Andrew Sheets: New Wrinkles for the 2022 Story
The start of 2022 has brought a surge in COVID cases, new payroll data, increased geopolitical risks, and shifts from the Fed. Despite these new developments, we think the themes from our 2022 outlook still apply.—– 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, January 7th at 2:00 p.m. in London. Right out of the gates, 2022 is greeting us with a surge of COVID cases, a US unemployment rate below 4%, geopolitical risk and new hawkish Fed communication. Amidst all these issues, the question waiting for investors is whether the thinking of late last year still holds. We think the main themes of our 2022 outlook still apply – solid growth and tighter policy within an accelerated economic cycle. But clearly, there are now a lot more moving parts. One of those moving parts is the growth outlook. Our 2022 expectation was that global growth remains above trend, aided by a healthy consumer, robust business investment and healing supply chains. But can that still hold given a new, more contagious COVID variant? For the moment, we think it can. Our economists note that global growth has become less sensitive to each subsequent COVID wave as vaccination rates have risen, treatment options have improved and the appetite for restrictions has declined. Modeling from Morgan Stanley’s US Biotechnology team suggests that cases in Europe and the US could peak within 3-6 weeks, meaning most of this year will play out beyond that peak. Having already factored in a winter wave of some form in our original economic forecast, we don’t think, for now, the main story has changed. There are, however, some wrinkles. Because China is pursuing a different zero COVID policy from other countries, its near-term growth may be more impacted than other regions. And the emergence of this variant likely reinforces another prior expectation: that developed market growth actually exceeds emerging market growth in 2022. A second moving part is a shift by the Federal Reserve. Last January, the market assumed that the first Fed rate hike would be in April of 2024. Last August? The market thought it would be in April of 2023. And today, pricing implies that the first rate hike will be this March. An update from the minutes of the Federal Reserve’s December meeting, released this week, only further reinforced this idea that the Fed is getting closer and closer to removing support. The Fed discussed raising rates sooner, raising them faster and reducing the amount of securities that they hold. Indeed, it would seem for the moment that central banks in a lot of countries are increasingly comfortable pushing a more hawkish line until something pushes back. And so far, nothing has. Equity markets are steady, credit spreads are steady and yield curves have steepening over the last month. The opposite of what we would expect if the markets were afraid of a policy mistake. As such, why should they stop now? For markets, therefore, our strategy is based on the idea of less central bank support to start the year. Our Foreign Exchange team expects further US dollar appreciation, while our US interest rate strategists think that yields will move higher, especially relative to inflation. We think that combination should be negative for gold but supportive for financial stocks both in the US and around the world. 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.
Graham Secker: Will Europe Be Derailed By Omicron?
Despite last year’s strong showing for European equities, will the recent spread of the Omicron variant derail our positive outlook for the region in 2022?—– 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 recent rise in Omicron cases and whether this could derail our constructive view on European equities for 2022. It’s Thursday, January the 6th at 2:00 p.m. in London. Before touching on Omicron and the case for European stocks in 2022, I want to start by looking back at last year, which ended up being a very good one for the region. True European equities did lag US stocks again in 2021, however, this is hard to avoid when global markets are led higher by technology shares given Europe has fewer large cap companies in this space. More impressive was Europe’s performance against other regions such as Japan, Asia and emerging markets. In fact, when we measure the performance of MSCI Europe against the MSCI All Countries World Index, excluding U.S. stocks, then we find that Europe enjoyed its best year of outperformance since 1998 which, to provide some context, was the year before the euro came into existence. As ever, past performance is not necessarily a good guide to future returns. However, in this instance, we do expect another year of positive returns for European stocks in 2022, with 7% upside to our index target in price terms, which rises to 10% once dividends are included. This is considerably better than our Chief US Equity Strategist, Mike Wilson, expects for the S&P, while Jonathan Garner, our Chief Asian Equity Strategist, also remains cautious on Asian and emerging markets at this time. While we think the underlying assumptions behind that positive view on European stocks are actually quite conservative – we model 10% EPS growth and a modest PE de-rating – equity investors are likely to have to navigate greater volatility going forward, given scope for higher uncertainty around COVID, inflation, and the impact of tighter monetary policy on asset markets. The first of these factors was arguably the most important for markets through November and December, however, recent evidence that emerged very late in the year – that Omicron is indeed considerably less severe than prior mutations – has boosted risk appetite across the region, helping push bond yields and equity prices higher. From a more fundamental perspective, we are also encouraged that the sharp rise in COVID cases across Europe over the last couple of months does not appear to be having a significant impact on the economy. Yes, we did see quite a sharp drop in business surveys in Germany through December, however, this doesn’t appear to be replicated elsewhere with the PMI services data in France and consumer confidence data in Italy staying strong for now. Going forward, we expect the driver of volatility and uncertainty to shift from COVID to central banks and the impact of tighter monetary policy on asset markets. While this issue will be relevant across all global markets, Europe should be less negatively impacted than elsewhere given the European Central Bank is unlikely to raise interest rates through 2022. In addition, the European equity market’s greater exposure to the more value-oriented sectors such as commodities and financials, should make it a relative beneficiary of rising bond yields, especially if – as our Macro Strategy team forecast – this is accompanied by rising real yields (which should weigh most on the more expensive stocks in the US) or a stronger US dollar (which is more of a headwind for emerging markets). Consistent with this outlook, we maintain a strong bias for value over growth here in Europe, with a particular focus on banks, commodity stocks and auto manufacturers. While all three of these sectors outperformed last year, we think they are still cheap and hence offer more upside from here. 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.
Michael Zezas: Why are Markets Unfazed by Omicron?
As 2022 gets underway, investors are concerned about the Omicron variant of COVID-19, yet markets are taking developments in stride, with higher stock prices and bond yields. Is this economic confidence misplaced?—– Transcript —–Welcome to 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, January 5th at 10:00 a.m. in New York. As we settle in for 2022, the early line of questioning from clients regards the impact of the Omicron variant of COVID 19. It’s been shattering records for infections globally and in the US, disrupting air travel as workers stay home sick. So why then are markets so far this week taking this in stride? Higher stock prices and bond yields reflect more economic confidence than concern. Is that confidence misplaced? Not necessarily, in our view. That’s because while Omicron is clearly a serious public health risk, the data suggests it may not trigger the level of public policy response that sustainably crimps economic activity, such as indoor capacity restrictions on service establishments or stay at home orders. Since the pandemic’s onset, such responses have largely been dictated by state and local governments, and as we pointed out in this podcast a month ago, in most cases where restrictions were tightened, rising COVID hospitalizations and lack of bed capacity were cited as the culprit. So far, the data suggests hospital capacity may not be a problem with Omicron. Consider studies from the UK and South Africa, which have shown that Omicron is substantially less likely than the previously dominant Delta variant to land people in the hospital. This likelihood is lessened even more if an infected person was previously vaccinated. So even as case counts soar above those prior waves, it’s not surprising to see that measures of hospital capacity stress across the US are yet to exceed those of prior waves. Further, as our colleagues in the Biotech Research team point out, the contagiousness of Omicron and subsequent protection against reinfection that the infected develop, at least for a time, has led to bigger but shorter infection waves in places like South Africa. This is why US government officials point out that Omicron could peak and fall quickly sometime this month. In short, the wave and any attendant economic risk could be over quickly, and this may be why investors are looking through it. Hence, we expect markets will refocus on inflation and Fed policy as key drivers for 2022, continuing to push bond yields higher this year in line with our team’s forecast. 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.
Jonathan Garner: Omicron Impacts Across Asia
As the Omicron variant spreads across Asia, renewed lockdowns and other earnings outlook disruptions have investors on alert, reinforcing our approach of cautious patience in the region.—– Transcript —–Welcome to Thoughts on the Market. I’m Jonathan Garner, Chief Asia and Emerging Market Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you a variety of perspectives, I’ll be talking about the impact of Omicron on China and Emerging Market Equities. It’s Tuesday, January the 4th at 7:30 a.m. in Hong Kong. As 2022 begins, our approach to Asia and EM equities remains one of cautious patience. Although these markets underperformed their peers in the U.S. and Europe last year, simple arguments of performance mean reversion in 2022 are not strong enough to warrant anything more aggressive at this juncture. We hear a lot these days about a turn in the Chinese policy cycle as a catalyst. And it’s fair to say that historically one would have been more optimistic at this juncture of the monetary and fiscal cycle for the outlook for domestic demand in China. This demand is crucial both for China’s own growth outlook to stabilize, as well as to give a boost to most other markets in Asia and EM. But this is not a normal cycle. China’s ‘zero COVID’ approach must now face off against Omicron. As this episode is being recorded, Xian – a major Chinese city with a population of over 13 million – is in its 12th day of a lockdown, which is now more severe in terms of restrictions on normal daily life than any seen in China since the original lockdown of Wuhan at the start of the pandemic. Two global companies with major semiconductor plants in the city have recently warned of production problems. And though there’s no formal national policy to curtail celebration of Chinese New Year at the end of this month, domestic media is already beginning to broadcast a message of staying at home and avoiding long distance travel. In China, as in EM, we’re continuing to track earnings estimates that are declining, which undermines the case for valuations – now roughly in line with long run averages – being sufficiently attractive to reengage. The situation is slightly better in Japan, where estimates are tracking sideways and individual markets – notably India and parts of Asean and Eastern Europe, Mid East and Africa – have been doing better than the EM overall. However, disruption caused by Omicron could change individual economic and hence earnings outlooks over the short to medium term. For example, India’s most recent COVID case count was up 35% day-on-day, with Omicron now present in 23 of 28 states. Maharashtra, Delhi and Tamil Nadu have reimposed restrictions on visits to public parks, beaches and other public spaces. Indeed, most of the countries we cover that had moved to a “living with COVID” approach are now having to reverse course. Take South Korea, which in mid-December, as ICU usage rose significantly, reimposed early closing restrictions on nightlife and a rule limiting public gatherings to no more than four fully vaccinated persons. Finally, our weekly track of flows to dedicated Asia and EM equity funds is now showing steady and persistent redemptions, as some of the very large inflows from this time a year ago start to reverse course. Those flows were driven by the notion that a strong, synchronized upswing was underway globally, which it was argued would lead to outperformance by Asia and EM, whose economies generally perform strongly in a global economic upswing. We argued at the time that 2021 would not be like 2006/07 and 2016/17 when that narrative did hold true. As 2022 begins, the global and local economic outlook is clearly weakening again, and hence our mantra of continued cautious patience. 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.
Michael Wilson: New Year, New Opportunities
With a new calendar year, the narrative in markets may not be shifting but there are still opportunities for investors to consider as growth rates, policy proposals, and interest rates shift in the coming year.—– Transcript —–Welcome to Thoughts on the Market and Happy New Year! 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, January 3rd at 11:30 a.m. in New York. So let’s get after it. A new year brings new investment opportunities, even if the narrative isn’t changing. More specifically, tightening monetary policy and decelerating growth supports our large cap defensive quality bias – a strategy that has worked well since we first started recommending it back in mid-November. On the first score, the Fed and other central banks appear to be determined to remove monetary accommodation in the face of higher inflation. Not only is inflation turning out to be an economic issue, but it’s quickly becoming a political one given this is a midterm election year. What this means is the Fed will likely turn out to be more hawkish than investors expect, and that hawkishness is likely to be front-end loaded so markets have time to recover by November. As for the second part of the narrative, we think growth will decelerate this year as most of our leading indicators point to that outcome. Furthermore, this dynamic should be supportive of defensives outperforming cyclicals amid large cap quality leadership. This week, we expand our analysis to the industry level and illustrate that within defensives, Health Care, REITS and Consumer Staples tend to be the best performers in a decelerating but positive growth regime. As we reflect on 2021’s strong performance from large cap U.S. equity indices last year, it’s hard to get too excited about any remaining upside this year. Having said that, most individual stocks have gone nowhere since March, with many in a deep bear market. In many ways, 2021 looked a lot like 2018 – a year of rolling corrections and rotations as investors continually sought out higher ground in the high-quality S&P 500 index. As we enter 2022, the key question for investors is to decide if they want to stay with the relative winners, or is it time to go bottom fishing? New calendar years tend to support the latter strategy as the pressure of keeping up with the index eases. Hence, the new opportunities for investors. While we continue to favor the large cap defensive tilt that has been working, we recommend creating a barbell with stocks that have already corrected but still offer good prospects at a reasonable valuation. Over the past nine months, the quality bias has driven more and more money into a handful of large cap growth stocks – further highlighting the importance of favoring large over small since March. But as we already noted, this crowding has left many smaller stocks behind. A few areas we think make sense to consider include consumer services and other businesses with pent up demand. In the more growth-y segments, we think biotech and China Internet are good bottom fishing candidates. Meanwhile, we would still be careful with very expensive tech stocks that remain unprofitable. One final development to watch closely is long term interest rates. With a significant move higher in inflation and the Fed’s pivot on policy, we think long term interest rates look too low. The sharp move higher today looks like the beginning of something more meaningful, and it could lead to new 52-week highs in short order if our technical view is correct. As such, we remain positive on financials as our sole cyclical overweight. A backup in rates is the reason, and that could be happening now. Bottom line, stick with a large cap defensive quality bias as we enter 2022, but balance it with financials and small mid-cap value stocks, particularly with the Fed and other central banks tightening policy faster than investors expect and rates likely back up. 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.
End-of-Year Encore: Space Investing
Original Release on August 24th, 2021: Recent developments in space travel may be setting the stage for a striking new era of tech investment. Are investors paying attention?—– Transcript —–Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays! Adam Jonas Welcome to Thoughts on the Market. I’m Adam Jonas, Head of Morgan Stanley’s Space and Global Auto & Shared Mobility teams. With the help of my research colleagues across asset classes and regions, I try to connect ideas and relationships across the Morgan Stanley platform to bring you insights that help you think outside the screen. Today, I’ll be talking about the Apollo Effect and the arrival of a new space race. It’s Tuesday, August 24th, at 10:00 a.m. in New York. In May of 1961, President John F. Kennedy announced America’s plan to send a man to the moon and bring him back safely to Earth before the end of the decade. This audacious goal set in motion one of the most explosive periods of technological innovation in history. The achievements transcended the politics and Cold War machinations of the time and represented what many still see today as a defining milestone of human achievement. In its wake, millions of second graders wanted to become astronauts, our math and science programs flourished, and almost every example of advanced technology today can trace its roots in some way back to those lunar missions. The ultimate innovation catalyst: the Apollo Effect. 60 years after JFK’s famous proclamation, we once again need to draw on the spirit of Apollo to address today’s formidable global challenges and to deliver the solutions that improve our world for generations to come. The first space race had clear underpinnings of the Cold War between the U.S. and the Soviet Union. Today’s space race is getting increased visibility due to a confluence of profound technological change, accelerated capital formation – fueled by the SPAC phenomenon – and private space flight missions from the likes of Richard Branson and Jeff Bezos. We think space tourism is the ultimate advertisement for the realities and the possibilities of Space livestreamed to the broadest audience. The message to our listeners is: get ready. This stuff is really happening. Talking about Space before the rollout of the SpaceX Starship mated to a Super Heavy booster is akin to talking about the Internet before Google Search, or talking about the auto industry before the Model T. We are entering an exciting new era of space exploration, one that involves the hand of government and private enterprises – from traditional aerospace companies to audacious new startups. This race is driven by commerce and national rivalry. And the relevance for markets and investors, while seemingly nuanced at first, will become increasingly clear to a wide range of industries and enterprises. The Morgan Stanley Space team divides the space economy into 3 principal domains: communications, transportation and earth observation. Our team forecasts the global space economy to surpass $1T by the year 2040. And at the rate things are going, it may eclipse this level far earlier. When I first started publishing on the future of the global space economy with my Morgan Stanley research colleagues back in 2017, very few people seemed to care, and even fewer thought it was material for the stock market. I would regularly ask my clients “on a scale of 0 to 10, how important is space to your investment process?” And by far the most common answer I received was 0 out of 10. A lot of folks said 0.0 out of 10, just to make the point. Not even four years later and, oh my goodness, how things have changed. The investment community and the general public are rapidly embracing the genre and becoming aware of its importance economically and strategically. So whatever your own area of market expertise, this next era of space exploration and the innovation and commerce that spawn from it, will matter to your work, and to your life. But beyond the national competition, the triumph, the glory, the failures and the many hundreds of billions of dollars that’ll be spent on launches, missions and infrastructure – is a reminder of something far bigger that we learned over a half a century ago during the Apollo era – that Space is one of the greatest monuments of human achievement, and a unifying force for the planet. Thanks for listening. And remember, 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.
End-of-Year Encore: Retail Investing
Original Release on September 30th, 2021: Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management, discusses the new shape of retail investing and the impact on markets.—– Transcript —–Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays!Andrew Sheets Welcome to Thoughts on the Market. I’m Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley Research.Lisa Shalett And I’m Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.Andrew Sheets And today on the podcast, we’ll be discussing the retail investing landscape and the impact on markets. It’s Thursday, September 30th, at 2p.m. in London.Lisa Shalett And it’s 9:00 a.m. here in New York City.Andrew Sheets Lisa, I wanted to have you on today because the advice from our wealth management division is geared towards individual investors, what we often call retail clients instead of institutional investors. You tend to take a longer-term perspective. As chief investment officer, you’re juggling the roles of market analyst, client adviser and team manager ultimately to help clients with their asset allocation and portfolio construction.Andrew Sheets Just to take a step back here, can you just give us some context of the level of assets that Morgan Stanley Wealth Management manages and what insight that gives you potentially into different markets?Lisa Shalett Sure. The wealth management business, especially after the most recent acquisition of E-Trade, oversees more than four trillion dollars in assets under management, which gives us a really extraordinary view over the private wealth landscape.Andrew Sheets That’s a pretty significant stock of the market there we have to look at. I’d love to start with what you’re hearing right now. How are private investors repositioning portfolios and thinking about current market conditions?Lisa Shalett The individual investor has been important in terms of the role that they’re playing in markets over the last several years as we’ve come out of the pandemic. What we’ve seen is actually pretty enthusiastic participation in markets over the last 18 months with folks, you know, moving, towards their maximum weightings in equities. Really, I think over the last two to three months, we’ve begun to see some profit taking. And that motivation for some of that profit taking has kind of come in two forms. One is folks beginning to become concerned that valuations are frothy, that perhaps the Federal Reserve’s level of accommodation is going to wane and, quite frankly, that markets are up a lot. The second motivation is obviously concern about potential changes in the U.S. tax code. Our clients, the vast majority of whom manage their wealth in taxable accounts, even though there is a lot of retirement savings, many of them are pretty aggressive about managing their annual tax bill. And so, with uncertainty about whether or not cap gains taxes are going to go up in in 2022, we have seen some tax management activity that has made them a little bit more defensive in their positioning, you know, reducing some equity weights over the last couple of weeks. Importantly, our clients, I think, are different and have moved in a different direction than what we might call overall retail flow where flows into ETFs and mutual funds, as you and your team have noted, has continued to be quite robust over, you know, the last three months. Andrew Sheets So, Lisa, that’s something I’d actually like to dig into in more detail, because I think one of the biggest debates we’re having in the market right now is the debate over whether it’s more accurate to say there’s a lot of cash on the sidelines, so to speak, that investors are still overly cautious, they have money that can be put into the market. You know, kind of versus this idea that markets are up a lot, a lot of money has already flowed in and actually investors are pretty fully invested. So, you know, as you think of the backdrop, how do you think about that debate and how do you think people should be thinking about some of the statistics they might be hearing?Lisa Shalett So our perspective is, and we do monitor this on a month-to-month basis has been that, you know, somewhere in the June/July time frame, you know, we saw, our clients kind of at maximum exposures to the equity market. We saw overall cash levels, had really come down. And it’s only been in the last two to three weeks that we’ve begun to see, cash levels rebuilding. I do think that that’s somewhat at odds with this thesis that there’s so much more cash on the sidelines. I mean, one piece of data that we have been monitoring is margin debt and among retail individual investors, we’ve started to see margin debt, you know, start to creep up. And that’s another indication to us that perhaps this idea that there’s tons of cash on the sidelines may, in fact, not be the case, that people are, “all in and then some,” you know, may be something worth exploring in the data because we’re starting to see that.Andrew Sheets So, Lisa, the other thing you mentioned at the onset was a focus on the tax environment, and that’s the next thing I wanted to ask you about. You know, I imagine this is an issue that’s at the top of minds of many investors. And your thoughts on both what sort of reactions we might get to different tax changes and also your advice to how individuals and family offices should navigate this environment.Lisa Shalett Yeah, so that’s a fantastic question, because in virtually every meeting, you know, that I’m doing right now, this question, comes up of, you know, what should we be doing? And we usually talk to clients on two levels. One is on it in terms of their personal strategies. And what we always talk about is that they should not be making changes in anticipation of changes in the law unless they’re really in need of cash over the next year or two. It’s really a 12-to-18-month window. In which case we would say, you know, consult with your accountant or your tax advisor. But typically, what we say is, you know, the changes in the tax law come and go. And unless you have an imminent, you know, cash flow need, you should not be making changes simply based on tax law. The second thing that we often talk about is this idea or this mythology among our client base that changes in the tax law, you know, cause market volatility. And historically that there’s just no evidence for that. And so, like so many other things there’s, you know, headline risk in the days around particular news announcements. But when you really look at things on a 3-month, 6-month, you know, 12- and 24-month, trailing basis on some of these things, they end up not really being the thing that drives markets.Andrew Sheets Lisa, one of the biggest questions—well, you know, certainly I’m getting but I imagine you’re getting as well—is how to think about the ratio of stocks and bonds together within a portfolio. You know, there’s this old rule of thumb, kind of the 60/40, 60% stocks, 40% bonds in portfolio construction. Do you think that’s an outdated concept, given where yields are, given what’s happening in the stock market? And how do you think investors should think about managing risk maybe differently to how they did in the past?Lisa Shalett That’s a fantastic question. And it’s one that we are confronted with, you know, virtually every day. And what we’ve really tried to do is take a step back and, make a couple of points. Number one, talk about, goals and objectives and really ascertain, you know, what kinds of returns are necessary over what periods of time and what portion of that return, you know, needs to be in current cash flow, you know, annualized income. And try to make the point that perhaps generating that combination of capital appreciation and income needs to be constructed, if you will, above and beyond the more traditional categories of cash, stocks and bonds given where we are in terms of overall valuations and how rich the valuations are in both stocks and bonds, where we are in terms of cash returns after inflation, and with regards to whether or not stocks and bonds at the current moment are actually behaving in a way that, you know, you’re optimizing your diversification.Lisa Shalett So with all those considerations in mind, what we have found ourselves doing is speaking to the stock portion of returns as being comprised not only of, you know, the more traditional long-only strategies that we diversify by sector and by, you know, global regions. But we’re including thinking about, you know, hedged vehicles and hedge fund vehicles as part of those equity exposures and how to manage risk. When it comes to the fixed income portion of portfolios, there’s a need to be a little bit more creative in hiring managers who have a mandate that can allow them to use things like preferred shares, like bank loans, like convertible shares, like some asset backs, and maybe even including some dividend paying stocks in, their income generating portion of the portfolio. And what that has really meant to your point about the 60-40 portfolio is it’s meant that we’re kind of recrafting portfolio construction across new asset class lines, really. Where we’re saying, OK, what portion of your portfolio and what products and vehicles can we rely on for some equity like capital appreciation and what portion of the portfolio and what strategies can generate income. So, it’s a lot more mixing and matching to actually get at goals.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.
End-of-Year Encore: Thematic Investing
Original Release on August 12th, 2021: Investor interest in thematic equity products such as ETFs has rapidly surged, particularly among tech themes. Why the momentum may only grow.—– Transcript —–Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays!Graham Secker Welcome to Thoughts on the Market. I’m Graham Secker, Head of the European and UK Equity Strategy Team.Ed Stanley And I’m Ed Stanley, Head of European Thematic Research.Graham Secker And today on the podcast, we’ll be talking about the continued interest in thematic investing in Europe. It’s Thursday, August the 12th, at 3 p.m. in London.Graham Secker So, Ed, I really wanted to talk to you today because investor appetite for thematic related equity products such as ETFs, mutual funds and the like has grown to the point that thematics has actually been carved out from our traditional sector research at Morgan Stanley. So as head of the European Thematic Investing team, can you walk us through what’s behind the increased interest in this area and how you see the thematic landscape evolving over the next couple of years?Ed Stanley Thanks, Graham. To understand thematics, first you have to look at the geographies. And when you do that, it’s really a two-horse race. Of the $450 billion in global thematic mutual funds in June this year, 60% of that was in Europe. So the lion’s share. And then there’s the U.S., which is the second largest geography for thematic investing, but growing very quickly indeed. If you look in the US year to date, for example, there have been over 100 thematic ETF launches– comfortably double the run rate of thematic starts in 2020. Once you’ve looked at geography, then you have to look at the landscape by theme. And this is where thematic investing gets really interesting. The breadth of and growth in thematic strategies is truly extraordinary. Fund starts are compounding over 40% over the last three years and inflows for those funds have seen high double digit, and even triple digit growth, so far this year. Most obviously, themes like genomics and eSports fall into that high growth category. We even saw a dedicated ETF launch in June this year, particularly trying to gain exposure to the metaverse, which is the first of its kind. So while we don’t make explicit forecasts on where we think thematic investing is going to be in a one year view, the momentum is showing no signs of slowing down. In fact, quite the opposite.Graham Secker So with any number of themes to choose from, the world really is your oyster, I think. So how do you whittle down or cherry pick where you spend your time?Ed Stanley It’s a great question and that’s really my number one challenge. While we’re never short of ideas, determining which theme is the zeitgeist of the day is absolutely critical. And to do that, our thematic research really hinges on two streams of analysis. On the one hand, demographic change and on the other, disruptive innovation. We believe that these two groupings and the subthemes therein hold the key to shifting future consumption patterns, which ultimately all investors need to be conscious of. But with that said, for most investors to be interested in a theme, it needs to be actionable within at least three to five years. Consequently, for a theme to work, investors need a relatively near-term catalyst. So when we’re looking within disruptive innovation, for example, we need to think what’s the catalyst to make investors care about this theme? Be that a product launch, start-up funding, falling technology costs, regulation or government policy. When you can twin up an interesting thematic idea with a catalyst, that’s really where we focus our attention.Graham Secker Another question I want to ask is, how do you test the pulse of the market to determine what is a live thematic debate and where you think investors may be too early or late to a theme?Ed Stanley Well, I suppose this really narrows down the previous point. So we now have our theme, so to speak. We have to ask ourselves, does the market already care about this theme or will the market care in the not-too-distant future? And this is where we think we’ve come up with a relatively interesting and novel solution to screen for that. Through a combination of four things: patent analysis, capital spending patterns by companies, the velocity of comments made by company management teams and finally, using Google Trends momentum data, we believe that we can relatively accurately pick which themes are either gathering momentum or, on the flip side, those that may have been past their initial peak of excitement.Graham Secker Okay. And on that point, what are some of the key themes you’re watching right now?Ed Stanley Well, I suppose one that we can’t ignore, particularly given my previous comments, is hydrogen. On all of the metrics I just mentioned, it’s flashing green. Whether that’s pattern analysis, company transcripts, CapEx intensity. It’s a hotly debated theme as investors try to grapple with this long-term potential for the fuel. But even more simply, if we take a step back, one really only needs to look at the fund startups to see where the really exciting themes are. If we look back to January 2018, for example, there are only a handful of fintech funds around the world. Today, there are nearly 200 that we’re keeping track of. Part of my role is to predict what is going to be the next fintech when it comes to themes. And the themes that are most likely to tick those boxes are, in my view, the near-term ones, electric vehicles, cybersecurity, 5G; the medium term, which encompasses augmented, virtual reality as well as eSports; and then longer term, you have space, quantum computing are all beginning to show telltale signs of thematic focus areas.Graham Secker Thanks, Ed. And finally, I want to ask you about concerns over a thematic bubble. There’s been an exponential rise in the number of thematic products being set up recently. There’s also been a high degree of attrition for thematic ETFs. So to what degree do you think the ongoing growth in thematic investing is here to stay? And how vulnerable do you think it could be to a prolonged technology bear market, for example?Ed Stanley You’re absolutely right. Plenty of thematic ETFs, particularly in the US, have come and gone. That will likely continue to happen, particularly in themes where hopes exceed reality. What happens in a prolonged downturn remains to be seen in all honesty. We don’t have enough back history from a wide enough variety or sample of these thematic funds, to be sure. But the test case of covid highlighted the early signs of structural growth in this market. There are more thematic funds post-covid than pre-. So my view is that this is absolutely a structural rather than a cyclical phenomenon, particularly as younger marginal investors increasingly want exposure to themes rather than sectors and geographies. But while I believe that thematic investing is a structural trend, no doubt it clearly leans towards tech-heavy equities and growth as a factor, particularly. So the bigger existential threat perhaps isn’t so much a bear market, but instead persistently high interest rate environments, which remains to be seen. But for now, at the very least, the future looks pretty bright for thematics in our view.Graham Secker Very interesting. Thanks for taking the time to talk today, Ed.Ed Stanley Great speaking with you, Graham.Graham Secker 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 to find the show.
End-of-Year Encore: Factor Investing
Original Release on August 26th, 2021: Equity investors have applied factor-driven strategies for years, but the approach has seen slow adoption in bond markets. Here’s why that may be changing.—– Transcript —–Andrew Sheets This week we are bringing you 4 encores of deep dives into different kinds of investing we consider at Morgan Stanley. Thanks to all our listeners for a great year and happy holidays! Andrew Sheets Welcome to Thoughts on the Market. I’m Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley, Vishy Tirupattur And I am Vishy Tirupattur, Head of Fixed Income Research at Morgan Stanley. Andrew Sheets And on this special edition. And on this special edition of the podcast, we’ll be talking about factor investing strategies and liquidity in corporate credit markets. It’s Thursday, August 26th, at 3:00 p.m. in London Vishy Tirupattur And 10:00 a.m. in New York. Andrew Sheets So Vishy, before we start talking about factor investing and credit, we should probably talk about what is factor investing and why are we talking about it. So, what is this concept and why is it important? Vishy Tirupattur Factor investing whose intellectual roots are from a seminal paper from two University of Chicago professors in the early 90s, Eugene Fama and Ken French. It effectively is a way of identifying companies to invest using rules based systematic investing strategies, be it identifying quality, identifying value, identifying momentum or volatility or risk adjusted carry. A bunch of these strategies involve setting up a set of rules and systematically in following those rules to build a portfolio. And we’ve seen that these strategies in the context of equities have substantially outperformed more discretionary strategies. Andrew Sheets So you can kind of think about it as the Moneyball approach to investing, that you think over time doing certain types of things in certain situations over and over again systematically is going to ultimately deliver a better long run result. Vishy Tirupattur Exactly right. Andrew Sheets So you mentioned that this has been a strategy that’s been around a long time in equity markets. Why hasn’t it been around in credit? And what’s changing there? Vishy Tirupattur The key for systematical rules-based investing strategies or factor investing is being an abundance of liquidity in the market. And the complexity of credit markets means that this has been a big challenge to implementing these types of strategies. For example, you know, S&P 500, not surprisingly, has 500 stocks. And underlying those 500 stocks are literally thousands of bonds that underlie those 500 stocks, that weigh in maturity, in coupon, in rating, in seniority, etc… Each of these introduces an element of complexity that just complicates the challenge associated with factor investing. Andrew Sheets So Vishy, that’s a great point, because if I want to buy a stock, there’s one stock, but if I want to buy a bond of that same company, there might be many of them with different maturities and different coupons. They’re just not interchangeable, and that does introduce complexity. Vishy Tirupattur So one big thing that’s happened is the advent of electronic trading. Electronic trading today accounts for almost a third of all trading in investment grade corporate credit and in over 20% of all trading in high yield corporate credit. This has made a significant difference and enables factor investing possible in the context of credit. Andrew Sheets So more electronic trading, more portfolio trading is improved liquidity and made certain types of factors, systematic strategies possible in credit. Are ETFs a part of this story? Obviously, those represent a portfolio of credit. We’re seeing rising volumes within the credit market of exchange traded funds. How do you see that playing into this trend? And what do you think is the outlook there? Vishy Tirupattur Absolutely. ETFs constitute portfolio trades and portfolio trading indeed has become a very, very big part of trading here. Even five years ago, ETFs accounted for about 5% of all the traded volumes in investment grade and maybe about 20% in high yield. Today, they account for 16% of all traded volumes investment grade and 50% of all the traded volumes in high yield. So, ETF and portfolio trading in general has enabled not only greater liquidity, but smaller issue sizes and smaller issuers, and that’s an important distinction. Andrew Sheets So how would this actually work in practice? You know, I could go out and I could just buy a credit fund that owns all the bonds in a particular market. Or I could try one of these factor strategies. What would the factory strategy actually be doing? I mean, what are the characteristics that our research suggests credit investors should be trying to favor versus avoid? Vishy Tirupattur Let me talk about two strategies. First is a risk adjusted carry strategy. So, you take the spread of the bond over Treasuries, so that gets the credit risk premium, divided by the volatility of excess returns of that particular bond over the last 12 months. Group all these bonds, sort them, and invest in the top decile that has the best risk adjusted return. And then rinse and repeat every month. And we have shown that using this strategy in investment grade, you can consistently beat the benchmark corporate bond index. So that’s one strategy. Vishy Tirupattur The other one is a momentum strategy. Momentum can be both from the bond returns as well as from the underlying stock returns. Our research has shown that by combining equity momentum signals and corporate bond momentum signals, we can also achieve substantial outperformance over the benchmark indices both in investment grade and high yield, even though in high yield the outperformance is even more significant. Andrew Sheets So Vishy, why do you think that works? Because it would seem really obvious that, you know, investors wouldn’t want to own bonds with a good return versus their volatility, that investors would want to own things that are going up and avoid things that are going down. So why would doing those things, why would following those rules, do you think, still deliver risk premium, still deliver return? Why do you think the market is kind of leaving those nickels kind of lying on the street for lack of a better word, for investors to pick up? Vishy Tirupattur Andrew, in the past this kind of a strategy that would involve, say, a monthly rebalancing, would mean very substantial transaction costs. What we would measure through the bid offer spreads in the bond market. So, 10 years ago, in plain vanilla investment grade bonds, the bid offer spreads, the spread in the difference between the spread of buying and selling bonds, was as high as 12 basis points. And today that number is 2-3 basis points. So, this means that transaction costs, thanks to the electronification, thanks to portfolio trading and ETF volumes, has meant very substantially lower transaction costs that makes these returns possible. And since factor investing is still at the very early stages of practice in credit markets, there are still large, unharvested risk premia in the credit markets for these types of strategies. Andrew Sheets And Vishy, my final question for you is, what are the risks here? If investors are going to look at the market from a systematic, more rules-based approach, what sort of questions should they be asking? Vishy Tirupattur I think key question to ask is how much dependencies there are on liquidity and how long will liquidity continue to be there in the markets. I think looking at this kind of analysis over multiple credit cycles, the four cycles, lower liquidity, higher liquidity periods, which is what we have done, those are the kinds of analyzes one would need to do to start paying greater attention to systematic investing strategies in credit. Andrew Sheets Vishy. Thanks for taking the time to talk. Vishy Tirupattur Andrew, always fun to talk 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.
Michael Zezas: A More Flexible Fed
Recent signals from the Fed are indicative of a willingness to change its mind quickly. While bond investors may be wary of the volatility this could bring, it may also create opportunities in the new year.—– Transcript —–Welcome to 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, December 22nd at 10:00 a.m. in New York. While investors may be focused on the gridlock on the Build Back Better fiscal plan, we think it makes sense to shift our focus from Capitol Hill to the Federal Reserve, which just made a big move, and one that arguably matters more to markets in the near term than developments out of Congress. Last week, the Fed announced a more aggressive tapering of asset purchases. Perhaps more importantly, it signaled an expectation of hiking interest rates three times next year, rather than the two times most forecasters expected. In the press conference following the announcement, Chair Powell repeatedly signaled his intent was to demonstrate both that the Fed takes seriously the risk posed by a recent uptick in inflation, as well as the flexibility of the Fed’s monetary policy, by discussing his willingness to adjust the taper and rate hike outlooks as data comes in. This last point is an important one for bond markets. In dealing with substantial uncertainty around the inflation outlook, you have a Fed that elected a pragmatic approach – a willingness to change its mind quickly as it sees fit. That’s not a novel approach, but it may be fresh to many investors today who may be more accustomed to the slower, more deliberate approach that economic conditions pressed the Fed to take under its previous two chairs. But such an approach means it’s harder to predict with confidence what will happen next to monetary rates. That uncertainty means more disagreement among investors, which in turn means more sustained volatility in the Treasury market. That’s not necessarily bad news for investors, though. In our view, it actually may lead to some interesting opportunities in 2022 for credit investors. In the muni market, for example, elevated rates volatility has, more often than not, caused market weakness as investors shy away from price uncertainty in an asset class they generally want to own for reasons of capital preservation and asset allocation. But muni credit quality, in our view, is likely to remain quite strong in 2022, with continued strong economic growth allowing municipal entities to lock in their credit gains from government aid and a sharp GDP recovery in 2020 and 2021. So, if volatility leads to price weakness, we’re likely to see this as an opportunity to add good credit, just at a cheaper valuation. So, beware the Fed and volatility, but don’t fear it. We’ll keep you updated here for the opportunities it may create. Happy holidays from all of us here at Thoughts on the Market. We’ll be back in the new year with more episodes. 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.