In the first of a two-part episode, Lisa Shalett, our Wealth Management CIO, and Andrew Sheets, our Head of Corporate Credit Research, discuss whether the era of “American Exceptionalism” is ending and how investors should prepare for a global market rebalancing.
Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.
Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.
Andrew Sheets: Today, the first of two episodes tackling a fascinating and complex question. Is American market dominance ending? And what would that mean for investors?
It's Wednesday, July 30th at 4pm in London.
Lisa Shalett: And it's 11am here in New York.
Andrew Sheets: Lisa, it's so great to talk to you again, and especially what we're going to talk about over these two episodes. , a theme that's been coming up regularly on this podcast is this idea of American exceptionalism. This multi-year, almost multi-decade outperformance of the U.S. economy, of the U.S. currency, of the U.S. stock market.
And so, it's great to have you on the show, given that you've recently published on this topic in a special report, very topically titled American Exceptionalism: Navigating the Great Rebalancing.
So, what are the key pillars behind this idea and why do you think it's so important?
Lisa Shalett: Yeah. So, , I think that that when you think about the thesis of American exceptionalism and the duration of time that the thesis has endured. I think a lot of investors have come to the conclusion that many of the underpinnings of America's performance are just absolutely inherent and foundational, right?
They'll point to America as a, economy of innovation. A market with regulation and capital markets breadth and depth and liquidity a market guided by, , laws and regulation, and a market where, , heretofore we've had relatively decent population growth.
All things that tend to lead to growth. , But our analysis of the past 15 years, while acknowledging all of those foundational pillars say, ‘Wait a minute, let's separate the wheat from the chaff.’ Because this past 15 years has been, extraordinary and different. And it's been extraordinary and different on at least three dimensions.
One, the degree to which we've had monetary accommodation and an extraordinary responsiveness of the Fed to any crisis. Secondly, extraordinary fiscal policy and fiscal stimulus. And third, the, the peak of globalization a trend that in our humble opinion, American companies were among, , the biggest beneficiaries of exploiting, despite all of the, political rhetoric that considers the costs of that globalization.
Andrew Sheets: So, Lisa, let me go back then to the title of your report, which is the Great Rebalancing or navigating the Great Rebalancing. So, what is that rebalancing? What do you think kind of might be in store going forward?
Lisa Shalett: The profound out performance, as you noted, Andrew, of both the U.S. dollar and , American stock markets have left the world, , at an extraordinarily overweight position to the dollar and to American assets.
And that's against a backdrop where, , we're a fraction of the population. We're 25 percent, , of global GDP, and even with all of our great companies, we're still only 33 percent of the profit pool. So, we were at a place where not only was everyone overweight, but the relative valuation premia of American equity assets versus, , equities outside or rest of world was literally a 50 percent premium.
And that really had us asking the question, is that really sustainable? Those kind of valuation premiums – at a point when all of these pillars, fiscal stimulus, monetary stimulus, globalization, are at these profound inflection points.
Andrew Sheets: You mentioned monetary and fiscal policy a bit as being key to supercharging U.S. markets. Where do you think these factors are going to move in the future, and how do you think that affects this rebalancing idea?
Lisa Shalett: Look, I mean, I think we went through a period of time where on a relative basis, relative growth, relative rate spreads, right? The, the dispersion between what you could earn in U.S. assets and what you could earn, , in other places, and the hedging ratio in those currency markets, , made owning U.S. assets, , just incredibly attractive on a relative basis.
As the U.S. now kind of hits this point of inflection when the rest of the world is starting to say, okay, in an America first and an America only policy world, what am I going to do?
And I think the responses are that for many other countries, they are going to invest aggressively . in defense, in infrastructure, in technology, , to, , respond to de-globalization, if you will.
And I think for many of those economies, it's going to help equalize not only growth rates between the U.S. and the rest of the world, but it's going to help equalize, , rate differentials. Particularly on the longer end of the curves, where everyone is going to spending money.
Andrew Sheets: That's actually a great segue into this idea of globalization, which again was a major tailwind for U.S. corporations and a pillar of this American outperformance over a number of years.
It does seem like that landscape has really changed over the last couple of decades, and yet going forward, it looks like it's going to change again. So, with rising deglobalization with higher tariffs, what do you think that's going to mean to U.S. corporate margins and global supply chains?
Lisa Shalett: Maybe I am, , a product of, my training and economics, but I have always been a believer in comparative advantage and what globalization allowed. True free trade and globalization of supply chains allowed was for countries to exploit what they were best at – whether it was the lowest cost labor, the lowest cost of natural resources, the lowest cost inputs. , And America was aggressive at pursuing those things, at outsourcing what they could, , to grow profit margins. And, , that had lots of implications.
And we weren't holding manufacturing assets or logistical assets or transportation assets necessarily, , on our balance sheets.
And, , that dimension of this asset light and optimized supply chains, , is something in a world of tariffs, in a world of deglobalization, in a world of create manufacturing jobs onshore, , where that gets reversed a bit. And there's going to be a, a financial cost to that.
Andrew Sheets: It's probably fair to say that the way that a lot of people experience American exceptionalism is in their retirement account.
In your view, is this outperformance sustainable or do you think, as you mentioned, changing fiscal dynamics, changing trade dynamics, that we're also going to see a leadership rotation here?
Lisa Shalett: Our thesis has been, , this isn't the end of American exceptionalism. , point blank, black and white. What we've said, however, is that we think that the order of magnitude of that outperformance is what's going to close, , when you start burdening, , your growth rate with headwinds, right?
And so, again, not to say that that American assets can't continue to, to be major contributors in portfolios and may even, , outperform by a bit. But I don't think that they're going to be outperforming by, , the magnitude, kind of the 450 - 550 basis points per year compound for 15 years that we've seen.
Andrew Sheets: The American exceptionalism that we've seen really since 2009, it's also been accompanied by really unprecedented market imbalances. But another dimension of these imbalances is social and economic inequality, which is creating structural, and policy, and political challenges.
Do these imbalances matter for markets? And do you think these imbalances affect economic stability and overall market performance?
Lisa Shalett: People need to understand what has happened over this period. When we applied this degree of monetary and fiscal, stimulus, what we essentially did was massively deleverage the private sector of America, right?
And as a result, , when you do that, , you enable and create the backdrop, , for the portions of your economy who are less interest rate sensitive, , to continue to, , kind of invest free money. And so, , what we have seen is that this gap between the haves and the have nots, those who are most interest rate sensitive and those who are least interest rate sensitive – that chasm is really, , blown out.
But also I would suggest an A economic policy conundrum. We can all have points of view about the central bank, and we can all have points of view about the current chair. , But the reality is if you look at these dispersions in the United States, you have to ask yourself the question, is there one central bank policy that's right for the U.S. economy?
I could make the argument that the U.S. GDP, right, is growing at 5.5 percent nominal right now. And the policy rate's 4.3 percent. Is that tight?
Andrew Sheets: Hmm.
Lisa Shalett: I don't know, right? The economists will tell me it's really tight, Lisa – [be]cause neutral is 3. But I don't know. I don't see the constraints. If I drill down and do I say, can I see constraints among small businesses?
Yeah. I think they're suffering. Do I see constraints in some of the portfolio companies of private equity? Are they suffering? Yeah. Do they need lower rates? Yeah. Do the lower two-thirds of American consumers need lower rates to access the housing market. Yeah.
But is it hurting the aggregate U.S. economy? Mm, I don't know; hard to convince me.
Andrew Sheets: Well, Lisa, that seems like a great place to actually end it for now and Thanks as always, for taking the time to talk.
Lisa Shalett: My pleasure, Andrew.
Andrew Sheets: And that brings us to the end of part one of this two-part look at American exceptionalism and the impact on equity and fixed income markets. Tomorrow we'll dig into the fixed income side of that debate.
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.
Joining the AI race also requires building out massive physical infrastructure. Our Head of Corporate Credit Research Andrew Sheets explains why credit markets may play a critical role in the endeavor.
Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.
Today – how the world may fund $3 trillion of expected spending on AI.
It's Friday July 25th at 2pm in London.
Whether you factor it in or not, AI is rapidly becoming a regular part of our daily lives. Checking the weather before you step out of the house. Using your smartphone to navigate to your next destination, with real time traffic updates. Writing that last minute wedding speech. An app that reminds you to take your medication or maybe reminds you to power off your device.
All of these capabilities require enormous physical infrastructure, from chips to data centers, to the electricity to power it all. And however large AI is seen so far, we really haven't seen anything yet. Over the next five years, we think that global data center capacity increases by a factor of six times. The cost of this spending is set to be extraordinary. $3 trillion by the end of 2028 on just the data centers and their hardware alone.
Where will all this money come from?
In a recent deep dive report published last week, a number of teams within Morgan Stanley Research attempted to answer just that. First, large cap technology companies, which are also commonly called the hyperscalers. Well, they are large and profitable. We think they may fund half of the spending out of their own cash flows.
But that leaves the other half to come from outside sources. And we think that credit markets – corporate bonds, securitized credit, asset-backed finance markets – they're gonna have a large role to play, given the enormous sums involved.
For corporate bonds, the asset class closest to my heart, we estimate an additional $200 billion of issuance to fund these endeavors. Technology companies do currently borrow less than other sectors relative to their cash flow, and so we're starting from a relatively good place if you want to be borrowing more – given that they're a small part of the current bond market. While technology is over 30 percent of the S&P 500 Equity Index, it's just 10 percent of the Investment Grade Bond Index.
Indeed, a relevant question might be why these companies don't end up borrowing more through corporate bonds, given this relatively good starting position.
Well, some of this we think is capacity. The largest non-financial issuers of bonds today have at most $80 to $90 billion of bonds outstanding. And so as good as these big tech businesses are, asking investors to make them the largest part of the bond market effectively overnight is going to be difficult.
Some of our thinking is also driven by corporate finance. We are still in the early stages of this AI build out where the risks are the highest. And so, rather than take these risks on their own balance sheet, we think many tech companies may prefer partnerships that cost a bit more but provide a lot more flexibility. One such partnership that you'll likely to hear a lot more about is Asset Backed Finance or ABF. We see major growth in this area, and we think it may ultimately provide roughly $800 billion of the required funding.
The stakes of this AI build out are high. It's not hyperbole to say that many large tech companies see this race to develop AI technology as non-negotiable. The cost of simply competing in this race, let alone winning it – could be enormous. The positive side of this whole story is that we're in the early innings of one of the next great runs of productive capital investment, something that credit markets have helped fund for hundreds of years.
The risks, as can often be the case with large spending, is that more is built than needed; that technology does change, or that more mundane issues like there not being enough electricity change the economics of the endeavor.
AI will be a theme set to dominate the investment debate for years to come. Credit may not be the main vector of the story. But it's certainly a critical part of it.
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.
U.S. tariffs have had limited impact so far on inflation and corporate earnings. Our Head of Corporate Credit Research Andrew Sheets explains why – and when that might change.
Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.
Today I'm going to talk about why tariffs are showing up everywhere – but the data; and why we think this changes this quarter.
It's Wednesday, July 16th at 2pm in London.
Investors have faced tariff headlines since at least February. The fact that it's now mid-July and markets are still grinding higher is driving some understandable skepticism that they're going to have their promised impact. Indeed, we imagine that maybe more of one of you is groaning and saying, ‘What? Another tariff episode?’
But we do think this theme remains important for markets. And above all, it's a factor we think is going to hit very soon. We think it's kind of now – the third quarter – when the promised impact of tariffs on economic data and earnings really start to come through.
My colleague Jenna Giannelli and I discussed some of the reasons why, on last week's episode focused on the retail sector. But what I want to do next is give a little bit of that a broader context.
Where I want to start is that it's really about tariff impact picking up right about now. The inflation readings that we got earlier this week started to show US core inflation picking up again, driven by more tariff sensitive sectors. And while second quarter earnings that are being reported right about now, we think will generally be fine, and maybe even a bit better than expected; the third quarter earnings that are going to be generated over the next several months, we think those are more at risk from tariff related impact. And again, this could be especially pronounced in the consumer and retail sector.
So why have tariffs not mattered so much so far, and why would that change very soon? The first factor is that tariff rates are increasing rapidly. They've moved up quickly to a historically high 9 percent as of today; even with all of the pauses and delays. And recently announced actions by the US administration over just the last couple of weeks could effectively double this rate again -- from 9 percent to somewhere between 15 to 20 percent.
A second reason why this is picking up now is that tariff collections are picking up now. US Customs collected over $26 billion in tariffs in June, which annualizes out to about 1 percent of GDP, a very large number. These collections were not nearly as high just three months ago.
Third, tariffs have seen pauses and delayed starts, which would delay the impact. And tariffs also exempted goods that were in transit, which can be significant from goods coming from Europe or Asia; again, a factor that would delay the impact. But these delays are starting to come to fruition as those higher tariff collections and higher tariff rates would suggest.
And finally, companies did see tariffs coming and tried to mitigate them. They ordered a lot of inventory ahead of tariff rates coming into effect. But by the third quarter, we think they've sold a lot of that inventory, meaning they no longer get the benefit. Companies ordered a lot of socks before tariffs went into effect. But by the third quarter and those third quarter earnings, we think they will have sold them all. And the new socks they're ordering, well, they come with a higher cost of goods sold.
In short, we think it's reasonable to expect that the bulk of the impact of tariffs and economic and earnings data still lies ahead, especially in this quarter – the third quarter of 2025. We continue to think that it's probably in August and September rather than June-July, where the market will care more about these challenges as core inflation data continues to pick up.
For credit, this leaves us with an up in quality bias, especially as we move through that August to September period. And as Jenna and I discussed last week, we are especially cautious on the retail credit sector, which we think is more exposed to these various factors converging in the third quarter.
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.
As U.S. retailers manage the impacts of increased tariffs, they have taken a number of approaches to avoid raising prices for customers. Our Head of Corporate Strategy Andrew Sheets and our Head of U.S. Consumer Retail and Credit Research Jenna Giannelli discuss whether they can continue to do so.
Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.
Jenna Giannelli: And I'm Jenna Giannelli, Head of U.S. Consumer and Retail Credit Research.
Andrew Sheets: And today on the podcast, we're going to dig into one of the biggest conundrums in the market today. Where and when are tariffs going to show up in prices and margins?
It's Friday, July 11th at 10am in New York.
Jenna, it's great to catch up with you today because I think you can really bring some unique perspective into one of the biggest puzzles that we're facing in the market today. Even with all of these various pauses and delays, the U.S. has imposed historically large tariffs on imports. And we're seeing a rapid acceleration in the amount of money collected from those tariffs by U.S. customs. These are real hard dollars that importers – or somebody else – are paying. Yet we haven't seen these tariffs show up to a significant degree in official data on prices – with recent inflation data relatively modest. And overall stock and credit markets remain pretty strong and pretty resilient, suggesting less effect.
So, are these tariffs just less impactful than expected, or is there something else going on here with timing and severity? And given your coverage of the consumer and retail sectors, which is really at the center of this tariff debate – what do you think is going on?
Jenna Giannelli: So yes, this is a key question and one that is dominating a lot of our client conversations. At a high level, I'd point to a few things. First, there's a timing issue here. So, when tariffs were first announced, retailers were already sitting on three to four months worth of inventory, just due to natural industry lead times. And they were able to draw down on this product.
This is mostly what they sold in 1Q and likely into 2Q, which is why you haven't seen much margin or pricing impact thus far. Companies – we also saw them start to stock up heavily on inventory before the tariffs and at the lower pause rate tariffs, which is the product you referenced that we're seeing coming in now. This is really going to help mitigate margin pressure in the second quarter that you still have this lower cost inventory flowing through.
On top of this timing consideration, retailers – we've just seen utilizing a range of mitigation measures, right? So, whether it's canceled or pause shipments from China, a shifting production mix or sourcing exposure in the short run, particularly before the pause rate on China. And then really leaning into just whether it's product mix shifts, cost savings elsewhere in the PNL, and vendor negotiations, right? They're really leaning into everything in their toolbox that they can.
Pricing too has been talked about as something that is an option, but the option of last resort. We have heard it will be utilized, but very tactically and very surgically, as we think about the back half of the year. When you put this all together, how much impact is it having? On average from retailers that we heard from in the first quarter, they thought they would be able to mitigate about half of the expected tariff headwind, which is actually a bit better than we were expecting.
Finally, I'll just comment on your comment regarding market performance. While you're right in that the overall equity and credit markets have held up well, year-to-date, retail equities and credit have fared worse than their respective indices. What's interesting, actually, is that credit though has significantly outperformed retail equities, which is a relationship we think should converge or correct as we move throughout the balance of the year.
Andrew Sheets: So, Jenna, retailers saw this coming. They've been pulling various levers to mitigate the impact. You mentioned kind of the last lever that they want to pull is prices, raising prices, which is the macro thing that we care about. The thing that would actually show up in inflation.
How close are we though to kind of running out of other options for these guys? That is, the only thing left is they can start raising prices?
Jenna Giannelli: So closer is what I would say. We're likely not going to see a huge impact in 2Q, more likely as we head into 3Q and more heavily into the all-important fourth quarter holiday season. This is really when those higher cost goods are going to be flowing through the PNL and retailers need to offset this as they've utilized a lot of their other mitigation strategies. They've moved what they could move. They've negotiated where they could, they've cut where they could cut. And again, as this last step, it will be to try and raise price.
So, who's going to have the most and least success? In our universe, we think it's going to be more difficult to pass along price in some of the more historically deflationary categories like apparel and footwear. Outside of what is a really strong brand presence, which in our universe, historically hasn't been the case.
Also, in some of the higher ticket or more durable goods categories like home goods, sporting goods, furniture, we think it'll be challenging as well here to pass along higher costs. Where it's going to be less of an issue is in our Staples universe, where what we'd put is less discretionary categories like Beauty, Personal Care, which is part of the reason why we've been cautious on retail, and neutral and consumer products when we think about sector allocation.
Andrew Sheets: And when do you think this will show up? Is it a third quarter story? A fourth quarter story?
Jenna Giannelli: I think this is going to really start to show up in the third quarter, and more heavily into the fourth quarter, the all-important holiday season.
Andrew Sheets: Yeah, and I think that’s what’s really interesting about the impact of this backup to the macro. Again, returning to the big picture is I think one of the most important calls that Morgan Stanley economists have is that inflation, which has been coming down somewhat so far this year is going to pick back up in August and September and October. And because it's going to pick back up, the Federal Reserve is not going to cut interest rates anymore this year because of that inflation dynamic.
So, this is a big debate in the market. Many investors disagree. But I think what you're talking about in terms of there are some very understandable reasons, maybe why prices haven't changed so far. But that those price hikes could be coming have real macroeconomic implications.
So, you know, maybe though, something to just close on – is to bring this to the latest headlines. You know, we're now back it seems, in a market where every day we log onto our screens, and we see a new headline of some new tariff being announced or suggested towards countries. Where do you think those announcements, so far are relative to what retailers are expecting – kind of what you think is in guidance?
Jenna Giannelli: Sure. So, look what we've seen of late; the recent tariff headlines are certainly higher or worse, I think, than what investors in management teams were expecting. For Vietnam, less so; I'd say it was more in line. But for most elsewhere, in Asia, particularly Southeast Asia, the rates that are set to go in effect on August 1st, as we now understand them, are higher or worse than management teams were expecting.
Recall that while guidance did show up in many flavors in the first quarter, so whether withdrawn guidance or lowered guidance. For those that did factor in tariffs to their guide, most were factoring in either pause rate tariffs or tariff rates that were at least lower than what was proposed on Liberation Day, right?
So, what's the punchline here? I think despite some of the revisions we've already seen, there are more to come. To put some numbers around this, if we look at our group of retail consumer cohort, credits, consensus expectations for calling for EBITDA in our universe to be down around 5 percent year-over-year. If we apply tariff rates as we know them today for a half-year headwind starting August 1st, this number should be down around 15 percent year-over-year on a gross basis…
Andrew Sheets: So, three times as much.
Jenna Giannelli: Pretty significant. Exactly. And so, while there might be mitigation efforts, there might be some pricing passed along, this is still a pretty significant delta between where consensus is right now and what we know tariff rates to be today – could imply for earnings in the second half.
Andrew Sheets: Jenna, thanks for taking the time to talk.
Jenna Giannelli: My pleasure. Thank you.
Andrew Sheets: And thank you as always for your time. If you find Thoughts to the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.
