On the eve of a competitive US election, our CIO and Chief US
Equity Strategist joins our head of Corporate Credit Research and
Chief Fixed Income Strategist to asses how investors are
preparing for each possible outcome of the race.
----- Transcript -----
Mike Wilson: Welcome to Thoughts on the
Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity
Strategist.
Andrew Sheets: I'm Andrew Sheets, head of
Corporate Credit Research at Morgan Stanley.
Vishy Tirupattur: And I'm Vishy Tirupattur,
Morgan Stanley's Chief Fixed Income Strategist.
Mike Wilson: Today on the show, the day
before the US election, we're going to do a conversation with my
colleagues about what we're watching out for in the markets.
It's Monday, November 4th, at 1130am in New York.
So let's get after it.
Andrew Sheets: Well, Mike, like you said,
it's the day before the US election. The campaign is going down
to the wire and the polling looks very close. Which means both it
could be a while before we know the results and a lot of
different potential outcomes are still in play. So it would be
great to just start with a high-level overview of how you're
thinking about the different outcomes.
So, first Mike, to you, as you think across some of the broad
different scenarios that we could see post election, what do
you think are some of the most important takeaways for how
markets might react?
Mike Wilson: Yeah, thanks, Andrew. I mean,
it's hard to, you know, consider oneself as an expert in these
types of events, which are extremely hard to predict. And there's
a lot of permutations, by the way. There's obviously the
presidential election, but then of course there's congressional
elections. And it's the combination of all those that then feed
into policy, which could be immediate or longer lasting.
So, the other thing to just keep in mind is that, you know,
markets tend to pre-trade events like this. I mean, this is a
known date, right? A known kind of event. It's not a surprise.
And the outcome is a surprise. So people are making investments
based on how they think the outcome is going to come. So that's
the way we think about it now.
Clearly, you know, treasury markets have sold off. Some of that's
better economic data, as our strategists in fixed income have
told us. But I think it's also this view that, you know, Trump
presidency, particularly Republican sweep, may lead to more
spending or bigger budget deficits. And so, term premium has
widened out a bit, so that’s been an area; here I think you could
get some reversion if Harris were to win.
And that has impact on the equity markets -- whether that's some
maybe small cap stocks or financials; some of the, you know,
names that are levered to industrial spending that they want to
do from a traditional energy standpoint.
And then, of course, on the negative side, you know, a lot of
consumer-oriented stocks have suffered because of fears
about tariffs increasing along with renewables. Because of the
view that, you know, the IRA would be pared back or even
repealed.
And I think there's still follow through particularly in
financials. So, if Trump were to win, with a Republican Congress,
I think, you know, financials could see some follow through. I
think you could see some more strength in small caps because of
perhaps animal spirits increasing a little further; a bit of a
blow off move, perhaps, in the indices.
And then, of course, if Harris wins, I would expect, perhaps,
bonds to rally. I think you might see some of these, you know,
micro trades like in financials give back some along with small
caps. And then you'd see a big rally in the renewables. And some
of the tariff losers that have suffered recently. So, there's a
lot, there's a lot of opportunity, depending on the outcome
tomorrow.
Andrew Sheets: And Vishy, as you think
about these outcomes for fixed income, what really stands out to
you?
Vishy Tirupattur: I think what is
important, Andrew, is really to think about what's happening
today in the macro context, related to what was happening in
2016. So, if you look at 2016; and people are too quick to
turn to the 2016 playbook and look at, you know, what a potential
Trump, win would mean to the rates markets.
I think we should keep in mind that going into the polls in 2016,
the market was expecting a 30 basis points of rate hikes over the
next 12 months. And that rate hike expectation transitioned into
something like a 125 place basis points over the following 12
months. And where we are today is very different.
We are looking at a[n] expectation of a 130-135 basis points of
rate cuts over the next 12 months. So what that means to me is
underlying macroeconomic conditions in where the economy is,
where monetary policy is very, very different. So, we should not
expect the same reaction in the markets, whether it's a micro or
macro -- similar to what happened in 2016.
So that's the first point. The second thing I want to; I'm really
focused on is – if it is a Harris win, it's more of a
policy continuity. And if it's a Trump win, there is going to be
significant policy changes. But in thinking about those policy
changes, you know, before we leap into deficit expansion, et
cetera, we need to think in terms of the sequencing of the policy
and what is really doable.
You know, we're thinking three buckets. I think in terms
of changes to immigration policy, changes to tariff policy,
and changes to tax code. Of these things, the thing that requires
no congressional approval is the changes to tariff policy, and
the tariffs are probably are going to be much more front loaded
compared to immigration. Or certainly the tax policy [is] going
to take a quite a bit of time for it to work out – even under the
Republican sweep scenario.
So, the sequencing of even the tariff policy, the effect of the
tariffs really depends upon the sequencing of tariffs itself. Do
we get to the 60 per cent China tariffs off the bat? Or will that
be built over time? Are we looking at across the board, 10
per cent tariffs? Or are we looking at it in much more sequential
terms? So, I would be careful not to jump into any knee-jerk
reaction to any outcome.
Andrew Sheets: So, Mike, the next question
I wanted to ask you is – you've been obviously having a lot of
conversations with investors around this topic. And so, is there
a piece of kind of conventional wisdom around the election or how
markets will react to the election that you find yourself
disagreeing with the most?
Mike Wilson: Well, I don't think there's
any standard reaction function because, as Vishy said --
depending on when the election's occurring, it's a very different
setup. And I will go back to what he was saying on 2016. I
remember in 2016, thinking after Trump won, which was a surprise
to the markets, that was a reflationary trade that we were very
bullish on because there was so much slack in the economy.
We had borrowing capabilities and we hadn't done any tax cuts
yet. So, there was just; there was a lot of running room to
kind of push that envelope.
If we start pushing the envelope further on spending or
reflationary type policies, all of a sudden the Fed probably
can't cut. And that changes the dynamics in the bond market. It
changes the dynamics in the stock market from a valuation
standpoint, for sure. We've really priced in this like, kind of
glide path now on, on Fed policy, which will be kind of turned
upside down if we try to reflate things.
Andrew Sheets: So Vishy, that's a great
point because, you know, I imagine something that investors do
ask a lot about towards the bond market is, you know, we see
these yields rising. Are they rising for kind of good reasons
because the economy is better? Are they rising for less good
reasons, maybe because inflation's higher or the deficit's
widening too much? How do you think about that issue of the rise
in bond yields? At what point is it rising for kind of less
healthy reasons?
Vishy Tirupattur: So Andrew, if you look
back to the last 30 days or so, the reaction the Treasury yields
is mostly on account of stronger data. Not to say that the
expectation changes about the presidential election outcomes
haven't played a role. They have. But we've had really strong
data. You know, we can ignore the data from last Friday
– because the employment data that we got last Friday was
affected by hurricanes and strikes, etc. But take that out of the
picture. The data has been very strong. So, it's really a
reflection of both of them. But we think stronger data have
played a bigger role in yield rise than electoral outcome
expectation changes.
Andrew Sheets: Mike, maybe to take that
question and throw it back to you, as you think about this issue
of the rise in yields – and at what point they're a problem
for the equity market. How are you thinking about that?
Mike Wilson: Well, I think there's two ways
to think about it. Number one, if it really is about the data
getting better, then all of a sudden, you know, maybe the
multiple expansion we've seen is right. And that, it's sort of
foretelling of an earnings growth picture next year that's, you
know, much faster than what, the consensus is modeling.
However, I'd push back on that because the consensus already is
modeling a pretty good growth trajectory of about 12 per cent
earnings growth. And that's, you know, quite healthy. I think,
you know, it's probably more mixed. I mean, the term premium
has gone up by 50 basis points, so some of this is about fiscal
sustainability – no matter who wins, by the way. I wouldn't say
either party has done a very good stewardship of, you know,
monitoring the fiscal deficits; and I think some of it is
definitely part of that. And then, look, I mean, this is
what happened last year where, you know, we get financial
conditions loosened up so much that inflation comes back. And
then the Fed can't cut.
So to me, you know, we're right there and we've written about
this extensively. We're right around the 200-day moving average
for 10-year yields. The term premium now is up about 50 basis
points. There's not a lot of wiggle room now. Stock market did
trade poorly last week as we went through those levels. So, I
think if rates go up another 10 or 20 basis points post the
election, no matter who wins and it's driven at least half by
term premium, I think the equity market's not gonna like that.
If rates kind of stay right around in here and we see term
premium stabilize, or even come down because people get more
excited about growth -- well then, we can probably rally a
bit. So it's much a reason of why rates are going up as much
as how much they're going up for the impact on equity multiples.
Vishy Tirupattur: Andrew, how are you
thinking about credit markets against this background?
Andrew Sheets: Yeah, so I think a few
things are important for credit. So first is I do think credit is
a[n] asset class that likes moderation. And so, I think outcomes
that are likely to deliver much larger changes in economic,
domestic, foreign policy are worse for credit. I mean, I think
that the current status quo is quite helpful to credit given
we're trading at some of the tightest spreads in the last 20
years. So, I think the less that changes around that for the
macro backdrop for credit, the better.
I think secondly, you know, if I -- and Mike correct me, if you
think I'm phrasing this wrong. But I think kind of some of the
upside case that people make, that investors make for equities in
the Republican sweep scenario is some version of kind of an
animal spirits case; that you'll see lower taxes, less
regulation, more corporate risk taking higher corporate
confidence. That might be good for the equity market, but usually
greater animal spirits are not good for the credit market. That
higher level of risk taking is often not as good for the lenders.
So, there are scenarios that you could get outcomes that might
be, you know, positive for equities that would not be positive
for credit.
And then I think conversely, in say the event of a
democratic sweep or in the scenarios where Harris wins, I do
think the market would probably see those as potentially, you
know, the lower vol events – as they're probably most similar to
the status quo. And again, I think that vol suppression that
might be helpful to credit; that might be helpful for things like
mortgages that credit is compared to. And so, I think that's also
kind of important for how we're thinking about it.
To both Mike and Vishy, to round out the episode, as we
mentioned, the race is close. We might not know the outcome
immediately. As you're going to be looking at the news and the
markets over Tuesday evening, into Wednesday morning. What's your
process? How closely do you follow the events? What are you going
to be focused on and what are kind of the pitfalls that you're
trying to avoid?
Maybe Vishy, I'll start with you.
Vishy Tirupattur: I think the first thing
I'd like to avoid is – do not make any market conclusions
based on the first initial set of data. This is going to be a
somewhat drawn out; maybe not as drawn out as last time around in
2020. But it is probably unlikely, but we will know the outcome
on Tuesday night as we did in 2016.
So, hurry up and wait as my colleague, Michael Zezas puts it.
Mike Wilson: And I'm going to take the
view, which I think most clients have taken over the last, you
know, really several months, which is -- price is your best
analyst, sadly. And I think a lot of people are going to do the
same thing, right? So, we're all going to watch price to see kind
of, ‘Okay, well, how was the market adjusting to the results that
we know and to the results that we don't know?’
Because that's how you trade it, right? I mean, if you get big
price swings in certain things that look like they're out of
bounds because of positioning, you gotta take advantage of that.
And vice versa. If you think that the price movement is kind of
correct with it, there's probably maybe more momentum if in fact,
the market's getting it right.
So this is what makes this so tricky – is that, you know, markets
move not just based on the outcome of events or earnings or
whatever it might be; but how positioning is. And so, the first
two or three days – you know, it's a clearing event. You
know, volatility is probably going to come down as we learn the
results, no matter who wins. And then you're going to have to
figure out, okay, where are things priced correctly? And where
are things priced incorrectly? And then I can look at my analysis
as to what I actually want to own, as opposed to trade
Andrew Sheets: That's great. And if I could
just maybe add one, one thing for my side, you know, Mike – which
you mentioned about volatility coming down. I do think that makes
a lot of sense. That's something, you know, we're going to be
watching on the credit side. If that does not happen, kind of as
expected, that would be notable. And I also think what you
mentioned about that interplay between, you know, higher yields
and higher equities on some sort of initial move – especially if
it was, a Republican sweep scenario where I think kind of the
consensus view is that might be a 'stocks up yields up' type of
type of environment. I think that will be very
interesting to watch in terms of do we start to see a different
interaction between stocks and yields as we break through some
key levels. And I think for the credit market that interaction
could certainly matter.
It's great to catch up. Hopefully we'll know a lot more about how
this all turned out pretty soon.
Vishy Tirupattur: It's great chatting with
both of you, Mike and Andrew.
Mike Wilson: 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.
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