Markets are contending with greater uncertainty around the US presidential election following President Biden’s withdrawal. Our Global Head of Fixed Income and Thematic Research breaks down what we know as the campaign enters a new phase.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the latest development in the US presidential race.

It's Thursday, July 25th at 2:30 pm in New York. 

Last weekend, when President Biden decided not to seek re-election, it begged some questions from investors. 

First, with a new candidate at the top of the ticket, are there new policy impacts, and potential market effects, resulting from Democrats winning that we haven’t previously considered? 

For the moment, we think the answer is no. Consider Vice President Harris. Her policy positions are similar to Biden’s on key issues of importance to markets. And even if they weren’t, the details of key legislative policies in a Democratic win scenario will likely be shaped by the party’s elected officials overall. So, our guidance for market impacts that investors should watch for in the event that Democrats win the White House is unchanged. 

Second, what does it mean for the state of the race? After all, markets in the past couple of weeks began anticipating a stronger possibility of Republican victory. It was visible in stronger performance in small cap stocks, which our equity strategy team credited to investors seeing greater benefits in that sector from more aggressive tax cuts under possible Republican governance. 

It was also visible in steeper yield curves, which could reflect both weaker growth prospects due to tariff risks, pushing shorter maturity yields lower, and greater long-term uncertainty on economic growth, inflation, and bond supply from higher US deficits – something that could push longer-maturity Treasury yields relatively higher. So, it's understandable that investors could question the durability of these market moves if the race appeared more competitive. 

But the honest answer here is that it's too early to know how the race has changed. As imperfect as they are, polls are still our best tool to gauge public sentiment. And there’s scant polling on Democratic candidates not named Biden. So, on the question of which candidate more likely enjoys sufficient voter support to win the election, it could be days or weeks before we have reliable information. That said, prediction markets are communicating that they expect the race to tighten – pricing President Trump’s probability of regaining the White House at about 60-65 per cent, down from a recent high of 75-80 per cent. 

So bottom line, a change in the Democratic ticket hasn’t changed the very real policy stakes in this election. We’ll keep you informed here of how it's impacting our outlook for markets. 

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our Chief Asia Economist explains how the region’s economies and markets would be affected by higher tariffs, and other possible scenarios in the US elections.

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Welcome to Thoughts on the Market. I’m Chetan Ahya, Morgan Stanley’s Chief Asia Economist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss a question that’s drawing increasing attention – just how the U.S. presidential election would affect Asian economies and markets. 

It’s Wednesday, July 24th, at 8 PM in Hong Kong. 

As the US presidential race progresses, global markets are beginning to evaluate the possibility of a Trump win and maybe even a Republican sweep. Investors are wondering what this would   mean for Asia in particular. We believe there are three channels through which the US election outcome will matter for Asia. 

First, financial conditions – how the US dollar and rates will move ahead of and after the US elections. Second, tariffs. And third, US growth outcomes, which will affect global growth and end demand for Asian exports. Well, out of the three our top concern is the growth downside from higher tariffs. 

The 2018 experience suggests that the direct effect of tariffs is not what plays the most dominant role in affecting the macro outcomes; but rather the transmission through corporate confidence, capital expenditure, global demand and financial conditions. 

Let’s consider two scenarios. 

First, in a potential Trump win with divided government, China would likely be more affected from tariffs than Asia ex China. We see potentially two outcomes in this scenario – one where the US imposes tariffs only on China, and another where it also imposes 10 percent tariffs on the rest of the world. 

In the case of 60 percent tariffs on imports from China, there would be meaningful adverse effect on Asia's growth and it will be deflationary. China would remain most exposed compared to the rest of the region, which has reduced its export exposure to China over time and could see a positive offset from diversification of the supply chain away from China. 

In the case where the US also imposes 10 percent tariffs on imports from the rest of the world, we expect a bigger downside for China and the region. We believe that in this instance – in addition to the direct effect of tariffs on exports – the growth downside will be amplified by significant negative impact on corporate confidence, capex and trade. Corporate confidence will see bigger damage in this instance as compared to the one where tariffs are imposed only on China as corporate sector will have to think about on-shoring rather than continuing with friend-shoring. 

In the second scenario, in a potential Trump win with Republican sweep, in addition to the implications from tariffs, we would also be watching the possible fiscal policy outcomes and how they would shift the US yields and the dollar. This means that the tightening of financial conditions would pose further growth downside to Asia, over and above the effects of tariffs. 

How would Asia’s policymakers respond to these scenarios? As tariffs are imposed, we would expect Asian currencies to most likely come under depreciation pressure in the near term. While this helps to partly offset the negative implications of tariffs, it will constraint the ability of the central banks to cut rates. In this context, we expect fiscal easing to lead the first part of the policy response before rate cuts follow once currencies stabilize. It’s worth noting that in this cycle, the monetary policy space in Asia is much more limited than in the previous cycles because nominal rates in Asia for the most part are lower than in the US at the starting point. 

Of course, this is an evolving situation in the remaining months before the US elections, and we’ll continue to keep you updated on any significant developments. 

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.

Our Head of Global Autos & Shared Mobility discusses what makes humanoid robots a pivotal trend with implications for the global economy.

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Welcome to Thoughts on the Market. I’m Adam Jonas, Morgan Stanley’s Head of Global Autos & Shared Mobility. Today I’ll be talking about an unusual but hotly debated topic: humanoid robots.

It’s Tuesday, July 23rd, at 10am in New York. 

We've seen robots on factory floors, in displays at airports and at trade shows – doing work, performing tasks, even smiling. But over the last eighteen months, we seem to have hit a major inflection point.

What's changed? Large Language Models and Generative AI. The current AI movement is drawing comparisons to the dawn of the Internet. It’s begging big, existential questions about the future of the human species and consciousness itself. But let’s look at this in more practical terms and consider why robots are taking on a human shape. 

The simplest answer is that we live in a world built for humans. And we’re getting to the point where – thanks to GenAI – robots are learning through observation. Not just through rudimentary instruction and rules based heuristic models. GenAI means robots can observe humans in action doing boring, dangerous and repetitive tasks in warehouses, in restaurants or in factories. And in order for these robots to learn and function most effectively, their design needs to be anthropomorphic. 

Another reason we're bullish on humanoid robots is because developers can have these robots experiment and learn from both simulation and physically in areas where they’re not a serious threat to other humans. You see, many of the enabling technologies driving humanoid robots have come from developments in autonomous cars. The problem with autonomous cars is that you can't train them on public roads without directly involving innocent civilians – pedestrians, children and cyclists -- into that experiment. 

Add to all of this the issue of critical labor shortages and challenging demographic trends. The global labor total addressable market is around $30 trillion (USD) or about one-third of global GDP. We’ve built a proprietary US total addressable market model examining labor dynamics and humanoid optionality across 831 job classifications, working with our economic team; and built a comprehensive survey across 40 sectors to understand labor intensity and humanoid ability of the workforce over time. 

In the United States, we forecast 40,000 humanoid units by 2030, 8 million by 2040 and 63 million by 2050 – equivalent to around $3 trillion (USD) of salary equivalent. But as early as 2028 we think you're going to see significant adoption beginning in industries like manufacturing, production, warehousing, and logistics, installation, healthcare and food prep. 

Then in the 2030s, you’re going to start adding more in healthcare, recreational and transportation. And then after 2040, you may see the adoption of humanoid robots go vertical. Now you might say – that’s 15 years from now. But just like autonomous cars, the end state might be 20 years away, but the capital formation is happening right now. And investors should pay close attention because we think the technological advances will only accelerate from here. 

Thanks for listening. And 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.

Our CIO and Chief US Equity Strategist explains that in the event of a Republican sweep in this fall’s U.S. elections, investors should not expect a repeat of 2016 given the different business environment.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity  Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about  why investors should fade the recent rally in small caps and other pro cyclical trades. 

It's Monday, July 22nd at 11:30am in New York.  

So let’s get after it.

With Donald Trump’s odds of winning a second Presidency rising substantially over the past few weeks, we’ve fielded many questions on how to position for this outcome. In general, there is an increasing view that growth and interest rates could be higher given Trump's focus on business-friendly policies, de-regulation, higher tariffs, less immigration and additional tax cuts.  

While the S&P 500 has risen alongside Trump's presidential odds this year, several of the perceived  industry outperformers under this political scenario have only just recently started to show relative outperformance. One could argue a Trump win in conjunction with a Republican sweep could be  particularly beneficial for Banks, Small Caps, Energy Infrastructure and perhaps Industrials. Although, the  Democrats' heavy fiscal spending and subsidies for the Inflation Reduction Act, Chips Act and other infrastructure projects suggest Industrial stocks may not see as much of an incremental benefit relative to the past four years. The  perceived industry underperformers are alternative energy stocks and companies likely to be affected  the most by increased tariffs. Consumer stocks stand out in terms of this latter point, and they have underperformed recently. However, macro factors are likely affecting this dynamic as well. For example, concerns around slowing services demand and an increasingly value-focused consumer have risen, too. 

It's interesting to note that while these cyclical areas that are perceived to outperform under a Trump Presidency did work in 2016 and through part of 2017, they did even better during Biden's first year. Our rationale on this front is that the cycle plays a larger role in how stocks trade broadly and at the sector level than who is in the White House. As a comparison, we laid out a bullish case at the end of 2016 and in early 2017 when many were less constructive on pro cyclical risk assets than we were post the 2016 election. It’s worth pointing out that the global economy was coming out of a commodity and  manufacturing recession at that time, and growth was just starting to reaccelerate, led by another China boom. Today, we face a much different macro landscape. More specifically, several of the cyclical trades mentioned above typically show their best performance in the early cycle phase of an economic  expansion like 2020-2021. They show strong, but often not quite as strong performance in mid cycle  periods like 2016-17. They tend to show less strong returns later in the cycle like today. Our late cycle view is further supported by the persistent fall in long term interest rates and inverted yield curve.  

We believe the recent outperformance of lower quality, small cap stocks has been driven mainly by a combination of softer inflation data and hopes for an earlier Fed cut combined with dealer demand and short covering from investors on the back of Trump’s improved odds. For those looking to the 2016 playbook, we would point out that relative earnings revisions for small cap cyclicals are much weaker today than they were during that period.   

Back in December when small caps saw a similar squeeze higher, we explored the combination of factors  that would likely need to be in place for small cap equities to see a durable, multi-month period of  outperformance. Our view was that the introduction of rate cuts in and of itself was not enough of a factor to drive small cap outperformance versus large caps. In fact, history suggests large cap growth tends to be the best performing style once the Fed begins cutting as nominal growth is often slowing at  this point in the cycle, which enables the Fed to begin cutting. We concluded that to see durable small cap  outperformance, we would need to see a much more aggressive Fed cutting cycle that revived animal spirits in a significant enough way for growth and pricing power to inflect higher, not lower like recent trends.  

We are monitoring small cap earnings expectations and small business sentiment for signs that animal  spirits are building in this way. Rates and pricing power are still headwinds; while small businesses are not all that sanguine about expanding operations, they are increasingly viewing the economy more  positively — an incremental positive and something worth watching. We will continue to monitor the  data in assessing the feasibility of this small cap rally continuing. Based on the evidence to date, we  would resist the urge to chase this cohort and lean back into large cap quality and defensives. 

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen, and share  Thoughts on the Market with a friend or colleague today. 

Our Head of Corporate Credit Research shares four reasons that he believes credit spreads are likely to stay near their current lows.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why being negative credit isn’t as obvious as it looks, despite historically low spreads.

It's Friday, July 19th at 2pm in London.

We’re constructive on credit. We think the asset class likes moderation, and that’s exactly what Morgan Stanley forecasts expect: moderate growth, moderating inflation and moderating policy rates. Corporate activity is also modest; and even though it’s picking up, we haven’t yet seen the really aggressive types of corporate behavior that tend to make bondholders unhappy. 

Meanwhile, demand for the asset class is strong, and we think the start of Fed rate cuts in September could make it even stronger as money comes out of money market funds, looking to lock in current interest rates for longer in all sorts of bonds – including corporate bonds. 

And so while spreads are low by historical standards, our call is that helpful fundamentals and demand will keep them low, at least for the time being. 

But the question of credit’s valuation is important. Indeed, one of the most compelling bearish arguments in credit is pretty straightforward: current spreads are near some of their lowest levels of several prior cycles. They’ve repeatedly struggled to go lower. And if they can’t go lower, positioning for spreads to go wider and for the market to go weaker, well, it would seem like pretty good risk/reward. 

This is an extremely fair question! But there are four reasons why we think the case to be negative isn’t as straightforward as this logic might otherwise imply.

First, a historical quirk of credit valuations is that spreads rarely trade at long-run average. They are often either much wider, in times of stress, or much tighter, in periods of calm. In statistical terms, spreads are bi-modal – and in the mid 1990s or mid 2000’s, they were able to stay near historically tight levels for a pretty extended period of time. 

Second, work by my colleague Vishwas Patkar and our US Credit Strategy team notes that, if you make some important adjustments to current credit spreads, for things like quality, bond price, and duration, current spreads don’t look quite as rich relative to prior lows. Current investment grade spreads in the US, for example, may still be 20 basis points wider than levels of January 2020, right before the start of COVID. 

Third, a number of the key buyers of corporate bonds at the moment are being driven by the level of yields, which are still high rather than spread, which are admittedly low. That could mean that demand holds up better even in the face of lower spreads. 

And fourth, credit is what we’d call a positive carry asset class: sellers lose money if nothing in the market changes. That’s not the case for US Treasuries, or US Equities, where those who are negative – or short – will profit if the market simply moves sideways. It’s one more factor that means that, while spreads are low, we’re mindful that being negative too early can still be costly. It’s not as simple as it looks. 

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.

Our experts discuss how high prices for auto insurance have been driving inflation, and the implications for consumers and the Fed now that price increases are due to slow.

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist.

Diego Anzoategui: I'm Diego Anzoategui from the US Economics team.

Bob Huang: And I'm Bob Huang, the US Life and Property Casualty Insurance Analyst.

Seth Carpenter: And on this episode, we're going to talk about a topic that -- I would have guessed -- historically we weren't going to think about too often in a macro setting; but over the past couple of years it's been a critical part of the whole story on inflation, and probably affects most of our listeners.

It's auto insurance and why we think we're reaching a turning point.

It's Thursday, July 18th at 10am in New York.

All right, let's get started.

If you drive a car in the United States, you almost surely have been hit by a big increase in your auto insurance prices. Over the past couple of years, everyone has been talking about inflation, how much consumer prices have been going up. But one of the components that lots of people see that's really gone up dramatically recently has been auto insurance.

So that's why I wanted to come in and sit down with my colleagues, Diego and Bob, and talk through just what's going on here with auto insurance and how does it matter.

Diego, I'm going to start with you.

One thing that is remarkable is that the inflation that we're seeing now and that we've seen over the past several months is not related to the current state of the economy.

But we know in markets that everyone's looking at the Fed, and the Fed is looking at the CPI data that's coming out. We just got the June CPI data for the US recently. How does this phenomenon of auto insurance fit into that reading on the data?

Diego Anzoategui: Auto insurance is a relatively small component of CPI. It only represents just below 3 per cent of the CPI basket. But it has become a key driver because of the very high inflation rates has been showing. You know, the key aggregate the Fed watches carefully is core services ex-housing inflation. And the general perception is that inflation in these services is a lagged reflection of labor market tightness. But the main component driving this aggregate, at least in CPI, since 2022 has been auto insurance.

So the main story behind core services ex-housing inflation in CPI is just the lagged effect of a cost shock to insurance companies.

Seth Carpenter: Wait, let me stop you there. Did I understand you right? That if we're thinking about core services inflation, if you exclude housing; that is, I think, what a lot of people think is inflation that comes from a tight labor market, inflation that comes from an overheated economy. And you're saying that a lot of the movement in the past year or two is really coming from this auto insurance phenomenon.

Diego Anzoategui: Yes, that's exactly true. It is the main component explaining core services ex-housing inflation.

Seth: What's caused this big acceleration in auto insurance over the past few years? And just how big a deal is it for an economist like us?

Diego Anzoategui: Yeah, so believe it or not, today's auto insurance inflation is related to COVID and the supply chain issues we faced in 2021 and 2022. Key cost components such as used cars, parts and equipment, and repair cost increased significantly, creating cost pressures to insurance companies. But the reaction in terms of pricing was sluggish. Some companies reacted slowly; but perhaps more importantly, regulators in key states didn't approve price increases quickly.

Remember that this is a regulated industry, and insurance companies need approvals from regulators to update premiums. And, of course, losses increased as a result of this sluggish response in pricing, and several insurance started to scale back businesses, creating supply demand imbalances.

And it is when these imbalances became evident that regulators started to approve large rate increases, boosting car insurance inflation rapidly from the second half of 2022 until today.

Seth Carpenter: Okay, so if that's the case, what should we think about as key predictors, then, of auto insurance prices going forward? What should investors be aware of? What should consumers be aware of? 

Diego Anzoategui: So in terms of predictors, it is always a good idea to keep track of cost related variables. And these are leading indicators that we both Bob and I would follow closely.

Used car prices, repair costs, which are also CPI components, are leading indicators of auto insurance inflation. And both of them are decelerating. Used car prices are actually falling. So there is deflation in that component. But I think rate filings are a key indicator to identify the turning point we are expecting this cycle.

Seth Carpenter: Can you walk through what that means -- rate filings? Just for our listeners who might not be familiar?

Diego Anzoategui: So, rate filings basically summarize how much insurers are asking to regulators to increase their premiums. And we actually have access to this data at a monthly frequency. Filings from January to May this year -- they are broadly running in line with what happened in 2023. But we are expecting deceleration in the coming months.

If filings start to come down, that will be a confirmation of our view of a turning point coming and a strong sign of future deceleration in car insurance inflation.

Seth Carpenter: So Bob, let me turn to you. Diego outlines with the macro considerations here. You're an analyst, you cover insurers, you cover the equity prices for those insurance, you're very much in the weeds. Are we reaching a turning point? Walk us through what actually has happened.

Bob Huang: Yeah, so we certainly are reaching a turning point. And then, similar to what Diego said before, right, losses have been very high; and then that consequently resulted in ultimately regulators allowing insurance companies to increase price, and then that price increase really is what's impacting this.

Now, going forward, as insurers are slowly achieving profitability in the personal auto space, personal auto insurers are aiming to grow their business. And then, if we believe that the personal auto insurance is more or less a somewhat commoditized product, and then the biggest lever that the insurance companies have really is on the pricing side. And as insurers achieve profitability, aim for growth, and that will consequently cost some more increased pricing competition.

So, yes, we'll see pricing deceleration, and that's what I'm expecting for the second half of the year. And then perhaps even further out, and that could even intensify further. But we'll have to see down the road.

Seth Carpenter: Is there any chance that we actually see decreases in those premiums? Or is the best we can hope for is that they just stopped rising as rapidly as they have been?

Bob Huang: I think the most likely scenario is that the pricing will stabilize. For price to decrease to before COVID level, that losses have to really come down and stabilize as well. There are only a handful of insurers right now that are making what we call an underwriting profit. Some other folks are still trying to make up for the losses from before.

So, from that perspective, I think, when we think about competition, when we think about pricing, stabilization of pricing will be the first point. Can price slightly decrease from here? It's possible depending on how intensive the competition is. But is it going to go back to pre-COVID level? I think that's a hard ask for the entire industry.

Seth Carpenter: You were talking a lot about competition and how competition might drive pricing, but Diego reminded all of us at the beginning that this industry is a regulated industry. So can you walk us through a little bit about how we should think about this going forward?

What's the interaction between competition on the one hand and regulation on the other? How big a deal is regulation? And, is any of that up for grabs given that we've got an election in November?

Bob Huang: Usually what an insurer will have to do in general is that for some states -- well actually, in most cases they would have to ask for rate filings, depending on how severe those rate filings are. Regulators may have to step in and approve those rate filings.

Now, as we believe that competition will gradually intensify, especially with some of the more successful carriers, what they can do is simply just not ask for price increase. And in that case, regulators don't really need to be involved. And then also implies that if you're not asking for a rate increase, then that also means that you're not really getting that pricing -- like upward pricing pressure on the variety of components that we're looking at.

Seth Carpenter: To summarize, what I'm hearing from Bob at the micro level is those rate increases are probably slowing down and probably come to a halt and we'll have a stabilization. But don't get too excited, consumers. It's not clear that car insurance premiums are actually going to fall, at least not by a sizable margin.

And Diego, from you, what I'm hearing is this component of inflation has really mattered when it comes to the aggregate measure of inflation, especially for services. It's been coming down. We expect it to come down further. And so, your team's forecast, the US economics team forecast, for the Fed to cut three times this year on the back of continued falls of inflation -- this is just another reason to be in that situation.

So, thanks to both of you being on this. It was great for me to be able to talk to you, and hopefully our listeners enjoyed it too.

Bob Huang: Thank you for having me here.

Diego Anzoategui: Always a pleasure.

Seth Carpenter: To the listeners, thank you for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen; and share this podcast with a friend or a colleague today.

Financial markets can be sensitive to news cycles, but our Global Head of Fixed Income and Thematic Research offers a word of caution about reacting to recent headlines about the US presidential election.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about development in the upcoming US elections.

It's Wednesday, July 17th at 10:30am in New York. 

Financial markets are starting to reflect the possibility of a Trump presidency. Investors may be taking cues from a few current developments. There’s the recent weakening of President Biden’s polling numbers in key swing states such as Pennsylvania, Michigan and Wisconsin. There’s also the ongoing discussion about whether he will remain the Democratic nominee. And there's also former President Trump’s increased win probabilities in prediction markets, as well as the perception that Democrats will have more trouble pursuing their agenda in the wake of the assassination attempt against him. 

To that end we’ve seen moves in key areas of markets sensitive to what we have argued will be the policy impacts of a Trump presidency, including a steepening of the US Treasury yield curve. But – a word of caution. These market reactions to recent political events may be rational, but it's not clear they’re sustainable.  

First, there are plausible ways investors’ perceptions of the likely outcomes of this election could shift. Voters can have very short memories, resulting in polls shifting to partisan priors. This happened with popular opinion on elected officials following notable incidents in recent years – such as the events of January 6th, 2021, the US withdrawal from Afghanistan, and more. Also, if President Biden were to withdraw as a candidate, it’s possible investors could perceive that a different candidate could tighten the race. For example, there have been recent surveys showing alternate Democratic candidates polling better than President Biden. 

Second, there’s also room for investors to misunderstand the policy path that could follow an election outcome as well as the impact of that path. For example, we’ve seen some recent press articles linking the broadening out of positive performance in the equity market to the likelihood of a Trump win on perceived benefits of friendlier tax policies that might result from this outcome. But if investors only focus on that policy, they’re not incorporating the potential offsetting effects that could come from policies that could challenge the economic growth outlook, such as higher tariffs – something former President Trump has advocated for. 

So bottom line, it makes sense to interrogate what seems like clear links between the upcoming election and markets.Some linkages are strong, and it’s possible that will make for a good investment strategy; others are weak and may break under scrutiny. We’ll help you sort it out here. 

Thanks for listening. If you enjoy the podcast, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Our Chief Global Cross-Asset Strategist explains why she sees a future for the 60/40 portfolio strategy, which worked well for over half a century and may continue to perform well – with some modifications.

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Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss the future of the 60/40 equity/bond portfolio.

 It’s Tuesday, July 16th, at 10am in New York.

Now investors have been asking: Is the 60/40 portfolio -- which allocates 60 percent to stocks and 40 percent to bonds -- dead? After all, the last two years saw some of the worst returns of this strategy in decades. Now, we think the concerns about this widely used strategy are not unfounded, but definitely a bit exaggerated. Exactly how one thinks about the right mix of equities and bonds within this type of portfolio though will need to change.

The strategy of investing 60 percent of a portfolio in equities and 40 percent in bonds to lower portfolio risk evolved from modern portfolio theory in the 1950s. To succeed, bonds must be less volatile than stocks and the correlation between stock and bond returns can't be 1 -- because that would mean a perfect positive correlation between stocks and bonds. And this correlation has been below 1 and low for a long time because growth and inflation have moved up and down in tandem for a long time. 

Now what does this have to do with anything, you may ask. Well, typically in an environment where equities are rallying on the back of strong growth, inflation is also increasing – which in turn means that nominal yields stay high, dampening bond returns; and vice-versa in a recessionary scenario. Now, in both of those cases, the negative stock-bond return correlations is related to the positive growth inflation correlation. Which explains why the strategy of the 60/40 equity/bond portfolio worked so well for decades, particularly in the low-vol, high-growth inflation correlation, low stock-bond returns correlation environment of the late aughts to 2010s. 

Unfortunately for investors though, this has not been the backdrop for the last few years. The highly unusual macro environment coming out of pandemic broke that relationship between growth and inflation, which in turn broke the relationship between stocks and bonds, led to a spike in fixed income volatility, and dragged bond returns to lowest levels in decades over the last couple of years. But we believe these factors will slowly normalize, which means 60/40-like strategies should work again. While the levels of correlation and bond volatility going forward may look different from history, and definitely different from the QE period, as long as bonds have lower risks than stocks – and there’s little to suggest they won’t – bonds will continue to be good diversifiers. 

But it’s important for investors to ask themselves: what could drive correlation between stocks and bonds going forward? Well, longer term, the path of correlation between the two assets depends in part on the relationship between economic growth and inflation, as I touched on earlier. And this is where AI can come in. Positive productivity shocks from GenAI tech diffusion and the energy transition may change that dynamic between growth and inflation. And at the same time, decoupling in the world’s key economic regions as a result of the transition to a multipolar world can alter the correlation between regional equities and rates. 

So, will the 60/40 portfolio be the strategy of the future? Or is it going to be more like 70/30 or even 50/50? Slower normalization of volatility and correlation means that a portfolio with more equity could yield better risk/reward than a 60/40 mix. On the other hand, as the world’s 65+ year-old population continues to grow over the next decades, this aging demographic may demand higher allocations to less volatile assets, even at the expense of lower returns. 

Or maybe, just maybe, there is another solution. Instead of a simple 60/40 like strategy, investors can look beyond government bonds to other diversifiers, and building a multi-asset portfolio with more flexibility. 

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.

Our Retail analyst and U.S. Internet analyst connect the dots on how technology is helping the retail industry to cash in on the future.

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Simeon Gutman: Welcome to Thoughts on the Market. I'm Simeon Gutman, Morgan Stanley's Hardlines, Broadlines, and Food Retail Analyst.

Brian Nowak: And I'm Brian Nowak, Morgan Stanley's US Internet Analyst.

Simeon Gutman: And on this episode of the podcast, we'll hear how retailers are using technology to make a comeback and set themselves up for the future.

It's Monday, July 15th at 6pm in London.

Brian Nowak: And it's 1pm in New York.

Simeon Gutman: Retail has taken a big hit over the last few years. The long tail of the pandemic, outbreaks of war and inflation have had a big impact on the landscape. However, our research suggests retail is finding its feet, and technology is playing a significant role.

Automation, AI, and retail media are the game changers here. And we're seeing retailers of larger scale and larger size disproportionately invest in these technologies -- which means it will not benefit all retailers equally.

My colleague Brian is here to help explain the technology and how these are manifesting themselves across the internet and technology landscapes. Brian, can you talk about how these things are materializing across your coverage universe?

Brian Nowak: Thanks, Simeon. Across the US internet space, we're seeing early emerging use cases for Generative AI of many types. We are seeing improved targeting on the advertising side. We are seeing new diffusion and creative models being built where advertisers can create new types of advertising copy using large language models. We are seeing new forms of customer service using large language models and Generative AI. And in effect, we are seeing companies across the entire internet space better analyze their first party data to drive more new people and customers to their platforms -- to drive higher conversion and share of wallets from those customers. And ultimately more durable multiyear top-line growth, which in some cases is also leading to higher free cash flow growth over the long term as well. It's early, but it's very encouraging with what we're seeing for Generative AI and retail media across the space.

Simeon Gutman: Can you talk about in more detail how retail media is influencing the success and the prospects for some of your companies?

Brian Nowak: Retail media is a emerging, rapidly growing, new high margin revenue stream that is moving across the internet space. Large companies are analyzing more of their data and essentially creating new advertising units that users and consumers can click on to drive transactions. And they're finding ways to better link these advertising dollars to transactions and ultimately creating a new revenue stream that we think is going to drive more durable top-line growth -- and because of its high margin nature, also more durable, multiyear free cash flow growth. It is benefiting the commerce players. It is benefiting the online advertising players. And it's also benefiting the advertising technology players.

So with that as a backdrop, Simeon, where are you seeing Generative AI, retail media, and maybe even automation, start to manifest itself throughout the retail landscape?

Simeon Gutman: Those are the three pillars of technology that are influencing retailers. Taking a quick step back, what's changing is that market share in retail is concentrating and consolidating among the largest players. And if you think about the investments required for some of these new capabilities, the companies that have the greatest ability to invest should see the greatest benefits. That means that the big could get bigger at an even faster rate. And this is why the stakes in retail are growing even faster.

Now with, respect to these technologies. Let's start with AI. AI is helping retailers analyze big pieces of data that they never had an ability to do in such a quick way. That could help them refine their search criteria to consumers scanning a website. That could help them improve the algorithms in a distribution center with robots creating orders.

Second, speaking of robots, bringing automation to distribution centers, supply chains for retailers can cost anywhere between 2 to 6 per cent of sales. There's a significant opportunity to reduce the amount of labor -- human labor -- in these distribution centers by automating them; whether it's dry goods, whether it's grocery items, as tricky as frozen and perishable items.

And then lastly, retail media, the way that you mentioned, Brian, the benefit to your companies is very similar to retailers. There are now advertising dollars that are moving into new channels, whether it's closed loop advertising in store or retail media that's appearing on websites -- where some of the larger and more successful companies have a lot of traffic and advertisers are intrigued to show them offers and deals to try to change their perception or behaviors.

So those three pieces of technology are slowly transforming the retailer. So next time you step into a retail store, there may be more technology that meets the eyes.

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.

Our Head of Corporate Credit Research explains why he expects the US Federal Reserve to make three rate cuts before the end of the year, starting in September.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about why it's looking more likely that the Fed should, and will, cut interests rates several times this year.

It's Friday, July 12th at 2pm in London.

Last week, we discussed why the case for Fed rate cuts this year was strengthening. Credit markets generally don’t care too much about the exact timing or pace of policy rates, but they do care if a central bank is behind the curve. 

That’s because over the last 40 years, the worst returns for credit have repeatedly overlapped with periods where the Fed was too late in reversing tight monetary policy. After all, interest rates impact the economy with a pretty long and variable lag; and a interest rate cut today may not be fully felt in the economy for 12 months – or even longer. It’s therefore important for a central bank to be proactive. 

And so, with the recent US economic data softer, and the Fed appearing in little rush to act, the concern was straightforward: if the Fed is waiting for signs of economic weakness to be obvious, it will take too long to lower interest rates to blunt this. The Fed will be behind the curve. 

This risk of acting too late hasn’t gone away, and it’s a key reason why we think credit investors should be rooting for economic data in the second half of this year to remain solid, in line with Morgan Stanley’s base case. But this week did bring some events that suggest the Fed may start to adjust rates soon. 

First, in testimony before the US Congress, Chair Powell repeatedly emphasized that the risks for the US economy are becoming more balanced. Previously, the Fed had appeared to be much more focused on an upside scenario where conditions are hotter rather than a scenario where growth slowed unexpectedly. 

Second, in data released yesterday, US Consumer Price Inflation – or CPI – came in lower than expected. Overall, prices actually fell month-over-month, something that hasn’t happened since May of 2020, a time when the pandemic was raging, and Fed rates were near zero percent. Morgan Stanley’s base case is that moderating inflation will lead the Fed to cut interest rates by 25 basis points in September, November and December of this year. 

For credit, the question of “what do these rate cuts” mean is an ‘and’ statement. If the Fed is lowering rates and growth is holding up, you are potentially looking at a mid-1990s scenario, the best period for credit in the modern era. But if the Fed is cutting and growth is weak … well, over and over again, that has not been good. 

We remain constructive on credit, expecting three Fed rate cuts this year to coexist with moderate growth. But weaker data remains the risk. For credit, good data is good. 

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.