Markets Weekly podcast - 22 February 2021
Can equities still grow, despite their high valuations? In this week’s Markets Weekly Podcast our host Gerald Moser, Chief Market Strategist, discusses this with Julien Lafargue, Head of Equity Advisory, both at Barclays Private Bank.
Moser analyses the latest results of the stronger-than-expected earnings season, including the US conundrum of robust retail coupled with high unemployment. Lafargue looks at the risk of valuations, inflationary pressure and the wisdom of investing in quality companies.
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Gerald Moser (GM): Hello its Monday the 22nd of February, and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.
My name is Gerald Moser, Chief Market Strategist with Barclays Private Bank, and each week we’ll be joined by guests to discuss both risks and opportunities for investors.
This recording will last around 15 minutes and will be broken down into three component parts. Firstly, I will 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, Head of Equity Strategies at Barclays Private Bank. With him, I will be discussing the key takeaways of the earning season, the level of equity market valuations, and risks posed to the upside and the downside for equities.
And finally, I will conclude by previewing the major events and data releases that are likely to shape the week ahead.
But first let's start with markets from last week. We continue to see a conundrum with US households. On one side, the January US retail sales report came in significantly above expectations, registering a 5.3% month on month gain after contraction of 1% in December. Core sales also rose 6% month on month.
The rebound in sales was fairly broad based across categories, although there does seem to be a tilt towards discretionary spending. We had expected to see an improvement in the January sales data after three months of contraction and Wednesday's report suggests that the boost to retail sales was likely fuelled by the additional fiscal support provided to households by the federal government in January.
With consumption spending off to such a solid start in Q1 we see some upside risks to our Q1 GDP forecast of 2.5%. But on the other hand, US initial jobless claims unexpectedly jumped to a four week high indicating fresh setbacks in the labour markets even as the coronavirus situation is being brought under control.
Claims for the week ending 13th February totalled 861,000, an increase of 13,000 from the previous week which was also upwardly revised. This is an extremely high level; a usual number would be around 300,000.
Now going back to inflation, a topic that we already discussed last week, the PPI continues to show stronger inflation than the CPI in the US.
Headline PPI rose 1.3% month on month and 1.7% year on year in January with widespread gains across energy, food, and core categories. Strong demand domestically as well as for US exports pushed prices higher.
We are optimistic about the outlook for producer prices and see it as a supporting factor for goods CPI and PCE inflation.
Now adding to the inflation point and the initial retail sales, on top of that you had a very strong forward looking US flash PMI both for services and manufacturing. On the back of those strong economic data, high PPI and fiscal stimulus expectations, the 10 year US Treasury note reached its highest level in a year hovering around 1.3%.
However, the January Fed minutes released last week reiterated their expectation for inflation to increase and indicated that monetary policy would not be altered until there's been a drastic improvement in the labour market situation and, as we discussed, we are far from that. But despite the commitment from the Fed, equity markets suffered from the higher rates and global equities ended the week in negative territory.
Now looking into Europe, the eurozone Q4 flash estimate GDP data was revised up slightly from a contraction of 0.7% to a contraction of 0.6%. But flash PMIs suggest that we continue to see a widening gap between manufacturing and services, with services suffering a further deterioration on the back of current lockdowns.
With services representing a large part of European economies it would suggest further contraction in Q1 European GDP. The only country in Europe where the trend was different is the UK.
Services flash reading improved meaningfully in February, probably a reflection of the successful vaccine rollout campaign, while manufacturing came below expectations. The fact that the weakness in the manufacturing index came from export orders would suggest some Brexit friction weighing on the sector.
Now let's turn to equities. Julien, it is a pleasure to have you on the podcast this morning. Since you were here last time, companies reported their latest earnings data. What are the key takeaways from those releases?
Julien Lafargue (JL): Thank you for having me. So I think there are two key takeaways. The first one when you look at the actual earnings is how strong they've been, particularly in the US.
To give some perspective, going into the earnings season the consensus was looking for about a 10% contraction in earnings for the fourth quarter of 2020. The actual number will turn out to be very close to plus 4% earnings growth in this quarter.
This is a phenomenal achievement when we remember that in Q4 2019 COVID-19 didn't exist and so the comparison for the Q4 of last year was actually very difficult. So the first key takeaway is a very or much stronger than expected earnings season.
The second takeaway that's more on the qualitative side looking at what companies have said, there hasn't been any strong common thread around companies’ comments.
The one thing we picked up though is more and more companies are mentioning higher inflationary pressure coming through, whether it's in raw materials or whether it's coming from the value chain process, thinking about some supply chain issues, threat issues, overall companies are pointing to the fact that prices or costs on their side are going higher and so the key question going forward will be will these companies be able to pass on that cost to their end consumer and protect their margin or are we going to see margin compression.
But overall a strong earning season but something to keep an eye is this ramp up in cost for companies.
GM: Thank you. So, does that trigger any change in your views in equity markets, your preference on sectors or countries? Did the earnings season confirm your views or is it triggering some changes there?
JL: It actually confirms our constructive stance, as you know we've been constructive on equity markets for a while now and really this earnings season has done one thing, which is to cement 2021 earnings expectation in terms of growth for this year. We feel that now that the base for on which 2021 earnings can grow is much more stable.
The reaction to that on our side has been to slightly increase our fair value estimate for the S&P 500 by about 200 point to 3900, because we have more confidence in companies’ ability to deliver these strong earnings.
There hasn't really been any changes in terms of sector selection or region selection. If you look at the earnings season in Europe it was better than expected but still very disappointing versus the US.
Europe saw earnings contract by about 10%. A function of that is just the sector mix with a lot of energy and financials and those sectors have struggled in the last quarter of last year.
So we very much remain as we've been i.e. positive on equity markets, slightly more so in the US than Europe, and from a sector perspective we continue to favour this sort of barbell approach between some growth and some cyclicality.
GM: Thanks, that's very clear. But one push back on a positive views on equities is about valuation. We see a lot of people questioning the level of valuation we see in equity markets and the question is, is it sustainable?
JL: Well clearly, valuation is as you said the number one push back. We've tried to address that in the past by trying to focus people's attention not so much on the absolute level of valuation like the PE ratio of markets at the moment but rather taking a more relative value approach so to speak and look at the market or the equity market in relation to other opportunities that are out there.
And that's why our focus has been specifically on the equity risk premium to try and identify whether there is still value in equity markets or not, and based on that metric we're getting too, I would say, not stretch territory but clearly equity markets have gotten more expensive, but a lot of that has to do with the fact that the 10-year yield has increased which has reduced this this equity risk premium.
So far, we don't think we are at a level that would raise concern. We are still going to see some upside from current levels, but clearly valuations aren’t as appealing as it once was and we believe, that at least at the market level, upside is going to be limited.
Now, that doesn't mean there is no opportunity, we will just focus our attention much more at the sector and even more so at the stock level really to find those opportunities that we cannot necessarily see, or at least as not clearly as we could have in the past at the index level.
GM: OK, so now that we've discussed valuation which clearly is risk number one on a lot of investors’ minds, what are the other risks and actually not only negative risk also potentially positive risk you see for equity markets?
JL: Well aside from inflation and the increased inflation or surge, a very strong surge in inflation could cause on the fixed income side and the yield side, the other important risk obviously has to do with the fiscal stimulus that market participants currently expects.
There's a lot of expectation that $1.9 trillion or so fiscal stimulus will be passed in the US in the coming weeks. There is also expectation that that will be followed by almost an equivalent, in terms of size, infrastructure stimulus.
So there is a lot of expectations for more money to be poured from a fiscal standpoint. There could be a disappointment on that front should government feel the need to actually cut back on those expenses in order to contain their deficit which are ballooning to unprecedented level.
This is not something that we feel is on the cards right now but that's clearly something worth monitoring in terms of downside risk, whether or not we're going to get this continued fiscal stimulus in the months ahead. That's on the negative side.
On the positive side, there is a lot of optimism already in the market but we could see positive surprise in our opinion coming on two fronts. First, as you’ve mentioned, retail sales have been extremely strong and we could see further growth on that front.
Market participant and the consensus economist, have apparently failed to estimate how much pent up demand has been built during the pandemic and if consumers decide to spend more because they feel better, because they can see the end of the tunnel when it comes to the pandemic, all the money that has been saved with saving rates remaining quite high plus all the extra stimulus that is coming in the consumer’s way that could really help boost consumption and therefore boost earnings.
So consumption is one thing that could surprise positively going forward and one of the reasons why we like the consumer discretionary sector.
The second upside risk could be a faster than expected return to normal as COVID-19 is being dealt with. This is very difficult to call, you know, we're not scientists we’re just looking at the data that is given to us.
We've seen encouraging sign coming from Israel for example. And you could imagine a scenario where COVID-19 becomes nothing else than the flu with regular shots every year or so and then life comes back to normal.
There is an expectation that things are going to be more normal going forward but really back to normal faster than expected that could be the second positive surprise.
GM: Thank you Julien, that’s very interesting. So, in a nutshell, still a preference for equities but a focus on quality and single stock selection.
Now turning to the week ahead, UK unemployment rate has remained fairly low while furloughed workers are classed as employed. The extension of the furlough scheme until April 2021 should keep the UK unemployment rate fairly stable until then.
Therefore, tomorrow's December data is unlikely to show great changes in unemployment although we do expect a small uptick from 5% in December.
One area of the UK economy which has been very much alive in the past few months is the UK housing market, but growth began to falter in January with the annual rate dropping to 6.4% from December's high of 7.3%.
Prices also fell 0.3% month on month, the first decline in seven months. This slowdown likely reflects the tapering in demand ahead of the stamp duty holiday ending in March. The February data that we will get this week from Nationwide will confirm whether this slow down in price growth is the start of a new trend.
Turning to the US, we will get the second estimate of the Q4 GDP data on Thursday and it will likely confirm the growth of 4% quarter on quarter shown in the advance data.
The market expects a small positive revision from the initial data, around 4.3%. As previously mentioned the US initial jobless claims remain stubbornly high.
The severe weather in the US, notably in Texas which represents 8% of the US GDP, is also likely to start affecting claims level for February.
This will make assessing the true state of the US employment market even more difficult over the next few weeks. Nonetheless we will continue to keep an eye on the Thursday claims numbers every week.
Finally, we will also turn to Washington where Biden's COVID plan is likely to make progress in the Congress and the Fed Chair Powell will also visit the Congress to deliver his semi-annual monetary policy report to both houses on Tuesday and Wednesday.
He is likely to reiterate the current Fed policy stance but questions on inflation, quantitative easing, and fiscal policy could prove interesting.
That's it for this week, wish you all a very successful week in terms of investment and look forward to talk with you again next week.
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