Markets Weekly podcast - 01 June 2021
We look at the appeal of infrastructure investments and what the mixed economic signals mean for US and European markets. Join host Henk Potts, Market Strategist at Barclays Private Bank, and special guest Vincent Policard, Partner and Co-Head of European infrastructure at global investment firm KKR, for this week’s Markets Weekly podcast.
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Henk Potts: Hello, it's Tuesday, the 1st of June, and welcome to the Barclays Private Bank Markets Weekly podcast recording to guide you through the turmoil of the global economy and financial markets.
My name is Henk Potts, Market Strategist with 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 move the markets and grab the headlines over the course of the past week, I’ll then analyse the outlook for infrastructure investment. Finally, I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.
It was a calmer week for markets in what's been a volatile month. Investor sentiment oscillates between optimism over the pace of the economic rebound versus the threat of price pressures on policy.
The balance continues to shine through in terms of the US data last week that showed weekly jobless claims fell for four straight weeks to a fresh pandemic low. Durable goods report showed orders for business equipment rose more than expected. Purchase of goods and services rose half of 1% in April, after an upwardly revised 4.7% jump in March, the biggest since last June. While the Fed's preferred measure of inflation, core PCE, rose 3.1% year on year in April. The consensus was for 2.9%.
There are some tentative signs that rising inflation is impacting activity and sentiment. US consumer confidence dropped for the first time this year as price pressures, concerns and reduced momentum in the labour market recovery curbed the improvement in sentiment.
US home sales fell more than forecast as higher prices started to restrain demand. Our view is that base effects, higher energy costs and supply chain bottlenecks are not enough to create sustainable inflationary pressures that would lead to an early policy lift-off for rates. But the noise around tapering asset purchases is likely to get louder the higher and longer this transitory period lasts.
In terms of equity market performance, the cyclical rotation trade came back to the fore for much of the week. Industrials, financials, commodities stocks pushed higher. Small-caps outperformed. The S&P 500 was up 1.2% last week, was up half of 1% over the course of the month. The Russell 2000 smaller-caps stocks index was up 2.4% last week and posted its eighth consecutive month of gains, which is the longest run since 1995.
In Europe, STOXX 600 rose 1% last week and was up 2.6% in May, hitting a record high.
In terms of gold, well it was trading at a four-month high last week, erasing the losses since the start of the year and registering its biggest monthly gain since July.
Gold has been benefiting from the weaker US dollar, which makes gold look less expensive for non-dollar denominated investors and buyers. Lower bond yields, that helps boost demand for zero-interest bearing precious metals and bullion is also seen as an attractive store of value, which, of course, is very topical at the moment, given the backdrop of rising inflation fears, outsized volatility in the cryptocurrency space. So gold is trading above $1,900 an ounce level, up three-tenths of one per cent for the year.
One of our key messages this year has been around the importance of diversification in this uncertain world. Having exposure to gold as part of a diversification strategy I think continues to be an imperative for many investors.
Moving on to data from Europe, the German economy contracted more than expected in the first quarter, output fell 1.8% quarter on quarter, 3.1% year on year, as coronavirus restrictions took their toll.
German household disposable income rose as the government maintained its job retention scheme and improved social benefits. But household spending fell 5.4% on the quarter as nervous consumers increased their savings rate to more than 23%.
But the outlook for Europe’s largest economy is becoming more positive. You look at the Ifo survey, this is a survey of 9,000 firms, showed business sentiment rose to a two-year high in May. The German government has recently raised its growth and inflation forecast. The government is projecting growth of 3.5% during the course of this year, 3.6% for 2022, saying the economy will reach its pre-pandemic level during the course of next year.
However, the government is projecting price inflation to jump in the short term. Think it will hit 2.2% this year, before easing back and averaging 1.5% during the course of 2022.
I think when we look more broadly at Europe, the outlook is also improving. As of mid-May, 30% of the population’s at least received one shot of the vaccine, with weekly vaccinations picking up on improved vaccine supply. Falling infections, hospitalisations and ICU occupancy rates are paving the way for a reduction of restrictions going into the summer months.
France has relaxed curfews and Italy and Germany have moved to lower risk tiers. The EU digital COVID certificate is slated to come into use on the 1st of July. The vaccine passport should help to facilitate travel between European states, but also pave the way for tourists from designated safe countries.
Stronger global demand, easing travel barriers should also benefit exports. However, a prolonged period of elevated unemployment, a scaling down of support measures and more pronounced economic scarring suggests European growth will continue to underperform the US and the UK.
So that was the global economy and financial markets last week. We’ll now move on to consider the outlook for infrastructure investment. I’m pleased to be joined by Vincent Policard, who’s a partner and co-head of European infrastructure at the American global investment firm KKR.
Vincent, great to have you with us today. So to get us started can you talk through the evolution of infrastructure as an asset class, perhaps picking up on the changing environment and themes within this space, including the shift from traditional infrastructure to digital infrastructure.
Vincent Policard: Pleasure and very happy to be with you today. So infrastructure as an asset class is fairly new. It really started in earnest about 15 years ago and it has really gone mainstream in the last handful of years.
Importantly, as you point out, there has been a number of evolutions in the asset class over that period of time. And that’s really mainly around the sectors and around the approach to investing.
If I think about the sectors, infrastructure investing started with some of the more traditional areas, including transportation assets, utilities, energy mid-stream.
But as you pointed out, in the last five to 10 years a number of new sectors have been added to that. The two most remarkable ones being around energy transition as well as digital infrastructure.
In addition to that evolution in the sectors that make up the infrastructure investing world, the way in which people invest has been evolving as well.
10-15 years ago the view was still that infrastructure was a fairly passive asset class where you basically had to buy the assets and sit on them and take your coupon. In the last five to 10 years the realisation has come that you have an ability, and frankly even a requirement, to be an active investor in the space if you want to be successful.
Today, though, we have a perfect storm for infrastructure. We have a big need for infrastructure spending, in particular around the two sectors energy transition and digital I was mentioning.
At the same time, you have a lack of public capital for that infrastructure investing and that has really led to higher acceptancy and need for private capital which is where the private infrastructure funds come in.
HP: OK, so building a little bit upon those concepts, what do you see as the key risks and the key benefits of allocating capital to infrastructure?
VP: I would say from today's standpoint you really have two types of risks. You have risks that have to do with some of the macro parameters in which you invest.
Clearly we are in a world where inflation may pick up, we are in a world where probably the cost of capital and the cost of funding has fallen and therefore you should expect a rise in interest rates, which in turn impacts the return that people will be expecting. So those are some of the macro risks that we need to assess and that we need to hedge against.
There is also frankly a lot of capital today chasing opportunity in the infrastructure world. A lot of managers have been raising capital and therefore back to my previous description, you really have to have a differentiated strategy and differentiated capabilities to be successful in the space.
In terms of the benefits, I would say the last 18 months have really demonstrated what is attractive about infrastructure as an asset class and I would really point us to three main topics. One is the stability and the resilience of that asset class even in the darkest hours of COVID, infrastructure managers and portfolios typically behaved well and performed well.
The second aspect is around yield. Infrastructure strategies typically deliver running cash yield out of their portfolios, which in today's world is a very desirable trade.
And finally the returns that the asset class has been achieving have been attractive both in absolute terms, but even more so when you consider it on a stochastic basis.
HL: We know there is increasing interest in infrastructure from governments and the public sector. Can you comment on how that impacts or supports activities undertaken in the private sector?
VP: You’re right. There is certainly an increasing focus of the public sector on infrastructure spending. In any historical periods of time when you have economic challenges, which is what we are facing currently, the multiplier effect of spending on infrastructure has always been recognised by governments and therefore the infrastructure spending has been a big focus for government policies.
It is in a way even more so the case today and I'm going back to the two transitions we were talking about, the digital transition on the one hand, the energy transition on the other hand. Those two transitions have very much in focus and at the centre of public policies in Europe, in the US, in Asia and as further increased scrutiny and the focus on infrastructure.
The important point, though, is that while there is a big focus from public stakeholders and infrastructure, there is limited capital to spend on infrastructure investments and therefore the need, the acceptability of private capital, be it on its own or be it as a complement to public spending is very much in focus.
And so you would expect to see in the next 5 to 10 years an increase in these partnerships, which is typically equal public private partnerships in the UK or in the US and that these partnerships and this need for private capital will be again very much in focus.
HL: OK. So my final question today is how would you position allocation to infrastructure through private funds versus, or indeed alongside, listed investment trusts?
VP: That’s certainly a very interesting question when it comes to infrastructure and clearly always a debate that you have to face between performance and liquidity. I would say the debate is probably less pronounced in the infrastructure world than it is maybe with some other alternative investments and the reason for that is back to the yield point I was making before.
So different from private equity or some other sectors and investments with an infrastructure investment, including in a private setting, you would expect to generate some healthy yield and liquidity out of the portfolio, which is mitigating the point that you would typically face with private investments.
In addition to that, and maybe because of that, what you find is that the offering of publicly or listed solutions for infrastructure is more limited than it is in other sectors. And in many cases, frankly, those listed vehicles contain investments, companies, opportunities that are not quite aligned with what private managers would typically do in the infrastructure space. And so today, when it comes to infrastructure investing, really the most favoured and the most mainstream way to access that asset class is really through the private managers.
HP: Well, thank you Vincent for your insights today. There's no doubt the flow of resources into infrastructure represents a significant step change that would create a broad range of opportunities for investors.
Moving on to look at the week ahead, where the focus will be on the OPEC+ meeting and the non-farm payroll report on Friday.
Oil hit a two-year high this morning, Brent trading above $70 a barrel. If demand continues to recover from the pandemic lows, US inventory data shows a larger than expected drawdown. Demand is expected to remain robust over the course of the next few months.
As US driving season starts, travel restrictions are eased across Europe, which has been offsetting concerns over weakening in demand coming through from China and the possibility of increased supply from Iran. Speculation grows at negotiations over its nuclear programme could lead to a lifting of oil export sanctions. Although even if sanctions are lifted, return of Iranian supplies expects to be tightly controlled.
OPEC+ are expected to remain committed to increasing supply in June by 700,000 barrels per day. There’s likely to be, I think, more of a debate around the planned 840,000 barrel per day production increase penciled in for July. Our forecasts are that we'll have is $66 a barrel during the course of this year, but we will be trading around $71 a barrel average during the fourth quarter.
The other aspect to watch out for this week, of course, the big market moving number will come on Friday with the non-farm payroll report. We expect job creation rebounded after the huge miss in April. Forecasting US economy created 675,000 jobs last month, consensus is at 633,000. But we look for the unemployment rate to hold steady at 6.1%, consensus has it down to 5.9%. So watch out for those figures at the end of the week.
With that, I'd like to thank you, once again, for joining us. We’d like to ask you back next week with our latest installment. But for now, may I wish you every success in the trading week ahead.
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