Markets Weekly podcast – 15 August 2022

Henk Potts (HP): Hello. It’s Monday, 15^th August 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 consider whether it’s possible, or even wise, to call the bottom of an equity market drawdown. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Over the past few months, markets, as we know, have become increasingly preoccupied by surging inflation, soaring energy prices, and weakening economic conditions. So, inevitably, the focus last week was on the US CPI print, demand growth forecasts from the International Energy Agency, the second-quarter GDP report in the UK, and the latest datapoints out of China.

In terms of market performance, the softer US inflation report and the corresponding recalibration of Fed hiking expectations helped stocks to rally, the dollar to weaken, and volatility to drop. The VIX index, also known as a fear gauge, dropped below 20 for the first time since April.

In terms of equity market performance, pretty impressive stuff. The S&P 500 rose 3.3% last week, the fourth week of gains and the longest positive streak since November 2021. European stocks were also higher last week, in fact closed at a two-month high on Friday, up 1.2% over the course of the trading week.

After a string of upside shocks, the US inflation report finally offered some tangible signs of moderation in price pressures. In terms of those headline numbers, US CPI came in at 8.5% year on year. That was down from 9.1% in June and versus the consensus of 8.7% as energy CPI declined 4.6% month on month, US gasoline prices are back below $4 a gallon for the first time since March, although food inflation is still running at plus 10% year on year, its highest level since the late 1980s.

The real downside surprise came in core inflation, which is perhaps more representative of the underlying inflation trend. Core CPI still rose 5.9% year on year, with the July reading monthly run rate more than halved from June. The easing of price pressures was particularly prevalent in categories, including used-cars, hotels, air fares, and car rentals, while shelter, housing inflation remains firm, plus 0.5% month on month, an easing of Brent conditions should begin to filter through to future readings.

We continue to expect the core US inflation readings will moderate into year-end due to slowing demand, elevated inventory levels, and an easing of supply constraints. In terms of our inflation forecast, we see headline CPI easing to 6% in December, then averaging just 2.9% during the course of 2023.

In terms of the policy impact, you’ll remember at the last meeting, well, the Fed chair, Jerome Powell, left the door open for another unusually large increase at the September meeting, he indicated that would be dependent on the incoming data.

Those key data points are very clear. It’s the labour markets, it’s the inflation print. The labour report, of course, is very robust. We could argue that’s now been balanced off by the softer inflation print, which perhaps adds to the evidence that it will be appropriate to slow the pace of increases as risks between inflation and economic weakness begins to level out.

But do remember we get another set of labour and inflation reports before the next Fed meeting, which could be crucial. But we think on the balance of probability, at this stage we look for the Fed to step down to a 50-basis point hike in September, followed by 25 basis point increments in November and December.

December increases project to be the final in the hiking cycle, when the target range hits 3.75% to 3.5%. Not such good news for the inflation picture has been the rise in energy prices that we saw during the course of last week, or certainly over the majority of last week, was some weakness on Friday. But oil prices have been bouncing back from the six-month lows that we have been seeing as a pincer movement of supply disruption and projections of rising global demand conspire to push Brent crude higher once again.

On the supply side, flows of Russian crude were briefly halted to central European refiners last week following a dispute over the paying of transit fees. A leak in Louisiana interrupted flows through to important pipelines. A more structured improvement in supply still looks unlikely, given the potential for a further rationing or embargo on Russian crude. Global inventory levels still remain historically low and OPEC+, as we all know, still has limited spare capacity.

On the demand side, the International Energy Agency raised its forecast for global demand growth for crude as a heatwave spurs demand, as does a switching away from pricier natural gas. The IEA sees global consumption rising by 2.1 million barrels per day this year. That’s up from its previous forecast of 380,000 barrels per day. On Friday, Goldman Sachs said rising demand and tight supplies could push oil futures as high as $130 a barrel by the end of the year.

Of course, investors will continue to monitor developments in the energy market very carefully. A further period of elevated prices would have negative ramifications for inflation projections, input costs for businesses, and household disposable income.

In terms of the UK, well, the impressive economic recovery, as we know, ground to a halt in the second quarter. In fact, output shrank for the first time since the pandemic. GDP fell, just 0.1% in the second quarter, but, remember, that was down from that 0.8% gain that we saw in Q1. The weakness was attributed to lower levels of household consumption, weakness in manufacturing, lower spending on COVID testing and vaccinations. The outlook, we have to say, for the UK economy remains somewhat gloomy, as surging inflation, higher interest rates, tight labour markets, and the rising tax burden are all expected to take their toll on growth prospects.

We do know the cost-of-living crisis is certainly playing out. The Bank of England forecasts show that household post-tax income will fall in real terms in both 2022 and 2023, even after factoring in the fiscal support the government announced back in May.

If you look at the peak-to-trough decline of more than 5% in household income, that would be the worst on record. Remember, this is in looking at data that goes back to the 1960s.

The Bank of England forecasts a recession will start in the UK from Q4 and will last for five quarters, with GDP by the end of 2024 2.5% lower than its previous forecasts, which would be a scale of contraction that we saw in the early 1990s. I have to say our forecast for next year is perhaps a little bit more optimistic than that. We expect a further support package in the winter, an easing of energy prices over the course of the forecast’s horizon, and a less aggressive policy path if global price pressures ease. We still expect a below-trend growth rate of 0.9% for the UK economy in 2023.

Moving on to China, where the People’s Bank of China surprised markets with a rate cut. That’s the first since January. What we do know is China’s growth profile has further weakened in July, as the world’s second largest economy struggles with the ramifications of its pursuit of its zero-COVID strategy, the slump that we’ve seen in the property market, and the regulatory crackdown.

Policymakers have clearly become more concerned about the depth and the breadth of the slowdown as industrial output, retail sales, fixed-asset investment, and property investment all falling short of economists’ expectations.

In terms of the growth outlook, China has an official growth target for this year of 5.5%, but the deterioration we’ve seen in the housing market, the dampening external demand, along with the lack of that truly aggressive fiscal and monetary stimulus package, suggests something closer to 3.1% is far more likely. We do see China’s economy bouncing back during the course of next year with growth of more than 5%, but no doubt policymakers will be monitoring that situation very carefully indeed. They still have plenty of levers to pull on if required.

So, that was the global economy and financial markets last week. In order to discuss market timing, I’m pleased to be joined by Alex Joshi, Head of Behavioural Finance for Barclays Private Bank.

Alex, great to have you with us today. Have we reached the bottom has been an increasingly common question in recent weeks and months. So, Alex, what are the main problems associated with answering that question?

Alex Joshi (AJ): Hey, good morning, Henk. While I’m missing the beach this morning, it is great to be back with you. So, this question of have we reached the bottom has been increasingly common in recent weeks and months. And it’s typically linked to a desire to see how the current macro and market stories play out before pulling the trigger on investment activity.

Now, in terms of market uncertainty and falls, this understandable nervousness can induce a desire to time the market, primarily to reduce unnecessary risk exposure, but also to capitalise on opportunities, and this is a very difficult sport, market timing, and can be very costly for investors.

Now, it is understandable this desire to do so, and a big part of that is psychological. You know, investors don’t like uncertainty, and certainly don’t like portfolio values falling, and with, you know, the market down against a backdrop of significant question marks around recessions, inflation, interest rates, the war etc, you know, negativity does become pervasive, you know, as we’ve seen consumer confidence and sentiment indicators have been falling month on month and this has a psychological impact.

As you’ve heard me say before, you know, losses psychologically tend to have a far larger impact on us than equally sized gains, and when we view markets and portfolios through this loss frame, it affects the way that information is perceived, the decisions we take, and, crucially, the risks that we’re willing to take to stem these losses. And so, when there’s uncertainty about where the bottom is, this only exacerbates the problem.

HP: So, have we reached the bottom?

AJ: So, calling the bottom is near impossible and we believe the value to clients comes from identifying the strong companies, which are capable of providing the outsized gains throughout the various stages of the business cycle over the long term.

Attempting to time the market introduces additional biases and risk into the decision-making process and can be very costly. Successful market timing requires three things. It requires getting the directionality right, speed of execution, but also having the composure to see it through even if the market’s moving against you.

In many cases, investors who attempt to time the market can end up buying at a high entry point. They wait for the market to fall, but for a better entry point, you know, sentiment needs to have worsened, which can actually make it far more difficult to get invested.

Successful market timing requires getting the selling right, getting that decision right, but also being successful about when you re-enter. And so, in many cases, we find that staying the course is typically going to be the better option for investors.

Now, we’ve done a bit of analysis around that, and we did this hypothetical scenario of two investors, a composed investor versus a nervous investor. Now, these two investors both have invested £1 million into the S&P 500 30 years ago, at the start of 1992. Now, the composed investor follows a very simple investment strategy of topping up £25k at the beginning of every quarter irrespective of market conditions. And so that investor’s £1 million portfolio would be worth just under £20 million today.

You then have a nervous investor who topped up, who did the £1 million initial investment, does the £25k top ups at the beginning of every quarter, but this investor sells out of equities into Treasury bills if there’s a 10% fall in the index in any given quarter, and only reinvests after three successful quarters of positive return.

Now, the net result is that nervous investor’s portfolio would actually be worth under a third of the value of the composed investor, which shows the value of staying the course.

HP: Alex, is there an alternative approach to getting invested for those with concerns?

AJ: Sure. So, phasing into markets could be one approach. This can make it easier, psychologically, to get invested as well as potentially offering a better average entry point if markets were to continue falling.

Now, a good example of when this potentially could have worked is the COVID-19 pandemic. If we think about 2020, and we think about the MSCI World, and we think about an investor who would have got invested at the start of 2020, just before the pandemic hit, well, they would have invested and their portfolio would have been up about 40% at the end of last year.

If we then compare that with an investor who would have phased in, so let’s take a lump sum, split that up into six equal parts, and that investor would have got invested across, you know, six tranches in the first six months of 2020. Well, that investor would have halved the maximum drawdown, versus the day one investor, and actually would have outperformed due to a lower average entry point, so that portfolio would be up 55%.

Now, if we consider a third investor, and that’s maybe many investors today, wanting to wait up to see past that uncertainty, wait for a bit more clarity to get invested. Well, an investor who would have sat on the sidelines for 2020 and got invested at the start of 2021, they would have missed a lot of the correction, of course, but they also would have missed some of the sharp recovery and actually would have underperformed quite significantly as a result, and that portfolio would be just up 24%.

So, this is phasing in, but I think it’s also important, at the same time, to just make a brief reference to cash, because I’ve spoken about waiting out here. We should remind all investors about the cost of cash in terms of forgone investment returns, but also the erosion from inflation.

Now, it might be a little bit odd to be talking about this given, you know, the falls in risk assets this year, but reluctance does lead to more reluctance, and in many cases, we see many investors who end up underweight risk assets over the long term. You know, whilst holding cash is an understandable way to protect against the possibility of losses in the short term, you know, long-term losses from inflation are guaranteed.

HP: OK. So, taking all those points into account, what is the core view regarding the future outlook and give us any final reflections you have for investors listening.

AJ: Although we find ourselves in a delicate situation with challenges to growth and inflation, our long-term view remains constructive. The base case is for a slowdown to be relatively mild and short-lived, particularly in the US, whilst it may be a bit more pronounced in Europe and the UK. And if this scenario was to play out, then we may indeed have seen the bottom in equity markets.

However, and it’s a big however, uncertainty remains elevated, and it wouldn’t take much for the narrative to change, so be that an escalation in geopolitical tensions, runaway inflation, China lockdowns, and in this context, we continue to believe that the focus should be on appropriate portfolio diversification.

So instead of buying and chasing the market for fear of missing out or waiting for perfect clarity, instead investors should be focusing on their long-term goals and how best to get there over time.

Now, final reflections, being relevant today as well as across the market cycle, I think it’s important to repeat them. All investors, you know, should not be assuming the worst, you know, and recession doesn’t necessarily mean a crisis. Secondly, check your biases. It’s important not to make in-the-moment decisions at a time like this. Thirdly, focusing on goals, why you’re investing and how do events and actions affect those. Fourth, this is part and parcel of investing. Volatility is part of the journey and the potential long-term returns from risk assets would be significantly lower if it wasn’t for these periods. And finally, it’s about opportunities, you know, remembering that opportunity sets can, and do, emerge during periods like these.

HP: Well, Alex, thank you for sharing your behavioural finance insights and the mental side of the investment process, reminding us of the importance of being humble about our ability to call markets day to day and the rationale for taking a longer-term perspective on portfolios.

Moving on to this week, where the focus will be on the US on Wednesday when we get retail sales and the release of the Fed minutes. For the July retail sales, we expect growth to soften, reflecting the moderation of spending in the control group as price levels edged down a bit in July and consumers appeared to hold back some spending in stores during the course of the month. We expect vehicle sales and food services to continue their growth momentum over the recent months, offering some support for the headline figure.

In terms of those FOMC minutes, we expect them to reiterate the themes at Powell’s July press conference, including an emphasis on restoring price stability, an intention to direct the policy stance to a moderately restrictive position, and downplaying the weak incoming spending data on hand just prior to that second-quarter GDP report.

In the UK, we get the inflation report, also on Wednesday, where we expect headline CPI to accelerate further in July, coming in at 9.7% year on year. That compares to that 9.4% reading we got in June, but for core CPI to move sideways 5.8%, the source of inflation moving increasingly towards food and energy.

With that, I’d like to thank you once again for joining us. I hope that you found this update interesting. 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.