Markets Weekly podcast – 24 January 2022

Henk Potts (HP): Hello. It’s Monday, 24^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 discuss the importance of remaining calm during times of volatility. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

As we know, risk aversion increased last week as the unsettled start to the year continued, with investors becoming increasingly concerned about faster policy normalisation, rising geopolitical tensions, and higher costs infringing upon corporate profitability guidance.

Markets last week worried that rising energy prices could further stoke inflation, thereby forcing central bankers to raise rates earlier and more aggressively. The resulting increasing yield has been putting pressure on equity markets. Remember, higher yields create greater competition for equities, and increases the discount applied to future cashflows.

In terms of bond yields, midweek the two-year US government bond yield rose above 1% for the first time since 2020. The 10-year Treasury yield was around 1.8%. And we saw it in Europe as well. German 10-year yields turned positive for the first time since May 2019, although demand for safe-haven assets on Friday saw global bonds rally.

In terms of equity market performance, well, global stocks registered their worst week since October 2020. The Nasdaq was down 6.8% last week, slipping into correction territory having fallen more than 10% from the November high.

The S&P 500 was down 5.6% over the course of the week, and is off 7.7% year to date. The lower levels of growth and tech stocks in Europe have been helping to limit some of the losses. The STOXX 600 in Europe was down last week, but only off 1.4%, and is down 2.7% in January.

The notion that cryptocurrencies are portfolio diversifiers has come under further pressure. Bitcoin fell 12% on Friday, dropping below $36,000 to its lowest level since July, and has now lost 45% of its value since the November peak.

Oil, as we’ve been discussing, touched its highest level since October 2014. Brent trading above $88 a barrel this morning. Crude has been driven up by fears of tightening supply and recovering demand.

Supply concerns have been growing. We’ve seen rising geopolitical tension between the likes of the West and Russia over Ukraine. Remember, Russia supplies the EU with around 40% of its gas. Opec+, as we know, have been officially slowly adding back production, but a number of its members, including Nigeria, Angola, and Libya, have been struggling to meet new production targets.

The International Energy Agency report last week forecast a tighter market in 2022 as stockpiles rapidly fall. They estimate the fact that global stockpiles are down by more than a billion barrels since the peak that we saw back in May 2020.

On the other side of the equation, demand has been recovering from the pandemic, and has remained resilient to Omicron. The IEA said demand increased by 1.1 million barrels per day in the fourth quarter, was up 5.5 million barrels per day in 2021. They forecast that 3.3 million barrels per day of demand will be added during the course of this year.

In terms of its impact on inflation expectations, however, to our mind they do seem overdone. The reality is crude prices would need to rise to around $120 a barrel, and stay there during the course of the year, in order to be a positive driver of inflation during the course of 2022.

Moving on to the UK, where the raft of data showed both the progress that the labour market has made over the course of the past year, but also highlighted the challenging near-term inflationary backdrop.

The Labour Force Survey, in the quarter to November, showed UK unemployment decreased by four-tenths of 1%, to 4.1%. The number of job vacancies rose to a new record high of 1.25 million.

UK December inflation continued the trend, and came in higher than expected. CPI printed at 5.4%. Remember, consensus was for around 5.2%. Contributions to the increase were widespread, and included food and drink prices, clothing and footwear, and furniture and hospitality.

In terms of the outlook for UK inflation, we expect it to further accelerate as Ofgem hikes the gas and electricity price cuts in April. Food could also add to the upside risk, due to the disruption caused by Brexit and labour shortages. We now see UK CPI peaking in April at 6.6%, but then easing back to around 3.6% by December.

In terms of the policy impact, well, elevated inflation, the labour market tightness, as we know, encouraged the Bank of England to increase rates by 15 basis points in December. We expect a further 25 basis point-hike in February, a further quarter of 1% in May, putting the UK base rate at 0.75% by the middle of the year.

In terms of Europe, well, a similar picture around inflation, but not necessarily in terms of policy. The eurozone, both headline and core inflation, hit a record high in December, as energy prices in the region surged. In fact, they contributed 2.5 percentage points to the headline reading.

Supply bottlenecks continue to create price pressures for goods and for food. Statistical factors actually resulted in services inflation registering a decline of 2.4%, but I don’t think we should read too much into that. As with other regions, we’ve increased our 2022 inflation projection for Europe, given the surge in energy prices and that higher contribution from food inflation.

We now expect the harmonised index of consumer prices to average 3.7%, before easing back through 2023 to average 1.5%. Given the relatively benign medium-term outlook for inflation and the fact that the recovery is less advanced, we still do not anticipate a rate hike by the European Central Bank till the end of 2023.

So that was the global economy and financial markets over the course of the past week. In order to discuss how investors can utilise behavioural finance techniques to make better investment decisions, I’m pleased to be joined by Alex Joshi, Behavioural Finance Specialist with Barclays Private Bank.

Alex, great to have you with us today. As we’ve been discussing, and as we know, it’s been a volatile start to the year. There’s been a vast array of disturbing headlines around multi-decade high inflation prints, surging energy prices, and, of course, a prospect of higher interest rates.

What should investors be doing to improve their decision-making process?

Alex Joshi (AJ): Hi, good morning, Henk. Thanks for having me on. So, I think one thing for investors to be doing at the moment is to be very aware of the power of narratives, narratives that can sweep up investors, and can actually result in buying the story and not the facts.

So, you know, this time last year we had a social-media-fuelled frenzy in meme stocks, which led to rises of 100% in just a matter of days. And there’s a lot that we can actually learn from that event to help at this present moment.

So, what happened last year, you know, was a very extreme example of the power of sentiment over rational analysis, at least in the latter stages. There was this belief that stocks could only go up, as retail investors on Reddit and other social media sites believed that they had to hedge funds with their short positions against the “ropes”, and so buying these stocks was very much a one-way trade, and a road to riches.

And whilst this is very extreme there are lessons here about being swayed by narratives, especially when they apply to short-term market moves where there’s a heightened risk of biased decision-making.

HP: Alex, we’ve seen an aggressive sector rotation play out over the course of the past few weeks. Investors are clearly concerned around inflation risk, so how do we apply the principles you’ve been talking about this morning, in the current risk-off backdrop?

AJ: So, the persistent inflation and the more hawkish monetary policy direction is a valid concern for investors, particularly given the speed and violence of the sector rotation being felt in portfolios.

And so, whilst there are reasons for tech or for growth stocks falling out of favour relative to value stocks, in response to this, it could be damaging for an investor’s long-term prospects to view it through a simple narrative of it simply being good or bad for particular sectors and styles, and acting accordingly.

So, by this I’m thinking of selling growth stocks, and trying to time back in. So, whilst an investor may think it’s the smart thing to do, given short-term movements and their expectation of where we’re going to be in the next few weeks or months, this can distract from the long term, and as well as distracting it actually can also affect the likelihood of achieving these long-term goals.

HP: So, what are the practical steps that you would suggest investors can take in order to maintain their focus?

AJ: So, as we say regularly, ask yourself why you’re investing. So, focus on your goals, and how events, and also your proposed actions, affect this likelihood of achieving goals. Just because investing is uncomfortable at times, it doesn’t necessarily mean that an investor’s strategy is the wrong one.

So, practically, if an investor at the moment is thinking about selling assets in response to the current turbulence, here are a series of questions to ask yourself, four to be precise.

So, are there alternative assets that I believe will generate superior returns to the assets I’m thinking of selling? Secondly, what returns may I miss out on from selling out of these assets? Thirdly, what may I miss out on from holding on to these assets?

And finally, if I don’t want to reinvest, do I expect to be more likely to achieve my long-term goals by holding onto cash instead of the investments I’ll be selling?

And so, this final one is an important one in the context of present inflationary fears. So, in times of turbulence, cash provides safety, but is this safety likely to affect or to help an investor reach their long-term goals?

If we think about current inflation, and the expectation that it’s going to be higher than has been seen in recent years, this is unlikely to help an investor with protecting and growing wealth over the long term.

But a point here on selling, just as we’re talking about it, is that selling is not a decision in isolation, as people think, but it’s essentially a decision to buy cash. And so I think it’s very important for investors to be thinking about cash, and whether their cash is being utilised effectively, and whether that’s going to be helping.

Now, let’s go back to narratives. It’s important to look beyond simple narratives at the facts, and the fact that there is far more nuance to the headlines. So, at the moment, even within sectors that have been affected, there’s significant dispersion between companies.

And this takes me on to my next point, which is about companies. And it’s important for investors to remember that you are investing in companies, and good quality companies with strong growth prospects don’t stop becoming good companies overnight just because of a change in macro environment.

So, investors should be looking for those companies, these strong companies, that can help you navigate volatility.

Now, talking about volatility, to help be resilient in the face of volatility, investors should have portfolios that are built to be resilient in the face of volatility. And by this, I mean investing in a portfolio with adequate diversification to help you through these periods.

It’s also important to remember that when moves are violent they can swing back just as quickly too, particularly when sentiment is extreme, as history shows. Last week, Henk, you spoke about a US consumer sentiment index being at recessionary levels, and being at the lowest level since the pandemic started, and we see that when sentiment is at these sorts of extremes it can swing back very, very quickly, and it can catch-out investors who are attempting to time the market.

And on timing the market, you know, it can be tempting to be opportunistic in the short term if you expect certain events or trends to continue, so for example at the moment if an investor expects the rotation trade to have legs, market timing can be costly.

As we’ve spoken about in the past, missing just a few of the best days of market performance can have very significant impacts long term, and this is due to the power of compounding. It’s our belief that time in the market is more important than market timing for long-term returns, highlighting the importance of staying invested, even when the journey becomes more turbulent.

Final point is to remember your investment horizon. For an investor who is investing for long-term goals, their investment horizon is likely to be much longer than present new cycles. So, we shouldn’t let bumps on the road prevent us from reaching our final destination.

HP: Well, thank you, Alex, for your insights today. We know the emotional decisions that investors make can have significant impact on returns, so it’s great to get some practical advice about improving the decision-making process.

Let’s move on to the week ahead. This week will be all about the FOMC meeting on Tuesday and Wednesday. The focus will be on clues as to, number one, the timing and the size of rate hikes, number two, the pace for winding down the asset-purchase programme, and number three, the timetable for the balance sheet runoff.

We look for the Fed to send a signal that the first rate hike is likely to occur in March. In the FOMC statement we expect the Committee to conclude that the economy is at full employment, and it will soon be appropriate to raise the policy rate.

In terms of the size of the hike we could expect in March, well, great debate, of course, in markets taking place. Will it be a quarter or a half of 1% increase? We still think that 25 basis points is more likely. The Fed don’t like to surprise markets with aggressive hikes.

More likely, we think to add a further 25 basis point hike later in the year, than lead off with 50 basis points if it feels it is falling behind the curve. And, remember, expectations are that inflationary pressures will still ease during the course of this year. Fifty basis points may be viewed as panic.

In terms of asset purchases, the Fed are expected to let its asset purchases end in mid March as scheduled, although some members may call for a quicker termination of asset purchases. Hence, there are risks that the Fed could amplify its March “lift-off” signal, by announcing that purchases will end at the January meeting.

In terms of markets, they’ll be also awaiting, as I say, clues as to the timing for the balance sheet runoff, which is expected to show it will begin soon after the rate lift-off. We think July is possible, and the pace of the runoff will be faster than we’ve seen in previous cycles. So we wait for, of course, the details to come through from the Federal Reserve on Wednesday evening.

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.