WEALTH MANAGEMENT INVESTMENT RESOURCES SEPTEMBER 20, 2018

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1 WEALTH MANAGEMENT INVESTMENT RESOURCES SEPTEMBER 20, 2018 Geo-Markets SCOTT HELFSTEIN, PhD Executive Director Morgan Stanley Wealth Management MATTHEW BROOKMAN Morgan Stanley Wealth Management The Midterms We explore the major issues and implications of the upcoming US midterm elections. Election outlooks usually rely on traditional party positions to identify potential market implications of electoral outcomes. Republicans, for example, are historically supporters of fiscal conservatism whereas Democrats are more apt to provide social welfare and pay for spending with higher taxes. This method may now run the risk of creating misleading or faulty conclusions given an unconventional White House willing to deviate from the traditional positions on a range of issues and a Republican Congress that has so far supported the executive branch s initiatives. As a result, investors may see greater variability in Washington policy on a range of issues as well as a higher likelihood of counterintuitive actions. Current fiscal policy is an example. Instead of the Democrats pursuing fiscal expansion and deficit spending as would be considered their norm, the Republicans have taken the lead with the tax bill. On the other side, Democrats are modestly aligned with the White House on an infrastructure bill, but a Democratic-controlled House of Representatives might not want to give this administration a political win ahead of the next presidential election. In this instance, Republicans may prove more apt to spend while Democrats advocate frugality. The executive branch finds itself more closely aligned on drug pricing to the Democrats, but its policies on immigration are probably further right than most Republicans would advocate. This unusual mix of policies spearheaded by the White House makes the analysis more difficult than usual. While we believe investors are better off focusing on economic fundamentals, however, midterm elections do exert modest impact on asset prices. For example, defensive sectors historically outperformed in the six months ahead of elections with cyclical sectors resuming leadership in the six months that follow. In other words, risk-off environments have generally persisted up until elections and have then receded. Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance. Please refer to important information, disclosures and qualifications at the end of this material.

2 We believe the ultimate impact of the upcoming US midterm elections on markets will be muted in this political cycle. Should Republicans maintain control of the House and Senate, investors could reasonably expect much of the same out of Washington such as continued effort at deregulation and little effort to restrain White House initiatives like the trade disputes. The most extreme switch in which the Democrats wrestle control of both chambers would likely leave them short of a veto-proof majority, meaning the Republican White House can block Democratic initiatives in areas like immigration and health care. The current political climate may further disintegrate should a raft of Democrats be elected, so investors may expect more of the same or political deadlock. The latter might be a reasonable option for markets that have already digested some major policy initiatives in the past two years. Some sectors may be disproportionately affected, but we do not see any obvious political configuration that pushes US equities significantly in one direction or the other. Emerging markets and international equities may get a boost from a political outcome that offers a softening response on trade disputes. We believe fixed income pricing could be vulnerable to either a second tax bill or an infrastructure bill, but both would be relatively small compared to the $1 trillion stimulus from the 2017 legislation. Tax reduction will most likely continue if the Republicans retain control and this may be modestly bearish for US Treasuries. An infrastructure bill may ensue with a split Democratic House and Republican Senate, and could be viewed as supporting growth or increasing the deficit and thereby neutral. US Political Landscape Republicans have held the levers of government since the inauguration of President Trump in 2017, the first period of pure party control since 2009 and 2010, the first two years of the Obama presidency. Not only has the GOP held majorities in both chambers of Congress and control of the executive branch, but it has also seen significant success at the state level. Between the federal government, governorships and state legislatures, Republican strength has left the Democrats in their most disadvantaged position in roughly 100 years. Though the balance of power shifted to the Republicans during the past decade s elections, there is a path to potential Democratic gains in the midterm elections. In the House of Representatives, where all 435 seats are up for election, the Democrats need a minimum 23-seat net gain to reclaim a majority. The Cook Political Report, a nonpartisan newsletter, rates 105 House races as competitive, with 42 noted as toss-ups. Of these 42 seats, 39 are currently held by Republicans, making the GOP more susceptible to electoral losses. Given current polls, this is well within the realm of possibility that Democrats can win their needed 23 seats. The Senate map, on the other hand, favors Republicans. With only one-third of the seats in the Senate up in any cycle, 42 Republicans and 23 Democrats will remain in place. While the Republicans are defending nine seats, Democrats are trying to retain 24, including 10 in states that President Trump won in Cook rates 18 seats (12 of them currently held by Democrats) as competitive and eight as toss-ups. The challenge of defending so many seats exposes Democrats to more downside risk than their Republican counterparts. This numerical advantage positions the Republicans to retain control of the Senate. Besides structural factors, there are other indicators that can help us understand the potential trajectory of elections. Retirements, fundraising performance and national sentiment have historically been measures of party success. In the current Congress, Republican retirements have far outpaced those across the aisle. In the House, 40 GOP representatives are not returning, including Speaker Paul Ryan, versus 20 for the Democrats. In the Senate, four Republicans are retiring compared with just one Democrat. These retirements are notable, as incumbency is an important advantage. Federal Election Commission data as of Sept. 18 shows fundraising for each chamber has also favored the Democrats, with the party s House and Senate Campaign Committees having raised 32% and 11% more than Republicans, respectively, year to date. Democrats also appear to be leading in small-dollar donations, which indicate enthusiasm in their voter base. Sentiment on the Democratic side seems inspired in a way unseen since Obama was elected a decade ago. Much like the GOP in 2010, large turnouts for primaries and special elections this year reveal a high level of motivation on the left. These factors have so far been reflected in national polling data. As of Sept. 18, statistician Nate Silver s polling aggregator and website FiveThirtyEight.com gives Democrats a 81% probability of flipping the House based on such factors as fundraising, past voting in districts and historical trends. In the aggregate generic ballot, a proxy for the popular vote and measure of party popularity, Democrats have maintained a sizeable lead this year that recently hit 8.8%. Many political analysts argue that a number above 7% is needed for Democrats to gain a majority in the House, but this is a coarse and imprecise analysis. FiveThirtyEight s equivalent model for the Senate gives Republicans a 67% chance of maintaining control of the chamber, with no forecasted change in seat composition. Please refer to important information, disclosures and qualifications at the end of this material. 2

3 Taking this all into consideration, one possible scenario for the midterm elections is a split Congress, with Democrats controlling the House and Republicans holding the Senate. Such scenario would likely be a return to the legislative deadlock that has characterized most of the past decade. Another potential scenario is a Republican victory that would continue to advance the White House agenda and extend the party s hold on government. The final scenario is a Democratic sweep, which may prove challenging given the Senate map, though not out of the question given the party s current momentum. A second issue worth noting is the sharp divergence on the importance of security, a blanket topic covering border security, terrorism and foreign policy. Republicans are more likely to indicate that security is a top priority. There is a 14% split, the largest among all the issues, with 19% of Republicans identifying the issue as a priority compared to only 5% of Democrats. One area that could prove meaningful is immigration, which the Republicans are more likely to consider a homeland security issue relative to the Democrats who have positioned this as a domestic welfare and human rights policy. Policy at Play Many of the policy debates at the center of the 2018 midterm campaigns cover familiar territory. Polls show that Democrats and Republicans agree on the most important issues of the election season, but the two sides are sharply divided on preferred policy prescriptions (see Exhibit 1). Policies that the electorate identifies as central include the economy, health care and social welfare. However, when giving details, Democrats describe issues such as wages and employment as top of mind, while Republicans identify taxes and regulation as more important. Two issues prove particularly interesting. The first is position on President Trump, which currently ranks as the single most important issue for voters. This position divides sharply along partisan lines while 84% of Republicans approve of the president s policies, the same proportions of Democrats disapprove. Republicans that identify position on President Trump as the key issue are broadly supportive, while Democrats are not. These differences in the electorate are reflected in respective party platforms. On the left, in addition to greater oversight of the executive branch, Democrats have campaigned on protecting and expanding the Affordable Care Act (ACA), increasing the national minimum wage, strengthening Social Security and Medicare and increased oversight of the financial and energy industries. On the right, Republicans have promised to make 2017 s tax cuts permanent, continue to roll back the ACA and strengthen border security and immigration policies. Health care and the economy feature prominently in both parties pitches, but the solutions proposed and even the problems identified differ greatly. We identify eight issues that will likely play a central role in the midterm elections where the parties have noticeable differences in the policy platform. These are trade, health care, immigration, taxes, spending, infrastructure, executive branch oversight and regulation. While there are differences among candidates within parties, both Democrats and Republicans have generic party platforms. The independent streak of this White House Exhibit 1: The President and the Economy Are Top of Mind for Voters 25% 20 Most Important Issue in Determining Vote Democrats Republicans Position on Trump Economy Security Health Care Seniors' Issues Source: Morning Consult as of July 23, 2018, Morgan Stanley Wealth Management Investment Resources Gun Policy Education Women's Issues Energy Please refer to important information, disclosures and qualifications at the end of this material. 3

4 complicates matters for the respective parties, since there are areas of significant deviation with the traditional Republican planks. Trade is likely to play a large role in the midterms given the risk of the administration s policy to the broader economy and its potential impact on voters in swing districts. Interestingly, this is also an area where Congress has limited ability to change the course charted by the executive branch. Historically, Republicans have called for less government intervention in the economy, and among those positions is free trade. That inclination seems to have become subservient to the White House view that trade deficits and unfair trading practices among many partners are harming the US. While Republicans have supported the White House, there are some red lines, including withdrawing from NAFTA. Democrats have traditionally been more protectionist on trade, but are unlikely to support this White House, possibly looking to change rules such as the Section 301 tariffs, which are permitted in retaliation to foreign violations of trade agreements or engagement in unfair practices. They might also challenge attempts to withdraw from NAFTA. Health care will also prove a critical election issue with the parties deeply divided. Republicans generally advocate repealing or scaling back the ACA, consistent with the view that government should play a smaller role in the economy. Conversely, Democrats are aiming to stabilize or even strengthen the ACA. At the extreme, some progressives will advocate a single payer system, which essentially creates a national health care insurance plan providing nearly universal coverage. While the Democrats and the White House have deep disagreements on ACA, there is alignment on drug pricing. The White House has called for legislation aimed at lowering prescription drug costs, a position not particularly popular with Republicans. Immigration is a heated discussion during this election season. Republicans have generally preferred merit based systems in which immigrants earn the right to residence and citizenship. The White House has arguably pushed the traditional Republican position further to the right, calling for more stringent immigration rules and framing the issue as a national security concern. The Democrats have generally treated immigration as a social issue and are campaigning on defending Deferred Action for Childhood Arrivals (DACA) and passing legislation to prohibit White House child separation polices. Democrats would ideally look at the Development, Relief, and Education for Alien Minors (DREAM) Act that sets a pathway for minors to achieve residency and citizenship. Taxes and spending are traditional areas of party disagreement. Republicans ordinarily campaign on fiscal conservatism, but that could prove difficult after the $1 trillion tax cut. They may also run on a Tax Reform 2.0 framework, which would make the 2017 individual tax cuts permanent and fix some flaws with the prior bill. To balance out further tax relief, Republicans may talk about smaller government in an attempt to maintain the visage of conservatism. This will be a challenge since the White House has generally proposed policies aimed at taxing less and spending more, exemplified by the second tax bill and proposed infrastructure spending. Democrats will propose shoring up the existing social safety net and may push for infrastructure legislation as well. They may also talk of rolling back the 2017 tax cuts to raise rates on companies. Additional policy issues are deregulation and potential presidential oversight. Republicans will continue to support White House deregulation efforts, while Democrats have traditionally discussed consumer protection issues like net neutrality. Differing views on presidential oversight could be meaningful since both Democrats and Republicans have identified support for the president as the top election issue. Much of the parties campaign rhetoric is defined by sentiment for the current administration, and desire for oversight could be a central argument. Republicans will not likely oppose the president, given his popularity among the base, but could potentially take action to limit his discretion on imposition of tariffs and trade disputes should events escalate. By contrast, Democrats may look at a range of measures from protecting Special Counsel Robert Mueller s investigation to immigration. If the Democrats take the House, it is possible they will claim a mandate to resist. The president will likely be subject to greater scrutiny and oversight if the Democrats were to take control of important committee agendas such as Oversight and Government Reform. However, if the Democrats pursue an agenda of countering the current administration, as the Republicans did to the Obama administration following the Tea Party wave in 2010, it could lead to a breakdown in the traditional assumptions. A Democratic House may not be inclined to expand the budgets of the executive branch. This thought process could then likely lend itself to legislative deadlock, and may challenge any potential bipartisan deal on infrastructure. Political posturing and the 2020 election cycle cannot be ruled out as a primary legislative motivation in a Democratic Congress. Please refer to important information, disclosures and qualifications at the end of this material. 4

5 Muddled Market Stakes Midterm elections will add noise to the markets and possibly increase the risk of a volatility spike. The makeup of Congress, however, will likely have a marginal impact on major markets. Interest rates, corporate earnings and underlying economics usually steer risk assets late in the economic cycle. Much of the impact may be limited to sector-specific moves in equities and modest repricing in the fixed income markets. Emerging markets may also be vulnerable given the centrality of trade in the administration s agenda. The market outlook focuses on the three most likely scenarios coming out of the midterms: Republicans keep control of Congress; Democrats take control of the House while Republicans control the Senate; and Democrats take both chambers. We try to discern the market impact of each case, recognizing that unusual political configurations challenge traditional geopolitical assumptions. Before looking at the scenarios there are a few conclusions that cut across all the potential outcomes. First, none of the outcomes is likely to have a major impact on medium- or long-term equity returns and therefore the elections may play a limited role relative to the broader trajectory of corporate performance and the economic cycle. The stock market has a modest preference for a split government, but we continue to believe fundamentals will be more important than political configuration (see Exhibit 2). Next, some form of action on immigration will likely be a policy priority under each outcome, but there is little reason to expect a major market response irrespective of a final bill that meets either the Republicans or Democrats ideal legislation. Finally, trade policy should factor into each scenario, but there may be little the legislative branch can do to alter White House policy regardless of Congressional control. We expect some minor differences in response to the White House, but ultimately the electorate, economy or markets may have to consider a veto if disputes escalate too far. Scenario 1: Republicans Hold Congress Should the Republicans maintain control over both houses of Congress, a follow-on tax bill may take first priority. Some party members want to make the personal tax changes permanent as it is now written, they expire in seven years to balance the probusiness perception of the bill. In addition, there are some technical fixes around issues like corporate interest deductibility initially put in place for budgeting purposes that would likely be changed. While further tax cuts may look like a government Exhibit 2: Stocks Have Performed Well When Congressional Control Was Split* 14% Democrat Republican Split *Average stock market return for congressional sessions by party control since 1970 Source: Bloomberg, Morgan Stanley Wealth Management Investment Resources stimulus, they would actually codify the system currently in place to ensure there is no reversion to the prior brackets in Markets are unlikely to put significant value on a modest stimulus aimed at maintaining the new status quo seven years out. The executive and legislative branches may try to come together on a stringent immigration bill as well as a third attempt at repealing the ACA. An immigration bill looks feasible under this scenario, but a repeal of ACA is likely to end much as prior attempts did. The administration will likely push for further deregulation and maintain the current trajectory on trade policy with little challenge from Congress. This mix of policies, we believe, is neutral for equities. The follow-on tax bill will not have the impact of the first. US sectors that could benefit from the Republican political monopoly include health care, energy and financials as the administration deregulation agenda pushes forward. While repeal of the ACA will likely fail, probability of legislation to control drug prices appears lowest in this scenario. Emerging markets may also struggle if Congress does not present at least modest opposition to White House trade policies. We also see little impact on fixed income in this setup, deviating from some other views. A follow-on tax bill would increase financing needs in the out years, but the impact is likely small relative to the $1 trillion just implemented. Further, the Republicans are still historically associated with fiscal conservativism, though that has been put to the test the last two years. This could come back as a GOP priority if the Democrats Please refer to important information, disclosures and qualifications at the end of this material. 5

6 win one or both chambers. A return to the traditional policy would keep the impact of a second tax bill small and reduce the likelihood of any movement on significant increase in infrastructure spending. Trade also plays a factor. Minimal restraints on the White House trade policy mean escalation could ultimately have an adverse impact on economic growth, which would pull interest rates down even if a second tax bill increases US Treasury supply. If trade disputes escalate or look to be prolonged, the dollar could get a safe-haven bid and strengthen. Scenario 2: Democrats Take the House A possible scenario based on recent polling is split control of Congress in which the Democrats take a majority in the House of Representatives and the Republicans maintain their control of the Senate. A follow-on tax bill may not be likely in this configuration, but probability of a modest infrastructure bill is the highest of the three scenarios. Both the Democrats and the White House have identified infrastructure as a priority. Democrats will be hesitant to give the White House a win before the next presidential election, but there could be a compromise package should the president decide against pursuing a second term. If the Republicans continue to control the Senate, the White House would have some leverage and allies in the negotiations, which is less so the case if the Democrats take both chambers. We think any infrastructure negotiated under these conditions is modest in size. Two priorities that Democrats are likely to advance should they wrestle control of the House is a health care stabilization bill and some type of immigration deal around the DACA program. While the White House has tried to push Congress into repealing ACA, there could be room for agreement on drug pricing. The White House has repeatedly pushed for action, and controlling health care costs has been a Democratic priority. Both an ACA stabilization effort and renewed discussions on drug prices could put the health care sector under pressure. A push on immigration reform will likely come out of the controversial policy of separating families at the border, which drew global attention earlier this year. Split control means the Democrats will not achieve their full range of objectives, but there could be sufficient interest in immigration to get a compromise. That the Democrats would like to find an immigration fix that leaves the White House with less discretionary control is indicative of a larger push for more legislative oversight of the executive branch. Democrats are likely to push for more oversight on issues ranging from trade to the Mueller investigation. Split control reduces the likelihood of any formal bills curtailing executive power and increases the chances of policy deadlock on many issues. Markets have traditionally been comfortable with split control and policy deadlock since the odds of major initiatives that upset the status quo decline. While this scenario is also neutral for equities, policy deadlock could lower some of the exogenous political risk that companies now face. Trade, the biggest risk, may persist since Democratic control of the House is probably insufficient to force major changes to White House positioning. To the extent that the White House moderates the current position, capital goods and industrials may be beneficiaries. Both may also benefit from a modest infrastructure package. Emerging markets could find some relief with a softer position on trade. Ordinarily, a majority Democratic House would be bearish for bonds as markets expect the party to increase taxes and possibly deficits in pursuit of a social agenda. We believe that expectation may be offset with concerns over policy deadlock, and therefore the split chamber scenario would be neutral for fixed income. With the exception of infrastructure, we think the White House and Democratic House will find working together difficult. The neutral view on fixed income goes hand-in-hand with a range-bound view of the dollar in this case. Softer trade stance would reduce macro risks and a safe-haven bid for the dollar, suggesting that a major move in this scenario could weaken the greenback. Scenario 3: Democrats Take House and Senate The third outcome is what some call the blue wave a Democratic majority in both the House and Senate. While we do not think this scenario is highly likely given the configuration of Senate seats up for reelection, recent Democratic momentum may not rule it out. Should the Democrats take the Senate, they would probably do so without a veto-proof majority, meaning any legislative action would still need presidential approval. Though Democratic majority in both chambers would have strong signaling effect, the most likely outcome is policy deadlock between the legislative and executive branches. This arrangement could make passing legislation harder than the split scenario given an emboldened Democrat party and isolated White House. Democrats will likely bring a number of party priorities to a vote and force White House vetoes on issues such as comprehensive immigration reform, ACA stabilization and perhaps even modest steps toward a single-payer health care system, net neutrality legislation as well as actions aimed at limiting White House authority on trade policy and deregulation. We believe this scenario would produce the most difficult deadlock of the three. Democratic majorities in both chambers Please refer to important information, disclosures and qualifications at the end of this material. 6

7 would give Democrats little incentive to negotiate rather than wait out two years with policies aimed at hampering the White House. They would have little reason to negotiate with the current administration. For this reason, we believe this outcome is neutral for equities. There is little room for compromise on major budget or fiscal issues other than infrastructure. Health care risks would likely remain elevated in this scenario, which could have the highest likelihood of drug price legislation. Increased scrutiny of trade and economic policies also support capital goods and industrials. Wholesale shift from Republican to Democratic leadership in the legislative branch signals more emphasis on social welfare. Democrats are unlikely to get major concessions from this White House, but fixed income markets may look through the next two years toward the possibility of a Democratic president and legislature. If the markets look that far out, fixed income could face pressure on the risk that higher taxes reduce future growth and more support for social welfare further increases the deficit and need for borrowed funds. We do not believe that a Democratic victory in November would trigger a major repricing given the policy deadlock, but there is some risk for investors. Election Year Market Reactions The market, like voters, will get the chance to opine on midterms. Since 1990, stock market returns in midterm election years have been mixed but skew positive, with an average 5.2%. More recently, the last three midterm years 2006, 2010 and 2014 have been particularly strong for equities. The stock market rose more than 10% in each instance. An interesting pattern we noticed in our analysis was the rotation within markets before and after Election Day. While the average overall market return in the six months leading up to the midterms was -1.1%, defensive sectors health care, telecom, consumer staples and utilities rose 3.8%, In comparison, noncommodity cyclical sectors tech, consumer discretionary, industrials and financials fell 3.6%, implying average relative defensive outperformance of 7.4%. This performance has historically flipped in the six months following the midterms. On average, cyclicals generated strong returns of 14.6%, outpacing defensives 7.1% in this period. The divergence translates to 7.5% relative outperformance for cyclicals. This year has followed this pattern with defensives slightly edging out cyclicals since May. Looking farther out, the 12 months following midterm elections have historically been very positive for equities. In midterm election years since 1930, there have only been two instances of negative returns in the subsequent year. Furthermore, average performance has been a robust 12.9%. Regardless of party or result, investors have been rewarded after the votes are tallied. Partisan control of Congress has coincided with markedly differing equity results. Since 1970, annual returns have averaged 11.0% under a full Republican Congress and 5.7% for a Democratic one. Ironically, split control has coincided with the strongest performance an 11.9% average. Given our expectation of split control, these results could bode well for equities. Exhibit 3: Defensive vs. Cyclical Performance Six Months Before and After Elections 15% % Defensives vs. Cyclicals, Six Months After Elections Defensives vs. Cyclicals, Six Months Before Elections Source: Bloomberg, Morgan Stanley Wealth Management Investment Resources Please refer to important information, disclosures and qualifications at the end of this material. 7

8 Fixed income returns following midterm elections are much less directionally conclusive. Each part of the yield curve appeared to be impacted differently. Since 1978, yields on two-year US Treasuries have risen by an average of 19 basis points in the 365 days following elections, consistent with the risk-on results in equities. The 10-year US Treasury has increased slightly, just 23 basis points. Finally, the 30-year Treasury has moved upward by the smallest amount, just 13 basis points. On the whole, these moves are not that large, and the story they tell is much less discernable than equities. Conclusion The 2018 midterm election should offer political excitement, but we believe the market reaction will be relatively muted. With Republicans in control of the White House for the next two years, whether Democrats take one or both chambers increases the likelihood of policy deadlock. This might be welcome by markets after two years of policy volatility and increased uncertainty. Near-term geopolitical risk for markets may become elevated as policy discourse likely becomes more heated, but we believe this will be short-lived. Unconventional political positions from the White House, in addition to centrality of the president s approval ratings in the election, could push the respective parties to adopt counterintuitive policies. Most notably, Republicans might step away from the fiscal conservative position with a second tax bill, while the Democrats might abandon an infrastructure bill to avoid giving the White House a win. The Democrats would become the deficit hawks and the Republicans the doves in such a scenario. Currently, trade appears to be the biggest geopolitical risk to markets, and the election may do little to reduce policy uncertainty. The White House has broad authority. Congress could look to roll back specific powers, but we do not expect this risk to decline meaningfully after the midterms unless there are deals forged between now and the first week of November. For more information, please contact your Financial Advisor. We caution against using generic or conventional political positions for simple extrapolations of policy in this season. Please refer to important information, disclosures and qualifications at the end of this material. 8

9 Risk Considerations Investing in foreign markets and emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies. Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention. Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment. Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate. Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio. Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets. Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy. Investors should consult with their tax advisor before implementing such a strategy. Disclosures Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance. The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this material. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. 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Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events. Please refer to important information, disclosures and qualifications at the end of this material. 9

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