Markets Weekly podcast - 12 December 2022
What lessons could investors apply from the past 12 months of heightened volatility to their future decision-making processes? As 2022 comes to a close, our Head of Behavioural Finance Alex Joshi reflects on a year of market shocks and geopolitical upheavals. While our host and Market Strategist Henk Potts explores the downturn in the UK housing market, falling oil prices and the upcoming US inflation report.
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Henk Potts (HP): Hello. It’s Monday, 12th December 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 will then reflect on the lessons that have been learnt from a behavioural finance perspective during the course of this year. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
Risk assets were under pressure last week. Geopolitical tensions remained elevated and hardy economic data maintained pressure on policymakers. Investors, you could argue, actually, refrained from making large bets ahead of this week’s US inflation report and the raft of central bank rate decisions.
In Europe, the STOXX 600 fell nine-tenths of 1% last week. The S&P 500 fell 3.4% over the course of the week, its biggest weekly decline since 23rd September, although still up 9.7% during the course of this quarter.
Equity markets have rallied strongly over the course of the past couple of months on China-reopening hopes, reduced energy security concerns in Europe, at least in the short term, and resilient earnings. The catalyst, however, to push materially higher from here, we feel, would need to be coming from confirmation that the central bank pivot is within sight, growth has troughed, and corporate earnings can, indeed, hold up.
Brent traded below $80 a barrel last week for the first time since January, compared to the high of $139 in March after the war in Ukraine broke out. Crude prices have fallen as traders worry that weaker global activity, ongoing restrictions in China, which is the world’s largest importer, higher interest rates, and the stronger dollar will drag down global demand, although most forecasts suggest that demand will remain relatively resilient and supply will continue to be constrained during the course of next year.
OPEC+ have reduced their demand growth forecast for next year, but still expect demand to increase by 2.24 million barrels per day in 2023. Meanwhile, supply concerns persist, as Russian exports remain under pressure. There’s plenty of production disruption in a number of key countries, including the likes of Libya, Nigeria, and Venezuela. US production has also been underperforming expectations.
Meanwhile, OPEC+ have cut their targeted output by 2 million barrels per day. That equates to around about 2% of global supply, and inventory levels remain close to historic lows. Barclays expects oil to trade progressively higher through the course of next year with Brent averaging $98 a barrel, WTI averaging $93 a barrel in 2023.
There was further evidence of a downturn in the UK housing market last week. The data from the Halifax showing that house prices fell 2.3% in November, the third consecutive monthly decline, the sharpest drop in 14 years. Annual house price appreciation remains positive but has slowed sharply from 8.2% in October to 4.7% in November.
Why is that the case? Well, the UK property sector has been impacted by the rapid rise in interest rates, with average two-year mortgage rates hovering around 6% over the course of the past few weeks. Rising inflation has been hitting affordability measures. If you look at mortgage approvals, well, they declined 10.6% in October.
Whilst the Office for Budget Responsibility forecasts that UK house prices could decline by as much as 9% between the fourth quarter of this year and the third quarter of 2024, we should remember there are still a range of supportive factors in place. Eighty three percent of mortgages in the second quarter, in the UK, were on a fixed rate. Remember, that’s versus 51% back in 2007. So, it will take some time for borrowers’ payments to reset.
Unemployment rates are low, household balance sheets still look very healthy, and over the course of the past couple of years lenders have been testing affordability against a much more stringent framework. There also continues to be a structural supply and demand imbalance for UK houses and sterling remains relatively cheap, making property investment attractive for international buyers.
So, that was the global economy and financial markets last week. In order to discuss the importance of understanding behavioural finance in the decision-making process for investors, I’m pleased to be joined by Head of Behavioural Finance for Barclays Private Bank Alex Joshi.
Alex, great to have you with us today. As we know, it’s been a turbulent ride for investors through the course of 2022. From a behavioural perspective, how would you summarise the year?
Alex Joshi (AJ): Hi, Henk. It’s great to be back. Well, this year’s been quite the rollercoaster. It’s been characterised by falling asset values with the S&P down 17%, in large part in response to central banks hiking rates to fight surging inflation, and one contributing reason being the war in Ukraine.
Whilst many have been glad to see the resumption of normality post COVID, in China that’s remained at the fore, with the zero-COVID policy weighing on economic growth and market sentiment. And, meanwhile, in cryptoland, the rollercoaster journey has continued. The VIX was down roughly 63%, has had multiple days plus or minus 15%, and the recent collapse of the exchange FTX has highlighted many of the concerns that have been associated with the sector.
So, this has led to an abundance of two things this year, the first being volatility and the second being uncertainty, which, on the whole, investors don’t like. So, let’s start with volatility. Well, the VIX hit levels in March that have not been seen since the great financial crisis. The S&P is down 17%, but almost exactly two months ago it was down 25%.
There have been big swings too. We’ve had a few big one-day moves. I count 12 days with moves greater than 3% in both directions. In the summer, we had quite a significant rise. In July, the S&P was up 9%. And much of this has been in response to these changing expectations around rate hikes and the balance between surging inflation and recessionary fears.
Now, this has led to a lot of uncertainty. There have been questions like, when will the war end? When will inflation and rates peak, and at what level? Will, and when will, major economies fall into recession and when will China open up? Now, this has led to a lot of uncertainty around one key question that I’ve heard a lot this year, which is have we reached the bottom? Because there’s been a lot of uncertainty over the size of losses, investors will rightly be asking how far will portfolios continue to fall? When will it be a good time to invest for those who’ve been waiting for some clarity or market calmness?
And from a behavioural perspective, this can be very unsettling. You’ve got losses and uncertainty over how big they could be, which can induce selling behaviours in certain investors. For others, it can lead to hesitation around committing capital to markets, as well as general anxiety and a lack of satisfaction with the investment journey, which shouldn’t be downplayed. So, I recognise that many investors will be keen to see an end to 2022 and be hoping that Santa Claus brings a calmer and sunnier 2023.
HP: Well, Alex, as you say, it’s certainly been a year of volatility and uncertainty. So, when we bring that all together, what are the key lessons that we’ve learnt through the course of this year?
AJ: Sure. So, whilst 2022 has been extremely eventful and unusual, if you think about the correlation between equities and bonds, the size of the drawdowns, one of the key lessons isn’t actually unique to 2022, but it actually applies to every year. And that is that in investing, unexpected events do occur and they continue to occur year after year. It’s just, at the time, each event seems extremely important, it takes up a lot of investor focus, and it can induce lots of investors to position in a particular way.
From a behavioural perspective, there’s a concept called the availability heuristic. And so, a heuristic is a mental rule of thumb, and the event that is heuristic is a phenomenon where we typically overweight, or apply greater weight to, events which are more dramatic or more emotive, and this can be at the expense of the long term, long-term data, long-term trends in investing. But the global economy and markets get past them and do recover.
So, what’s the lesson or the learning in that? It’s the importance of keeping focused on one’s long-term goals and sticking to the plan, because there’s a risk of being derailed by these events and news. Now, that being said, it’s important at the same time to keep up with more significant changes in the macro and market environment and their impact on one’s own individual portfolio so as to be able to undertake good investment hygiene such as rebalancing portfolios. So, for example, after the significant moves we’ve seen in fixed income yields this year.
Now a caveat to that, I’ve just mentioned rebalancing and not more significant changes to asset allocation, as it’s important to hold a core asset allocation, which is designed for the long term, given the long-term nature of the capital market assumptions which typically underpin them. You know, recently one of our colleagues in the quant team was asked how should investors react to this fundamental change in the environment? And in response to that, the world hasn’t fundamentally changed, it’s just being presently driven by different macro factors.
And so that’s why it’s important to have a core asset allocation, but then to be able to be nimble with smaller tactical tweaks to protect and to capitalise on these shorter-term movements.
HP: At this time of year we, inevitably, do start to think about what lies ahead. What are the key principles that investors should keep in mind for 2023?
AJ: So, there are four things I’d say here. And readers of our Outlook will recognise them.
So, the first is goals. So, be clear on what you’re trying to achieve over the long term, and use that as the lens through which to consume investment news and when considering how to capitalise on opportunities or mitigate risks. Remember that the key risk to all investors should be that of not reaching one’s goals. So, when looking back at the year and looking forward, think first about what it is that you’re seeking to achieve and whether you’re well positioned for that versus overly focusing on calendar-year performance. Remember, for a long-term investor, a calendar year is just a set of arbitrary dates, 365 days apart.
The second is around diversification, and the reasons for diversification are well known. But there’s an additional benefit, a behavioural benefit which is that a well diversified portfolio can also help shield from the emotions that volatility induces, which can exacerbate behavioural biases. So, a well diversified portfolio provides the foundations for clear decision-making whilst others might be panicking, say. And on that I’d say, you know, it’s been spoken about here on this podcast this year about the importance of diversification beyond just the 60/40 portfolio, thinking about private assets, for example.
Third, is the importance of having open and regular conversations with a trusted advisor, which can be very beneficial from a behavioural perspective, in particular during stressed market conditions, to support but also to challenge us to ensure that we don’t fall foul of behavioural biases, like the confirmation bias, which is a bias where we seek, and we pay, more attention to data and stories that confirm our pre-existing views and beliefs.
Now, these first three are to help with staying the course, but that shouldn’t be the sole focus. And so, number four is to recognise opportunities. You know, as yourself, Henk, and guests have discussed in recent weeks, Barclays Private Bank sees an improvement in the long-term outlook. However, they might still be able to see uncertainty and volatility in the shorter term.
So, I’d remind all investors that a recession doesn’t necessarily mean a crisis. When the situation looks at its worst and sentiment is at its lowest, in many cases the dawn is not far off. Good news can spark, you know, quite considerable rebounds. But also realise that the macro situation doesn’t need to fully turn around for opportunities for investors to pop up. Asset classes that may have been bad for portfolios in the past are providing opportunities, like in fixed income.
So, a final point is to think about if you are well positioned to take opportunities up when they arise, which means thinking about how you’re utilising cash. This year, with rising rates, many investors have been turning to the safety as well as the higher yields from cash, but it’s important to think about appropriate allocation to it versus other asset classes and how well positioned you are to reach your goals, taking into account the costs of higher inflation and the need to beat it to both protect and grow wealth over the long term.
HP: Well, thank you, Alex, for your insight today. We’ve certainly learnt through the course of this year about, as you say, the importance of maintaining composure, being diversified, distinguishing between short-term noise and the longer-term economic and financial market fundamentals, and, as you say, remaining focused on long-term goals continue to be really important.
Let’s move on to the week ahead. Market participants will need to remain focused with an important US inflation report and a raft of major central bank decisions. Tuesday’s US inflation report will be closely watched. Households, businesses, and policymakers will be hoping for a further moderation.
We expect headline CPI to print at plus two-tenths of 1% month on month, and 7.2% year on year in November. That compares to the 7.7% increase that we saw in October. The easing of price pressures should be driven by slower increases in food and energy prices. Core inflation is expected to come in at 6% year on year with strength in services, particularly shelter, whilst core goods are projected to remain in modest disinflation.
In terms of the outlook for US inflation, we forecast that CPI will be at 6.5% in December, falling to 2.7% by the time that we get to December 2023 and declining to 2.4% at the end of 2024. At this week’s major central bank meetings, we are expecting the Fed, the Bank of England, and the European Central Bank to all hike by 50-basis points.
In the US, we look for the Fed to transition to a slower rate of hikes with a step down to half of 1%, lifting the target range up to 4.25% to 4.5%. Markets will actually be focusing on the communication around the future path of policy. Investors will be looking for signals from the ‘dot plot’ on how high rates will go and for how long which, given the resilient economic data, particularly the robust labour market figures we’ve been seeing, is likely to be higher than the September projection.
In terms of the policy outlook for the US, we look for a further 50-basis point increase in February, a 25-basis point increase in March, putting the terminal rate for this cycle of 5% to 5.25%, then staying at that level to at least late next year, after which the timing of possible rate cuts will be determined by the intensity, the deterioration in labour market conditions, the level of disinflation, and the impact of tighter financial conditions on the broader economy.
Moving on to the European Central Bank, where we said we expect the Governing Council to increase its policy rate by 50-basis points, taking the deposit rate up to 2%, after which we look for two further 25-basis point hikes at the February and March meetings, with the hiking cycle ending at 2.5% in the first quarter next year. The risk, it has to be said, remains skewed to the upside with the possibility of a 50-basis point hike in February if inflation remains elevated or second round effects start to materialise.
Finally, for the Bank of England on Thursday, the MPC remains under pressure to take rates deeper into restrictive territory despite the onset of a recession. This is after UK inflation accelerated in October to 11.1%. Remember, that’s a 41-year high. Labour markets remain tight and fiscal tightening was backloaded. Inflation looks set to remain elevated in the UK. In fact, we’ve got it averaging 7.9% during the course of 2023, and then not falling below that 2% target level till the end of 2024.
The policy outlook for the UK, well, we continue to expect, as I say, a 50-basis point increase in the bank rate this week, another 50-basis point hike in February, 25-basis points in March, taking the terminal rate to 4.25% in the first quarter of next year.
And with that, we’d like to thank you once again for joining us. I hope that you found this update interesting. This is our last podcast for 2022. We will, of course, be back in January with our next instalment. But for now, may I wish you every success over the course of the trading week, and a happy and healthy festive period, and we’ll be back with you in the new year.
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