Thoughts on the Market

As we head into a new year, Europe faces multiple challenges across inflation, energy and financial conditions, meaning investors will want to keep an eye on recession risk, the ECB, and European equities. Chief European Equity Strategist Graham Secker and Chief European economist Jens Eisenschmidt discuss.----- Transcript -----Graham Secker Welcome to Thoughts on the Market. I'm Graham Secker, Morgan Stanley's Chief European Equity Strategist.Jens Eisenschmidt And I'm Jens Eisenschmidt, Morgan Stanley's Chief European Economist.Graham Secker And on this special episode of the podcast, we'll discuss our 2023 outlook for Europe's economy and equity market, and what investors should pay close attention to next year. It's Monday, November the 28th, at 3 p.m. in London.Graham Secker So Jens, Europe faces multiple challenges right now. Inflation is soaring, energy supply is uncertain, and financial conditions are tightening. This very tricky environment has already impacted the economy of the euro area, but is Europe headed into a recession? And what is your growth outlook for the year ahead?Jens Eisenschmidt So yes, we do see a recession coming. In year-on-year terms we see negative growth of minus 0.2% next year. There's heterogeneity behind that, Germany is most affected of the large countries, Spain is least affected. In general, the drivers are that you mentioned, we have inflation that eats into real disposable income that is bad for consumption. We have the energy situation, which is highly uncertain, which is not great for investment. And we do have monetary policy that's starting to get restrictive, leading to a tightening in financial conditions which is actually already priced into markets. And, you know, that's the transmission lack of monetary policy. So that leads to lower growth predominantly in 23 and 24.Graham Secker And maybe just to drill into the inflation side of that a little bit more. Specifically, do you expect inflation to rise further from here? And then when you look into the next 12 months, what are the key drivers of your inflation profile?Jens Eisenschmidt So inflation will rise, according to our forecast, a little bit further, but not by an awful lot. We really see it peaking in December on headline terms. Just to remind you, we had an increase to 10.7 in October that was predominantly driven by energy and food inflation, so around 70% of that was energy and food. And of course, it's natural to look into these two components to see what's going to happen in the future. Here we think food inflation probably has still some time to go because there is some delayed response to the input prices that have peaked already at some point past this year. But energy is probably flat from here or maybe even slightly falling, which then gets you some base effects which will lead and are the main driver of our forecast for a lower headline inflation in the next year. Core inflation will be probably more sticky. We see 4% this year and 4% next. And here again, we have these processes like food inflation, services inflation that react with some lag to input prices coming down. So, it will take some time. Further out in the profile, we do see core inflation remaining above 2% simply because there will be a wage catch up process.Graham Secker And with that core inflation profile, what does that mean for the ECB? What are your forecasts for the ECB's monetary policy path from here?Jens Eisenschmidt We really think that the ECB needs to have seen the peak in inflation, and that's probably you're right, both core and headline. We see a peak, as I said, in December, core similarly, but at a high level and, you know, convincingly only coming down afterwards. So, the ECB will have to see it in the rear mirror and be very, very clear that inflation now is really falling before they can stop their rate hike cycle, which we think will be April. So, we see another 50 basis point increase in December 25, 25 in February, in March for the ECB then to really stop its hiking cycle in April having reached 2.5% on the deposit facility rate, which is already in restrictive territory. So, Graham, turning to you, bearing in mind all that just said about the macro backdrop, how will it impact European equities both near-term and longer term?Graham Secker Having been bearish on European equities for much of this year, at the beginning of October we shifted to a more neutral stance on European equities specifically. But we've had pretty strong rally over the course of the last couple of months, which sets us up, we think, for some downside into the first quarter of next year. In my mind, I really have the profile that we saw in 2008, 2009 around the global financial crisis. Then equity valuations, the price to earnings ratio troughed in October a weight, the market rallies for a couple of months, but then as the earnings downgrades kicked in the start of 2009, the actual index itself went back down to the lows. So, it was driven by earnings and that's what we can see happening again now. So perhaps Europe's PE ratio troughed at the end of September. But once the earnings downgrades start in earnest, which we think probably happens early in 2023, we can see that taking European equities back down towards the lows again. On a 12-month view from here we see limited upside. We have 1-2% upside to our index target by the end of next year. But obviously, hopefully if we do get that correction in the first quarter, then there'll be more to play for. We just got a time entry point.Jens Eisenschmidt Right. So how should I, as an investor, be positioned then in the year ahead?Graham Secker From a sector perspective, we would be underweight cyclicals. We think European earnings next year will fall by about 10% and we think cyclicals will be the key area of earnings disappointment. So, we want to be underweight the cyclicals until we get much closer to the economic and earnings trough. Having been positive on defensives for much of this year, we've recently moved them to neutral. We've upgraded the European tech sector, the medtech sector, and also luxury goods as well.Jens Eisenschmidt So what are the biggest risks then to your outlook for 23, both on the positive and the negative side?Graham Secker So on the positive side, I'd highlight two. Firstly, we have the proverbial soft landing when it comes to the economic backdrop, whether that's European and or global. That would be particularly helpful for equities, if that was accompanied by a bigger downward surprise on inflation. So, if inflation falls more quickly and growth holds up, that would be pretty positive for equity markets. A second positive would be any form of geopolitical de-escalation that would be very helpful for European risk appetites. And then on the negative side, the first one would be a bigger profit recession. If earnings do fall 10% next year, which is our projection, that would be very mild in the context of previous downturns. So in our base case, we see European earnings falling 20%, not the 10% decline that we see in that base case. The other negatives that I think a little bit about is whether or not what we've seen in the UK over the last couple of months could happen elsewhere. I.e., interest rates start to put more and more pressure on government finances and budget deficits, and we start to see a shift in that environment. So that could be something that could weigh on markets next year as well.Graham Secker But, Jens, thanks for taking the time to talk today.Jens Eisenschmidt Great speaking with you, Graham.Graham Secker And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts, and share the podcast with a friend or colleague today.

As we enter the holiday shopping season, the challenges facing consumers and retailers look quite different from 2021, so how will inflation and high inventory impact profit margins?----- Transcript -----Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley's U.S. Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, today I'll discuss our outlook for holiday spending in the U.S. It's Friday, November 25th, at 1 p.m. in New York. With the holiday shopping season just around the corner, we collaborated with the Morgan Stanley U.S. economics team and several of the consumer teams, namely airlines, consumer goods, e-commerce and electronics, to analyze our consumer survey data around holiday spending. The big takeaway is that this year's holiday shopping season is going to be quite different from the one we had last year. In 2021, we saw major supply chain malfunctions that impacted inventories and caused shoppers to start buying much earlier in the season. Limited supplies also gave companies a lot of pricing power, and this year the situation looks like it is shaping up to be the exact opposite. High inventory levels should push stores to offer discounts as they attempt to clear merchandise off shelves. Companies offering the biggest discounts will be able to grab the largest wallet share, but this will likely be a hit to their profit margins. Additionally, inflation has weighed heavily on consumers throughout the year, and it remains their number one concern heading into the holiday shopping season. This year, we're likely to see a very bargain savvy consumer. Our survey showed that 70% of shoppers are waiting for stores to offer discounts before they begin their holiday shopping, and the majority are waiting to see deals in excess of 20%. Additionally, consumers are likely to be more price sensitive this year. About a third of consumers said they would buy a lot less gifts and holiday products if stores raise prices. U.S. consumers are largely expecting to spend about the same amount on holiday gifts and products this year versus last year. So retailers will be competing for a similarly sized pool of revenue as last year, and will have to offer competitive prices to get shoppers to choose their products. This creates a really tough environment for profit margins. We also asked consumers specifically if they are planning to spend more or less this year in a variety of popular gift areas. The biggest spending declines are expected for luxury gifts, sports equipment, home and kitchen and electronics, all areas where we saw overconsumption during lockdown. Looking at the industry implications, services are expected to hold up better than goods overall. Department stores and specialty retailers, consumer durable goods, large volume retailers and tech hardware are all likely to face a more challenging season. On the other hand, demand for travel and flights remains very strong, and the Morgan Stanley transportation team remains bullish on the U.S. airlines overall, as they believe travel interest remains resilient despite consumer and macro fears. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

While the recent meeting between U.S. President Biden and China’s President Xi has signaled near term stability for the relationship between the two countries, investors will need to understand what this means for future economic disconnection.----- Transcript -----Welcome to Thoughts on  the Market. I'm Michael Zezas, Head of Global Thematic and Public Policy Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, November 23rd, at 10 a.m. in New York. Last week, many of my colleagues and I were in Singapore meeting with clients for Morgan Stanley's annual Asia Pacific Summit. Top of mind for many was the recent meeting between U.S. President Biden and China's President Xi. In particular, there was much Thanksgiving that the two sides seemed to agree on a few points that would create some near-term stability in the relationship. But we caution investors not to read more into their meeting beyond that, and accordingly continue to prepare for a multipolar world where the U.S. and China disassociate in key economic areas. True, there were statements of respect for each other's position on Taiwan, a return to key policy dialogs, and a recognition on both sides of the importance of the bilateral relationship to the well-being of the wider world. But that doesn't mean the two sides found a way to remain interconnected economically. Rather, it just signals that economic disconnection may be orderly and spread out as opposed to disorderly and quick. Look beyond the soothing statements from the meeting, and you see policies on both sides showing work toward economic disconnection with industrial policies and trade barriers aimed at creating separate economic and technological ecosystems. An orderly transition to this state may be costly, but it need not be disruptive. This dynamic still leaves plenty of cross-currents for markets. It's good news overall for the macroeconomic outlook as it takes a potential growth shock off the table. It's also good for key geographies that will benefit from investment towards supply chain realignment, such as Mexico, as we recently highlighted in collaborative research with our Mexico strategist. But it poses challenges for companies that will be compelled to take on higher labor and CapEx costs as the U.S. seeks distance from China on key technologies. Semiconductors have been and will continue to be a key space to watch as the sector incrementally shifts production to higher cost areas in order to comply with U.S. regulatory demands. So bottom line, we should all feel a bit better about the outlook for markets following the Biden/Xi meeting, but just a bit. The U.S.-China relationship isn't going back to its inter-connected past, and the cost of disconnecting in key areas is sure to hurt some investments and help others. With Thanksgiving this week, I want to take a moment to thank you, our listeners, for sharing this podcast with your friends and colleagues. As we pass another exciting milestone of 1 million downloads in a single month, we hope you continue to tune in to thoughts on the market as we navigate our ever changing world. Happy Thanksgiving from all of us here at Morgan Stanley.

The year ahead outlook is a process of collaboration between strategists and economists from across the firm, so what were analysts debating when thinking about 2023, and how were those debates resolved? Chief Cross-Asset Strategist Andrew Sheets and Head of Fixed Income Research Vishy Tirupattur discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's Chief Cross Asset Strategist. Vishy Tirupattur: And I am Vishy Tirupattur, Morgan Stanley's Head of Fixed Income Research. Andrew Sheets: And on this special episode of the podcast, we'll be discussing some of the key debates underpinning Morgan Stanley's 2023 year ahead outlook. It's Tuesday, November 22nd at 3 p.m. in London. Vishy Tirupattur: And 10 a.m. in New York. Andrew Sheets: So Vishy, within Morgan Stanley research we collaborate a lot, but I think it's not an exaggeration to say that when we sit down to write our year ahead outlooks for strategy and economics, it's probably one of the most collaborative exercises that we do. Part of that is some pretty intense debate. So that's what I was hoping to talk to you about, kind of give listeners some insight into what are the types of things that Morgan Stanley research analysts were debating when thinking about 2023 and how we resolved some of those issues. And I think maybe the best place to start is just this question of inflation, right? Inflation was the big surprise of 2022. We underestimated it. A lot of forecasters underestimated inflation. As we look into 2023, Morgan Stanley's economists are forecasting inflation to come down. So, how did that debate go? Why do we have conviction that this time inflation really is going to moderate? Vishy Tirupattur: Thanks, Andrew. And it is absolutely the case that challenging each other's view is critically important and not a surprise that we spent a lot of time on inflation. Given that we have many upside surprises to inflation throughout the year, you know, there was understandable skepticism about the forecasts that US inflation will show a steady decline over the course of 2023. Our economists, clearly, acknowledge the uncertainty associated with it, but they took some comfort in a few things. One in the base effect. Two, normalizing supply chains and weaker labor markets. They also saw that in certain goods, certain core goods, such as autos, for example, they expect to see deflation, not just disinflation. And there's also a factor of medical services, which has a reset in prices that will exert a steady drag on the core inflation. So all said and done, there is significant uncertainty, but there are still clearly some reasons why our economists expect to see inflation decline. Andrew Sheets: I think that's so interesting because even after we published this outlook, it's fair to say that a lot of investor skepticism has related to this idea that inflation can moderate. And another area where I think when we've been talking to investors there's some disagreement is around the growth outlook, especially for the U.S. economy. You know, we're forecasting what I would describe as a soft landing, i.e., U.S. growth slows but you do not see a U.S. recession next year. A lot of investors do expect a U.S. recession. So why did we take a different view? Why do we think the U.S. economy can kind of avoid this recessionary path? Vishy Tirupattur: I think the key point here is the U.S. economy slows down quite substantially. It barely skirts recession. So a 0.5% growth expectation for 2023 for the U.S. is not exactly robust growth. I think basically our economists think that the tighter monetary policy will stop tightening incrementally early in 2023, and that will play out in slowing the economy substantially without outright jumping into contraction mode. Although we all agree that there is a considerable uncertainty associated with it. Andrew Sheets: We've talked a bit about U.S. inflation and U.S. growth. These things have major implications for the U.S. dollar. Again, I think an area that was subject to a lot of debate was our forecast that the dollar's going to decline next year. And so, given that the U.S. is still this outperforming economy, that's avoiding a recession, given that it still offers higher interest rates, why don't we think the dollar does well in that environment? Vishy Tirupattur: I think the key to this out-of-consensus view on dollar is that the decline in inflation, as our economists forecast and as we just discussed, we think will limit the potential for US rates going much higher. And furthermore, given that the monetary policy is in restrictive territory, we think there is a greater chance that we will see more downside surprises in individual data points. And while this is happening, the outlook for China, right, even though it is still challenging, appears to be shifting in the positive direction. There's a decent chance that the authorities will take steps towards ending the the "zero covid" policy. This would help bring greater balance to the global economy, and that should put less upward pressure on the dollar. Andrew Sheets: So Vishy, another question that generated quite a bit of debate is that next year you continue to see quantitative tightening from the Fed, the balance sheet of the Federal Reserve is shrinking, it's owning fewer bonds and yet we're also forecasting U.S. bond yields to fall. So how do you square those things? How do you think it's consistent to be forecasting lower bond yields and yet less Federal Reserve support for the bond market? Vishy Tirupattur: Andrew, there are two important points here. The first one is that when QT ends, really, history is really not much of a guide here. You know, we really have one data point when QT ended, before rate cuts started happening. And the thinking behind our thoughts on QT is that the Fed sees these two policy tools as being independent. And stopping QT depends really on the money market conditions and the bank demand for reserves. And therefore, QT could end either before or after December 2023 when we anticipate normalization of interest rate policy to come into effect. So, the second point is that why we think that the interest rates are going to rally is really related to the expectation of significant slowing in the economic growth. Even though the U.S. economy does not go into a contraction mode, we expect a significant slowing of the U.S. economy to 0.5% GDP growth and the economy growing below potential even into 2024 as the effects of the tighter monetary policy conditions begin to play out in the real economy. So we think the rally in U.S. rates, especially in the longer end, is really a function of this. So I think we need to keep the two policy tools a bit separate as we think about this. Andrew Sheets: So Vishy, I wanted us to put our credit hats on and talk a little bit about our expectations for default rates. And I think here, ironically, when we've been talking to investors, there's been disagreement on both sides. So, you know, we're forecasting a default rate for the U.S. of around 4-4.5% Next year for high yield, which is about the historical average. And you get some investors who say, that expectation is too cautious and other investors who say, that's too benign. So why is 4-4.5% reasonable and why is it reasonable in the context of those, you know, investor concerns? Vishy Tirupattur: It's interesting, Andrew, when you expect that some some people will think that the our expectations are too tight and others think that they are too wide and we end up somewhat in the middle of the pack, I think we are getting it right. The key point here is that the the maturity walls really are pretty modest over the next two years. The fundamentals, in terms of coverage ratios, leverage ratio, cash on balance sheets, are certainly pretty decent, which will mitigate near-term default pressures. However, as the economy begins to slow down and the earnings pressures come into play, we will expect to see the market beginning to think about maturity walls in 2025 onwards. All that means is that we will see defaults rise from the extremely low levels that we are at right now to long-term average levels without spiking to the kinds of default rates we have seen in previous economic slowdowns or recessions. Andrew Sheets: You know, we've had this historic rise in mortgage rates and we're forecasting a really dramatic drop in housing activity. And yet we're not forecasting nearly as a dramatic drop in U.S. home prices. So Vishy, I wanted to put this question to you in two ways. First, how do we justify a much larger decrease in housing activity relative to a more modest decrease in housing prices? And then second, would you consider our housing forecast for prices bullish or bearish relative to the consensus? Vishy Tirupattur: So, Andrew, the first point is pretty straightforward. You know, as mortgage rates have risen in response to higher interest rates, affordability metrics have dramatically deteriorated. The consequence of this, we think, is a very significant slowing of housing activity in terms of new home sales, housing starts, housing permits, building permits and so on. The decline in those housing activity metrics would be comparable to the kind of decline we saw after the financial crisis. However, to get the prices down anywhere close to the levels we saw in the wake of the financial crisis, we need to see forced sales. Forced sales through foreclosures, etc. that we simply don't expect to see happen in the next few years because the mortgage lending standards after the financial crisis had been significantly tighter. There exists a substantial equity in many homes today. And there's also this lock-in effect, where a large number of current mortgage holders have low mortgage rates locked in. And remember, US mortgages are predominantly fixed rate mortgages. So the takeaway here is that housing activity will drop dramatically, but home prices will drop only modestly. So relative to the rest of the street, our home price forecast is less negative, but I think the key point is that we clearly distinguish between what drives home pricing activity and what drives housing activity in terms of builds and starts and sales, etc.. And that key distinction is the reason why I feel pretty confident about our housing activity forecast and home price forecast. Andrew Sheets: Vishy, thanks for taking the time to talk. Vishy Tirupattur: Always a pleasure talking to you, Andrew. Andrew Sheets: Happy Thanksgiving from all of us at Thoughts on the Market. We have passed yet another exciting milestone: over 1 million downloads in a single month. I wanted to say thank you for continuing to tune in and share the show with your friends and colleagues. It wouldn't be possible without you, our listeners. 

While the outlook for 2023 may seem relatively unexciting, investors will want to prepare for a volatile path to get there, and focus on some key inflection points.----- Transcript -----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, November 21st, at 11 a.m. in New York. So let's get after it. Last week, we published our 2023 U.S. equities outlook. In it, we detail the path to our 2023 year end S&P 500 price target of 3900. While the price may seem unexciting relative to where we're currently trading, we think the path will be quite volatile with several key inflection points investors will need to trade to make above average returns next year. The main pushback in focus from investors has centered around the first inflection - the near-term tactical upside call we made about a month ago.Let's review a few key points of the call as we discuss how the rest of the year may play out. First, the primary tactical driver to our bullish call was simply respecting the 200 week moving average. As noted when we made the call last month, the 200 week moving average does not give way for the S&P 500 until a recession is undeniable. In short, until it is clear we are going to have a full blown labor cycle where the unemployment rate rises by at least 1-1.5%, the S&P 500 will give the benefit of the doubt to the soft landing outcome. A negative payroll release also does the trick. Second, in addition to the 200 week moving averages key support, falling interest rate volatility led to higher equity valuations that are driving this rally. Much like with the 200 week moving average, though, this factor can provide support for the higher PE's achieved over the past month, but is no longer arguing for further upside. In other words, both the 200 week moving average and the interest rate volatility factors have run their course, in our view. However, a third factor market breadth has emerged as a best tactical argument for higher prices before the fundamentals take over again. Market breadth has improved materially over the past month. As noted last week, both small caps and the equal weighted S&P 500 have outperformed the market weighted index significantly during this rally. In fact, the equal weighted S&P 500 has been outperforming since last year, while the small caps have been outperforming since May. Importantly, such relative moves by the small caps and average stocks did not prevent the broader market from making a new low this fall. However, the improvement in breadth is a new development, and that indicator does argue for even higher prices in the broader market cap weighted S&P 500 before this rally is complete. Bottom line tactically bullish calls are difficult to make, especially when they go against one's fundamental view that remains decidedly bearish. When we weigh the tactical evidence, we remain positive for this rally to continue into year end even though the easy money has likely been made. From here, we expect more choppiness and misdirection with respect to what's leading. For example, from the October lows it's been a cyclical, smallcap led rally with the longer duration growth stocks lagging. If this rally is to have further legs, we think it will have to be led by the Nasdaq, which has been the laggard. In the end, investors should be prepared for volatility to remain both high intraday and day to day with swings in leadership. After all, it's still a bear market, and that means it's not going to get any easier before the fundamentals take over to complete this bear market next year. As we approach the holiday, I want to say a special thank you to our listeners. We've recently passed an exciting milestone of over 1 million downloads in a single month, and it's all made possible by you tuning in and sharing the podcast with friends and colleagues. Happy Thanksgiving to you and your families.

At the recent 20th Party Congress in China, policy makers made economic growth a top priority, but what are the roadblocks that may be of concern to global investors?----- Transcript -----Welcome to Thoughts on the Market. I'm Robin Xing, Morgan Stanley's Chief China Economist. Along with my colleagues, bringing you a variety of perspectives, today I will discuss the outlook for China after the 20th Party Congress. It's Friday, November 18th, at 8 a.m. in Hong Kong. China's Communist Party convenes a national Congress every five years to unveil mid to long term policy agenda and reshuffle its leadership. The one concluded two weeks ago marks the 20th Congress since the party's founding in 1921. One of the key takeaways is that economic growth remains the Chinese government's top priority, even as national security and the supply chain self-sufficiency have gained more importance. The top leadership's goal is to grow China to an income level on par with medium developed country by 2035. We think this suggests a per capita GDP target of $20,000, up from $12,000 today, and it would require close to 4% average growth in GDP in the coming decade. Well, this growth target is achievable, but only with continued policy focus on growth. While China's economy has grown 6.7% a year over the last decade, its potential growth has likely entered a downward trajectory, trending toward 3% at the end of this decade, there is aging of the Chinese population, which is a main structure headwind. That could reduce labor input and the pace of capital accumulation. Meanwhile, productivity growth might also slow as geopolitical tensions increase the trend towards what Morgan Stanley terms slowbalization. The result of which is reduced foreign direct investment, particularly among sectors considered sensitive to national security. In this context, we believe Beijing will remain pragmatic in dealing with geopolitical tensions because of its reliance on key commodities and the fact exports account for a quarter of Chinese employment. So China is very intertwined with global economy and it relies a lot on the access to global market. Another issue of concern to global investors is China's regulatory reset since 2020 and its impact on the private sector. It seems to have entered a more stable stage. We don't expect major regulatory surprises from here considering that the party Congress didn't identify any new areas with major challenges domestically, except for population aging and the self-sufficiency of supply chain. As investors adopt a "seeing is believing" mentality towards their long term concerns around China's growth, policy, geopolitics, the more pressing near-term risk remains COVID zero. This is likely the biggest overhang on Chinese economic growth and the news flow around reopening have tended to trigger market volatility. We see rising urgency for an exit from COVID zero in the context of its economic cost, including lower income growth, elevated youth unemployment and even fiscal sustainability risks. We think Beijing will likely aim for a calibrated COVID exit, and the three key signposts are necessary to facilitate a smooth reopening, elderly vaccination, availability of domestic COVID treatment pills and facilities, and continued effort to steer public opinion away from fear of the virus. Considering it could take 3 to 6 months for the key signposts to play out, we expect a full reopening next spring at the earliest. This underpins our forecast of a modest recovery starting in the second quarter of 2023, led by private consumption. Before a full reopening, we see growth continue to muddle through at the subpar level, sustained mainly by public CapEx. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

With risks to both home sales and home prices continuing to challenge the housing market, investors will want to know what is keeping the U.S. housing market from a sharp fall mirroring the great financial crisis? Co-heads of U.S. Securitized Products Research Jim Egan and Jay Bacow discuss.----- Transcript -----Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-head of U.S. Securitized Products Research here at Morgan Stanley. Jay Bacow: And I'm Jay Bacow, the other Co-head of U.S. Securities Products Research. Jim Egan: And on this episode of the podcast, we'll be discussing our year ahead outlook for the U.S. housing market for 2023. It's Thursday, November 17th, at 1 p.m. in New York. Jay Bacow: So Jim, it's outlook season. And when we think about the outlook for the housing market, we’re not just looking in 2023, people live in their houses for their whole lives. Jim Egan: Exactly. We are contemplating what's going to happen to the housing market, not just in 23, but beyond in this year's version of the outlook. But just to remind the listeners, we have talked about this on this podcast in the past, but our view for 2023 hasn't changed all that much. What we think we're going to see is a bifurcation narrative in the housing market between activity, so home sales and housing starts, and home prices. The biggest driver of that bifurcation, affordability. Because of the increase in prices, because of the incredible increase in mortgage rates that we've seen this year, affordability has been deteriorating faster than we've ever seen it. That's going to bring sales down. But the affordability for current homeowners really hasn't changed all that much. We're talking about deterioration for first time homebuyers, for prospective homebuyers. Current homeowners in a lot of instances have locked in very low 30 year fixed rate mortgages. We think they're just incentivized to keep their homes off the market, they're locked into their current mortgage, if you will. That keeps supply down, that also means they're not buying a home on the follow, so it means that sales fall even faster. Sales have outpaced the drop during the great financial crisis. We think that continues through the middle of next year. We think sales ultimately fall 11% next year from an already double digit decrease in 2022 on a year over year basis. But we do think home prices are more protected. We think they only fall 4% year over year next year, but when we look out to 2024, it's that same affordability metric that we really want to be focused on. And, home prices plays a role, but so do mortgage rates. Jay, how are we thinking about the path for mortgage rates into 2024? Jay Bacow: Right. So obviously the biggest driver of mortgage rates are first where Treasury rates are and then the risk premium between Treasury rates and mortgages. The drive for Treasury rates, among other things, is expectations for Fed policy. And our economists are expecting the Fed to cut rates by 25 basis points in every single meeting in 2024, bringing the Fed rate 200 basis points lower. When you overlay the fact that the yield curve is inverted and our interest rate strategists are expecting the ten year note to fall further in 2023, and risk premia on mortgages is already pretty wide and we think that spread can narrow. We think the mortgage rate to the homeowner can go from a peak of a little over 7% this year to perhaps below 6% by 2024. Jim, that should help affordability right, at least on the margins. Jim Egan: It should. And that is already playing a role in our sales forecasts and our price forecasts. I mentioned that sales are falling faster than they did during the great financial crisis. We think that that pace of change really inflects in the second half of next year. Not that home sales will increase, we think they'll still fall, they're just going to fall on a more mild or more modest pace. Home prices, the trajectory there also could potentially be more protected in this improved affordability environment because I don't get the sense that inventories are really going to increase with that drop in mortgage rates. Jay Bacow: Right. And when we look at the distribution of mortgage rates in America right now, it's not uniformly distributed. The average mortgage rate is 3.5%, but right now when we think how many homeowners have at least 25 basis points of incentive to refinance, which is generally the minimum threshold, it rounds to 0.0%. If mortgage rates go down to 4%, about 2.5 points below where they are right now, we're still only at about 10% of the universe has incentive to refinance. So while rates coming down will help, you're not going to get a flood of supply. Jim Egan: We think that’s important when it comes to just how far home prices can fall here. The lock in effect will still be very prevalent. And we do think that that continues to support home prices, even if they are falling on a year over year basis as we look out beyond 2023 into 2024 and further than that. Now, the biggest pushback we get to this outlook when we talk to market participants is that we're too constructive. People think that home prices can fall further, they think that home prices can fall faster. And one of the reasons that tends to come up in these conversations is some anchoring to the great financial crisis. Home prices fell about 30% from peak to trough, but we think it's important to note that that took over five years to go from that peak to that trough. In this cycle home prices peaked in June 2022, so December of next year is only 18 months forward. The fastest home prices ever fell, or the furthest they ever fell over a 12 month period, 12.7% during the great financial crisis. And that took a lot of distress, forced sellers, defaults and foreclosures to get to that -12.7%. We think that without that distress, because of how robust lending standards have been, the down 4% is a lot more realistic for what we could be over the course of next year. Going further out the narrative that we'll hear pretty frequently is, well, home prices climbed 40% during the pandemic, they can reverse out the entirety of that 40%. And we think that that relies on kind of a faulty premise that in the absence of COVID, if we never had to deal with this pandemic for the past roughly three years, that home prices would have just been flat. If we had this conversation in 2019, we were talking about a lot of demand for shelter, we were talking about a lack of supply of shelter. Not clearly the imbalance that we saw in the aftermath of the pandemic, but those ingredients were still in place for home prices to climb. If we pull trend home price growth from 2015 to 2019, forward to the end of 2023, and compare that to where we expect home prices to be with the decrease that we're already forecasting, the gap between home prices and where that trend price growth implies they should have been, 9%. Till the end of 2024 that gap is only 5%. While home prices can certainly overcorrect to the other side of that trend line, we think that the lack of supply that we're talking about because of the lock in effect, we think that the lack of defaults and foreclosures because of how robust lending standards have been, we do think that that leaves home prices much more protected, doesn't allow for those very big year over year decreases. And we think peak to trough is a lot more control probably in the mid-teens in this cycle. Jay Bacow: So when we think about the outlook for the U.S. housing market in 2023 and beyond, home sale activity is going to fall. Home prices will come down some, but are protected from the types of falls that we saw during the great financial crisis by the lock in effect and the better outlook for the credit standards in the U.S. housing market now than they were beforehand. Jay Bacow: Jim, always greatv talking to you. Jim Egan: Great talking to you, too, Jay. Jay Bacow: And thank you all for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app, and share the podcast with a friend or colleague today. 

In looking ahead to 2023, the big dynamics of this year are poised to shift and investors will want to look for safety amidst the coming uncertainty. Chief Cross Asset Strategist Andrew Sheets and Global Chief Economist Seth Carpenter discuss.----- Transcript -----Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's global chief economist. Andrew Sheets: And I'm Andrew Sheets, Morgan Stanley's chief cross-asset strategist. Seth Carpenter: And on part two of this special two-part episode of the podcast, we're going to focus on Morgan Stanley's Year Ahead strategy outlook. It's Wednesday, November 16th, at 10 a.m. in New York. Andrew Sheets: And 3 p.m. in London. Seth Carpenter: Andrew, on the first part of this, you spent a bunch of time asking me questions about the outlook for the global economy. I'm going to turn the tables on you and start to ask you questions about how investors should be thinking about different asset prices going forward. There really was a big change this year, we came out of last year with big growth, things slowed down, but inflation surprised everyone to the upside. Central banks around the world started hiking rates aggressively. We've seen massive moves in FX markets, especially in the dollar. Things look very, very different. If you were to say, looking forward from here to the next year, what the biggest conviction call you have in terms of asset allocation, what would it be? Andrew Sheets: Thanks, Seth. It's that high grade bonds do very well. You know, I think this is a backdrop where 2022 was defined by surprisingly resilient growth, surprisingly high inflation, and surprisingly hawkish monetary policy relative to where I think a lot of investors thought the year would start. And, you know, if I think about 2023 and what you and the economics team are forecasting, it's big shifts to all three of those dynamics. It's much softer growth, it's softer inflationary pressure. And it's central banks pausing their tightening cycles and then ultimately easing as we look further ahead. So, you know, 2022 is exceptionally bad for high grade bonds, investment grade rated bonds, whether they're governments or mortgages or securitized bonds or municipals. So as the economy slows, as investors are looking for some safety amidst all that economic uncertainty, we think high grade bonds will be the place to be. Seth Carpenter: What is it that's so special about investment grade bonds as opposed to, for example, high yield bonds? And what is it about fixed income securities instead of equities that you think is so attractive? Andrew Sheets: Yeah. Thanks, Seth. So I do think there's an important distinction here because, you know, if I think about a lot of different assets in the market, I think there are a lot of assets that are primarily concerned at the moment with rate uncertainty or policy uncertainty. When will the ECB finally stop hiking rates? When will the Fed finally stop hiking rates? How high will Fed funds go? Now there's another group of assets, and I think you could put the S&P 500 here, U.S. high yield bonds here that are concerned about those questions of interest rates. Obviously, interest rates matter for these markets, but those markets are also concerned about the economic slowdown and how much will the economy slow. So I think when people look into the year ahead, what you want to focus on are assets that are much more about whether or not rate uncertainty falls than they are about how much will the economy decelerate. So we think of high grade bonds as a perfect example of an asset class that cares quite a bit about interest rate uncertainty while being a lot less vulnerable to the risk that the economy slows. And I think emerging market assets are also an example of an asset class that's really sensitive, maybe more sensitive to the question of how high will the Fed hike rates? And just given where it's currently priced, given how much it's already declined this year, might be a lot less sensitive of that question of, you know, whether or not the U.S. goes into recession or whether or not Europe goes into recession. So good for high grade bonds and then we think good for emerging market assets. Seth Carpenter: Okay. That makes a lot of sense. High grade bonds, fixed income, obviously, you talked a little bit about where some of the risks are. And whenever I think about fixed income securities and I think about risk, how are you advising clients to think about market-based risks around the world as we're going into the next year?  Andrew Sheets: I think you a point that you and your team have made that central banks, especially the Fed, are very aware of the liquidity risks around quantitative tightening and might modify it if they felt it was starting to lead to less functional markets. I think that's important. I think if that's our assumption, then investors shouldn't avoid these markets simply because there's a possibility that they could have a more liquidity challenge backdrop. Secondly, and I think this is also an important point, while central banks are going to be backing away from the government bond markets, we think there's a good chance that households and other investors will be moving towards these markets. So, you know, we think that there's actually some pretty good potential for households to do a little bit of reallocation, to have less money in equities, to have a little bit more money in bonds, and that the much higher yields that these households are seeing could be a catalyst for that. Seth Carpenter: We're sitting here having a conversation, looking around the world. One of the natural topics to get on to if you're thinking globally is about currencies and exchange rates. How should we be thinking about where currency markets will be going from here forward into next year? What's the outlook for different currencies? Is there a set of currencies that might outperform? Are there ones where investors still need to be very wary? Andrew Sheets: Yeah. So I think when talking about currencies, we have to start with the dollar, which in some ways is the benchmark against which everything else is measured. And you know, our foreign exchange strategists do think the dollar has peaked. Looking into next year, if we see slower growth, less inflation, less hawkish policy, you know, we think that will be less good for the dollar, maybe even negative for the dollar. So we see the dollar peaking and declining over the course of 2023. We think the euro does better, as we do think investors will look to reengage in European assets next year and so investment flows can be more supportive. We do think some of the more cyclical currencies, things like the Australian dollar and New Zealand dollar can do a little bit better as the market gets maybe a little bit more optimistic about better Chinese growth next year. And we think some of the large EM currencies can also outperform relative to their forward. Seth Carpenter: That makes a lot of sense. I guess the other point that you and I discussed in the first part of this podcast is about inflation and how commodity prices have factored into the evolution of inflation over the past couple of years. How should we be thinking about commodities for investors going into 2023 as a place to step back from risk? What do you think? Andrew Sheets: So commodities were an asset class that we liked at this time last year when we wrote our 2022 outlook. It was an asset class that we were overweight and we maintained that position through this year. But I think that picture is changing a little bit. You know, first, the attractiveness of other asset classes is now better because those other asset classes have fallen a lot relative to commodities over the course of 2022. And, you know, commodities are an asset class that can be sensitive to when growth actually slows. They tend to be less anticipatory. And so they've held up well, I think even as other asset classes have become more worried about the prospect of a recession. And so if the odds of a recession are rising, even if they're not the base case in the US and then they are the base case in Europe, maybe that presents a little bit more danger. But that needs to be balanced against the fact that commodities do have a number of attractive properties. They provide a hedge against inflation and some commodities, especially energy commodities, pay a quite high carry or a quite high yield for holding them, buying them on a forward basis and holding them to maturity. In the case of oil, we think prices will come in well ahead, more than 20% ahead of where kind of the market is implying the price next year. So it's a more nuanced story. It's a story where we think energy continues to outperform metals within the commodities complex, but more of a relative value story than a directional story for the year ahead. Seth Carpenter: So what I'm taking away from what you've told me so far, that if a shift to a year of fixed income, maybe the dollar has peaked, and then a more nuanced story when it comes to commodities, what would you leave our listeners with as a closing story? Where would you want to wrap things up in terms of leaving our listeners with advice? Where do they need to be the most cautious? And are we going to go into a year where volatility finally comes down from the sort of tumult that we've seen this year? Andrew Sheets: So I think this idea that we might not have an all clear on recession risk in the US kind of well into the start of 2023, the idea that Europe will be in recession at the start of 2023, I think that makes us a little bit cautious to buy cyclical assets here and I think that applies to things like metals, copper, that applies to high yield bonds and loans. And then we think the S&P 500 will also be tricky. So we think the S&P 500 is probably worse risk reward than other asset classes. It doesn't fall over the course of the year on our forecasts, but it has a very choppy range. And when we think about sector and style, I think it's being open to having different preferences depending on where you're looking. And we think EM assets will be on the leading edge of any recovery. That is where we're more favorable towards early cycle sectors like tech and tech hardware. You know, in Europe you're kind of in the middle. That's where we like banks and energy kind of deep value sectors that have quite high dividend yields. And in the US we're more defensive. But you know, something that links all of those themes is that both US defensive, equities, banks and energy in Europe, and tech and semis and Asia, they're all quite high yielding sectors. And so we do think this is a backdrop where the idea of gaining income is not just about high grade bonds, that there are a lot of different pockets of the market where, you know, this is a year to look for the more solid income candidate and income strategy on a cross asset basis. You know, don't swing for the fences yet in terms of buying cyclicality, and we think we'll wait for a better opportunity to do that as we move into 2023. Seth Carpenter: All right, Andrew. Well, I have to say, that was a great summary at the end. I really appreciate you taking the time to talk. Andrew Sheets: Great speaking with you, Seth. Seth Carpenter: And thank you to our listeners. If you enjoy thoughts on the market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

As we look ahead to 2023, we see a divergence away from the trends of 2022 in key areas across growth, inflation, and central bank policy. Chief Cross Asset Strategist Andrew Sheets and Global Chief Economist Seth Carpenter discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's chief cross-asset strategist. Seth Carpenter: And I'm Seth Carpenter, Morgan Stanley's global chief economist. Andrew Sheets: And on the special two-part episode of the podcast, we'll be discussing Morgan Stanley's Global Year Ahead outlook for 2023. Today, we'll focus on economics, and tomorrow we'll turn our attention to strategy. It's Tuesday, November 15th at 3 p.m. in London. Seth Carpenter: And it's 10 a.m. in New York. Andrew Sheets: So, Seth I think the place to start is if we look ahead into 2023, the backdrop that you and your team are forecasting looks different in a number of important ways. You know, 2022 was a year of surprisingly resilient growth, stubbornly high inflation and aggressively tightening policy. And yet as we look ahead, all three of those elements are changing. I was hoping you could comment on that shift broadly and also dig deeper into what's changing the growth outlook for the global economy into next year. Seth Carpenter: You're right, Andrew, this year, in 2022, we've seen growth sort of hang in there. We came off of last year in 2021, a super strong year for growth recovering from COVID. But the theme this year really has been a great deal of inflation around the world, especially in developed markets. And with that, we've seen a lot of central banks everywhere start to raise interest rates a great deal. So what does that mean as we end this year and go into next year? Well, we think we'll start to see a bit of a divergence. In the developed market world where we've seen both a lot of inflation and a lot of central bank hiking, we think we get a great deal of slowing and in fact a bit of contraction. For the euro area and for the U.K, we're writing down a recession starting in the fourth quarter of this year and going into the beginning of next year. And then after that, any sort of recovery from the recession is going to be muted by still tight monetary policy. For the US, you know, we're writing down a forecast that just barely skirts a recession for next year with growth that's only slightly positive. That much slower growth is also the reflection of the Federal Reserve tightening policy, trying to wrench out of the system all the inflation we've seen so far. In sharp contrast, a lot of EM is going to outperform, especially EM Asia, where the inflationary pressures have been less so far this year, and central banks, instead of tightening aggressively to get restrictive and squeeze inflation out, they're actually just normalizing policy. And as a result, we think they'll be able to outperform. Andrew Sheets: And Seth, you know, you mentioned inflation coming in hot throughout a lot of 2022 being one of the big stories of the year that we've been in. You and your team are forecasting it to moderate across a number of major economies. What drives a change in this really important theme from 2022? Seth Carpenter: Absolutely. We do realize that inflation is going to continue to be a very central theme for all sorts of markets everywhere. And the fact that we have a forecast with inflation coming down across the world is a really important part of our thesis. So, how can we get any comfort on the idea that inflation is going to come down? I think if you break up inflation into different parts, it makes it easier to understand when we're thinking about headline inflation, clearly, we have food, commodity prices and we've got energy prices that have been really high in part of the story this year. Oil prices have generally peaked, but the main point is we're not going to see the massive month on month and year on year increases that we were seeing for a lot of this year. Now, when we think about core inflation, I like to separate things out between goods and services inflation. For goods, the story over the past year and a half has been global supply chains and we know looking at all sorts of data that global supply chains are not fixed yet, but they are getting better. The key exception there that remains to be seen is automobiles, where we have still seen supply chain issues. But by and large, we think consumer goods are going to come down in price and with it pull inflation down overall. I think the key then is what goes on in services and here the story is just different across different economies because it is very domestic. But the key here is if we see the kind of slowing down in economies, especially in developed market economies where monetary policy will be restrictive, we should see less aggregate demand, weaker labor markets and with it lower services inflation. Andrew Sheets: How do you think central banks respond to this backdrop? The Fed is going to have to balance what we see is some moderation of inflation and the ECB as well, with obvious concerns that because forecasting inflation was so hard this year and because central banks underestimated inflation, they don't want to back off too soon and usher in maybe more inflationary pressure down the road. So, how do you think central banks will think about that risk balance and managing that? Seth Carpenter: Absolutely. We have seen some surprises, the upside in terms of commodity market prices, but we've also been surprised at just the persistence of some of the components of inflation. And so central banks are very well advised to be super cautious with what's going on. As a result. What we think is going to happen is a few things. Policy rates are going to go into restrictive territory. We will see economies slowing down and then we think in general. Central banks are going to keep their policy in that restrictive territory basically over the balance of 2023, making sure that that deceleration in the real side of the economy goes along with a continued decline in inflation over the course of next year. If we get that, then that will give them scope at the end of next year to start to think about normalizing policy back down to something a little bit more, more neutral. But they really will be paying lots of attention to make sure that the forecast plays out as anticipated. However, where I want to stress things is in the euro area, for example, where we see a recession already starting about now, we don't think the ECB is going to start to cut rates just because they see the first indications of a recession. All of the indications from the ECB have been that they think some form of recession is probably necessary and they will wait for that to happen. They'll stay in restrictive territory while the economy's in recession to see how inflation evolves over time. Andrew Sheets: So I think one of the questions at the top of a lot of people's minds is something you alluded to earlier, this question of whether or not the US sees a recession next year. So why do you think a recession being avoided is a plausible scenario indeed might be more likely than a recession, in contrast maybe to some of that recent history? Seth Carpenter: Absolutely. Let's talk about this in a few parts. First, in the U.S. relative to, say, the euro area, most of the slowing that we are seeing now in the economy and that we expect to see over time is coming from monetary policy tightening in the euro area. A lot of the slowing in consumer spending is coming because food prices have gone up, energy prices have gone up and confidence has fallen and so it's an externally imposed constraint on the economy. What that means for the U.S. is because the Fed is causing the slowdown, they've at least got a fighting chance of backing off in time before they cause a recession. So that's one component. I think the other part to be made that's perhaps even more important is the difference between a recession or not at this point is almost semantic. We're looking at growth that's very, very close to zero. And if you're in the equity market, in fact, it's going to feel like a recession, even if it's not technically one for the economy. The U.S. economy is not the S&P 500. And so what does that mean? That means that the parts of the U.S. economy that are likely to be weakest, that are likely to be in contraction, are actually the ones that are most exposed to the equity market and so for the equity market, whether it's a recession or not, I think is a bit of a moot point. So where does that leave us? I think we can avoid a recession. From an economist perspective, I think we can end up with growth that's still positive, but it's not going to feel like we've completely escaped from this whole episode unscathed. Andrew Sheets: Thanks, Seth. So I maybe want to close with talking about risks around that outlook. I want to talk about maybe one risk to the upside and then two risks that might be more serious to the downside. So, one of the risks to the upside that investors are talking about is whether or not China relaxes zero COVID policy, while two risks to the downside would be that quantitative tightening continues to have much greater negative effects on market liquidity and market functioning. We're going through a much faster shrinking of central bank balance sheets than you know, at any point in history, and then also that maybe a divided US government leads to a more challenging fiscal situation next year. So, you know, as you think about these risks that you hear investors citing China, quantitative tightening, divided government, how do you think about those? How do you think they might change the base case view? Seth Carpenter: Absolutely. I think there are two-way risks as usual. I do think in the current circumstances, the upside risks are probably a little bit smaller than the downside risks, not to sound too pessimistic. So what would happen when China lifts those restrictions? I think aggregate demand will pick back up, and our baseline forecast that happens in the second quarter, but we can easily imagine that happening in the first quarter or maybe even sometime this year. But remember, most of the pent-up demand is on domestic spending, especially on services and so what that means is the benefit to the rest of the global economy is probably going to be smaller than you might otherwise think because it will be a lot of domestic spending. Now, there hasn't been as much constraint on exports, but there has been some, and so we could easily see supply chains heal even more quickly than we assume in the baseline. I think all of these phenomena could lead to a rosier outlook, could lead to a faster growth for the global economy. But I think it's measured just in a couple of tenths. It's not a substantial upside. In contrast, you mentioned some downside risks to the outlook. Quantitative tightening, central banks are shrinking their balance sheets. We recently published on the fact that the Fed, the Bank of England and the European Central Bank will all be shrinking their balance sheet over the next several months. That's never been seen, at least at the pace that we're going to see now. Could it cause market disruptions? Absolutely. So the downside risk there is very hard to gauge. If we see a disruption of the flow of credit, if we see a generalized pullback in spending because of risk, it's very hard to gauge just how big that downside is. I will say, however, that I suspect, as we saw with the Bank of England when we had the turmoil in the gilt market, if there is a market disruption, I think central banks will at least temporarily pause their quantitative tightening if the disruption is severe enough and give markets a chance to settle down. The other risk you mentioned is the United States has just had a mid-term election. It looks like we're going to have divided government. Where are the risks there? I want to take you back with me in time to the mid-term elections in 2010, where we ended up with split government. And eventually what came out of that was the Budget Control Act of 2011. We had split government, we had a debt limit. We ended up having budget debates and ultimately, we ended up with contractionary fiscal policy. I think that's a very realistic scenario. It's not at all our baseline, but it's a very realistic risk that people need to pay attention to. Andrew Sheets: Seth, thanks for taking the time to talk. Seth Carpenter: Andrew, I always like getting a chance to talk to you. Andrew Sheets: And thanks for listening. Be sure to tune in for part two of this episode where Seth and I will discuss Morgan Stanley's year ahead. Strategy Outlook. If you enjoy thoughts of the market, please leave us a review on Apple Podcasts and share this podcast with a friend or colleague today.

As we transition away from our fire and ice narrative and into the late cycle stage, investors will want to change up their strategies as we finish one cycle and begin another.----- Transcript -----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, November 14th, at 11 a.m. in New York. So let's get after it. Last year's fire and ice narrative worked so well, we decided to dust off another Robert Frost jewel to describe this year's outlook, with The Road Not Taken. As described by many literary experts, and Frost himself, the poem presents the dilemma we all face in life that different choices lead to different outcomes, and while the road taken can be a good one, these choices create doubt and even remorse about the road not taken. For the year ahead, we think investors will need to be more tactical with their views on the economy, policy, earnings and valuation. This is because we are closer to the end of the cycle at this point, and that means that trends in these key variables can zig and zag before the final path is clear. In other words, while flexibility is always important to successful investing, it's critical now. In contrast, the set-up was so poor a year ago that the trends in all of the variables mentioned above were headed lower in our view. Therefore, the right choice or strategy was about managing or profiting from the new downtrend. After all, Fire and Ice the poem is not a debate about the destination, it's about the path to that destination. In the case of our bear market call, it was a combination of both fire and ice - inflation and slowing growth, a bad combination for stocks. As it turned out, the cocktail has been just as bad for bonds, at least so far. However, as the ice overtakes the fire and inflation cools off, we're becoming more confident that bonds should beat stocks in this final verse that has yet to fully play out. That divergence can create new opportunities and confusion about the road we are on, and why we have recently pivoted to a more bullish tactical view on equities. In the near term, we maintain our tactically bullish call as we transition from fire to ice, a window of opportunity when long term interest rates typically fall prior to the magnitude of the slowdown being reflected in earnings estimates. This is the classic late cycle period between the Fed's last hike and the recession. Historically, this period is a profitable one for stocks. Three months ago, we suggested the Fed's pause would coincide with the arrival of a recession this cycle, given the extreme inflation dynamics. In short, the Fed would not be able to pause until payrolls were negative, the unequivocal indicator of a recession, but too late to kick save the cycle or the downtrend for stocks. However, the jobs market has remained stronger for longer, even in the face of weakening earnings. More importantly, this may persist into next year, leaving the window open for a period when the Fed can slow or pause rate hikes before we see an unemployment cycle emerge. That's what we think is behind the current rally, and we think it can go higher. We won't have evidence of the hard freeze for a few more months, and markets can dream of a less hawkish Fed, lower interest rates and resilient earnings in the interim. Last week's softer than expected inflation report was a critically necessary data point to fuel that dream for longer. We expect long duration growth stocks to lead the next phase of this rally as interest rates fall further. That means Nasdaq should catch up to the Dow's outsized move higher so far. Unfortunately, we have more confidence today than we did a few months ago in our well below consensus earnings forecast for next year, and that means the bear market will likely resume once this rally is finished. Bottom line, the path forward is much more uncertain than a year ago and likely to bring several twists and periods of remorse for investors wishing they had traded it differently. If one were to take our 12 month S&P 500 bear, base and bull targets of 3500, 3900, and 4200 at face value, they might say it looks like we are expecting a generally boring year. However, nothing could be further from the truth. In fact, we would argue the past 12 months have been boring because a bear market was so likely we simply set our defensive strategy and stayed with it. That strategy has worked well all year, even during this recent rally. But that kind of strategy won't work over the next 12 months, in our view. Instead, investment success will require one to turn over the portfolio more frequently as we finish one cycle and begin another. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people to find the show.