The World You Knew Is Never Coming Back with Morgan Stanley’s Michael Zezas

12:03Michael Zezas:Pretty much. Yeah. Not, not by design by accident. I feel like most of my good career moves have been by accident as opposed to design.

12:10Downtown Josh Brown:Yeah. So, all right. But so everyone in the industry is getting those questions. Yeah. So, uh, but you are at that time at one of the largest investment banks in the world.

12:20Michael Zezas:Yeah.

12:20Downtown Josh Brown:So I would imagine the volume is higher, but also the level at which people are making investment decisions based on what you say is significant.

12:29Michael Zezas:Yeah.

12:30Downtown Josh Brown:You were also in uncharted waters. We had never seen a first presidential term like that.

12:35Michael Zezas:Yeah.

12:35Downtown Josh Brown:So how did you, how did you navigate that and actually give people something that was meaningful, but not commit to something where you couldn't have possibly known the outcome?

12:45Michael Zezas:Well, I think the first thing is we came into that environment with a really good collaborative culture as a research department. so I could define with a decent degree of conviction on my own like what I thought a Trump presidency was going to mean in terms of this policy will happen this one won't and here are kind of ones that are uncertain but in any case you know now let's like map out the fundamental impacts and we had enough people with enough collaborative interest to do that that we were able to put together roadmaps into the election in 2016 and then throughout 2017 we're like okay If tax policy happens this way versus that way, it's going to mean, you know, this fundamentally for this sector, let's compare it to valuation and let's, right.

13:27Michael Zezas:So there was enough people to collaborate with in a good culture that we could work on a cross asset, cross region basis to map all this stuff out. So really like credit to my colleagues and to the culture of Morgan Stanley. You know, from there, it did start feeling like we were like chasing our tail a little bit. And this is where I always try to, if I can, like carve out time, be like, can we step back and put together like a secular theme or like a framework that we can, we think it's going to be durable for years. And so it became pretty obvious in 2017 that this was not business as usual.

14:05And a lot of clients were asking us the question, hey, like, when is this going back to business as usual?

14:12Michael Zezas:Okay. Like, you know, we were starting to flirt with tariffs. those income into play in 2018 um but you know president trump calling ceos into the white house like all sorts of stuff that just you know now seems like quaint but then just seemed wild these

14:27Downtown Josh Brown:were to your point these were bombs being dropped on the market on a daily he would tweet at the ceo of pfizer right and voice his displeasure over drug pricing and pfizer would lose 50 billion dollars in market cap yeah like these were not trivial things they now we look back and we laugh because you know none of those bombs actually detonated and did any lasting damage but like in that moment market participants were like shocked like oh wait a minute yeah the white house is now a player on the on the chessboard yeah and like is the queen frankly right so we'd

15:02Michael Zezas:be taking those style of questions from hedge fund managers but then you know official institutions overseas central banks would be like okay just like tell us how long we need to like white knuckle this until things go back to it to normal and then is it going to be 2005 again right yeah and so and my view was and we ended up putting a lot of work around it was like things are not going back to normal in fact um what you're seeing is kind of what american voters have elected maybe they haven't elected the tactical application of it. But when you kind of look back, a lot of things had changed underneath the surface.

15:40Michael Zezas:It's like Jake Sullivan, who was national security advisor under Biden, talks about it as the new Washington consensus. It's sort of very clear in hindsight. But the old Washington consensus was like, you know, whether you're Republican or Democrat, going back to the early 80s all the way, you know, maybe let's call it until the financial crisis, you agreed on certain things. You're like, free trade's a good idea. The government should not be involved in the economy. Multilateral institutions are good, right? Soft power in the U.S. is a good idea. And now, if you look at voter attitudes, they're like, we don't really see the value in any of that.

16:21Michael Zezas:Now, maybe they don't see the value in jacking tariffs up all the way or going to war in the Middle East, right? Or that's what the polling would suggest. But they don't see value in supporting some of those principles that were kind of key to this U.S.-led, principles-based, laissez-faire economics, international economic system that like everyone - They didn't benefit them. Right. Or at least they didn't see those benefits, right? Right.

16:49Downtown Josh Brown:It benefited, but not in a direct enough way where they said, yes, I care about NATO. or I care about NAFTA, or I think it's good that China is in the WTO. Like, they either were very against those things because they hadn't seen any real wage growth in 15 years. And their communities had opioid addiction problems and they had family members who were sent into wars of choice. And they just looked away after 15 years of that shit. They were like, this isn't helping me. I'm not getting ahead. The economy is leaving me behind. I want to vote for volatility. I want somebody to break everything.

17:28Michael Zezas:Yeah. And so like you could see that right in front of your face. And if the counter argument is, well, let me explain to you why free trade has been really good relative to like a past you didn't actually experience. Yeah. What's that saying? When you're explaining you're losing, right? Like, so that's not to say that voters have elected the optimal outcome here, but it's what they've chosen.

17:52Downtown Josh Brown:Right. So you arrived at that in the late 20-teens. Like, not only is this very different, but also it's not going back. Yeah. And it's probably going further.

18:02Michael Zezas:Yeah. And so this was the genesis of our whole multipolar world thematic.

18:07Downtown Josh Brown:So brag about that because you were right. I'll quote you to you, and then you can react. From 2020, our call was and is that there's been a regime change driven by shifting voter preferences. and with it comes the need for financial decision makers of all kind to invest with the understanding that the best benefits of globalization were behind us and that geopolitical fragility is on the rise okay great we're six years uh hence great call yeah okay yeah i mean and now

18:38Michael Zezas:identifying this early was i think important but it was also sort of complicated at the time to understand when these trends would actually manifest in like real, you know, tangible investable themes. Right. Because, you know, you, I think we said with a high degree of confidence, like trade barriers are going up, they're not coming down. Right. And, you know, obviously Biden was president in between Trump's two terms. And, um, we always run an investor survey ahead of the election and the investor survey ahead of 2020, most investors said, yeah, that Trump winning would be better for markets than Biden.

19:17Michael Zezas:But if you answered Biden was better for markets, you were also very likely to answer a separate question on the survey that said, oh, well, Biden's going to take tariffs down. We're going to roll them back. Right. And then we didn't. Which was wrong. Because it's, first of all, it's not as if the Democrats and Biden wanted to go back to some free trade norm with China. And in fact, they kind of want to do the opposite, but their tactics were very different. So of course you wouldn't bring down tariffs proactively if you're trying to negotiate with China. So the point that like the direction of travel and trade barriers, whether they're going to be tariff or non-tariff driven was like, was pretty obvious.

19:54Michael Zezas:The direction of travel on industrial policy, which is to say the government getting more involved. It was pretty obvious. So you just needed time to work out in terms of manifesting into, okay, money being spent on, for lack of a better term, re-industrialization. Reshoring, onshoring, whatever you want to call it. Yeah. And then of course, with the US sort of exercising a different stature on the global stage and some of these geopolitical conflicts coming together, Russia, Ukraine, now the US and Iran sort of highlighting some very critical choke points, you know, corporate America, C-suites across the globe kind of get the message.

20:34Michael Zezas:Like we, you know, we can no longer sort of optimize for globalization. We need what our investment bankers call an anti-fragile strategy. So you're starting to get these supply chain shifts to work around those choke points, to work around those other sensitivities. Some of them self-imposed by the U.S. or trade bearers to say, we don't want people doing this kind of business in China. and it takes a long time and a lot of money to rewire those things.

21:01Downtown Josh Brown:I would say no stock better exemplifies what you're talking about than Intel. So this is a company that was ridiculed for having adopted this strategy of, we're going to be the fab that's based in North America, not Taiwan.

21:13Michael Zezas:Yeah.

21:13Downtown Josh Brown:And we are going to build microchip plants in Arizona, because of course. And the stock price, I think, derates, I don't know, 20 multiple points. Yeah. It's almost like a single digit. It almost trades like an automaker. And then they start losing money. And all of a sudden, there's this idea driven in part by what you're talking about, the White House directly, but also sort of the needs of the industry post lockdowns and post inflation is like we can't rely on just chips from Taiwan. We need to actually have stuff that gets made here. and there's a total rethink on intel and then they join the ai parade yeah and then you see a stock go from i don't know where it was fifteen dollars to eighty dollars yeah um and that's a lot of market cap along the way you think that's like sort of what we're what we're getting at yeah and

22:08Michael Zezas:it's a good example here of some of the policy continuity right because obviously the government took a stake where did right they took a stake in intel which is a big departure and where that come from that came from the chips act which was something that was completed on a bipartisan basis when Joe Biden was president. So there's actually a fair amount of continuity across these industrial policy choices. And I'd argue, you know, we're starting to get questions about the midterms and midterm elections. I think that's going to be a lot more noise than signal, any outcome there. There's not a lot of policy change that comes out of different midterm election outcomes.

22:44Michael Zezas:Policy continuity is actually far more important. So that, and like, we haven't even started talking about AI yet. You sort of have like AI is kind of this like exogenous technological shock driving tons of CapEx. And then I'd say a largely like a policy driven, okay, impetus to just, well, we're going to spend a lot of money to rewire global commerce in a way that we think suits our values better. Is that economically optimal or not? I think an economist would probably say not, but you know, it almost doesn't even matter what the answer to that question is, but like, you know, it's good for winning elections.

23:22Downtown Josh Brown:So that's, that's why it's the policy.

23:24Michael Zezas:Well, and, and either way we're going to spend trillions of dollars trying to figure it out.

23:29Michael Batnick:Michael, I think it's, it's really hard to draw a direct line from policy to investing all of the time. You say it's noisy now. I think it's always noisy. Yeah. And I think maybe this has an inkling to do with the rise of the prediction markets because there is so much geopolitical uncertainty. And even if you get a policy call right or whatever, you then have to nail how investors are going to react to that. And now it's like, well, F all that. Let's just go straight to the source. Like, will this happen? Yes or no. I don't have to bet on this and then industrials.

24:00Downtown Josh Brown:Will the Democrats take the house or not? I don't need to figure out what stocks to buy. Right. Will CPI come in?

24:06Michael Batnick:Will CPI come in hot or cold? And then I have to figure out, well, man, are stocks extended? Do I buy gold?

24:12Downtown Josh Brown:Do I sell gold? Yeah.

24:13Michael Zezas:Yeah, no, if you're talking about a sort of, first of all, we really like prediction markets as another probability assessment of what's going to happen. I don't think I have any edge on predicting election outcomes. We, you know, we know the uncertainty is implied by polls. OK, I think sometimes people put a lot of false precision on polls. If you treat them with a healthy amount of uncertainty that they deserve and you understand polling errors, none of the election outcomes over the last few cycles would have been all that surprising. Prediction markets, I think, are just like another very useful comparison to the polls and they help you with that.

24:55Michael Zezas:Yeah, I mean, to the extent you want to express like a pure view on a certain outcome, like that matters. I mean, the world that I travel in tends to be like, well, can I use prediction markets to hedge a certain outcome? Yeah. And that's far more complicated.

25:09Michael Batnick:But just a tying policy.

25:11Michael Zezas:Yeah.

25:12Michael Batnick:I'm sorry to cut you off. A tying policy to investing. That's not easy. It's intellectually very stimulating. But that's really hard.

25:19Michael Zezas:Well, because my thought is this. If you understand the long-term implications of a policy choice, which can't be done in a vacuum. It can't. Like we, you know, if we think, you know, like going into last year, okay, we knew tariffs were going higher. Were they going to go as high as like the average effective rate of like 30%, which is kind of where, you know, things were going on Liberation Day? Were they going to settle somewhere in between? You know, we had a base case written down of somewhere in between. I think the average effective rate is sitting in like the sort of like 12 to 15 % range now.

25:55Michael Zezas:That's roughly where we were coming into last year, though. we had it kind of kicking in more later. Well, then we've got to, okay, so we can apply that to goods. We've got to work with our economists. We're going to feed it through in the inflation forecast. That's going to feed into the central bank policy. That's going to feed into every single macro market estimate that we have. And obviously, we're dealing with the consumer analysts and anyone else who's affected by it to make sure that like, okay, we think we understand the policy. Here's multiple scenarios for it. Now you have to contextualize that within all the other sort of variables driving the price of your asset class.

26:38Michael Zezas:So in that sense, like there, we don't really put together playbooks like this policy equals, you know, X or Y. Because you can't because there's other things happening. It's a multivariable problem.

26:49Downtown Josh Brown:Well, that's a great example. So last year, if in January I had told you two months from now, Now the president's going to sit in the Rose Garden and put this poster board up with specific tariffs for every country. And some of them are going to be insane levels that nobody has in their estimates.

27:06Michael Zezas:Yeah.

27:07Downtown Josh Brown:And then he's going to reverse because the stock market's going to have a negative reaction. But still, they're going to be 15%, let's say. Yeah. And in some industries, higher. And there's still going to be like all sorts of rhetoric about tariffs for the rest of the year. So I told you this last January, it comes to pass in March. But had I given – not you, the colloquial you. Had I given the street definitive, this is what's going to happen. Right. The tariffs are going to be 5x higher. But what would everyone do? They would immediately drop their earnings estimates, especially for industrials.

27:41Downtown Josh Brown:And they would probably lower the multiple that we'd be willing to pay for stocks. In both cases, they would have been drastically wrong directionally.

27:49Michael Zezas:Yeah.

27:50Downtown Josh Brown:So we had huge earnings expansion, which is the AI story. and we had, I think, multiples rising throughout the course of last year. Yeah. So that's why it's to Michael's question, like even if you nail the outcome of a policy.

28:06Michael Zezas:Yeah. It has to be considered, yeah. There's a multi-variable. There's too many other things. And like in that, like last year, like much credit to Seth Carpenter and the economics team. A lot of our competitors went straight to recession call. And within like a day.

28:22Downtown Josh Brown:Yeah.

28:22Michael Zezas:And like we're not there. There's a lot of other things counterbalancing this in addition to the uncertainty around the negotiations themselves. So it has to be dealt with in that way. And listen, like, I like to think that we, there's a reason that we try to have such a collaborative culture and such a like cross asset cross region culture. It's because any of these problems affecting any individual asset class coverage area is a multivariable problem. And that's how we put ourselves out to clients. I'll say based on like our readership data, our follow-on engagement data, that's what they like.

28:58Michael Zezas:Like if you're doing collaborative work, you're going to get more than one standard deviation engagement than other folks. And it's also, by the way, like what LLMs have a hard time doing. So we're just going to lean more and more into it.

29:14Downtown Josh Brown:What is what LLMs have a hard time doing?

29:15Michael Zezas:Doing basically like with a simple…

29:18Downtown Josh Brown:or cross-discipline?

29:20Michael Zezas:Cross-discipline, cross-asset. And like, listen, maybe there are some agent orchestrations in the future which might help with that. But, you know, certainly right now, giving a generalist a big thematic question that has a lot of variable inputs into it and saying, figure this out working with an LLM, we get really low success rate with that. We've been testing that a lot ourselves. We talked to LLM optimization specialists. That seems to be low success rate. So it's something that even coming into the AI environment, we leaned into culturally because we thought there was a lot of alpha there.

29:55Michael Zezas:But now we think it's just increasingly a part of the strategy of how we have to serve as clients.

30:00Michael Batnick:So we'll get to the AI stuff, obviously. But we mentioned the tariff stuff. And even if you could have predicted perfectly, not to believe at this point, but the markets move so fast these days.

30:10Michael Zezas:Yeah.

30:10Michael Batnick:So, so fast. So you could be thinking about the implications and the market could be pricing in, you know, whatever is going to eventually happen. John, can you talk to the chart for it, please? We're looking at the policy uncertainty index versus the VIX. And there is a gigantic spread between the two. And usually they're directionally correlated. But there seems to be such a heightened level of geopolitical uncertainty that is not really translating into equity markets. And you saw this during the war where everyone's scratching their head. It's like, wait a minute. This was supposed to be the black swan event.

30:44Michael Batnick:Everybody was supposed to, was expecting if this happens, all right, S &P limit down, crude ups, whatever, doubled. And we just - Like for 30 years,

30:52Downtown Josh Brown:someday we're going to bomb Iran and they're going to close the Strait of Hormuz and it's going to be lights out for the global economy. And I think the VIX got to 50. Maybe, I don't - Maybe for five minutes.

31:02Michael Batnick:The transmission mechanism between elevated geopolitical uncertainty and equities and fixed income and other instruments, it's a really weird disconnect.

31:12Michael Zezas:It is. And I've got theories. I don't have any great explanations. But I think one of them is I think when you're dealing with something that taken to its logical end is potentially existential for the economy and markets, maybe sometimes your optimal strategy is to put a really low probability on it actually going all the way through. So World War III.

31:37Michael Batnick:Right. What was that sort of thing that Art Cashin said about the bombs?

31:40Downtown Josh Brown:Yeah, Art Cashin from the New York Stock Exchange. told a story about his first week at work. His early 60s. And the rumor going around the floor was the missiles from Cuba were in the air. So he's running around trying to get sell orders off and his boss grabs him by the collar and says, Art, what are you doing? He said, the missiles are in the air. I'm selling. He said, no, no, no, no, no. You buy when the missiles are in the air. Because if they hit, who cares? If they don't hit, that's where all the money is made.

32:08Michael Zezas:And there were no missiles, thankfully. Yeah, I mean, I hate to be so like cavalier about it but like but i think there's a lot of wisdom in that i mean we i think it was like 20 i can't remember it was 2017 or 2018 when north korea was testing a bunch of missiles and there's a lot of rhetoric between the u.s and north korea going on and um you know our korea investors wanted some research around that to help them navigate and hedging and you're like what do you want me to tell you is there really research yeah right like yeah so um dig a hole Right, right. It's, yeah. So, I mean, not to suggest that straight-up Hormuz closure is nearly as existential as that, but it's not irrational, in my view, to presume that an administration, which has shown itself to be sensitive to economic, not perfectly sensitive, right?

33:01Michael Zezas:I'm not one of those people who's like, oh, the White House is never going to react. Sometimes we get the question like, what percentage down does SPX have to be before the White House reverses course? It's not that simple. But at least there is some sensitivity.

33:15Downtown Josh Brown:It's not that far off either. But I think the market – I think the White House is aware of the 200-day moving average. I think the Fed is too. And I think anybody that suggests otherwise is just not really paying that close attention. but we seem to pull rabbits out of hats. We get in the vicinity of like an actual downturn. I don't think anyone wants to cause a bear market, especially if they're just giving speeches.

33:40Michael Zezas:Yeah. I mean, that's fair. I guess the end of the day I would say is it's not irrational for, for investors to see positive outcomes around some of these friction points. And then of course they could be proven wrong over time.

33:56Michael Batnick:Well, they were right. I mean, And the other thing is earnings estimates kept rising and 100 % right. Yeah.

34:01Downtown Josh Brown:But before we do the AI story, which we'll finish with, I do want to get to investing in a multipolar world. And this is so this is new for most people who are in the market. They haven't been alive at a time where all of a sudden the Europeans and the Japanese decide it's in their best interest to not just leave everything to America. and to start thinking about their own ability to build and mechanize and defend. And to me, like that's one of the bigger changes of this era. And it's sort of, I guess, started with the Ukrainian, the conflict in Ukraine, and then I guess Israel and Iran. And it's just like every step forward seems to make the numbers go higher.

34:49Downtown Josh Brown:Let's put this chart up, total reinvestment and re-industrialization in Europe. And he was not that this is all military, obviously, but just like just this idea. Everybody needs their own supply chains. Yeah. Germany, France, Italy can't just be tourist destinations. Like they have to be industrialized countries again. And they have to get serious about not relying on China or the US. And that I think there's a huge investment implications. And I think they're actually positive.

35:18Michael Zezas:Yeah.

35:18Downtown Josh Brown:So I look at overseas stocks last year, had a great year. and maybe sometimes what certain country markets need is a little bit of fear and a little bit of paranoia for the animal spirits to get going. I mean, it's not ahistorical to suggest we've had some great bull markets as a result of building for war. It's just reality.

35:40Michael Zezas:No, that's historically accurate. There's another way to say it. But I mean, if you're going to spend on capital and productive capacity, whatever it's catalyzed by, At least in the early stages, it's basic algebra in terms of how it drives growth. There's always the lingering questions, and the questions will linger for AI also about what's the ultimate ROI on this. But I just don't think we're not there yet.

36:07Downtown Josh Brown:Does that make these countries more – does that make Japan – does that make developed ex-US more investable from an equity perspective? the fact that these countries are now going through this sort of cathartic moment where they're shaking off the post-World War II stasis and they're getting serious now about re-industrializing.

36:28Michael Zezas:We think so, but would like nuance it a bit differently for like Europe versus Japan. Like Europe is about industrialization, defense, and Marina Zavalloc, who's our European an equity strategist has a good theory of the case around Europe being kind of a sneaky AI beneficiary, right? Just because of how, you know, asset heavy those businesses are and how like there could be some good productivity gains there.

36:59Michael Batnick:It's not asset heavy, it's heavy asset. You're right. I'm sorry.

37:04Michael Zezas:We'll allow it. Sorry. We'll allow it. Halo. Halo. I know. I know. in Japan there was already some stuff going on before all this came into play there was a lot of corporate governance reform a little bit more nationalism than we've seen in a few decades some healthy inflation creeping in and by the way you've got a household base there that like 50 % is invested in deposits I think the number is about 7 trillion dollars So risk-averse, sort of sclerotic markets. They're getting better now. For a generation, there was not really a reason they had to think differently. Right. So the short answer is yes.

37:50Michael Zezas:So just like nuance of the bit based on each region.

37:53Downtown Josh Brown:Okay. I want to ask you about AI because it's almost like to discuss anything else misses probably the biggest cycle of CapEx that any of us will ever see. If the numbers even get close to the projections, is it like$15 trillion over the next 10 years or whatever people are saying? I mean, who knows?

38:17Michael Batnick:You guys have an estimate for$2.9 trillion

38:19Downtown Josh Brown:in global CapEx. That's just for - 25 to 28. Till 28.

38:23Michael Zezas:And that's just for the data centers.

38:25Downtown Josh Brown:And that's before the robots even show up. And that's before everything goes autonomous. and that's before uh mars like there are a lot of other things that okay yeah so are we like in the fourth inning of ai spend or is this like has the game even started yet how do you like how do you talk to in groups of investors about whether or not they've missed a lot of the gains or like what's still to come is there is there room to make new investments today yeah i think there's

38:55Michael Zezas:plenty of room. I don't know if it's first inning or fourth inning. It's early. I think nobody really knows. Right. Yeah. And I mean, so Steven Bird runs our thematic research team and talk about people who started their career in one area and to become specialized and really valuable in another area. He was our energy and utilities analyst for years. Utilities is a very sleepy area, but gets pulled into becoming an AI expert because, well, all this stuff's got to get powered. And like, No one knows more than him about whether or not we can power this and how it's going to happen and the step functions together.

39:27Michael Zezas:Oh, that's interesting. Yeah, yeah. And he's great. He runs all of our thematic research now. So I think the short answer is in terms of the build-out, still pretty early stages in terms of the compute that the hyperscalers say that they want to develop, right? And so whether or not you think the hyperscalers are going to get, you know, super high ROI or something that's good, Either way, like they're going to pay to develop a lot more of it. And the sort of governors, the constraints around that build out, which are energy and labor, maybe a little bit of policy. If anything sort of like is making that a bit earlier stage, things are going maybe slower than the people who want to invest in this.

40:11Downtown Josh Brown:So this gets back into your area of expertise. You know, there's big concentration of data centers in Virginia for reasons that are really interesting. uh it's where aol started yeah saying the first data center was there to serve them yeah and then as a result it's like the data center capital of the world yeah um but you are starting to hear stories about communities that either for environmental reasons or for the just the reasons of we don't like ai yeah but you're starting to see sort of grassroots it's not very loud i don't think it's not anything of consequence but they did you know the concept of ai definitely

40:48Michael Zezas:has like a pr problem big time and in yeah you're seeing it manifest in kind of a non-partisan way right since virginia california oklahoma like you know it doesn't not red or blue yeah different people objecting to it for different reasons right um it's not listen it's a risk we have to watch it's not a big enough relative to the build out and where build outs can happen around data centers and other you know like like other parts of the infrastructure for it to like matter all that much but we have to watch it. But the other thing to say, because you're like, is it early is it not? You know, our economics team has about a quarter of GDP growth this year coming from just like the build-out of the current build-out of AI.

41:32Michael Zezas:Like really very little baked in from a productivity perspective. So that's the other aspect of it.

41:37Downtown Josh Brown:Oh, just the construction aspect of it is driving that quarter of GDP. Just the, like the, yeah, just like the - Literally laying down pipes and building structures. Mm-hmm.

41:46Michael Zezas:Okay.

41:46Downtown Josh Brown:Do you think a productivity boom

41:47Michael Zezas:is coming? Yeah, we think so. I think it's hard to time it exactly. Right. I mean, listen, speaking to someone who's actively trying to put AI into all of our processes in the department and my boss, Katie Hubert, he's been very forward looking on this. And even before I stepped into this position of sort of driving this and all sorts of like innovative takes on the future of research that require AI being linked into the process. You know, industrializing this stuff in large organizations and unlocking that productivity is, you know, sometimes easier said than done. the individual productivity that somebody might be experiencing at home, or if they're starting a business from scratch using some of these tools, that could be mind boggling.

42:33Michael Zezas:But inside of a large organization where you're linking workflows and people together, it could take time. My only point being that, do you see major productivity gains this year, next year, the year? It wouldn't surprise me if it still takes a little bit. The direction of travel is pretty clear.

42:49Downtown Josh Brown:Don't you have to see it in tech companies themselves first? They're already very productive companies, but I just, it struck me that like we're selling all this AI and we expect the recipients of the technology to be able to run their businesses more efficiently. And of course we want to hear about restaurants with rising profit margins. And we want to hear about hotel companies and insurance companies, of course. But like, wouldn't the first place we see it be at the technology companies themselves who are actually developing the tech.

43:23Michael Zezas:And I mean, and listen, just going by what they report about themselves, they're seeing that. And I'd say that our team does a lot of primary research on this. So we cover about 3 ,400 stocks globally. Stephen Byrd and Katie will do this thing periodically where every analyst has to sort of map their coverage into whether you're an AI enabler, an AI adopter, and to what degree based on your assessment of the company. And then we'll do surveys of the management of those companies and we'll also scrape the transcripts, the earnings transcript of those companies to see who's actually reporting something tangible.

44:06Downtown Josh Brown:So is it 20 % of the S &P seeing tangible benefits in their financial statements from the use of AI? Yeah, so it's 50%.

44:14Michael Zezas:So MSCI world, the number is exactly right. But like it's, I think at the beginning of last year, it was like 20%. We're up into like the 30s now. So it's climbing. And then for companies that we mapped as AI adopters, from 2024 to 2025, the average EBIT expansion was 2x faster than the non-adopters. So the benefits are there. They're starting to rise.

44:46Michael Zezas:But, you know, to the point of it, like, specifically translating into, like, GDP, like, that's a bit of a different measurement problem. But in any case, you're starting to see the tangible benefits show up in earnings for sure.

45:00Michael Batnick:So, right now, it is a lot of charts in here. John, let's pull up chart. My God. I sound like Mike Francesa. Which chart are we looking at? Chart 20.

45:12Downtown Josh Brown:You wish.

45:13Michael Batnick:chart 20.2 um okay we're looking at the consensus 2027 eps change for ai infrastructure stocks insane 42 the s &p 500 at 10 and the s &p 500 x ai infrastructure um just three percent man this

45:33Michael Zezas:better go up for this to work yeah i mean i think i mean i think it will no i mean we think it will too but you're right there's been this at least in terms of like the broadening theme okay and this is not my area of expertise, but you know, uh, uh, so I'm gonna, I'm gonna do my best Mike Wilson for a second here. Um, there's been the divergence between the, you know, actual earnings broadening and like the price broadening out. And we expect those things to reconcile, but you're right. Like it hasn't, it hasn't shown up in enough places quite yet. I mean, stocks are

46:06Downtown Josh Brown:front running that, like, are you saying this or backwards the other way? Okay. Yeah. So it's It's a good year for the S &P on a headline basis. But percent of stocks positive is below average, not substantially so. It's about average.

46:24Michael Zezas:Yeah.

46:24Downtown Josh Brown:We keep hearing that the next leg of this bull market will happen away from the AI hyperscalers. Yeah. And we'll broaden out to the rest of the market. And obviously, every sector has its own reasons for rallying or not rallying. Energy is obvious. Housing related is obvious. like what the drivers are there. But do you need, do you guys as a house view? Yeah. Do you guys think we actually even need this broadening out and we need to see all these AI users start beating earnings or can we just continue on the way we've, we've gone with this sort of concentrated subset of AI champions driving all the growth and the market hold up.

47:05Michael Zezas:It's an interesting way to phrase the question. I don't know if we'd say you need it, but that's the way we think it's going to happen.

47:11Downtown Josh Brown:You think it'll play out that way? Yeah. That'd be very positive for a lot of investors. Yeah. Okay. Because people that are not exposed enough to AI are looking at the tape and they're saying, why is everyone having so much fun?

47:23Michael Zezas:Yeah. Yeah. I mean, so we do a sort of big collaborative mid-year and year ahead outlook process every single year where you bring together all the strategists, the economists. and for the last two cycles been pretty consistent on broadening out of equities in the U.S. plus some of the secular trends we talked about overseas and equities kind of lean things and it's not that bonds are a bad place to be but they're going to serve more as a diverse fire coupon like returns etc because you're in a you know secular enough growth environment driven by a lot of these kind of major CapEx trends that, you know, that's going to be the norm for a couple of years.

48:11Michael Batnick:You know what's interesting? So we're seeing this right now. The Mag 7, like Meta and Microsoft, I know it's just two, and they're acting like shit. And NVIDIA got smacked down after trying to break out. It's not acting awesome. The Mag 7 are up 70 basis points year to date. The equal weight S &P is up 11%. Yeah. The Nasdaq 100, this is wild. You have the MAG7 or flat, which is 40 % of the Qs. And the NASDAQ 100 is up 19 % year to date. I don't know what the equal weight version is. It's obviously got to be more than that. So the NASDAQ equal weight is up. Huh. Delete this, John. It's not up more than that.

48:49Michael Batnick:But whatever.

48:49Downtown Josh Brown:The NASDAQ 100 is up 19 % year to date. Without its largest stocks doing all that much as a group. So, all right. So maybe that broadening thing is already taking place. Here it is. Here it is. This is what I was looking for.

49:00Michael Batnick:Equal weight tech. again, the MAG7 are flat. Equal weight tech. RSPT is the ticker. It's up 39 % year to date.

49:12Downtown Josh Brown:Yeah. So we got the broadening in tech. Yeah.

49:16Michael Batnick:That's good. That's a crazy spread. It'll start somewhere.

49:20Downtown Josh Brown:I want to ask you about the midterms. Are you getting a lot of questions from investors, hedge funds, whatever? You said earlier in the show, you think it's mostly going to be noise that comes out of that and there will be policy continuity. Is there a way where that goes wrong? Or what are people asking about this cycle?

49:38Michael Zezas:I suppose the way that view is wrong is if either Democrats or Republicans win so big that they— Which is not the forecast. No. Well, and you asked about prediction markets earlier. I think coming in here, prediction markets had Dems at like an 80 % chance to take the House and to take both the House and the Senate, it's kind of a toss-up about 50-50. But if you map out... The Senate comes down to Maine, basically? Yeah, right, exactly. And the thing is, right, so the point is, if it comes down to one of those states, you're talking about the Dems getting to 50, 51 seats. But even if they got to 52, 53 seats, you don't have filibuster-proof majority to push anything meaningful through.

50:24Michael Zezas:You definitely don't have the majority to overcome any veto. so if you know like if clients question like oh well is the the tax cuts i got passed a couple years ago are those at risk no right i mean because the i believe the democrats are sincere in wanting to reform that but they don't they're not going to have the votes and they certainly aren't going to have the white house for another um couple of years okay um so it's more and like can they rest back the power on like trade and tariffs again practically speaking not like it is there you know congress over years delegated that authority to the president they can take it right back but you need the votes in order so there's no political shock that we don't think

51:06Downtown Josh Brown:there's a political shock coming at some point this fall based on anything that we're seeing currently i don't think so they're not and you're not giving people the impression that there's going to be some sort of fireworks yeah i mean here's the caveat could there be knee-jerk reaction

51:21Michael Zezas:in the markets if you get a result that is surprising on election night in favor of a change of power, right? So, you know, Democrats effectively take control. Both chambers do better than expected. And the next day, the next week, you know, anything that's associated with like a positive, right? So, you know, the tax benefits from the OBBBA, you know, the sort of sectoral distribution of those a lot of that's been sort of more small cap friendly like could you see some temporary weakness there on like a knee-jerk that oh this presages that three years down the line there's going to be a major tax change no one's going to trade on that i mean yeah right and if they did i would say fade that right that's that's not the right way to think about it because in two two years till the next election cycle might as well be a hundred years what's the most

52:13Downtown Josh Brown:surprising question that you've gotten from an institutional investor or a hedge fund manager this year what made you think the hardest or what made you really have to go to the drawing board um well i'll tell you what like we got a lot when the iran stuff started there wasn't questions

52:32Michael Zezas:about whether or not straight or hormuz would become a choke point but there were a lot of like very technical questions about like you know how much oil is going through who can get it through there um you know uh what are sort of the like puts and takes around like the gulf coast countries and their involvement and that's another thing where we just had to like pull in a team effort and um not a big hormones expert going into that going into it no i will say like i i literally i knew what it was on the map i knew that it's on the right side all right i i i knew that like well well, it's just the contingency planning playbook.

53:14Michael Zezas:If Iran gets attacked, that's sort of the, if they view it as existential. You make it sound so obvious.

53:19Downtown Josh Brown:I don't think our military knew that. Well, it seemed not to have had a plan for that. It would be, I think our military probably knew that.

53:27Michael Zezas:Like it's a question of whether or not you thought it would happen. And I'll say this in fairness to that debate. You have to go back, I think to, I'm not going to get this exactly right, but there was something called the tanker wars back in the 80s was like the last time iran ever really shot at some ships and it was widely thought it would be um not in their self-interest to do that unless they felt like an existential crisis because otherwise it would sort of turn the world against them well clearly this feels pretty existential to them in any case reached that threshold where they said yeah we're doing this right right i mean i think it's self-evident so you know so the questions we start getting are like really all about the technical aspects how many ships can go through under what conditions etc you know credit to uh martin ratz who's our our commodities analyst out of london who just knows the puts and takes of the oil market is certainly as well as anyone that i know um and to his ability to lean into using some of these ai tools that we now have for people is able to like wire things up pretty quickly using open source information to like map out right like exactly what could flow through at what rate under which conditions and so that was a hard question i got i didn't answer it but i knew you know this is i think testament to to the firm like

54:49Michael Batnick:we can get you the right person michael what what impact do you think all this ai and the ability

54:54Michael Zezas:for everybody to know everything really fast yeah is going to have on markets that's such a fascinating

54:59Michael Batnick:anything to think about?

55:01Michael Zezas:Um, it's, yeah, that's a great question because I think a lot of what we know or a lot of what we think about as being very smart people in markets, like that level of intelligence, I think has become table stakes pretty soon. Right. Um, the ability to layer Monte Carlo analysis on a financial model, again, it's not like any, we're the first people have ever thought of monte carlo analysis but like now you can just do it really easily right and without having to like hire a statistician and have a supercomputer operating next to you um or do like large-scale document analysis right like um you know you know let's let's score bond indenture documents let's do 40 000 of them a time let's map in the spreads and let's see opportunities like stuff like that which i call like like level three research stuff that you just couldn't have done before.

55:57Downtown Josh Brown:You needed an army of bodies and now you don't. Now it's a powerful chip and somebody that knows how to get the best out of the machine with the right prompt, which is a skill, I suppose. It's a skill. But you remove a big competitive advantage from gigantic research organizations.

56:16Michael Batnick:Well, I guess, but so you, you need the human judgment there also at the end of the day.

56:19Michael Zezas:Right. So you, you, you, yeah, you, you remove the need for, to have a giant research. However, you also increase the possibility and the probability that people like just, just like there's AI slop and, you know, like video and the stuff you see on like Instagram, there could be tons of like research slop.

56:38Downtown Josh Brown:right you'll get overfit like the machine wants to please us right it wants to give us what we seem to want because it's every business on earth is now an engagement business yeah every business is netflix and tiktok yeah so the machine doesn't want you to turn it off yeah so it will to your point keep asking the question it'll eventually give you something that sounds right yeah and

57:01Michael Zezas:even like yeah like like before i said we know you know it's not like no one's ever heard of Monte Carlo analysis before, but just hearing about it and knowing how to do it the right way are two different things, right? So you said, I don't know if the word used was wisdom or experience, but like, I actually think that's an important difference. Judgment. Judgment, right. Like what's, you were saying, what's the difference between wisdom and knowledge? Like tomato is a fruit you got, but you don't put it in a fruit salad.

57:27Downtown Josh Brown:Knowledge, wisdom is you don't put tomato in a fruit salad. Right.

57:30Michael Zezas:So like, that's still really, really important. and I think you need a like network of experts to really sort through that noise or you could start making some big mistakes and judgment so what happens in the future when everyone's enabled like this it might not look all that different than now where there's you know people chasing narratives and that aren't right and ultimately they get proven wrong and people are wiser and and you know operate better more sustainably over time before we let you out of here can we do like

58:01Downtown Josh Brown:a little Morgan Stanley research lightning round? Sure. Okay. What's the house view on employment in the AI era? Are you guys optimistic that the new jobs will come along on time so that we don't have like a big air pocket? Or do you guys think there are going to be some tough years for young workers before these new opportunities present themselves or maybe some other option that I'm not thinking of.

58:29Michael Zezas:I mean, I would say optimistic until proven otherwise, kind of like eyes wide open. So our economists have done a lot of work breaking down the sort of mapping the types of work and the economic data that map over to the skills that are considered disruptible. I'm trying to see where is the unemployment cohorts higher and lower than others. And like - Legal and accounting. Yeah, and like you squint, You see some difference in youth unemployment, but you got to squint at the moment. And so I'd say mostly optimistic, but vigilant.

59:08Downtown Josh Brown:Not that you're going to make stock picks, but Enterprise SaaS, the SaaSpocalypse, was the Morgan Stanley outlook for, I mean, this is, I think, the standout negative group of the year.

59:19Michael Zezas:Yeah. And these are some very large companies, companies that you guys are probably covering all of

59:26Downtown Josh Brown:them. What is Morgan Stanley saying to people that ask about our values being created there, or is it going to be harder than maybe the, maybe harder to make money there going forward?

59:40Michael Zezas:Well, I mean, I think both it's going to be harder there fundamentally, and there's value being created. And we think a lot of what happened in the markets was overblown. The ability for these companies to industrialize in a way that individuals in a large organization, you know, might not necessarily be able to do things for themselves means that there's still a moat there. You think that's enough of a moat that would justify investment in these companies or? Yeah, I mean, I'm not expert enough to say on those specific companies, but just like conceptually, I would say like, we're not a buyer of the idea that everyone's just going to write software for

1:00:23Downtown Josh Brown:themselves well the morgan stanley research budget include as much money going to enterprise sass three years from now as it does today or will uh compute and anthropic bills eat a bigger chunk of that expenditure like yeah obviously you don't know for sure but if you had to guess directionally

1:00:42Michael Zezas:it's it seems to be i mean it's a good question because it's hard to like distinguish between just like buying the tokens and then some of the other service providers that plug into them I mean, listen, I think our budget going towards tech solutions is probably going to be pointed higher, at least a percentage of the budget. But a lot of the solutions that Katie and her team are putting together really boil down to making sure it's not just about token usage. It's also about having the right data plugged in and the right sort of use cases that kind of come from that. So I'm not trying to avoid your question.

1:01:20Michael Zezas:I just think it's not as simple. And like, we don't know. Yeah. Well, we don't know. First lightning round ever. Sorry. Well, it's too hard. Yeah. How about yes?

1:01:29Downtown Josh Brown:Here's an easier question. Here's an easier question. How do Morgan Stanley clients feel about Kevin Warsh and the new Fed? Yeah. I would say fine.

1:01:40Michael Zezas:Bond market seems okay. Yeah. Right. I think so far he hasn't had to do much, but so yeah, I think the answer is fine, which is a boring answer. But there would be, I think, far more anxiety if you've gone with one of these less traditional names that have been thrown out there. People are really embracing unorthodox economic views.

1:02:02Downtown Josh Brown:Kevin Hassett or somebody coming from pure politics. Yeah, or someone who is perceived to be just somebody who is going to take a phone call from the White House.

1:02:12Michael Zezas:And I would say this, even in that situation, we probably would have leaned against the concept that the Fed substantially compromised. As Seth and our econ team point out all the time, we're like, there's a whole committee there. There's not just one person. And so, sure, communication could get scrambled. It could get confusing, but it wouldn't necessarily, if you just looked back on it in history on like a chart with like what the policy rate was relative to inflation and growth, it might not look all that. crazy now we don't have to deal with that hypothetical debate really i mean we we gotta you know we we still have to pay attention he's traditional enough yeah now now let's let's see if we're right i mean we're gonna we're about to learn but yeah so the the short answer is fine

1:02:55Downtown Josh Brown:okay so on balance uh morgan stanley is like not the most bullish on the street but you guys are pretty constructive on most asset classes and uh sort of like if if the earnings growth delivers we don't get a worse geopolitical situation in the Middle East, and the interest rate picture is probably just more of the same. Like if those things hold constant, we should finish out the year in pretty good shape.

1:03:22Michael Zezas:Yeah, I think that's right. And it's largely buoyed by the secular trends and themes that are driving this around CapEx and AI and dealing with this transition to a multipolar world.

1:03:33Downtown Josh Brown:I want to tell you, we really learned a lot from you today. and thank you so much for coming to the show. Did you have fun today?

1:03:38Michael Zezas:I did and I really appreciate

1:03:40Downtown Josh Brown:you guys giving me the opportunity. Want to come back sometime? Of course. Are you busy tomorrow? No. Yeah, what time? Like 7.30 a.m. short? Dude, thank you so much for being part of the show. Where can people find more from you and from your team? If somebody says, Michael Zis is great, I want to hear more of what he has to say. What's the right place to go?

1:04:00Michael Zezas:Morgan Stanley Institute. Go to the webpage, sign up for the Morgan Stanley Institute newsletter. We're bringing together all the thought leadership across the firm for all types of financial decisions.

1:04:09Downtown Josh Brown:The Morgan Stanley Institute. This has been Michael Zezus. Thank you guys so much for listening. Thanks for watching. Have a great weekend. We'll talk to you soon. Thank you.

1:04:47Michael Batnick:or the man who lived in the woods for 30 years, or even the woman who snuck her lover out of prison in a dog crate. Pick a card, any card. Tap to listen now to Snap Judgment from KQED on Spotify.