Thoughts on the Market

Our Head of Corporate Credit Research Andrew Sheets recaps an exceptional year for credit — but explains why 2025 could be a more challenging year for the asset class.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Today I’ll be discussing the Outlook for global Credit Markets in 2025.It’s Monday, Dec 2nd at 2 pm in London.Morgan Stanley Strategists and Economists recently completed our forecasting process for the year ahead. For Credit, 2025 looks like a year of saying goodbye.2024 has been an exceptionally good environment for credit. As you’ve probably grown tired of hearing, credit is an asset class that loves moderation and hates extremes. And 2024 has been full of moderation. Moderate growth, moderating inflation and gradual rate cuts have defined the economic backdrop. Corporates have also been moderate, with stable balance sheets and still-low levels of corporates buying each other despite the strong stock market.The result has been an almost continuous narrowing of the extra premium that companies have to pay relative to governments, to some of the lowest, i.e. best spread levels in over 20 years.We think that changes. The U.S. election and resulting Republican sweep have now ushered in a much wider range of policy outcomes – from tariffs, to taxes, to immigration. These policies are in turn driving a much wider range of economic outcomes than we had previously, to scenarios that include everything from much greater corporate optimism and animal spirits, to much weaker growth and higher inflation, under certain scenarios of tariffs and immigration.Now, for some asset classes, this wider range of outcomes may simply be a wash, balancing out in the aggregate. But not for credit. This asset class doesn’t stand to return more if corporate activity booms; but it stands to still lose if growth slows more than expected. And given the challenges that tariffs could pose to both Europe and Asia, we think these dynamics are global. We see spreads modestly wider next year, across global regions.But if 2025 is about saying goodbye to the credit-friendly moderation of 2024, we’d stress this is a long goodbye. A key element of our economic forecasts is that even if major changes are coming to tariffs or taxes or immigration policy, that won’t arrive immediately. Today’s strong, credit-friendly economy should persist – well into next year. Indeed, for most of the first half of 2025, Morgan Stanley’s forecasts look much like today: moderate growth, falling inflation, and falling central bank rates.In short, when thinking about the year ahead, 2025 may be a turning point for credit – but one that doesn’t arrive immediately. Our best estimate is that we continue to see quite strong and supportive conditions well into the first half of the year, while the second half becomes much more challenging. We think leveraged loans offer the strongest risk-adjusted returns in Corporate Credit, while Agency Mortgages offer an attractive alternative to corporates for those looking for high quality spread.Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Original Release Date November 15, 2024: Our head of Corporate Credit Research Andrew Sheets explains why a stronger economy, moderate inflation and future rate cuts could prompt deal-making.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Today I’ll discuss why we remain believers in a large, sustained uptick in corporate activity. It's Friday, November 15th at 2pm in London. We continue to think that 2024 will mark the start of a significant, multiyear uplift in global merger and acquisition activity – or M&A. In new work out this week, we are reiterating that view. While the 25 percent rise in volumes this year is actually somewhat short of our original expectations from March, the core drivers of a large and sustained increase in activity, in our view, remain intact. Those drivers remain multiple. Current levels of global M&A volumes are still unusually low relative to their own historical trend or the broader strength that we see in stock markets. The overall economy, which often matters for M&A activity, has been strong, especially in the US, while inflation continues to moderate and rate cuts have begun. We see motivations for sellers – from ageing private equity portfolios, maturing venture capital pipelines, and higher valuations for the median stock. And we see more factors driving buyers from $4 trillion of private market "dry powder," to around $7.5 trillion of cash that's sitting idly on non-financial balance sheets, to wide-open capital markets that provide the ability to finance deals. These high level drivers are also confirmed bottom up by boots on the ground. Our colleagues across Morgan Stanley Equity Research also see a stronger case for activity – and we polled over 60 global equity teams for their views. While the results vary by geography and sector, the Morgan Stanley Equity analysts who cover these sectors in the most depth also see a strong case for more activity. The policy backdrop also matters. While activity has risen this year, one reason it might not have risen as much as we initially expected was uncertainty about both when central banks would start cutting rates and the outcome of US elections. But both of those uncertainties have now, to some extent, waned. Rate cuts from the Fed, the ECB, and the Bank of England have now started, while the Red Sweep in US elections could, in our view, drive more animal spirits. And Europe is an important part of this story too, as we think the European Union’s new approach to consolidation could be more supportive for activity. For investors, an expectation that corporate activity will continue to rise is, in our view, supportive for Financial equities. Where could we be wrong? M&A activity does fundamentally depend on economic and market confidence; and a weaker than expected economy or weaker than expected equity market would drive lower than expected volumes. Policy still matters. And while we view the incoming US administration as more M&A supportive, that could be misguided – if policy changes dent corporate confidence or increase inflation. Finally, we think that a more multipolar world could actually support more M&A, as there’s a push to create more regional champions to compete on the global stage. But this could be incorrect, if those same global frictions disrupt activity or confidence more generally. Time will tell. Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Original Release Date November 1, 2024: Our US Fintech and Payments analyst reviews a recent survey that reveals key trends on how Gen Z and Millennials handle their personal finances.----- Transcript -----Welcome to Thoughts on the Market. I’m James Faucette, Morgan Stanley’s Head of US Fintech and Payments. Today I’ll dig into the way young people in the US approach their finances and why it matters.It’s Friday, November 1st, at 10am in New York. You’d think that Millennials – also commonly known as Gen Y – and Gen Z would come up with new ways to think about money. After all, they live most of their lives online, and don’t always rely on their parents for advice – financial or otherwise. But a survey we conducted suggests the opposite may be true. To understand how 16 to 43 year-olds – who make up nearly 40 per cent of the US population – view money, we ran an AlphaWise survey of more than 4,000 US consumers. In general, our work suggests that both Millennials and Gen Z’s financial goals, banking preferences, and medium-term aspirations are not much different from the priorities of previous generations. Young consumers still believe family is the most important aspect in life, similar to what we found in our 2018 survey. They have a positive outlook on home ownership, college education, employment, and their personal financial situation. 28-to-43-year-olds have the second highest average annual income among all age cohorts, earning more than $100,000. They spend an average of $86,000 per year, of which more than a third goes toward housing. Gen Y and Z largely expect to live in owned homes at a greater rate in five to 10 years, and younger Gen Y cohorts' highest priority is starting a family and raising children in the medium term. This should be a tailwind for many consumer-facing real estate property sectors including retail, residential, lodging and self-storage. However, Gen Y and Z are less mobile today than they were pre-pandemic. Compared to their peers in 2018, they intend to keep living in the same area they're currently living in for the next five to 10 years. Gen Y and Z consumers reported higher propensity for saving each month relative to older generations, which could be a potential tailwind for discretionary spending. And travel remains a top priority across age cohorts, which sets the stage for ongoing travel strength and favorable cross-border trends for the major credit card providers. In addition to all these findings, our analysis suggests several surprising facts. For example, our survey results contradict the widely accepted notion that younger generations are "credit averse." The vast majority of Gen Z consumers have one or more traditional credit cards – at a similar rate to Gen X and Millennials. Although traditional credit card usage is higher among Millennials and Gen Z than it was in 2018, data suggests this is driven by convenience, not financing needs. Younger people’s borrowing is primarily related to auto and home loans from traditional lenders rather than fintechs. Another unexpected finding is that while Gen Y and Z are more drawn to online banking than their predecessors, about 75 per cent acknowledge the importance of physical branch locations – and still prefer to bank with their traditional national, regional, and community banks over online-only providers. What’s more, they also believe physical bank branches will be important long-term. Overall, our analysis suggests that generations tend to maintain their key priorities as they age. Whether this pattern holds in the future is something we will continue to watch.Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Morgan Stanley’s CIO and Chief U.S. Equity Strategist Mike Wilson joins Andrew Pauker of the U.S. Equity Strategy team to break down the key issues for equity markets ahead of 2025, including the impact of potential deregulation and tariffs.----- Transcript -----Mike Wilson: Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist.Andrew Pauker: And I'm Andrew Pauker from our US Equity Strategy Team.Mike Wilson: Today we'll discuss our 2025 outlook for US equities.It's Tuesday, November 26th at 5pm.So let's get after it.Andrew Pauker: Mike, we're forecasting a year-end 2025 price target of 6,500 for the S&P 500. That's about 9 percent upside from current levels. Walk us through the drivers of that price target from an earnings and valuation standpoint.Mike Wilson: Yeah, I mean, I think, you know, this is really just rolling forward what we did this summer, which is we started to incorporate our economists’ soft-landing views. And, of course, our rate strategist view for 10-year yields, which, you know, factors into valuation.We really didn't change any of our earnings forecast. That's where we've been very accurate. What we've been not accurate is on the multiple. And I think a lot of clients have also -- investors -- have been probably a little bit too conservative on their multiple assumption. And so, we went back and looked at, you know, periods when earnings growth is above average, which is what we're expecting. And that's just about 8 percent; anything north of that. Plus, when the Fed is actually cutting rates, which was not the case this past summer, it's just very difficult to see multiples go down. So, we actually do have about 5 percent depreciation in our multiple assumption on a year-over-year basis, but still it's very high relative to history.But if the base case plays out, but from an economic standpoint and from a rate standpoint, it's unlikely earnings rates are going to come down. So, then we basically can get all of the appreciation from our earnings forecast for about, you know, 10-12 percent; a little bit of a discount from multiples, that gets you your 9 percent upside.I just want to, you know, make sure listeners understand that the macro-outcomes are still very uncertain. And so just like this year, you know, we maybe pivot back and forth throughout the year … as [it] becomes [clear], you know, what the outcome is actually going to be.For example, growth could be better; growth could be worse; rates could be higher; the Fed may not cut rates; they may have to raise rates again if inflation comes back. So, I would just, you know, make sure people understand it's not going to be a straight line no matter what happens. And we're going to try to navigate that with, you know, our style sector picks.Andrew Pauker: There are a number of new policy dynamics to think through post the election that may have a significant impact on markets as we head into 2025, Mike. What are the potential policy changes that you think could be most impactful for equities next year?Mike Wilson: Yeah, and I think a lot of this started to get discounted into the markets this fall, you know, the prediction polls were kinda leaning towards a Republican win, starting really in June – and it kind of went back and forth and then it really picked up steam in September and October. And the thing that the markets, equity market, are most excited about I would say, is this idea of deregulation. You know, that's something President-elect Trump has talked about. The Republicans seem to be on board with that. That sort of business friendly, if you will, kind of a repeat of his first term.I would say on the negative side what markets are maybe wary about, of course, is tariffs. But here there’s a lot of uncertainty too. We obviously got a tweet last night from President-elect Trump, and it was, you know, 10 percent additional tariffs on certain things. And there’s just a lot of confusion. Some stocks sold off on that. But remember a lot of stocks rallied yesterday on the news of Scott Bessent being announced as Treasury Secretary because he's maybe not going to be as tough on tariffs.So, what I view the next two months as is sort of a trial period where we're going to see a lot of announcements going out. And then the people in the cabinet positions who are appointed along with the President-elect are going to look at how the market reacts. And they're going to want to try to, you know, think about that in the context of how they're going to propose policy when they actually take office.So, a lot of volatility over the next two months as these announcements are kind of floated out there as trial balloons. And then, of course, you also have the enforcement of immigration and the impact there on growth and also labor supply and labor costs. And that could be a net negative in the first half of next year. And so, look, it's going to be about the sequencing. Those are the two easy ones that you can see – tariffs of some form, and of course, immigration enforcement. And those are probably the two biggest potential negatives in the first half of next year.Andrew Pauker: Mike, the title of our Outlook is “Stay Nimble Amid Changing Market Leadership,” and I think that reflects our mentality when it comes to remaining focused on capturing the leadership changes under the surface of the market. We rotated from a defensive posture over the summer to a more pro-cyclical stance in the fall. Talk about our latest views when it comes to positioning across styles, themes, and sectors here.Mike Wilson: Yeah, I mean, you know, you have to understand that that pivot was not about the election as much as it was about kind of the economy, moving from the risk of a hard landing, which people were worried about this summer to, soft landing again. And then of course we got the Fed to, you know, aggressively begin a new rate cutting cycle with 50 basis points, which was a bit of a surprise given, you know, the context of a still decent labor markets.That was the main reason for kind of the cyclical pivot, and then, of course, the election outcome sort of turbocharges some of that. So that's why we're sticking with it for now.So, to be more specific, what we basically did was we went to quality cyclical rotation. What does that mean? It means, you know, we prefer things like financials, maybe industrials, kind of a close second from a sector standpoint. But this quality feature we think is important for people to consider because interest rates are still pretty high. You know, balance sheets are still a little stretched and, you know, price levels are still high.So that means that lower quality businesses -- and the stocks of those lower quality businesses -- are probably a higher risk than we want to assume right now. But going into year end first and in 2025, we're going to stick with what we've sort of been recommending. On the defensive side. We didn't abandon all of them – because of , you know, we don't know how it's going to play out. So, we kept Utilities as an overweight because it has some offensive properties as well – most notably lever to kind of this, power deficiency within the United States. And that, of course with deregulation, a new twist on that could be things like natural gas, deployment of, you know, natural gas resources, which would help pipelines, LNG facilities potentially, and also, new ways to drive electricity production.So, with that, Andrew, why don't you maybe dig in a little bit deeper on our financials column, and why it's not just, you know, about the election and kind of a rotation, but there's actually fundamental drivers here.Andrew Pauker: Yeah, so Financials remains our top sector pick, following our upgrade in early October. And the drivers of that view are – a rebounding capital markets backdrop, strong earnings revisions, and the potential for an acceleration in buybacks into next year. And then post the election, expectation for deregulation can also continue to drive performance for the sector in addition to those fundamental catalysts. And then finally, even with the outperformance that we've seen for the group, over the last month and a half or so, relative valuation remains on demand – and kind of the 50th percentile of historical levels.So, Mike, I want to wrap up by spending a minute on investor feedback to our outlook. Which aspects of our view have you gotten the most questions on? Where do investors agree and where do they disagree?Mike Wilson: Yeah, I mean, it's sort of been ongoing because, as we noted, we really pivoted, more constructively on kind of a pro-cyclical basis a while ago. And the pushback then is the same as it is now, which is that equities are expensive. And I mean, quite frankly, the reason we pivoted to some of these more cyclical areas is because they're not as expensive. But that doesn't take away from the fact that stocks are pricey. And so, people just want to understand this analysis that, you know, we did this time around, which kind of just shows why multiples can stay higher.They do appreciate that, you know, things can change. So, you know, we need to be, you know, cognizant of that. I would say, there's also debate around small caps. You know, we're neutral on small caps; we upgraded that about the same time after having been underweight for several years.I think, you know, people really want to get behind that. It's been a; it's been a trade that people have gotten wrong, repeatedly over the last couple years trying to buy small caps. This time it seems like there may be some more behind it. We agree. That's why we went to neutral. And I think, you know, there are people who want to figure out, well, why? Why don't we go overweight now? And what we're really waiting for is for rates to come down a bit more. It's still sort of a late cycle environment. So, you know, typically you want to wait until you kind of see the beginnings of a new acceleration in the economy. And that's not what our economists are forecasting.And then the other area is just this debate around government efficiency. And this is where I'm actually most excited because this is not priced at all in my view. There's so much skepticism around the ability or, you know, the likelihood of success in shrinking the government. That's not really what we're, you know, hoping for. We're just hoping for kind of a freezing of government spending. And it's so important to just, to think about it that way because that's what the fiscal sustainability question is all about, where then rates can stay contained. But then if you take it a step further, you know, our view for the last several years has been that the government has been essentially crowding out the private economy, and that really has punished small, medium businesses as well as many consumers.And so, by shrinking or at least freezing the size of the government and redeploying those efforts into the private economy, we could see a very significant increase in productivity, but also see a broadening out in this rally. I mean, one of the reasons the market's been; equity market's been so narrow is because is because scale really matters in this crowded out, sort of environment.If that changes, that creates opportunity at the stock level and that broadening out, which is a much healthier bull market potential.So, what are you hearing from investors, Andrew?Andrew Pauker: Yeah, I mean, I think the debate now, in addition to the factors that you mentioned, is really around the consumer space. A lot of pessimism is in the price already for consumer discretionary goods on the back of – kind of wallet share shift from goods to services, high price levels and sticky interest rates in addition to the tariff risk.So, what we did in our note this week is we laid out a couple of drivers that could potentially get us more positive on that cohort. And those include a reversion in terms of the wallet share shift actually back towards goods. I think that would be a function of lower price levels. Lower interest rates – our rate strategists expect the 10-year yield to fall to 355 by year end 2025. So that would be a constructive backdrop for some of the more interest rate sensitive and housing areas within consumer discretionary.Those are all factors that watching closely in order to get more constructive on that space. But that is another area of the market that I have received a good amount of questions on.Mike Wilson: That's great, Andrew. Thanks a lot. Thanks for taking the time to talk today.Andrew Pauker: Thanks, Mike. Anytime.Mike Wilson: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.