Original Release Date: December 3, 2025
Our Global Head of Fixed Income Research and Public Policy
Strategy Michael Zezas and Chief Global Cross-Asset Strategist
Serena Tang address themes that are key for markets next year.
Read more insights from Morgan Stanley.
----- Transcript -----
Michael Zezas: Welcome to Thoughts on the
Market. I'm Michael Zezas, Global Head of Fixed Income Research
and Public Policy Strategy.
Serena Tang: And I'm Serena Tang, Morgan
Stanley's Chief Global Cross-Asset Strategist.
Michael Zezas: Today we'll be talking about
key investor debates coming out of our year ahead outlook.
It's Wednesday, December 3rd at 10:30am in New York.
So, Serena, it was a couple weeks ago that you led the
publication of our cross-asset outlook for 2026. And so, you've
been engaging with clients over the past few weeks about our
views – where they differ. And it seems there's some common
themes, really common questions that come up that represent some
important debates within the market.
Is that fair?
Serena Tang: Yeah, that's very fair. And,
by the way, I think those important debates, are from investors
globally. So, you have investors in Europe, Asia, Australia,
North America, all kind of wanting to understand our views on AI,
on equity valuations, on the dollar.
Michael Zezas: So, let's start with talking
about equity markets a bit. And one of the common questions – and
I get it too, even though I don't cover equity markets – is
really about how AI is affecting valuations. One of the concerns
is that the stock market might be too high, might be overvalued
because people have overinvested in anything related to AI. What
does the evidence say? How are you addressing that question?
Serena Tang: It is interesting you say that
because I think when investors talk about equities being too
high, of valuations – AI related valuations being very stretched,
it's very much about parallels to that 1990s valuation bubble.
But the way I approach it is like there are some very important
differences from that time period, from valuations back then.
First of all, I think companies in major equity indices are
higher quality than the past. They operate more efficiently. They
deliver strong profitability, and in general pretty solid free
cash flow.
I think we also need to consider how technology now represents a
larger share of the index, which has helped push overall net
margins to about 14 percent compared to 8 percent during that
1990s valuation bubble. And you know, when margins are higher, I
think paying premium for stocks is more justified.
In other words, I think multiples in the U.S. right now look more
reasonable after adjusting for profit margins and changes in
index composition. But we also have to consider, and this is
something that we stress in our outlook, the policy backdrop is
unusually favorable, right? Like you have economists expecting
the Fed to continue easing rates into next year. We have the One
Big Beautiful Bill Act that could lower corporate taxes, and
deregulation is continuing to be a priority in the U.S.
And I think this combination, you know, monetary easing, fiscal
stimulus, deregulation. That combination rarely occurs outside of
a recession. And I think this creates an environment that
supports valuation, which is by the way why we recommend an
overweight position in U.S. equities, even if absolute and
relative valuation look elevated.
Michael Zezas: Got it. So, if I'm hearing
you right, what I think you're saying is that comparisons to some
bubbles of the past don't necessarily stack up because
profitability is better. There aren't excesses in the system.
Monetary policy might be on the path that's more accommodative.
And so, when compared against all of that, the valuations
actually don't look that bad.
Serena Tang: Exactly.
Michael Zezas: Got it. And sticking with
the equity markets, then another common question is – it's
related to AI, but it's sort of around this idea that a small set
of companies have really been driving most of the growth in the
market recently. And it would be better or healthier if the
equity market were to perform across a wider set of companies and
names, particularly in mid- and small cap companies. Is that
something that we see on the horizon?
Serena Tang: Yes. We are expecting U.S.
stock earnings to sort of broaden out here and it's one of the
reasons why our U.S. equity strategy team has upgraded small caps
and now prefer it over large caps. And I think like all of this –
it comes from the fact that we are in a new bull market. I think
we have a very early cycle earnings recovery here. I mean, as
discussed before, the macro environment is supportive. And Fed
rate cuts over the next 12 months, growth positive tax and
regulatory policies, they don't just support valuations. They
also act as a tailwind to earnings.
And I think like on top of that, leaner cost structures,
improving earnings revisions, AI driven efficiency gains. They
all support a broad-based earnings upturn. and our U.S. equity
strategy team do see above consensus 2026 earnings growth at 17
percent. The only other region where we have earnings growth
above consensus in 2026 is Japan; for both Europe and the EM we
are below, which drive out equal weight and slight underweight
position in those two indices respectively.
Michael Zezas: Got it. And so, since we
can't seem to get away from talking about AI and how it's
influencing markets, the other common question we get here is
around debt issuance related to AI.
So, our colleagues put together a report from earlier this year
talking about the potential for nearly $3 trillion of AI related
CapEx spending over the next few years. And we think about half
of that is going to have to be debt financed. That seems to be a
lot of debt, a lot of potential bonds that might be issued into
the market – which, are credit investors supposed to be concerned
about that?
Serena Tang: We really can't get away from
AI as a topic. And I think this will continue because AI-related
CapEx is a long-term trend, with much of the CapEx still really
ahead. And I think this goes to your question. Because this
really means that we expect nearly another [$]3 trillion of data
center related CapEx from here to 2028. You know, while half of
the spend will come from operating cash flows of hyperscalers, it
still leaves a financing gap of around [$]1.5 trillion, which
needs to be sourced through various credit channels.
Now, part of it will be via private credit, part of it would be
via Asset Backed Securities. But some of it would also be via the
U.S. investment grade corporate credit bond space. So, add in
financing for faster M&A cycle, we forecast around [$]1
trillion in net investment grade bond issuance, you know, up 60
percent from this year.
And I think given this technical backdrop, even though credit
fundamentals should stay fine, we have doubled downgraded U.S.
investment grade corporate credit to underweight within our cross
asset allocation.
Michael Zezas: Okay, so the fundamentals
are fine, but it's just a lot of debt to consume over the next
year. And so somewhat strangely, you might expect high yield
corporate bonds actually do better.
Serena Tang: Yes, because I think a high
yield doesn't really see the same headwind from the technical
side of things. And on the fundamentals front, our credit team
actually has default rates coming down over the next 12 months,
which again, I think supports high yield much better than
investment grade.
Michael Zezas: So, before we wrap up,
moving away from the equity markets, let's talk about foreign
exchange. The U.S. dollar spent much of last year weakening, and
that's a call that our team was early to – eventually became a
consensus call. It was premised on the idea that the U.S. was
going to experience growth weakness, that there would also be
these questions among investors about the role of the dollar in
the world as the U.S. was raising trade barriers. It seemed to
work out pretty well.
Going into 2026 though, I think there's some more questions
amongst our investors about whether or not that trend could
continue. Where do we land?
Serena Tang: I think in the first half of
next year that downward pressure on the dollar should still
persist. And you know, as you said, we've had a very
differentiated view for most of this year, expecting the dollar
to weaken in the first half versus G10 currencies. And several
things drive this. There is a potential for higher dollar
negative risk premium, driven by, I think, near term worries
about the U.S. labor markets in the short term. And as investors,
I think, debate the likely composition of the FOMC next year.
Also, you know, compression in U.S. versus rest of the world.
Rate differentials should reduce FX hedging costs, which also
adds incentive for hedging activity and dollar selling.
All this means that we see downward pressure on the dollar
persisting in the first half of next year with EUR/USD at 123 and
USD/JPY at 140 by the end of first half 2026.
Michael Zezas: All right. Well, that's a
pretty good survey about what clients care about and what our
view is. So, Serena, thanks for taking the time to talk with me
today.
Serena Tang: And thank you for inviting me
to the show today.
Michael Zezas: And to our audience, thanks
for listening. If you enjoy Thoughts on the Market, please leave
us a review and share the podcast. We want everyone to listen.
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