Markets Weekly podcast – 17 January 2022

Henk Potts (HP): Hello. It’s Monday, 17^th 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. 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 for corporate earnings and possible impact on equity markets. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

It was another volatile week for equity markets, and specifically the technology sector, as investors continued to assess whether the rotation trade has further legs. A late turnaround on Friday helped to limit losses on Wall Street, but the major benchmark still closed in negative territory for the week.

The S&P 500 and the Nasdaq were both down around three-tenths of 1% over the course of the five trading days. The Nasdaq, in fact, has fallen for three straight weeks.

Over in Europe, the STOXX 600 was also in negative territory, falling 1% over the course of the week, its biggest weekly decline since 26^th November. Hawkish rhetoric from the JP Morgan boss pushed Treasury yields higher on Friday. Jamie Dimon forecast seven hikes by the Federal Reserve, although like all good forecasts has failed to say over what timeframe.

Ten-year Treasury yield has risen for four consecutive weeks, and finished up 1.78%.

On the data front, investors spent the week digesting, in the United States, the elevated inflation print and disappointing retail sales figures. And in China, the latest growth numbers and the corresponding People’s Bank of China policy response.

We know investors and central bankers were bracing themselves for another red-hot US inflation print, and that’s exactly what they got. The consumer price index surged to 7% in December, the largest annual gain since June 1982. Month-on-month CPI rose half of 1%, which was actually a deceleration from the 0.8% increase registered in November.

In terms of core inflation, which as we know strips out the volatile food and energy components, it rose 5.5% from a year earlier. That’s the biggest advance since 1991.

In terms of contribution, price pressures shone through in terms of shelter, used cars, and food. Energy prices, which have been a strong contributor to inflationary pressures over the course of the past year, eased in December. That was for the first time since April, as domestic gasoline prices fell compared to the prior month.

In terms of the immediate outlook, economists have been raising their forecasts, perhaps now seeing CPI peaking around 7.4% in April, as supply bottlenecks take longer to resolve. Services inflation looks set to be anchored by shelter.

In terms of the impact on policy, well, the 7-handle on CPI coupled with the unemployment below 4%, suggests there are few obstacles that will stop the Federal Reserve from hiking interest rates in March. Markets are now pricing in a more than 90% chance of that happening.

However, we can expect some of the hysteria around these elevated inflation prints to calm down through the course of the second half of this year, as bottlenecks ease and demand rebalances towards services, which should reduce price pressures in terms of core goods.

US CPI is forecast to be printing around 2.5% at year-end, which should begin to be reflected in rate hiking expectations, and discourage economists that have been suggesting five or six hikes during the course of this year, with perhaps three hikes being far more likely.

Data on Friday showed US retail sales missed expectations by a wide margin, and consumer confidence slumped, in January. The University of Michigan Consumer Sentiment Index fell to its second lowest reading in a decade, driven by concerns over inflation, while retail sales fell 1.9% in December. That’s the biggest fall in 10 months.

Estimates were for a decline, but only of 0.1%. Ten of the 13 categories showed declines in receipts. Supply issues, Omicron restrictions, and inflation fears held back demand. As a result of the incoming data, economists have been downgrading their fourth quarter and Q1 growth forecasts.

But actually the outlook for the consumer, we think, for the rest of the year probably looks a little bit more positive. Household consumption should be supported by the healthy labour market, the huge accumulation of excess savings during the course of the pandemic, and strong underlying demand. We expect private consumption growth in the US to be around about 3.4% during the course of this year, which will be supportive of that broader growth figure.

In terms of China, well, the Chinese economy slowed in the fourth quarter to 4% year on year, which was actually ahead of expectations. Consensus forecast was around 3.6%, but it was the weakest pace that we’ve seen since the second-quarter 2020, and down on the 4.9% registered in Q3.

China’s growth profile has come under pressure from a range of factors, including the slump in the property market, energy shortages, the regulatory crackdown, and, of course, its zero-COVID strategy, which has been impacting domestic consumption levels.

If we look at property investment, it slumped 14% year-on-year in December. Retail sales in December only rose 1.7%. That was compared to 3.9% in November.

While other central banks are hiking rates to combat inflation, the People’s Bank of China surprised the markets by cutting the cost of medium-term loans for the first time since April 2020. They also cut its seven-day reverse repo rate.

As we look out for the rest of 2022, the two main growth drivers, particularly the likes of property and exports, we think will continue to slow during the course of this year. We’re only anticipating a modest recovery in terms of consumption. Therefore, look for growth to moderate during the course of this year, from the 8.1% that was registered in 2021 to around 4.7% this year.

Given that weaker growth profile, economists are certainly anticipating additional monetary and fiscal support over the course of the next few months.

So that was the global economy and financial markets over the course of the past week. In order to discuss what we can expect from the fourth-quarter earnings season, I’m pleased to be joined Julien Lafargue. He’s Chief Market Strategist with Barclays Private Bank.

Julien, great to have you with us today. We know equities registered some impressive gains during the course of 2021. That was partly due to the recovery that we saw in terms of earnings. In the third quarter, casting our eyes back of course, we saw some blockbuster numbers. But what are the expectations going into the fourth-quarter earnings season?

Julien Lafargue (JL): So going into this fourth quarter of 2021 earnings season, expectations are reasonable. They’re high by historical standards, in the sense that analysts expect US companies in the S&P 500 to deliver north of 20% year-over-year earnings growth.

But if you look at this number compared to what we’ve seen throughout 2021, is actually fairly normal. In the second quarter of last year, earnings almost doubled in the US, so 20-23% is a more reasonable expectation.

A lot of the earnings growth is coming from the energy sector, the industrial sector, and the materials sector. If you exclude those, obviously earnings growth expectation will be much more muted, closer to 9-10% actually.

If you look at Europe, on the other hand, earnings expectations are for close to a 50% year-over-year increase in earnings growth, which is a very high number, but again it compares to 150% back in the second quarter of last year.

So expectations are elevated by historical standards, but we’re starting to see clearly this normalisation in terms of year-over-year growth.

HP: Julien, let’s think about earnings expectations from a sector perspective. Which sectors do you think are likely to beat consensus expectations, and which could disappoint?

JL: So from a sector perspective, as I mentioned, expectations are fairly high on a couple of sectors, thinking about energy, industrials, materials. And that’s just a function of easy comparable versus a year ago. When you look at which sectors are most likely to overall under deliver, we think that sectors with a good exposition to the macroeconomic momentum are likely to fare pretty well in this earnings season.

You’ve seen financials reporting earnings, or some of them at least in the US, starting at the end of last week, and earnings have been higher than expectations. Now that doesn’t mean the stock reacted necessarily positively, but earnings were better than expected. In fact, almost 100% of the financials have beaten expectations so far in the US.

So we do expect the majority of sectors to deliver slightly better-than-expected earnings, which means that the underlying growth, instead of the 22-23% expected at this point, we could end up closer to 25% or even 30%, but the magnitude of those surprises is much lower than what we’ve experienced throughout 2021, and we think some sectors may struggle to really deliver very high surprises.

In particular, consumer discretionary seems to be one that is a bit at risk of disappointing, simply because if you look at retail sales, for example, they’ve been lower than expected in December, and it looks like the tail end of 2021 wasn’t that strong for the US consumer.

The other key question will be around technology, and whether the technology sector can outperform expectations. In the US, the market is looking at around 14-15% earnings growth in this quarter, or the last quarter.

We believe this is a reasonable number, and we expect some positive surprises on that front. However, again, we think it’s likely to be much more muted compared to what we’ve experienced so far this year.

So, overall, this should be a good earnings season in terms of number of beats versus the number of misses, but we don’t expect the same kind of positive surprises that we’ve seen in the past. And, from a sector perspective, we do believe that cyclical sectors are likely to deliver better results than the more defensive higher, typically higher growth type of companies.

HP: Well, we know it’s been a volatile start to the year for stock markets. What impact do you think this earnings season will have on broader equity markets?

JL: Well, the first impact that this earnings season should have is allowing investors to focus again on the micro versus the macro. A lot of the talks, a lot of the moves, have been driven by what’s been happening at the economic level or what’s been happening on the rates side.

With the earnings season, it’s always a good chance to focus back on what are those companies actually doing. Are they delivering on earnings, are they growing? And that’s going to be the first real takeaway from this earnings season, ie are earnings coming through?

The second key element, I think, that’s going to be very closely watched during this earnings season, as always, is guidance, and what do companies expect when looking forward to 2022.

Here we think companies will probably be on the cautious side. They usually are, but this time around it’s probably going to be the case even more so, simply because they’re giving those guidance at the time when the US is battling with an Omicron wave, where the economic momentum isn’t certain, where there’s a lot of speculation as to what may happen with interest rates down the line.

So I think companies will be reluctant to give a firm outlook. When they will probably give a relatively wide range in terms of expectation, but overall we expect companies to guide the market for continued earnings growth in 2022. Obviously, it’s going to be to a lesser degree in terms of growth in prior years, but we feel that the current expectation, around 9% earnings growth in the US, is likely to be sustained post this earnings season.

The most important, I think, takeaway from this earnings season for the investor community, though, will be around margins. And we’ve seen that with financials already last week, where, although some of those banks have published higher-than-expected bottom-line numbers, investors, or the market in general, didn’t necessarily react that well to this publication because, when looking at the details, in particular how much costs have outpaced revenue growth. This has raised concerns around what it means for not only this group, but the overall market and the overall US companies, in terms of margins.

We are seeing sign of wage pressures in specific sectors, and it looks like, at least from early indication from the banks that have reported so far, that this is actually happening, that their cost base is growing faster than their revenues are, which, obviously, puts pressure on profitability, and on margin.

And I think a key question for investors will be, is there a read across in this earnings season as to what margins are going to do in 2022?

Expectations are for margins to be relatively stable, but if we do see this wage pressure continue, then there is definitely a risk on the margin side, and the question is what will companies do? If they still need to hire, and they still need to pay up employees, what will they do to protect margins?  What kind of cost are they going to try and lower in order to maintain their profitability? I think this is going to be the main theme for the markets when it comes to this earnings season.

HP: Julien, thank you for your insights today. We know that the figures that companies deliver will be important. Equally important will be those outlook statements. As we go through the next few weeks, I’m sure that we’ll have you back on to discuss what we’ve learnt from those management teams.

Let’s move on to the week ahead. In the UK is where the market focus will be, with the raft of data releases. On Tuesday we expect the unemployment rate, in the quarter to November, to remain unchanged at 4.2%. On Wednesday, we get another inflation report. December CPI, we think, will ease back to 5%, reflecting some of the base effects. And on Friday, we get the GfK consumer confidence index, and we expect that to remain subdued at -15.

So lots for the markets to digest in terms of the UK growth profile as we go through the course of the next few days.

But 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.