Markets Weekly podcast - 07 June 2021

Henk Potts: Hello. It's Monday the 7^th, June, and welcome to Barclays Private Bank Markets Weekly Podcast recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts. Market Strategist at 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. I will then analyse the outlook for sustainable investment. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Equity markets were in a holding pattern, at near record levels last week, as investors wait to establish whether stronger economic growth will increase corporate earnings and propel indexes higher. Or conversely, whether inflation spikes will be enough to unnerve central bankers, forcing them into raising rates early, undermining the recovery and potentially derailing the recovery.

Once again, though, there was evidence to support both theories last week. The OECD latest report is projecting a brighter outlook for the global economy than previously forecast. As vaccine rollouts allow businesses to resume operations and the US pumps trillions of dollars into the world's largest economy.

They are now forecasting global growth at 5.8% this year and 4.4% for 2022. Global growth has now returned to pre-pandemic levels, although has missed out on expected growth if it wasn't for the medical crisis. They're also forecasting US growth at 6.9% with a stimulus plan adding three to four percentage points to domestic growth and one percentage point to global growth.

The organisation is encouraging central banks to keep financial conditions relaxed, saying spare capacity should help to avoid a sustained increase in inflation. We know inflation continues to print higher. Euro Area inflation is actually at its highest level in more than two years in May.

Consumer prices rose an annual rate of 2% in May up from 1.6% in April, topping the European Central Bank’s target for the first time since 2018. Price pressures are emerging from rebounding demand. The 13% jump in energy prices was the biggest contributor. Supply bottlenecks are encouraging producers to hike prices, IHS Eurozone purchasing managers’ index for manufacturing showed factories lifted their prices by the most in almost 18 years. Robust demand allows them to pass them to pass on higher costs to consumers.

In terms of the outlook for eurozone inflation, if you start to look beyond the seasonal, the technical factors, subdued eurozone inflation's likely to continue with weakness in labour markets and household disposable income and green core inflation at depressed levels.

We expect CPI to peak in the fourth quarter at 2.3%, then price pressures start to fade next year as low base effects washes out. We expect CPI to average just 1.1% in 2022, well below the target level.

In terms of US data, well the granddaddy of all data points, non-farm payroll report, was out on Friday, was more intensity awaited than normal given the historic miss we saw in April. The report showed some momentum return to US labour markets in May. 559,000 jobs were created, though the consensus was for 675,000, helping to push the unemployment rate down to 5.8%. Majority of the gains came from the service sector. However, the headline number still represents a modest disappointment.

What did we learn? Well, people returning back to the labour force remains at a weaker pace than expected. Both manufacturers and service industry operators are reporting difficulty in hiring staff. Average hourly earnings rose 2% year on year. Adding to the evidence that supply constraints are starting to push up wages.

If sluggish participation becomes permanent, certainly increases the risk of inflation. In terms of the outlook, US economic backdrop, as we know, is improving that should filter through to further job creation. New orders and inventory boosted May’s ISM manufacturing PMI. Vaccination rates are rising, the US is administering around a million doses a day. Service sector is reopening.

If you look at economists forecast, they expect growth in the US economy to be somewhere around about 10% during the course of the second quarter. We think the employment report is unlikely to change the tone of next week's Fed meeting.

The FOMC are expected to communicate its intention, to look through transitory inflation pressures and focus on its full employment mandate. But thinking about talking about tapering is certainly a tune that's been getting louder.

In terms of equity markets performance last week, European stocks closed at a record high, registering a third consecutive week of gains. STOXX 600 was up eight-tenths of 1% over the course of the week. S&P 500 was up six-tenths of 1%, 10-year treasury yields shed 3.3 basis points to finish at its lowest level since April the 22nd.

So that was the global economy and financial markets last week. We will now move on to look at the future of sustainable investment. I'm pleased to say that we're joined by Mike Topley, who heads up our Sustainable Portfolio Management offering in Barclays Private Bank. His team aims to provide clients with a way of maximising risk-adjusted returns for a portfolio of businesses that are helping to advance global sustainability.

Mike, great to have you with us today. A lot of terms, as we know, get thrown around in terms of this space, which may or may not lead to confusion. So let's start off. What is the differences between ESG and sustainable investing, if any?

Mike Topley: Yes. Hi, Henk. Well, I think you're quite right. The terms in this space often get used interchangeably, particularly between environmental, social and governance (ESG) investing and sustainable investing. Often, the two terms are used kind of somewhat synonymously, but they're not the same thing.

So, so ESG, it provides an insight into the internal operational quality of a business and the ability of that business to mitigate against risks or to future cash flow that may arise from environmental, social and governance factors.

So you might look at things like the ability of a company to attract and retain top talent, which might result in higher profitability, or their ability to mitigate against rising carbon costs. Again, as a measure of profitability, or if they have good corporate governance, it can be an indication of whether or not they can lower their costs of capital, which can result in higher valuations.

But ESG is just an internal look at operational quality. It doesn't look at what a company is selling. So, for instance, you could have a machine gun factory with a solar panel on the roof, and a great dental plan, would be a very high ESG quality, but it's not very sustainable, which is why you have all these ESG leaders ETFs with things like Coca-Cola and McDonalds in it.

These businesses are incredibly well run. They're very high operational quality, but they're selling fizzy drinks and burgers. And that doesn't naturally feel like a sustainable business.

So sustainable investing goes beyond ESG and looks at what a company is selling. And often that might be whether or not their products are aligned to the UN sustainable development goals. And as an example, for instance, at the moment we're doing a lot of work looking at connectivity, a solution to marginalisation, particularly in the emerging world.

And particularly for women, if you can get a smartphone into the hands of a woman in the emerging world, it's suddenly gives her access to online healthcare, gives that access to online education, to online market places, online banking and suddenly you start getting more societal inclusion and you can lift people out of poverty and that you can start to bring down population growth rates and reduce the stress on the environment.

So, ESG is that internal look at operational quality. But sustainable investing goes beyond that to look at whether or not the products that a company is selling is helping to make the world more sustainable.

HP: We know the performance of the wider ESG sustainable space has certainly been very good over the course of the past year. Could you explain why this is the case and perhaps, as equally important, do you think it will continue?

MT: I think when you look at this, ESG through the lens of operational quality, it makes a lot of sense. You know, the pandemic was arguably the ultimate test for ESG and the companies with good operational quality, the companies that had health & safety policies in place were more likely to stay operational.

The ones with diverse supply chains were, you know, more likely to be able to fill their, their inventories. And therefore, you know, these businesses tended to do quite well over the last year, while those that had poor ESG quality might've seen outbreaks of COVID in their factories, which resulted in them having downtime.

So it makes sense, intuitively, that companies with high operational quality we're able to stay operational and continue to be profitable during the pandemic. And likewise, if you look at sustainability, we need innovation in order to solve our global challenges. If you look at things like climate change, we need innovation. And a lot of this innovation doesn't exist yet. So the companies that are providing these solutions, these technologies, are more likely, you know, to do quite well out of this.

HP: Okay. So let's focus down a little bit and think about things from an investment perspective. What are the key areas that could provide the best opportunities for investors over the course of the next few years?

MT: I mean, there's a lot, there's a lot of very interesting stuff going on in the sustainable investing space at the moment.

You know, we've got holdings in companies that make bacteria that increases the shelf-life of food by another week. You know, 8% of global emissions is from food that's never eaten. Or it’s a bacteria that's been used for helping improve soil quality. Or we own companies that are making specialty chemicals that allow you to turn the temperature on your washing machine down to 30, which means you're using less energy.

But the area that particularly excites me, I think, is in the advanced technology space. You know, these advanced technologies that are beginning to completely reshape how our world works, and in particular artificial intelligence, which I think is probably the single technology that has the greatest potential for addressing our global, you know, sustainability challenges.

And why I think it's so good, it's because AI enables us to do things that humans couldn't do before. You know there was a great example, it was actually back in 2017 now, when the guys at DeepMind, launched the AlphaGo AI, where it taught it to play that ancient game Go. Which people always thought, you know, a computer could never beat humans because it was pure creativity.

There's more moves than there are atoms in the universe. And yet they taught this AI to play against itself. And it got better and better. And they started watching it and they saw it, oh, look, it's learnt the castling move from the 16th century or the pincer move from the 17th century, or whatever those moves were. And then it got better than humans.

And then they left it playing and it started learning these alien strategies that no-one had ever thought about. And people were like, wow, you know, this is enabling us to play the game Go better than we ever could before.

And that's the power of AI, it enables us to do things that we couldn't do. And now you're seeing similar technologies being used to, you know, help reduce the energy usage of heating and cooling buildings, which is 20% of global emissions.

Or, you know, AI has been used now to detect stage one cancer more effectively than we've ever been able to do before. Understanding how proteins fold up, being used to optimise traffic flows, you know, through, cities. For drug discovery, for, for discovering superconducting materials that could be potentially used in nuclear fusion, which would be completely game-changing and, and arguably only doable because of artificial intelligence.

So I think that's a very exciting area of the market at the moment. I think we'll, uh, you know, continue to shape our world in the years to come

HP: Well, thank-you Mike, for your interesting, dare I say inspirational insights. There's no doubt that sustainable investing is a structural change to the way investors allocate capital. We'll be assessing, and of course, shaping developments closely in the months and the years to come.

Moving on to the week ahead where the focus will be on US inflation and the European Central Bank meeting. Pressures from reopening and supply bottlenecks are expected to push up headline and core CPI in May, as companies pass on those higher costs to consumers.

In the US we look for the May CPI to print at 4.8% year on year, core to print at 3.6%.

In terms of the European Central Bank, we expect staff to revise marginally lower 2021 growth, but raise 2022 and 2023 projections. The European Central Bank is expected to revise its 2021 inflation projection higher to between 1.7 and 1.8% and assess the risk to growth and inflation forecasts as balanced.

Most importantly, the governing council is expected to keep the pace of its pandemic emergency purchase programme in Q3 at, or close to, the Q2 average with a risk of slightly less dovish language. Reducing the pace would be interpreted as tapering by markets, which could tighten financial conditions, of course, when the economic outlook still remains uncertain.

So that's our view of the global economy, financial markets and the outlook for sustainable investing. We hope you found today's podcast interesting and thought provoking. We will of course be back next week, but until then we wish you every success in the trading week ahead.