Markets Weekly podcast - 18 October 2021

Henk Potts (HP): Hello. It’s Monday, 18^th October 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, and 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 consider the outlook and the implications for the third-quarter 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 solid week of gains for equity markets last week as investors put concerns over inflationary pressures to one side and focused on the fundamentals of corporate earnings.

In terms of equity market performance, the S&P 500 was up 1.8% over the week. That’s the best weekly percentage gain since July. It’s now only 1.6% off its 52 week high of 2^nd September and up 19% year to date. Actually, European stocks outperformed last week. The STOXX 600 was up 2.7%, the biggest weekly gain since March.

Moving on to the data, where investors digested US retail sales and inflation figures, US retail sales numbers showed the recovery in August continued in September. Headline retail sales rose seven tenths of 1% month on month. Consensus was actually for a decline of 0.2%. The pickup was driven by a return to school spending. There was strong demand for clothing, general merchandise and non store retails.

Another factor that could have been driving sales was the high COVID-19 caseloads in August and September, which slightly redirected spending away from services back into goods. August retail sales were also revised higher.

Turning to the outlook, stimulus effects are waning, so we would expect year-on-year sales growth rates to settle at lower levels once spending patterns normalise. However, the outlook for the US consumer remains positive given the high levels of pent-up demand, the positive labour market recovery, which as we know has been accompanied by robust wage growth, and a huge accumulation of excess savings during the course of the pandemic.

We think savings rates should eventually ease back from elevated levels and consumption will pivot away from goods into services as cases fall, but we think private consumption growth of 3.1% in 2022 should help to support growth during the course of next year.

In terms of inflation, headline CPI increased four-tenths of 1% month on month in September. That’s up 5.4% year on year. Core rose 0.24%, or 4% year on year, which was in line with expectations. The report demonstrated further weakness in used cars, hotels and airfares due to continued COVID disruption in consumer-facing and travel-related services, but this was offset by strengthening energy, food and shelter costs.

In terms of the outlook for inflation, we think US inflationary pressures may be higher and for longer than previously projected with supply-side problems taking longer to resolve. We now expect headline CPI to peak at 5.7% in December, but maintain a view that it will back down to 1.9% in the fourth quarter of next year.

Turning to the UK, the latest labour market and GDP data increased pressure on the MPC to consider an early rate hike, but there’s still a vast array of uncertainty which makes predicting the path of policy very difficult.

In terms of UK growth, August GDP came in slightly softer than expected. Growth was four-tenths of 1% month on month. The market was looking for a figure closer to half of 1%. Growth was driven by the recovery that we’d been seeing in terms of the service sector, particularly in terms of hospitality, arts and entertainment.

There was also, actually, a meaningful contribution from industrial production and mining. This was partly offset by weakness in health and wholesale along with retail and the motor trade. The ONS did significantly revise up its second-quarter estimate of growth. The UK economy is now eight-tenths of 1% below its pre pandemic level.

We think the UK economy will grow somewhere round about 7% during the course of this year, then ease back as we look through the course of 2022, where we expect growth of 4.2%.

In terms of the UK labour market, well, it continued to improve in the third quarter in the lead up to the end of the furlough scheme. The measure of employees on payrolls in September increased by 207,000 and surpassed the February 2020 level for the first time in the pandemic.

Unemployment continued to fall in the three months to August, though it’s difficult to read too much into this given the fact that there were still around about a million people on the furlough scheme.

Headline wage growth for the three months to August was 7.2%, albeit when taking into account the base and compositional effects, the ONS estimates a rather wide range of underlying pay growth is probably closer to 4.1% to 5.6%.

In terms of the outlook, vacancies continue to grow and are now at record levels although there are concerns around the mismatching of skills.

So going back to the path of policy, it still remains confusing, as I said. Markets have been reacting to comments made by the Bank of England. Governor Bailey has warned of a potentially very damaging period of inflation unless policymakers take action. Some market participants have taken this to mean the November meeting is now live.

In recent weeks, of course, traders have been increasing their bets of an early rate hike now pricing in 0.75% rate by mid 2022. Remember, that’s up from the current historic low of just 0.1%.

Our view is the current macro backdrop doesn’t warrant a hike but we acknowledge the MPC could feel compelled to raise rates earlier to meet market expectations. If the MPC does hike, then the risk of a policy mistake increases substantially, with a combination of monetary and fiscal tightening posing a significant challenge to the UK economy in 2023.

Let’s finish off by reviewing the data that we’ve seen out of China this morning, which showed the economy significantly weakened during the course of the third quarter as the headwinds from the property slump, the energy crisis and its zero-COVID strategy continued to take its toll.

GDP expanded at 4.9% year on year. The market was looking for a figure closer to 5%. So certainly not a massive miss there, but it is significantly weaker than the 7.9% growth rate we saw in the second quarter.

Underneath the headline number it shows industrial production rose 3.1%. Consensus was for 3.8%. Retail sales were up just 4.4%. Fixed asset investment rose 7.9% over the course of the first nine months of the year.

What we do know is the property sector has been hit hard by authorities, which have been imposing restrictions on financing and tighter mortgage rules in an attempt to cool it. There’s also, of course, been the fallout from the Evergrande debt crisis on land sales.

Electricity shortages have forced a number of manufacturers to slow or stop production. China’s tight COVID restrictions have also been restraining the recovery in terms of consumer spending.

In terms of the outlook for the growth profile, well, growth is inevitably decelerating down to a new trend rate. We expect growth to slow further in the fourth quarter, coming in somewhere round about 4.7%, and then we’ve pencilled in 5.5% for next year and 5.3% as you look out through 2023.

So that’s the global economy and financial markets last week. In order to discuss the outlook for earnings I’m pleased to be joined by Julien Lafargue, Chief Market Strategist for Barclays Private Bank.

Julien, great to have you with us today. It’s been somewhat of a nervous time for equity market investors over the course of the past few weeks. Let’s start off by thinking how important will this earnings season be?

Julien Lafargue (JL): Well, like any other earnings season, this one is going to be a good chance for investors to move away from the macro noise and into the micro details of how companies are actually performing in this quite challenging environment, to say the least. So it will be a key instrument into deciding how much upside we see from here.

As we’ve said repeatedly in the past, a lot of the bull market that we’ve seen has been driven by valuations. Right now, valuations appear quite full and, therefore, you need the support of earnings in order to help the stock market move higher.

HP: OK. So, let’s get into the numbers. What is the consensus expecting and what do you think will happen?  And also which sectors are likely to be the winners and losers?

JL: Well, this one is a bit of an odd one in the sense that we, or the consensus, is looking at sales growth of about 14% in the US for the quarter and that’s fairly similar to what we saw in the first quarter of this year.

However, from an earnings growth perspective, always year on year, the consensus is looking at about 32% earnings growth in the US and that compares to 52% back in the first quarter. So you see that there’s quite a similar top line.

The bottom line growth is much weaker in this third quarter and that is a function of, I think, all the issues that have been discussed, our plans over the past few months, mainly inflationary pressure coming from higher input costs, higher labour costs in some industries, supply shortages. All this is really putting some pressure on companies’ profitability and that’s why the market is expecting a lower growth rate. In fact, the market is actually expecting earnings to be lower quarter over quarter, which is quite unusual. Typically, you’ll see progression quarter after quarter, but not this time.

So out of this 32% earnings growth, we believe that the market or companies are likely to surprise positively but up by a margin that is more in line with historical average. On average, throughout the quarters companies have been able to beat consensus expectations by about 5%, 6% or 7%. Over the past two or three quarters we’ve seen surprises coming much, much stronger than that, to the tune of 25% plus. And we think we’re going to go back to a more neutral level of surprises.

In addition, we’re expecting to see wide divergence across companies and sectors depending on how much impact those issues around input costs and supply shortages will have had on their businesses.

Obviously, companies that have a lot of exposure to the manufacturing process, some part of the industrial complex, in particular some consumer names, thinking about autos etc, for example, were heavily reliant on supply chains will likely suffer the most, albeit most impacted. On the other hand, companies that have limited exposure to supply chains, so if you think about software companies, for example, these are much, much more likely to surprise positively because they won’t have to face those headwinds.

HP: OK. As we know, the numbers are, of course, just one part of the earnings season. The other is around guidance. What are the key things that you’re focusing on from companies that will give us a guide to their future performance?

JL: Well, as I said earlier, clearly we want to understand what the consensus is currently looking for in terms of earnings growth for the rest of this year, but also 2022 and even up to 2023, if those numbers are realistic or are we going to see negative earnings revision or even positive earnings revision from here? 

Currently, the consensus is looking at broadly 9% to 10% earnings growth for 2022 and 2023, and those numbers have been fairly stable all the time. So what we want to hear from companies is, first, do they see an end to those shortages and supply-chain issues?  Is it something that’s going to take place in the first half of next year, toward the second half of next year or is it something they expect to last much, much longer?

And the second key element that we’re going to pay attention to is which companies and which sectors are exhibiting the pricing power that is required in the current environment to offset the pressure put on margins by higher input costs?

This really varies from company to company and some may be able to pass on higher input costs immediately, some may have to delay, but what we want to understand is the current rise in input costs is that something that’s going to have an impact towards, again, the first half of next year, or is it something that has to be factored in for the longer term?

So really inflation and supply chains are going to be the major topic during this earnings season.

HP: Well, thank you, Julien, for your insight on the earnings season today. We will of course be monitoring both the figures and the guidance from companies very carefully over the course of the next few weeks.

Let’s move on to the week ahead where the focus will remain on the UK, with inflation, consumer confidence data and PMI surveys all released. We forecast the UK September CPI will come in at 3.1% year on year. Of course there are upside risks to that forecast.

We expect UK consumer confidence will show a sharp deterioration given the broad based negative headwinds and headlines facing households including energy prices, food and fuel shortages, fiscal and monetary policy tightening and the end of support schemes, including the furlough programme and the uplift in Universal Credit.

We anticipate October’s PMIs to moderate with services forecast at 54.5 and manufacturing at 55.

In Europe we also expect the October PMIs will show both services and manufacturing growth ease further from September, resulting in the composite print coming in at 55 from 56.2 last month.

In the US it’s relatively likely that the focus will be on industrial production figures on Tuesday and existing home sales on Thursday.

And with that, I’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.