Markets Weekly podcast - 19 April 2021
Where are we in the credit cycle and what’s behind a sizzling stock market? Join host Jai Lakhani, Investment Strategist, and Michel Vernier, Head of Fixed Income Strategy, both of Barclays Private Bank for this and more in this week’s Markets Weekly podcast.
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Jai Lakhani (JL): Hello, its Monday April 19 and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will help you navigate through the volatility of the global economy and financial markets.
My name is Jai Lakhani, Investment Strategist with Barclays Private Bank. Each week we’ll be joined by guests to discuss the topics that matter most for investors and evaluate the risks and opportunities.
Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. I'll then take a look at credit cycles and why they are important for investors.
Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
If there was one theme to take away from last week, it was that the market is adding more conviction to the economic recovery playing out as vaccine distribution continues to accelerate, the US reopens, and consumers returned to the market with pent up savings and direct cheques from the US recovery fund.
Taking a look at the market in more general terms, as Q1 earnings season kicked off we saw strong earnings growth that beat expectations from the likes of JPMorgan, Goldman Sachs, and Bank of America.
The S&P 500 and Dow Jones, as a result, continued to break record highs with the S&P 500 up 0.36% on the week. The euro Stoxx 600 eclipsed last week’s high and was up 0.7%. The FTSE 100 crossed 7,000 points on Friday to reach its highest level since February 2020 and in China the CSI 300 index was boosted on Friday by strong GDP data.
GDP growth hit a record high on a year-on-year basis of 18.3%, boosted by retail sales data recovering and fixed asset investment in the property sector.
Whilst the growth was resilient and the Chinese consumer appears to be making their way back into the market, taking a look at growth on a quarter-on-quarter basis shows a bit more weakness, which was weaker than the economists expected at 0.6%.
What does this highlight? It highlights the importance of financial conditions remaining supportive in the region as China continues more sustainable GDP growth.
Economic data from the US also appeared to be key in fuelling markets. March retail sales data rose by 9.8% month-on-month. This was much higher than Barclays Investment Bank's forecast of 6% and consensus of 5.8%.
What was driving it? Well, states in the US reopened, we had base effects after a weak February posting because of the freezing conditions in Texas, and consumers receiving their stimulus cheques.
According to the IRS, we had three batches of economic impact payments which were distributed from March 12 to March 26 and these totalled $335 billion. The strength was broad based as all 13 categories reported month-on-month increases and states reopening allowed for retail services and restaurants to experience strong demand gains.
Taking a look at the US employment data, initial jobless claims also fell to 576,000 in the week ending April 10. That is the lowest reading so far in the recovery. This does appear to bode well for the April payroll data and it is showing the US labour market continuing to recover as states reopen.
It is worth pointing out that before the shock of the pandemic, weekly claims were typically running around 200,000 so we will need to see a continuation of this trend to really see a full healing especially as February payroll data was 8.4 million below the peak in February 2020.
With inflation being a cause for concern for markets this year, it was interesting that US Consumer Price Index (CPI) surprising expectations to the upside at 2.6% year-on-year didn't see yields rising or equity markets struggling as a result.
What’s more is the strength in inflation also appeared to go further than just base effects and transitory pressures with services inflation rising sharply as hotel and restaurants reopened in many states
Markets for now appear to be reassured by US Federal Reserve speeches and the minutes two weeks ago which highlight this idea that we are still in the beginning stages of the recovery.
Fed Chair Jerome Powell in his comments to the Economic Club of Washington DC last week furthered this. Powell mentioned that asset tapering is a long way away. It's no surprise therefore the US 10-year finished the week at 1.58%.
The move lower in yields despite strong economic data and higher inflation could also be explained by a lot of geopolitical uncertainty. We also had vaccine fears. Johnson & Johnson was suspended in the US due to blood clots.
When we take a look at geopolitical tensions, we need to look no further than the US and Russia. Looking at these tensions in more detail, the US announced a series of sanctions against Russia.
US financial institutions are not allowed to invest into newly issued bonds in the ruble debt market from the beginning of June 14. In addition, 32 entities and individuals are sanctioned as well as six companies which are thought to support the government hacking.
The US, of course, blames Russia for the 2020 US presidential election meddling. We've also had the SolarWinds hacking attack, the poisoning of Alexei Navalny, and what has happened more recently in terms of Russia deploying a large number of troops at the border of Ukraine.
Calls from the European Union and G7 group of nations were for Russia to deescalate tensions and Russia, at the same time, said plans from the US to send warships to the Black Sea would be provocative.
Despite this, we didn't see a weakening ruble. If anything, it slightly strengthened from previous weakness and I guess the reason for this is that when we take a look at the sanctions, they do pale when compared to previous sanctions.
Foreign buyers in Russia's primary market are only 10% and Russia appears fairly robust against these sanctions. However, it does highlight a risk in the emerging markets market and this is why we favour diversification, particularly in the bond market, and there is a risk of sanctions rising spreads in Russia's bonds.
Markets this week are likely to continue to focus on earnings season and more importantly guidance. Good news remains priced in and thus anything not meeting expectations has the potential to be punished.
So that was the global economy and financial markets last week. Let's move on to consider credit cycles. I'm pleased to say that I'm joined by Michel Vernier, our Head of Fixed Income Strategy for Barclays Private Bank.
Michel, thanks for joining us today and let's get started. Today we're going to talk about the credit cycle. Can you explain to us what a credit cycle is and why investors would look at credit cycles?
Michel Vernier (MV): Yes, hello Jai. So, the credit cycle describes a pattern in the economy and financial markets. The idea and the observation behind a credit cycle is that access to credit or funding for households and companies vary over time and meanwhile the ease of access to credit and asset levels are directly interconnected.
In a full credit cycle, you have four phases. It starts with the expansion phase; there you have easy access to funds. Companies and households have cash to invest or spend.
The asset prices are surging during this period until reaching peak levels. At a certain degree of credit, the credit costs are too high and the asset base is not sufficient to serve the credit costs and the asset prices start to decline.
The lower asset base can eventually lead to higher default and more stress and this is what investors call the ‘Minsky moment’ after the US economist Hyman Minsky. We have seen this during the great financial crisis in 2008. Once we went to such a downturn, at some stage the repair phase kicks in and this is followed then by the recovery phase.
Investors like the idea of cycles as it provides a recurring familiar environment and may provide a guidance on how to allocate assets in a portfolio.
JL: So now we know what a credit cycle is and why it's important. My next question is how would one know where we are in the credit cycle?
MV: Yes, that's a good question. The vast amount of factors you typically look into and you can divide them into three buckets, into three main segments: economic factors, the asset quality and liquidity.
So, you look at defaults, liquidity conditions, level of bond issuance, corporate profitability, lending surveys, and many other factors and each factor like defaults, for example, can give you an idea where we are on the credit cycle.
But be careful, as not all factors are always leading to the same conclusion and it's important to note that credit cycle is very often longer than economic cycles or other cycles.
Again, if you think of the great credit crisis, the debt build-up took over 10 years, if not much longer depending on how you want to look at it. US economist Kenneth Rogoff goes as far to say that a credit cycle can last over half a century, in fact.
JL: That's interesting. So, given the stage we are at in the credit cycle, what do the mentioned input factors tell us? After the crisis, one would assume we passed the cycle and we're going into a new one?
MV: Yes, precisely. The most obvious factors are default rates and, according to Moody's and various other houses, it seems very likely that we have passed the peak and default rates are going down again.
In the same way, spreads and other factors point to a repair phase, if not recovery phase already, but remember the rise in defaults was caused by an exogenous factor so not really the typical pattern we just described. And, meanwhile, that is increasing not declining so going back to Kenneth Rogoff, this current credit cycle may not have reached the peak.
JL: I'm sure many investors, like myself, would hear this and err on the side of caution. If there is still risk, should we not rather pare down exposure and get out of investments?
MV: We can wait another 30 years, of course. But we all know that during these longer cycles, money can be earned.
Investments should not stop, and it is important to stay invested but equally it can help think about the idea of the credit cycle and put things into a broader perspective. With this, investors know what to watch out for when navigating through this environment.
JL: Well, thank you Michel for your insights today on what credit cycles are, how to distinguish where we are on the credit cycle, and how to be prepared as an investor. Clients will undoubtedly need this when focusing on optimising their portfolios.
Moving on to the key events this week. With regards to central bank meetings, we have the European Central Bank (ECB) meeting on Thursday. We see no change for now after March’s announced pandemic emergency purchase programme pace increase in Q2.
The governing council is likely to reiterate the determination of keeping financial conditions favourable, but there is unlikely to be a framework as of yet, and that a recovery is coming but it is delayed and not derailed.
The ECB is facing a euro area that has seen a short-term worsening in economic outlook as restrictions increase to curb the rising cases and inflation continues to remain very weak.
What will the market need to see? Well, it will need to see an increase in purchases in Q2 in order for the governing council to have credibility.
It's our view that more will need to be done to reflate the economy and promote a recovery and we see an increase in quantitative easing to 700 billion euros at the December meeting.
On the data front, April flash manufacturing and services purchasing managers’ index (PMI) in the eurozone, UK, and US will help to gauge the continuing effect of the pandemic on economic activity.
Taking a look at manufacturing, in all three regions it printed strongly in March with the eurozone PMI showing its greatest degree of improvement in the survey’s history.
Services in the UK printed in expansionary territory for the first time since October and this was despite the country remaining in lockdown. Eurozone services printed in contractionary territory, however, but they were still at their highest reading since August.
Composite readings in all three regions actually printed in expansionary territory. So, taking a look at the April flash readings, it will indicate whether the introduction of restrictions across Europe and the reduction of restrictions in the UK in April have had a significant impact on the demand outlook.
The US, similar to the UK, is seeing a continued reopening and we will see whether this could boost services even higher than the 60.4 reading in March.
There is a lot of data as well from the UK, with the February employment data, March retail sales and inflation data.
Taking a look at the employment data, it's worth pointing out that the UK unemployment rate has remained fairly low while furloughed workers are classed as employed. The extension of the follow scheme until the end of September 2021 should therefore keep the UK unemployment rate fairly stable.
Therefore, in Tuesday’s February data, it's unlikely to really show great changes in UK unemployment.
Taking a look at retail sales, well this jumped 2.1% month-on-month in February, following an 8.2% slump in January. What February showed was a recovery in retail sales during the second month of lockdown as retailers really found new ways to allow consumers to access their goods.
The proportion of goods spent online increased to 36.1% – that's the highest on record. What Friday's March data will indicate is whether consumers have increased their buying during the third month of national lockdown or are choosing to hold back their spending for the re-opening in the spring.
Taking a look at inflation, well inflation in the UK has been fairly subdued and March’s CPI print will likely confirm rates at disinflationary levels.
We had February's reading of 0.4% year-on-year and we only expect a slight increase to 0.6%. However, after remaining this subdued in Q1, we actually expect inflation to rise substantially in Q2 as the vaccine distribution increases, the economy reopens, and consumers unlock this pent-up demand.
From the US, jobless claims data remains an important source in gauging the US labour market recovery. Claims in the week ending April 10 did fall to their lowest during the whole recovery period, so signs of a gradual recovery in the job market are starting to emerge.
However, despite these improvements, the level of claims remain elevated and will likely remain so until the US achieves herd immunity through vaccinations.
And with that we'd like to thank you once again for joining us. We will of course be back next week but for now I wish you a successful trading week ahead.
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