Markets Weekly podcast - 26 July 2021

Henk Potts (HP): Hello. It’s Monday, 26^th July 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 for Barclays Private Bank. Each week I’ll be joined by guests to discuss both risks and opportunities for investors.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We’ll then discuss the earnings season. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

As we know, it was a turbulent week for global financial markets last week. The most aggressive pullback of the year playing out in equity markets on Monday as investors appear concerned about coronavirus flare-ups around the world, slowing economic growth momentum and peak earnings growth.

However, supportive comments from central banks, a raft of consensus-beating corporate results, renewed support for mega tech helped to calm nervous investors, allowing indexes to rapidly rebound into positive territory.

In terms of the weekly performance, the S&P 500 closed at a record high, in fact was up 2% over the course of the week. It’s now up 97% from those pandemic lows. In Europe, the STOXX 600 was up 1.5%, that’s the biggest weekly advance since the start of May. Ten-year treasury yields hovered around 1.3% mark on Friday which was 17 basis point higher than the five-month low set on Tuesday.

The increase in volatility certainly no surprise to us. There have been a number of risks we think we need to be cognisant of over the course of the next few weeks and months. Number one, of course, is medical. We heard from the World Health Organization last week. They warned that global cases and deaths are rising again after a period of sustained declines, spurred by the spread of the highly contagious Delta variant. Populations with low vaccination rates, of course, are particularly vulnerable.

While the vaccine rollout has been impressive we need to appreciate it’s also been uneven and there are obviously a range of virus vaccine unknowns including the development of mutations, efficacy levels against existing and future variants, length of immunity and the impact of vaccine hesitancy, all of which have the potential to delay reopening plans and stall the recovery.

Other risks include recent inflation prints, which as we know have come in at multi-decade highs. Evidence that growth rates have peaked in some key economies as they begin the exit recovery phase. For example, we think that growth rates in the US peaked in the second quarter.

China’s numbers actually have probably been a little bit more resilient than expected. The world’s second largest economy will inevitably drift down to a new trend growth rate.

In terms of earnings, yes, we’ve seen some exceptional growth numbers from corporates, but that’s against the very low base of last year. Earnings growth rates will, of course, not be sustained at current levels in the coming quarters.

However, on the positive side, global growth forecasts for this year and next remain robust. We forecast the global economy will grow at 6.3% this year and 4.6% in 2022. That compared, to put it in some sort of context, to the average growth rate for the global economy between 2000 and 2019 of 2.7%.

Elevated inflation still looks transitory. We think that’s likely to peak as we get into the fourth quarter before easing back towards target levels in 2022. Central bankers haven’t been spooked by the short-term spike and investors appear to have become more relaxed about the threat of inflation leading to an early policy lift off.

In terms of earnings, 87% of S&P companies that have reported results have beaten Wall Street estimates, according to Bloomberg data. Perhaps more importantly, and we’ll come on to this, management teams appear to be becoming more confident selectively allowing them to upgrade outlook statements. Earnings forecasts for 2022 still projecting solid growth.

So what does that mean for investors? I think they should be reassured by the fundamentals, should be looking to take advantage of any future dip.

As we know the main event of the week came in the form of the European Central Bank meeting. The ECB offered a dovish tone. They incorporated the revised price stability objectives into their latest statement and warned that the rapid spread of COVID-19 Delta variant poses a risk to the eurozone’s recovery.

Policymakers pledged to keep rates in negative territory for longer in an effort to boost inflation, saying they would not hike borrowing costs until it sees inflation sustainably maintaining that 2% target and we don’t think that’s going to happen any time soon.

The European Central Bank, which we should remember has failed to achieve its inflation target for most of the past decade, is projecting inflation will remain subdued in the coming years. The ECB is forecasting inflation will average just 1.5% in 2022 and 1.4% in 2023.

In terms of asset purchases, there were no reported discussions on changes to its €1.85 trillion pet programme which is buying €80 billion a month of eurozone debt. Remember, that programme is due to expire in March but the European Central Bank President Lagarde said any discussion about exiting the programme would be premature.

The statement is seen as reducing the chances of a near-term tapering of purchases. From a strategy perspective the dovish tone should put more pressure on European yields to stay lower and is likely to support peripheral bonds.

One central bank that hasn’t been comfortable with the build-up in inflationary pressures has been the Bank of Russia. On Friday they hiked rates by a full percentage point, their largest increase in six years and the fourth consecutive hike that’s pushed the main borrowing costs up by 225 basis points since March, to 6.5%.

Policymakers consider the neutral range to be somewhere between 5 and 6%. Surging demand, as the economy reopens and limited capacity growth, coupled with the rapid rise in commodity prices and weaker rouble, propelled inflation to 6.5% in June. That’s the highest in almost five years, putting pressure on real disposable incomes once again.

The central bank now sees inflation ending the year between 5.7 and 6.2%. Despite the risk of the aggressive hiking cycle infringing upon demand and disrupting the recovery, the central bank left the door open for a further hike at their September meeting, although a softening of the language suggests a 25 to 50 basis point hike looks far more likely.

So that was the global economy and financial markets last week. Let’s move on to consider the key takeaways so far from the second-quarter earnings season. I’m pleased to be joined by Julien Lafargue, Chief Market Strategist for Barclays Private Bank.

Julien, great to have you with us today. We know, of course, it’s still early days in terms of companies coming to the market telling us how well they’ve done during the course of the second quarter, but from those that have reported how well have they performed against consensus expectations and which sectors have been generating the surprises?

Julien Lafargue (JL): Well, just like you’ve mentioned in your recap of the week, we’ve seen amazing numbers coming through in the US. More than 85% of companies are beating expectations for the S&P 500. It’s still early days. We’ve had about 100 companies reported. This week is going to be the major week where you’re going to have all the big tech reporting, but so far the numbers are exceptional.

Earnings growth, if you look at the blended rate, so the companies that have already reported and those that are going to report in terms of consensus expectation, currently it’s tracking at close to 80% year-over-year earnings growth, which is one of the highest earnings growth rate ever recorded.

So earnings have been spectacular. The one thing that is a bit different is the surprise factor. Q1 was a very, very strong quarter in terms of surprises. On average companies beat consensus expectations by 25%. So far this quarter it’s a bit lower than that. We’re tracking at about 17%. So companies are still delivering better-than-expected results, but not to the extent of what we saw in the first quarter of this year.

In terms of sectors, really the surprises are coming across the board. The sectors posting the highest earnings growth are those that were basically the most affected by base effects last year, everything that had to close in 2020.

So industrials, consumer discretionary, energy, financials, materials are all featuring at the top of the league in terms of earnings growth and staples, utilities, healthcare are at the bottom but yet they’re still posting positive earnings growth. Whilst healthcare is growing about 20%, staples about 15%, so even those companies that are growing less are still growing by a decent amount.

HP: OK. Interesting to hear. As always, of course, that headline number is only one part of the reporting season. Markets, which we know look forward, all show interest in those outlook statements. Is it fair to say that management teams are now finally becoming more confident?

JL: Yeah, I think that’s totally fair and to be honest for us it was a surprise. Going into the earnings season we felt that there was little incentive for management teams to sound bullish. As you referred to, the global macroeconomic momentum is sort of slowing down after this very strong recovery.

We’ve seen a flare-up in the number of COVID cases all over the world and so it seems, looking at those elements, that companies would probably take a rather cautious approach when it comes to guiding the market for the following quarters.

But fair to say so far we haven’t really heard companies mentioning COVID as a big risk. I think they’re all pretty much bullish about the outlook. They feel that the recovery has lagged and that to me is probably the most interesting surprise of this earnings season so far. There doesn’t seem to be any sort of concern around COVID and around the macroeconomic outlook.

HP: So we know, of course, inflation has been the hot topic over the course of the past few weeks. Are we now starting to see the impact of that hitting companies?  If so, which sectors do you think perhaps are most vulnerable to higher input costs?

JL: That’s clearly, so far at least though it’s probably going to remain until the end, the number one topic in terms of management discussions during earnings calls. Inflation is clearly top of mind for both management teams but also analysts and market participants.

As I say, it’s still early days but clearly we’ve seen some signs that inflation is starting to die off. If you look at some companies, mostly in the staples sector, they have had to increase pricing over the first and the second quarter to try and make up for higher input costs in the form of higher commodity costs, higher shipping costs etc, etc, but the reality is twofold.

Well, first some of those companies cannot really afford to pass on the entirety of those increasing costs and some of those cost increases have been significant. You’ve seen some commodity prices double, right, so it’s difficult for you to increase your price by more than a few percentage points and so companies are taking a bit of a hit on margins because they are not able to pass on the full amount of input cost increases.

Second is even those companies that have decent pricing power are taking their time to implement those price increases. They don’t want to go in one go and put all increases at once, they are trying to stagger those price increases to make sure they don’t kill the demand. Which means that for this quarter, probably next quarter as well, you’re still going to see, even for those companies with the highest pricing power, you’re still going to see a hit on margins.

So far companies that seem to have struggled most appear to be in the consumer staple sector and that’s just a function of the industry’s dynamic. It’s hard to really have a strong, very strong pricing power. You do have some, but not enough to offset those input costs.

Companies in the chemicals space probably have fared better, but it will be interesting this week to hear about luxury companies, because they tend to be the gold standard when it comes to pricing power and by the end of this week we’re probably going to have a better idea of what the overall sense in terms of margins and inflation.

HP: Let’s bring it all together, Julien, if we can. Is there anything that we’ve heard from companies so far that’s encouraged you to change your stance from an equity strategy perspective?

JL: Well, we came into this earnings season with the feeling that maybe our expectations for earnings were a bit too much on the cautious side, but we wanted to because we had this concern that companies could maybe use the slowdown in macroeconomic momentum and the higher COVID cases to bring down their guidance, but it looks like the opposite is actually happening as we speak.

And so for us that just reinforces the view that probably our outlook is on the conservative side and if anything earnings expectations for this year should probably be bumped up a bit.

So it’s not a major move, it’s more for confirmation than a full upgrade so to speak. But clearly for us this earnings season set a very strong base for earnings to progress but also for markets and the momentum of the market to help equities stay where they are. We don’t expect the tone of further upside, but at least those strong earnings should provide some downside buffer because financials have been so strong.

HP: Well, thank you, Julien, of course for keeping us updated on the corporate earnings picture. We will continue to analyse the results as they flow through.

Let’s move on to consider the outlook for this week, where the focus will be on the Fed meeting and the Politburo meeting in China. The Fed will be considering the when and the how for the tapering of asset purchases.

In terms of the when, the committee will assess how much progress has been made towards achieving the dual mandate. We strongly doubt that participants have seen enough progress to signal tapering is forthcoming, yet we think the Fed’s communication will become incrementally more hawkish in the assessment of the balance of risk, paving the way for a reduction in November.

In terms of how, we continue to believe the committee will taper its purchases of mortgage-backed securities and Treasuries simultaneously and proportionately.

We expect China’s quarterly Politburo meeting to take a cautious view on growth and for macro policy to stay accommodative to stabilise domestic demand amid repeated local COVID outbreaks. High frequency trackers suggest moderation in terms of the manufacturing sector and a gradual, but uneven, recovery playing out in terms of the service sector.

And with that we’d like to thank you once again for joining us. We will of course be back next week with our latest instalment, but for now may we wish you every success in the trading week ahead.