Markets Weekly Podcast - 16 Nov 2020

This week our host Henk Potts, Market Strategist for EMEA, Barclays Private Bank, is joined by Julien Lafargue, Head of Equity Strategy, Barclays Private Bank. They discuss the expectations that can be pinned on a vaccine in the near-term as well as considering the medical and logistical challenges that could hinder distribution. Potts and Lafargue also dissect latest market movements and Q3 earnings data, including whether the rotation from growth to value stocks will continue.

Henk Potts (HP): Hello its Monday the 16th November and welcome to the Barclays Private Bank markets podcast, the weekly recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist for Barclays Private Bank and each week I'll be joined by guests to discuss both risks and opportunities for investors. This recording will last around about 15 minutes and be broken down to three component parts.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. I’ll then move on to our focus section where we’ll spend a few minutes discussing a specific investment theme.

This week I'm pleased to say our special guest is Julien Lafargue, he's Head of Equity Strategy with Barclays Private Bank. We will discuss the impact of a potential vaccine on equity markets, whether investors should join the rotation into value stocks and discuss the outlook for European equities.

Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Let's start firstly by reviewing last week's action. I think investors spent actually much of last week trying to look through the dark near term virus risk to the brighter vaccine horizon. As we have said many times before, a true normalisation of activity will only occur when a vaccine has been developed, tested, and globally distributed.

It can be argued that we witnessed the first true tangible step towards normality last week as Pfizer and BioNTech announced the clinical trial results of its COVID-19 vaccine candidate.

The vaccine showed an impressive 90% efficacy in preventing coronavirus infections. Dr Fauci has previously stated that a vaccine that is 50 or 60% effective would be acceptable.

There are now hopes of course that the vaccine will be fast tracked for approval before the end of this year. What do these results tell us?

They prove that science can indeed provide an answer to tame the virus. Other vaccines with similar mechanisms are also being developed which should help with the battle against the disease.

I think while the update is clearly positive we do need to be realistic around the speed of progress and potential logistical challenges. We know global roll out will take some time, storage conditions could prove to be onerous. There are also questions over things like the length of immunity, side effects and vaccine hesitancy which could impede upon getting to herd immunity levels.

In the meantime, there's no doubt coronavirus data remains alarming with infections accelerating at a rapid rate and containment measures intensifying. If you look at the figures around the world there’s now 53.4 million confirmed cases, deaths now stand at a tragic 1.3 million.

In recent days the US, Japan, Russia and the UK have all registered record daily coronavirus cases. The prospect of tighter restrictions in many regions loom large and growth forecasts for the fourth quarter have indeed been tumbling. In terms of market reaction, it was somewhat a tale of two halves it has to be said.

At the start of the week risk sentiment got a shot in the arm from the vaccine results, stocks surged: we saw the MSCI all country index in a record high, bond yields jumped, crude and the US dollar rallied.

The cost to protect corporate debt against default in the US and Europe sank. Investors were betting that there's a reduced requirement to shelter in safe haven assets so gold, the Japanese yen, the Swiss franc all slumped.

There's a rotation, as we've been hearing about, into value and cyclical sectors that helped Europe to outperform. There are also perhaps some early signs that ‘stay at home’ trade that's been really prevalent during the course of the coronavirus may start to unwind.

We saw small caps outperforming the tech mega caps. Sectors that outperform, perhaps no real surprise, is those value sectors, those that have been beaten down over the course of the past few months. They included the banks, the energy and the industrials. We also saw a rebound in travel and leisure.

In fixed income the reflation trade came back into view. 10-year Treasury bond yields spiked, in fact hit 0.95% last week, that's its highest since March 20^th.

However, as the week went on investors were hit, I think, with a dose of reality as the medical data deteriorated and central bankers warned the prospect of a vaccine isn’t enough to put an end to the economic challenges created by the pandemic so risk asset is back.

For the week the S&P 500 was still positive, it was up 2.2%. In Europe we did see that outperformance, STOXX 600 was up 5.1% marking the best two-week rally since May 2001.

I think from an investment strategy perspective, given the radical outperformance of growth stocks over value it is not a surprise some rebalancing has been taking place. I think with the event risk of the US election out of the way, expectations of a successful vaccine starting to be priced in, and modest US stimulus package anticipated for next year the potential for upside surprises has reduced.

Investors are expected to re-focus on the fundamentals that include the shape of the recovery, ongoing central bank support, and corporate earnings expectations.

What we do know is that policy support remains vital. There was positive news out of Europe last week. It's been reported that European Union is getting close to signing off on its 1.8 trillion-euro budget as well as the recovery fund, both of which should boost the bloc's fragile recovery.

European recovery plan, to remind you, allowed the Commission to raise 750 billion euros and mutualise debt. Fears that the implementation of the plan could be delayed have eased as members agreed the mechanism linking EU funds to the rule of law.

Once agreed, disbursements from the recovery fund are likely to be paid twice a year and will be linked to milestones, approved countries are implementing the required reforms and investments.

In terms of timing, 10% of the fund is expected to be paid out in the first half of next year. In terms of the impact this is likely to have, well the proposals we know not only supports weak economies, particularly those southern European ones, but also commits to much greater levels of fiscal integration, a decision that reduces concerns about fragmentation risks of the European Union.

The European Commission projections claim the recovery plan will add 2% to the European Union's economic output in coming years.

And the other good news from a global perspective is the fact that free trade is back. 15 Asian Pacific countries have signed a huge trade deal that paves the way for reduced barriers for a third of the world's population and economic output.

The regional comprehensive economic partnership was a decade in the making. It brings the powerhouses of China, Japan and South Korea together with the Association of South East Asian countries.

In terms of its impact, it creates this formal trading zone or will eventually create this formal trading zone with agreements on tariffs, on customs, services and investment procedures.

Very much seen as a victory for global trade prospects and reduces the US influence over Asian trading conditions. So that's how markets finished during the course of last week.

Let's move on to our focus section. Julien good to have you with us today.

Julien Lafarge (JL):Good morning.

HP: Let's begin with investors reaction to that potential Pfizer vaccine. As we know it was a strong performance on equity markets during the course of last week. Did the news of a vaccine materially change your outlook for equity markets?

JL: Well it's clearly a very strong positive. It was expected that we would get some news, possibly towards the end of this this year, so it's coming slightly earlier than expected but maybe more importantly, the quality of the data that we've seen so far in terms of efficacy has surprised us quite positively so definitely this is a positive development.

Now, is it a game changer compared to expectation? That remains to be seen. Obviously there are logistical constraints with the particular vaccine, the Pfizer vaccine that has been put forward.

There are also questions as to when really the world will be able to get its hands on this vaccine and go back to normal. And probably this won’t happen until the second half of next year.

So clearly it gives some hope, we now see some light at the end of the tunnel and probably other vaccines are going to follow suit, but we're entering a period where cases in terms of new infection as well as unfortunately deaths are likely to continue rising for the time being.

So, a positive development but not something that at least for the next three to six months will definitely change the way the pandemic is evolving.

HP: Okay, so bearing that in mind let's think a little bit about how investors should be positioned. We know for much of this year the focus has very much been on these growth stocks, the technology stocks.

However, within the last couple of weeks’ investors have been looking for bargains, particularly in value stocks. Do you think this value trade can continue to outperform going forward?

JL: Well this time it probably has further legs than previous episodes of sector rotation that we've seen. We wouldn't get too carried away though. We don't think that it's right for investors to switch portfolio from one or the other completely.

I think the approach that we would like to take is probably a bit more of a balanced approach. Growth was really the place to be for the last few years, but going forward we feel that having this more balanced exposure is probably best.

Unfortunately, value doesn't really benefit from this compounding effect that you have with growth or what we prefer to call quality names ie companies that have for now some visibility in terms of growth even if it's not the highest growth out there, as well as a strong balance sheet.

So when you invest in those type of company you tend to benefit from a strong compounding effect over the years because this particular group is able to deliver growth whatever happens in terms of economic backdrop and where we are in the cycle.

This compounding effect is so strong that if you have a three, five or ten year investment horizon, being involved with those company or being invested in those companies is probably what’s going to deliver you the best return.

Value can have bursts of outperformance but it's unlikely to last for a very long period of time and as the cycle eventually turns back into maybe a more difficult period, then you will suffer significant underperformance. So we would re-balance a bit portfolios but always keep this strong core of quality companies.

HP: Thank you. So that's a few thoughts around what it means in terms of sector position. Let's move onto geographical exposure within asset class, in particular of course equity markets.

As the European Union seems to be making some progress on that recovery fund does that make you more bullish on European equity markets? A great debate of course taking place amongst investors at the moment - do they continue to stick with the United States or do they now start to take advantage of some of these lower valuations in Europe?

JL: Well it looks like the recovery fund is probably more of a late 2021 potentially more 2022 story in terms of when the impacts will really be felt at the economic level and at the companies level.

Of course the market will discount that in advance but it still feels like it's quite far from where we are today. I think the short term driver for Europe has more to do with this value trend that we just talked about.

Europe tends to be a more of a value market, at the index level, at least based on the composition of the indices. You have more exposure to banks, more exposure to industrials, more exposure to insurers and all that means the as investors rotate away from being only invested in growth into more value, then Europe is in a good spot to deliver some short term outperformance.

But really for us, as we were discussing before, this whole idea about compounding makes Europe more of a trading market than one where you just want to invest passively and ride it out.

What we want to do in Europe is to be really focused on finding those quality companies. Unfortunately, they are under represented at the index level, that's why we want to use active management in Europe to really focus on those companies and nothing else.

So a slightly better outlook for Europe, potentially some outperformance in the short term but really for us the message is: if you want to be in Europe, then you want to be active when you invest in Europe.

HP: Well, thank you Julien for sharing your insights into the outlook for equity markets today with their specific views on sectors and how investors should be positioned going into 2021, certainly a topic that we will return to in coming weeks.

Let's move on to what investors will be focused on this week. In fact, we've already got data coming out of China that underscores the V shaped recovery in the world's second largest economy.

Figures on Monday show that for October industrial production in China rose 6.9%. We know investors very much focusing on retail sales as the number becoming much more important component of China's growth profile.

Retail sales growth accelerated to 4.3% in October from 3.3% in September. Fixed asset investment is also positive about 1.8% for the first 10 months of the year. The unemployment rate inched down to 5.3%. Certainly Asia looking very strong in terms of that economic recovery.

Beyond Asian markets we will also be focusing this week on October retail sales data from the UK and from the United States, both of which will signal the health of the consumer.

We know UK retail sales have been positive; September was the fifth consecutive month of month on month growth but what we also know is the magnitude of this growth has significantly reduced since June and is likely to be weighed down by virus prevalence and local restrictions.

Looking at the United States, September retail sales data for the US also beat expectations we had 1.9% month on month growth.

As consumer spending is the most important driver of the US economy, strength in retail sales is a key indicator of the economic recovery. For US October retail sales figures we expect growth of 0.5% month on month.

Against the backdrop of suppressed economic activity, inflation rates as we know remain generally subdued. Wednesday's UK October consumer price index (CPI), we look for CPI to come in at just 0.1% year on year. In the euro area, core inflation is expected to slide further as national lockdown measures depress services inflation figures coming through.

And with that I'd like to thank you once again for joining us. We hope you found this podcast interesting, informative, and it’s given you a guide as how you should position your portfolio from an equity perspective in the current environment.

We will of course be back next week with our latest instalment, but for now, may I wish you every success in the trading week ahead.