy.
More specifically, the two-year US Treasury yield is now 180 basis points below the Fed Funds Rate which is in line with the widest spread in 40 years, a level associated with a hard landing. This is the bond market's way of messaging to the Fed that they are late in getting started with rate cuts. This doesn't mean the Fed can't get ahead of it, but they may need to move faster to keep investors' hopes alive.
As a result, the odds of a 50 basis point cut have increased over the past week but it’s still well below a certainty. This is unusual going into an FOMC meeting and is setting markets up for a greater surprise either way. How the markets react to what the Fed does this week will have an even greater influence on investor sentiment than usual, in my view. Ideally, rates should rise at both the front and back end if the bond market likes the Fed’s actions because it signals they aren’t as far behind in trying to orchestrate a soft landing. Conversely, a fall in rates will be a vote of lower confidence.
On the other side of the ledger, we have the equity market which appears to be highly convicted that the Fed has already secured the soft landing, at least at the index level. Today, the S&P 500 trades at 21x forward earnings, which also assumes a healthy path of 10 percent earnings growth in 2024 and 15 percent growth in 2025.
Under the surface, the market has skewed much more defensively as it worries more about growth and less about high inflation. I have commented extensively in this podcast about this shift that started in April and why we have been persistently recommending defensive quality for months. With the significant outperformance of defensive sectors since April, the internals of the equity market may not be betting on a soft landing and reacceleration in growth as the S&P 500 index suggests.
Keep in mind that the S&P 500 is a defensive, high-quality index of stocks and so it typically holds up better than most stocks as growth slows in a late cycle environment like today. These growth concerns will likely persist unless the data turn around, irrespective of what the Fed does this week.
In the 11 Fed rate cutting cycles since 1973, eight were associated with recessions while only three were not. The performance over the following year was very mixed with half negative and half positive with a very wide but equal skew. Specifically, the average performance over the 12 months following the start of a Fed rate cutting cycle is 3.5 percent – or about half of the longer-term average returns. The best 12-month returns were 33 percent, while the worst was a negative 31 percent.
Bottom line, it’s generally a toss-up at the index level. The analysis around style and sectors is clearer. Value tends to outperform growth into the first cut and underperform growth thereafter. Defensives tend to outperform cyclicals both before and after the cut. Large caps also tend to outperform small caps both before and after the first rate cut. These last two factor dynamics are supportive of our defensive and large cap bias as Fed cuts often come in a later cycle environment. It’s also why we are sticking with it.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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After sending global markets in a brief tailspin in early August, the Bank of Japan is once again the center of attention. Our Global Chief Economist and Chief Asia Economist discuss the central bank’s next steps to help ease volatility and inflation.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.
Chetan Ahya: And I'm Chetan Ahya, Chief Asia Economist.
Seth Carpenter: And on today's episode, Chetan and I are going to be discussing the Bank of Japan and the role it has been playing in recent market turmoil.
It's Friday, September 13th at 12.30pm in New York.
Chetan Ahya: And it's 5.30pm in London.
Seth Carpenter: Financial markets have been going back and forth for the past month or so, and a lot of what's been driving the market movements have been evolving expectations of what's going on at central banks. And right at the center of it has been the Bank of Japan, especially going back to their meeting at the very end of July.
So, Chetan, maybe you can just level set us about where things stand with the Bank of Japan right now? And how they've been communicating with markets?
Chetan Ahya: Well, I think what happened, Seth, is that Bank of Japan (BoJ) saw that there was a significant progress in inflation and wage growth dynamic. And with that they went out and told the markets that they wanted to start now increasing rate hikes. And at the same time, the end was weakening.
And to ensure that they kind of convey to the markets that they want to be now taking rates higher, the governor of the central bank came out and indicated that they are far away from neutral.
Now while that was having the desired effect of bringing the yen down, i.e. appreciated. But at the same time, it caused a significant volatility in the equity markets and make it more challenging for the BoJ.
Seth Carpenter: Okay, so I get that. But I would say the market knew for a long time that the Bank of Japan would be hiking. We've had that in our forecast for a while. So, do you think that Governor Ueda really meant to be quite so aggressive? That meeting and his comments subsequently really were part of the contribution to all of this market turmoil that we saw in August. So, do you think he meant to be so aggressive?
Chetan Ahya: Well, not really. I think that's the reason why what we saw is that a few days later, when the deputy governor Uchida was supposed to speak, he tried to walk back that hawkishness of the governor. And what was very interesting is that the deputy governor came out and indicated that they do care for financial conditions. And if the financial conditions move a lot, it will have an impact on growth and inflation; and therefore, conduct of monetary policy.
In that sense, they conveyed the endogeneity of financial conditions and their reaction function. So, I think since that point of time, the markets have had a little bit of reprieve that BoJ will not take up successive rate hikes, ignoring what happens to the financial conditions.
Seth Carpenter: But this does feel a little bit like some back and forth, and we've seen in the market that the yen is getting a little bit whipsawed; so the Bank of Japan wants to hike, and markets react strongly. And then the Bank of Japan comes out and says, ‘No, no, no, we're not going to hike that much,’ and markets relax a little bit. But maybe that relaxation allows them to hike more.
It kind of reminds me, I have to say, of the 2014 to 2015 period when the Federal Reserve was getting ready to raise interest rates for the first time off of the zero lower bound after the financial crisis. And, you know, markets reacted strongly -- when then chair Yellen started talking about hiking and because of the tightening of financial conditions, the Fed backed down.
But then because markets relaxed, the Fed started talking about hiking again. Do you think that's an apt comparison for what's going on now?
Chetan Ahya: Absolutely, Seth. I think it is exactly something similar that is going on with Bank of Japan.
Seth Carpenter: So, I guess the question then becomes, what happens next? We know with the Fed, they eventually did hike rates at the end of 2015. What do you think we're in line for with the Bank of Japan, and is it likely to be a bumpy ride in the future like it has been over the past couple months?
Chetan Ahya: Well, so I think as far as the market’s volatility is concerned, we do think that the fact that the BoJ has come out and indicated that their reaction function is such that they do care about financial conditions. Hopefully we should not see the same kind of volatility that we saw at the start of the month of August.
But as far as the next steps are concerned, we do see BoJ taking up one more rate hike in January 2025. And there is a risk that they might take up that rate hike in December.
But the reason why we think that they will be able to take up one more rate hike is the fact that there is continued progress on wage growth and inflation; and wage growth is the most important variable that BoJ is tracking.
We just got the last month's wage growth number. It has risen up to 3 percent. And going forward, we think that as the BoJ gets comfort that next year's wage negotiations are also heading in the right direction, they will be able to take one more rate hike in January 2025.
Well, Seth, I think, you know, when we are talking about this volatility that we saw in the financial markets and particularly yen, the other side of this story is what the Fed has to do, and what is Fed indicating in terms of its policy path. And we saw that, after the nonfarm payrolls data, Governor Waller was indicating that the Fed could consider front-loading its rate cuts. What are your thoughts on that?
Seth Carpenter: So, we do think the Fed's getting ready to start cutting rates. Our baseline is that they move at 25 increments per meeting, from now through the middle of next year. I would take Governor Waller's comments though about front-loading cuts -- which I took to mean, you know, the possibility of 50 basis point rate moves -- very much in context, and with a grain of salt.
When he gave that speech, I think what he was trying to do, and I think the last paragraph of that speech really bears it out. He was saying there's a lot of uncertainty here. He said, if the data suggests that they need to front load rates, then he would advocate for it. But he also said that, if the data implied that they need to cut at consecutive meetings, he'd be in favor of that as well. So, he was saying that the data are going to be the thing that drives the policy decisions.
But thanks for asking that question. And thanks to the listeners. If you enjoy this podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or a colleague today.
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Our Head of Corporate Credit Research looks at the Fed’s approach to rate cuts, seasonal trends and the US election to explain why the next month represents a crucial window for credit’s future.
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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 discuss why the next month is a critical window for credit.
It's Thursday, September 12th at 9am in New York.
We’ve liked corporate credit as an asset class this year and think the outlook over the next 6-12 months remains promising. At a high level, credit likes moderation, and that continues to be exactly what Morgan Stanley’s economists are forecasting; with moderate growth, moderate inflation, and moderating policy in the US and Europe. Meanwhile, at the ground level, corporate balance sheets are in good shape, and demand for fixed income remains strong, dynamics that we think are unlikely to shift quickly.
But this good credit story is now facing a critical window. As we’ve discussed recently on this program, the Fed has taken a risk with monetary policy, continuing to keep interest rates elevated despite increasing indications that they should be lower. U.S. inflation has been coming down rapidly, to the point where the market now thinks the rate of inflation over the next two years will be below what the Fed is targeting. The labor market is slowing, and government bond markets are now assuming that the Fed will have to make much more significant adjustments to policy.
And so, this becomes a race. If the economic data can hold up for the next few months, while the Fed does make those first gradual rate cuts, it will help reassure markets that monetary policy is reasonable and in-line with the underlying economy. But if the data weakens more now, the market is vulnerable. Monetary policy works with a lag, meaning rate cuts are not going to help anytime soon. And so, it becomes easier for the market to worry that growth is slowing too much, and that the cavalry of rate cuts will be too late to arrive.
The second immediate challenge is so-called seasonality. Over almost a century, September has seen significantly weaker performance relative to any other month. Seasonality always has an element of mysticism to it, but in terms of specific reasons why markets tend to struggle around this time of year, we’d point to two factors. First, after a summer lull, you tend to see a lot of issuance, including corporate bonds issuance. And for Equities, September often sees more negative earnings revisions, as companies aim to bring full-year estimates in line with reality. Lots of supply and weaker earnings revisions are often a tough combination.
A final element of this critical window is the approaching US election. This appears to be an extremely close race between candidates with very different policy priorities. If investors get more nervous that monetary policy is mis-calibrated, or seasonality is unhelpful, the approaching election provides yet another reason for investors to hold back.
All of this is why we think the next month is a critical window for credit, and why we’d exercise a little bit more caution than we have so far this year. But we also think any weakness is going to be temporary. By early November, the US election will be over, and we think growth will be holding up, inflation will keep coming down, and interest rate cuts will be well underway. And while September is historically a bad month for stocks and credit, late-October onward is a different and much better story. Any near-term softness could still give way to a stronger finish to the year.
Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
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Office buildings continue to struggle in the post-pandemic era, but our Chief Fixed Income Strategist notes that other properties have turned a corner.
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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, today I'll be talking about how the challenges facing the US commercial real estate markets have evolved and talk about where they are headed next.
It's Wednesday, Sep 11th at 10 am in New York.
Over the last year and half, the challenges of commercial real estate, or CRE in short, have been periodically in the spotlight. The last time we discussed this issue here was in the first quarter of this year. That was in the aftermath of loan losses announced by a regional bank that primarily focused on rent-stabilized multifamily and CRE lending in the New York metropolitan area. At the same time, lenders and investors in Japan, Germany and Canada also reported sizable credit losses and write-down related to US commercial real estate.
At that time, we had said that CRE issues should be scrutinized through the lenses of lenders and property types; and that saw meaningful challenges in both – in particular, regional banks as lenders and office as a property type.
Rolling the calendar forward, where do things stand now?
Focusing on the lenders first, there is some good news. While regional bank challenges from their CRE exposures have not gone away, they are not getting any worse. That means incremental reserves for CRE losses have been below what we had feared. Our economists’ expectations of Fed’s rate cuts on the back of their soft-landing thesis, gives us the conviction that lower rates should be an incremental benefit from a credit quality perspective for banks because it alleviates pressure on debt service coverage ratios for borrowers. Lower rates also give banks more room to work with their borrowers for longer by providing extensions. For banks, this means while CRE net charge-offs could rise in the near term, they are likely to stabilize in 2025.
In other words, even though the fundamental deterioration in terms of the level of delinquencies and losses may be ahead, the rate of change seems to have clearly turned. In that sense, as long as the rate cuts that we anticipate materialize, the worst of the CRE issues for regional banks may now be behind us.
From the lens of property types, it is important not to paint all property types with the same brushstroke of negativity. Office lots remain the pain point. Looking at the payoff rates in CMBS pools gives us a granular look at the performance across different property types.
Overall, 76 per cent of the CRE loans that matured over the past 12 months paid off, which is a pretty healthy rate. However, in office loans, the payoff rate was just 43 per cent. Other property types were clearly much better. For example, 100 per cent of industrial property loans, 96 per cent of multi-family loans, 89 per cent of hotel loans that matured in the last 12 months paid off. The payoff rates in retail property loans were a bit lower but still pretty healthy at 76 per cent, in clear contrast to office properties. Delinquency rates across property types also show a similar trend with office loans driving the lion’s share of the overall increase in delinquencies.
In short, the secular headwinds facing the office market have not dissipated. Office property valuations, leasing arrangements and financing structures must adjust to the post-pandemic realities of office work. While this shift has begun, more is needed. So, there is really no quick resolution for these challenges which we think are likely to persist. This is especially true in central business district offices that require significant capex for upgrades or repurposing for use as residential housing.
Overall, we stick to our contention that commercial real estate risks present a persistent challenge but are unlikely to become systemic for the economy.
Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen to this and share Thoughts on the Market with a friend or colleague today.
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With the generational shift in the US housing market underway, our analysts discuss the impact this trend will have on residential real estate investing.
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Ron Kamdem: Welcome to Thoughts on the Market. I'm Ron Kamdem, head of Commercial Real Estate Research and the US Real Estate Investment Trust team within Morgan Stanley Research.
Lauren Hochfelder: And I'm Lauren Hochfelder, Co-Chief Executive Officer of Morgan Stanley Real Estate Investing, the global private real estate investment arm of the firm.
Ron Kamdem: And on this special episode of Thoughts on the Market, we’ll discuss the tangible impact of shifting demographics on the residential real estate investing space.
It's Tuesday, September 10th at 10 am in New York.
So, Lauren, for several years now, we've been hearing about millennials overtaking the baby boomers. As a reminder, millennials are people between the age of 28 and 43. So someone like me. And there’s about 72 million millennials right now. Baby boomers are around 59 to 78; and there's about 69 million at the moment. This demographic shift will have a profound impact on all sectors of the economy, including residential housing. So, let's lay the foundation first. What are the current needs of baby boomers and millennials when it comes to their homes?
Lauren Hochfelder: Yeah, this is such an interesting moment, Ron, because as you say, their needs are shifting. Over the last 15 years, what have millennials wanted? They have wanted multifamily. They have wanted rental apartment units. And by the way, they've wanted, generally speaking, small ones in cities.
Ron Kamdem: Yup.
Boomers? They have been disproportionately residing in single family homes that they own, and that they've owned for a long time. But here we are, as millennials reach peak household formation years and boomers approach their 80-year-old mark. There's a real shift.
We have millennials growing up and growing out, and boomers growing older. And that means millennials need more space; boomers need more services. Housing with increased care options. And that really leads to three things.
One, pockets of oversupply of multifamily. Developers develop to the rearview mirror; and we have way too much of what they wanted yesterday and too little of what they wanted to what they want tomorrow. The second is increased demand for single family rental in more suburban locations to meet the needs of those millennials. And the third is increased demand for senior housing for the boomers.
Ron Kamdem: Excellent. So, when we look at the next five to ten years, let's consider each of these generations. Demand for senior housing is increasing significantly. Where are we in this process, and what's your expectation for the next decade?
Lauren Hochfelder: Look, we think this is the golden age for senior housing. The demand wave is upon us, supply is way down. And by the way, labor costs, which have been a real headwind, are finally abating. New construction of senior housing has basically fallen off a cliff. It is down 75 per cent from its peak; if you look at the first quarter of this year, it's basically at GFC levels. And third, the senior wealth effect. Not only do seniors need this product, they can afford it.
They have been in those homes, they've owned those homes for a very long time, and over that period, home prices have appreciated. So, seniors are in a position where they can really afford to move into these senior living facilities.
Ron Kamdem: And what about millennials? As they get older, how are their housing needs evolving?
Lauren Hochfelder: I'd say three things. It's they need more space. So single family rental versus multifamily. The second is migratory shifts, right? It's no longer -- I have to live in San Francisco or New York. You're seeing real growth in the southeast and Texas. And the third is this preference to rent. Now, a lot of that's affordability driven.
Ron Kamdem: Right.
Lauren Hochfelder: But I think there's also mobility. There's just general preference. I mean, this is a generation that doesn't own a landline, right? So, they want to rent. They don't want to buy.
Ron Kamdem: So, given these trends as an actual real estate investor, how do you view the supply and demand dynamics within residential investing? And where do you see the biggest opportunities?
Lauren Hochfelder: Look, I think housing in general is attractive to invest in. There's simply too little of it. But you really can't paint a broad brush. You need to invest in the type of housing with the best outlook. And you and I can sit here and debate what's going to happen with interest rates. But what is not debatable is that these two large age groups are going to drive demand disproportionately.
And so rather than speculating on interest rates, let's calculate the number of people in these generations. And so that means that we want to invest in single family. We want to invest in seniors housing, and we want to invest in the markets where these groups want to live.
So, let's turn it around. We've been talking about this growing senior population and, you know, we and my side of the business. We've been investing in a lot of senior housing communities. But how does this affect your world? You cover the entire US public real estate investment trust universe. How are you thinking about these things?
Ron Kamdem: So, our investors are really focused on secular trends that they can invest over a long period of time. And there's really two that I would like to call out. So, the first is the rise of senior housing communities.
As you mentioned earlier, if you think about the US population, the population that's 65 and over is really the addressable market. And we do expect that number to rise to about 21 per cent of the population or 71 million people.
Lauren Hochfelder: So, think about one in four people being eligible or appropriate for senior housing. It's amazing.
Ron Kamdem: That’s an incredible demand function.
Now, the second piece of it is historically these seniors have actually shied away from senior housing. So, the first sort of trend and inflection point that I want to call out is we do think there's an opportunity for penetration race -- not only to flatten out, but to start increasing. And that's driven exactly by your earlier comment, which is affordability. Remember, about 75 per cent of seniors actually own their own homes, and they've seen a significant amount of price appreciation. Since 2010, their home prices have gone up 80 per cent, which is about two times the rate of inflation.
Second investable trend is the move of outpatient services outside of the hospital setting. So, if you go back to the eighties, only about 16 per cent of services were being done outside of the hospital. In 2020, that number was close to 68 per cent and we think that's going to keep rising. The reason being because of surgical advances, there's a lot of projects that can be done outside of the hospital. Whether it's, you know, knee replacements, trigger finger surgery, cataract surgeries, and so forth. In addition to that, the expansion of Medicare coverage has allowed for reimbursement of these services, again, outside of the hospital.
So, we think these are trends that are in place that should continue over the next sort of decade and drive more demand to the healthcare real estate space.
Lauren Hochfelder: So, what should we be nervous about? What concerns you?
Ron Kamdem: Look, I think on the senior housing side, there's always two factors that we focus on. So, the first is labor. This remains a very labor-intensive industry. But in the US, historically, people coming out of college, they're not necessarily going into the health care space. So, there's been moments of labor shortages. This happened exactly after the pandemic. Luckily, today, the labor situation has abated and you're seeing sort of labor costs back to inflationary type levels.
The second piece of it is just the age of the facilities. Now, keep in mind, there's still a lot of facilities with the average age of about 41, right. And everybody has in the back of their mind, these older facilities with older carpets and so forth. So, when we're thinking about investing in the space, we're always focused on the newer assets, the better quality that are going to provide a better experience for the tenant.
Lauren Hochfelder: So, given these shifts, what segments of your world are poised to benefit the most?
Ron Kamdem: The real estate public market, there's about 160 REITs across 16 different subsectors; and the senior housing subsector is by far the most compelling in our minds. If you think about the REIT market, the average sort of earnings growth is 3 to 4 per cent. However, the senior housing sector, we think you can get 10 per cent or more growth over the next three to five years. The reason being when the pandemic hit, this was an industry that saw occupancy go from 90 per cent to 75 per cent.
There was a moment in time where people thought you'd never put any seniors in the facility again. Well, the exact opposite has happened, and now we're seeing occupancy gains of about 300 basis points of about 3 per cent every year. On top of some pricing power, call it 5, 6 or 7 per cent. So, we're looking at a sector where we think organically you can grow sort of high single digits. With a little bit of operating leverage, you can get to a total earning growth of double digits, which is very compelling relative to the rest of the REIT market.
Lauren Hochfelder: Let's go back to your generation, as you said. Let's go back to the millennials. How do those shifting needs affect which part of the universe you would invest in?
Ron Kamdem: One of the things that I think every real estate owner’s thinking about is how to integrate their platform so that they're more millennial friendly. They're going online. They're using their phones, and I think we're seeing a much bigger investment in marketing dollars on a web presence, on a web platform, and on a mobile friendly app, certainly to be able to interface with that millennial and help with customer acquisitions.
So, I would say that's probably the biggest difference -- is how you target that population in a different way than you did historically.
Lauren Hochfelder: Yeah, I mean we all shop online, shouldn't we get our homes online, right?
Ron Kamdem: That's right. All right, Lauren. Well, thanks for taking the time to talk.
Lauren Hochfelder: Yeah, this been great, Ron. I always enjoy us catching up.
Ron Kamdem: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen. It helps more people to find the show.
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Lauren Hochfelder is not a member of Morgan Stanley’s Research department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research department and from the views of others within Morgan Stanley.
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Following weaker-than-expected August jobs data, our CIO and Chief U.S Equity Strategist lays out how the Federal Reserve can ease concerns about a possible hard landing.
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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 the labor market’s impact on equity markets.
It's Monday, Sept 9th at 11:30am in New York. So let’s get after it.
Last week, I wrote a detailed note discussing the importance of the labor data for equity markets. Importantly, I pointed out that since the materially weaker than expected July labor report, the S&P 500 has bounced more than other "macro" markets like rates, currencies and commodities. In the absence of a reacceleration in the labor data, we concluded the S&P 500 was trading out of sync with the fundamentals.
Over the past week, we received several labor market data points, which were weaker than expected. First, the Job Openings data for July was softer than expected coming in at 7.7mm versus the consensus expectation of 8.1mm. In addition, June's initial result was revised lower by 274k. This essentially supported the view that the weak payrolls data in July may, in fact, not be related to weather or other temporary issues.
Second, the job openings rate fell to 4.6%, which is very close to the 4.5% level Fed Governor Waller has cited as a threshold below which the unemployment rate could rise much faster. Third, the Fed's Beige Book came out last week. It indicated that activity remains sluggish with 9 of the 12 Federal Reserve districts reporting flat or declining activity in August, though commentary on labor markets was more neutral, rather than negative. These data sync nicely with the Conference Board’s Employment Trends Index, which I find to be a very objective aggregate measure of the labor market's direction. This morning, we received the latest release for August Conference Board labor market trends and the trend remains down, but not necessarily recessionary.
Of course, the main event last week was Friday's monthly jobs and unemployment reports, where the payroll survey number came in below consensus at 142k. In addition, last month's result was revised lower from 114k to 89k. Meanwhile, the unemployment rate fell by only a couple of basis points leaving investors unconvinced that July’s labor weakness was overstated.
Given much of these labor and other growth data have continued to skew to the downside, the macro markets (like rates, currencies, and Commodities) have been trading with more concern about potential hard landing risks. Perhaps nowhere is this more obvious than with 2-year US Treasuries. As of Friday, the spread between the 2-year Treasury yields and the Fed Funds Rate matched the widest levels in the past 40 years. This pricing suggests the bond market believes the Fed is behind the curve from an easing standpoint. On Friday, the equity market started to get in sync with this view and questioned whether a 25bp cut in September would be an adequate policy response to the labor data. In the context of an equity market that is still quite rich and based on well above average earnings growth assumptions, the correction on Friday seems quite appropriate.
In my view, until the bond market starts to believe the Fed is no longer behind the curve, labor data reverses course and improves materially or additional policy stimulus is introduced, it will be difficult for equity markets to trade with a more risk on tone. This means valuations are likely to remain challenged for the overall index, while the leadership remains more defensive and in line with our sector and stock recommendations. We see two ways in which the Fed can get ahead of the curve—either faster cutting than expected which is unlikely in the absence of recessionary data; or the labor data starts to improve in a convincing manner and 2-year yields rise. Given the Fed is in the blackout period until next week’s FOMC meeting, and there are not any major labor data reports due for almost a month, volatility will likely remain elevated and valuations under pressure overall. This all brings our previously discussed fair value range for the S&P 500 of 5000-5400 back into view.
Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen, and share Thoughts on the Market with a friend or colleague today.
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Our Head of Corporate Credit Research, Andrew Sheets, expects a sticky but shallow cycle for defaults on loans, with solid quality overall in high-grade credit.
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Andrew Sheets: 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 discuss some longer-term thoughts on the credit market and the economic cycle.
It's Friday, September 6th at 2pm in London.
Concerns around US growth have risen, an issue that will probably persist even after today’s US Payrolls report came roughly inline with expectations. At Morgan Stanley, we continue to expect moderate slowing in growth, not a slump. By the middle of next year, our economists see growth slowing to a still respectable 2% growth rate, and a total of seven rate cuts.
While growth is set to slow, we think corporate balance sheet metrics are unusually good in the face of this slowing. Indeed, the credit quality of the US investment grade and BB credit markets, which represent the vast majority of corporate credit outstanding, have actually improved since the Fed started hiking rates.
Now, looking ahead, there's understandable concern that these currently good credit metrics won't be sustainable as companies will have to refinance the very cheap borrowing that they received immediately after COVID, with the more expensive costs of today's currently higher yields. But we actually think balance sheets will be reasonably robust in light of this reset, and so their ultimate rate sensitivity could be relatively low.
One reason is that a wave of refinancing means companies have already tackled a significant portion of their upcoming debt, reducing the so-called rollover or refinancing risk. Interest coverage for floating rate borrowers has stabilized and should actually improve as the Fed starts to lower rates.
The debt service costs for higher rated companies will increase as cheaper debt matures and has to be replaced with more expensive borrowing; but we stressed this is a pretty slow process given the long-term nature of a lot of this borrowing. And so, overall, we think the headwinds from higher debt costs are going to be manageable, with the problems largely confined to a smaller cohort of the lowest quality issuers.
We think all of that will drive a so-called sticky but shallow default cycle, with defaults driven by higher borrowing costs at select issuers rather than a single problem sector or particularly poor corporate earnings. And there are also some important offsets. Morgan Stanley's forecast suggests that the Fed will be cutting rates, which will reduce overall borrowing costs over the medium term. And another notable theme over the last two years is that more defaults have been becoming so-called restructurings rather than bankruptcies. These restructurings are more likely to leave a company operating -- just under new ownership -- and create less negative feedback into the real economy.
Now, against all this, we're mindful that credit spreads are tight, i.e. lower than average. But importantly, we don't think this reflects some sort of euphoria from either the lenders or the borrowers.
All-in borrowing costs for corporates remain high, and that's made corporates less likely to be aggressive or increase their leverage. Indeed, since COVID, the overall high yield bond and loan markets have actually shrunk. Leverage buyout activity has been muted and corporate leverage has gone sideways.
These are not the types of things you see when corporates are being particularly aggressive and credit unfriendly. Credit markets love moderation and that's very much what Morgan Stanley's economic forecasts over the medium term expect. Spreads may be tight. But we think they're currently supported by strong fundamentals, modest supply, and improving technicals.
Today's roughly inline payroll number won’t resolve the uncertainty around growth, but longer term, we think the picture remains encouraging.
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.
- Visa fler
