Markets Weekly podcast - 08 February 2021

Henk Potts (HP): Hello its Monday the 8th 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 Henk Potts, Market Strategist with 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 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 Alex Joshi, Behavioural Finance Specialist with Barclays Private Bank.

We'll discuss what investors can learn from the recent retail trading frenzy. And finally I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.

In terms of markets, last week global equities rebounded at pace as the Reddit retail revolt showed some signs of running out of steam, although it may still have future positioning implications for hedge funds.

Investors actually spent most of the week trying to refocus on the fundamentals of vaccine hopes, robust earnings - particularly coming through from the technology sector - and of course stimulus optimism as President Biden tries to win Congressional support for his proposal. In terms of the vaccine, expectations have been solidifying that we will see continued and material improvement in the healthcare situation in the coming months with 10 Coronavirus vaccines approved for use in at least one country.

Last week the number of global vaccinations surpassed the total number of confirmed cases for the first time. More than 128,000,000 vaccine doses have been administered. Israel, Gibraltar, and the UAE had the highest percentage of their population vaccinated.

In terms of market performance, US equities hit a record high last week. S&P 500 was up 4.5% over the course of the trading week.

In Europe a similar type of gain: STOXX 600 rose 3.5% - that in fact was its biggest weekly advance since the week ending the 13th of November, but it's still 5.6% below its 52-week high that was achieved on the 19th of February 2020.

Brent traded just below $60 a barrel - that's the highest level since February last year - on expectations we will be seeing an economic recovery against the backdrop of OPEC continuing to reduce supply.

In terms of the UK, well the focus was on the MPC where they kept rates at 0.1% and bond purchases at £895 bn.

The Bank of England offered a more optimistic economic outlook than economists had expected and fears from markets that they would introduce negative interest rates were put to one side.

The UK economy continues, as we know, to be weighed down by the third lockdown which has been extended into March. Brexit, of course, has become a reality. There is some evidence that friction at the borders is weighing on supply chains and exports.

Unemployment has risen to its highest level in four years and is projected to surge if and when the furlough programme is withdrawn. But there are some positives. The UK government has successfully been rolling out its vaccination programme, looks to be on target to protect vulnerable groups by mid-February.

The UK is currently doing around about 2.5 million jabs a week. When corrected for the size of population that's 40% more than we see in the United States and five times the pace that we've been seeing compared to European peers.

The Bank of England said the vaccination programme should support household spending, helping to propel growth to 5% for the year.

In terms of the policy outlook, I think given the vast areas of uncertainty the MPC remains on hold but still vigilant. They will continue to assess the shape of the recovery over the course of next few months before coming to a decision.

If by the middle of the year incoming data points to slow or stalling recovery, then the Bank of England may want to step in to allow the economy to reset on a higher growth path. If a new monetary easing package is required it would likely involve a faster pace of asset purchases, more dovish forward guidance, and maybe the last resort of course would be negative interest rates.

The central bank gave financial institutions six months to prepare for negative rates but only as a contingency not as a signal of its intentions. We should remind ourselves of course the threat of negative rates, is nearly as powerful as introducing them but without the side effects.

Markets reacted to the more positive tone coming through from the Bank of England. We saw UK banking stocks jump, gilt yields rose to their highest level since March, the pound hit its strongest level against the euro since May.

In terms of the data, market focus was very much on eurozone GDP and inflation figures. Flash estimates suggest the eurozone contracted by 0.7% in the fourth quarter.

The data points to an economy that is running around about 95% of the pre-crisis level. It suggests some adaption to restrictions as well as the benefit of leaving some sectors open compared with the spring lockdown.

The decline was driven by lower household consumption, especially in services, with lockdown measures pushing forced and precautionary savings rates higher, while investment and trade have partially made up for the weaker consumer.

In terms of the outlook for growth, fourth quarter decline of course puts the eurozone on track fort this double dip recession. New COVID cases in Europe are at upper elevated levels, vaccination programme has got off to a relatively slow start.

As a result, European governments are expected to keep restrictions in place at least until the end of February and potentially significant tougher measures coming through for some countries.

What does that mean? Well, it will continue to weigh on household consumption. There’s also signs bottlenecks in global supply chains are risking disruption in the so far resilient manufacturing sector.

In terms of the future growth profile we see the eurozone contracting by 1.5% in the first quarter followed by a mild improvement in the second quarter as vaccinations, the warmer weather eases restrictions.

The second half of the year I think looks stronger as the region inches towards herd immunity as well as higher public investment. Full year growth we think will come in at 3.7%, with only a return to pre pandemic levels by the first quarter of 2022.

In terms of eurozone inflation, well surged from minus 0.3% to plus 0.9% in January, however the increase was driven by temporary and seasonal factors such a reversal of the VAT cut in Germany, delayed winter sales.

So I think policy implications still remain limited. While base effects will boost inflation figures during the course of this year, weakness in labour markets and household disposable incomes we’ve been talking about should anchor core inflation at depressed levels.

We estimate CPI will average just 1.1% during the course of this year, in the eurozone, which of course is well below target levels.

Very quickly on the US employment report that we saw on Friday. We know it came in below consensus that’s for a second straight month.

The US economy created only 49,000 jobs in January, the December decrease was revised lower. The unemployment rate actually declined to 6.3%, that’s as the labour force participation rate fell.

Market reaction, well it's one of those cases where bad news is good news. Stocks rose as investors bet the weak report ramps up pressure on lawmakers to agree a bigger stimulus package.

So that was the global economy and financial markets last week. We will now turn to behavioural finance to understand how insights around investor psychology can help us explain much of the recent retail trading frenzy, discuss what investors can learn from an event like this.

Alex, good to have you with us today. We know increases of 1000% over the course of a matter of days followed by of course equally spectacular downward moves can lead many to conclude that markets or at least market participants are irrational.

Is that really the case?

Alex Joshi (AJ): Good morning Henk and thanks for having me.

So, a speculative rally in a struggling and heavily shorted video games retailer, fuelled by euphoric members of a message board of posts filled with rocket ship emojis and memes may indeed be irrational, but it is wrong to say that of all investors or financial markets more generally.

People don't behave like the perfectly rational homo economicus of finance textbooks. Heuristics, which are mental rules of thumb, cognitive biases and emotions all affect decisions.

They can indeed become extremely powerful at times and can be used to explain much of what we've witnessed recently with the so called ‘meme stocks’.

So behavioural finance thus provides us with a useful lens through which to examine what's been happening here.

What is behavioural finance? Well, it brings together psychological, social, cognitive, and emotional factors on the investment decisions of individuals which can give us a more informed picture of the investor.

Whilst it's easy to dismiss the retail rally as a short lived story about speculation a lot can be learnt from it by all investors as we humans behave in fairly systematic ways.

We have seen from tulips to cryptocurrencies and will continue to see much of the underlying drivers of this recent episode play out again.

It's also worth bearing in mind that the democratisation of investing with commission free and gamified trading apps is likely to continue, and across asset classes too, which does raise some interesting questions on the implications for markets.

HP: So bearing that in mind please take us through these behavioural factors that are likely to lead to such dizzying heights.

AJ: Sure. So first I think it's important just to state that it's extremely difficult to unpack events and provide one definitive explanation as a combination of factors have played a role here.

So, something got the ball rolling and there are many reasons to choose from: fundamental beliefs, a high profile addition to the board of GameStop, even personal amusement reasons.

Then there is also a technical story here. Being a heavily shorted stock and much of the trading via options the stock going up for short sellers and option market makers to buy stock, which cause it to go up more with the positive feedback loop there.

And then we add in rapidly growing numbers of people who are long because they see everyone else long and making extraordinary returns and the speculative herding behaviour really takes off.

Vast numbers of traders entering the market at extremely high price levels as the ‘get rich quick’ mania takes hold.

So there are a few key biases here. The first: simple narratives can take precedence over rational arguments and with GameStop there’ve been a couple that have really taken hold.

So first is this extremely simple and even jesterly phrases of ‘stonks only go up’ this ‘to the moon’ belief that the price had to keep rising due to the size of short positions by hedge funds and then evolved into a second David v Goliath one about Main Street versus Wall Street.

We are social creatures and so the social aspect here is also extremely important. Part of a bubble involves hearing about others that have made big fortunes and here on Reddit the user base, many of which were sharing daily returns, grew four fold from 2 to 8,000,000 in just over a week.

And so the extremely bullish sentiment with an extremely large proportion hearing about and starting trading for the first time, something which we can see from sign ups on the Robinhood training app, became an echo chamber where buying the stock seemed like a one-way bet fuelled by two key biases.

So the first is the confirmation bias which is a tendency to search for, interpret, favour, and recall information in a way that confirms or supports one’s prior beliefs or conclusions and the availability heuristic which is an overweighting of information which can be more readily recalled, including more recent information.

So here, these extremely bullish posts on Reddit, in many cases at the expense of all other data and analysis. So this mania, leads to the fear of missing out and makes it difficult to take a step back to assess the situation rationally based on all the relevant information for the decision.

One last point here is that it's not all irrational or emotion filled people that enter into a bubble.

There are those who clearly see it is a bubble, but seek to profit from the lack of sophistication of the herd.

However, with these people there is still an overconfidence in one's ability to time the market and control events, as we typically exhibit overconfidence about our own abilities, which will also affect these investors.

HP: Of course, what’s equally important is how do these same traders behave when the price collapses. Take us through what they do in that type of circumstance.

AJ: Sure, so sentiment can change extremely quickly in just normal market conditions let alone when the exuberance displayed is so extreme. Understanding that stocks can go down as well as up is very different from actually experiencing it, especially if this is a new experience.

So psychologically losses have been shown to have twice as large an impact on people than an equally sized gain. The aversion to losses that traders and investors can display can induce higher levels of risk taking or simply selling out of the market completely.

An investor’s negative sentiment can then be exacerbated by negative headlines, which will be no short supply as the downturn starts and so in times of stress an investor’s emotional time horizon shortens, which distorts their risk perception so investing suddenly seems far riskier than it did just one day before.

As humans, we obviously don't like uncertainty and in the face of potentially large losses, as the way down can seem precipitous especially given the majority have bought near the top, so selling to stem the losses can seem like the best way to gain control.

However, seeking emotional comfort in the short term can come at the expense of long term returns.

The unfortunate part of all of this is that many sellers in corrections or downturns, more generally aren't forced sellers with a liquidity need, what they're actually low on is emotional liquidity which is the composure to stay invested.

HP: Well that's very interesting. My final question for you today is what are the really big lessons that investors can take away from an episode like this?

AJ: So, I think there are two key lessons here Henk. So I think the first is that timing the market is extremely difficult.

During this episode it's likely there's a few people made a lot, a lot will have lost some, and undoubtedly a few will have lost a lot.

I bet that very few people envisaged a scenario where they wouldn't have sold out before the crash, including those who clearly saw it was a bubble and seek to exploit it.

The market can be extremely volatile in the short term and unpredictable events, many unrelated to fundamentals, and so in this case for example curbs on the buying and trading platforms, can unexpectedly move markets. So that's the first.

The second is that whilst this is an extreme event, behavioural biases are exhibited to some extent by all investors and so it highlights the importance of having an awareness of one’s own behavioural proclivities over the course of the cycle.

Awareness is one thing, but how can investors protect themselves from them? Well, speculative episodes highlight the benefits of having a robust investment process with predefined rules for trading to ensure that decisions are made based on rational arguments and mitigating the potential impact of biases and emotions.

So think of the advice to sleep on it and not do anything in the heat of the moment, well applied to investing.

As we start seeing the fallout from this, with the stock down already 80% from its peak in just a matter of days, it also highlights the need for and the benefits of having adequate diversification in one's portfolio for all market participants.

HP: Well thank you very much Alex for your insights today. We know emotions certainly play an important role in investors’ decisions.

Understanding that’s the case and incorporating that knowledge into the investment process can save, as you have been talking about, not only a lot of money but also a number of sleepless nights.

Let's move onto the week ahead. The focus there will be on the UK GDP numbers and inflation data coming through from the US and China.  

Friday's UK preliminary fourth quarter GDP and December's GDP estimate data will give an indication of the economic performance coming into 2021.

After third quarter growth was impressive at 16%, disruption caused, as we've been talking about, by the third wave and renewed lockdowns in the fourth quarter means we expect to see a contraction of around about 0.8%, taking the contraction for 2020 to 10.3%.

In terms of inflation data, against a backdrop of suppressed economic activity we know inflation rates generally remain subdued. The US January year on year core Consumer Price Index (CPI) on Wednesday will likely continue to show disinflationary pressures, which we expect to see throughout the first quarter.

The December reading of 1.4% year on year was driven by food and energy with underlying price pressures subdued across major goods and services categories. In terms of China, CPI has been muted with year on year growth only 0.2% in December.

We expect CPI to fall back into negative territory in January and remain volatile in the near term, before returning to positive figures in the second quarter of this year.

With that I'd like to thank you once again for joining us. We hope you found this podcast interesting, it’s been informative and provided you with a suitable warning about acting on investment advice from social media platforms.