Thoughts on the Market

Yesterday, the U.S. Federal Reserve raised interest rates by another 75 basis points. What is driving these above average rate hikes and what might the effect on markets be?-----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 Thursday, July 28th at 4 p.m. in London. Yesterday, the Federal Reserve raised rates by 75 basis points, and the Nasdaq market index had its best day since April of 2020, rising over 4%. It was a day of big moves, but also some large unanswered questions. A 75 basis point rise in Fed funds is large and unusual. In the last 30 years, the Fed has only raised rates by such a large increment three times. Two of those instances were at the last two Federal Reserve meetings, including the one we had yesterday. These large moves are happening because the Fed is racing to catch up with, and get ahead of, inflation, which is currently running at about 9% in the U.S. In theory, higher fed rate should slow the economy and cool inflationary pressure. But that theory also assumes that higher rates work with a lag, perhaps as long as 12 months. There are a couple of reasons for this, but one is that in theory, higher rates work by making it more attractive to save money rather than spend it today. Well, I checked my savings account today and let's just say the rate increases we've had recently haven't exactly shown up. So the incentives to save are still working their way through the system. This is part of the Fed's predicament. In hockey terms, they're trying to skate the proverbial puck, aiming policy to where inflation and the economy might be in 12 months time. But both inflation and their policy changes are moving very fast. This is not an easy thing to calibrate. Given that difficulty, why did the markets celebrate yesterday with both stock and bond prices rising? Well, the Fed was vague about future rate increases, raising market hopes that the central bank is closer to finishing these rate rises and may soon slow down, or pause, its policy tightening as growth and inflation slow. After all, long term inflation expectations have fallen sharply since the start of May, perhaps suggesting that the Fed has done enough. And as my colleague Michael Wilson, Morgan Stanley's chief investment officer and chief U.S. equity strategist, noted on Monday's podcast, markets have often seen some respite when the Fed pauses as part of a hiking cycle. But it's also important to stress that the idea that the Fed is now nearly done with its actions seems optimistic. The last two inflation readings were the highest U.S. inflation readings in 40 years, and Morgan Stanley's economists expect core inflation, which is an important measure excluding things like food and energy, to rise yet again in August. In short, the Fed's vagueness of future increases could suggest an all important shift. But it could also suggest genuine uncertainty on growth, inflation and how quickly the Fed's actions will feed through into the economy. The Fed has produced some welcome summer respite, but incoming data is still going to matter, significantly, for what policy looks like at their next meeting in September. 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 midterm polls have shown a preference for republican candidates, this lead is narrowing as the election grows closer, and the full ramifications of this ever evolving race remain to be seen.-----Transcript-----Welcome the Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy 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, July 27th, at 1 p.m. in New York. We're still months away from the midterm elections, and polls still show strong prospects for Republicans to win back control of Congress. As we previously discussed, such an outcome could result in stalling key policy variables for markets such, as tax changes and regulations for tech and cryptocurrency. But remember not to assume that such an outcome is a sure thing. Take, for example, recent polls showing voters' preference for Republican congressional candidates over Democrats actually narrowing. A month ago, the average polling lead for Republicans was nearly 3%, it's now closer to 0.5%. Some independent forecasting models even now show the Democrats as a slight favorite to hold the Senate, even as they assess Democrats are unlikely to keep control of the House. The reasons for Democrats' improvement in the polls are up for debate, but that's not the point for investors. In our view, the point is that the race is still evolving and that can have market ramifications. Even if Democrats don't ultimately keep control of Congress, making it a closer race means markets may have to account for a higher probability that certain policies get enacted. Take corporate tax hikes, for example. Recent news suggests they're off the table, but if Democrats hold Congress, it's likely they'd be revisited as a means of funding several of their preferred initiatives. That could pressure a U.S. equity market already wary of margin pressures from inflation and slowing growth. A more constructive example is the clean tech sector. Again, reports are that the plan to allocate money to clean energy is off the table, but this could be revisited if Democrats keep control. Hence, improved Democratic prospects could benefit the sector ahead of the election. The bottom line is that the midterm elections are still a market factor over the next few months. We'll keep you in the loop right here about how it all plays out. 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 young, digitized consumers have popularized the “Buy Now, Pay Later” payment system across global markets, there may yet be related market opportunities in Latin America.-----Transcript-----Welcome to Thoughts on the Market. I'm Jorge Kuri, Morgan Stanley's Latin America Financials Analyst. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the rise of Buy Now, Pay Later, or BNPL, in Latin America. It's Tuesday, July 26th, at 2 p.m. in New York. As many of you no doubt remember, the COVID lockdowns of 2020 and 2021 were boom times for e-commerce, as quarantines made us all habitual online shoppers. This period also helped fuel the Buy Now, Pay Later payment method, which allows online shoppers the ability to make a purchase and defer payments over several installments with no fees or interest when paid on time. Buy Now, Pay Later first gained traction in New Zealand and Australia, then in Europe and most recently in the U.S. and now BNPL could offer a vast market opportunity in Latin America. In fact, we see volumes reaching $23 billion in Mexico and $21 billion in Brazil by 2026. So let's take a closer look at why. BNPL in Latin America is driven by a number of secular tailwinds, starting with favorable demographics: BNPL appeals to young, digitalized consumers who fuel the electronification of payments and e-commerce. Combine that with low credit penetration, growing consumer awareness and merchant acceptance, and you have a recipe for strong and sustainable multi-year growth. Mexico and Brazil offer the most attractive market opportunities within Latin America. In Mexico, the population is very young and digitalized - 65% is 39 years old or younger, and smartphone penetration among individuals 18 to 34 years is 83%. Yet the population of unbanked adults is quite large, 51% do not have a bank account and 80% do not have a credit card. Digitalization of payments is a big tailwind, as cash remains by far the most frequently used payment method, while e-commerce penetration is expected to double and reach 20% by 2026.In Brazil, the situation is a bit different. Similar to Mexico, the population is young and digitalized. But in contrast, credit penetration is higher in Brazil, with 75% of households utilizing at least one form of credit and one or more credit cards. The ubiquity and effectiveness of PIX, the instant payments ecosystem in Brazil, combined with the large and fast growing e-commerce industry and the boom in fintech companies, could facilitate the distribution and acceptance of BNPL in the country.It's worth noting that the BNPL opportunity does not come without risks. Delinquency risk is obvious given the unsecured nature of the product, adverse selection risks and a challenging macroeconomic environment. Most BNPL providers have some funding disadvantages and competition among both BNPL players and incumbent banks will likely ensue. Despite these various risks, BNPL remains one of the most significant multi-year trends to watch in Latin America financials. Thanks for listening. If you enjoy this 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 markets grapple with pricing in inflation, central bank rate hikes, and slowing growth, can the recent S&P 500 rally help investors gauge what may happen next for equities?-----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, July 25th, at 11 a.m. in New York. So let's get after it. Since the June lows at 3650, the S&P 500 has been range trading between those lows and 3950. However, this past week, the S&P 500 peaked its head above the 50 day moving average, even touching 4000 for a few hours. While we aren't convinced this is anything but a bear market rally, it does beg the question is something going on here that could make this a more sustainable low and even the end to the bear market? First, from a fundamental standpoint, we are more convicted in our view that S&P 500 earnings estimates are too high, and they have at least 10% downside from the recent peak of $240/share. So far, that forecast has only dropped by 0.5%, making it difficult for us to agree with that view that the market has already priced it. Of course, we could also be wrong about the earnings risk and perhaps the current $238 is an accurate reflection of reality. However, with most of our leading indicators on growth rolling over, we continue to think this is not the case, and disappointing growth remains the more important variable to watch for stocks at this point, rather than inflation or the Fed's reaction to it. Having said that, we do agree with the narrative that inflation has likely peaked from a rate of change standpoint, with commodities as the best real time evidence of that claim. We think the equity market is smart enough to understand this too, and more importantly, that growth is quickly becoming a problem. Therefore, part of the recent rally may be the equity market looking forward to the Fed's eventual attempt to save the cycle from recession. With time running short on that front. And looking at past cycles, there's always a period between the Fed's last hike and the eventual recession. More importantly, this period has been a good time to be long equities. In short, the equity market always rallies when the Fed pauses tightening campaign prior to the oncoming recession. The point here is that if the market is starting to think the Fed's about to pause rate hikes after this week’s, this would provide the best fundamental rationale for why equity markets have rallied over the past few weeks despite the disappointing fundamental news and why it may signal a more durable low. The problem with this thinking, in our view, is  it's unlikely the Fed is going to pause early enough to save the cycle. While we appreciate that investors may be trying to leap ahead here to get in front of what could be a bullish signal for equity prices remain skeptical that the Fed can reverse the negative trends for demand that are already now well-established, some of which have nothing to do with monetary policy. Furthermore, the demand destructive nature of high inflation is presenting itself today will not easily disappear even if inflation declined sharply. This is because prices are already out of reach in areas of the economy that are critical for this cycle to extend in areas like housing and autos, food, gasoline and other necessities. Secondarily, high inflation provides a real constraint for the Fed to pause or pivot, even if they decided a risk of recession was imminent. That's the main difference versus more recent cycles and why we think it remains a good idea to stay defensively oriented in one's equity positioning until further earnings disappointments are factored into consensus estimates or equity prices. 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.

This week the European Central Bank surprised economists and investors alike with a higher than anticipated rate hike, so why this hike and what comes next? Chief Cross-Asset Strategist Andrew Sheets and Chief European Economist Jens Eisenschmidt discuss.-----Transcript-----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Jens Eisenschmidt: And I'm Jens Eisenschmidt, Morgan Stanley's Chief Europe Economist. Andrew Sheets: And on this special episode of Thoughts on the market will be discussing the recent ECB rate hike and the path ahead. It's Friday, July 22nd at 4 p.m. in London. Andrew Sheets: So, Jens, I want to talk to you about the ECB's big rate decision yesterday. But before we do that, I think we should start by laying the scene of the European economy. In a nutshell, how is Europe's economy doing and what do you think are the most salient points for investors to be aware of? Jens Eisenschmidt: Great question, Andrew. We have revised downwards our growth outlook for the euro area economy on the back of the reduced gas flow coming out from Russia into Germany starting at some point in mid-June. And we are now seeing a mild recession for the euro area economy setting in towards the end of this year and the beginning of next. This is in stark contrast to what the ECB, as early as June, has been saying the euro area economy would look like. I think incoming data, since our call for a bit more muted economic outlook, has been on the negative side. So for instance, we just today had the PMIs in contractionary territory. So the PMIs are the Purchasing Managers Indexes, which are soft indicators of economic activity. Soft because are survey evidence they're essentially questions ask industry participants about what they see on their side, and out of these questions an index is derived for economic activity. So all in all, the outlook is relatively muted, as I said, and I think a recession is clearly in the cards. Andrew Sheets: But Jens, why is growth in Europe so weak? When you think about things like that big decline in PMI that we just saw this week, what's driving that? What do you think is the key thing that maybe other forecasters might be missing in terms of driving this weakness? Jens Eisenschmidt: I mean, Europe is very, very close to one of the largest, geopolitical conflicts of our time. We have, as a consequence of that, to deal with very high energy prices. The dependance on Russian gas, for instance, is very high in several parts of Western Europe. But you're right, we have still accommodative monetary policy, so, all in all, we still have positive and negative factors, but we think that the negative factors are starting now to have the bigger weight in all this. And we have seen for the first time, as you just mentioned to PMI's in contractionary territory, while we are of course having a bit in the service sector, a different picture which is still driven from reopening dynamics coming out from COVID. So everybody wants to have a holiday after they didn't have one last year and the year before. Andrew Sheets: So I guess speaking of holidays, it involves a lot of driving, a lot of flying. I think that's a good segway into the energy story in Europe. This has been a really challenging dynamic because you've had obviously the risk of energy being cut off into Europe. When you think about modeling scenarios of less energy being available via Russia, how do you go about modeling that and what could the impact be? Jens Eisenschmidt: No, that's really the hard part here. Because, ultimately, if the energy is flowing and continues to flow, you can rely on data that goes back and that gives you some relationship between the price and then what the impact on economic activity on that price schedule will be. But if energy is falling to levels where governments have to decide duration, then the modeling becomes so much harder because you have to decide then in your model who gets gas or oil and at what price. That makes it very hard and it also explains why there's a huge range of model outcomes out there showing GDP impact for some economies as deep, in terms of contraction, of 10 to 15%. We are not in that camp. We think that even in a situation of a total cut off of, say, Russian gas, the euro area economy would contract, but not as deeply. Part of that is that we think that some time has elapsed since the threat has first become a possibility and the system has adjusted to some extent. And then what you get is a system that's a little bit more resilient now to a cut than it may have been in March. Andrew Sheets: Jens. I think that's also a good connection to the inflation story. So on one hand, inflation dynamics in Europe look quite similar to the U.S. On the other hand those inflation dynamics seem somewhat different from the U.S., core inflation is not as high, wage inflation is not as high. Could you kind of walk us through a bit of how you see that inflation story in Europe and how it's similar or different to what we see going on in the U.S.? Jens Eisenschmidt: There is clearly a difference here, and I think the ECB has never been tiring in stressing that difference that most of the inflation here in Europe is driven by external factors. And here, of course, energy is the big elephant in the room. It's not helped by the fact that we had a depreciation of the Euro against the U.S. dollar and most of the energy is, as we know, a built in U.S. dollar. We also have a significant food inflation, and of course, it's also linked very, very tightly to the conflict in Ukraine, where we have Ukraine as a big food exporter. Just think of oil, think of wheat, all these things that are in the headlines. So that's structurally different from a situation in the U.S. where you do have a significant part of the inflation being internal demand driven. And of course that leads to interconnection with a very tight labor market to a higher core inflation. Now core inflation in the euro area has also been picking up and it's certainly not at levels where the European Central Bank can be happy with. But, you know, all in all, both our set of assumptions and forecasts as well as the ECB's in the end boil down to a slight overshoot in the medium term of their inflation target. Andrew Sheets: So Jens, all of this brings us back to the main event, so to speak. The European Central Bank raised interest rates yesterday for the first time since 2011, and it was a pretty large increase. It was a half a percentage point increase. So what's driving the ECB thinking here and how is it trying to weigh all these different factors, in a world where rates are rising? Jens Eisenschmidt: So indeed, the ECB yesterday ended its negative rates policy, which was designed for a completely different environment, an environment of a persistent undershoot of its inflation target. By all available measures, they are now at target or above. So that in itself justifies ending this policy, and this is what they did yesterday. Now, of course, there is a concern that the high inflation that we see today is feeding into wage negotiations, is feeding into a process of more structurally higher inflation, and that risks the anchoring inflation expectations. So there is a need, even if you see the economy going weaker, there is a need to tighten its monetary policy. At the same time, they have this geopolitical conflict just very near to them. They have the risk to growth that we were talking about before. So that also means you cannot just now go out and line out a significant path of rate increases. So that leads to the second component of their decision yesterday. So they were say we will go meeting by meeting and we will be data dependent in our move. Andrew Sheets: So Jens, let's bring this back to markets. When you look at what markets are currently expecting from the ECB in terms of rate hikes out over the next, say, 18 months, do you think the ECB is likely to deliver more tightening than those rates imply or deliver rates that are lower than those current market expectations? Jens Eisenschmidt: So if you just talk about where markets see the ECB peaking, that's at 1.5%. We agree, just that we don't agree on the timing. So we, for instance, see the ECB going 50 basis points in September, but then slowing down to 25 in October and another 25 in December. And then we really see the ECB pausing until September next year. And the pause is introduced because the economy is weakening and significantly so, and we see this centered around the end of the year. Now in the markets, there is a bit of an assumption that the ECB will be more aggressive in terms of getting to the 1.5% earlier. Not necessarily still this year, but at some point early next year. Andrew Sheets: And just from the perspective of markets, you know, this is a reason why Morgan Stanley's foreign exchange team thinks that the euro will continue to weaken against the dollar. It's both a function of Jens your weak growth forecasts, but also potentially this idea that rates won't rise in Europe quite as fast as the market is expecting. Which would mean somewhat less support for the currency. Andrew Sheets: Jens, thanks for taking the time to talk. Jens Eisenschmidt: Thanks a lot, Andrew. It was a pleasure being with you. Andrew Sheets: 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. 

Original Release on July 1st, 2022: As inflation continues to be a major concern for the U.S., investors will want to pay attention to how spending, travel and sentiment are changing for consumers.-----Transcript-----Welcome to Thoughts on the Market. I'm Michelle Weaver, a U.S. equity strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be sharing the pulse of the U.S. consumer right now amid elevated inflation and concerns about recession. It's Thursday, July 7th, at 2 p.m. in New York. Consumer spending represents roughly 65% of total U.S. GDP. So if we're looking for a window into how U.S. companies could perform over the next 12 months, asking consumers how confident they're feeling is a great start. Are consumers planning on spending more next month or less? Are people making plans for outdoor activities and eating out or are they staying at home? Are they changing travel plans because of spending worries? These are a few of the questions that the equity strategy team asks in a survey we conduct with the AlphaWise Group, the proprietary survey and data arm of Morgan Stanley Research. We recently decided to change the frequency of our survey to biweekly to get a closer look at the consumer trends that will affect our outlook. So today, I'm going to share a few notable takeaways from our last survey, which was right before the July 4th holiday. First, let's take a look at sentiment. The survey found that inflation continues to be the top concern for two thirds of consumers, in line with two weeks before that, but significantly higher compared to the beginning of the year. Concern over the spread of COVID-19 continues to trend lower, with 25% of consumers listing it as their number one concern versus 32% last month. And 41% of consumers are worried about the political environment in the U.S. versus 38% two weeks ago, a slight tick up. Apart from inflation, low-income consumers are generally more worried about the inability to pay rent and other debts, while upper income consumers over index on concerns over investments, the political environment in the U.S., and geopolitical conflicts. A second takeaway to note is that consumer confidence in the economy continues to weaken, with only 23% of consumers expecting the economy to get better. That's the lowest percentage since the inception of our survey and down another 3% from two weeks ago. In addition, 59% of consumers now expect the economy to get worse. This lines up with the all-time lows observed in a recent consumer sentiment survey from the University of Michigan. A third takeaway is that consumers are planning to slow spending directly as a result of rising prices. 66% of consumers said they are planning to spend less over the next six months as a result of inflation. These numbers are influenced by income level, with lower income consumers planning to reduce spending more. We also asked consumers where they were planning to reduce spending in response to inflation. Dining out and take out, clothing and footwear, and leisure travel were among the most popular places to cut back, and all represent highly discretionary spending. And finally, the survey noted that travel intentions are considerably lower to the same time last year, with 55% of consumers planning to travel over the next six months, versus roughly 64% in the summer of last year. We also asked consumers if they were planning to cancel or delay post-Labor Day travel because of inflation. Generally, planned travel post-Labor Day is in line with broader travel intentions. Cruises and international travel were the most likely to be delayed or postponed. So what's the takeaway for investors? It is important to allocate selectively as consumer behavior shifts in order to cope with inflation and company earnings and margins come under pressure. Our team recommends defensive positioning, companies with high operational efficiency, and looking for idiosyncratic stories where companies have unique advantages. 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.  

Interest in ESG investing has risen exponentially in recent years, leading to increased scrutiny around, and appreciation for, the hard data. Head of U.S. Public Policy Research and Municipal Strategy Michael Zezas and Head of the ESG Fixed Income Research Team Carolyn Campbell discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, head of U.S. Public Policy Research and Municipal Strategy. Carolyn Campbell: And I'm Carolyn Campbell, head of the ESG fixed income research team at Morgan Stanley. Michael Zezas: And on this special edition of the podcast, we'll be assessing the next phase of the environmental, social, governance, ESG, market. It's Wednesday, July 20th, at 10 a.m. in New York. Michael Zezas: As some listeners may have read, in late May of this year, the Securities and Exchange Commission proposed new rules that would require ESG funds to disclose their goals, criteria and strategies, along with data measuring ESG progress. And this tells us that although the market for ESG investing has grown, so has investor desire to see real data and empirical analysis on impact. And this could be seen as really the next phase of the ESG market, that companies and funds won't just claim to be focused on ESG but will provide real proof. So, Carolyn, just to set the stage, I notice that people sometimes use the term sustainable investing and ESG interchangeably. So, I think it might be good to start with what exactly ESG is. Carolyn Campbell: At its core ESG is about adding a new lens to risk management in our investment practices by looking at environmental, social and governance factors in addition to our traditional financial metrics and whatnot. ESG has been around in some way, shape or form for decades, beginning with what we call negative exclusions. Initially, that looked like excluding companies that conflicted with religious views such as gambling, alcohol or pornography. But it's probably best known more recently for what we would think of as the fossil fuel divestment movement; selling out of coal and oil and gas companies, for example. On the other end of the spectrum, we've got impact investing where money is put towards projects that are both worthy financial investments but are also meant to generate some type of positive impact, whether it be environmental or social. In between, ESG can look like a lot of things, whether that's selecting companies that are best in class or building a portfolio geared towards a certain theme like biodiversity, net zero or gender diversity. Michael Zezas: Now, you're a fixed income strategist and ESG investing through the bond market is a bit newer and still evolving. What are some of the challenges of investing in ESG through bonds as opposed to stocks? Carolyn Campbell: Well, so one big difference in fixed income is that there are products that are actually dedicated sustainability assets. Companies, governments and super nationals can issue bonds that are specifically ESG instruments, which isn't something that you can quite do in the stock market. The most common is the green bond. The net proceeds of the issuance go towards green projects, which can be things like retrofitting your buildings to be more energy efficient, building out a solar paneled roof, reducing water waste and so on. There are also social bonds with projects related to decreasing inequality or access to health care and sustainability bonds, which fund both types of projects. We spend a lot of time trying to understand how these instruments trade compared to normal vanilla bonds from the same issuer. A big driver of the difference in price and performance is that there are just a lot fewer of these label bonds and quite a large appetite to invest in them. So those supply and demand dynamics have historically helped these labor bonds trade well, particularly in the primary market. We recently completed some analysis, though, that found that when you strip away a lot of the structural differences, the premium afforded to these green bonds is pretty small over time, just around half a basis point. The big difference comes from green bonds that go the extra mile. These bonds have voluntary external verification, science-based targets, so on and so forth. Investors can see the green criteria of the bond and feel confident that the governance structures are in place to ensure the materiality of the green bond going forward. And these bonds on average trade with higher premiums to their vanilla counterparts than just your regular green bond. Michael Zezas: So I want to get into some of the challenges I mentioned at the start around the debate over ESG's impact and validity. What's been the catalyst for the increased scrutiny over what's often called 'greenwashing?' Carolyn Campbell: Yeah, great question. So if we take it back a step, ESG really took off during 2020 with the onset of the pandemic. And there was a surge of focus on, and enthusiasm around, ESG and climate change more broadly. The market's grown exponentially since then, and it was natural that some of these new products and developments would be met with a raised eyebrow. Protests and social unrest in 2020, for instance, marked a turning point for companies with society asking companies to state their values upfront and to start walking the walk. Much of the scrutiny around ESG is ensuring that companies are not taking advantage of ESG as a marketing exercise to generate goodwill and are, in a sense, putting their money where their mouth is. That's really accelerated this year with the war in Ukraine, which is highlighted that within ESG there are some potentially competing priorities, namely the social cost of high energy prices versus the far reaching implications of climate change, or the rising food insecurity versus a more sustainable value chain. Investors have begun to adopt more nuanced views of what ESG is and how it might evolve in a world with higher volatility and decades-high inflation prints. And not everybody has the same definition of what ESG means to them. At the end of the day, the debate centers around, is it affecting change, and if so, by how much? Michael Zezas: So I certainly understand the clamor for demonstrable proof of impact. But would you say that, even with incidents of greenwashing, has ESG moved the needle on achieving its goals? Carolyn Campbell: Another great question, and unfortunately, it's probably still too early to tell. ESG is really about playing the long game and moving the market's focus away from its bias towards short-termism. So the effects of these new cleaner investments might not necessarily be realized overnight. I think what is clear, though, is that the global greenhouse gas emissions haven't declined in recent years, despite this push towards more sustainable investing. In fact, 2021 marked the highest amount of global CO2 emissions ever recorded. That being said, while policy development at the federal level on climate might be facing some serious headwinds here in the US, there has been a positive push from the private sector to decarbonize, regardless of a legislative incentive. Just because we haven't seen a decline in emissions yet, doesn't mean it won't happen. It just means that there's a lot more work to do and a lot more money that needs to flow towards these sustainable solutions. Michael Zezas: So one of your key skills as a strategist is how you apply data and empirical analysis to ESG investments. Can you walk us through your work and your process? Carolyn Campbell: We start every report with a research question—how do you see factors, impacts, spread performance, for instance, or how much of a premium do these green bonds trade with? Sometimes these questions are commonly discussed and dissected in the news, in academic research and so on. But we try to begin each project with no presupposition of what we might find so that we don't bias our results. We want to let the data and results speak for itself. And we're not trying to push an agenda. We're trying to get to the bottom of complex problems that investors demonstrably care about. ESG data is incredibly tricky because it tends to have a shorter history than most financial metrics and is released slowly and often with lags. That doesn't give us a ton of wiggle room, but once we know the question we're trying to answer, we always start by collecting data, and we'll look for data from myriad sources: public and private, startups, the US government—you name it, we've looked into it. And then sadly, a lot of the work is data cleaning, as any data scientist listening knows all too well. Once we build the dataset, we start tackling that research question. Sometimes we're doing something a bit more simplistic, like standardizing metrics in order to facilitate a comparison of different instruments or companies. This is a big hurdle for ESG in particular, because we don't have anything like GAAP accounting metrics that every company has to report on. Just getting to a point where you can do an apples to apples comparison is not always straightforward. Often though, we look to use different types of regression models or other types of machine learning techniques to understand relationships in the market and to build the confidence in our results. Once we have those results, it's all about visualizing it in a compelling and clear way. Michael Zezas: If an investor is interested in the ESG space, what should they keep front of mind as they consider their investments? Carolyn Campbell: ESG is full of tradeoffs and it's rarely straightforward. We mentioned some of these dilemmas before, such as the social cost of the high gas prices and the implications of climate change by continuing to rely on fossil fuels. It's never clear cut. ESG isn't a one size fits all solution, and different investors are going to have different priorities. Understanding your priorities at the outset and keeping those as a guiding light will help keep the investment process on track and drown out some of the noise. That being said, it's also important in this fast evolving space to be flexible to new information and to be adaptable. The world looks very different now than it did a year ago or five years ago, and ESG in particular is rapidly changing with new regulations, new issues and new conflicts every day. Relying on the data and facts and understanding how trends change within the industry will be of utmost importance. Michael Zezas: Carolyn, thanks so much for talking. Carolyn Campbell: Great talking with you, Michael. Michael Zezas: And 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 U.S. Equities continue to face challenges this year, investors may want to look to a more positive story across the world—the reopening of China.-----Transcript-----Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. equity strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about China's reopening as COVID Zero policies evolve. It's Tuesday, July 19th, at 3 p.m. in New York. Recently, our China economics team has become more positive on the region due to the relaxation in domestic and international travel policies and signs of gradual reopening. The team believes that in order for China to shift away from COVID Zero, the three necessary conditions will be sufficiently high vaccination coverage, a broadening toolbox to preserve health care capacity and a change in public perception of COVID. Progress has been made on all of these conditions, and the team expects the economy to reopen more broadly in the back half of the year and that a COVID Zero exit could happen towards year-end. This is notable for global investors since the broad U.S. equity turmoil of the last few months makes it important to look for stocks whose stories are not levered to the market at large and are more thematic ideas. The potential reopening of a country with 1.4 billion residents hits both of these criteria. To dig into this, the US equity strategy team, headed by Chief Investment Officer Mike Wilson, and our European Equity Strategy Team, led by Graham Secker, sourced industries and names that could have high revenue exposure to China. We then asked sector analysts which stocks they thought stand to benefit the most from the reopening. In the US, the biggest beneficiaries were in the consumer discretionary, materials, industrials and information technology sectors. The names who stand to benefit here are American brands that have consumer appeal, benefit from out of home experiences or feature China as a key driver of revenue, where pent up demand could provide tailwinds. In Europe, the potential beneficiaries are companies that have the highest revenue exposure to China. But it's important to be selective here, as a relatively large number of industrial and commodity focused stocks could be exposed to wider concerns around a global economic slowdown. For that reason, companies who also have exposure to the Chinese consumer may be best positioned. Narrowing even further from a top-down perspective, we think the most direct beneficiary of a potential reopening narrative in China is the luxury goods sector, also known as consumer durables in MSCI terminology, which has the third highest China exposure of any European sector after semiconductors and materials. Relevant to the reopening angle specifically, the team believes the luxury sector has the highest exposure to the China consumer and is a beneficiary of reduced restrictions around travel. Given this exposure and the recent pullback in government bond yields, they have upgraded the sector to overweight from a top-down strategy perspective. 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.

Some investors think a potential recession is already priced in but given defensive leadership, labor statistics and incoming Fed rate hikes, it may be too early to tell.----- 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, July 18th, at 11 a.m. in New York. So let's get after it.Last week, we highlighted how extreme the 12-month price momentum weightings are for defensive sectors. In fact, it's unprecedented for this type of price momentum to occur outside of an economic recession. One reaction to this development we've heard from many clients is that a recession must already be priced based on this relationship. If true, then defensive leadership is likely to reverse with something else taking the lead, like growth stocks or even cyclicals. We disagree and believe defensive leadership will likely persist until either a recession is officially announced, or the risk of a recession is definitively extinguished.In our view, the first outcome can only be achieved with a series of negative payroll data releases, something that still seems far away given last month's 372,000 new job additions. The second outcome—a soft landing—will also be hard to prove to the market until earnings revisions bottom out and companies stop doing hiring freezes.With respect to the recession outcome, the odds have been steadily increasing now for months. Morgan Stanley's proprietary economic model is currently suggesting a 36% probability of a recession in the next 12 months. Historically speaking, once it reaches 40%, it's usually a definitive reading that recession is oncoming. Furthermore, jobless claims have been rising the past few weeks. Secondarily, the household survey for total employment peaked in March and has fallen by approximately 400,000 jobs so far. While not the gold standard for measuring labor market health, it's worth watching closely as things can change rapidly for hiring and firing, particularly when profits come under significant pressure, as we expect. Finally, the job openings data has started to roll over, albeit from record high levels, while consumer and business confidence readings remain at record lows.In the very near term, equity markets seem to be digesting another hot Consumer Price Index release very well, even as concerns rose that the Fed might raise rates as much as 100 basis points next week. Our view is that 75 basis points is still the base case, and that should be plenty to keep the Fed on track to getting ahead of the curve. Importantly, the bond market seems to agree with the yield curve inverting the most since the 2000 cycle, quickly catching up to the defensive leadership of the stock market. The bullish take which this market seems to want to try and run with one more time, is that the Fed can pivot before a recession arrives.The other positive that has investors excited again is the fact that bank stocks had a strong rally on Friday, even as the earnings results were quite mixed. While this kind of price action is a necessary condition for the bear market to be over, we would caution that second quarter results are likely to be the first of several cuts, not just for banks, but for the market overall.The bottom line is that this earnings season is likely to be the first of several disappointing ones, especially if a recession is the endgame. Therefore, staying defensively oriented in one's equity positioning should remain the best course of action for the next several months.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.

This week brought yet another reading of inflation that exceeded expectations, but if markets and central banks are able to think long-term, there may be some hope on the horizon.----- 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, July 15th at 4:00pm in London.One of the big stories this week was, once again, a high reading of US inflation that came in above economists’ expectations. If that sounds familiar, it’s because it is. US consumer price inflation was also higher than expected in June, May and April.These upside surprises to inflation create a trio of problems. First, investors will feel more confident if inflation starts coming down, and this is yet another month where that isn’t the case. Second, the Fed has been adamant that it will keep raising interest rates until inflation moderates, which means that more rate hikes are likely coming. And third, this sets up a real predicament; the Fed wants to bring inflation down, and sees this as key to its credibility, but raising rates today won’t do much for inflation over the short-term. That creates additional uncertainty.Markets are responding to that uncertainty by raising expectations of how much the Fed will increase rates in the near-term, while simultaneously becoming more worried about medium-term growth, and lowering expectation of rates over the long term. That has inverted the yield curve, something that, while rare, has historically signalled high odds of a recession.What’s notable, however, is that while there is intense focus on the concerns and negative surprises from the current rate of inflation, the longer-term picture is arguably getting better. One can observe expected rates of inflation over the next 5, 10 or 30 years, also called inflation break-evens. Those expectations have been falling rapidly over the last 2 months.In the US, markets currently see US Consumer Price Inflation to average about 2.35% over the next decade. That is more than half-a-percent lower than where that same estimate was just two months ago, and it’s similar to where these expectations were in March of 2021. 2.35% is also pretty close to the Fed’s inflation target; markets do not see inflation accelerating in an uncontrolled manner over the long term.For investors, think of this dynamic as one of short-term pain but longer-term gains. Near-term high inflation, and uncertainty of when it will decline, could keep the Fed cautious and argues against buying the dip.But looking further out, the market is giving encouraging signs that inflation is a manageable problem, and that central bank actions are working at addressing it. In the autumn, we could see a situation where the inflation data is moderating, while long-term inflation expectations confirm that that moderation continues. For markets, and for central banks, that would be much more helpful.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.