Markets Weekly podcast - 10 May 2021

Henk Potts (HP) Hello its Monday the 10^th May and welcome to the Barclays private bank markets weekly podcast, the recording 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 market and grabbed the headlines over the course of the past week.

I’ll then analyse the outlook for equity markets given some of the information that we’ve been receiving from companies as part of the first quarter earnings season. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

We know it was volatile week for risk assets. Investors were rattled by unexpected and perhaps unintended hawkish comments from Janet Yellen, a pickup in coronavirus cases in Asia and a renewed lockdown in Singapore.

It was a week when disappointing labour data in the United States translated into positive equity market performance, as markets breathed a sigh of relief that a more elongated recovery phase would alleviate price pressures, allow central bankers to remain ultra-accommodative for longer and encourage policymakers to push ahead with aggressive fiscal stimulus.

Equities also benefited from surging commodity prices and consensus beating corporate results. In terms of market performance, equity indexes in Europe and United States finished the week at record highs.

The S&P 500 was up 1.2% over the course of the week, in Europe the STOXX 600 rose 1.7%, its strongest performance since the week ending March 12^th.

Perhaps most significantly was the initial reaction in bond markets where 10-year treasury yield briefly traded below 1.5% for the first time since early March before retracing the decline. Over the week, yields slipped 5.6 basis points. Elsewhere, the dollar weakened, gold strengthened to finish the week at $1,833 an ounce.

We’ve seen this morning crude prices are up, trading up around 0.9%, gasoline futures are up 1.8%, trading at their highest level since May 2018.

This is on concern over supply disruption from the colonial pipeline, which carries two and a half million barrels per day of diesel, gasoline and jet fuel to the east coast of the United States and that has been taken offline by a cyber-attack.  

The impact of course will be determined by how long the outage last. The positives are inventory levels are still plentiful and we're not yet in the driving season in the United States.

Moving back to the non-farm payroll report, which once again proved its powers as a market moving data point. Given the strength expressed in the high-frequency data, investors had geared themselves up for a positive number.

Consensus was for the US economy to create 950,000 jobs last month, which would have actually represented a significant acceleration of hiring from the February and March figures and the unemployment rate to tick lower. When the report came through it showed payrolls increased by just 266,000, the March increase was downwardly revised and the unemployment rate rose to 6.1%.

Economists put the shortfall down to a range of short-term factors including shortage of labour, supply chain bottlenecks and of course the old favourite weather disruption.

In terms of the impact, I think the report shows workers are still cautious about coming back to work till, further progress is made on controlling the pandemic. But any discussion of tapering from the Federal Reserve will be taken off the table at least for the June meeting.

However, there's no need we think to overreact to the report. Fundamentals of the US economy remains strong, which in time should lead to the further recovery in activity and strengthening employment.

Moving on to the Bank of England, we know they kept rates on hold at the main meeting, maintained the size of the asset purchase program but slowed the pace of weekly buying.

The bank raised its growth forecast for this year to 7.25% from the previously predicted 5% and forecast inflation will be closer to the 2% target level in a second and third quarter of this year.

Changes you have to say weren’t a surprise, the outlook for the UK economy has been improving due to the successful vaccination programme, the reopening of the economy, robust household consumption and a lower projected peak level of unemployment.

The March budget remind you delivered a much bigger fiscal stimulus package than expected and the UK economy should benefit from the spill-over effects of the US fiscal stimulus packages. In terms of the outlook, consumer strength will continue to be important.

The UK consumer should be supportive of economic growth as the economy reopens and pent-up demand should unleash some of that £200 billion of excess savings built up during the course of the pandemic.

We are expecting lower peak unemployment, we see unemployment peaking at 5.8% in the fourth quarter, substantially lower than the previous projections.

Inflation still feels like it’s under control, we think it’ll peak at 2.3% in the fourth quarter of this year, first quarter of next year, then start to ease back. We see CPI averaging 1.7% this year, 1.9% in 2022.

We are now expecting the UK economy to grow at 5.9% this year, 4.7% in 2022. All of which adds to the evidence that sterling will continue to strengthen during the course of this year particularly against the euro.

In terms of the policy outlook, the prospect of negative interest rates has all but evaporated. The MPC is expected to maintain the status quo as a recovery plays out. We expect rates to be on hold at that historically low rate of 0.1% through 2022.

Risk of an earlier rate rise? Well there are upside risks if a significantly stronger recovery materialises and inflation is projected to be sustainably above the 2% mark.

That could be driven by higher than expected consumption, consumers running down accumulated savings at a faster rate, faster recovery in labour markets creating wage growth or businesses starting to exert some pricing power, in response to the robust demand.

However, we should remember tax hikes announced during the course of the budget already mitigate some of the risk of further overheating.

Moving onto India, the Indian economy has come under renewed pressure by a second wave that is currently the world's fastest rising pandemic curve.

Reaching a peak last week of more than 400,000 daily cases. Last week the RBI announced a new loan relief package for small businesses and pledged to inject $6.8 billion liquidity to support the economy.

The move helped sovereign bonds to gain. Yields on 10-year note fell below 6%. In term of the economic impact, the government has implemented local lockdowns which has impacted activity and employment.

Assuming restrictions are in place until the end of June, we estimate the economic losses around $40 billion, which will bring our baseline GDP projections down 1% during the course of this year, to still a respectful 10% year-on-year figure. For the global macro outlook, the economic spill-over from India COVID surge, means we think it's likely to be even smaller.

HP: So that was a global economy and financial markets last week. Let’s move on to consider the impact of the first quarter earnings season. It’s a pleasure be joined by Julien Lafargue, Chief Market Strategist for Barclays Private Bank.

Julien, good to have you with us today. Let's start off, what is your main take away from what looks like being a very strong earnings season.

Julien Lefargue (JL): Well good morning and thank you very much for having me Henk. I think it’s undoubtedly a very strong earnings season both in the US and in Europe. If you look at the US in particular, we’ve now had most companies reporting, companies in the S&P500, and the earnings growth rate is likely to end up very close to 50% year on year.

That is one of the best quarters we’ve seen for a very very long time. And actually this is a stronger earnings season in the sense that unusually, for this quarter, analysts had been revising up their expectation going into the earnings season.

Typically, analysts tend to lower the bar as we approach the earnings season. This time around, it was the opposite.

And although the consensus was looking for 20-25% earnings growth for this quarter, we can see that if numbers do come towards 50, that’s almost double what the consensus was banking on, so it’s a very very strong earnings season.

Clearly you have base effects helping, and those base effects will likely continue into the second quarter of the year, but you cannot question the strengths of corporate America at this point of the cycle.

HP: We know there’s more to the earning season than the headline numbers. Equally important are of course, the outlook statements. Are management teams optimistic about the speed of the recovery?

JL: Yes, so clearly one other takeaway was the fact that despite a very strong base 25% positive surprise, we haven’t seen companies or stocks really reacting that much and clearly not in tune with the strong beats that we’ve seen.

And part of that is linked to the fact that expectations were high and probably priced in going into earnings season, but the second is the comments that were made by companies’ management teams. CEOs and CFOs were quite optimistic talking about the future, however, there were a couple of items that probably, clouded a bit the outlook.

The first one was the fact that we are experiences shortages, it’s particularly acute in some sectors that rely on semiconductors, I am thinking about the auto sector, for example, part of the industrial complex as well.

Those company tended to be a bit more cautious because, they just couldn’t control the level of production they will have in the coming quarters due to these shortages. The second element, I think relates to inflation costs.

Companies have that due to these shortages but also the strong increase in commodity prices over the last 12 months, they are seeing pressure on their cost lines.

Some of those companies have been able to implement pricing hikes, in order to pass on those extra costs to their underlying customers, but some of them have struggled to be as reactive, and so there’s a question to be asked around margins going into the rest of the year, and I think this is also a reason why the market wasn’t necessarily giving companies full credit for the strong beats, thinking that as the year goes on, we may see less strong momentum from an earnings perspective, given the pressures on costs.

HP: OK so putting it all together, does the earnings season really change your view on equity markets going forward?

JL: Well we’ve been constructive on equity markets, we’ve been cautious in terms of valuations and upside for markets, probably a tiny bit too cautious, and as we speak the S&P 500 is zooming in onto our bull-case scenario.

But if anything, this earnings season really cements our expectation of a strong earnings recovery this year, and should provide a strong fundamental support for equity markets going forward. Clearly valuations are extended, but, with the strong earnings, you find a justification for those extended valuations.

So we do remain constructive going forward. However, we would just point out that we’re probably approaching several peaks, and that is something we discuss in market perspectives this month. Several peaks in the form of macroeconomic momentum is likely to be peaking.

You’ve seen the ISM surveys, for example, starting to roll over. The jobs report, on Friday was a bit of a disappointment, so probably most of the recovery is behind us now, and improvement going forward will be slower.

You’re also likely to see this peak in momentum when it comes to earnings, after Q2. So Q1 was very strong and Q2 is likely to be stronger because of base effect. But going into the second half of the year, earnings gross is likely to come right down, back to much more sustainable levels in the +10% to +15% year over year earnings growth, type of range.

All this means that markets ahead are likely to be bumpier, more volatility, but that doesn’t mean that we expect a significant contraction in the short or medium term - we just believe that the upside from here will be harder to come by.

(HP) Well Julien thank you for your insights they giving strong actually market performance that you alluded to, there's no doubt investors be watching earnings growth very carefully during the course of this year and of course the projections into 2022.

Moving onto the key events for this week, I think the focus will once again be on US data, particularly the US inflation but also UK GDP numbers.

We expect CPI in United States to have risen 3.4% year-on-year in April, those figures published on Wednesday. This would leave headline inflation at its strongest annual rate of increase since 2011, when the economy was emerging from the great financial crisis.

That said we are of the view that this will not lead to a sustained and significant overshoot of the Fed’s 2% inflation target, given the sizeable amount of slack still present in the labour market.  For the UK we expect March GDP to print at 1.75% month on month.

We expect all main sectors to contribute positively, with construction expected to print particularly well given the strong PMIs. Despite most lockdown restrictions remaining in place, services are expected to grow, given confidence effects of better public health situation and the successful vaccine roll out.

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