Markets Weekly podcast – 10 January 2022
In this week’s podcast, Dorothee Deck, our Cross Asset Strategist, reflects on last year’s winners and losers across asset classes, and considers what we can expect in 2022. Host Henk Potts, our Market Strategist, also shares his latest insights on US Federal Reserve policy, energy markets, and the potential path of the pandemic.
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Hello. It’s Monday, 10th January 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 review asset class performance in 2021, consider how investors should be positioned for this year. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
But we know it’s been a nervous start to the year for investors. Initially, traders appeared to have returned to their desks with a risk-on bias, driven by a perceived reduction in the risk from the Omicron variant, the above-trend GDP growth predicted for this year, and robust corporate earnings projections.
However, the Fed minutes provided a dose of reality by reminding investors that policy normalisation is very much firmly on the agenda for this year, putting pressure particularly on US equities, and specifically on the highly valued tech sector, and propelling bond yields higher.
So, in terms of market performance last week, the S&P 500 hit a record high, we should remember, on Monday, but then sold off to close the week down 1.9%, representing the worst start to the year since 2016.
The Nasdaq technology market was down 4% over the course of the week. That’s its worst week since February 2021.
It was also a down week for European equities, although the region’s lower exposure to growth stocks limited the losses. The STOXX 600 was only down three-tenths of 1% over the week.
From a sector perspective, something we have been talking about, the banking sector, which we know benefits from rising rates, recovering economies and cheap valuations, outperformed. The S&P 500 bank index rose 9.4% over the course of the week. The European banking sector traded at its highest ever in three years, on Friday.
Lots of action, of course, in bond markets last week. Yields on 10-year Treasuries spiked 29 basis points to around 1.8%, compared to 1.5% at the end of last year, the biggest weekly gain since September 2019, and the highest yield since January 2020.
European borrowing costs also rose. The yield on 10-year Bunds edged towards 0%, its highest since May 2019. Higher yields have been reducing demand for zero interest-bearing assets such as gold. Net flows out of gold ETFs equated to $9 billion during the course of last year. That’s the biggest annual withdrawal since 2013.
Remember, gold hit a record high of $2,067 an ounce in August 2020. The gold price is now down around about 14% from its peak.
We know that markets are continuing to monitor the path of the pandemic. The highly transmissible Omicron variant sent daily infections to record highs during the course of last week. In fact, last week the US broke through the one million new infections milestone for the first time.
Hong Kong has reimposed social interaction restrictions and suspended flights from eight countries. China, which of course continues to pursue that zero Covid strategy, shut down two cities encompassing more than 14 million people.
However, the number of hospitalisations and deaths have not registered the corresponding surge, particularly amongst those that have been vaccinated. This decoupling has eased market fears around the impact of the variant. Sentiment’s also been boosted by selected authorities reducing a range of testing and isolation requirements.
So, what does it mean in terms of the virus, and the impact, as we look through the course of 2022? Well, we continue to believe that the pandemic will transition into an endemic. We don’t anticipate the intense widespread lockdowns that were implemented in early 2020. We acknowledge that science has made great progress over the course of the past couple of years.
Vaccinations have proved to be successful, and can be adapted to meet new challenges. We should also recognise that households and businesses have demonstrated they’re able to adapt to tighter restrictions, which should reduce the impact of any renewed curbs on physical interaction.
The path of policy normalisation, of course, will be a key driver of economic growth and asset class performance during the course of this year. The FOMC minutes provided an early wake-up call for markets, by concluding the pandemic-related bottlenecks were likely to persist longer than expected, thereby fostering more sustained price pressures.
Signs of a tightened labour market means the US is rapidly approaching full employment, and there are also growing concerns that the Federal Reserve inflation expectations may have become unanchored.
The December employment report provided evidence of further progress on the full employment mandate, although the headline figures we saw fell short of expectations. So, in terms of nonfarm payrolls, the US economy created 199,000 jobs in December, well short of consensus, a consensus that was much closer to around 450,000. Leisure and hospitality disappointed, although October and November estimates were revised higher.
However, almost all other areas of the reports seemed to offer upside surprise. The household survey, for example, showed the unemployment rate fell to 3.9%, down from 4.2%. That’s the lowest since February 2020 and just below the medium FOMC participants’ estimate of long-run unemployment.
The labour force participation rate held steady. Hourly wages surged 4.7% from a year ago. So, the hawkish tone from the minutes, the solid labour market report we think add to the expectation of an earlier rate lift off, and a sooner and faster initiation of the balance sheet runoff.
In terms of rate expectations, look for that first US interest rate increase to come through in March. We expect three hikes in 2022 and a further three more in 2023, placing the policy rate range at the end of next year at between 1.5 and 1.75%.
We know that energy prices, of course, jumped last year, and were a major driver of inflationary pressure. Brent crude rose 50% in 2021. It’s made a solid start to the year. Last week crude prices were up around about 5%. This was due to concerns over tensions in Russia and, of course, the unrest that’s been taking place in Kazakhstan. Brent crude trading above $81 a barrel this morning.
So, investors will be watching the supply and demand dynamic very carefully during the course of this year. At last week’s meeting, the 23 nation OPEC+ alliance indicated that they expect demand for oil will continue to recover this year, despite rising COVID cases and the implementation of travel restrictions.
The cartel is now predicting a smaller supply surplus in the first quarter, and vowed to implement the production increase in February.
In terms of that recovery in demand, OPEC estimates that oil demand jumped 5.7 million barrels per day in 2021. Forecast demand in 2022 will hit 100.6 million barrels per day, which will surpass pre-pandemic levels.
If you look at OPEC’s Joint Technical Committee, they said the impact on demand of the Omicron variant will be mild and short-lived, now estimate that production will exceed worldwide demand by 1.4 million barrels per day in 2022, compared to its previous estimate of 1.7 million barrels per day.
So, the group will officially add 400,000 barrels per day in February, leaving a further three million barrels per day to be unwound by September if it’s to fulfil its previous commitment.
In terms of the outlook, we think OPEC+ will continue to try and maintain the balancing act. They want to produce enough energy to meet the recovery in demand and avoid inflationary spikes, but will be mindful that further COVID restrictions, particularly in China, could infringe upon demand in a meaningful way. They will also be monitoring the expected increase in non-OPEC supply and discussions around the releasing of strategic reserves. Therefore, we’ll expect the group to maintain its flexible approach.
So that was the global economy and financial markets over the course of the past week. In order to discuss how investors should be positioned for the coming year, I’m pleased to be joined by Dorothee Deck. She’s the Cross-Asset Class Strategist with Barclays Private Bank.
Dorothee, great as always to have you with us today. Let’s start by quickly reviewing financial market performance during the course of last year. Which were the best and which were the worst performing asset classes in 2021? And how would you characterise the past year?
Dorothee Deck (DD): Thanks a lot, Henk. Good to be here. So, 2021 was another strong year for risk assets, with stocks outperforming bonds by about 30% in the US and Europe, and commodities closing the year up 40%.
So, US stocks were up 29%, closely followed by European stocks, up 26% in euro terms. This was a strong reversal from 2020, when European stocks actually underperformed the US by 16% in local currency terms. It’s worth noting that for both regions those strong results were delivered with a high degree of persistence.
To put it in context, over the course of last year, US and European indices were up on a weekly basis over 65% of the time, which is close to historical highs. And in contrast, emerging market equities were down 2% last year, hurt by China.
So, the main characteristic of 2021 was the change in leadership across and within asset classes, from long-duration assets to reflation winners. So, for example, government bond returns were flat to slightly negative across the US, Europe, UK and Japan, and duration generally underperformed. Credit returns were flat to slightly positive, with high yield outperforming investment grade modestly. And in contrast, real assets had an outstanding year, fuelled by inflation fears.
So, the commodity complex was by far the best-performing asset class, up 40% in 2021, led by energy, up 61%, followed by industrial metals, up 30%.
HP: So, you mention a change in leadership across and, of course, within asset classes during the course of 2021. How did this materialise within equity markets?
DD: So, within equities we also saw a rotation out of the more defensive, long-duration parts of the market into reflationary plays. The best-performing sectors within the MSCI World were energy, up 42%, followed by tech, financial and real estate up 30%.
Unsurprisingly, energy benefited from the rally in the oil price, while financials benefited from the economic recovery, and the rising yields and inflation. Both sectors are typical reflationary plays, and they had actually underperformed quite significantly in 2020.
The main laggards were the more defensive or long-duration sectors, such as utilities, consumer staples and communication services, up between 11% and 15%. And our cyclical basket outperformed defensives by 5% last year, versus down 1% in 2020.
Now, when it comes to styles, the picture was a bit more mixed. So, the best-performing factor last year was quality, up 26%. The worst-performing ones were min vol and momentum, up 15% each.
Value outperformed growth by only 1% last year, but that was actually a strong reversal from the 26% underperformance in 2020. Value has basically been underperforming for the past 15 years, with only brief periods of reversal, but it’s worth flagging that since late November, value has actually been outperforming by over 10%, as yields have jumped.
And finally, small cap underperformed large cap by 6% last year, which we thought was relatively unusual given the strength of the ISM and the strong performance of risk assets in general.
HP: OK. So that’s what we’ve been seeing in terms of the rear view mirror. Most importantly, of course, for investors is where we go forward from here. So, Dorothee, take us through the outlook for markets as you see them in 2022. And where do you see the main risks?
DD: So, we see four main risks. First, COVID, obviously, leading the risk of further restrictions and slower growth, but also prolonged supply-chain disruptions and price pressures. Second, inflation, which could result in more aggressive central bank action. And, as you mentioned earlier, central banks have recently turned more hawkish, with the BoE surprise hike in December and the Fed signalling three hikes this year.
But if you look at the four previous hiking cycles, it’s interesting to note that equities have actually performed well in the month prior to the first hike. They have typically seen a mild short-lived sell-off soon after the first hike, but they have tended to resume their uptrend quite quickly as the Fed continued to tighten. Third, a continued slowdown in China. And, fourth, geopolitics.
To put this in a market context, this is also happening at a time when valuations look stretched across major asset classes. Equity market breadth has narrowed considerably in the past 12 months, especially in the US where market indices have continued to hit new highs. And finally, we haven’t seen a correction since March 2020. So, all this should lead to an increase in volatility this year, and investors should position accordingly and put hedges in place.
However, our base case is that as long as growth remains above trend and central banks do not tighten excessively, then stocks should continue to beat bonds and risk assets should continue to outperform.
The macro backdrop remains favourable, with global activity supported by large excess savings, commodity financial conditions, and expected pick-up in capex and restocking.
Now, after three exceptional years, we expect equity returns to moderate this year as the economy decelerates, and we see the potential for mid to high single digit total returns from equities including dividends, and we think markets will continue to be driven primarily by strong earnings growth, albeit at a slower pace, partially offset by multiple contraction.
HP: OK. So, let’s try and narrow down the questions a little bit, and think about opportunities for clients. How should investors be positioned within equity portfolios over the course of the next year?
DD: So, in the near term, ie in the next six months, we believe the current environment favours cyclicality, value and non-US equities. At the sector level, and for the first half of the year, we favour areas of the market that are more sensitive to an economic rebound, benefit from higher yields and inflation, and enjoy superior pricing power. So that includes financials, energy, industrials and basic materials.
In contrast, we’re cautious on the more defensive, long-duration parts of the markets such as consumer staples, healthcare, utilities, telecoms, as well as the broad technology index. And this is due to their lower sensitivities to the cycle and their vulnerability to higher yields and inflation.
Now, given regional market composition or sector preferences actually translate into a preference for non-US equities over their US peers, and more specifically for Europe, including the UK, followed by Japan and emerging markets. And to be more specific, financials are over represented in Europe and emerging markets. Cyclicals, ex-tech, are more heavily weighted in Europe and Japan, and to a lower extent in EM, and the US market is dominated by tech and healthcare.
And in terms of styles, we continue to favour quality growth over the medium to long term, but over the next six months our sector views translate into a preference for value versus growth. And that’s because financials are heavily concentrated in value indices, while tech dominates growth indices. And this call is also heavily supported by valuations, which have become quite extreme in recent months, with the relative PE discount now 30% below its 10-year average.
HP: Well, thank you, Dorothee, for your insight today, and highlighting both risks and opportunities for investors over the course of next year and, of course, beyond.
Let’s move on to the week ahead. The focus this week will be on the US inflation print on Wednesday, where we look for a deceleration in month-on-month increase in December due to a reduction in energy pressures.
Retail gasoline prices were lower in the United States in December than in November. We expect food inflation to remain robust, due to a pick-up in demand from the hospitality sector. Labour shortages have been behind elevated price pressures in some of the service sector categories. Hurricane Ida led to an increase in new and used car prices.
In terms of the numbers, we look for headline CPI to rise fourth-tenths of 1% month on month, but that compares to the 0.8% increase month on month we saw in November, but we look for year-on-year CPI to print at that elevated level, 6.9%.
In terms of the outlook, we see US CPI probably peaking somewhere around 7% in January, then drifting low as we go through the year, and in fact annual CPI could be back to the 2% mark by December of this year. So, markets will be watching those figures very carefully and, of course, making an assumption around what that’s going to do in terms of Fed policy.
And 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.
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