Our Global Cross-Asset Strategist and Global Chief Economist
discuss the state of asset markets at the midway point of 2024,
and why the current backdrop suggests positive directions for
several key markets.
----- Transcript -----
Seth Carpenter: Welcome to Thoughts on the
Market. I'm Seth Carpenter, Morgan Stanley's Global Chief
Economist.
Serena Tang: And I'm Serena Tang, Morgan
Stanley's Chief Global Cross Asset Strategist.
Seth Carpenter: And yesterday, Serena, you
and I discussed Morgan Stanley's global economic mid-year
outlook. And today, I'm going to turn the tables on you, and
we'll talk about asset markets.
It's Tuesday, May 21st, at 10am in New York.
Okay, so yesterday we talked about all sorts of different parts
of the macro environment. Disinflation, inflation, central bank
policy, growth. But when you think about all of that -- that
macro backdrop -- what does it mean to you for markets across the
world?
Serena Tang: Right, I think the outlook
laid out by your team of stable growth, disinflation, rate cuts.
That is a great backdrop for risk assets, one of the reasons why
we got overweight in global equities. Now, there will likely be
low visibility and uncertainty beyond year end, and why we
recommend investors should focus on the triple C's of cheap
optionality, convexity, and carry.
That very benign backdrop suggests more bullish possibilities.
Your team has noted several times now that the patterns we're
seeing now and what we expect have parallels to what happened in
the mid 1990s -- when the Fed cut in small increments, US growth
was sustained at high levels, and the labor market was strong.
And now I'm not suggesting that this is 1990s and we should party
like it. But just that the last time we found ourselves in this
kind of benign macro environment, risk assets -- actually most
markets did really well.
Seth Carpenter: So, I will say the 1990s
was a pretty good decade for me. However, you mentioned some
uncertainty ahead, low visibility. We titled
our macroeconomic outlook ‘Are we there yet?’ Because I
agree, we do feel like we're on a path to something pretty good,
but we're not out of the woods yet. So, when you say there's some
low visibility about where asset markets are going, maybe beyond
year end, what do you mean by that?
Serena Tang: I think there's less
visibility going into 2025. And specifically, I'm talking about
the US elections. When I think about the range of possible
outcomes, all I can confidently say is that it's wide, which I
think you can see reflected in our strategist's latest forecast.
Most teams actually have relatively constructive forecast returns
for their assets in the base case, but there's an unusually wide
gap between their bull and bear cases for bond and equity
markets.
Seth Carpenter: Let me narrow it down a
little bit because equity markets have actually performed pretty
well during the first half of the year. So what do you think is
going to happen specifically with equities going forward? How
should we be thinking about equity markets per se?
Serena Tang: Equities have rallied a lot,
but we've actually gotten more bullish. I talked about the three
Cs of cheap optionality, convexity, and carry earlier, and I
think European and Japanese equities really tick these boxes.
Both of these markets also have above average dividend yields,
especially for a dollar-based FX hedge investor.
Serena Tang: Where we think there might be
some underperformance is really in EM equities, but it's a bit
nuanced. Our China equity strategy team thinks that consensus
mid-teens earnings growth expectation for this year will still
likely to disappoint given the Chinese growth forecast that you
talked about yesterday.
Seth Carpenter: Alright, in that case. Let
me flip over to fixed income. A lot of that is often driven by
central banks. Around the world, you just mentioned
EM equities may be struggling a little bit. A lot of EM
central banks are either cutting a little bit ahead of the Fed,
but being cautious, worrying about not getting too far ahead of
the Fed. So, if that's what's going on with policy rates at the
very front end of the curve, what's happening in fixed income
more broadly?
Serena Tang: We generally see government
bond yields lower over the forecast horizon for two reasons. On
your team's forecast of central banks cutting rates and also in
the US, an optical rise in the unemployment rate, our macro
strategy team forecasts for the 10 year U.S. Treasury yields to
fall to just above 4 per cent by the end of this year. And
because government bond yields will be coming down, we also
expect yields for spread products like agency MBS, investment
grade, etc. to also come down. But I think for these spread
products, returns can be positive beyond that duration piece.
Serena Tang: So, credit loves moderation,
and I think the mild growth backdrop your team is forecasting for
is exactly that. US fixed income more generally should also see
renewed flows from Japanese investors as FX hedging costs come
down over the next six months. All of this supports tighter than
average spreads.
Seth Carpenter: Okay, so we talked about
equities, we talked about fixed income. Big asset class that we
haven't talked about yet are commodities. How bullish are you
going into the summer? What do you think is going to go on and
can that bullish view that you guys have last even longer?
Serena Tang: So for crude oil, our
strategists see market tightness over the summer, which could
drive Brent to about $90 per barrel. You have demand coming in
stronger than expected, and of course OPEC has extended its
production agreement.
But we also don't really expect prices to hold over the medium
term. Non-OPEC supply should meet most of the global demand
growth later this year and into 2025, which sort of leaves very
little room for OPEC to unwind production cuts. We expect Brent
to revert back steadily to its long-term anchor, which is
probably somewhere around $80 per barrel.
Serena Tang: For copper, it’s actually our
metal strategist's top pick right now, and it's very much driven
by, I think, tightening supply and demand balance. You've had
significant mine supply disruptions, but also better than
expected demand and new drivers such as -- we've talked about AI
a lot, data centers and increasing participation.
Serena Tang: And on gold, in our
view, pricing is likely to remain pretty choppy as investors
have to weigh inflation risk, incoming data, and the Fed path.
But historically, that first rate cut tends to be a very positive
catalyst for gold. And we see risks more skewed to our bull case
at the moment.
Seth Carpenter: Okay, so talked about
equities, talked about fixed income, talked about commodities.
These are global markets, and often when investors are looking
around the world and thinking about what it means for them,
currencies come into it, and everybody's always going to be
looking at the dollar. So why don't you run us through the Morgan
Stanley view on where the US dollar is going to go over the rest
of this year, and maybe over the next 12 months.
Serena Tang: The short answer is we see the
dollar staying stronger for longer. Yes, we expect central banks
to begin cutting this year. But the pace of cuts and ultimate
destinations are likely to vary widely. Now another potential
dollar tailwind is an increased risk premium being priced for the
2024 US elections. We think that investors may begin to price in
material risks to dollar positive changes in US foreign and trade
policy as the election approaches, which we assume will sort of
begin ramping up in the third quarter.
Seth Carpenter: All right, let's step back
from the details. I want you to bring us home now. Give me some
strategy. So where should people lean in, where should we be
looking for the best returns and where do we need to be super
cautious?
Serena Tang: In our asset allocation
recommendation, we recommend overweight in global equities,
overweight in spread products, equal weight in commodities, and
underweight in cash.
We really like European and Japanese equities on the back of
pretty strong earnings revision, attractive relative valuations,
and good carry for a dollar based investor. We like spread
products. Not so much that our strategists are not expecting
duration to do well. We are still expecting yields to come down.
Serena Tang: Where we are
most cautious on, really, continues to be EM equities.
From a very top down perspective, the outlook we have is
constructive stable growth, continued disinflation, rate cuts.
These make for a good environment for risk assets. But
uncertainties beyond year end, that really argues for investors
to look for assets which have those triple Cs, cheap optionality,
convexity, and carry.
And we think Japanese and European equities and spread products
within fixed income take those boxes.
Seth Carpenter: Alright, looking at the
clock, I'm going to have to cut you off there. I could talk to
you all day. Thank you for coming in and letting me turn the
tables relative to yesterday when you were asking me all the
questions.
Serena Tang: Great speaking with you, Seth.
And yes, I know we can go on forever.
Seth Carpenter: And thank you for
listening. If you enjoy Thoughts on the Market, please leave us a
review wherever you get your podcasts. And share this episode
with a friend or a colleague today.
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