Markets Weekly podcast - 25 October 2021

Henk Potts (HP): Hello. It’s Monday, 25th 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. 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 discuss the importance of understanding confirmation bias in our investment decision-making process. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Equity markets maintained their upward trajectory last week with US stocks registering fresh record highs as companies delivered on elevated earnings expectations.

In terms of equity market performance, the S&P 500 was up 1.6% last week. It’s up 5.5% so far in October.

In Europe, equities registered a third straight week of gains. The STOXX 600 was up half of 1% last week. It’s now up 3.8% this month, and is less than 1% off that August record high.

While the corporate picture is encouraging, there are still plenty of warnings emanating from the macro backdrop. Supply and demand imbalances are pushing up energy prices. Supply-chain disruption continues to impact the production and transportation of goods. And central bankers are finding it increasingly difficult to dismiss multi-year high inflation as transitory and coming under increasing pressure to raise rates earlier.

Alongside bottlenecks and price pressures, data releases from the likes of China are also pointing to moderating growth rates, all of which is adding to the stagflation nervousness which has been reflected in fixed income returns.

Global bonds are on course for their worst year since 2005. The Bloomberg Global Aggregate Index, which is a benchmark of government and corporate debt, is down 4.3% year to date. Yields on two-year Treasuries rose to their highest level in 18 months on Friday. Ten-year yields touched 1.7%.

However, we retain our constructive outlook for the global economy. Supply disruption should ease, as restrictions are lifted and capacity increases. Policies will remain relatively supportive during the course of next year. Inventories need to be restocked and the service sector certainly has plenty of room to recover.

Employment we think will strengthen and savings rates should normalise, and that should be supportive of consumption levels. So the exiting of the recovery phase, I think, inevitably means a slowdown from the extraordinary levels. But underlying growth is still strong, and we think that the global economy will grow somewhere round about 4.5% during the course of next year.

Oil prices were up 1% last week, its seventh straight weekly gain. Brent crude is trading above $86 a barrel this morning, is up more than 50% year to date, and has been trading at its highest level since October 2014.

This is on the reports that OPEC+ group failed to pump enough oil to meet their output targets in September. Global oil supplies also suffered from the hurricanes that have been impacting US production.

A report last week showed that US inventories were at their lowest level since October 2018, exacerbating that supply-and-demand deficit as the global economy recovers.

Calls are certainly getting louder for the OPEC+ producers to agree to turn on the taps at their next meeting which is on 4th November. So far, the group has only agreed to slowly restore all output cuts from the early days of the pandemic by the end of next year, but analysts are predicting higher prices for longer with implications, of course, for input costs, disposal incomes and inflationary forecasts. And inflation and its impact on the path of policy continues to be a big focus for investors.

September’s UK inflation print demonstrated price pressures continued, with headline CPI rising 3.1% year on year. The latest figures, remember, do not include the full impact on the spike in petrol prices during the crisis or the Ofgem 12% energy price cap increase that came into effect in October. The prospects of a prolonged gas squeeze suggest that further increases in the energy cap will be on the cards as we look to next year, before declining in 2023.

The increase in the energy component leads us to project that headline CPI will rise at 4.7% in April 2022. Along with the energy impact, we expect retailers will be trying to pass on higher input costs to consumers, and anticipate food and clothing inflation will rise over the coming months.

The Bank of England’s chief economist last week said UK inflation could hit 5% in the coming months. Taking these changes into account we estimate the CPI will average now at 3.6% next year, but then decelerate as we go through 2023 to average 1.8%.

The upside risk to these forecasts is likely to emerge from the supply shortage in labour markets specifically driven by the end of economic migration from the European Union.

The increase in inflation expectations is most likely enough to convince the Monetary Policy Committee they’ll need to raise rates in order to maintain credibility. We think, therefore, that a near-term hike is now unavoidable but don’t think the November meeting is plausible.

We think we can see that first hike 15 basis points at the December meeting followed by a quarter of 1% in February next year, and another 25 basis points in May. That would take the bank rate back to 0.75% and we’d expect it to maintain that level for some time. Nevertheless, given the broad base risk to recovery, the wide range of headwind space in the UK economy, it’s certainly conceivable the Bank of England may have to reverse these hikes as we go through 2023.

Speaking of hikes, the Bank of Russia hiked rates by more than expected on Friday, as inflation continues to push higher. The 75 basis point increase to 7.5%, was the sixth consecutive and the biggest interest rate hike since July. The central bank has now increased rates by 325 basis points this year.

The governor of the Bank of Russia warned that further hikes are possible given the inflation outlook. Consumer inflation accelerated to 7.6% in October, which is nearly double that 4% target.

Russian policymakers very much squarely focused on dampening inflationary pressures despite growth rates starting to moderate. Activity is expected to decelerate further, due to rising COVID cases and the introduction of new restrictions in the past few days.

We do expect inflation to remain elevated during the course of this year, the central bank seeing it in a range of between 7.4% and 7.9% towards the end of the year, and then edging down as we look through next year to between 4% and 4.5% and then remaining close to that target level.

We did see markets reacting to the decision. Bond yields jumped, the rouble surged. Interest rate hikes and higher energy prices have made the rouble one of the best performing emerging market currencies over the course of the past month. And it is a reminder, of course, emerging markets do need to tame inflation, and that’s been encouraging them to raise rates. So along with Russia, Brazil have hiked and South Africa is expected to follow suit.

So that was the global economy and financial markets last week. In order to help us understand how we, as investors, can improve our decision making I’m pleased to be joined by Alex Joshi, Barclays Private Bank’s Behavioural Finance Specialist.

Alex, great to have you with us today. As we’ve been talking about it, it feels like there’s a huge amount of news flow for investors to digest at the moment. Is inflation transitory or not, will supply-chain disruptions last, and of course, the timing of rate hikes. What can investors do to make sense of all of this?

Alex Joshi (AJ): Hi, Henk. Thanks for having me on. Yeah, there’s a lot going on at the moment and it can feel a pretty complex time to be investing. But this is a very good learning opportunity and debate is actually very good for improving our own decision making. So, I think investors should recognise the value of hearing alternative viewpoints. And a key reason for this is to challenge our own confirmation bias.

So, what is confirmation bias?  It’s this tendency that we have to seek out, or to pay more attention to information which confirms our own pre-existing beliefs and views and it’s extremely prevalent in all walks of life. So, for example, during political elections there’s lots of talk of echo chambers, for example, and it’s very prevalent in investing as well, for investors of all levels of sophistication.

But unfortunately, a bias like this can have consequences. So, for example, taking short-term tactical positions which don’t pay off. But also, more damaging potentially, is if it has an impact on long-term asset allocation decisions.

So, for example, an investor having an overweight to a particular asset class or a sector, based on a long-held view that they have which may have worked in the past but there may be new information which contradicts that an investor may not be paying attention to.

HP: OK, Alex. So how do investors go about minimising the potential impact of confirmation bias?

AJ: So, the key thing to do is to pay attention to and actively seek out opposing views. The good thing about investing news flow is that you’ve got lots of debate, you’ve got lots of diverging views around events. So, there’s no shortage of information here to consume.

And I think the key thing to do is to use that and consider your own views, and consider if you were to be wrong, for example, if an event happened that you didn’t predict, what would the impact be, but what would the impact be on your own individual portfolio?

If you consider some new information and you think that there could be a potential impact, ask yourself do you have adequate hedging for an event like this. And following on from that, is your portfolio well diversified? Because diversification in many cases is going to be the best way to protect yourself from events that occur in the future, predicted or unpredictable.

It’s also important for investors to recognise that financial markets reflect real life and that the markets are made up of individual companies. The outlook is constantly changing and so previous investment decisions, which may have been good ones at the time, but may not be if new information comes to light, which is not a problem.

You know, as humans we suffer in many cases what’s called a sunk cost fallacy which is if we have invested time, resources, energy into a project, into an investment decision, for example we can feel wedded to it even if we recognise it may not be the best one to continue with.

Our portfolio managers, for example, may be positive on the long-term prospects for a company and they invested at a certain point in time, but if new information comes to light which changes that they’ll exit which is not a bad thing. At the time it was a good decision, but something recently happened which changes the outlook, which is fine, and so humility is a very valuable trait when it comes to investing.

HP: So, let’s try and bring all these concepts together. How do we square thinking about short-term events, the day-to-day noise that we’re continually bombarded with, of course, with being a long-term investor?

AJ: Yeah, sure. So, it’s important for investors to be aware of events that are shaping the direction of markets, things that are being discussed on this podcast, other publications and in general news.

But it’s also important to recognise that as a long-term investor, as many of our listeners are going to be, if you’ve got the building blocks in place for successful long-term investing, and by this I mean following a strategic asset allocation which leads to a well-diversified portfolio that’s setting you up well for the long term, then the investor doesn’t need to be reactive to all events.

And it’s important to remember your investment portfolio is not the market. There’s this tendency, you know, to talk about the market as if it’s one entity that goes up or down based on whether news is good or bad, but actually the picture is far more nuanced in reality. You know, lots of the news flow that investors are hearing, which takes up headlines, and lots of discussion on a day-to-day basis, this might not be very material to an individual investor achieving their long-term goals, yeah?

Much of this, as you referenced, much of this short-term news may just be noise which is not going to be critical. And if anything, acting and reacting to news like this potentially can be actually damaging for an investor, when it comes to long-term returns. We speak very much in our publications around the difficulties of timing the market, we’ve also spoken about how overtrading can reduce returns over the long term.

And so one approach that many investors take is a core-satellite approach. So having a core long-term portfolio which generates the bulk of the returns, but then have a small satellite which is useful for taking short-term positions, trying to be opportunistic around some of this news flow and enhance returns.

So, in summary, I think it’s important for investors to recognise the value of different views, to challenge and to improve your own thinking and decision making. You know, some of these short-term views may be useful, they may allow you to enhance returns with some tactical positioning, but it’s important for investors to be striking the right balance between that and a core long-term portfolio which is going to generate the bulk of the returns, and ultimately is also going to allow an investor to protect and grow their wealth over time.

HP: Well, thank you, Alex, for your insight today. We know that improving the decision-making process can certainly help investors to maximise returns but also, perhaps equally importantly, reduce some of those potential mistakes.

Moving on to the week ahead, where we get the UK budget and the three-year spending review which will be coming out on Wednesday, the OBR’s updated forecast should show a lower deficit given the emergency policies have been less expensive, the economic recovery has been faster than anticipated. Beyond this, the borrowing profile is likely to include higher debt interest spending, but this may be offset by improved assumptions on the economic outlook leaving the outlook for the public finances little changed.

Although various policy measures have been reported for the upcoming budget we do not believe these will materially affect the public finances, with the Chancellor unlikely to alter the contours of the already restrictive policy mix meaningfully.

The spending review, of course, will allocate money to departments for the coming three-year period giving the government an opportunity to provide clarity on how previously promised money for capital spending will translate into those twin objectives of levelling up a net zero transition.

In the US, the focus will be on house prices and consumer confidence figures on Tuesday. We forecast home prices to have continued increasing at a brisk pace. Consumer demand for homes remains strong, supported by healthy household balance sheets, improving labour markets and low mortgage interest rates. In addition, low inventory levels, especially for existing homes, should add to the upside pressure on home prices.

We look for the Conference Board’s index of consumer confidence to have edged higher to 110 in October. Gains in the labour market, the gradual decline in COVID-19 caseloads are likely to boost consumers’ near-term outlook with respect to income and in employment.

In Europe, the focus will be on the European Central Bank meeting on Thursday, although we don’t expect too many changes in policy to emerge on that with the central bank likely to maintain its relatively dovish stance.

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.