Our Chief Fixed Income Strategist takes listeners behind the curtain on Morgan Stanley’s expectations for markets over the next 12 months.

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Welcome to Thoughts on the Market. I am Vishy Tirupathur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the key debates we engaged in during the mid-year outlook process.

It's Tuesday, June 4th at 1pm in New York.

Over the last few episodes, you've been hearing a lot about Morgan Stanley's midyear outlook, where our economists have forecasted a sunny macro environment of decelerating growth and inflation, and policy easing in most developed market economies, leading to a positive backdrop for risk assets in the base case, especially in the second half of the year.

But beyond the year end, many uncertainties -- uncertainties of outcomes and uncertainties of the consequences of those outcomes -- point to a wider range of outcomes, driving a wider than normal bull versus bear skew in our expectations for markets over the next 12 months.

As always, these outlooks are the culmination of a process involving much deliberation and spirited debate among economists and strategists across all the regions and asset classes we cover. I thought it might be useful to detail some of these debates that we've had during the process to shed a better light on the forecast in our outlook.

First, given the many changes to market pricing of Fed's rate cuts year to date, driven by higher-than-expected inflation, the path ahead for US inflation was heavily debated. Our economists argued that the acceleration in goods and financial services prices, which explains a substantial portion of the upside in the first quarter inflation data should decelerate from here. And also that leading indicators point to a weaker shelter inflation ahead. Their analysis also showed that residual seasonality contributed to the unexpected strength in first quarter [20]24 inflation data, suggesting a payback has to happen in the second half of 2024.

The outlook for China economy and our cautious stance on the market was another point of debate, mainly because China's growth has surprised to the upside relative to our 2024 year ahead outlook. Our economists argued that while there are a few policy positives on housing and green products mitigating the debt deflation spiral, growth remains unbalanced and subpar. So, we discussed our cautious stance on China equity markets against this backdrop and concluded that the equity market recovery is still very challenging in China.

Third, given the combination of favorable technicals, solid fundamentals, and a relatively benign economic outlook, we debated whether corporate credit, on which we are constructive, should we be even more constructive in our forecasts. After all, the setup for corporate credit has many elements similar to those during the mid 1990s, when, for example, US IG index spreads were about 30 basis points tighter versus the current spread targets.

Our strategist highlighted the significant differences in the market structure, the composition of the index, and the duration of the underlying bonds that make up this index today, versus 1990s -- all of which put a higher floor on spreads, which explains our spread targets.

The debates notwithstanding, we cannot argue with the benign macro backdrop and what that means for the second half of 2024. We turn overweight in global equities and overweight in a range of spread products within fixed income, most notably agency MBS, EM Sovereign credit, leveraged loans, securitized credit, especially CLO equity tranches.

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Our Chief Cross-Asset Strategist explains why the high correlation between stocks and bonds could work in investors’ favor throughout the second half of this year.

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Welcome to Thoughts on the Market. I’m Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I’ll discuss why we believe bonds and equities can both rally this year, with the still-elevated correlations between the two assets a boon rather than a bane to investors.

It’s Monday, June 3rd at 10am in New York.

In our mid-year outlook two weeks ago, we expressed our bullish view on both global equities and parts of fixed income space like agency mortgage-backed securities and leveraged loans, on the back of the benign economic backdrop our economists are forecasting for in the second half of 2024.

Now, this may be surprising to some. Received wisdom is that in an environment of rate cuts and falling yields, equities can't perform well because the former usually maps to growth slowdowns. When equities see double-digit upside – which is what we’re projecting for European equities – it’s unusual for bonds to also see strong and positive returns, which is what we’re projecting for German government bonds.

And I want to push back on this received wisdom that we can’t have an ‘everything rally’. When we look at the annual performance of global stocks and 10-year US Treasuries every year going back to 1988, in the 13 times when the Fed cut rates over the course of the year, bond yields were lower and equities were up 43 per cent of the time. And in those periods, stock returns averaged 18 per cent while yields fell over 1 percentage points. ‘Everything rallies’ happen often in this very macro backdrop of benign growth and Fed cuts we’re expecting, And when they do happen, everything indeed rallies – strongly.

Or to frame it another way – our expectations for both global equities and fixed income to see strong total returns this year is the flipside of what markets had experienced in 2022. Now back then, unlike in most other prior cycles, stock-bond return correlations were high because inflation was elevated even as growth was sluggish, meaning that bonds sold off on higher rates expectations, and equities on bad earnings. Today, with our view that global growth can be robust while disinflation continues, the opposite will likely be true; bonds should rally on lower rates expectations, and equities on strong earnings revisions. Stock-bond return correlations are still elevated, but it should work in an investor’s favor this year.

Lean into it. Good macro, fair fundamentals, pockets of attractive valuations all make for a strong environment for risk assets, a reason for us to get more bullish on European and Japanese equities, but also in fixed income products like leveraged loans and Collateralized Loan Obligations.

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.