Thoughts on the Market

Over the last decade private markets have outperformed versus public markets, but given the recent public market volatility, will private markets continue to attract investors? Head of Brokers, Asset Managers, and the Exchanges Team Mike Cyprys and Head of European Asset Managers, Exchanges, and Diversified Financials Research Bruce Hamilton discuss.----- Transcript -----Mike Cyprys: Welcome to Thoughts on the Market. I'm Mike Cyprys, Morgan Stanley's Head of Brokers, Asset Managers and Exchanges Team. Bruce Hamilton: And I'm Bruce Hamilton, Head of European Asset Managers, the exchanges and Diversified Financials Research. Mike Cyprys: And on this special episode of the podcast, we'll talk about our outlook on the private markets industry against an uncertain macro backdrop and market upheaval. It's Tuesday, November 1st at noon in New York. Bruce Hamilton: And 4 p.m. in London. Mike Cyprys: We spend most of our time on this podcast talking about public markets, which are stocks and bonds traded on public exchanges like Nasdaq and Euronext. But today, we're going to talk a little bit about the private markets, which are equity and debt of privately owned companies. You probably know it as private equity, venture capital and private credit, but it also encompasses private real estate and infrastructure investments, all of this largely held in funds owned by institutions such as pension funds and endowments and increasingly high net worth investors. Today, there is nearly 10 trillion of assets held across these funds globally. But despite the different structure, private markets have been faced with the same macro challenges facing public markets here in 2022. So Bruce, before we get into some of the specifics, let's maybe set the context for our listeners. How have private markets fared vis a vis public markets over the last decade? Bruce Hamilton: So the industry has grown at around 12% per annum on average over the past decade in terms of asset growth and a faster 17% over the past three years, driven by increasing allocations from institutional investors attracted to the historic outperformance of private markets versus public markets, a smoother ride on valuations given that assets are not mark to market, unlike public markets, and an ability to source a more diversified set of exposures, including the faster growth in earlier stage companies. Mike Cyprys: And what are some of the near-term specific risks facing private markets right now amidst this challenging market backdrop? Bruce Hamilton: The near-term concerns really focus around the implications of a tougher economic environment, impacting corporate earnings growth at the same time that increasing central bank interest rates across the globe are feeding into increased borrowing costs for these companies. This raises questions on how this will impact the profitability and investment returns from these companies and whether investors will continue to view the private markets as an attractive place to allocate capital. The uncertain economic outlook has dramatically reduced the appetite to finance new private market deals. However, there are factors that mitigate the risks forced to refinance in the short term. Secondly, corporate balance sheets are in relatively good health in terms of profits to cover interest payments or interest cover. Moreover, flexibility built into financing structures such as hedging to lock in lower interest rates should reduce the impact of rising rates. Importantly, the private market industry also has significant dry powder, or available capital, to invest in new opportunities or protect existing investments. For players active in the private markets. We think that there are undoubtedly risks in the near term, linked to congested fundraising with many private market firms seeking to raise capital from clients against a decline in public markets, which has left clients with less money in their pockets. From the performance of existing portfolio companies, given the more difficult market and economic environment and from subdued company disposal and investment activity linked to the more difficult financing markets. This has kept us pretty cautious on the sector this year. Bruce Hamilton: But Mike, despite these near-term risks and concerns, you remain convicted in your bullish outlook on the next five years. In a recent work, you've outlined five key themes that you see lifting private markets to your 17 trillion assets under management forecast. What are these themes and how do you see them playing out over time? Mike Cyprys: Look, clearly, I would echo your concerns in the short term. And I do think growth moderates after an exceptional period here. But we do see a number of growth drivers that we feel are more enduring. Specifically, five key engines of growth, if you will. First is democratization of private markets that we think can spur retail growth and unlock a $17 trillion addressable market or TAM. This is the single largest growth contributor to our outlook. Product development, investor education and technological innovation are all helping unlock access here as retail investors look to the private markets for income and capital appreciation in addition to a smooth ride with lower volatility versus the public markets. The second growth zone is private credit that we think is poised to penetrate a $23 trillion TAM as traditional bank lenders retrench, providing an opportunity for private lenders to step in. For corporate issuers, private credit offers greater flexibility on structure and terms, and provides greater certainty of execution. For investors, it can provide higher yields and diversification from public credit. The third growth zone is infrastructure investing, which we think can help solve for decades-long underinvestment and addresses a $15 trillion funding gap over the next 20 years. This is underpinned by structural tailwinds for the 3 Ds of digitization, decarbonization and deglobalization. The fourth growth zone is around liquidity solutions. As you know, the private markets are illiquid. And so as the asset class grows, we do expect some investors will want to find ways to access some degree of liquidity over time. And that's where solutions such as secondaries and NAV based lending can be helpful. The fifth and final growth zone is around impact in ESG investing. In public markets, we've seen significant asset flows into ESG and impact investing strategies as investors look to have a positive impact on society. And we expect that this will also play a role in the private markets, though it's a bit earlier days. Today we estimate about 200 billion invested in private market impact strategies, and we think that can reach about 850 billion in five years time. Mike Cyprys: So for investors, this does boil down to an impact on publicly traded companies. Given the specific challenges of the current environment, Bruce, which business models do you think are best positioned to succeed both near-term and longer term? And what should investors be looking at? Bruce Hamilton: Well, Mike, whilst we think the challenging macro conditions could continue to weigh on the sector near-term, we think that investors may want to look at companies with the best exposure to the five growth themes that you mentioned, who are building out global multi-asset investment franchises with diverse earnings streams, a high proportion of durable management fee related earnings—rather than heavy reliance or more volatile carry or performance fees—and deployment skewed to inflation protected sectors like infrastructure or real estate. Mike Cyprys: Bruce, thanks for taking the time to talk. Bruce Hamilton: Great speaking with you, Mike. Mike Cyprys: 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.

Despite companies beginning to report earnings misses and poor stock performance, the S&P 500 is on the rise, leading many to wonder how the Fed will react to this new data in their coming meeting.----- 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, October 31st at 11 a.m. in New York. So let's get after it. Two weeks ago, we turned tactically bullish on U.S. equities. Some clients felt this call came out of left field, given our well-established bearish view on the fundamentals. To be clear, this call is based almost entirely on technicals rather than the fundamentals which remain unsupportive of most equity prices and the S&P 500. Today, we will put some meat around the fundamental drivers for why this call can work for longer than most expect. Last week was the biggest one for third quarter earnings season in terms of market cap reporting. More specifically it included all of the mega-cap tech stocks that make up much of the S&P 500. On one hand, these companies did not disappoint the fundamental bears like us who've been expecting weaker earnings to finally emerge. In fact, several of these large tech stocks reported third quarter results that were even worse than we were expecting. Furthermore, the primary driver of the downside was due to negative operating leverage, which is a core part of our thesis on earnings as described in the fire and ice narrative. However, these large earnings misses and poor stock performance did not translate into negative price performance for the S&P 500 or even the NASDAQ 100. This price action is very much in line with our tactical bullish call a few weeks ago. In addition to the supportive tactical picture we discussed in prior notes, we fully expected third quarter results to be weak. However, we also expected most companies would punt on providing any material guidance for 2023, leaving the consensus forward 12 month earnings per share estimates relatively unchanged. This is why the primary index didn't go down in our view, and actually rose 4%. The other driver for why the S&P 500 rose, in our view, is tied to the upcoming Fed meeting this week. While the Fed has hawkishly surprised most investors this year, we've now reached a point where both bond and stock markets may be pricing in too much hawkishness. First, other central banks are starting to slow their rate of tightening. Second, there are growing signs the labor market is finally at risk of a downturn as earnings disappoint and job openings continue to fall. Third, the 3 month 10 year yield curve is finally inverted, and that is one item Fed Chair Jay Powell has said he's watching closely as a sign the Fed has gone far enough. However, the best evidence the Fed has already done enough to beat inflation comes from the simple fact that money supply growth has collapsed over the past year. Money supply is now growing just 2.5% year over year. This is down from a peak of 27% year over year back in March of 2021. A monetarist which suggests inflation is likely to fall just as rapidly as it tends to lag money supply growth by 16 months. This means longer term interest rates are likely to follow, which can serve as a driver of higher valuations until the forward earnings per share estimates fall more meaningfully. What this all means for equity markets is that we have a window where stocks can rally on the expectation inflation is coming down, which allows the Fed to pause its rate hikes at some point in the near future, if not this week. Moreover, this pause must occur while earnings forecasts remain high. The bottom line is that we continue to think there's further upside toward 4000 - 4150 from the current 3900 level. However, for that to happen, longer term interest rates will need to come down, and that will likely require a less hawkish message from the Fed. That puts a lot of pressure on this week's Fed meeting for our tactical call to keep working. If the Fed comes in hawkish and squashes any hopes for a pause before it's too late, the rally could very well be over. More practically, anyone who jumped on board this tactical trade should use 3700 on the S&P 500 as a stop loss for remaining bullish. Conversely, should longer term interest rates fall after Wednesday's meeting, we would gain more confidence in our 4150 upside target for the trade and even consider further upside depending on the message from the Fed. 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. 

As the U.K. grapples with structural, political, and economic issues, how are markets affected across assets, and what stories may look better for investors than others? Chief Cross-Asset Strategist Andrew Sheets and U.K. Economist Bruna Skarica discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan stanley's Chief Cross-Asset Strategist. Bruna Skarica: And I'm Bruna Skarica, Morgan Stanley's U.K. Economist. Andrew Sheets: And on part two of this special two part edition of the podcast, we'll be talking about the market implications of the latest political, economic and market developments in the U.K. It's Friday, October. 28th at 2 p.m. in London. Bruna Skarica: So Andrew, we already discussed the economic outlook for the U.K., and today I'd like to turn our conversation to you and your cross asset views. Obviously the current economic and political situation in the U.K. has a very significant impact on both macro and micro markets. Let's start with one of the number one investor questions around the U.K., which is the mortgage market. Roughly one in four mortgages has a variable rate and current estimates suggest that more than a third of UK mortgage holders will see their rates rise from under two to over 6% over the next year. What is your outlook for the mortgage market and its impact on the U.K. consumer, especially amid what is already severe cost of living crisis? Andrew Sheets: Like the U.S. most household debt in the U.K. is held in the form of mortgages. Unlike t,vhe U.S., though, those mortgages tend to have a quite short period where the rate is fixed. The typical U.K. mortgage, the rate is only fixed for 2 to 5 years. Which means that if you bought a house in 2020 or 2021, a lot of those mortgages are coming due for a reset very soon. And that reset is large. The mortgage, when it was taken out in 2020, might have had a rate of 2%. The current rate that it will reset to is closer to 6%. So that's a tripling of the interest rate that these homeowners face. So this is a very severe consumer shock, especially if you layer it on top of higher utility bills. This is, I think, a big challenge that, as you correctly identified in our conversation yesterday, that the Bank of England is worried about. And, you know, this is one reason why we think the pound will weaken. I'm sure we'll talk about the pound more, but if rate rises in the U.K. work their way into the household much faster because the mortgage fixed period is much shorter, maybe that means the Bank of England can't hike as much as markets expect. Whereas the Fed can because the dynamics in the mortgage market are so much different. Bruna Skarica: Indeed. Now, aside from that, U.K. rates have also seen a historical level of volatility this year. The pound as well has been weak all year, even though it has rallied a bit recently. Perhaps let's focus on the currency first. How do you see the pound from here? Do you think the downside risks have subsided or the structural risks still remain? Andrew Sheets: So the pound is a very inexpensive currency. It's inexpensive on a number of the different valuation measures that we look at, purchasing power parity, a real effective exchange rate and it's certainly fallen a lot. But our view is that the pound will fall further and that this temporary bounce that the pound has enjoyed in the aftermath of another new leadership team in the country is ultimately going to be short lived. A lot of the economic challenges that were there before the mini budget are still there. Weak economic growth, a large current account deficit, trade friction coming out of Brexit. And also I think this part about the Bank of England maybe not raising rates as much as the market expects, there's that much less interest income for investors for holding the pound. We forecast a medium term level for the pound relative to the dollar, about 1.05, so still lower from here. And we do think the pound will be the underperformer across U.K. assets. Bruna Skarica: Now aside from the pound I've mentioned, investors have been very focused on the UK rates market where we have indeed seen a lot of volatility in recent weeks. Now what do valuations look like here after all the fiscal U-turns? And is Morgan Stanley still bearish on gilts? Andrew Sheets: It's common to talk about historic moves in the global market and sometimes you realize you're talking about a market that's been around for 10 years or 20 years. The U.K. bond market's been around for hundreds of years. And we saw some of the largest moves in that history over the last 2 months. So these have been really extreme moves, both up and down, as a result of the fallout from that mini budget. But going forward we think U.K. rates will rise further from here, we think bonds will underperform and there are a couple of reasons for that. One is that the real interest rate on U.K. gilts, the yield above expected inflation, it's not very high, it's about zero actually. Whereas if I invest in a U.S. inflation protected security, I get about 1.5% more than the inflation rate. And then I think you add on this challenge of it's a smaller market, you add on the challenge of there's more political uncertainty, and then you add in the the risk that inflation stays higher than the Bank of England expects, that core inflation remains more persistent. And I think all of these are reasons why the market could inject a little bit more risk premium into the gilt market. One other thing that's been highlighted by our colleagues in interest rate strategy, is just simply there's a lot of supply gilts. There's supply of gilts not just because the governments running a deficit, but there's supply because the Bank of England was a major buyer and a major holder of gilts during the year of quantitative easing and it's shifting towards quantitative tightening. So heavy supply, low real rates, and I think a potential for kind of a higher risk premium are all reasons why we think gilts underperform both bonds and treasuries. Bruna Skarica: Now that you mentioned quantitative tightening, of course, the Bank of England is planning to sell its credit holdings as well. What is the situation in the sterling credit market? Can you walk us through the challenges and opportunities there right now for both domestic and foreign investors? Andrew Sheets: Yeah. So I think the credit market in the U.K. is actually one of the better stories in this market. Now it's not particularly liquid. But I think where sterling credit has some advantages is, one, it's actually a relatively international market. Only about half of it references U.K. companies, the other half of it is global companies, including a lot of U.S. issuers. So the credit market is not a particularly domestically focused index to the extent people are worried about the U.K. domestic situation. It's a market that trades at a spread discount to the U.S., both because of some of the recent volatility and the fact it's a little bit less liquid. this is a market that yields around 6.5% - 6.75% on investment grade credit. That's, I think, a pretty good return relative to expected inflation, relative to where we think credit risk is in that market. So, you know, amidst some other more difficult stories, we think the credit market might end up being a relatively better one. Bruna Skarica: Finally, let's take a step back perhaps, and take a look at some of the U.K.'s structural vulnerabilities. The U.K. has a very weak net international investment position, it's reliant on foreign money to fund some of its deficit and despite the recent fiscal U-turns, the U.K.'s fiscal deficit is still relatively large. In the context of these vulnerabilities, can you maybe discuss how recent events have affected foreign investors' confidence, and how do you see things going forward? Andrew Sheets: Yes, so I think this is a really important issue and maybe a good one to close on. The U.K., as you just mentioned, runs a very large current account deficit. It imports much more than it exports, and when you do that you need to attract foreign capital to make up that difference. Now the U.S. also imports more than it exports, the U.S. also runs a large current account deficit, but because the U.S. is this large deep capital market, it's seen as a relative winner in the global economy in terms of both the makeup of its companies and its longer term growth it tends to have an easier time attracting that foreign capital. The U.K. has more challenges there. It's a much smaller market, it doesn't have the same sort of tech leadership that you see in the U.S. and in terms of attracting the foreign capital into the equity market, well, that's been more difficult because you've had some uncertainty over what U.K. corporate tax policy will be. The U.K. equity market also tends to be quite energy and commodity focused. So in an ESG focused world, it's more complicated to attract inward investment. And then on the bond market side, the U.K.'s bonds don't yield more than U.K. inflation at the moment. So again, that's probably worked against attracting foreign investment. So maybe one other factor there that is important and we've touched this in a glancing way throughout this conversation, is brexit. That the U.K.'s exit from the European union does still present a number of big uncertainties around how U.K. companies and the U.K. economy will operate relative to its largest trading partner. And so, again, we can see a scenario where just simply higher risk premiums or lower valuations are ultimately needed to clear the market. Andrew Sheets: So Bruna, thanks for taking the time to talk. Bruna Skarica: Thanks, Andrew. Andrew Sheets: 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 the U.K. deals with a bout of market volatility, political transitions, and sticky inflation, how will policy makers and the Bank of England respond, and where might the U.K. economy be headed from here? Chief Cross-Asset Strategist Andrew Sheets and U.K. Economist Bruna Skarica discuss.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's Chief Cross-Asset Strategist. Bruna Skarica: And I'm Bruna Skarica, Morgan Stanley's U.K. Economist. Andrew Sheets: And on this special two part edition of the podcast, we'll be focused on the latest political, economic and market developments in the United Kingdom and how investors should think about the situation now and going forward. It's Thursday, October 27th at 2 p.m. in London. Andrew Sheets: So Bruna, the world's eyes have been on the U.K. over the last couple of months, not only because it's the world's sixth largest economy, but because it's been experiencing an unprecedented level of market volatility, and it also has had an unusually large amount of political volatility. So I think a good place to start this discussion is just taking a step back. How would you currently frame the economic challenges facing the U.K.? Bruna Skarica: Indeed, the level of volatility has truly been historic, both in the macro space, in the market and in politics. Now, in terms of what Prime Minister Sunak has on his tray coming into number 10, first let me mention the fiscal challenges. Chancellor Hunt, who's currently in number 11, has already reversed nearly all the measures from the mini budget, which was the catalyst of all this turbulence. Still, there is more to come. We think another £30 billion of fiscal tightening will be needed to stabilize debt to GDP ratio in the medium term. So more austerity, which of course, will be negative for growth. Now, this fiscal tightening, of course, comes in order to facilitate Bank of England's monetary tightening and help return inflation to the 2% target. The Bank of England has already hiked the bank rate to 2.25%, and we expect further hikes to come. So a lot of monetary tightening weighing on growth, too. And all of this is coming in the context of a very large external shock, that is the energy price move that has led to a spike in utility bills that the state is helping to counter, but that is weighing on UK's disposable income.Andrew Sheets: Given all of these challenges, how do you think the Bank of England is going to react? They have an upcoming meeting on November 3rd, and they’re facing a backdrop where on the one hand the U.K. has some of the highest core inflation in the developed world, and on the other hand it has a number of these risks to growth which you just outlined. How do you think they try to thread that needle and what do you think they ultimately do? Bruna Skarica: Indeed, the Bank of England has this year had a really complicated task at its hand. What started as the energy shock to inflation first impacting headline inflation, then spread on to pretty much every part of the consumer basket. The Bank of England we think has no choice but to tighten further from here. Chief Economist Pearl, in the aftermath of the mini budget, said that there will be a significant monetary response to the fiscal news and financial market volatility. As I mentioned, the mini budget was almost entirely scrapped, volatility subsided and so we think this significant response on November 3rd will come in the form of a 75 basis point hike. And we also see clear messaging from the Bank of England next week that this should be perceived as a one off level shift and that the pace of tightening will slow from December, as a lot of monetary tightening has already been delivered. We're expecting a 50 basis point move from the bank then and then two more 25 basis points hikes in the first quarter of next year, leaving the terminal rate at 4%. Andrew Sheets: In the Bank of England's thinking, how does inflation come down? You know, because you still have imported inflation from a weak currency, you still have some of the higher friction cost to trade coming through from Brexit, you still have quite high core inflation. What do you think the Bank of England is looking at that gives it conviction? Alternatively, what do you think is the most likely way those predictions could be wrong? Bruna Skarica: Well, the first thing to mention is the energy price inflation. It is true that our in-house Morgan Stanley view is that energy prices, for example natural gas prices, will not meaningfully correct from here. However, even if they stay at their current levels, inflation itself is going to slow and that's going to be a big drag on headline inflation over the course of next year and more so into 2024 and 2025. Additionally, the U.K. has seen a very sharp increase in traded goods inflation and our Morgan Stanley in-house view is that some of this is going to come off next year in the U.S. and the DM space more broadly, which we think will help lower U.K.'s headline and core inflation over the course of next year too. We do think services inflation will remain stickier. We think it's going to average around 5% next year actually, because our labor market's very tight and wage growth will remain at levels that are not consistent with meeting the 2% inflation target. However, the traded goods and energy prices we think should help with lowering headline inflation, and that is what the Bank of England is reflecting in its forecasts.Andrew Sheets: So Bruna you mentioned the strength of the U.K. labor market holding up despite, you know, a number of these macroeconomic challenges. What's going on there? What do you think explains the strength and how big of a problem do you think that is for the Bank of England's policy challenges? Bruna Skarica: That's a great question because our employment levels are actually not yet back to where they were pre-COVID. So a question arises as to why is our labor market this tight? And it's all about supply, really. The U.K.'s participation rate has been very subdued in the aftermath of the COVID shock. Some of it has to do with Brexit, a slowdown in migration flows from the EU from 2020 onwards because of course we've seen COVID and the Brexit shock coincide. However, much of it is to do with the drop in participation of U.K. born labor. For example, we now have a record high number of potential workers out with the labor force due to self-reported health issues. The health care backlog and NHS waiting lists are at an all time high and we now seem to have very limited fiscal space to address this. So we actually took down our own labor supply growth forecasts recently. This means that we do expect the slowdown in employment growth and when the recession comes shedding of employees over the course of next year, and that to be the main factor driving the rise in the unemployment rate. Andrew Sheets: So you have been calling for a recession around the end of the year in the U.K. and weak growth really through the middle of 2023. Is that still your forecast and what are the most likely factors that could change it? Bruna Skarica: Yes, that is still the case. We are looking for a 1% contraction in 2023 and for a recession to kick off in the second half of 2022. In terms of positive catalysts, I would say if natural gas prices fall further, the government will have more fiscal space to support the economy as opposed to using the funds to counter the external energy price hit. It would, of course, help with keeping the inflation somewhat lower. More resilient consumer spending, perhaps as some of those pandemic excess savings are spent, is another upside risk. But we see a very low probability of this happening. And finally, a more aggressive global disinflation, something I've mentioned when it comes to global traded goods inflation, leading to a faster return to positive real income growth, that's another factor to think about, and that would be beneficial for consumers and of course for overall U.K. GDP growth. So those are the main positive factors, I would say. Andrew Sheets: Bruna, thanks for taking the time to talk. Bruna Skarica: Great speaking with you, Andrew. Andrew Sheets: And thanks for listening. Be sure to tune in for the upcoming Part two of our conversation about the U.K. 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 the U.K. attempts stabilize its debt to GDP ratio, as well as curb inflation, the question becomes, to what extent will the Bank of England continue to tighten monetary policy?----- Transcript -----Welcome to Thoughts on the Market. I'm Seth Carpenter, Global Chief Economist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about recent developments in the U.K. and what the implications might be for other economies. It's Wednesday, October 26th, at 10 a.m. in New York.The political environment in the U.K. is fluid, to say the least. For markets, the most important shift was the fiscal policy U-turn. The tax cuts proposed by former Chancellor Kwarteng have been withdrawn apart from  two measures related to the National Health Service and property taxes. In total, the reversal of the mini budget tax cuts brings in £32 billion of revenue for the Treasury. Media reports suggested that Chancellor Hunt was told by the fiscal watchdog, the OBR, that medium term stability of the debt to GDP ratio would require about £72 billion of higher revenue. There's a gap of about £40 billion implying tighter fiscal policy to come. The clearest market impact came from the swings in gilt yields following the original fiscal announcement. The 80 basis point sell off in 30 year gilts prompted the Bank of England to announce an intervention to restore financial stability for a central bank about to start actively selling bonds to change course and begin buying anew was a delicate proposition. But so far, the needle appears to have been threaded. And yet, despite the recent calm, the majority of client conversations over the past month have included concern about other possible market disruptions. Part of the proposed fiscal plan was meant to address surging energy prices. Inflation in the UK is 10.1% of which only 6.5% is core inflation. The large share of inflation from food and energy prices works like a tax. From a household perspective, the average British household has a disposable income of approximately £31,000 a year and went from paying just over £1,000 a year for electricity and gas to roughly £4,000. Households lost 10% of their disposable income. Of course, the inflation dynamics in the U.K. resemble those in the euro area, in the latter headline inflation is 10%, but core inflation constitutes just under half of that. The hit to discretionary income is even larger for the continent. Our Europe growth forecasts have been below consensus for this reason. We look for more fiscal measures there, but our basic view is that fiscal support can only mitigate the depth of the recession, not avoid it entirely. Central banks are tightening monetary policy to restrain demand and thereby bring down inflation. The necessary outcome, then, is a shortfall in economic activity. For the U.K. the structural frictions from Brexit exacerbate the issue and the Bank of England, like our U.K. team, expect the labor force itself to remain inert. Consequently, after the recession, even when growth resumes, we expect the level of GDP to be about one and a half percent below the pre-COVID trend at the end of 2023. For the Bank of England, we are looking for the bank rate to rise to 4%, below market expectations. The shift in the fiscal stance tipped the balance for our U.K. economist Bruna Skarica. She revised her call for the next meeting down to 75 basis points from 100 basis points. And so while the next meeting may be a close call, in the bigger picture we think there will be less tightening than markets are pricing in because of the tighter fiscal outlook. 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.

The Biden administration recently imposed new trade restrictions on exports to China, but what sectors will be impacted and will we continue to see more policy pressure from the U.S. to China?----- 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 Tuesday, October 25th, at 10 a.m. in New York. On October 7th, the Biden administration announced another round of controls on the export of advanced computing and semiconductor equipment to China. The stated goal is to protect U.S. national security and foreign policy interests by limiting China's ability to develop cutting edge chip and computing technology. This news drove volatility in equity markets in China recently, but we think it shouldn't come as a surprise to investors. In fact, we argue that investors should expect the U.S. to continue pressing forward with trade restrictions on China. It's all part of our slowbalization and multipolar world frameworks. In short, as China's economy grows into a legit challenger to U.S. hegemony, U.S. policy has changed to protect its economic and military advantages. Export controls are one of those policies springing from a law passed in 2018, one of the few pieces of legislation that received bipartisan support during the Trump administration. And this law gives broad authority to the executive branch to decide what's in scope for export restrictions. So as the competition between the U.S. and China grows and new technologies over time become old technologies, expect export controls and other non-tariff barriers to spread across multiple industries. Other policy barriers could arise, too. As we've stated in prior podcasts, we still see scope for Congress to create an outbound investment control function for the White House. All in all, the net result is a managed delinking of the U.S. and China economies in some key sectors. For investors, the read through is clear; the policy pressure from the U.S. and China is unlikely to abate any time soon. The bad news from this? It means new costs to fund the supply chains that will have to be built, a particular challenge for tech hardware companies globally. The good news? This isn't a hard decoupling of the U.S. and China. Slowly but surely, these measures set up new rules of engagement and coexistence for the U.S. and China economies, meaning the worst outcomes for the global economy are likely to be avoided. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

As equities enjoy their best week since the summer highs in June, investors seem at the mercy of powerful market trends, so when might these trends take a turn to the downside?----- 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, October 24th, at 11:30 a.m. in New York. So let's get after it. Last week, we made a tactically bullish call for U.S. equities, and stocks did not disappoint us. The S&P 500 had its best week since June 24th, which was the beginning of the big summer rally. As a reminder, this is a tactical call based almost purely on technicals rather than fundamentals, which remain unsupportive of higher equity prices over the next 3 to 6 months. Furthermore, the price action of the markets has become more technical than normal, and investors are forced to do things they don't want to, both on the upside and the downside. Witness September, which resulted in the worst month for U.S. equities since the COVID lockdowns in March of 2020. The same price action can happen now on the upside, and one needs to respect that in the near term, in our view. As noted last week, the 200 week moving average is a powerful technical support level for stocks, particularly in the absence of an outright recession, which we don't have yet. While some may argue a recession is inevitable over the next 6 to 12 months, the market will not price it, in our view, until it's definitive. The typical signal required for that can only come from the jobs market. While nonfarm payrolls is a lagging indicator that gets revised later, the equity market tends to be focused on it. More specifically, it usually takes a negative payroll reading for the market to fully price a recession. Today, that number is a positive 265,000, and it's unlikely we get a negative payroll number in the next month or two. Of course, we also appreciate the fact that if one waits for such data to arrive, the opportunity to trade it will be missed. The question is one of timing. In the absence of hard data from either companies cutting guidance significantly for 2023 or unemployment claims spiking, the door is left open for a tactical trade higher before reality sets in. Finally, as we begin the transition from fire to ice, falling inflation expectations could lead to a period of falling interest rates that may be interpreted by the equity market as bullish, until the reality of what that means for earnings is fully revealed. Given the strong technical support just below current levels, the S&P 500 can continue to rally toward 4000 or 4150 in the absence of capitulation from companies on 2023 earnings guidance. Conversely, should interest rates remain sticky at current levels, all bets are off on how far this equity rally can go beyond current prices. As a result, we stay tactically bullish as we enter the meat of what is likely to be a sloppy earnings season. We just don't have the confidence that there will be enough capitulation on 2023 earnings to take 2023 earnings per share forecasts down in the manner that it takes stocks to new lows. Instead, our base case is, that happens in either December when holiday demand fails to materialize or during fourth quarter earnings season in January and February, when companies are forced to discuss their outlooks for 2023 decisively. In the meantime, enjoy the rally. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

The U.K.’s economy continues to face a host of challenges, including high inflation and a weak currency, and while these problems are not insurmountable, they may weigh significantly on the economic outlook.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for 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, October 21st at 2 p.m. in London. The eyes of the financial world remain on the United Kingdom, the world's 6th largest economy that is facing a complicated, interwoven set of challenges. We talked about the U.K. several weeks ago on this program, but I wanted to revisit it. It's a fascinating cross-asset story. First, among these challenges is inflation. High U.K. Inflation is partly due to global factors like commodity prices, but even excluding food and energy core inflation is about 6.5%. And since the U.K. runs a large current account deficit, importing much more than it exports, a weak currency is driving even higher costs through all those imported items. Meanwhile, Brexit continues to reduce the supply of labor and increase the costs of trade, further boosting inflation and reducing the benefit that a weaker currency would otherwise bring. The circularity here is unmissable; high inflation is driving currency weakness and vice versa. High inflation has depressed U.K. real interest rates, making the currency less attractive to hold. And high inflation relative to other countries undermines valuations. On an inflation adjusted basis, also known as purchasing power parity, the British pound hasn't fallen that much more than, say, the Swiss franc over the last year. If inflation is high, why doesn't the Bank of England simply raise rates to slow its pace? The bank is moving, but the Bank of England has raised rates by less than the market expected in 6 of the last 8 meetings. The Bank of England's hesitation is understandable, most UK mortgage debt is only fixed for 2 to 5 years, which means that roughly $100,000 loans are resetting every month. The impact is that higher rates can flow through into the economy unusually fast, much faster than, say, in the United States. Another way to slow inflation will be through tighter fiscal policy. But here we've seen some rather volatile recent political headlines. The U.K. government initially proposed a plan to loosen fiscal policy, but following a volatile market reaction has now changed course and reversed a number of those proposals. It still remains to be seen exactly what policy the U.K. government will settle on and what response the markets will have. The UK's problems are not insurmountable, but for now they remain significant. Our U.K. interest rate strategists think that expectations for 5 year inflation can move higher, along with yields. While our foreign exchange strategists are forecasting a lower British pound against the dollar. The one bright spot for the U.K. might be its credit market. Yielding over 7%, U.K. investment grade credit actually represents issuers from all over the world, including the United States. While less liquid than some other markets, we think it looks increasingly attractive as a combination of stability and yield amidst an uncertain environment. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you. 

While European earnings have been remarkably resilient this year, and consensus estimates for earnings and corporate margins remain high, there may be reason to believe there’s further yet to fall. ----- Transcript -----Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the outlook for European earnings for the upcoming third quarter reporting season and beyond. It's Thursday, October the 20th, at 2 p.m. in London. Having been cautious on European equities for much of this year, we have recently started to flag the potential for more two-way price action in the near-term, reflecting a backdrop of low investor positioning, coupled with the potential for an inflection in U.S. inflation and interest rates over the next few months. To be clear, we haven't seen either of these two events occur yet, however we are conscious that each week that passes ultimately takes us closer to just such an outcome. Given that high inflation and rising interest rates have been the key drivers pushing equity valuations lower this year, any sign that these two metrics are peaking out would suggest that we are approaching a potential floor for equity PE ratios. However, while this is good news to a degree, history suggests that we need to be closer to a bottom in the economic and earnings cycle before equity markets put in their final price low. So far this year, European earnings have stood out for their remarkable resilience, with the region enjoying double digit upgrades on the back of currency weakness and a doubling of profitability for the energy sector. Looking into the third quarter reporting season, we expect this resilience to persist for a bit longer yet. Currency effects are arguably even more supportive this quarter than last, and the global and domestic economies have yet to show a more material slowdown that would be associated with recessionary conditions. Our own third quarter preview survey also points to a solid quarter ahead, with Morgan Stanley analysts expecting 50% of sectors to beat consensus expectations this quarter versus just 13% that could miss. Longer term, however, this same survey paints a more gloomy picture on the profit outlook, with our analysts saying downside risks to 2023 consensus forecasts across 70% of European sectors and upside risks in just 3; banks, insurance and utilities. In the history of this survey, we have never seen expectations this low before, nor such a divergence between the short term and longer term outlooks. From our own strategy perspective, we remain cautious on European earnings and note that most, if not all of our models are predicting a meaningful drop in profits next year. Specifically, consensus earnings look very optimistic in the context of Morgan Stanley GDP forecasts, current commodity prices, dividend futures and the latest readings from the economic indicators we look at, such as the purchasing managers indices. In addition to a likely top line slowdown associated with an economic recession, we see significant risks around corporate margins, too. Over the last 12 to 18 months, inflation has positively contributed to company profitability, as strong pricing power has allowed rising input costs to be passed on to customers. However, as demand weakens, this pricing power should wane, leaving companies squeezed between rising input costs and slowing output prices. In this vein, our own margin lead indicator suggests that next year could see the largest fall in European margins since the global financial crisis. However, consensus estimates assume that 16 out of 20 European sectors will actually see their margins expand next year. Our concern around overly optimistic earnings and margin assumptions next year is shared by many investors we speak to. However, this doesn't necessarily mean that all of the bad news is already in the price. Analyzing prior profit cycles suggests that equity markets tend to bottom 1 to 2 months before earnings revisions trough, and that it takes about 7 to 8 months for provisions to reach their final low. If history repeats itself in this cycle, this would point to a final equity low sometime in the first quarter of 2023, even if price to earnings ratios bottom later this year. 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.

As the EU puts new regulations on sustainability funds, how will categorization of these funds be impacted, and how might that change investment strategies? Head of Global Thematic and Public Policy Research Michael Zezas and Head of Fixed Income and ESG Research Carolyn Campbell discuss.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Global Thematic and Public Policy Research. Carolyn Campbell: And I'm Carolyn Campbell, I lead our Fixed Income and ESG Research Team. Michael Zezas: And on this special episode of Thoughts on the Market, we'll focus on sustainability funds and their investment strategies within an evolving regulatory context. It's Wednesday, October 19th, at 10 a.m. in New York. Michael Zezas: There are just over 1400 dedicated fixed income sustainability funds with assets under management, around $475 billion off from a peak of $545 billion at the end of 2021. This is a sizable market, but as EU regulators weigh in on what these funds can and can't own, it begs the question what kinds of bonds might they start buying? So Carolyn, let's maybe start with the essentials behind the EU Sustainable Finance Disclosure Regulation, SFDR, and what it requires of financial market participants. Specifically, what are Article 8 and Article 9 products? Carolyn Campbell: So under the SFDR, fund managers are required to classify their funds in one of three ways. The first, Article 8, or what's known as a light green fund, is a sustainability fund that promotes environmental or social characteristics. The dark green funds, which are Article 9 funds, invest in sustainable investments and have an environmental or a social factor as an objective. They also, importantly, cannot do significant harm to other environmental or social objectives. And then lastly, we have the non sustainability funds which are Article 6. Michael Zezas: And despite the regulator's goal to increase transparency and accountability, there's still a high degree of uncertainty in the regulatory landscape around what can and should be included in sustainability funds. What does this uncertainty mean for the types of products that are currently being included in these funds, and how might that change in the future? Carolyn Campbell: So by and large, the regulatory uncertainty has meant that funds are more likely to take a conservative approach when constructing their holdings for fear of regulatory repercussions or just reputational risk. In particular, where investors need to have a "sustainable investment" that does not do significant harm to other environmental objectives, which is what we have in Article 9, we expect to see them gravitate increasingly towards high quality green bonds. And as a reminder, green bonds are different from regular bonds because the net proceeds of those bonds goes towards green projects. Think of it as retrofitting buildings to be more environmentally friendly, investing in climate change adaptation solutions, or building out clean transportation infrastructure. Green bonds fit pretty neatly into these Article 9 funds because they're demonstrably sustainable investments. And since you know where the proceeds are going, it's less likely that they're violating that last part, the ‘do no significant harm’. So some of the Article 9 funds are full green bond funds. But the ones that are not actually only hold around an average of 10% of their fund in green bonds or other types of ESG label bonds like social or sustainability bonds. And we see similar figures in the Article 8 funds as well. So we expect that green bonds of higher quality, meaning that they're aligned with the more rigorous EU green bond standard that report on impact have limited amounts of proceeds going towards refinancing, have limited look back periods etc.. Those stand to benefit from an increased appetite from these sustainability funds for the best types of green bonds. Michael Zezas: Carolyn, you've noted that most ESG funds currently favor low emission sectors, particularly financials. What about sectors that were previously maligned by ESG funds, the so-called high emitting or hard to abate sectors? What is the rate of change approach that might benefit these sectors? Carolyn Campbell: So the SFDR is structured in a way to favor the low emitting sectors because they have to report on the principal adverse impacts and because they can't do significant harm. But what we're increasingly hearing is an appetite to invest directly in the transition. So allocating funds to the higher emitting companies, but those that have viable decarbonization plans and for which an improvement on different ESG metrics may drive better financial performance. When we look to the fund holdings of the fixed income sustainability funds, we see that they're currently underweight these sectors despite some real opportunity from the transition. As ESG has evolved this year, so too should the types of strategies that we see adopted across the funds. And companies that are leading the way in their sectors stand to benefit from increased demand from sustainability funds that adopt these approaches, particularly in those sectors that are hard to abate or traditionally high emitting. Michael Zezas: Finally flows into fixed income sustainability funds increased throughout 2021, topping out at $17 billion in February. But inflows have been on a downward trajectory throughout the first half of 2022. What are the key drivers behind this decrease and what's your outlook for the secular growth story for ESG, both near-term and longer term? Carolyn Campbell: So there are a couple of things driving those declining inflows. First and foremost, the macro backdrop has significantly changed this year versus last year. We've seen regular large rate hikes from central banks around the world to combat high inflation, increased market volatility. It's a tougher environment all around this year in general, and it's not just sustainability funds that are seeing slowing inflows and even outflows. In fact, sustainability fund flows have held up remarkably well given all of this. Then you add in the fact that ESG is facing a bit of a reckoning. There's more vocal pushback in the press, from politicians and from those in the industry themselves on what ESG is and what are its merits. But we don't think this will hurt the growth of ESG in the long term. Rather, we think that sustainability strategies are undergoing an evolution towards more nuance and rigor, away from more simplistic approaches that we've seen adopted in the past. Climate change and sustainability more broadly will be a defining trend for at least the next decade, and this transition requires significant capital. That provides an interesting and unique opportunity for investors, and we've seen sustained demand from both institutional and retail clients for these different types of ESG strategies. Michael Zezas: So Carolyn, thanks for taking the time to talk. Carolyn Campbell: Great speaking with you, Michael. Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.