Markets Weekly podcast - 16 August 2021

Jai Lakhani (JL):  Hello, and welcome to the latest Markets Weekly podcast. My name is Jai Lakhani, Investment Strategist at Barclays Private Bank.

This podcast is going to be split into three sections. Firstly, I’ll discuss what happened in markets last week. Next, we’re going to look at the importance of education on investor biases in decision making. And finally, I’ll conclude by previewing the week ahead.

In terms of markets, well, it was a quieter week on the data front but markets continue to shrug off fears related to the Delta variant with record highs continuing to be broken.

The S&P 500 was up seven tenths of 1% and the Euro Stoxx 600 up 1.27%. It’s worth pointing out that this is its longest run of record high sessions in over three decades. The FTSE 100 was also up 1.3% and treasuries rallied on Friday with the US 10 year hovering around the 1.28% mark. However, Asian markets continued their struggle.

This was primarily due to three factors. One, China’s zero tolerance approach for spreading of the Delta variant. Two, Beijing’s efforts to rein in key sectors such as tech. And finally, what we’ve been seeing in recent months which is macroeconomic data coming in a bit weaker and the July data today was below consensus with retail sales, industrial output and fixed asset investment disappointing.

Is this, therefore, a sign to exit the region?  Well, we always knew that China’s momentum was peaking and this just confirms it. But it’s transitioning to a more stable and solid growth and with policy support likely. And with sentiment really at its worst a contrarian move, actually in fact increasing exposure not decreasing it considering our more constructive medium term outlook could make more sense.

Oil also continued its recent struggle as a result of the Delta variant. This is especially due to China, it’s worth pointing out there the world’s largest crude importer and the potential impact of global demand waning.

On top of that you had President Biden urging OPEC to increase supply given the impact higher oil prices could have on the economic recovery. However, when we look at inventories they remain tight and OPEC have kept their forecast for 2021 demand unchanged suggesting the floor on prices really does remain in place. Brent Crude ended the week at $71 a barrel and it’s worth pointing out that we see Brent averaging $75 in Q4 before increased production next year brings that average down to $68.

As we know, higher gasoline prices over the past few months have had an impact on inflation and the key datapoint investors focused on last week was Wednesday’s July US CPI data. And whilst inflation remained at its 13 year high of 5.4%, more or less in line with consensus expectations of a slight drop to 5.3%, there were some clear signs that these elevated price pressures they may have peaked. This is also something that we talk about in the focus article of the August market prospectus.

The drop in the month on month rate, well, it was the most in 15 months. Core CPI increased 0.3% below that consensus of 0.4% but markedly below June’s 0.9% reading. We all know about used car prices how much they’ve risen in the past few months as a result of semiconductor shortages.

They rose 10.5% in the month prior and this contributed to half of the CPI’s rise in June, but when we look at July they were only up 0.2% and index data such as the Manheim Used Car Index and J.D. Power Index is already showing that momentum here may have peaked.

Similarly, when we think about airline fares they have fuelled service inflation as travel restrictions have been eased but they fell 0.1% in July after four consecutive months of rising previously. This certainly suggests to us that the worst may be behind us.

What was the impact on markets?  Well, despite being the centre of discussion in recent months it appears for now the Fed has won in conveying its message that it would not be bothered by temporary higher prices with investors instead focused on the jobs market.

This picture may of course change should price pressures remain in the fourth quarter and this could be a possibility given the fact we’ve seen shipping costs remain at elevated levels and China on Thursday closing the world’s third largest port as a result of the Delta variant spreading.

You also had the passage through the Senate of President Biden’s $1 trillion infrastructure package. The package includes $550 billion in new federal spending providing 65 billion to expand high speed internet access, 110 billion for roads, bridges and other projects, 25 billion for airports and the most funding for Amtrak since the passenger rail service was founded in 1971.

And so whilst on the surface the bipartisan agreement reached in the Senate it is significant. It was widely anticipated by markets and the bill certainly faces some hurdles. Number one, the 100-member progressive Caucus led by speaker Nancy Pelosi they’ve said that they’re not even going to vote on the bill unless and until the Senate passes separate an even more ambitious 3.5 trillion social policy bill this autumn.

Secondly, and this is a key point with fiscal stimulus, Congress faces the prospect of a shutdown on 1st October and they’re going to need to raise the debt ceiling by 1st November. So what does this mean in terms of the bill really passing?

Well, in order for it to get through the House of Representatives it’s probably going to have to be watered down even further and this will be less of a concern for markets spooked by aggressive fiscal stimulus.

On the UK side, Q2 GDP data was released on Thursday and there were three key factors. Firstly, the extension of support schemes. Secondly, the impressive vaccination programme. And finally, the subsequent reopening of economic activity really boosted growth in Q2.

Growth rose by 4.8% and was driven by an impressive 1% month on month rise in June after May stalled. When we think about it it makes sense that June was strong and it was a welcome month for the beleaguered service sector as hospitality fully reopened in England. Accommodation and restaurants they contributed 34 basis points to that 1% rise and health and social care added a further 0.45% percentage points.

Going forward, however, the picture may not be as rosy as this. When we think shorter term we’ve got supply side shortages of goods mentioned in PMI surveys, we’ve got a mismatch in the labour market, and when we think about July workers either becoming infected or having to self isolate as a result of the pingdemic could slow down activity. It also remains to be seen the impact of the furlough scheme ending and support packages being taken away longer term.

Putting that all together we see UK growth of 6.9% in 2021 and 4.3% in 2022 with the UK only achieving pre pandemic levels in Q1 next year.

So that was markets last week. However, a topic that continues to gain importance and arguably should be at the bedrock of portfolio decisions is behavioural finance. I’m pleased to be joined by Behavioural Finance Specialist Alex Joshi.

Alex, thank you for joining us today and as we know hindsight is 2020. The S&P 500 has quite remarkably now gone 193 days without a 5% correction. Usually we get several a year but we’ve also had 44 all-time highs in the past 52 weeks.

So given this, talk us through the importance of looking back at past decisions alongside the resulting portfolio allocation. Does it further highlight the importance of staying invested given the uncertain backdrop we had leading up to this performance?

Alex Joshi (AJ): Well, good morning, Jai, and good morning to all listening.

So, yes, the summer holidays are a good time for reflection on many aspects of our lives and investments should be no different. You know, when it comes to evaluating our investments the outcomes are of course important but so is the process which leads to those outcomes.

And why is process important?  Well, because there are many factors that govern investment success and actually one of these is just lucky timing. If investors are looking for sustained returns over the long term one of the best ways of achieving this is to have a robust decision making process, one which leads to a well-diversified portfolio which is built to perform across a range of market conditions.

So it’s, therefore, good practice to periodically look back at our investment decisions taken during a given period and objectively assess the rationale for these decisions, the outcome of those specific investments as well as any impacts upon investment allocations with a view to learning for future decision making and making tweaks to portfolios if necessary.

So I mentioned the rationale here because we as humans make decisions for reasons such as our emotions which can introduce biases into the decision making process. So you’ve mentioned the performance of the S&P. Well, someone who may have sold out of investments during a volatile period or one of falling markets for fear of losses may have struggled to get back into market and then missed this recovery.

So this aversion to losses is an example of a behavioural bias which can be particularly damaging over the long term especially as history shows us that it typically pays for an investor to get and stay invested rather than hold cash.

JL: That’s interesting. So that’s one bias that you’ve mentioned and one that I have to mind is that with most of us sadly facing summer holidays in our home country is now more than ever an important time to consider home bias in investment decisions?

AJ: So definitely a good time to be thinking about this given the time of year but also how prevalent this bias is amongst investors. So, what is home bias?  What are the implications?

Well, home bias is where investors overweight their home market in their portfolio and so as a result invest disproportionately more in assets locally compared to their share in the global market.

There are many reasons to explain why as investors we do this. One of these is behavioural and that is familiarity. So, familiarity can give us a feeling of control. We feel we can influence the outcome and so investors may perceive an information asymmetry concerning foreign based companies attaching more risk to investing abroad than is deserved simply because, you know, companies abroad are understood less.

The problem with this, however, is that familiarity has a cost. So I’ve mentioned familiarity here, many investors are holding local assets due to control. In other words, investing locally feels less risky. However, a home biased portfolio can do the opposite. By being overly exposed to specific risks inherent in that particular region it actually increases the risk of a portfolio relative to one with a wider geographical spread.

A second reason is around performance. There is a risk of lower performance. An investor with a home biased portfolio can miss out on a particular sector for example that plays an important role in economic growth globally. So for example European indexes lack some of the large technology component of their US peers which have been big drivers of market valuations.

So it’s important for investors to strike a balance between the comfort from a home biased portfolio and potentially more profitable investments which they are less familiar with.

Here specifically we’re talking about geography but this also extends to asset classes, you know, financial instruments. The key takeaway here is that it’s important for an investor’s portfolio to not be overly concentrated in a range of factors, geography being one of them.

JL: OK. So we now know the importance of evaluating past decisions and home bias in evaluating portfolio allocation. So what do you see as food for thought with regards to decision making for the latter half of the year?

AJ: So it all comes down to discipline. So some of the points that I’m going to discuss now relate to H2 but actually refer to decision making in general. And so I think it’s important for us to be aware that emotions, heuristics, biases affect our decision making.

How do we overcome them?  Well, it’s through greater awareness, attention and planning that investors can guard themselves from making poor choices and also maximise the likelihood of positive outcomes.

And so I’m going to discuss seven points here in, which refer to decision making generally.

So, number one, it’s important for investors to recognise their goals, clarify what their objectives are and agree to them with a trusted advisor. This can make it easier to align investment decisions and ensure that you don’t go off course when markets take a turn for the worse potentially.

Secondly, to have a plan. It’s important to have a goal but it’s also important to have a specific plan to help you achieve those goals. One with rationale, timelines and rules for actions to be taken in different scenarios is even more valuable. It can also keep you anchored therefore during difficult market conditions.

Number three, prepare for the unexpected. Unexpected events don’t make the world more uncertain, they simply show us how uncertain it already was. So it’s important to prepare for uncertainty. The best way is, of course, through a diversified portfolio of quality assets which is built to perform in different conditions.

Number four, rethink risk. So risk is very synonymous with volatility and whilst volatility is uncomfortable this isn’t the most material risk for investors. It’s the risk of poor decisions that prevent you from reaching your investment goals and so investors should be keeping focus on their goals and thinking about how market events affect their ability to reach those goals.

Number five, as we’ve just discussed, is recognise your biases and emotions. And so the best way to do that is to periodically review past decisions as the first step to improving them and also building a process which is systematic and is built around these identified biases to help you reduce their impact. You know, anywhere where your skill, knowledge or time limit your ability to follow that process then delegating to experts is a potential avenue to take.

Number six, be patient. Sadly, investing can include long term thinking to generate a core portfolio but also short term tweaks or opportunistic trades. So it’s important for investors to have sight of both of these over the long term.

And finally, it’s to see beyond. You know, we attach great importance to vivid current events which affect us personally and this is an evolutionary trait designed to protect us from harm but if overweighted it can bias us. So it’s important for all investors to recognise that every year uncertainty provides both risks but also opportunities for those investing for the future.

JL: Well, thank you, Alex, for these key insights and we’ll continue to evaluate the importance of investor behaviour in achieving the optimal portfolio allocations.

Moving on to data to watch out for next week, the UK June unemployment data we looked at more closely given June’s GDP post. In the three months to May unemployment fell to 4.8%. With the BoE’s more hawkish August meeting July inflation data will also be key to see if price pressures remain at their almost three year high of 2.5% achieved in the month prior or we start to see a similar story to that of the US were momentum appears to have peaked.

When we think about retail sales US and UK retail sales both rose strongly in June at 0.6% and 0.5% in June. With strong payroll data from the US in July, that 934,000 new jobs created and the UK fully reopening we’ll see if this translates into further consumer purchases.

With that, I’d like to thank you for joining us today and we wish you a successful trading week ahead.