Our Chief Global Economist Seth Carpenter and Global
Cross-Asset Strategist Serena Tang return to conclude their
two-part episode on 2026 outlooks and explain why the market
environment is turning in favor of risk assets, especially U.S.
stocks.
Read more insights from Morgan Stanley.
----- Transcript -----
Seth Carpenter: Welcome to Thoughts in 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: Yesterday, Serena, we discussed
our views on the global economy, and today I'm going to turn the
tables on you and start asking you questions about our market
outlook and how to invest across regions and across asset
classes.
It's Tuesday, November 18th at 10am in New York.
Alright, Serena in 2025, global markets rode some significant
volatility driven by tariffs, policy uncertainty. Things went up,
they went down. Equities ultimately outperformed bonds as rate
cuts began. But cross-asset strategy depended so much on
identifying correlations, opportunities – all in a world that is
still adapting to the new geopolitical dynamics and what seemed
like evolving rules.
So, with that backdrop, could you just broadly tell us what the
investment strategy should be in 2026?
Serena Tang: We think 2026 will be a strong year
for risk assets as you have unusually pro-cyclical policy mix
that's supportive of earnings. And that frees up markets to shift
the focus from global macro concerns, which of course have
dominated this year, to more micro asset specific narratives.
Particularly those related to AI CapEx investment.
And I think such a constructive environment really calls for a
risk on tilt. We recommend equities over credit and government
bonds, with a preference for U.S. assets.
Seth Carpenter: Okay. I think last year we had
some preference, at least for U.S. equities. Are there any other
big rotations versus more of the same that you really want to
highlight for folks?
Serena Tang: In terms of, I think the strategy
outlook itself, a big shift has been what we think drive investor
focus the most. Our strategy mid-year outlook had focused heavily
on global macro risks, right? Especially those, I think, emanated
from trade tensions, which you alluded to earlier.
I think this time around as the distribution of outcomes on
tariffs, I think, has become a bit narrower, it's very much more
about asset specific stories. And yes, you know, to your point
about being, bullish on U.S. equities, we've maintained that view
this time round and believe that U.S. equities can generally do
better than rest of world.
As you know, Mike Wilson, a colleague and chief U.S. equity
strategist, he has a price target of 7800 for the S&P 500
index …
Seth Carpenter: Wow.
Serena Tang: Beating the expected returns from
other regional equities by like quite a bit. So that's not
changed. But I think that with this backdrop of post cyclical
policy combo lifting U.S. earnings, we've also turned more
bullish on high-yield corporate credit – that is bonds which are
riskier.
I think very much like U.S. equities, we believe that the asset
class can benefit from the combination of monetary deregulation
policy. But there's also like a very interesting technical
component there, which is, as we expect, a surge in investment
grade issuance to fund AI related CapEx. I think the high-yield
market will be more insulated from this, which means
outperformance versus higher quality corporate bonds.
Seth Carpenter: Got it. Okay. So, as you're
coming up with these strategies and these recommendations in lots
of ways, it just relies on forecasting. And I have to say I'm
sympathetic to how hard forecasting is, especially when it comes
to the future. In our economic forecast, we also included a bunch
of different alternate scenarios because I just see that much
uncertainty in the global economy.
So, with that as a backdrop, nothing is for sure. But where would
you say your highest conviction calls are when it comes to
investing in 2026?
Serena Tang: Well, as I mentioned, we like U.S.
equities and that remains a very high conviction call for us. [I]
sort of dug through the details of that already. And so, I want
to turn to a[n]other high conviction view, which is curve
steepening. We see pretty material U.S. treasury curve steepening
over the next year. I think even as a macro strategist, actually
expect yields at least in the backend to be mostly range bound.
And this steepening will be very much driven by what happens in
the two-year point – I think as markets continue to, we think,
underpriced, future Fed easing and growth slow down tail risks.
Seth Carpenter: So that's super helpful in terms
of the places where you're convicted. Let me be perhaps a little
bit unfair because nothing is in fact certain. And so, if there
are things that we feel pretty sure about, there've got to be
things where we're either not sure or parts of the market that
really pose the most risk.
So, if I asked you then, where do you see the biggest risk for
investors in markets next year, what would you say?
Serena Tang: So, one of them really is AI
investment cycle abruptly ending. And this has been a topic of
huge debate in all of the investor meetings that we've had over
the last several weeks. Because the idea is you have a sharp
pullback in investment in the next 12 months, which could trigger
a pretty cascading effect. And of course that would likely
pressure U.S. equities, I think given hyperscalers index weight.
But could weirdly enough benefit IG credit by reducing issuance,
which has been the main driver of wider spreads in our forecast.
But I think the other risk here actually is if animal spirits run
a bit too hot. Underlying our equities over credit over rates
allocation is some revival in animal spirits, but it's not the
kind of irrational exuberance that marks the end of cycle in our
view.
Given, I think there's still rational belief in that policy
triumvirate that we touched on earlier, that can still be
supportive of risk. But you know, I think if sentiment does
overheat then our allocation tilt towards cyclicals and beta
would be wrong. And historically late cycle expansions see
investment grade outperforming high yield inequities, with bonds
eventually leading returns.
The last risk, I think, to our asset allocation, is really the
Fed. Either the FOMC not easing further over the next 12 months
or if it changes its reaction function. And I think both of those
will have very different implications of what happens to the
front end of the yield curve. So, my question to you, Seth, is
what do you see as the probability around both of those
scenarios?
Seth Carpenter: Look, with the data that we have
before the government shut down, it was clear there was a
tension. Spending by households, spending by businesses was
strong. Employment data were getting weaker and weaker, and the
Fed has decided to start cutting to err on the side of insulating
against further deterioration in the labor market.
So, one thing that could upend our forecast is that the real
signal is from the spending. Spending stays strong, the labor
market eventually catches up to the stronger spending, and we
start to see job gains come back. If that happens, especially
with inflation now running notably above the Fed's target, I just
don't really think we're going to get anywhere near the number of
rate cuts that we forecast or that are already priced into
market. So, you'd have to see a reversal.
How likely is that you can't rule it out? I'd say 20 percent or
something like that. Maybe a little bit more. On the other hand,
to the downside. I wonder if what you're getting at a little bit
is there's going to be some turnover in the personnel at the Fed.
And do we have to worry about a fundamentally different reaction
function from the Fed going forward and cutting rates
aggressively, even if the macro considerations don't warrant? Is
that really what you were getting at?
Serena Tang: Yes. I think that has been the
question on the forefront of investors' minds…
Seth Carpenter: Yeah, I think that's a real
question. The way I look at it is Chair Powell is in charge of
the Fed now. His term goes through May of next year. And so,
until we get to the middle of next year, I don't really think
there's any fundamental change in how the Fed does business. But
it really does seem like we're going to have a new Fed chair in
June of next year. But even there, we have got to remember that
the committee is a committee and that's how policy is decided.
And so, if there was a new chair who really, really, really
wanted to take policy in a truly unorthodox way, I also don't
think that's really feasible over the second half of next year –
because there just won't have been that much turnover in terms of
the personnel of the Fed. That's how we're looking at it for now.
I really don't think that latter version of the world is a big
risk. That said, I'm going to throw it back to you [be]cause I
always have to get the last word.
You talked about asset classes, bullish on U.S. equities. We
talked about high yield bonds; we talked about some of the risks
that markets have to face. But one thing I didn't hear – and we
do have a global investor base – Is about currencies and
specifically the dollar.
So, this time last year, the team made a pretty bold call that
the dollar would depreciate a great deal. And here we are and the
dollar has come off a lot on net over this year. That stabilized
a little bit. Maybe not for the whole year [be]cause that kind of
forecasting is hard for currencies. But what do you see over the
next few months called the next half year for the dollar? Is it
going to continue the trend or do you think we should see a
reversal?
Serena Tang: So, we do think the dollar will
continue its trend downwards from here to the middle of next
year. And I know, I know. There's been a lot of discussion,
there's been a lot of debate around whether the dollar has
basically stopped where we are. But the thing is, you know, going
back to what you mentioned around the path for growth in the U.S.
and unemployment in the U.S. – if we do see softer economic data
in the first half of next year, that can drive the dollar
downwards. In fact, we're once again, more bearish than consensus
on the dollar by the middle of next year.
Seth Carpenter: Got it. All right. That's super
helpful. Serena, thank you so much for taking the time to talk
with me today and let me ask the questions of you.
Serena Tang: Always a pleasure, Seth.
Seth Carpenter: And thank you 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 a
colleague today.
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