Markets Weekly podcast - 15 November 2021

Henk Potts (HP): Hello. It’s Monday, 15th November 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.

This week we’ll take a step back from the noise of the markets, to focus on our 2022 outlook. I will start off with an overview of the macroeconomic outlook, and then I’ll be joined by our chief market strategist to consider how investors should be positioned for next year and beyond.

In terms of assessing the outlook for the global economy, over the course of the next few minutes I will look at the progress made over the course of this year, then take you on a whistle-stop tour of the global economy, giving you some of our key forecasts for some of the major regions, and then finish off by considering one of the major risks that investors will be looking at during the course of next year, which, of course, is inflation.

The reassuring news is the speed and the magnitude of the economic recovery seems far better now than it looked at the start of the year. As expected, the shape of the recovery has been robust, but it’s also been turbulent and uneven. Our enhanced growth trajectory forecasts have been driven by a range of factors, including the improving health situation, relaxation of restrictions, ongoing aggressive policy support, and, of course, the strength of the consumer.

We now expect global growth to be an impressive 6.1% during the course of this year. That’s the strongest post-recession growth rate that we’ve seen in more than eight decades, and a strong upgrade from the 4.7% projection we made back in January.

As we look to 2022, we think the strong momentum is likely to continue, as the recovery phase continues to play out. Policies remain relatively supportive. The service sector has room to recover, and inventories need to be restocked.

We also anticipate that employment should strengthen, and savings rates should normalise, which should support consumption, and in turn growth. We, therefore, are forecasting above-trend growth of 4.5% for 2022.

To put that in some sort of context for you, the average annual growth rate between 2000 and 2019 was 2.7%. However, while the world is likely to grow robustly next year, we do acknowledge the peak of the pandemic recovery has now passed.

There are clear signs that the two largest economies have already achieved their highest growth rate in the recovery. In the US, activity, as we know, has been coming under pressure from the Delta variant, supply constraints, and the waning impact of stimulus on the final demand for goods.

That said, the US consumer, the driving force behind the economy, still looks in very good shape. It’s got a healthy labour market. We expect the US to recover the 22.4 million jobs lost during the course of the pandemic at the end of next year. We’ve got a huge amount of accumulated savings, estimated to be in the region of around $2.7 trillion, and strong underlying demand.

The scaled-down fiscal spending package, we think, will provide a moderate boost to growth over the long term as well.

We’re forecasting an annual growth figure of 4% for the US economy next year, which is still, we have to say, very respectable. We will, of course, be watching China’s slowdown very carefully. Pressure has been coming from the slump in the property market, the energy crisis, the regulatory crackdown and China’s zero-COVID strategy, with property and exports easing during the course of next year, and only a gradual pace of recovery in consumption investment. We forecast that Chinese GDP growth will moderate to 5.3% in 2022 from 8% during the course of this year.

The biggest risk to growth remains COVID variants, given the zero-tolerance approach adopted by authorities, but despite the short-term pressures, long term we remain optimistic about China’s contribution to global growth, as it transitions away from its reliance on cheap labour, low-end manufacturing to focus on becoming a responsible, high tech, domestic consumption-led nation.

As we look to Europe, after a prolonged period of restrictions and relatively lacklustre vaccination programme, Europe’s delayed recovery, as we know, finally started to gather momentum in the second quarter of this year. The medical outlook has improved substantially, consumer activity has been bouncing back, and the labour market recovery has been markedly stronger than expected.

Disbursements from the €750 billion Next Generation European Union recovery fund should also help support growth, and transform the economy over the course of the next few years. We think Spain and Italy will be the biggest beneficiaries of that.

In terms of policy, we expect the European Central Bank will continue quantitative easing during the course of next year, and we wouldn’t expect a rate hike to materialise till the end of 2023, or indeed early 2024. In terms of growth, we’re pencilling 4.3% for next year.

The UK economy? Well, it’s enjoyed a far stronger recovery than was initially envisaged at the start of 2021. The successful vaccination programme, the faster reopening of the economy, and the bigger-than-expected fiscal package have all contributed to the bounce back from the depths of the recession.

We think growth this year will be somewhere round about 7%. However, pressure has been building. It’s been building in terms of Brexit disruption, but also the expectation of higher taxes and rate hikes as we look out over the course of the next couple of years.

Brexit has created friction at the border. That’s been disrupting supply chains and impacting the level of products on shelves. It’s also led to a shortage of labour, particularly in the key service sector.

Think about taxes, the UK government’s laid out extensive plans to increase corporate dividend and National Insurance taxes over the course of the next few years. Arguably, it’s the biggest revenue raising exercise since the 1970s, and the tax hike equates to somewhere round about 1.6% of national income.

Also, policy is certainly going to be on the agenda for investors as they look at the UK economy during the course of next year. Interest rate hikes now look unavoidable. We think that the first hike will come at the December meeting, with 15 basis points. Then, expect by the middle of next year UK rates to be a 0.75%, but we do think there is a risk of a policy mistake playing out, and rate hikes may actually be reversed as you look through 2023.

In terms of UK growth, next year not too bad at all, 4.2%. Then you start to see the pressure of those elements building, in terms of the UK economy, as you look beyond 2022, so for 2023 forecasting growth of just 1.3%.

In terms of inflation, the risks that we see there, given the broad range of both demand pull and cost-push, inflationary pressures and the low base effects, perhaps no surprise that year-on-year inflation prints have risen significantly over the course of the past few months.

There are still a number of factors that suggest the inflationary pressures we have been seeing are transitory, and we’ll start to see them ease back as we look towards the second half of next year.

If you look at the level of spare capacity in many economies, it still remains reasonably high compared to the start of the recession. Supply-chain disruption should ease as restrictions are removed and capacity increases.

Wage inflation is really the one to watch out for, but we think it should dissipate, as inactive younger and older populations return back to the labour market, as the medical outlook improves, furlough programmes are unwound, schools reopen, and extended unemployment benefits are scaled back.

We also think that global demand is likely to rebalance away from goods into services during the course of next year, and structurally the rapid digitalisation, the ongoing investment in technology, is also likely to keep price pressures muted over the course of the next few years.

What does that mean in terms of the outlook for policy?  Well, given the fact that inflationary pressures have been higher for longer, we would expect asset-purchase schemes to be wound down quicker, interest rate hikes to come earlier than previously projected. However, we do not expect central banks to embark upon an overly aggressive, extensive rate-hiking cycle, and we would expect rates to settle somewhere beneath their neutral level, and certainly beneath their historic averages.

So that’s how we see the global economy playing out over the course of the next year. Let’s move on to consider how investors should be positioned. I’m pleased to be joined by Julien Lafargue, Barclays Private Bank Chief Market Strategist.

Julien, great to have you with us today. Taking into account the economic backdrop, what can investors expect in terms of asset class returns as we look through 2022 and beyond?

Julien Lafargue (JL): Well, starting with 2022, what investors should expect really is more muted returns, and that is a function of where we’re starting from a valuation standpoint. Obviously, equity markets have rallied significantly from their lows, and rates remain depressed.

So, for 2022, we do expect still a positive year for risk assets, and that’s why we’re maintaining a pro-risk tilt in how we’re positioned. But we do believe that the returns that are going to be achieved over the next 12 months, are significantly lower than what has been achieved over the past 12 months.

Specifically, in the fixed income market, where really the room for rates to move lower and bond prices to move higher seem fairly small.

On the equity side, we do believe that earnings are going to be the key driver of upside, when valuations are going to continue to contract somewhat. As a result, expecting a total return of 8%, maybe up to 10%, is probably a good base-case scenario for us.

Now, that’s 2022. If we look beyond that, and we’re pleased to have released our five-year capital market assumption as part of our 2022 outlook, I think the message very much remains the same. In the next five years, investors should be prepared to generate lower returns than they have in the past five years.

What’s interesting, though, is, if you look at where those returns are going to come from, it’s similar to 2022, ie equities are going to outperform fixed income, at least in our view, but there is opportunity to generate substantially higher returns and, more importantly, higher risk-adjusted return, for investors who are willing to diversify away from those two simple asset classes, or bonds and equities, and look into things like private markets, whether it’s on the equity or on the debt side, hedge funds.

Now, as well as real assets, and in the context of higher inflation, this is critical, and real assets would encompass things like real estate as well as commodities.

So, in summary, lower returns going forward, and an increased requirement to diversify portfolios outside of the typical 60/40.

HP: Well, Julien, it’s certainly interesting to hear your thoughts around the death of the 60/40 portfolio, and the importance of incorporating a broader range of assets into portfolios.

If we can, I’d like to get a bit more practical. How should investors be positioning their portfolios as you look forward to the year ahead?

JL: As I mentioned before, it’s important to maintain a risk tilt in portfolio. So, first and foremost, this means overweighting equities over fixed income. The other key call that we think clients should make, or the key consideration going into next year, is how do I position myself within each asset class, and we do expect higher volatility, and so we do expect investors to have to rotate portfolios more often than they have in the past.

In the equity space, we would probably start the year with more cyclicality than we have in the past few months, and that means overweighting sectors such as financials, industrial, basic resources as well as energy. However, as we move throughout the year, we believe that this leadership could be reversed as the market grows increasingly cautious around the outlook for growth beyond 2022.

At that point, leadership should return to more of the defensive sectors, in particularly tech or healthcare, which are two key high conviction, long-term calls for us.

So it’s important to consider those sector rotations as we go into next year. In the fixed income space, again, selection will be key in this environment of very low interest rates.

We see the most value in the middle of the curve, towards the five, seven-year segment. And when it comes to credit, we would look at, selectively, some high-yield names, but again the importance here is how selective you want to be. And I think, when thinking about 2022, investors should really consider active management as a way to not only improve returns, but also lower the risk that they carry in their portfolios.

HP: Julien, let’s think a little bit about risk for investors as you look towards 2022. We’ve already mentioned inflation, of course. That’s certainly one of the biggest risks that you’ll be watching out for, but what else, alongside inflation, will you be considering?  And equally important, I suppose, how should investors try to mitigate some of those risks?

JL: Well, as you say, inflation is probably the wildest card looking into 2022. We see other risks, four of them in particular. The first one is growth. There are concerns that growth could be slightly lower than expected, and a key deciding factor in how the global growth will pan out for 2022, is China, and whether China will decide to remove some of the restrictions they’ve been imposing recently, and whether they’re going to decide to stimulate their economy as we go through 2022.

If they fail to do so, China being such a large contributor to overall economic growth, this is a key downside risk in our opinion. We do think that more easing is coming from China, but probably we’re going to have to wait to the end of the first quarter or the second quarter of next year, before we see real easing from China.

The second main risk is obviously what central banks will do, and that is just a function of what inflation, and what growth, will do. Our view here is that the market may be a bit too optimistic in its view of central banks’ ability to normalise monetary policy. We do believe central banks, in particular the Fed, but also the ECB, will be cautious in their approach, and we don’t see many hikes on the horizon, at least initially.

Beyond those two risks, the other one that we see is geopolitics, and politics in particular. We haven’t had, really, a lot of geopolitical noise in the past few months, as all our attention was focused on the pandemic. But as this fades, we do believe that geopolitical tensions, which haven’t really dissipated at all, they’ve just been hidden behind a problem that was the pandemic, we believe those tensions could start to flare up again.

That’s on the geopolitical front, and obviously China, with the US and Taiwan in particular, is a big topic. But there is also politics at play. We have a couple of important elections. We’re still trying to figure out how it’s going to leave Germany, but there’s also this important election in France, which could potentially, towards the first and second quarter of next year, bring back the political-risk premium in Europe, something worth monitoring.

And finally, the last big risk for 2022, and really beyond that, is the energy transition. We see this energy transition as a very, very attractive source of opportunities for investors, but also it presents a risk both for economies, central bank policies, and a key question is if this energy transition will be inflationary, in the first place, will it hurt growth or not? And depending how government, companies manage this transition, this could have obviously both upside and downside risks to our base case.

HP: Well, thank you, Julien, for your insight today. There’s no doubt as the global economy and central bank policy begins to normalise over the course of the next year, there will be both risks and opportunities for investors.

As Julien said, being and staying invested in equity markets is important, focusing on an active management, and being diversified, along with incorporating private assets and hedge funds into portfolios, may be a good way to navigate what is set to be an interesting few years.

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 I wish you every success in the trading week ahead.