Thoughts on the Market

Elections, geopolitical risks and rate cuts are driving markets in the short term. But there are three trends that could provide long-term investment opportunities.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about three key investment themes for 2024. It's Wednesday, January 17th at 10 a.m. in New York.

Markets will have plenty of potential near-term catalysts to contend with in 2024. There's elections, geopolitical risks as tensions rise with regional conflicts in Europe and the Middle East, and key debates about the timing and pace of central bank rate cuts. We'll be working hard to understand those debates, which will influence how markets perform this year.

But what if you're thinking a bit longer term? If that's you, we've got you covered. As it's become our annual tradition, we’re rolling out three secular themes that Morgan Stanley research will be focused on developing collaborative, in-depth research for, in an effort to identify ways for investors to create potential alpha in their portfolio for many years to come.

The first theme is our newest one, longevity. It's the idea that recent breakthroughs in health care could accelerate the trend toward longer and higher quality human lives. To that end, my research colleagues have been focused on the potential impacts of innovations that include GLP-1 drugs and smart chemo. Further, there's reason to believe similar breakthroughs are on the horizon given the promise of AI assisted pharmaceutical development. And when people lead longer lives, you'd expect their economic behavior to change. So there's potential investment implications not just for the companies developing health care solutions, but also for consumer companies, as our team expects that, for example, people may consume 20 to 30% less calories on a daily basis. And even asset managers are impacted, as people start to manage their investments differently, in line with financing a longer life span. In short, there's great value in understanding the ripple effects into the broader investment world.

The second theme is a carryover from last year, the ongoing attempts to decarbonize the world and transition to clean energy. Recent policies like the Inflation Reduction Act in the US include substantial subsidies for clean energy development. And so we think it's clear that governments and companies will continue to push in this direction. The result may be a tripling of renewable energy capacity by 2030. And while this is happening, climate change is still asserting itself and investment should pick up in physical capital to protect against the impact. So all these efforts put in motion substantial amounts of capital, meaning investors need to be aware of the sectors which will be crimped by new costs and others that will see the benefits of that spend, such as clean energy.

Our third theme is also a carryover, the development of AI. In 2023, companies we deemed AI enablers, or ones who were actively developing and seeking to deploy that technology, gained about $6 trillion in stock market value. In 2024, we think we'll be able to start seeing how much of that is hype and how much of that is reality, with enduring impacts that can create long term value for investors. We expect clear use cases and impacts to productivity and company's bottom lines to come more into focus and plan active research to that end in the financials, health care, semiconductor, internet and software sectors, just to name a few. So stay tuned. We think these debates could define asset performance for many years to come. And so we're dedicated to learning as much as we can on them this year and passing on the lessons and market insights to you.

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As earnings season kicks off, market valuations continue to trend high based on major growth expectations. However, investors may want to keep an eye on liquidity.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, July 10th at 11 a.m. in New York. So let's get after it.

With year to date U.S. equity returns driven nearly 100% by higher valuations, the market either doesn't care about earnings or it expects a major reacceleration in growth both later this year and next. One might argue that the higher valuations are anticipating the end of the Fed's rate hiking campaign, even though the bond market doesn't seem to agree with that conclusion, given the recent rise in yields. In short, the price earnings ratio for the S&P 500 is up approximately 15%, and with interest rates up this year, the equity risk premium has collapsed by 100 basis points to its lowest level since the tech bubble era.

With second quarter earnings season beginning this week, 'better than feared' likely isn't going to cut it anymore. While earnings results so far this year remain right on track for the sharp earnings recession we forecast, we don't expect second quarter earnings to disappoint expectations in aggregate, given second quarter estimates have now been revised lower by 7.5% since the beginning of the year. Instead, we would point out that the consensus bottom-up second quarter EPS forecast for the S&P 500 is -7% year over year, hardly exciting. Furthermore, the consensus pushed out the trough earnings per share growth quarter from the first quarter to the second quarter over the last three months. We expect this trend to continue through the balance of the year, which would also be in line with our forecast. In other words, no big second half recovery as the consensus and valuations now expect. More specifically, third quarter is when our forecast starts to meaningfully diverge from the consensus. This means the key driver for stocks during this earnings season will come via company guidance for the out quarter rather than the second quarter results. We suspect some companies will begin to walk down the estimates, while others will continue to tell a more optimistic story. In short, this earnings season should matter more than the prior two, and should provide significant alpha opportunities for investors in terms of both longs and shorts.

In our view, the year to date multiple expansion has occurred for a couple of reasons beyond earnings growth optimism. One, excess liquidity provided by global central banks amid a weaker U.S. dollar and the FDIC bail out of depositors. And two, excitement around artificial intelligence’s potential impact on productivity and earnings growth. On the liquidity front we think that support is starting to fade. One way of measuring liquidity is global money supply in U.S. dollars. One of the reasons we turned tactically bullish last October was due to our view that the U.S. dollar was topping. This, along with the China reopening and the Bank of Japan's monetary policy actions, added close to $7 trillion to global money supply over the following six months. We've pointed out previously that the rate of change on global money supply is correlated to the rate of change on global equities, as well as the S&P 500. Over the past few months, global money supply in U.S. dollars has begun to shrink again, just as the Treasury begins to issue over a trillion dollars of supply to restock its coffers post a debt ceiling resolution last month.

As an early indicator that market liquidity is fading, nominal ten-year yields broke out last week above the psychologically important 4% level, and real rates are making new cycle highs. Interest rate volatility also picked up as uncertainty about the Fed's next moves increased. Neither higher interest rate levels nor volatility are generally conducive to higher equity valuations.

Bottom line, with earnings season upon us, we aren't expecting any fireworks from the earnings reports directly. However, with expectations for growth now much higher than six months ago, we suspect it will be a 'sell the news' event for many stocks, no matter what the companies post, as the market begins to look ahead to what is likely going to disappoint lofty expectations.

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Third-quarter consumer spending was strong, but a growing gap between middle- and higher-income consumers may affect the holiday shopping season.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley U.S Equity Strategy Team.

Sarah Wolfe: And I'm Sarah Wolfe and the U.S Economics Team.

Michelle Weaver: On this special episode of the podcast, we wanted to give you an update on the U.S. consumer and a preview of our holiday spending expectations this year. It's Tuesday, November 21st at 10 a.m. in New York.

Michelle Weaver: Sarah, recent data releases and your modeling suggests that U.S. consumer spending will begin to slow more meaningfully in 2024 and 2025. And you've argued that the slowdown in consumption is driven by a cooling labor market which weighs on real disposable income and elevated rates, putting further pressure on debt service costs. Given all this, would you say that the U.S. consumer is still healthy as we approach the holiday season and the end of the year?

Sarah Wolfe: You're exactly right. Consumer spending in the third quarter was very strong, and we know that there's going to be some more of that underlying momentum pulled into the fourth quarter, which includes holiday shopping season. Just last week, we got the October retail sales report, which did show a notable deceleration in consumer spending from the third quarter into the fourth quarter, but still positive retail sales. There are a few reasons, however, that, you know, we take pause at saying that the holiday shopping season is going to be very strong. The first is that there is this growing discrepancy between the health of a struggling lower middle income household versus the solid higher income household. The second is the expiration of the student loan forbearance. We know that about half of borrowers have started making payments as of October. And the third is the wallet shift away from goods and toward services that will impact the type of holiday spending. I would like to hone in on this discrepancy between the health of the lower middle income household and higher income households. We've highlighted that lower middle income households have been pulling back more in discretionary and they've been trading down as they're disproportionately being hit by tighter lending standards, higher inflation, higher debt service costs. And that's likely going to reflect the type of holiday spending that we see this year. In particular, higher income households have just more buying power, they're more willing to spend on experiences. And so we could just see that holiday shopping that's more skewed towards higher income spenders and that's more experience oriented will be the winners of this holiday shopping season.

Michelle Weaver: What specific trends have you seen in U.S. consumer spending in the third quarter? And what do you expect for the final quarter of this year?

Sarah Wolfe: Consumer spending in the third quarter was really strong because the labor market largely was very resilient, and as a result, we saw that there was just more momentum for goods and services spending, so both reaccelerated into the third quarter. However, what we could see is that there still is this clear preference shift on experiences over goods in particular accommodations, travel, etc. And so I think that's going to feed through into the type of holiday shopping that we see this year.

Michelle Weaver: And I know that during Covid, consumers were able to save a lot more money than usual. How are these excess savings balances looking now and what do you expect going forward?

Sarah Wolfe: We estimate that about 40% of the excess savings stockpile has been spent down, so there's still a pretty hefty 60% of excess savings sitting among households. However, we do not expect much more drawdown in excess savings across 2024. The reason is that our work shows that the excess savings stockpile is increasingly being held by the highest income households. They, first of all, have a lower propensity to consume out of savings, but more importantly, they had been willing to spend down their excess savings over the past two years. But that was to fuel their pent up demand for the services, economy recovery. And now that we've seen a full recovery on that side of the economy, there's really just less desire, less willingness to spend out of excess savings. Further, we're seeing that there's been an increasing movement from liquid to less liquid assets. So more and more of that savings is not just sitting in cash under the bed and so it's less likely to make its way into consumer spending. Michelle, based on your recent survey work in collaboration with U.S. Equity Analyst, wha...

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

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

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

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

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

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

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

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

But there’s also a longer run story here.

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

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

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

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

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As the advancement of generative AI takes off, how might this inflection point in technology impact markets, companies, and investors alike? Equity Analyst and Head of U.S. Internet Research Brian Nowak and Head of the U.S. Software Research Team Keith Weiss discuss.

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Brian Nowak: Welcome to Thoughts on the Market. I'm Brian Nowak, Equity Analyst and Head of U.S. Internet Research for Morgan Stanley.

Keith Weiss: And I'm Keith Weiss, Head of the U.S. Software Research Team.

Brian Nowak: Today, we're at Morgan Stanley's annual Tech, Media, and Telecom conference in downtown San Francisco. We've been here most of the week talking with industry leaders and emerging companies across the spectrum, and the topic on everyone's mind is clearly A.I. So today, we're going to share some of what we're hearing and our views on the rise of artificial intelligence tools. It's Thursday, March 9th at 2 p.m. here on the West Coast.

Brian Nowak: All week, Keith and I have been meeting with companies and speaking with new companies that are developing technologies in artificial intelligence. We've written research about how we think that artificial intelligence is reaching somewhat of an iPhone inflection moment with new people using new tools, and businesses starting to realize artificial intelligence is here to stay and can drive real change. Keith, talk to us about how we reached this moment of inflection and how do you think about some of the big picture changes across technology?

Keith Weiss: Well, thank you for having me, Brian. So we've been talking about artificial intelligence for some time now. Software companies have been infusing their solutions with machine learning driven type algorithms that optimize outcomes for quite some time. But I do think the iPhone analogy is apt, for two reasons. One, what we're talking about today with generative AI is more foundational technologies. You can almost think about that as the operating system on the mobile phone like the iOS operating system. And what we've heard all week long is companies are really seeing opportunity to create new apps on top of that operating system, new use cases for this generative AI. The other reason why this is such an apt analogy is, like the iPhone, this is really capturing the imagination of not just technology executives, not just investors like you and I, but everyday people. This is something that our kids are coming home from high school and saying, "Hey, dad, look at what I'm able to do or with chatGPT, isn't this incredible?" So you have that marketing moment of everybody realizes that this new capability, this new powerful technology is really available to everybody.

Keith Weiss: So, Brian, what do you think are going to be the impacts of this technology on the consumer internet companies that you cover?

Brian Nowak: We expect significant change. There is approximately $6 trillion of U.S. consumer expenditure that we think is going to be addressed by change. We see changes across search. We see more personalized search, more complete search. We see increasing uses of chatbots that can drive more accurate, personalized and complete answers in a faster manner across all types of categories. Think about improved e-commerce search helping you find products you would like to buy faster. Think about travel itinerary AI chatbots that create entire travel itineraries for your family. We see the capability for social media to change, better rank ordering and algorithms that determine what paid and organic content to show people at each moment. We see new creator tools, generative AI is going to enable people to make not only static images but more video based images across the entire economy. So people will be able to express themselves in more ways across social media, which will drive more engagement and ultimately more monetization for those social media platforms. We see e-commerce companies being able to better match inventory to people. Long tail inventory that previously perhaps could not find the right person or the right potential buyer will now better be able to be matched to buyers and to wallets. We see the shared economy across rideshare and food delivery also benefiting from this. Again, you're going to have more information to better match drivers to potential riders, restaurants to potential eaters. And down the line we go where we ultimately see artificial intelligence leading to an acceleration in digitization of consumers time, digitization of consumers wallets and all of that was going to bring more dollars online to the consumer internet companies.

Brian Nowak: Now that's the consumer side, how do you think about artificial intelligence impacting enterprise in the B2B side?

Keith Weiss: