Stock tickers may not immediately price in uncertainty during times of geopolitical volatility. Our Head of Corporate Credit Research Andrew Sheets suggests a different indicator to watch.

Read more insights from Morgan Stanley.

----- Transcript -----

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 how we're trying to simplify the complicated questions of recent geopolitical events.

It's Friday, June 27th at 2pm in London.

Recent U.S. airstrikes against Iran and the ongoing conflict between Iran and Israel have dominated the headlines. The situation is complicated, uncertain, and ever changing. From the time that this episode is recorded to when you listen to it, conditions may very well have changed again.

Geopolitical events such as this one often have a serious human, social and financial cost, but they do not consistently have an impact on markets. As analysis by my colleague, Michael Wilson and his team have shown, over a number of key geopolitical events over the last 30 years, the impact on the S&P 500 has often been either fleeting or somewhat non-existent. Other factors, in short, dominate markets.

So how to deal with this conundrum? How to take current events seriously while respecting that historical precedent that they often can have more limited market impact? How to make a forecast when quite simply few investors feel like they have an edge in predicting where these events will go next?

In our view, the best way to simplify the market's response is to watch oil prices. Oil remains an important input to the world economy, where changes in price are felt quickly by businesses and consumers.

So when we look back at past geopolitical events that did move markets in a more sustained way, a large increase in oil prices often meaning a rise of more than 75 percent year-over-year was often part of the story. Such a rise in such an important economic input in such a short period of time increases the risk of recession; something that credit markets and many other markets need to care about. So how can we apply this today?

Well, for all the seriousness and severity of the current conflict, oil prices are actually down about 20 percent relative to a year ago. This simply puts current conditions in a very different category than those other periods be they the 1970s or more recently, Russia's invasion of Ukraine that represented genuine oil price shocks. Why is oil down? Well, as my colleague Martin Rats referred to on an earlier episode of this program, oil markets do have very healthy levels of supply, which is helping to cushion these shocks.

With oil prices actually lower than a year ago, we think the credit will focus on other things. To the positive, we see an alignment of a few short-term positive factors, specifically a pretty good balance of supply and demand in the credit market, low realized volatility, and a historically good window in the very near term for performance. Indeed, over the last 15 years, July has represented the best month of the year for returns in both investment grade and high yield credit in both the U.S. and in Europe.

And what could disrupt this? Well, a significant spike in oil prices could be one culprit, but we think a more likely catalyst is a shift of those favorable conditions, which could happen from August and beyond. From here, Morgan Stanley economists’ forecasts see a worsening mix of growth in inflation in the U.S., while seasonal return patterns to flip from good to bad.

In the meantime, however, we will keep watching oil.

Thank you as always for your time. If you find Thoughts the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

Our Australia Materials Analyst Rahul Anand discusses why critical minerals may be the Achilles’ heel of humanoids as demand significantly outpaces supply amid geopolitical uncertainties.

Read more insights from Morgan Stanley.

----- Transcript -----

Rahul Anand: Welcome to Thoughts on the Market. I'm Rahul Anand, Head of Morgan Stanley’s Australia Materials Research team.

Today, I'll dig deeper into one of the vital necessities for the development of robotics – critical minerals – and why they're so vital to be front of mind for the Western world today.

It's Wednesday, June 25th at 8am in Sydney, Australia.

Humanoid robots will soon become an integral part of our daily lives. A few weeks ago, you heard my colleagues Adam Jonas and Sheng Zhong discuss how humanoids are going to transform the economy and markets. Morgan Stanley Research expects this market to reach more than a billion units by 2050 and generate almost [$] 5 trillion in annual revenue.

When we think about that market, and we think about what it could do for critical minerals demand, that could skyrocket. And the key areas of critical minerals demand would basically be focused on rare earths, lithium and graphite.

Each one of these complex machines is going to require about a kilo of rare earths, 2 kgs of lithium, 6.5 kgs kilos of copper, 1.5 kgs of nickel, 3 kgs of graphite, and about 200 grams of cobalt. Importantly, this market from a cumulative standpoint by the year 2050, could be to the tune of about $800 billion U.S., which is staggering.

And beyond that market size of $800 billion U.S., I think it's important to drill a bit deeper – because if we now consider how these markets are dominated currently, comes the China angle. And China currently dominates 88 percent of rare earth supply, 93 percent of graphite supply and 75 percent of refined lithium supply. China recently placed controls on seven heavy rare earths and permanent magnet exports in response to tariff announcements that were made by the U.S., and a comprehensive deal there is still awaited.

It's very important that we have to think about diversification today, not just because these critical minerals are so heavily dominated by China. But more importantly, if we think about how the supply chain comes about, it's now taking circa 18 years to get a new mine online, and that's the statistic for the past five years of mines that came online. That number is up nearly 50 percent from last decade, and that's been driven basically by very long approval processes now in the Western world, alongside very long exploration times that are required to get some of these mines up and running.

On top of that, when we think about the supply demand balance, by 2040 we're expecting that the NdPr, or the rare earth, market would be in a 26 percent deficit. Lithium could be in a deficit close to 80 percent. So, it's not just about supply security. It's also about how long it will take to bring these mines on. And on top of that, how big the amount of supply that's required is really going to be.

I know when you think about 2040, it sounds very long dated, but it's important to understand that we have to act now. And in this humanoid piece of research that we have done as the global materials team, which was led by the Australian materials team, we basically have provided 34 global stocks to play this thematic in the rare earths, lithium and rare earth magnet space.

It's also very important to remember and keep front of mind that as part of the London negotiations that happened between U.S. and China, no agreement was reached on critical military use rare earth magnets and exports. Now that's an important point because that's going to play as a key point of leverage in any future trade deal that comes about between the two countries.

This remains an evolving situation, and this is something that we are going to continue monitoring and will bring you the latest on as time progresses.

Look, thanks for listening. If you enjoy the show, please leave us a review and share thoughts on the market with a friend or colleague today.