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By Chetan Ahya, Morgan Stanley chief economist and global head of economics

Twice a year, the Morgan Stanley macro research team huddles in a time-honoured ritual – outlook season. We come together to debate and reassess our forecasts and narratives, challenging each other while collaborating to provide clients with a consistent and coherent view of the world.

In a few hours’ time, you will be receiving our 2021 outlooks in your inboxes. As a preview, here’s a summary of our views.

We remain constructive on the prospects for macro and markets in 2021. On the macro side, we think that the global economy will enter the next phase of the V-shaped recovery. In the first stage, the global economy has reached pre-COVID-19 output levels, a milestone we expect to pass this quarter. By 2Q21, we envision the economy getting back on its pre-COVID-19 path (i.e., where GDP would have been absent the COVID-19 shock).

Three features will distinguish the global economy in 2021:

1. A synchronous global recovery: At 6.4%Y, our 2021 global growth forecast remains above consensus (5.3%Y), a stance bolstered by the news on vaccines and antibody treatments. We are more bullish than consensus because we believe that the COVID-19 shock has not dampened private sector risk appetite significantly, while policy stimulus has proved to be more than a backstop. We think that a global synchronous recovery, last seen in 2017, will unfold in 2021. While rising COVID-19 cases may lead to tighter restrictions and weigh on DM activity in the near term, EM growth will continue to accelerate. Emerging from the winter, the easing of restrictions will lift growth in DMs, which will join the rest of the world from March/April 2021. While the consumer has been driving the recovery so far, we expect the capex cycle to kick in from 2Q21.
2. EMs boarding the reflation train: The past eight years have been tough for EMs, as a series of challenges have brought about a prolonged downturn. While it is tempting to blame structural issues for weak EM growth, we think that cyclical challenges and exogenous shocks (e.g., China and commodity price slowdowns, trade tensions and COVID-19) played a bigger role in keeping EM growth well below potential. However, we see a turn in 2021. The COVID-19 situation is now improving in a broad range of EMs and their recoveries are gaining momentum. In 2021, a widening US current account deficit, low US real rates, a weaker dollar, China’s reflationary impulse and EMs ex China’s own accommodative domestic macro policies will lead to a sharp rebound in growth. As this cyclical recovery takes hold, it can help create a virtuous cycle where stronger nominal GDP growth alleviates some of the pressure from structural issues like the need to consolidate public finances.
3. Inflation regime change in the US: We see an altogether different inflation dynamic taking hold, especially in the US. While we argued for the return of inflation in this cycle earlier this year, 2021 will lay down the marker for this thesis. The US economy will reach both pre-COVID-19 levels and its pre-COVID-19 path over the course of 2021. Even so, both monetary and fiscal policy will remain much more accommodative relative to 4Q19. Our chief US economist Ellen Zentner expects underlying core PCE inflation to rise to 2% in 2H21 and move sustainably higher from 1H22. In contrast, the consensus doesn’t expect inflation to reach 2% until 2022.

A constructive macro view provides a supportive backdrop for risk assets: Our chief cross-asset strategist Andrew Sheets believes that while abnormality defined 2020, 2021 will be characterised by a return to more normal conditions (economic growth recovering, control of the virus improving and uncertainty declining). Markets will also follow much of the ‘normal’ post-recession playbook. Our strategy team recommends investors overweight equities and credit against government bonds and cash and sell USD. Within equities, they would overweight cyclicals and underweight defensives across regions, and expect US small-caps to outperform large-caps.

The risks to our views are twofold. In the near term, an even sharper rise in hospitalisations in the US or Europe could prompt policy-makers to adopt stricter lockdown measures than our base case, pushing near-term growth lower and also delaying the return to the pre-COVID-19 path. Looking a bit further out, US inflation could surprise to the upside from 2H21, particularly if we get a large fiscal package. This could challenge the market’s view on inflation and create a disruptive shift in expectations for Fed policy.

US equity futures surged out of the gate following the 6pm ET reopen. There was some debate as to the catalyst: according to some the Moderna covid vaccine may hit as early as tomorrow, and a favorable outcome would have a similar result to last Monday’s Pfizer surprise which sent the S&P as high as 3,668 before fading much of the losses.

As JPMorgan said over the weekend when discussing the likelihood of a continuation of the “value” stock rotation, “this makes the forthcoming vaccine announcement by Moderna particularly important as a comparable vaccine effectiveness to that of the Pfizer earlier this week “would help to sustain this week’s value rotation trade. At the same time, an announcement of vaccine effectiveness by Moderna that would be seen as significantly weaker could prompt some further reversal of the value rotation trade.”  

Another explanation for the spike in early risk sentiment floated by Bloomberg is that contrary to expectations, two of Joe  Biden’s coronavirus advisers said they oppose a nationwide U.S. lockdown as too blunt.

“There is certainly elevated chatter that potential shutdowns in the U.S. will weigh more in the near-term and maybe so, but investor sentiment is the most elevated since 2017,” Pepperstone head of research Chris Weston said.

Meanwhile, in an indication that the rally is not merely on the back of value stocks, the Nasdaq jumped even higher, and rose as much as 1% in early trading, which in turn would be a bet on continued deflation, and may be a result of growing trader convictions that in the absence of a sizable fiscal stimulus ($1 trillion or more), the Fed will likely step in with more QE, especially since the Treasury is facing net issuance of over $2.4 trillion in 2021 with less than $1 trillion currently monetized by the Fed under the current $80BN Treasury/month schedule.

Whatever the reason, on Friday both the S&P 500 and small caps (Russell 2000), rallied to new all time highs, and if the early euphoria is any indication…

… tomorrow we should see new records across the board, especially with the S&P is now poised for an upside breakout, a key technical according to Morgan Stanley’s Michael Wilson.

Something unexpected happened in China last week and it triggered a shockwave across Chinese bond markets.

The abrupt 1 billion yuan ($151 million) bond default on Friday of a state-owned coal mining company in Central China’s Henan province, one of China’s most populous provinces with more than 95 million people, set off reverberations across China affecting its parent company, industry peers and other state-owned bond issuers and triggered an investigation by the interbank bond market regulator. The default came just weeks after Brilliance Auto, a carmaker owned by the Liaoning provincial government which owns 25% of a venture with BMW, announced it would default on a 1 billion yuan bond which matured in late October.

As Caixin reports, Yongcheng Coal and Electricity Holding Group, which just last month got the highest possible, AAA rating from a domestic credit rating company, failed to repay an ultra-short-term bond that matured Tuesday, according to a statement posted by the Shanghai Clearing House.

The default of Yongcheng’s bond – which now has 24.4 billion yuan worth of bonds outstanding, among which 6 billion yuan will mature by the end of 2020 according to Bloomberg- immediately set off a chain reaction affecting other coal mining companies and local government financing vehicles in other provinces. As shown in the chart below, local government bonds as far away as Yunnan province were affected.

• Jizhong Energy Resources’s 5.4% 2021 note fell 7% to 87 yuan, a record low;
• Pingdingshan Tianan Coal Mining’s 5.07% 2023 bond rebounded modestly from a record low, last trading at 79.

A large state-owned bank directed institutional clients to sell all bonds issued by local governments in the southwestern province after Yunnan Urban Construction Investment Group Co.’s offshore bond plunged, according to Bloomberg.

Coal mining enterprises in Shanxi and Hebei provinces either canceled bond issuance plans or slashed fundraising targets. Traded coal bonds plunged across China. On Friday, the SSE 50 Index of Shanghai’s largest stocks slumped as much as 2.1%, led by banks and insurers as bonds of Chinese commodity producers tumbled after the Yongcheng default.

“The wind has changed direction,” a senior bond market participant told Caixin. Under the pressure of debt replacement, many local governments may have more incentive to let debt-ridden LGFVs or state-owned enterprises go bankrupt and restructure, the market participant said.

To be sure, the Yongcheng default is likely just the first of many: China’s coal industry suffered a big hit from the Covid-19 pandemic as demand weakened. Data from the National Bureau of Statistics indicated that the sector’s profits fell 30.1% year-on-year in the first nine months. Yongcheng Coal is also involved in fuel processing, an industry where profits plunged 66.2% during the same period.

In response, the National Association of Financial Market Institutional Investors (NAFMII), China’s interbank bond market regulator, said last Thursday it was launching a “self-disciplinary” investigation into Yongcheng and related intermediary institutions. NAFMII said the probe would look into whether Yongcheng and intermediary companies fully disclosed risks and could result in penalties or referrals to “relevant departments” if fraud and violations are found.

The Yongcheng default also caught institutional bondholders off guard. Even on the default date, some institutions had just bought the bond maturing that same day, an institutional bondholder told Caixin. Analysts at China International Capital Corp. said the default can be traced to certain historical reasons, but it exceeded market expectations.

As we reported a few months ago, parent company Henan Energy and Chemical Industry Group, the province’s largest state-owned company by assets, also defaulted on its own debt. The Henan government bailed it out, giving creditors some peace of mind, but this time, some institutional bondholders that failed to get their money back say they fear the provincial government won’t extend a helping hand.

Meanwhile, according to Caixin sources, the Henan government’s senior officials are debating whether the government should bail out Yongcheng.

The first company to take a hit was the parent company. In a statement, Henan Energy and Chemical said that existing debt financing instruments have cross-protection clauses for investors that were triggered by Yongcheng’s default.

Yongcheng and its parent have a total of 26.5 billion yuan of bonds that have such cross-protection clauses with a grace period of 10 business days. This means that if Yongcheng’s default constitutes a default of the parent’s corresponding debt, it may lead to further pressure on short-term debt payments.

The default, which marked a sea-change in how investors view China’s propensity to bailout SOE, immediately affected borrowing planned by other coal mining companies and local government financing vehicles (LGFVs). Shangqiu, a city next to Yongcheng, canceled a planned issuance of 500 million yuan of LGFV bonds Thursday. A bond market participant told Caixin that the underwriters for the Shangqiu bond said a day earlier that the issuance would go as planned.

* * *

And yet, as bonds tumbled the “Robinhooders” of the institutional world quickly swooped in to BTFD: according to the FT, vulture funds are racing to buy bonds of troubled Chinese state-owned enterprises, after the sharp sell-off.

“The central government won’t allow the situation to deteriorate as that could lead to systemic risks,” said a hopeful David Huang, a Shanghai-based bond fund manager who spent Rmb20m to buy a three-year note by Brilliance Auto for 20 cents on the dollar. “That creates an investment opportunity” he added hoping that the PBOC would do what the Fed did in March and backstop the distressed issuers.

Not everyone agreed: other investors viewed the defaults as a sign that government bailouts of distressed state companies, once taken for granted by most investors, could no longer be guaranteed. “Our investment decision had been based on the belief that triple-A rated state firms are safe investments regardless of their fundamentals,” said the chief ratings officer at a Shanghai-based bond fund. “That’s no longer the case.”

And as investors grappled with the new reality of a China where risk of default is once again an overarching consideration, they were also puzzled by the defaults in part because many of the SOEs had previously boasted seemingly strong fundamentals. As noted above both Yongcheng and Brilliance had received triple A ratings and each had more than 20 billion yuan in  cash on their balance sheet, according to their most recent financial statements.

“What else can we trust if both the rating agencies and financial statements aren’t credible?” asked the Shanghai fund manager.

Making matters worse, investors were also unnerved that Yongcheng and Brilliance have spun off profitable assets before defaulting, including Brilliance’s shares in the BMW joint venture: “This has set a bad example, that the SOEs can be as irresponsible as private firms in avoiding debt payment,” one Yongcheng creditor said, shocked that the Chinese government can be, gasp, “irresponsible”.

Yet for the BTFDers of the world, the crash presents a buying opportunity: managers of vulture funds told the Financial Times they had placed “significant” purchase orders for bonds issued by struggling SOEs, under the expectation that regional governments will step in (and effectively bail them out if they made the wrong decision: “If they let Yongcheng or Brilliance go under, no state firms in Henan or Liaoning will ever be able to tap the bond market again,” said Mr Huang. “The government won’t let that happen.”

Maybe… but suddenly bets that China will just keeping bail everyone out look far more risky. In a lengthy twitter thread, famed China strategist and finance professor Michael Pettis laid out his thoughts on the subject of vulture funds buying the troubled bonds, and why this could prove to be a catastrophic “strategy”:

Very interesting article: China-based high-yield funds have rushed in to buy bonds of troubled Chinese state-owned enterprises on the back of a sharp sell-off caused by the default last week of a Henan coal-mining SOE.

Their buying, however, has almost nothing to do with credit analyses and is little more than a highly-speculative, binomial bet on whether or not the government will step in, as they have in the past, and restructure liabilities in a way that resolves the default.

Basically these funds are betting that, once again, the regulators will be so frightened by the short-term impact of allowing a default that they back away and arrange a bailout. One fund manager cited in this article makes no bones about the strategy: “The central government won’t allow the situation to deteriorate as that could lead to systemic risks.”

He adds: “If they let Yongcheng or Brilliance go under, no state firms in Henan or Liaoning will ever be able to tap the bond market again. The government won’t let that happen.”

I spent much of my career trading developing-country bonds, and I’ve seen many versions of this game before. This really isn’t an investment “strategy”. It is nothing more than a very simple bet that the regulators still have enough firepower to prevent defaults, and that they think the short-term costs of allowing defaults still exceed the long-term benefits. Until the regulators decide that they cannot keep kicking the can down the road, a strategy of buying bad news will always be profitable, after which the strategy will always blow up.

This is just Russian roulette, in other words: you’ll probably win any given round, and every time you win you will be more convinced than ever that the odds are in your favor, but they aren’t. This “strategy” always ends the same way.

The irony here is that longer the game goes on, and the more investors play this game, the more they undermine the long-term ability of the market to act as an efficient allocator of capital, and the more costly they make it for the regulator to keep preventing defaults.

Once regulators believe that long-term costs of keeping the game going exceed short-term cost of allowing real defaults, or once too-high debt levels reduce their ability to kick the can further down the road, they will bite the bullet and allow the defaults to take place.

The only question is when will that time come: in the case of Yongcheng it was last Friday; the problem is that in China there are thousands of similar SOE, which are effectively insolvent absent government support, and if the rug is suddenly pulled from underneath them one by one, China can forget all about the great influx of foreign capital that it needs in a time when it hopes to fund its nascent current account deficit and replicate the US experience of having foreign investors fund China’s economic growth going forward.

Authored by Jack Phillips via The Epoch Times,

Former federal prosecutor Sidney Powell, a Trump campaign lawyer, suggested in a Sunday interview that there is still more evidence coming out in President Donald Trump’s claims of voter fraud and irregularities.

“We’re getting ready to overturn election results in multiple states,” Powell said, saying that she has enough evidence of election fraud to launch a widespread criminal investigation.

“I don’t make comments without having the evidence to back it up,” she added, saying that elections software switched “millions of votes” from Trump to Democratic nominee Joe Biden.

Powell notably provided legal counsel to Gen. Michael Flynn in 2019. She was named to Trump’s legal team in the past several days.

Powell said a whistleblower came forward and said the elections software was designed to “rig elections,” saying that “he saw it happen in other countries,” referring to voting systems Dominion Voting Systems and Smartmatic, or perhaps other software and machines.

“We have so much evidence, I feel like it’s coming in through a fire hose,” Powell said, while noting that she won’t reveal the evidence that she has.

“They can stick a thumb drive in the [voting] machine, they can upload software to it even from the Internet … from Germany or Venezuela even,” she said, adding that operations “can watch votes in real-time” and “can shift votes in real-time,” or alleged bad actors can “remote access anything.”

“We’ve identified mathematically the exact algorithm they’ve used—and planned to use from the beginning” that allegedly switched votes to Biden, Powell remarked.

Powell also made reference to a 2019 investigation from Sens. Amy Klobuchar (D-Minn.), Elizabeth Warren (D-Mass.), Ron Wyden (D-Ore.), as well as other Democratic lawmakers into Dominion Voting Systems, Election Systems & Software, and Hart InterCivic. The senators had expressed concerns about the security of the voting systems.

“(W)e have concerns about the spread and effect of private equity investment in many sectors of the economy, including the election technology industry—an integral part of our nation’s democratic process,” wrote the lawmakers in their letters to the firms about a year ago.

“These problems threaten the integrity of our elections and demonstrate the importance of election systems that are strong, durable, and not vulnerable to attack.”

Later in the Sunday morning interview, Powell said that her team has “detected voting irregularities that are inexplicable” in states where officials believe they have valid systems.

Democratic presidential nominee Joe Biden, left, and President Donald Trump in file photographs. (Getty Images; Reuters)

During the election, Republicans in the House were able to flip at least 11 seats while the GOP is poised to maintain control of the Senate. Some conservatives have questioned how such a voting pattern is possible for Biden to win the presidential election, let alone receive more votes than any other presidential candidate in American history, including President Barack Obama’s victory in 2008.

Companies Respond

The Department of Homeland Security’s cybersecurity agency issued a statement on Thursday calling the 2020 general election the “most secure in American history,” despite multiple legal challenges alleging a variety of alleged voting irregularities across a number of battleground states.

“The November 3rd election was the most secure in American history. Right now, across the country, election officials are reviewing and double-checking the entire election process prior to finalizing the result,” read the statement released by the Cybersecurity and Infrastructure Security Agency (CISA).

Smartmatic, in a statement on Saturday, said that it has no ties with Dominion Voting Systems. Powell suggested that Smartmatic is operated by Dominion in the interview.

Dominion, over the past several weeks, has repeatedly denied its systems were compromised in some way.

“In the aftermath of the 2020 general election, there has been a great deal of misinformation being circulated about Smartmatic and other companies that provide election technology to voting jurisdictions in the US. We would like to dispel these incorrect statements with facts,” the firm wrote, adding that it “has never owned any shares or had any financial stake in Dominion Voting Systems.”

Dominion also refuted allegations that its machines changed votes from Trump to Biden on Election Day and beyond.

“Dominion Voting Systems categorically denies any claims about any vote switching or alleged software issues with our voting systems,” a company spokesperson said in a statement to The Denver Post. “Our systems continue to reliably and accurately count ballots, and state and local election authorities have publicly confirmed the integrity of the process.”

If Joe Biden wants to deliver on the Democrats’ promise of eliminating hundreds of billions of dollars in student debt, he is likely going to need a Democratic Senate to do so.

And a Democratic senate hinges on two Georgia races in January, the Wall Street Journal notes. If Democrats lose those, they could try to force through forgiveness as an executive order, though there is no guarantee it will survive a legal challenge.

Democrats know that nothing secures voting loyalty more than promises of “free stuff” – maybe this is why it was literally days after the election, on November 12, with results still being contested, that Elizabeth Warren reminded Joe Biden publicly that she wanted him to cancel the debt (as if we all didn’t already know):

WARREN URGES BIDEN TO CANCEL BILLIONS DOLLARS OF STUDENT DEBT

Congrats to everyone who paid theirs off legitimately

— Quoth the Raven (@QTRResearch) November 12, 2020

Warren had previously paired with Chuck Schumer and joined another 13 Democrats who introduced a resolution urging up to $50,000 in loan forgiveness per borrower via executive action. It was never taken up by a full Senate. 

As a reminder, Biden campaigned on trying to forgive $10,000 in debt for every American with student loans to help them deal with the economic effects of the pandemic. He has also sought to forgive debts to public colleges for those earning under $125,000 per year and anyone who can show they were “defrauded” by for-profit colleges. 

Democrats already tried to get $10,000 in relief through for all borrowers this year as part of the CARES Act, but wound up compromising with a Republican Senate to suspend debt payments through September 30. The Republican Senate still broadly opposes large-scale debt forgiveness, an aide told the WSJ.

Robert Shireman, an Education Department official, formerly of the Obama administration, said: “I do expect that the Biden administration will take some action on student debt outside of anything that happens through Congress. The question is how far they will go.”

Meanwhile, we noted a Schiff Gold report days ago that said in Q3, student loan balances rose by $23 billion from the second quarter, citing Federal Reserve data. Forty-five million Americans now owe $1.7 trillion in student loan debt. Total outstanding student loan balances have surged by $54 billion year-on-year.

One of the reasons student loan debt continues to increase despite falling college enrollment is the glut of student loan money pushed up the cost of a college education. The federal government pushed the widespread availability of student loans. It was supposed to make it possible for everybody to go to college.

But there was an unintended consequence. It made a university education unaffordable and ended up saddling millions of Americans with crushing levels of debt. Studies have shown the influx of government-backed student loan money into the university system is directly linked to the surging cost of a college education.

Another reason student loan balances continue to surge upward is that borrowers aren’t making payments on their loan principal. This was a trend before the pandemic that has accelerated in the year. Many student loans were moved into automatic forbearance as the coronavirus economic chaos unfolded. President Trump signed an executive order extending interest-free federal student loan forbearance through Dec. 31, 2020.

More than 1 in 4 student loan borrowers are either in delinquency or default.

But don’t worry. Neel Kashkari has an app for that. Brrr…

Authored by Zachary Stieber via The Epoch Times,

Social media website Parler said Saturday that its previously unknown investor is billionaire Rebekah Mercer, after speculation from some activists that the site was linked to Russia…

In a press release, Parler said Mercer is backing the site.

“Rebekah Mercer is a great friend, an American patriot, and most importantly committed to the Parler vision of neutrality and data privacy. We are grateful for her support since 2018, and her early faith in the founders has enabled us to reach these heights,” CEO John Matze said in a statement.

Mercer said she started Parler with Matze “to provide a neutral platform for free speech, as our founders intended, and also to create a social media environment that would protect data privacy.”

“Benjamin Franklin warned us: ‘Whoever would overthrow the liberty of a nation must begin by subduing the freeness of speech.’ The ever increasing tyranny and hubris of our tech overlords demands that someone lead the fight against data mining, and for the protection of free speech online. That someone is Parler, a beacon to all who value their liberty, free speech, and personal privacy,” she added.

Mercer, 46, is the daughter of hedge fund manager Robert Mercer. The Mercer family has donated to a bevy of conservative companies and causes over the years.

Mercer “is widely known for her dedication to philanthropy and upholding American values,” Parler said.

Dan Bongino speaks onstage during Politicon 2018 at the Los Angeles Convention Center in Los Angeles, Calif., on Oct. 21, 2018. (Phillip Faraone/Getty Images for Politicon)

The unknown backing of Parler, which is partially owned by conservative radio host Dan Bongino, was subject to rampant speculation.

Dave Troy, co-curator of Tedx MidAtlantic and self-described disinformation specialist, claimed that the site was linked to Russia because Matze is married to a Russian national.

A screengrab that appeared to be from Fox News showing a chryon about Parler being backed by left-wing billionaire George Soros also circulated on social media. A Fox News spokeswoman confirmed to The Epoch Times that the screengrab was fake.

Parler bills itself as a free speech social media platform. According to its community guidelines, Parler acts against illegal content like child pornography but will not remove content or accounts “on the basis of the opinion expressed within the content at issue.”

“Parler’s policies are, to use a well-known concept in First Amendment law, viewpoint-neutral,” the guidelines state.

The number of accounts skyrocketed from about 4.5 million to 10 million in recent days.

Matze said the reason is people don’t trust big technology companies like Facebook and Twitter amid an escalation in censorship on those platforms.

“They’re really overreaching to an extent that’s scary, and people are really realizing this. They’re waking up and saying: we’ve got to do something about it,” Matze said.