Morgan Stanley’s midyear outlook defied the conventional view in
a number of ways. Our analysts Serena Tang and Vishy Tirupattur
push back on the pushback to their conclusions, explaining the
thought process behind their research.
Read more insights from Morgan Stanley.
----- Transcript -----
Serena Tang: Welcome to Thoughts on the
Market. I'm Serena Tang, Morgan Stanley's Chief Cross-Asset
Strategist
Vishy Tirupattur: And I'm Vishy Tirupattur,
Morgan Stanley's Chief Fixed Income Strategist.
Serena Tang: Today's topic, pushback to our
outlook.
It's Friday, June 6th at 10am in New York.
Morgan Stanley Research published our mid-year outlook about two
weeks ago, a collaborative effort across the department, bringing
together our economist views with our strategist high conviction
ideas. Right now, we're recommending investors to be overweight
in U.S. equities, overweight in core fixed income like U.S.
treasuries, like U.S. IG corporate credit. But some of our views
are out of consensus.
So, I want to talk to you, Vishy, about pushback that you've been
getting and how we pushback on the pushback.
Vishy Tirupattur: Right. So, the biggest
pushback I've gotten is a bit of a dissonance between our
economics narrative and our markets narrative. Our economics
narrative, as you know, calls for a significant weakening of
economic growth. From about – for the U.S. – 2.5 percent growth
in 2024 goes into 1 percent in 2025 and in 2026. And Fed doesn't
cut rates in 2025, and cuts seven times in 2026.
And if you look at a somewhat uninspiring outlook for the U.S.
economy from our economists – reconciling an uninspiring economic
outlook on the U.S. economy with the constructive view we have on
U.S. assets, equities, credit, treasuries – that's been a source
of contention.
So how do we reconcile this? So, my pushback to the pushback is
the following; that they are different plot lines across
different asset classes. So, our economists have slowing of the
economy – but not an outright recession. Our economists don't
have rate cuts in 2025 but have seven rate cuts in 2026.
So, if you look at the total number of rate cuts that are being
priced in by the markets today, roughly about two rate cuts in
[20]25, and about between two and three rate cuts in 2026, we
expect greater policy easing than what's currently priced in the
markets. So that makes sense for our constructive view on
interest rates, and in government bonds and in duration that
makes sense.
From a credit point of view, we enter this point with a much
better credit fundamentals in leverage and coverage terms. We
have the emergence of a total yield-based buyer base, which we
think will be largely intact at our expectations, and you layer
on top of that – the idea that growth slows but doesn't fall into
recession is also constructive for higher quality credit. So that
explains our credit view.
From an equities view, the drawdowns that we experienced in
April, our equity strategists think marks
the worst outcomes from a policy point of view that we could have
had. That has already happened. So looking forward, they look for
EPS growth over the course of the next 12 months. They look for
benefits of deregulation to kick in. So, along with that seven
rate cuts, get them to be comfortable in being constructive about
their views on equities. So all of that ties together.
Serena Tang: And I think what you mentioned
around macro not being the markets is important here. Because
when we did some analysis on historical periods where you had low
growth and low inflation, actually in that kind of a scenario
equities did fine. And corporate credit did fine. But also, in an
environment where you have rather unencouraging growth, that
tends to map onto a slightly risk-off scenario. And historically
that's also a kind of backdrop where you see the dollar
strengthen.
This time out, we have a very out of consensus view; not that the
dollar will weaken, that seems quite consensus. But the degree of
magnitude of dollar weakening. Where have you been getting the
most pushback on our expectations for the dollar to depreciate by
around 9 percent from here?
Vishy Tirupattur: So, the dollar weakness
in itself is not out of consensus, largely driven by narrowing of
free differentials; growth differentials. I think some of the
difference between the extent of weakness that we are projecting
comes from the assessment on the policy and certainty. So, the
policy uncertainty adds a greater degree of risk premia for
taking on U.S. assets.
So, in our forecast, we take into account not only the
differentials in rates and growth, but also in the policy
uncertainty and the risk premia that the investors would demand
in the face of that kind of policy uncertainty. And that really
explains why we are probably more negative on the outcome for
U.S. dollar than perhaps our competition.
Serena Tang: The risk premium part, I think
bring us to one of the biggest debates we've been having with
investors over, not just the last few weeks, but over the last
few months. And that is on U.S. exceptionalism. Now clearly, we
have a view that U.S. assets can outperform over the next six to
12 months, but why aren't we factoring in higher risk premium for
holding any kind of U.S. assets? Why should U.S. assets still do
well?
Vishy Tirupattur: So, as I said earlier, we
are calling for the economy to slow without tipping into
recession. We are also calling for greater amount of policy
easing than what is currently priced in the markets. Both those
factors are constructive.
So, I think we also should keep in mind the sheer size of the
U.S. markets. The U.S. government bond markets, for example,
are 10 times the size of comparably rated European bond markets,
government bond markets put together. The U.S. equity markets is
four-five times the size of the European equity markets. Same
thing for investment grade corporate credit bonds. The market is
many, many times larger.
So, the sheer size of the U.S. assets makes it very difficult for
a globally diversified portfolio to substantially under-allocate
to U.S. assets. So, what we are suggesting, therefore, is that
allocate to U.S. assets, where there are all these opportunities
we described. But if you are not a U.S. investor, hedge the
currency risk. Not hedging currency risk had worked in the past,
but we are now saying hedge your currency risk.
Serena Tang: And the market size and
liquidity point is interesting. I think after the outlook was
published, we had a lot of questions on this. And I think it's
underappreciated, how about, sort of, 60 percent of liquid, high
quality fixed income paper is actually denominated in U.S.
dollars. So, at the end of the day, or at least over the next six
to 12 months, it does seem like there is no alternative.
Now Vishy, we've talked a lot about where we are getting
pushback. I think that one part of the outlook where – very
little discussed because very highly consensus – is credit. And
the consensus is credit is boring. So how do you see corporate
credit, and maybe securitized credit, fit into the wider
allocation views on fixed income?
Vishy Tirupattur: Boring is good for a
fixed income investor perspective, Serena. Our expectation of
rate cuts, slowing growth but not going tipping into recession,
and our idea that these spreads are really not going very far
from where they are now, gets us to a total return of about over
10 percent for investment related corporate credit.
And that actually is a pretty good outcome for credit investors.
For fixed income investors in general that calls for continued
allocations to high quality credit, in corporate credit as well
as in securitized credit.
Serena Tang: So just to sum up, Morgan
Stanley Research has very differentiated view this time around on
how many times the Fed can cut, which is a lot more than what
markets are pricing in at the moment, how much yields can fall,
and also how much weakening in the U.S. dollar that we can get.
We are recommending investors to be overweight U.S. equities and
overweight U.S. core fixed income like U.S. treasuries and like
U.S. IG corporate credits. And as much as we're not arguing
[that] U.S. exceptionalism can continue on forever, over the next
six to 12 months, we are constructive on U.S. assets.
That is not to say policy uncertainty won't still create bouts of
volatility over the next 12 months. But it does mean that during
those scenarios, you want to sell U.S. dollars rather than U.S.
assets.
Vishy, thank you so much for taking the time to talk.
Vishy Tirupattur: Great speaking with you,
Serena.
Serena Tang: And for those tuned in, 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.
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