Thoughts on the Market

Morgan Stanley

Short, thoughtful and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

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#1752
Friday · 4 min
AI Boom Faces a Higher-Yield Roadblock
Our ABS Strategist Carolyn Campbell explains how rising borrowing costs are slowing the AI data center boom and what could drive a rebound in financing. Read more insights from Morgan Stanley. ----- Transcript ----- Carolyn Campbell: Welcome to Thoughts on the Market. I'm Carolyn Campbell, Morgan Stanley's Asset-Backed Securities Strategist. Today, why the AI boom is running into an unexpected obstacle: the cost of borrowing money. It's Friday, October 16th, at 10am in New York. Demand for data center facilities is booming. Yet even as companies race to build more capacity, the financing for them is becoming increasingly expensive. And that tension is creating an interesting story in credit markets. Since January, five-year Treasury rates have climbed more than one percentage point, and spreads for data center assets have also gone wider. At the beginning of 2026, the highest-rated data center bonds offered yields below 5 percent. Today, similar bonds are yielding closer to 7 percent, and that increase matters enormously for companies trying to finance multi-billion-dollar facilities. Many operators turn to the securitized credit markets to raise money. Essentially, they issue bonds backed by the income generated by their data centers. By the time these bonds are issued, construction on the data center is complete, the power is secured, and the rent is already being paid. So, on the one hand, cash flows are stabilized – but there is a catch. These facilities often sign long-term leases well before they seek financing in the securitized credit market. By the time they're ready to issue these bonds, rental income is already locked in. And so, when interest rates rise quickly, as we've seen this year, and these borrowing costs increase, revenues aren't necessarily keeping pace. Our analysis suggests that when borrowing costs approach 8 percent, issuing these bonds becomes significantly more challenging under these current financing terms. And we're already seeing the effects in the market. So far in 2026, data center operators have issued around [$] 15 billion in ABS and another [$] 7 billion in the CMBS markets. That's roughly in line with last year's pace, but it's below what we'd expect given the extraordinary growth in data center demand this year. Still, we believe the slowdown in supply is temporary. Our forecast suggests that U.S. data center power capacity could grow from roughly 60 gigawatts today to 150 gigawatts by 2028; although there are some constraints on power availability that could leave capacity 30 percent to 40 percent below these projections. Regardless, much of the lease capacity that comes online will require debt financing, and these operators have ambitious growth plans. So, they have some options to navigate these higher rate environments. They might borrow less against their properties. They might accept lower investment returns in the near term. Or they can turn to different credit channels that offer more flexible financing structures. So, where does this leave the market? To take into account the higher rate environment, we've lowered our forecast slightly for 2026 and 2027 for securitized credit data center issuance. But the amount of lease capacity that's set to come online in 2028 is so high that we've actually held those numbers steady. All told, we now expect around a [$] 120 to a [$] 150 billion of supply over the next couple of years. That's substantial financing activity, even with the higher interest rates creating near-term challenges. The higher cost of borrowing may slow the pace of data center financing for now, but the scale of the build-out ahead suggests that this market still has plenty of room to grow. And there are pockets within the market that we do like. We've talked a lot about the hyperscaler data centers, which are big campuses leased to one or two hyperscaler tenants, often with 10- or 15-year leases. But the other part of the market, the colocation data center market, is where we see a lot of value today. These campuses have many different types of tenants, many different industries represented, and they often have shorter leases. Given the sharp increase in data center rental rates and vacancy rates around 1 percent, these data center operators are more quickly able to monetize the changes that we're seeing in the industry. That flexibility could prove particularly valuable when borrowing costs remain elevated. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1751
Thursday · 4 min
The Missing Piece in Latin America’s Bull Case
Our Chief Latin America Equity Strategist Nikolaj Lippmann explains why Brazil’s election, the cost of capital, AI investment and geopolitics could help unlock a new era of growth across Latin America. Read more insights from Morgan Stanley. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Nikolaj Lippmann, Morgan Stanley's Chief Latin America Equity Strategist. Today – why Brazil could be the missing piece of what we call LatAm Spring, and what AI has to do with it. It’s Thursday, October 15th, at 10am in New York. Brazilian equities rallied sharply last week after a surprising first-round presidential election result. Flávio Bolsonaro finished ahead of President Lula, setting up a runoff later this month. The outcome remains uncertain. But for investors, I think there’s a bigger question. Can Brazil approach a policy shift that unlocks something the country has lacked for years: investment. We've long argued that Latin America is moving from a consumption-led economy towards an investment-led cycle, thanks to: 1. Changing geopolitics; 2. investment-friendly policies; and 3. The potential for lower interest rates. What's more, this fits into the framework of the AI CapEx cycle, driving the global and especially the U.S. economy that has moved from consumption to CapEx, as argued by Mike Gapen, our U.S. economist. We're already seeing signs of this LatAm Spring in Argentina, Chile, Peru and Colombia. Brazil could be the largest missing piece. And there are three reasons why. First, the cost of capital. Brazil remains one of the world's most expensive places to invest. High government debt and elevated interest rates have made fixed income investment more attractive than equities or entrepreneurial risk-taking. But credible fiscal reform could change that equation. Lower government spending could reduce borrowing costs, strengthen the currency, and encourage private investment. Which means capital could shift from sitting in fixed-income assets toward funding growth. Second, AI. AI might seem unrelated to Brazilian politics, but we see an important connection. Our global framework suggests that annual capital spending could rise from roughly $2.5 trillion to about $5 trillion - $6 trillion as companies build out global AI infrastructure. And Latin America has a critical role to play. Data centers need electricity. Electricity requires energy infrastructure. And the infrastructure requires copper, lithium, and other critical minerals. Latin America as a whole supplies roughly 10 percent of the world's energy, holds about 20 percent of global energy reserves, about 30 percent of global copper, and approximately 60 percent of the world's lithium resources. So, we've argued that Brazil and Argentina look increasingly like Texas, with exports of energy and of agriculture. And one other area around politics where Brazilians could perhaps learn or be inspired from peer Latin American countries and gather some inspiration from Texas could be around deregulation. For Brazil, lower interest rates and greater policy credibility could make participating in this investment boom considerably easier. And that brings me to the third factor: geopolitics. Brazil has strengthened its economic ties with the East, while remaining deeply connected to Western capital markets and U.S. technology. A more balanced relationship could improve access to capital markets and support long-term investments. Of course, an election result alone doesn't guarantee change. Fiscal discipline, policy execution, and global financing conditions remain critical. Higher U.S. Treasury yields are an especially important risk for a region carrying substantial debt. But consider what's already happening elsewhere. Mexico contributes hardware to the AI supply chain. Chile is rebuilding its investment pipeline. And Peru is benefiting from mining activity. Argentina is attracting capital after significant policy changes. As Latin America's largest economy, Brazil could have substantial regional implications if it moves in the same direction. That's ultimately our LatAm Spring thesis: a shift away from consumption toward investment, entrepreneurship, and capital formation. There's still a long road ahead, but Brazil could be the most important test of whether that spring truly takes hold. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen to podcasts and share Thoughts on the Market with a friend or colleague today.
#1750
Wednesday · 8 min
What to Expect From the UK Budget
The UK budget arrives later this month amid competing predictions about growth, inflation and public finances. Andrew Sheets and Bruna Skarica examine how the country’s economy defies expectations. Read more insights from Morgan Stanley. ----- Transcript ----- Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Bruna Skarica: And I'm Bruna Skarica, Morgan Stanley's Chief UK Economist. Andrew Sheets: Today, the UK makes a budget. Why it matters? And more generally, what we've gotten right and wrong about the country. It's Wednesday, October 14th, at 2pm in London. Bruna, it's great to be here talking with you, and I'd like to get into a bigger discussion on the UK and what we've gotten right and wrong about the direction of the country this year. But more immediately, it has a very big event coming up. What is the budget, and why is there so much focus on it? Bruna Skarica: The budget is the UK's key fiscal event. It is the time of year when the Chancellor receives a refresh of economic forecasts and decides whether he needs to respond to these, whether there's any spending cuts or increases that are required, and whether there's any tax hikes or potentially tax cuts that are required too. All with the view of ensuring fiscal consolidation and executing on what is a self-imposed fiscal framework. Here in the UK, the main target for the Treasury is to achieve current budget balance in year three of the forecast. The fiscal watchdog forecasts five years of economic variables, and the idea is, by the third year, we ought to be spending outside of investment expenditure as much as we're receiving in tax receipts. So, all of that happens once a year in the budget. Andrew Sheets: Now, I might just stop you there [be]cause in the context of these other budget pictures that we see around the world – the U.S. is running a large budget deficit, France is running a large budget deficit, Japan's increasing its budget deficit. That actually seems like a quite ambitious goal within the next three years; to balance that outside of the interest expenses. Can you just talk maybe a little bit more about that process and the thinking behind it? Bruna Skarica: Yeah, sure. The idea really is to ensure that over the next five years, not only do we get the current budget balanced while allowing for borrowing for investment, which is, of course, a favorable way to borrow because it boosts growth. But also, that within the five-year period, we're able to get debt-to-GDP ratio down. In order for that to happen, we need to be running a primary surplus around 1.5 percent of GDP. Now, very often in UK macro, we tend to look at three-year forecasts, five-year forecasts. We talk about medium-term headrooms. But I think it's important here to take stock of where we are at this moment in time. We think that in this fiscal year, [20]26-[20]27, primary deficit – our entire expenditure outside debt servicing costs minus tax receipts – we see that at just under 1 percent of GDP. The IMF is a little bit above 1 percent of GDP for UK. But for example, the IMF sees French primary deficit at 2.9 percent this year, with the U.S. measure forecast at 4.9 percent. So already, UK has actually made a lot of progress in its consolidation path. Andrew Sheets: And Bruna, talking about this announcement specifically, could you maybe talk about just one or two items that you'd be on the watch for as potential surprises? Or decisions that the market is really focused on? Bruna Skarica: Sure. So, we do know that the Treasury is looking at ways of alleviating some of the pressures stemming from higher inflation, higher energy inflation in particular. So, the scale of support that will be provided to households and the scale of reduction in headline inflation, I do think will be in focus on the day. We're expecting a relatively low-key budget, so the scale of measures at around £10 billion, which is much more moderate than what we saw in October 2024 and in November 2025. However, we do think there is scope for some, let's say, higher level announcements. For example, Prime Minister Burnham is particularly focused on devolution in the UK, decentralization. And there might be a roadmap ahead for how different mayors and different regions in the UK get to keep their portion of income tax revenues and what they might do with it in order to boost regional growth. UK does stand out as the country in G7 space that has the most centralized fiscal system, and this might start to be changed from this fiscal event onwards. Andrew Sheets: Okay, so now I'd like to take a step back and do a little marking to market. You know, you and I on this program, a couple of different times this year, have been talking about the UK, and those conversations have generally been upbeat. I think both of us were of the view that the UK could actually be a bit better of a story than expected. And maybe we start with the good news. What do you think has been going right? Bruna Skarica: So, for one, growth has outperformed in the first half of the year. In line with our long-standing thesis that UK ought to be a beneficiary of the global AI boom, the main driver of the upside surprise has been the tech sector. It's running at 8 percent year-on-year, this year. We have also seen a bit stronger consumer spending growth than anticipated. And again, this reflects, we think, our long-standing thesis on fairly clean household. But also corporate balance sheets, I should mention, that tend to provide a fairly big buffer in one of energy shocks. UK consumers have elevated savings, also elevated savings stocks, and so in energy shocks such as the one we've seen in the first half of the year, perhaps there is some reduction in desired level of savings, which allows consumers to support their spending habits. All of this means that this year we see UK growth at 1.3 percent. Now, our U.S. colleagues are looking for 2.3 percent. Still, U.S. growth looks relatively stronger than any European country, including the UK. However, I would say that 1.3 percent is about 30 basis points higher than where we were a couple of months ago when the energy shock started, so it is important to take that into account. Andrew Sheets: And I'd also note that UK stocks are up about 10 percent this year, and its currency, the pound, is materially outperformed the euro or the Japanese yen. But Bruna, I think it's pretty safe to say that sentiment towards the UK feels pretty downbeat. I think it's probably gotten worse as the year has gone on. So, what's gone wrong and what's been worse than we were expecting? Bruna Skarica: Yeah. So, while I do think that in the U.S. there is a lot of focus on the benefits from the AI boom and the AI build-out, in Europe, we're still waiting to see the sentiment shift towards how much growth and potential growth in particular can benefit from adopting AI. We're more constructive, I would say, than probably the average forecaster here. We're pointing to healthy productivity growth performance in the UK private sector, printing productivity growth at 1.8 percent; whereas in the U.S. this figure is a bit above 2 percent over the second quarter this year. So, not too different, I would say. So, I think the pessimism around potential GDP growth is really what's driving the view that whenever an external energy shock tends to hit, such as the one we've seen this year with higher oil and natural gas prices, it'll be embedded in the economy for a longer period of time. Because ultimately a spare capacity is very tight. And so businesses and consumers will try and preserve their real purchasing power, and inflation will remain elevated for a longer period of time. Again, we tend to be a bit more constructive on this. We think the economy has enough spare capacity for this energy shock to come and go without material adjustments in the bank rate. We're expecting two hikes. But the market is still pricing four hikes. And certainly in conversations with investors, we are more and more talking about the scenarios in which these could be delivered. So that, of course, means higher gilt yields, which means higher debt servicing costs, and that overall, I do think tends to dampen sentiment. Andrew Sheets: Well, Bruna, a lot to watch in the days and weeks ahead. And thank you so much for taking the time. Bruna Skarica: Thank you, Andrew. Andrew Sheets: And thank you as always for listening. If you find Thoughts on the Market useful, let us know by leaving a review wherever you hear us. And also tell a friend or colleague about us today.
#1749
Tuesday · 4 min
Asia Fixed Income Needs a Bigger Map
Our Head of Asia Credit Strategy Kelvin Pang explains why investors would benefit from a broader fixed income market in Asia, with opportunities across more countries, local-currency credit and dollar-denominated bonds. Read more insights from Morgan Stanley. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Kelvin Pang, Head of Asia Credit Strategy [at] Morgan Stanley. Today – why the challenge in Asia fixed income may not be the region at all, but the way investors have traditionally looked at it. It’s Tuesday, October 13th at 8am in Hong Kong. Picture this. You’re shopping in a supermarket. As you walk down the aisles, you notice half of them are off limits. It’s unexpected. Something similar has happened in Asia fixed income. The region’s fundamentals remain supportive, but the traditional investment universe has become increasingly constrained. The pressure began in early 2023, when U.S. policy rates rose above those in much of Asia for the first time since before the Global Financial Crisis. The environment that had supported Asian bond markets for years turned upside down. Consider Asia-dollar credit. Issuers have increasingly turned to cheaper local-currency financing, which is shrinking dollar-bond supply. Asia-dollar credit is now on track for a fifth straight year of negative net supply. At the same time, investment-grade spreads have tightened to 55 basis points. That makes Asia investment-grade credit the most tightly valued major credit market globally. And investors have taken notice of this. Assets in dedicated Asia credit and high-yield funds have fallen 62 percent from their 2021 peak – from roughly $75 billion USD to around $29 billion USD. But we feel Asia itself is not the problem. In fact, Asia Pacific nominal GDP could rise from $41 trillion USD in 2025 to [$]54 trillion by 2031. That would account [for] roughly one-third of global nominal GDP growth over that period. And most importantly investment is also accelerating. Asia’s capital spending could rise from $11 trillion to [$]16 trillion by 2030. That would mark the strongest industrial cycle since the mid-2000s. And we think this extends well beyond AI, with energy, defense, and broader industrial investment all playing major roles. The key issue here is how investors have traditionally looked at Asia. They basically need a bigger map. That broader map is what we call APAC fixed income. Traditional Asia fixed income has largely focused on U.S.-dollar credit and local-currency government bonds across emerging Asia. APAC fixed income adds convertible bonds and local-currency corporate credit. It also brings Japan and Australia into the mix. So, what’s the advantage of this broader map? You see, each of these pieces behaves differently. Convertible bonds let investors participate in regional growth through their equity link. APAC dollar credit plays a more defensive role, with a mostly investment-grade, U.S.-dollar-denominated profile. Local-currency rates provide exposure to interest rates, currencies and the economic cycle. At the same time, local-currency corporate credit broadens credit and sector exposure. Together, they create a more flexible mix of risks across changing economic conditions. For example, when growth and inflation rise together, convertible bonds can benefit from their equity link. In a recession, currency-hedged local bonds can benefit from falling rates while limiting foreign-exchange risk. During stagflation, dollar credit can offer more defensive characteristics. Our portfolio analysis since 2023 suggests a diversified APAC fixed-income portfolio could target a 7.5 percent return with a vol[atility] of roughly 4 percent, depending on allocation constraints. Investors also increasingly need to manage currency exposure as the dollar cycle shifts. For years, investors could navigate Asian bonds with a relatively narrow toolkit. Today’s market demands more flexibility. The opportunity in Asia has not disappeared. The better question may be whether investors are looking at enough of it. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1748
October 12 · 4 min
The Politics of Powering AI
Energy costs are a key election issue and AI data centers are adding to the debate. Our Head of Public Policy Research Ariana Salvatore looks at policy discussions in Washington that could determine how the U.S. powers its next technological boom. Read more insights from Morgan Stanley. ----- Transcript ----- Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of Public Policy Research at Morgan Stanley. Today, I'll discuss the growing energy demands of AI and what the government can do in response. It's Monday, October 12th at 10am in New York. Markets and policymakers are preparing for a potentially important debate following the November elections. The future of American energy infrastructure. And at the center of that debate is an increasingly urgent question: How can the U.S. build enough power infrastructure to support the AI investment cycle – without passing the costs on to everyday electricity consumers? Late last month, lawmakers in Congress introduced the bipartisan American Affordability and Jobs Act. That legislation represents a significant effort to reform federal permitting. But importantly, it also includes provisions that require data centers to cover the transmission costs associated with their projects. We think that's a notable development, particularly as we think about the legislative agenda after the November elections. Of course, the path forward still remains uncertain given substantial policy differences and a limited legislative calendar after the elections. But why might this matter for markets? Well, first, it's worth considering the scale of the energy challenge. My colleague Stephen Byrd and his team recently updated their projections for the U.S. data center power shortfall. They now see a potential 57-gigawatt gap through 2028, and that's before accounting for new solutions that could accelerate access to power. That's up from their previous estimate of 38-gigawatts. And that's why the permitting proposal is so important. There are two elements that I'd highlight. First is the effort to accelerate infrastructure development. The bill would reform federal environmental reviews and provide greater certainty for projects that have already received approvals. We think that can help reduce delays and uncertainty around new energy projects, although permitting reform alone won't resolve constraints involving equipment, labor, or grid capacity. The second element is the growing focus on who pays for the infrastructure, and here the proposal actually builds on an existing policy initiative. Earlier this year, a number of hyperscalers signed on to the Ratepayer Protection Pledge. That's a voluntary agreement under which companies commit to securing the electricity needed for their data centers and pay for associated power infrastructure upgrades rather than passing the costs on to residential consumers. The pledge was subsequently expanded to include a broader group of utilities, developers, and state participants. Now, what's different about the permitting reform bill is its potential shift from voluntary commitments toward federal requirements. In particular, the proposal would require data centers to cover their associated transmission costs. That's an area where we think policymakers from both parties appear to share concerns about electricity affordability, even though they may disagree over the broader approach to energy policy. Looking beyond the elections, we think that creates two related policy catalysts for investors to watch. The first is whether Congress can reach an agreement on permitting reform that helps accelerate the construction of energy infrastructure. And second, whether lawmakers move to establish a more formal cost-sharing requirement for data centers. The eventual policy mix, we think, could influence both the timing and the economics of new projects. Faster approvals could make some investments more attractive. But requiring developers to absorb additional transmission costs could also change where projects are built and which power solutions they pursue. A changing policy framework could also reinforce the importance of alternatives. Of course, legislation is far from guaranteed. The elections will shape the political environment in which these negotiations continue, and any final agreement could differ substantially from the current proposal. But stepping back, I think there's a broader takeaway. For much of the AI investment cycle, the focus has been on the pace of technological innovation and capital spending. Increasingly, though, policy decisions around electricity infrastructure, permitting, and affordability could become just as important in determining how quickly that investment translates into operational capacity. The permitting bill is an early indication of how D.C. may approach those challenges after the elections. And for investors, the central question may be less about how much companies are willing to spend on AI and more about how quickly and at what cost they can secure the power needed to support it. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1747
October 9 · 4 min
Will High Yields Crack the Market’s Resilience?
Markets have remained resilient despite the prospect of higher-for-longer rates. Our Global Head of Fixed Income Research Andrew Sheets considers the risks building beneath the surface. Read more insights from Morgan Stanley. ----- Transcript ----- Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Today, exploring further the question that seems to be on everyone's mind: At what point do higher rates become a problem for markets? It's Friday, October 9th, at 2pm in London. We recently hosted Morgan Stanley's ninth annual European Credit Conference here in London. Fifty companies, over a thousand investors, and to some extent, one dominating question. The market has been impressively resilient this year – but as yields rise, at what point does this change? I think a good place to start with this question is whether the current level of interest rates are obviously wrong. And I don't think it's clear that they are. Growth in the U.S., Europe, and Asia remains surprisingly robust and has for a lot of this year. Meanwhile, inflation across regions is still generally above central bank targets. Too high, and a sign that conditions are more likely too hot than too cold. That's the opposite of what the wrong level of rates would imply – as rates that were too high would be curtailing activity and pushing inflation down below target. Thanks in part to the scale of AI spending and how insensitive the spending has been to the level of interest rates; we're just not seeing this. I think the yield curve is also confirming this message that the level of rates for now is okay. In an environment where the market thinks that central banks have raised rates too much, it will often so-call invert the yield curve. Pushing short-term interest rates above longer-term ones on the belief that rates that are too high today will need to be lowered when conditions weaken in the future. We're not seeing that, and that is, I think, a pretty important indicator. At the risk of being pedantic, I think there's also the premise of the question around resilience. At one level, without a doubt, markets have been impressively solid given the large rise in yields this year. U.S. and European stocks have been posting double-digit gains. Credit spreads, a measure of risk premium, sit near multi-decade lows. But under the surface, that resilience isn't so apparent. Spreads on the lowest-rated credits, so-called triple CCCs, have increased significantly this year across both the U.S. and Europe. Publicly traded BDCs, which contain portfolios of lower-rated private credit, have traded at widening discounts to their book value. And even in the mighty U.S. stock market, my colleague Mike Wilson and our U.S. equity strategy team note that over half of the 3000 largest stocks have seen a drawdown of at least 20 percent since June, which happens to be the month that yields started to rise. 2026 may be showing that global growth overall is just less sensitive to higher rates than was initially expected. Large government deficits in the U.S., Europe, and Asia, and large spending on AI may be two reasons why. With growth strong and inflation still too high, rates may be simply seeking out a level that they think will keep things in balance. But the interest rate that helps balance – this technology and spending boom – are not the same rates that keep a smaller, weaker, or a more indebted company happy. If higher rates are needed to balance things overall, the weaker tails of the market can still suffer. We've seen this in the past, particularly 2005. Back then, a large U.S. government deficit, booming China CapEx, and significant U.S. housing wealth all helped push up rates. The overall econom y held up for several more years. But weaker parts of the credit market were challenged by those rates more quickly. We think the same may be true today and therefore favor an upper quality bias. We favor high-yield bonds over loans and decompression across credit indices. Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.
#1746
October 8 · 9 min
High Mortgage Rates and a Stuck Housing Market
U.S. mortgage rates are hovering around their highest levels in three years. Morgan Stanley Co-Heads of Securitized Products Research Jay Bacow and James Egan examine the forces keeping homeowners locked in and buyers priced out of the housing market. Read more insights from Morgan Stanley. ----- Transcript ----- Jay Bacow: Jim, [we’re] getting a lot of questions about mortgage rates. We've been flying across the country talking to people. Are your arms tired? James Egan: I'm hoping that all the extra flapping will give them just a little bit more definition so we can show them off as we talk about adjustable-rate mortgages. Jay Bacow: And that is the definition of an ARM. Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley. James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley Jay Bacow: Today, we're here to talk about mortgage rates: how quickly they've moved, why they're here, where they might go, and what it means for the mortgage and housing market. It's Thursday, October 8th, at 9am in New York. Jim, as of this recording, the 10-year is over 5.3 percent. Rates haven't closed this high since 2002. The 30-year mortgage rate is around 7.5 percent. It’s about 150 basis points up since the beginning of February. James Egan: Right. There have been quick moves in rates that has led to quick moves in mortgage rates. There are a lot of implications to that – from affordability, the housing market, mortgage market. But when we think about the relationship between mortgage rates and interest rates, Jay, there's also a feedback mechanism there. Convexity hedging is what it's typically called. Can you discuss the role that that might have played in this current episode? And what we should expect going forward? Jay Bacow: Sure. So, the biggest driver of mortgage rates is Treasury rates. And Treasury rates are driven by a number of factors, and right now most people would point to inflation expectations and geopolitical concerns. However, as Treasury rates go higher, homeowners that currently have a mortgage are less likely to move. And because they're less likely to move, that means that the average life of those mortgages that investors own gets longer. And because mortgage investors typically want to keep their duration profile constant – as the average life of those mortgages gets longer, they are then going to need to either sell those mortgages or sell Treasuries, which will cause yields to go even higher. And there's a bit of a feedback loop on that, which can pressure yields and mortgage rates even higher. But what we would say is, at this point, we don't think there's a huge mechanism of that going through at this rate level. The average mortgage rate that homeowners have in America is almost exactly 4.5 percent. Obviously, they're less likely to move as rates go up. But they're 300 basis points out of the money. So, from that point, it matters. But it didn't matter as much as when rates were a little lower. However, Jim, 7.5 percent mortgage rate – what does this do for housing affordability? Can you put that in context? James Egan: Yeah. So, if we just think about this in terms of what a 7.5 percent mortgage rate implies for the monthly payment on the median-priced home, we are now up over $325 dollars if we use that 7.5 percent – assuming home prices are where they are today, incomes are where they are today. That monthly payment's up over $325 from where we are at local lows in February; or where we were at local lows in February. That's a 17 percent increase, in terms of that monthly payment over just a seven-month period. Jay Bacow: Alright, so, 17 percent increase over a seven-month period, that's kind of scary. But as you and I have talked about in the past, given the fixed rate nature of the U.S. mortgage market, it's a tad misleading for the average homeowner in America. So, what does this do to sales? Obviously, it's scary for new homeowners, though. James Egan: Right. Look, you brought up the implications from a duration perspective, a convexity hedging perspective. All of this is just how the lock-in effect continues to have material implications for the housing market, for mortgage markets. But yes, these affordability issues – not that bad for homeowners who have an average rate below 4.5 percent. That's not changing. Over 90 percent of the balance or count of mortgages, depending on how you want to look at it, in the United States remains fixed rate. Their payments aren't changing, right? But the marginal home buyer, things are getting less affordable. I don't like to use the term demand destruction. I think that sounds a little bit too over the top here. But like we are seeing some of our higher frequency or more leading indicator demand metrics show a little bit of softening here. Pending home sales, past two months, 3 to 5 percent down year-over-year. Purchase applications, which had been very strong, in September, they were down about 10 percent year-over-year. So, look, we were seeing a little bit of demand increases this year. We were up about 2 percent year-to-date through July. It's a small increase off of a very, very low base. But we think you're going to see with rates at these levels, if we maintain these levels, is effectively the probability or any real ability of the market to escape to the upside from an activity perspective? That probability keeps coming down. And we're going to be stuck in this turnover, very range-bound, lowest level of sales as a percentage of the housing market in 40 years. Jay Bacow: So really low activity, what does that do to prices? Is there some flow through? Is there relief coming? James Egan: Look, as demand softens, the kind of first-order expectation or the heuristic should be that prices should soften as well. But again, lock-in effect; what we've actually seen is the rate of growth for existing listings at these levels has slowed. And it's slowed pretty materially. That's actually led to home price appreciation accelerating over the past few months. We've gone from just 0.7 or 0.8 percent four months ago to 1.9 percent for the data that we just received. We think that that level is kind of sustainable here, and we're going to be between like roughly 2 percent, give or take, for the remainder of this year. Now, you and I have both been mentioning the lock-in effect throughout the course of this. Yes, an overwhelming majority of the market is fixed rate right now. But the media, our conversations with clients, there's been a lot of discussion of potentially a growing share of adjustable-rate mortgages to kind of help the marginal homeowner with affordability. What are we seeing in ARMs right now? Jay Bacow: Okay. Yeah, so great question, and we are seeing a pickup in ARM issuance. If we look at the percentage of mortgages that were ARMs through the first half of this year and compare them to the percentage of ARMs in the first half of last year, it's increased by about 1 percent on aggregate issuance. It's went from about a little over 15 percent to a little over 16 percent. And so, 1 percent increase is not a huge number by itself, but when we're talking about a little over $2 trillion of expected issuance in the course of the year across the entire mortgage market, this does help on the margin. And we do think, as we said in the past, that more uptake of ARMs would likely be a little bit of a positive solution to some of the affordability challenges. But Jim, if people take out more ARMs, recognizing that most people only have two arms, should we be worrying about a repeat of the financial crisis and lending standards? James Egan: So, this is a question that we get a lot when we start talking about moving away from fixed-rate mortgages. And the point that I want to stress; that we want to stress here, is not all ARMs are created equal… Jay Bacow: Mine are stronger than yours? James Egan: Sure, we'll go with that. But also, if we control for borrower characteristics, right? Credit scores, loan-to-value ratios, debt-to-income ratios, right? And then we compare performance of adjustable-rate mortgages to fixed-rate mortgages, 7-1 ARMs, 10-1 ARMs, they perform very much like fixed-rate mortgages. It's really the short-reset ARMs, what we'll call affordability products. So, they only have 24-month or 36-month fixed periods. Those are what have historically showed a much higher rate of default and something that would get us a little bit more concerned about lending standards if those were the products we're talking about. Thankfully, they're not right now. The ARM growth that we're seeing is in the 5-1, 7-1, 10-1 space. Those have historically, again, controlling for borrower performance, performed like fixed-rate mortgages. And so, we think that you can expand mortgage product into ARMs and do it responsibly. Jay Bacow: All right. Jim, always a pleasure speaking with you. James Egan: And always great speaking to you too, Jay. And to all of our regular listeners out there, thank you for adding us to your playlist. Let us know what you think wherever you get this podcast, and share Thoughts on the Market with a friend or colleague today. Jay Bacow: Go smash that subscribe button.
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October 7 · 4 min
Will Midterms Test the AI Investment Cycle?
The AI investment boom has been a defining force in markets. Our Head of Public Policy Research Ariana Salvatore looks at whether the U.S. midterm elections could change the spending and policies behind it. Read more insights from Morgan Stanley. ----- Transcript ----- Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of Public Policy Research at Morgan Stanley. Today, what the midterms could mean for the AI investment cycle. It's Wednesday, October 7th at 10am in New York. I've spoken on this podcast before about the broader implications of the midterm elections. This time, I want to go a little deeper on what they could mean specifically for AI sentiment. We think about that through two separate channels. The first is data center opposition, where we do think the elections can be an important catalyst. The second is broader AI safety and regulation, where we think the election outcome matters much less. And that distinction is important. It suggests that the midterms are more likely to influence investor confidence in the pace and the durability of AI infrastructure spending, rather than fundamentally rewriting the rules governing AI. Let's start with data centers. Our base case is still a conditional build-out. We still expect substantial AI infrastructure investment, but increasingly subject to conditions around things like power costs, grid investment, siting, permitting, water use, and community impact. We don't expect a broad federal pause on data center development. AI compute is increasingly being viewed in Washington as strategic infrastructure, particularly when you consider competition with China. So, we think that national security framing should remain supportive of the build-out. But here's the important point for these elections. Many of the policy levers that can actually delay a project sit well below the federal level. Think about things like interconnection approvals, large load electricity tariffs, zoning, water permits, and tax abatements. Those are all generally controlled by states, utility commissions, and local governments. So, when it comes to AI infrastructure, we actually think governors, state legislatures, and public utility commissions may ultimately matter more than control of any one Senate seat in particular. And that brings us to sentiment. At the federal level, we think a Republican sweep would likely be the most constructive outcome for AI infrastructure sentiment. Now, that's because investors would likely expect fewer regulatory constraints ahead. As well as a greater likelihood of active support for permitting reform, additional power generation, and development on federal land. A divided government outcome, we think, looks closer to the status quo. It would preserve questions about the durability of the build-out, but the gridlock in D.C. would also leave many of the substantive decisions at the state and local level. And lastly, we think a Democratic sweep would be the least constructive outcome for sentiment. Now, importantly, that doesn't mean that we expect a nationwide data center moratorium, as I said. Rather, investors could interpret Democratic outperformance as increasing the probability of tighter local restrictions in the near term, and potentially much more federal scrutiny after the next 2028 elections. So that's the infrastructure side. What about AI regulation more broadly? Here, we think the midterms are actually much less consequential. Our expectation remains for incremental and fragmented regulation rather than a sweeping new federal regime. AI safety, data governance, and frontier model oversight, we think can certainly see targeted action. But we just don't think congressional composition by itself is likely to trigger comprehensive legislation – unless there's a sufficiently high-profile safety or security incident. Executive agencies are also likely to remain the more important actors on tech restrictions and model access. And that gets us to the main takeaway for investors. The midterms probably won't determine whether the AI investment cycle continues. We think the strategic case for expanding U.S. compute capacity remains intact. What they can influence, however, is the friction around that build-out. Where the projects get built, how quickly they receive approval? Who bears the cost? And ultimately, how confident investors are in the durability of AI CapEx? So, when we think about what happens in November through an AI lens, we'll be watching D.C. But in many cases, the more important signals can come from governors' races, utility commissions, and local elections – because that's where the politics of AI are increasingly meeting the physical constraints of actually building it. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1744
October 6 · 4 min
Japan’s Banks Enter a New Era of Opportunity
Our Japan Financials Analyst Mia Nagasaka explains why a once-in-30-year investment cycle could transform corporate financing and open a new chapter for Japanese banks. Read more insights from Morgan Stanley. ----- Transcript ----- Welcome to Thoughts on the Market. I’m Mia Nagasaka, Head of Japan Financials Research at Morgan Stanley MUFG Securities. Today – a once-in-30-year investment cycle is changing how investors think about Japanese banks. It’s Tuesday, October 6th, at 10am in Tokyo. For decades, Japanese companies had more cash than investment opportunities. But now it's changing. This marks a new chapter for Japanese banks. The first stage of recovery was largely about interest rates. As Japan moved away from negative rates, higher lending yields helped bank margins and earnings. This next stage is about growth in the banking business itself, driven by companies investing more and needing more external capital. In fact, we think Japan is entering its first meaningful capex cycle in nearly three decades. Investment needs are broadening, from labor-saving technology to the replacement of aging equipment. Companies are also becoming more active in reallocating capital toward businesses where they see stronger returns. For banks, the most direct opportunity is lending. We expect Japan’s domestic loan market to grow from about 588 trillion yen, or roughly 3.7 trillion U.S. dollars, in the fiscal year ending March 2026 to roughly 712 trillion yen, or about 4.5 trillion dollars, by March 2031. Loan growth could run at around 5 percent annually early in the investment cycle, then settle at about 3 to 4 percent. And the financing opportunity extends beyond loans. Take Japan’s debt capital markets, where companies raise money by issuing bonds. We expect them to grow from about 52 trillion yen, or roughly 331billion dollars, to 63 trillion yen, or about 401 billion dollars, by March 2031. We also forecast the M&A market to rise from 23 trillion yen, or roughly 146 billion dollars, to 32 trillion yen, or about 204 billion dollars, over the same period. Large projects often need several forms of financing, so lending can open the door to underwriting and advisory fees as well. This gives banks more ways to generate earnings. In the early phase, banks can benefit mainly from lending and project finance. As projects mature, fee-based businesses such as capital markets and M&A can contribute more. This makes the opportunity look less like a short-lived lending boom and more like a multi-stage financing cycle. The key measure to watch is return on equity, which shows how effectively a bank turns shareholder capital into profit. Japan’s megabanks are currently generating ROEs of roughly 10 to 11 percent. We see a path toward around 15 percent over the medium term. Structural growth in corporate financing demand alone could add about 1 to 1.5 percentage points. So, the bigger story is not simply that rates have risen. Japan may be moving from an economy defined by excess savings and underinvestment toward one where companies need capital to grow. If that transition continues, banks could have substantially more productive opportunities to deploy their balance sheets. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1743
October 5 · 5 min
Canada’s Next Growth Phase
Recent headlines about Canada have focused on trade uncertainty and weak productivity. But our Global Economist Arunima Sinha explains why the country may be on the cusp of a stronger, investment-led growth cycle. Read more insights from Morgan Stanley. ----- Transcript ----- Arunima Sinha: Welcome to Thoughts on the Market. I'm Arunima Sinha from Morgan Stanley's Global and U.S. Economics teams. Today, why Canada's economy may be closer to a new growth phase. It's Monday, October 5th at 10am in New York. Canada has been in the news recently. There have been lots of headlines related to trade, around population growth, around weak productivity, years of underinvestment. And those are real constraints, and they have weighed on the near-term outlook. At Morgan Stanley, we are more constructive on the medium-term outlook for Canada. And we recently wrote a report around this along with our strategists titled, “Canada: The Next Acceleration.” And, from our perspective, we think that the near-term uncertainty around trade is actually clouding the opportunity for global investors. There are three points that we make in the report. We estimate that the growth model in Canada over the next three to four years can actually pivot from the export-led growth story that we've seen over the past few years into one that emphasizes capital deepening and greater technological diffusion across the economy. So, it really is about the domestic build-out and the opportunity in shifting away from trade and export-led growth into a more productive economy – that's not just larger over time but can actually grow at a much faster pace as well. And so, by our estimates, we think that potential growth in Canada could feasibly rise from about 1.5 percent to closer to 1.75 percent. The way that we see it, this really doesn't require things to start from scratch. There are already large capital pipelines that are in place. But one of the things that we do note is that a lot of these pipelines are actually concentrated in a few sectors. So, about half of these are in utilities and oil and gas, transportation. These sectors together combine about 13 to 14 percent of the gross value add for the economy. But they actually account for more than half of the announced capital pipelines. And so, for the money that's going into the economy – and a lot of this is going into structures – it's not going as much into machinery and equipment. And so, while the capital build-out is going to support the widening, we also need to think about crowding in private investment into other sectors. And some of these other sectors that we've identified in the note, such as finance, information services, that have historically had much greater gains in productivity – they would need to see bigger capital intentions as well. The other opportunity that we identify for the Canadian growth model is – although the near-term population growth has been slowing, it doesn't actually change the longer run demographic picture. We looked at what the numbers would be for the working age population growth for Canada, taking 2025 as a starting point. And what we see is that Canadian working age population is going to rise by about 3 percent by 2035, by 5 percent by 2040, and 6 percent by 2045. Meanwhile, most of the developed economy peers are going to see shrinkage in their working age populations. And so that is really going to give Canada a window into the rest of the 2030s to continue to accelerate its growth model. From our perspective, the test for the next few years is going to be whether the investment that's being undertaken in a few sectors spreads beyond the big projects. And it really lifts productivity across the economy. Construction, manufacturing, agriculture, and wholesale will be especially important because they are machinery intensive, technology adoption remains low, and recent productivity gaps are large. If those sectors begin to improve, Canada could enter the 2030s with a much stronger growth engine than it has today. And in our perspective, Canada's potential growth could actually pivot from being about 1.5 percent today to entering the 2030s with close to 2 percent in potential output growth. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share our Thoughts on the Market with a friend or colleague today.
#1742
October 2 · 5 min
The Tension Between Equities and Bonds
Our Global Head of Fixed Income Research Andrew Sheets examines what rising rates could mean for equity valuations, earnings and investor appetite. Read more insights from Morgan Stanley. ----- Transcript ----- Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Today, thinking about equity resilience in the face of rising bond yields. It's Friday, October 2nd at 2pm in London. The benchmark U.S. 10-year Treasury yield has risen about 100 basis points this year. Global equities, at the same time, are up about 13 percent. And those two facts sit in an uncomfortable tension. After all, higher bond yields give investors better return options elsewhere, and they also make future corporate profits worth less today, which in theory should push stock prices lower. But there's a wrinkle here. That valuation theory actually has two moving parts. What we're referring to here is what we would call a dividend discount model or a Gordon Growth Model, where the value of a company today is worth the value of its dividends divided by the difference of its required rate of return and its growth rate. The higher the required rate of return, which interest rates push up, hurts a stock valuation. It increases the denominator. But a higher growth rate, well, that works in the opposite direction. That decreases the denominator. It makes the company worth more. Hopefully, this is intuitive. if a company has to meet a higher return hurdle, it will be worth less today. If a company's growing faster, all else equal, it's worth more. And that, we think, goes a long way to actually explain what's going on in markets today. Because corporate profits are growing quickly. Over the last year, profits for the S&P 500 are up about 30 percent, and the earnings growth for the median company, well, that's still up in the mid-teens. Growth in Europe, Asia, and emerging markets have also been historically strong. Indeed, if you'd told me on January 1st that the S&P 500 would be up about 13 percent, and at the same time, U.S. Treasury yields would be up about 100 basis points, I probably would have told you with reasonable confidence that stocks would look more expensive relative to bonds. But they don't. The valuation of the equity market, the P/E ratio, has fallen significantly as yields have risen. But because earnings have risen so much more, stocks are still higher. And the so-called equity risk premium, the difference between the earnings yield and the bond yield, it's pretty stable year to date. Now there's another way that higher yields could hurt the stock market. They could simply cause people to sell their stocks and buy those higher yielding bonds. But so far, we're not seeing evidence of that. The flows that we track continue to show money flowing into both stocks and bonds. And the two markets are moving in the same direction day to day. They're showing positive correlation, which is not the outcome you'd expect if people were shifting money from one to the other. There's also an interesting way that companies have a say in this debate. Investors every day look at the market and decide if these yields are high enough that they want to buy them. But companies look at the same yield and say, "Is this low enough that we would want to sell?" And so especially for the companies that are funding the AI build-out – these large technology companies with so much AI spending to do. Many of them, even at these higher yields, are still saying these are attractive levels to issue at. And are more attractive than, say, issuing more stock. The other factor that's always important to keep in mind whenever we're debating long-term valuation questions between stocks and bonds, or really any asset class, is that valuation is a slow-moving force. It is often not terribly predictive of the next six or even 12 months. Indeed, if we think about the difference between the earnings yield on the equity market, the inverse of the P/E ratio, and what the bond market yields, that difference. Well, that difference only explains about 10 percent of returns between stocks and bonds over the next month. Now, valuation is more powerful the longer you give it. And so, extend that horizon out over the next three years and that valuation gap between bonds and equities, well, explains about half the three-year outcome. Markets are not equations that are solved once a quarter. They are ongoing arguments about the future. And when growth is strong, investors are simply more willing to give growth and that future potential the benefit of the doubt. We think this goes a long way to helping to explain the equity market's resilience despite Treasury yields moving well above five percent. But it's also raising the bar. Higher yields simply leave less room for earnings disappointment. Those profits need to keep growing quickly. Thank you, as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.
#1741
October 1 · 12 min
How AI and Tokenization Could Reshape Wealth Management
Betsy Graseck and Michael Cyprys explore how AI could expand advisor capacity and tokenized assets could grow into a $2.3 trillion market by 2030. Read more insights from Morgan Stanley. ----- Transcript ----- Betsy Graseck: Welcome to Thoughts on the Market. I'm Betsy Graseck, Morgan Stanley's Global Head of Banks and Diversified Finance Research. Michael Cyprys: And I'm Mike Cyprys, Head of U.S. Brokers, Asset Managers, and Exchanges Research at Morgan Stanley. Betsy Graseck: Today, we're looking at the next phase of growth across asset and wealth management – and how tokenization, AI, and changing investor flows could reshape the industry. It's Thursday, October 1st at 9am in New York City. Assets under management, or AUM, are near record highs across the globe, with a lot changing beneath the surface. Now, much of the recent AUM growth has come from markets rather than from net new client flows. And meanwhile, fees do remain under pressure. At the same time, technologies like AI and tokenization are creating new opportunities for both asset and wealth managers. Our base case has tokenized real world assets growing from roughly [$]40 billion today to about [$]2.3 trillion by 2030. Mike, let's start with tokenization. What are the use cases that matter most near term? Michael Cyprys: So, as we think about it, there's a number of use cases that we see. The most compelling ones really are around cash treasuries and collateral. Take for example, earning yield. Some tokenized funds allow you to earn interest by the minute or the second that is invested rather than having to remain invested by that 4pm cutoff that is the case today. Another benefit is allowing collateral to move around a lot more easily, and this can help support a shift toward 24/7 markets. So, if securities can trade 24/7 – or derivatives – you may also need the cash leg of that transaction to keep pace. Right now, there are certain futures contracts that do trade over a weekend, but those positions do need to be pre-funded on Friday. So that's going to limit perhaps the full uptake for that of 24/7 until you can get the movement of the collateral to keep pace. And that's where tokenization can come in to help solve a real market need. There's also trapped collateral that's just sitting around the world, where institutions and corporates just keep pockets of liquidity in different places just in case they need it at a moment's notice. There’s a cost to that while it sits idle. But tokenization can allow for just more just-in-time movement of money, say with tokenized deposits, tokenized money funds, or stable coins. And another use case is around investors outside the U.S. that may not have as easy access to U.S. markets. But tokenization can help lower barriers, reduce frictions, and allow for greater access to U.S. market exposure. Private markets get a lot of attention, but we think that's maybe a little bit further out. So, to put some numbers around this, today there's around [$]40 billion of tokenized real-world assets. So, think tokenized stocks, bonds, funds. In our base case, we could see that growing to about [$]2.3 trillion by 2030, with a vast majority tied to these collateral mobility and reserve and treasury management use cases. Betsy Graseck: Pulling up a notch, we are expecting assets under management to reach about [$]247 trillion by 2030. But revenue growth is expected to lag asset growth. Mike, what really separates the firms that can grow above market trends you expect? Michael Cyprys: Yeah. So, as you said, most of the growth is going to be driven by market beta, right? So, we have expectation for about 9 percent growth annually in assets under management for about $160 trillion globally today to about $250 trillion by 2030. We expect about three-quarters of that growth rate comes from market beta, which leaves you around 2.5 percent for organic asset growth. So, growing just AUM with the market is not going to really be enough to differentiate. And so, as we think about, you know, how one can differentiate? First, I think it comes down to where one is positioned across the industry. We do see flows concentrating in passive solutions and selected private markets, and the economics can be pretty different there as well. Another way to differentiate is through distribution. Wealth, retirement, model portfolios, customized solutions, all of those channels are becoming much more important. And so, you want to be closer to where that asset allocation decision is actually getting made. And another point of differentiation is around operating leverage, and that's where AI comes in, which I'm sure is a topic we're going to get to in a little bit. That we think can help allow money managers to expand research coverage, can allow salespeople to cover more clients, allow for adding more products and customization without adding necessarily a lot more people and cost at the same rate. So, look, bottom line, I'd say, we think above market growth from having the right products, the right distribution, getting them in front of the right clients, and the technology to scale that just a lot more efficiently. Betsy Graseck: And how important is that AI tool going to be, in your opinion, for separating yourself from the pack? And is it more top-line generative or cost efficiency generative? Michael Cyprys: I think it's critical. It's both. I think it changes the competitive game because a lot of the economics are very different across the businesses, right? Take passive and index investing, for example, that continues to take share. It's a low-fee business, so there scale really matters. In solutions and private markets, the revenue opportunity is better, but you need more capabilities and distribution reach. And in private markets, origination is also key, as well as distribution, right? You can have private credit or an infrastructure product out there in the marketplace. But if you can't get it into a wealth or retirement or insurance channels, then you're leaving a lot of growth on the table. And then with traditional active, performance still matters, but the wrapper is key. Distribution matters more so than ever, and active ETFs are a great example of that. Betsy Graseck: And one question on AI is: How far along do you think it is in your coverage embedded already in the workflow and the processes across your group, your asset managers? Michael Cyprys: So, we're pretty early days here. A lot of firms, already have AI tools today: RFP tools, sales tools, tools within the operational and distribution side. But saving someone, you know, 10 minutes on a task doesn't necessarily show up in the P&L, right? You need to start removing entire steps from workflows. And then using that time savings to cover more clients, to launch more products, do more research, and ultimately slow the pace of hiring. And that's where we think the industry needs to move towards, away from these, sort of, point solutions into an enterprise workflow. And that is tools that connect across the entire organization, underpinned by the same data and the same controls. And our work suggests that this could be pretty meaningful over time, perhaps up to as much as 15 points worth of operating margin improvement – for the leaders over time. But we don't assume that all falls to the bottom line. We expect it to – you know, a lot of that's going to get reinvested, and a portion probably also gets competed away. And when we look at our forecasts for the money managers we cover, I'd say we have modest improvement in operating margins over the next couple of years. And, to your point, on cost versus revenue, we may actually see it on the revenue side first, as it can help allow for more client touches, broader coverage, and faster product development. Betsy Graseck: Okay. So, or as you mentioned, early days. How do you see AI and tokenization impacting either the leverage opportunities, the operating leverage opportunities, or the revenue growth opportunities? Let's start with AI. Michael Cyprys: We think that the potential here is to really improve the capacity to serve clients. As you think about today, the time that advisors spend actually not talking to clients, right? When you think about time that they're spending on meeting prep or research, notes, follow-ups, onboarding. And that's a lot of administrative work that is wrapped up, in terms of the advisor’s relationship there. And our work suggests that call it about half of that advisor time could be freed up. Then advisor capacity could increase upwards of 30 to 40 percent on our numbers, and that can also increase the quality and the experience that the clients receive. We also see a broader opportunity beyond just the advisor. As you look across the advisor team and the organization, we see an overall cost to serve to come down quite materially. And I know this is a question you didn't ask it, but that's out there. We don't see AI replacing financial advisors, particularly at the higher end, just given the importance of that trusted relationship. And if anything, the value of that advisor probably goes up, particularly just given there's so much change happening around the world every which way you look. And then you overlay that with the aging demographic trends. We actually think there could be a bull market for advice as we look ahead. And AI could be that tool to enable the industry to execute on that market opportunity set and also help expand the TAM in terms of the ability of the industry to capture that opportunity set and bring advice to more people than was ever possible before. Betsy Graseck: And this would be incremental to your growth outlook that you indicated earlier of 7 percent? Michael Cyprys: This could be incremental… Betsy Graseck: Okay! Michael Cyprys: ... to that opportunity potentially over time. Betsy Graseck: Anything on tokenization that is an opportunity for wealth managers? Michael Cyprys: Oh, absolutely. And I think that we're really, really early days; just scratching the surface on this in tokenization and wealth. You know, I think one way to frame tokenization and wealth is it could just make the client balance sheet that much more productive. And this creates some risk as we talk about in the report for the traditional wealth model with respect to sweep cash and the monetization of that, right? If clients hold less idle cash, that could put some pressure on deposit and sweep economics. But that could also be offset by new lending opportunities at the same time. So, wealth firms need to be able to support tokenized assets and lending capabilities without losing that client relationship to someone else's platform. And that's why longer term, the wallet or the client interface becomes pretty important – because that's where the investments, cash borrowing, payments, all of that comes together. Betsy Graseck: And all of this happening right ahead of Nasdaq and NYSE's December 6th, a big event. Michael Cyprys: That's right. U.S. equity markets are going 23/5 on December 6th. Betsy Graseck: Meaning that the only hours they will be closed every day are between... Michael Cyprys: 8 and 9pm. Betsy Graseck: And that's on a pathway to 24/7 ultimately, you believe? Michael Cyprys: That's our expectation, as you have other disruptors around the world that are looking to provide retail with access to 24/7 markets. Betsy Graseck: Exciting times, Mike. As you indicated in the beginning, we have 79 percent growth with AI and tokenization potentially amping that up ahead of a pathway to a 24/7 market. Michael Cyprys: Indeed. Betsy Graseck: Thank you so much for joining us here on Thoughts on the Market, Mike. Michael Cyprys: It's been great speaking with you, Betsy. Betsy Graseck: 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 colleague today.
#1740
September 30 · 5 min
4 Market Signals Ahead of the Midterms
As investors look toward the U.S. midterm elections, the biggest question is what could change. Our Head of U.S. Public Policy Research Ariana Salvatore outlines the signals worth watching. Read more insights from Morgan Stanley. ----- Transcript ----- Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of U.S. Public Policy Research at Morgan Stanley. Today, I'll be talking about the upcoming 2026 midterm elections. It's Wednesday, September 30th, at 10am in New York. As the elections inch closer, investors are increasingly asking about potential ramifications. We just put out a deep dive covering our expectations, and we arrive at four key takeaways. The first, midterms are unlikely to change the core executive-led policy agenda. As we've been noting for some time, a lot of the policy uncertainty that markets have dealt with since the beginning of 2025 has actually come from the executive branch rather than Congress. Tariffs, trade policy, deregulation, immigration, and export controls are all variables that are going to remain within the White House's authority. So even if control of Congress changes, we don't think investors should assume that those parts of the policy agenda simply go away. Where Congress actually matters more is on fiscal policy. But even there, the range of outcomes is relatively narrow. The main differences revolve around the timing of scheduled SNAP and Medicaid cuts, defense spending, and how future government funding and debt limit negotiations evolve. So, that's our first takeaway. Midterms can change the mechanics of governing, but probably not the broader direction of the executive agenda. That means policy uncertainty, at least across those vectors I mentioned, is likely to stay high. Takeaway number two, we'd be careful about treating the midterms as a direct signal for the 2028 presidential election. Historically, what we see is the issues that dominate a midterm don't necessarily translate to the next presidential race. Looking at the six midterm-to-presidential cycles since 1994, the top-ranked issue changed in five of them. And the issue that ultimately proved decisive in the presidential election was actually already visible at the midterm in only two of the six cases. What elections can tell us, however, is where some of the policy fault lines are beginning to form. We're watching four debates in particular in that context: the fiscal and Social Security debate, individual tax landscape, restrictions on data center development, and healthcare. In our view, across those variables, the useful signal isn't simply which party wins more seats. It's which versions of these policies are beginning to gain traction with voters and within the parties themselves. That actually brings us to takeaway number three. AI is one area where the midterms could matter, but mainly through data center policy rather than broad AI regulation. We think it's important to separate those two issues. So first, on data centers, we do see midterms as a catalyst. And that's because many of the most important policy levers sit at the state and local level: permitting, siting, grid interconnection, large load electricity rates, and tax incentives. So that means that the governorships, utility commissions, and state legislatures can actually have a much more immediate effect on the pace and the location of the build-out than Congress itself. In that vein, our base case remains a conditional build-out, meaning the expected level of AI CapEx can continue. But likely it's going to increasingly concentrate in locations where developers can address concerns around things like electricity costs, infrastructure, water, and community impacts. Broader AI safety regulation is different. Here, we think government configuration actually matters less, and that's because we see comprehensive federal legislation as pretty unlikely in the near term, absent a high salience event or incident. So congressional control is not necessarily the key driver. And finally, takeaway number four: for markets, we see more micro implications than macro ones. For equities, the composition and cohesion of the congressional majority can matter for individual sectors. Congress that's able to negotiate changes to scheduled SNAP or Medicaid cuts, for example, could have implications for consumer and healthcare companies. AI related sectors could also respond to changes in expectations and sentiment pertaining to data center restrictions. For rates, the key question is whether the election produces fiscal outcomes that materially change expected deficits. United Republican control would be the only outcome preserving reconciliation as a potential vehicle. Divided government, conversely, would narrow the scope for new legislation and put more emphasis on funding and debt limit negotiations. And for the dollar, our strategists see the transmission mechanism running primarily through U.S. yields and the growth outlook rather than the election itself. So, bottom line, we don't think the 2026 midterms are likely to produce a wholesale change in the policy or macro backdrop. But there will be important lessons to pick up along the way. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen. And share Thoughts on the Market with a friend or colleague today.
#1739
September 29 · 4 min
China’s $12 Trillion Manufacturing Upgrade
Our China Industrials Analyst Sheng Zhong explains how AI, robotics and a major investment cycle could transform China’s manufacturing base and its role in global supply chains. Read more insights from Morgan Stanley. ----- Transcript ----- Sheng Zhong: Welcome to Thoughts on the Market. I’m Sheng Zhong, Morgan Stanley’s China Industrials analyst. Today – how AI and automation are transforming China’s factories, and what that could mean for global manufacturing. It’s Tuesday, September 29th, at 3 PM in Hong Kong. For decades, Made in China has been shorthand for scale, speed, and low-cost manufacturing. Now the story is shifting toward something more ambitious: using technology, productivity, and industrial know-how to shape not just what gets made, but how it gets made. We call this transition Industry 5.0. Industry 4.0 was about connecting machines and digitizing production. Industry 5.0 goes a step further, using AI to improve how factories schedule production, manage quality, and maintain equipment. China is starting from a position of enormous scale. It represents roughly 28 percent of global manufacturing value-added and covers all 666 industrial subcategories defined by the United Nations. There are already more than 30,000 basic-level smart factories and more than 100 million connected industrial devices. That industrial base also gives China a strong platform for robotics. Traditional industrial robots generally perform fixed tasks. Embodied AI could make machines more flexible, allowing them to gain new capabilities through software and updated models. That could effectively turn some physical labor into software-upgradable capital. And the numbers give you a sense of how quickly this could scale. China could go from selling about 8 million robots a year in 2025 to 29 million in 2030, and 76 million by 2035. That’s roughly a ninefold increase in annual sales in just a decade. Scaling robotics and AI across such a large manufacturing base will require a lot of capital. We estimate Industry 5.0 could generate about $12 trillion USD of incremental industrial investment in China from 2026 through 2035. Around $5.5 trillion USD would go toward factory upgrades, including robotics, smart equipment, and software, while roughly $6 trillion USD would support new industrial capacity. But that investment cycle is likely to build gradually. We expect industrial capex growth of about 4 to 5 percent annually in 2026 and 2027, before accelerating toward 6 to 7 percent from 2028 as excess capacity is absorbed, technology bottlenecks ease, and AI adoption broadens across factories. If that investment translates into higher productivity, the economic impact could be meaningful. By 2035, China’s industrial profit margin could rise to 8 percent from roughly 5 today. Industry 5.0 could lift China’s potential GDP level by around 3.5 percent, helping cushion some of the drag from an aging population. And China’s share of global manufacturing value-added could increase from about 28 percent to 30 percent. And those changes would not stop at China’s borders. Final assembly can shift to new locations, but the supplier networks, machinery and production know-how behind it are much harder to replicate. We estimate only around 40 percent of China-to-U.S. exports can be readily substituted. That means China’s role may increasingly extend beyond exporting finished goods to supplying the equipment, components and industrial systems used to make them elsewhere. That is the move from Made in China toward Made by China. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1738
September 28 · 5 min
The Stock Market’s Bad Breadth
Fewer companies have been driving equity market gains in 2026. Our CIO and Chief U.S. Equity Strategist Mike Wilson looks at what investors should make of the narrowing rally as the year enters its final stretch. Read more insights from Morgan Stanley. ----- Transcript ----- Mike Wilson: Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing the Market’s Bad Breadth. It's Monday, September 28th at 11:30 am in New York. So, let’s get after it. The market is up this year. That's the good news. But over the last six weeks, I've been watching something that’s giving me pause. This rally has been carried by a shrinking group of stocks. More than half of the Russell 3000 is at least 20 percent below its June highs and the S&P 500 forward multiple has fallen to 19 times, close to a new low for the year. Meanwhile, earnings growth is still running in the mid-teens for the median stock and revisions breadth is approaching cycle highs for the S&P 500. That is not complacency. It is a market that has already done a lot of work to price higher energy costs, a tighter Fed, AI disruption, questions around returns on capital, and geopolitical risk. Last week on the podcast, I noted that this is classic mid-cycle behavior. Earnings are absorbing lower valuations, and quality is taking the baton from the early-cycle winners. Groups that have led powerfully from the rolling-recession trough have been among the weakest areas recently: Autos, Semis, and short-cycle Industrials. That is what tends to happen when the cycle matures and the Fed turns less friendly. The market stops paying for high beta. And starts rewarding free cash flow, stable margins, operating efficiency, and earnings that are still being revised higher. That is why I continue to favor large-cap quality, particularly asset-light, services-oriented, and fee-based businesses. Having said that, there is still one problem to resolve. Breadth improved through most of the summer even as crude and yields moved higher. The deterioration came after Jackson Hole. That’s when markets began discounting a more hawkish Fed reaction function. The percentage of S&P 500 stocks above their 200-day moving average fell from roughly 75 percent to below 50 percent, while the index held up much better. That divergence cannot persist forever. Either breadth catches up to price, or the index comes down to meet breadth. If bond volatility does not settle down soon, it could spill over into equity vol and we would see the S&P 500 price come down about 5 or 10 percent. Frankly, I would welcome it. A final index-level correction is often how a multi-month correction beneath the surface ends. There has been a lot of focus on the Fed’s recent pivot to rate hikes. However, the two-year yield is already above the level implied by the Fed’s projections. To me this suggests the bond market has been leaning too hawkish in the near term. The bigger uncertainty is how the new Fed Chairman approaches liquidity and the balance sheet. He is more of a monetarist than his predecessors, and markets are still trying to understand what that means in practice. My expectation is that the Fed ultimately provides liquidity if financial conditions tighten too far. But markets may test that resolve first. Bond volatility, funding stress, and whether equity volatility follows are the key signals. If those pressures ease, breadth can catch up and drive the market higher. If they do not, the index probably has more correcting to do. There is also a new, constructive story developing for investors: AI adoption is moving from promise to practice. Companies with higher AI adoption are seeing stronger margins and earnings trends, but consensus still assumes many of those benefits fade in the out-years. We think that’s too conservative. Productivity gains tend to compound, not immediately disappear. Earnings momentum is broadening from enablers to adopters, while adopter valuations have reset to more attractive levels. That supports a barbell approach – own select enablers where earnings durability justifies the premium, but increasingly own adopters where improving fundamentals are not yet fully reflected in expectations. Bottom line, the market is not ignoring risk. It has priced the risks through lower valuations, weaker breadth, and major leadership rotations. What remains unresolved is the gap between a resilient index and a much weaker average stock. The answer is that we probably see breadth improve and the index level come in before a surge to new all time highs. That’s why, I still want to overweight large-cap quality, but use October weakness to add to riskier stocks. The market may need one more uncomfortable adjustment. But that may be exactly what sets up a stronger finish to the year. I will be here to guide you. Thanks for tuning in; I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out!
#1737
September 25 · 10 min
AI Meets the Physical Economy
Morgan Stanley Research analysts Michelle Weaver, Ravi Shanker and Dave Arcaro discuss two industrial inflection points: how long it will be before autonomous trucking becomes a reality and why power infrastructure is racing to keep up with AI-driven demand. Read more insights from Morgan Stanley. ----- Transcript ----- Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's U.S. Thematic and Equity Strategist. Ravi Shanker: I'm Ravi Shanker, Morgan Stanley's U.S. trade transportation analyst Dave Arcaro: And I'm Dave Arcaro, Morgan Stanley's Utilities, Power & Clean Energy analyst. Michelle Weaver: Today, what we learned at Morgan Stanley's Industrials Conference about the changing economics of autonomous trucking and the increasingly tight power market supporting the AI build-out. It's Friday, September 25th at 10am in New York. Now, I know we're all on the road taking meetings post-conference, so the audio might sound a little bit different, but we wanted to bring you the latest from our annual Industrials Conference that recently concluded in Laguna Beach, where two themes really stuck out. The growing physical infrastructure demands behind AI, particularly power, and the shift in autonomous trucking from proving the viability of the technology to commercializing it at scale. Ravi, after roughly a decade of development, you've said autonomous trucking is entering a critical 12 to 18-month period ahead of serial commercial production. What's changed, and why is the debate shifting from whether the technology works to whether it can be commercialized at scale? Ravi Shanker: I think for 10 years the industry has been focused on making the technology work. but with players like Aurora now putting up almost half a million miles of fully driverless revenue-generating operations, on public highways in the U.S., day and night, rain and shine, for different customers. With people like Kodiak, also running, several trucks, in revenue-generating service, for customers like Atlas, I don't think there is much debate on the technology itself. And so, I think the debate is now moving from does this work to can this work for me? Where the next steps are going to be dotting i's and crossing t's on the path to actually pressing these trucks into commercial service rather than having to prove that it works in the first place. Michelle Weaver: Your research suggests that autonomous trucking can deliver roughly a 20 percent lower cost per mile, while higher utilization could be an even bigger source of value. What are the key assumptions behind that math? And what still needs to happen operationally for fleets to capture those benefits? Ravi Shanker: Yeah, so we recently updated our TCO math, on autonomous trucks and published a North American insight, where we revised and revisited our views on autonomous trucking with a lot of proprietary data, in there as well. And part of that new TCO math, again, I think revisited some of the changes in the split of operating costs of trucking over the last several years. First of all, I'll kind of throw a huge disclaimer out there that your mileage may vary, right? Because, depending on who you are as a trucker, if you're public or private, small or large, dry van or reefer, heavy or asset light, long haul or short haul, your split of costs are going to be slightly different. But we started out, by looking at the ATRI's national average. And labor accounts for 35 to 40 percent of the P&L of the average trucker. So, when you take the driver out and substitute that with an autonomous driver, if you will. Even after paying the autonomous technology company roughly 85 cents a mile, for the autonomous operation, you will still save a significant amount of money. Versus the 40 percent of the roughly $3 per mile that it costs for labor today. In addition to that, fuel is another third of your cost structure. And there, an autonomous truck should be anywhere from 13 to 22 percent more fuel efficient. We have taken the low end of the scale to be conservative. And then you layer on insurance savings, maintenance savings on top of that. Even if you add some incremental costs, either for human drayage at both ends or for the truck itself being more expensive – we believe you will save about 20 percent per mile versus a human driver today. And I'll point out that the unit economic savings are only about a-third of the total savings with the utilization benefit driving another two-third savings on top of that. Michelle Weaver: But there, there still seems to be a notable disconnect between how much freight carriers and shippers think can be automated and how much of the network may actually be suitable to be automated. What's the industry potentially underestimating? Ravi Shanker: Yeah. We have seen this in our conversations. Again, part of our report was conducting detailed surveys and in-depth interviews with a lot of our coverage companies. And I will say that there still needs to be a lot of education, of how these trucks work, where they work, what the unit economics are going to be out there. There's still a lot of misinformation. For instance, there's this big perception that you still need human drivers at both ends of an autonomous truck move because these trucks can only operate on a highway. And here's where our AlphaWise analysis, comes in. I think it's the first of its kind analysis where we use geolocation data to pinpoint 10,000 plus of the largest commercial facilities belonging to the hundred largest commercial shippers in the U.S. And we found out that the average [00:05:00] commercial facility is less than two miles away from the nearest ramp point. And these trucks can comfortably do seven to 10 miles, if not longer, off a highway on main roads to get to their end destinations. So, I think you just need a lot of education in the industry. And that is part of the dotting of i's and crossing of t's that we think the industry needs to do in the next 12 months before we see the start of serial commercial production next year. Weaver: Thanks, Ravi. I want to bring Dave into the conversation here, and that question of turning demand into real world capacity brings us naturally to power, where the challenge is also increasingly about physical infrastructure and execution. Dave, coming out of Laguna, you describe management commentary across power equipment as notably positive. What surprised you most about what you heard on demand bookings and project activity? Arcaro: Yeah, absolutely. What surprised me most was probably how consistent the commentary was across companies, across large frame turbine providers and the smaller, on-site power equipment players, the new entrants and the more mature companies in the market. Very consistent feedback. All very positive. And I would say also what surprised me too was the lack of disruption across the board. You know, we all see the headlines about data center moratoriums, political pushback, community challenges that really, it seemed, to increase the risk of data center execution and delays out in the market. But at least with the power equipment companies, they're just not seeing it. You know, in terms of the feedback that we heard from management teams across the board at Laguna, they review project timelines actively with their customers, and that's all still intact. We haven't seen any changes in bookings or slot reservations for equipment deliveries. Still seems to be a very stable and very strong backdrop across the board. Weaver: One of the broader conference themes was the availability of power is becoming a bottleneck for AI infrastructure. How are equipment shortages, longer wait times, and customers planning further ahead affecting pricing? And how far ahead can the industry see? Arcaro: Yeah, we are seeing equipment companies booking out orders farther and farther. The large frame gas turbines, to give you a couple examples, from companies like GE Vernova, they're now in conversations to contract turbines for 2031 and 2032. Smaller equipment companies like INNIO, who make, smaller scale engines for data centers, they're in conversations with customers and taking reservations into 2029 and 2030. So, what we heard from the conference as well was that utilities, which is a big customer for this equipment, they're looking out farther and farther now into the 2030s. That's new and that's a surprisingly long time in terms of how far they're looking out. And we're also hearing data centers looking out toward the end of the decade, you know, late 2020s in terms of trying to secure their power equipment in advance. We would still consider it very much a seller's market. Pricing has been rising, and companies at the conference gave further indications that it's likely to keep rising, what looks like into the 2030s from here. We just haven't seen any signs of softening yet, really regardless of the company or the equipment type that they're selling into the market. So still farther and farther out that we're seeing visibility into the order flow, and with that is also coming firm and even rising prices into the 2030s. Weaver: Investors often frame the power debate as electricity from the grid versus smaller power sources built on-site at data centers. Based on what you heard at Laguna, how should investors think about the balance between those two approaches? Arcaro: Yeah, it's an interesting dynamic. When you talk to utilities and some of the large frame turbine companies, they all say that all this data center demand is going to the grid. Eventually, it's all going to go to the grid. When you talk to the smaller equipment manufacturers and the power as a service providers, they say nobody wants the grid. They see long-term opportunities to sell, on-site power equipment and contract it with their end customers for 15 to 20 years, and we're seeing evidence of that. So, I think, it'll stay It's an ongoing debate among, investors as well. On our end, we think the on-site power market is going to be an extremely large market as we get toward 2030, given limitations in how much power is likely to be accessible from the grid over time for the data center industry. But I would say, my takeaway and my observation from the conference that I would highlight is that it's a really favorable market and favorable backdrop for both sides. Michelle Weaver: From autonomous freight to the power needed to support AI, one message from Laguna was clear. The next phase of technology adoption increasingly depends on what the physical economy can actually build and scale. Ravi and Dave, thanks for taking the time to talk. Shanker: Thanks, Michelle. Arcaro: Thanks for having me. Weaver: And to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.
#1736
September 24 · 13 min
The Global Diesel Problem
Diesel is at the center of an international supply squeeze, with prices rising to historic highs. Andrew Sheets and Martijn Rats unpack why this industrial fuel matters far beyond the pump. Read more insights from Morgan Stanley. ----- Transcript ----- Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Martijn Rats: And I'm Martijn Rats, Head of Commodity Research at Morgan Stanley. Andrew Sheets: Today, the secret life of diesel and why there's so much attention on it. It's Thursday, September 24th at 2pm in London. Diesel is a fuel that I think a lot of investors may be aware of but not familiar with, so to speak. It's often the other price that you see when you're driving down the road. But Martijn, it's incredibly important for the industrial side of the economy and unusually disrupted by current geopolitical events. And so, I'd like to really start at the top, or technically the middle of the barrel, so to speak. What is diesel and what makes it so special? Martijn Rats: Yeah. When people talk about diesel at the moment, they really talk about sort of three things combined. They talk about outright diesel, as well as jet fuel and also heating oil. These are effectively part of the same pool of molecules coming out of the refinery. And so, when you look at that sort of pool of molecules, you talk about the things that fuel trucks, trains, ships, tractors in agriculture, excavators, generators, home heating. It is a molecule that has a tremendously broad range of applications. It's really the fuel of the industrial economy. One of the characteristics of diesel is that it has very high energy density. In contrast to, say, gasoline, electrifying the uses of diesel is harder because it carries so much punch. Andrew Sheets: And why has there been so much on diesel recently, given the current energy disruption in these geopolitical events? Martijn Rats: Yeah. So, the global refining system normally processes about 85 million barrels a day of crude oil and from that, it makes a range of products. Diesel is at the heart of it. But it's only one of many. At the moment, we are short in terms of refinery runs, i.e., the amount of crude that refineries process to the extent of about somewhere between 4 to 5 million barrels a day. So, 4 to 5 million barrels a day on a base of 85, you're talking about 5 to 6 percent. That may not sound like a lot, but in the world of commodities, where prices really depend on relatively small changes, that is actually a very large amount. That sort of 4 or 5 million barrels a day of refineries that are currently not running, they are fifty-fifty, either in the Middle East or in Russia. In the Middle East, it is a story of the Strait of Hormuz and refineries locked behind the strait, and they can't export their products. Some of them are also damaged, although information on that is hard to find. And then the other half that is out is in Russia, where they are effectively taken out by Ukrainian drone attacks. In total, that's sort of 4 to 5 million barrels a day of refining capacity that is not running. 40 percent of their output would typically be diesel, so we are missing something like 1.5 million barrels a day of global diesel supply, all into the seaborne market. Now, I mentioned the seaborne market because the seaborne market is the traded market where traders buy and sell cargoes to each other. And that is where, from a physical market perspective, price formation takes place. The global seaborne diesel market is an 8 million barrel a day market. And so given that all of the supply we're missing is also into the seaborne market, the comparison to make is to say that we're missing about, sort of, close to 1.5 million barrels out of an 8 million barrel a day traded… Andrew Sheets: A pretty large percentage, yeah. Martijn Rats: Absolutely. That is very, very large, and that is hard to offset. Every other refinery around the world that can run is running flat out. The margins are all-time highs. So, there's a lot of incentive to run very hard. But nevertheless, it's left the market very, very tight. Andrew Sheets: So, that tightness in the market shows up via price. And just talk us through a little bit about what has happened to the price of diesel and its related fuels. You know, I think a lot of listeners are probably more familiar with the price of gasoline. They're more familiar with the barrel of oil that's often the quoted benchmark in the market. But what has been happening to these diesel prices? Martijn Rats: Yeah. So, the way to really tell that story is to look at what we call the crack spread. So, making a barrel of refined product, including diesel, of course, you start with crude oil. So, the price of crude oil impacts the price of the refined product. So, quite often we focus more on the uplift from the price of crude to get to the price of the refined product, and we call that the crack spread. Under normal conditions, say a year ago, crude was $70, and then the price of diesel was another $20 on top of that. And so, you got to diesel being 70 plus 20 is $90 per barrel. At the moment, crude is higher. Crude is about $100 per barrel. Crude has rallied. But the increment on top of it has spiked. So, a couple of days ago we got to all-time high nominal term diesel prices over $200 per barrel. So, we're now having a situation that is [$]100 for crude plus another [$]100 to get to the diesel price. So, the crack spread is something that normally lives in a range of, like when the diesel market is weak, maybe sort of $8, $9, $10. When the market is normal, close to $20. If it's very strong, $25 to $30. Now, that incremental crack spread is $100 per barrel, and that is something that we've not seen before. It is stronger than it was in 2022, when we also had a moment of a severe diesel crisis. Didn't last very long in 2022, but the crack spread got to sort of $60, $70 per barrel. So, that highlights the extent to which the price of diesel has rallied. Andrew Sheets: So, Martijn, you mentioned this crack spread. You know, I think if we all go back to our organic chemistry, this is the refineries literally cracking a barrel of oil down into constituent distillates and other pieces. But given those very high prices for diesel, why don't the refiners just refine more? Why aren't the incentives increasing production? What's getting in the way of that? Martijn Rats: Yeah. That's just a matter of like the physical reality of the system. So, when you build a refinery, you often quite think about two things. What crudes are available to me. So, if you're in the United States, you have U.S. shale crudes, or you have crude from Mexico, Canada. And based on those, you then also think about, you know, what is my consumption, where I am likely to be. And based on that, you build a certain configuration – that converts the crudes that you can buy into the products that your specific customer set might need. You fix the configuration of the refinery at the time you build it. And once it's built, there is a little bit of flexibility to say, "Oh, well, maybe at the moment I make a little bit more diesel and a little bit less gasoline," and change the – what we call the yield of these products. Like a little bit within, you know, a few percentage points range. But that flexibility is small, so the only thing you can do to make more diesel is to run the refinery at 100 percent utilization. That is currently where we are. That has already happened. And then you put in the crude that you buy, you get the products for which your refinery is then designed, and that's it. There are no other… Andrew Sheets: You can’t just turn a big dial that says more diesel. Martijn Rats: No. You can't say, "Oh, well, I don't like my naphtha output this week, so let's not make any naphtha for the chemical industry. Let's only make diesel." It's not contained in the barrel of crude and the kits that you have – takes many years to rebuild and probably very expensive. So you're kind of then stuck. I mean, it is what it is. Andrew Sheets: So Martijn, where is this leaving the global story? You know, if we think about just the relative price of this. Again, you mentioned it's an incredibly important fuel for agriculture, for industry… What's it looking like kind of across the major regions? Martijn Rats: Yeah. Look, it leaves a very tight market at the moment. I mean, it's relatively straightforward. The price of diesel depends very heavily on how the geopolitics of the Middle East and Russia sort of play out. So, in terms of the traded price that you see on the screen every day, it swings around very heavily with how the market foresees the future with regards to these two conflicts. So, one week things flare up, the price of diesel rallies. The following week the market feels a bit more optimistic maybe around a deal, so then things sort of sell off. So, we have to live with that sort of geopolitical sort of reality. But other than that, those who can afford it pay a high price to effectively erode demand amongst sets of consumers who cannot afford these higher prices. You see a substitution, for example, what I thought was very interesting last week. Some of the train companies in the United States were talking about a truck-to-train substitution of very high levels of cargo loads on trains because simply the diesel on trucks is too expensive. So, you see those behavioral changes come through. Andrew Sheets: But that point about demand destruction is really important because, you know, a point that you've made over many years is this idea that the solution to higher prices is higher prices. That that reduces the demand for the fuel, that helps these markets recorrect. And yet, you know, we're hitting prices in diesel that are near all-time highs, and we've yet to see that demand really pull back a lot. A lot of economic indicators are still pretty good. What does that tell you maybe about where the demand destruction price really is? Martijn Rats: Making estimates of the demand destruction price sort of bottom up in a sort of modeling sense, going sort of end use by end use, has turned out on many occasions to be very, very challenging analysis. But we can sort of look at the market and say under certain conditions, prices have spiked and what were these conditions? And we can sort of try to learn something from that. We had a very severe diesel crisis in 2022 when the Russia-Ukraine conflict started, and effectively Russian diesel had to be significantly rerouted around the world. We got to $200 per barrel. Andrew Sheets: Right about where we are now… Martijn Rats: Right about where we are. That didn't last very long. Big spike to [$]200, and it sold off. In March-April, we got to [$]200, and it sold off. And now, a couple of days ago, we reached that again. And so, in the trading behavior of the market, it does look like what happens at [$]200 – there either is demand destruction. Or there may not be demand destruction in the fullness of time, but buyers just take a pause. And this makes it quite difficult to kind of really unearth this issue in the sense that in the end, a lot of customers also have inventories of their own. Like airlines have tanks with jet fuel. In Europe, you have a lot of households that use heating oil for home heating if they're not connected to the gas grid. And they have tanks in their gardens. And so, there are a lot of tertiary inventories, as we call them, where people can effectively afford to stop buying for a little bit and see how things pan out, and then they buy later. And so, the actual data points that we have on demand destruction, even at this price, they're actually not that convincing. There seems to be some... There clearly is in China. In China, we have seen signs of demand destruction at these very high prices. But in the rest of the world, either there are subsidies in place, or people draw on their own inventories for a bit. Or they just absorb it because it's an indisplaceable fuel in the short run. Actually, it's not all that convincing that there is a lot of demand destruction even at these prices. Andrew Sheets: So, Martijn, the last thing I want to ask you about is – this is a fuel that is central to a lot of key industrial processes, as we've discussed, agriculture, trucking. What is the risk that the countries that have more of this refining capacity stop exporting it to the rest of the world. Try to keep more of it to themselves in order to cushion the domestic price impact? Martijn Rats: That risk is very real. We've already seen some of this earlier on in the Hormuz crisis in March and April. For example, China at some point announced an export ban on all refined products. In retrospect, that wasn't quite as forcefully implemented as it was announced. But nevertheless, the Chinese government did announce that, and we saw a initially large decline. The government of South Korea at some point banned refined product exports. In the United States, there are voices that say that this might be something that the government should consider. I would say, though, about the U.S. diesel export ban, there is a good reason why this has not happened yet. Because the United States is broadly balanced in gasoline, domestic production of gasoline by the refiners. It broadly equals to domestic consumption. And there is a tiny little bit of exports. But in the overall scheme of things, it's not much. In diesel, it has a very large surplus, which is exported. But if there were to be an export ban and that diesel cannot leave the country – for a little bit, you can store it. But you'd fill up those tanks very, very quickly. When those tanks are full, you then need to slow down the refineries because otherwise you simply have diesel that you cannot get rid of. If you slow down the refineries, and this is how we come back to the start of the discussion, the mix of products that you produce is broadly fixed. So, if you slow down the refineries, you make less gasoline. And so, in the United States, you can get the counterintuitive outcome that a diesel export ban could lead to higher gasoline prices. So, a lot of these things have unintended consequences, and there are good reasons why they haven't happened yet. Andrew Sheets: I think that's a fascinating and counterintuitive way to think about it. Thank you, Martijn, as always, for taking the time. Martijn Rats: My pleasure. Andrew Sheets: And thank you for listening. If you find Thoughts on the Market useful, let us know by leaving a review wherever you hear us. And also tell a friend or colleague about us today.
#1735
September 23 · 9 min
The Unexpected Investment Case for AI Safety
Tighter AI safety requirements could reshape the pace of AI investment. Ariana Salvatore and Michael Zezas dig into why the spending may shift toward more compute, not less. Read more insights from Morgan Stanley. ----- Transcript ----- Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of U.S. Public Policy Research at Morgan Stanley. Michael Zezas: And I'm Michael Zezas, Deputy Global Head of Research at Morgan Stanley. Ariana Salvatore: Today, we'll be talking about AI safety and regulation. It's Wednesday, September 23rd, at 10am in New York. We put out a note last week on AI frontier capability gain and the associated safety risks. Those have been in focus in recent weeks, and as a result, we've gotten a number of questions about the path forward for government regulation. So today, Mike and I are going to get into some of the newest developments, where we think things are headed, and how the midterms could shape that path. Michael Zezas: Yeah, and this is pretty important because the concern is that if AI safety scrutiny increases, it's going to slow everything down. You might have less CapEx, fewer model releases, and there's all sorts of downstream effects for the pace of U.S. growth and investment strategy in equities and throughout the AI investment theme. But Ariana, you and the team landed in a bit of a different place and are arguing that a bigger focus on AI safety could end up being a tailwind to compute spend rather than a brake on it. Can you break that down for us? Ariana Salvatore: Sure. So, the way we see this playing out, is there are five potential states of the world. Some include industry self-policing; some include the prospects for heavier government intervention. Across all of them, as you mentioned, we actually think this is a pretty big tailwind to compute spend and CapEx more broadly. That's because as the labs integrate greater safety monitoring infrastructure, we think that spend is only going to accelerate, especially as LLM capabilities increases at a nonlinear rate. Similarly, on the regulation front, we think there are a few things that prevent something like a large comprehensive AI regulation bill from coming to fruition. We think there's really three, kind of, key obstacles to something like that happening. The first is the politics. So, the president himself has said he's against some sort of large-scale regulation. The second is the procedure. So mechanically speaking, there would need to be a legislative vehicle for this sort of thing to ride on. That's hard to see emerging in the very near term. And the third is precedent. So, historical precedent here tells you that usually regulation is catalyzed by some sort of high salience event. That's why our framework for government reaction here hinges on two components: incident salience, as I just mentioned, and instrument availability. Instrument availability basically reflects the extent to which the government already has a tool that it can pull in this direction. So, that's how we think about it going forward. That doesn't mean all policy action is off the table, but that supports our expectation for higher CapEx, higher compute spend over the coming years. Michael Zezas: Right. So, the idea is that the spending continues and the things that would otherwise limit that spending, you don't see as real plausible policy options at the moment. And can you break this down a little bit more? Because I know there's a lot of different proposals floating around Washington, D.C. from policymakers right now. What are you paying attention to? Ariana Salvatore: We don't expect an overarching AI regulatory authority in the near term. Now, importantly, we also don't expect sweeping open weight model regulation. The reason for that is threefold. First of all, we think the U.S. is keen on maintaining this managed stability relationship with China. We've written about the expectations around the U.S.-China summit. That's kind of a delicate balance that we think is likely to persist. So, overly restricting open weights models might throw a little bit of a wrench into that equilibrium that we see. So that's the first reason. The second reason is diffusion. We think the U.S. administration wants to see the proliferation of open weights models. We know that companies are using some sort of hybrid of open and closed weight. So, to the extent that, you know, banning these models would slow adoption, we don't think that's in the interest of the administration. And the third reason is purely mechanical. It's really hard to enforce these sorts of restrictions. Once a model weight is published online, it can be really hard to clamp down exactly who and where it's going to. Obviously, companies can download them, customize them, et cetera. So, the enforcement picture here is also really challenging. That being said, we do think that the executive can continue to lean in and, sort of, make some incremental adjustments or changes on the regulatory front. But we think it's likely less severe than some of the proposals you're seeing in Congress right now. Things like the Kill Switch Act, for example, which basically mandate that companies can maintain an ability to shut down models at a moment's notice, right? If a certain threshold is crossed. So, that's something that we see as less likely to come to fruition. But again, setting safety standards, guardrails, all of that from the administration we think is possible in the near term. Michael Zezas: What about some of the pushback that would at least appear to be rising at the state and local level around construction of data centers? Is that something that you think might materially slow the industrial build-out and the CapEx levels around AI? Ariana Salvatore: So far, what we've seen is that AI safety risks are not the top of the priority list when it comes to data center pushback, right? So, things like environmental concerns, affordability – those tend to be the main vectors of the opposition. That being said, we've gotten the question, right, to your point, of does this, sort of, risk focus mean that the data center backlash is likely to grow? We think that it could, but at the same time, we think this is a highly idiosyncratic issue, meaning that this is something to pay attention to on a very granular level. Certain states and localities will be the ones to really administer these restrictions, and we think in the aggregate, hyperscalers are going to be able to continue to mitigate. We've already seen these mitigation measures employed. We're still constructive on AI CapEx this year and next, because overall, we see the build-out really becoming more of a conditional build-out. So, that means contingent upon some of these concessions, maybe it's more expensive in certain areas. But overall, we don't think that the concerns around safety are going to derail that story. Michael Zezas: So, then when it comes to data centers, the conditions that might be being put on their construction at the state and local level, for the most part – those building out the data centers have been willing to make those concessions, so it hasn't slowed that much. Is that fair? Ariana Salvatore: That's right, and it really depends on where the pushback is coming from, right? So, in some cases, you're seeing communities push back on things like water usage, right? And we're seeing the hyperscalers come out and respond and say explicitly, you know, how much water they're using in some of these operations. Google is proposing a regulatory framework, so that's something that they're mitigating through that lens. In another example, you've got local communities pushing back on just, sort of, disruptions to quality of life, and you're seeing companies like Meta announce a fund to engage more locally there. So, it really is different. There's no one-size-fits-all solution here. But yes, I agree with you that overall, we don't think this is going to meaningfully constrain the build-out. Michael Zezas: Got it. So, it seems like the idea here is that the secular trend around AI development is going to continue in your view. Is there any way that you think the midterm elections or the outcome around that might change your thinking? Ariana Salvatore: So, I think the midterms will be important for sentiment, but when it comes to the actual policy path, we don't think they're the main driver, and there's two key reasons for that. The first is obviously the president is not changing until 2029. So, the fact that President Trump still has to be involved in any capacity – if we were to see a bill emerge from Congress to us gives a little bit of clarity on what that bill could actually look like. And so ultimately, whatever comes to fruition will have to be a product of collaboration between Democrats, Republicans in Congress, and the president. So, that's a pretty much a constant. The second reason I would say is because, as I kind of alluded to earlier, you tend to see government response when there's a high salience event. And in that case, it doesn't really matter what the government configuration is if it's reactionary. When you think back to things like the pandemic, we saw the CARES Act. In 2008-2009, you saw the ARRA. Those are all efforts that were produced in a divided government. And so, in that vein, we basically think that you need to see some sort of event catalyze a response. The key driver is not going to be government configuration. It's going to be the salience of that event specifically. Michael Zezas: Okay, got it. So, the guidance to investors on the back of all of this is what? Ariana Salvatore: So, the thematic recommendations from our team are intact, right? So, what we were talking about is basically we see these all converging towards a tailwind to CapEx and a tailwind to compute supply. So, in that vein, we still think that you should own inference compute bottlenecks because of that excess demand relative to supply. We think that's going to persist regardless of most of the policy scenarios. We also think own leaders in cybersecurity, as we mentioned. This should drive increased spend, especially as open weight models become much more capable. And then in the third piece, we think you should own AI adopters. AI models are already pretty capable to drive significant productivity. We think that that's just going to continue to unlock. The last thing I would mention, we didn't really get into it in this podcast, but in this conversation we typically also talk about AI sovereignty and the U.S.-China restrictions here. So, in that context, we would avoid negative exposure to rising U.S.-China technology transfer restrictions. We think that's an increasing probability because we do see the governments taking more of an active role, which we think drives bifurcation of the global market. Michael Zezas: Well, Ariana, thanks for breaking it down. Appreciate talking to you today. Ariana Salvatore: Always great speaking with you, Mike. And thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.
#1734
September 22 · 5 min
Why Central Banks Are Raising Rates Again
Central banks are turning more hawkish as inflation risks increase. Our Global Chief Economist and Head of Macro Research Seth Carpenter explains what that means for the Fed, ECB and Bank of Japan. Read more insights from Morgan Stanley. ----- Transcript ----- Seth Carpenter: Welcome to Thoughts on the Market. I’m Seth Carpenter, Morgan Stanley’s Global Chief Economist and Head of Macro Research. Today, I’m going to talk about all the movement we’ve seen in central banks and how it’s changing our forecasts. It’s Tuesday, September 22, at 10 a.m. in New York. Over the past two weeks, our economists here at Morgan Stanley have revised their outlooks for the Fed, the ECB, and the Bank of Japan to include more rate hikes. Each economy faces different challenges, but all three central banks have arrived at roughly the same conclusion: growth has remained remarkably resilient despite all of the shocks hitting the global economy. And renewed energy-price pressures have increased the risk that inflation proves more persistent than they had previously expected. The clearest example—and our biggest revision here—is the Fed. Now for much of this year, we had actually thought the Fed might avoid hiking interest rates altogether. But in addition to this increase that we just saw at the September FOMC meeting, we now expect two additional rate hikes—in December and in March that will bring the terminal rate up to 4.25 to 4.5 percent. While Chair Warsh has highlighted the inflationary implications of higher energy and commodity prices, for me, the more important signal was the assessment that policy is not sufficiently restrictive. So in our view, the Fed appears to be reassessing not just the inflation outlook, but the amount of restraint that is required to bring inflation sustainably back to target. But even with all of that said, we’re still looking at this shift as more of a recalibration of policy for the Fed rather than a fundamental shift in policy. And so the market may have—just may have—overestimated how much hiking is left. But the shift does have clear and important market implications. Our rate strategists expect investors to pull forward additional tightening expectations in the near term, while increasingly questioning how long policy can remain at restrictive levels before growth starts to slow. But more broadly, the Fed now appears a bit more sensitive to energy-driven inflation pressures, and that strengthens the case for a firmer dollar. Over recent months, rising energy prices have supported the euro because investors have seen the ECB respond more aggressively than the Fed. That maybe former asymmetry could be changing. Our foreign-exchange strategists therefore continue to favor dollar strength, particularly against the yen. Now Europe does face a similar inflation challenge to the Fed, though through a different mechanism. The renewed rise in natural-gas and other energy prices has led our economists to revise up their inflation forecast materially and, therefore, to add in another ECB rate hike in December. But we have got to keep in mind that it is not energy prices all by themselves that have changed the outlook. Economic activity in the euro area has also proven to be much more resilient than we had anticipated. And that reduces concerns that an additional modest tightening of policy would derail growth. And so if you take it all together, the ECB is increasingly focused on preventing higher energy costs from feeding into broader inflationary dynamics. Now Japan might seem different, but the underlying story is really surprisingly similar. For decades, the BoJ’s challenge was generating inflation. But now policymakers are now increasingly concerned about the possibility that inflation will overshoot its target. After the BoJ’s hike last week, we expect it to raise rates to 1.5 percent in December and then raise rates further, to about 1.75 percent, in March. Like the Fed and the ECB, the BoJ faces an economy that has absorbed tighter financial conditions much better than had been expected. And yet, unlike the Fed and the ECB, our strategists believe that markets have become too aggressive in pricing the eventual destination of rates. And that creates scope for expectations to be revised lower over time. As a result, while Japanese rates may continue to rise gradually, our foreign-exchange strategists still expect a broader trend of yen weakness to emerge once temporary positioning effects fade. So the common thread across all three of these central banks that I’ve discussed is that, while the energy shock has changed the inflation conversation, the resilience in growth has further changed the policy conversation. And so for investors, next year is probably going to be characterized by higher policy rates and a stronger dollar than markets expected at the beginning of the year. Well, thanks for listening. And If you enjoy the show, please leave us a review and share Thoughts on the Market with a friend or colleague today.
#1733
September 21 · 4 min
Market Resilience Isn’t Complacency
Our CIO and Chief U.S. Equity Strategist Mike Wilson discusses why quality stocks, strong earnings and price momentum support his view that the bull market remains intact. Read more insights from Morgan Stanley. ----- Transcript ----- Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing the ongoing mid-cycle transition. It's Monday, September 21st at 11:30 am in New York. So, let’s get after it. The S&P 500 is near record highs. That’s despite rising energy prices, two wars running in parallel and AI safety concerns back in the headlines. Meanwhile central banks are tightening. On paper, that's a lot of reasons to be nervous. So are investors just being complacent? I don't think so. More than 40 percent of the Russell 3000 has fallen at least 20 percent since June, while the S&P 500’s forward price earnings multiple has fallen back to 19 times, which is almost 20 percent lower than a year ago. At the same time, median stock earnings growth is running around 15 percent, and revisions breadth is back near cycle highs. Falling valuations alongside strong earnings growth is not complacency. It is the definition of a classic mid-cycle transition. That distinction matters because mid-cycle markets tend to frustrate almost everyone. The index can remain resilient while much of the market corrects. Earnings can stay strong while multiples fall. And leadership can change without the bull market ending. Last week’s Fed meeting fits squarely into that framework. The 25-basis-point hike was largely priced, so the real information was Chair Warsh’s willingness to follow through on his commitment to fight inflation. Recent core inflation data were firmer than expected, but the details were not uniformly hot. Some of the upside was concentrated in a handful of categories, shelter remained soft, and tariff pass-through appears to be fading. That gave the Fed room to act without forcing investors to assume we are heading into another 2022-style tightening campaign. In my view, the hike can enhance credibility. If investors believe the Fed is acting early enough to contain inflation, a higher policy rate can reduce uncertainty and term premium rather than automatically driving long-term financing costs higher. But the rate hike is not my concern. A few additional hikes over the next year are unlikely to end this bull market if earnings remain strong. The bigger unknown is how a Warsh-led Fed approaches the balance sheet, money supply, and credit growth. His philosophy has historically leaned more monetarist than prior Fed chairs. However, we still don’t know how aggressively he will apply it – or how much influence he will have over the rest of the committee. That matters because the private economy is using more capital, and an overly restrictive approach to liquidity could become more consequential than the policy rate itself. This is one reason I continue to favor large-cap quality. High free-cash-flow yield, low accruals, and operating-efficiency factors are leading, while the high-sales-per-employee factor has been one of the strongest recent performers. That also aligns closely with our preference for AI adopters rather than the enablers. Price momentum is not disappearing. But its composition is changing toward quality, services-oriented, asset-light, and fee-based businesses. That is exactly what should happen during a mid-cycle transition. The near-term swing factor remains energy prices. Another meaningful rise in crude or refined products would put upward pressure on the expected policy path, long-end yields, and bond volatility in an unhealthy way. It would also arrive during a period when midterm-election seasonality often produces a 5 to 10 percent index correction. In a worst-case near-term scenario, the S&P 500 could trade near 7100, but I would view that as a tactical correction within the bull market – not a change in our fundamental views. Either way, I remain convicted in our 8,000 year-end price target. The bottom line is that this market is behaving exactly like a mid-cycle market should: valuations are compressing, earnings are carrying the load, and leadership is moving toward quality. The index may look calm, but plenty of concern has already been priced at the stock level. The mistake would be confusing resiliency with complacency—and missing the rotation taking place in plain sight. Thanks for tuning in; I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out!

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