Reflecting on 90 Years: Market Uncertainty and the Power of History

In the latest episode of Thoughts on the Market, Andrew Sheets, head of corporate credit research at Morgan Stanley, explores the historical context of the firm’s inception 90 years ago. By examining the first bond deal issued by Morgan Stanley during the aftermath of the Great Depression, Sheets draws compelling parallels to modern financial markets, challenging the assumption that economic uncertainty must inevitably lead to wider credit spreads.

The Context of the Great Depression and the Birth of Morgan Stanley

The narrative begins in the early 1930s, a period defined by the "Great Depression." Sheets highlights how the collapse of the financial system was exacerbated by banks that simultaneously managed customer deposits and engaged in "much riskier and more volatile financial market activity." Following the stock market crash—which saw a decline of over 40% in 1929 and a staggering 86% from peak to trough by 1932—the Roosevelt administration introduced radical reforms.

Central to these reforms was the "Glass-Steagall Act," which forced a separation between traditional deposit-taking/lending and financial market trading/underwriting. It was in this legislative environment in 1935 that Morgan Stanley was founded to focus on the latter.

A World of Extreme Uncertainty

To understand the significance of Morgan Stanley’s first bond issuance, one must consider the environment of 1935:

• Economic Struggles: Despite the "New Deal policies," unemployment remained above 17%.
• Global Instability: Europe was struggling, and the "Second World War" was only four years away.
• Market Valuation: The S&P Composite Equity Index was at a mere 12, compared to its current level of approximately 6,700.

It was into this volatile world that Morgan Stanley brought its first deal: a 30-year corporate bond for a AA-rated US utility.

The Yield Revelation: Challenging Intuition

Using digitized archives from the "Federal Reserve Bank of St. Louis," Sheets reveals a surprising data point: the first bond issued by Morgan Stanley carried a yield of just 3.55%. Remarkably, this was only "70 basis points" over comparable U.S. Treasury bonds.

This finding serves as a critical lesson for modern investors. Despite the "market maelstrom" of the 1930s, the market still priced high-quality corporate credit with a very narrow spread.

Lessons for Modern Credit Markets

Sheets concludes by applying this historical insight to the present day. He argues that this 90-year-old data point is a "clear data point" demonstrating that even in periods of significant economic uncertainty, "high-quality corporate bonds can trade at very low spreads."

He notes that the "extra spread" required by investors 90 years ago is "almost exactly the same as today." Consequently, Sheets urges investors to remain "judicious" about becoming overly pessimistic or "turning too negative on corporate credit too early." Even when "headline spreads look low," history suggests that the market’s appetite for quality remains resilient, offering a sober reminder that market psychology often transcends the immediate fears of the headline news.