Markets Weekly podcast - 11 January 2021

Henk Potts (HP): Hello it’s Monday the 11th of January and welcome to 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 be broken down into 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, Head of Equity Strategy with Barclays Private Bank.

We will discuss what returns investors can expect from equity markets this year, where there is the greatest opportunity from a geographical and sector perspective, and consider expectations for the fourth quarter earnings season.

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

Let's start with reviewing last week. Investors started 2021 as they finished 2020 with an insatiable appetite for equities and a penchant for cryptocurrencies.

Equity markets remained resilient last week as investors refused to be unnerved by surging coronavirus infections, the disturbing protests in the US capital and slowing momentum in the US labour market.

Risk sentiment remained positive as market participants priced in expectations. The long awaited blue wave will lead to a more aggressive US fiscal policy that will drive growth in the world's largest economy and the growing number of vaccine approvals and higher roll out rate will alleviate the economic paralysis caused by COVID-19 restrictions.

In terms of market performance, the S&P 500 hit an all-time high on Friday, it was up 1.8% over the course of the trading week. European equities outperformed, in fact equities in Europe had their best start to the year since 2009, STOXX 600 jumped 3%.

Expectations of higher debt and inflation certainly playing out in government bond markets; 10-year Treasury yield hit 1.1% for the first time since March 30^th.

Bitcoin traded above $42,000 up more than a third over the course of seven days driven by retail momentum investors and a small but rising institutional exposure.

Total cryptocurrency valuations hit the $1tr mark for the first time last week, somewhat of an incredible performance for something that was created by an algorithm.

Last time cryptocurrencies rallied at this rate was back in 2017 when Bitcoin I think rose something like 1400%, but I’ll remind you it went on to lose 80% of its value in 2018 and markets getting a little bit nervous it has to be said. We've seen in the past two days Bitcoin prices slid as much as 21%.

We do know investors had very much Georgia on their minds last week as the much hyped blue wave finally emerged from the Senate run-off elections. The GOP lost control of the Senate for the first time since 2014.

With the Senate split 50/50 Vice President Kamala Harris will hold the casting vote, thereby improving the new administration's ability to implement its domestic policy agenda which is likely to focus on consumer and workers’ rights, climate and ESG, along with diversity and inclusion.

In terms of the immediate impact expect the Biden administration to pursue additional stimulus. We know that Democrats have been in favour of increasing cheques sent to individuals from $600 to $2000. They’re also likely to think about adding local aid and consumer forbearance provisions.

On COVID, a Democrat led congress may re-empower the Fed, the Treasury to re-establish lending facilities that were shut down as a result of the December COVID relief legislation. In terms of those broader policy objectives, focus will be on tax where there can be expected to see a consideration of a bank tax or financial transaction tax and possibly changes to the corporation tax rate.

On trade, we can anticipate a review or renegotiation of some deals but also anticipate less volatility and lower levels of confrontation with China. On China there is continued bipartisan concern but with greater emphasis on multilateralism. We are unlikely to see an immediate unwinding of the Trump era sanctions.

The focus very much likely to be on intellectual property rights, US manufacturing, climate, and human rights. For big tech we are likely to see an increased focus on issues related to competition: anti-competitive conduct, antitrust laws, and current enforcement levels.

Legislation we think will face an uphill challenge but expect personnel at the enforcement agencies to more heavily scrutinise and regulate the industry.

The true impact of the Senate election, well it certainly makes a difference as to what legislation gets onto the floor and which appointments get approved. However, we should note it's not an open goal for Democrats.

Significant pieces of legislation still require broad support so centrists on both sides of the aisle now hold the true balance of power.

Beyond the US elections the OPEC+ (Organization of the Petroleum Exporting Countries) meeting was in focus. After a protracted meeting Saudi Arabia stepped up to the plate and agreed an extra 1 million barrels per day cut.

Most other states’ production levels will hold steady while Russia and Kazakhstan will be allowed to pump more in February and March, but only a combined 75,000 barrels per day, a modest increase for the two largest non-OPEC producers in the alliance.

In terms of the impact, Saudi Arabia are taking a proactive, pragmatic approach. The cut will help to re-balance near term supply and demand dynamics as short term demand comes under renewed pressure from tighter COVID restrictions. Crude prices jumped 5% on the announcement, they're trading at their highest level in 10 months.

They’ve risen 9 out of the past 10 weeks. Brent trading around $56 this morning. Medium term outlook: crude prices will be driven of course by the speed and the shape of the economic recovery.

Assuming a robust rebound in an increasingly vaccinated world can anticipate Brent trading somewhere around the $80.00 mark by the time that we get to the fourth quarter.

On the data front: manufacturing continues to lead the recovery, helping to offset services weakness. US ISM manufacturing survey showed factory output accelerated to its highest level of nearly 2.5 years in December, mirroring gains in Europe and China. Manufacturing accounts for nearly 12% of the US economy.

Changes in work patterns have been driving demand for electronics, for home improvement products, and exercise equipment. Despite the current robust demand, US manufacturing output is still around about 4% lower than pre-pandemic levels.

The pandemic induced supply bottlenecks, as we know, have been driving up costs for manufacturers and virus protocols including absenteeism, short term shut downs to sanitise factories have been limiting manufacturing growth potential.

The other data to watch out for of course was the US employment report. We know that economic momentum in the US has slowed in recent weeks, particularly in the all-important service sector. Headline numbers: well payrolls declined by more than expected, in fact they fell 140,000.

Put that in some sort of context, the market was looking for a gain closer to 50,000. The weakness has been led by the leisure and hospitality sectors. Hospitality has lost 3.9 million jobs since January, that's a 23% drop.

Payroll employment is 9.8 million below where it stood last February but the unemployment rate did hold steady at 6.7%. In terms of the outlook for US labour market, well we’re talking about 2021, certainly being a year of recovery for the US economy where we think growth will top more than 4%. As a result, US companies should be re-hiring workers.

We project the US unemployment rate will be back to 5% at the end of this year, significantly below that pandemic peak of 14.7% but above that pre-COVID rate of 3.5%.

So that's the state of the global economy. Let's turn our attention to a deeper dive on equities. Julien, good to have you with us today.

Julien Lafargue (JL): Thank you, good morning Henk.

HP: Equity markets as we know have had a strong start to the year. How much upside is realistic from here?

JL: Well clearly it has been a surprising strong start of 2021. Over the medium term we do still see more upside in equities than in fixed income and that is why we maintain that bias in our portfolios.

Now, if you talk about the shorter term it does feel like a lot of good news is in the price already. Equity market seems to be priced for perfection at those levels. Whether you look at it from an earnings perspective or from a valuation perspective, we do see very little room for error.

To put that in into perspective we have a US equity market that is trading north of 20 times forward earnings, and those earnings are pretty punchy. The consensus is expecting growth north of 20% for 2021 and so in our mind we always try to think about where the surprise could come from.

Markets tend to react more to surprises than absolute levels, and given where we are now we feel that the risk for negative surprise is probably higher than for positive surprise. Positive surprise could come in the form of more stimulus in the US, maybe an infrastructure spending plan, but all those things may take time to materialise.

Whereas on the negative side you could have disappointment on those fronts, but you could also have another wave of COVID infections bringing more lockdowns, you could have disappointed earnings.

So, what we really want to do right now is to be focused on diversification at the portfolio level. We're not into chasing this market, we want to keep a clear focus on our investment goals and try to take the relevant amount of risk to achieve those goals but not trying to be overly involved in markets that we believe will remain volatile in the short term.

HP: Okay, so bearing that in mind have you changed your views in terms of sectoral or geographical allocation as the year has gone on?

JL: Not really. We've maintained a strong focus for some time now on quality investing, and by quality we think about companies that have a good amount of visibility into their earnings stream, but also the ability to generate strong free cash flow.

We view that as very important, especially in the current environment because this free cash flow can then be re-invested in the company and promote future growth, and that's really what we want to focus on.

So from a geographical standpoint you tend to find higher quality companies at the index level, in the US and in emerging markets and we are keeping this barbell approach between those two regions as our favourite regions.

We remain a bit more cautious on Europe and Japan, not necessarily that we think there is anything wrong with those regions. When you look at those markets from an index level perspective you find that you don't have this quality tilt that you find in the other regions and as such we would really focus on active management in those two regions, Europe and Japan.

When it comes to sector again, where you find the highest quality company, we tend to see them in the technology space and when I mention technology, it’s not the sector itself but the ecosystem of technology.

So you have high quality companies that have a technological angle in industrials, as well as consumer company, consumer discretionary in particular, and we also like healthcare for the growth it brings, as well as the defensive element that you find in the healthcare space. So, not a lot of change at this point, we are obviously going to revisit that throughout the year but for now we are happy to stay the course.

HP: So let's turn our attention to the immediate focus for investors. We know we are about to enter the fourth quarter earnings season. What do you expect?

JL: So looking at the fourth quarter of 2020 earnings season I think it's important, as always, to look at what the consensus is expecting really and whether again we're going to see positive or negative surprises.

The consensus at this point is looking for 10% year-over-year earnings contraction, that's for the US, in the fourth quarter. If you exclude the energy sector, which obviously has been quite volatile, the earnings growth contraction is around 6.6%.

So again earnings are feeling the impact of COVID, we're going to see earnings contract. In our mind this number is probably a bit too pessimistic and companies have had a tendency to beat earnings expectations so we could by the end of the earnings season see earnings being flat year-over-year.

Unfortunately, we don't really think that this number will matter a lot. Investors seem to be much more focused on 2021, in particular the second half of 2021, when the real recovery should eventually take place as more and more people get vaccinated.

But even more so people are looking at 2022 and that's really the only way you can sort of justify current valuation. Companies are unlikely to say anything about 2022, they might give a bit more for upbeat tone around 2021 and that's really what we're going to be focused on, what type of guidance do we get if any from companies.

As I mentioned before, we do feel that at this stage, expectations are pretty high already and it’s going to be very difficult in our mind for earnings revision to turn positive as the earnings season goes on.

So going into this earning season, same message. We really want to be focused on high quality company, opportunities are most likely to be at the stock level, we don't expect the earnings season to be a game changer when it comes to the broad direction of markets.

HP: Julien thank you for your insights today. We will of course continue to offer commentary on the equity outlook over the course of the coming weeks and months.

Moving to the week ahead. Thursday's UK November GDP estimate data will give us a good indication of the impact of the second national lockdown on the progress of the recovery of the UK economy.

Monthly GDP grew just 0.4% in October, it was still down 8.2% year-on-year, the effects of the pandemic still weighing heavily on UK economic activity.

Against a backdrop of suppressed economic activity, inflation rates remain generally subdued. US December year-on-year core consumer price index on Thursday will likely continue to show disinflationary pressures, with month on month CPI growth of only 0.2% in November.

China CPI has been muted with a 0.6% month-on-month contraction in November. November also saw surprises in the year-on-year CPI data with a contraction of 0.5%, significantly lower than the market was anticipating.

Trade, as we know, is an important part of the Chinese economy and has experienced a significant recovery since the early damage of the pandemic. Exports from China jumped 21% year-on-year in December following an 11.4% year-on-year gain a month earlier.

We expect to see this export strength sustained in the first quarter as China continues to gain global export market share.

With that I'd like to thank you once again for joining us. We hope that you found this podcast interesting, informative and it's given you a guide to the opportunities in equity markets during the course of this year.

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