Markets Weekly podcast – 25 July 2022

Julien Lafargue (JL): Thank you for joining a new edition of Barclays Private Bank’s Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and once again, I will be your host today.

As usual, we will start this podcast by taking a look at the recent events that shaped markets before moving on to our guest segment. And this week I’m delighted to be joined by Alex Joshi, Head of Behavioural Finance at Barclays Private Bank. As investors, keeping a cool head is key to success and Alex will tell us how to remain cool and chilled in this environment.

But first, let’s spend some time looking at last week’s market action. The key event of the week was clearly the ECB meeting, as for the first time in 11 years the European Central Bank hiked interest rates. Not only that, but they somewhat surprised the market by increasing rates by half a percentage point when the market was expecting a 25-basis point move.

So, it’s official. The era of negative interest rates has ended. Well, for now at least. The ECB justified its decision by its anticipation that inflation should remain, and I quote, “undesirably high for some time”. But this hike wasn’t really what markets cared about. There were two other new pieces of information that are much more relevant.

First, the ECB has scrapped its forward guidance. We were told a few weeks ago by Christine Lagarde that July should see a 25-basis point hike and 50 basis points would be on the table for September, and it now looks like the opposite may actually happen.

But even that isn’t for certain, as the central bank will now assess monetary policy on a meeting-to-meeting basis. In other words, investors are left blind as to what comes next, and we know that uncertainty isn’t investors’ best friend.

The other key piece of information was the long-awaited launch of the anti-fragmentation tool, basically the process by which the ECB intends to prevent Italian spreads to widen against their German counterparts. The TPI or Transmission Protection Instrument is the solution the ECB came up with. Behind the fancy acronym, the ECB has simply committed to intervene in the sovereign bond market to prevent spread widening

Now, and this is something investors didn’t anticipate, there are a lot of conditions actually attached to the ECB’s intervention. For the central bank to come to its rescue, a country will need to meet four criteria.

The first one is compliance with the EU fiscal framework, so no excess yield deficit procedure. The second is the absence of severe macroeconomic imbalances. The third one is a sustainable trajectory of public debt, which will be assessed by the ECB. And finally, a sound and sustainable macroeconomic policy backdrop complying with EU commitments with regards to the recovery fund.

However, these criteria will be only “an input” into the Governing Council’s decision-making process, and, as President Lagarde stressed in the press conference, the ECB ultimately decides on the deployment of TPI. This discretion is new and again introduces some uncertainty.

Markets like to test central banks and we would not be surprised to see further volatility ahead as investors try to find out if, and at what point, the ECB would intervene.

Now, outside of the ECB, we also got more and more Q2 earnings releases. It’s still very early in the reporting process, but as we expected the overall feeling so far is pretty mixed with significant misses being offset by better-than-feared results.

This week will be a key factor as many large cap US technology companies are due to report. We will probably see clearer after that but so far, our view hasn’t changed and we still expect earnings revision to be negative on the back of Q2 publications. However, this is widely anticipated and shouldn’t be a negative catalyst for the broader markets.

Now, moving on from last week’s highlights to today’s guest segment, it’s time to welcome Alex Joshi and to spend some time reflecting on our behaviour when markets are challenging as they’ve been so far this year.

Alex, thank you so much for joining us. Global equities are down significantly from their peak. We’re actually in bear market territory. Consumer and investor confidence is also quite low. So, can you explain what happens to us psychologically during a bear market?

Alex Joshi (AJ): So, during bear market periods, negativity becomes pervasive. There are lots of negative headlines, consumer confidence sentiment indicators continue to fall and, in many cases, hit lows. And what this tells us, it means that negative emotions take over and this can have quite significant impacts on decision-making.

At a period like this, losses become the name of the game and the lens through which we think about markets. And what does this do? Well, it affects the way that we perceive information, the decisions that we take, and also the risks that we’re willing to take. And the big risk during a bear market is the risk of taking short-term decisions that have long-lasting consequences.

So, for example, despite having the liquidity to see through a period like this, selling out of markets due to, you know, low levels of composure, which help an investor sleep better at night in the short term, but then can have an impact on the ability to reach long-term goals of protecting and growing wealth.

JL: Great. So why are these periods so challenging from a decision-making perspective?

AJ: Well, these periods are really difficult because it’s very difficult to anticipate how we’ll feel during a bear market until it hits. And this can affect even the best plans.

So, if we take, for example, an investor with a plan made a few months ago to phase into the markets gradually, and the decision may have been taken to increase comfort with getting invested, but then also potentially benefit from a lower entry point. Well, a period like this and the emotions of anxiety that it can bring about, can lead to a desire to pause or wait for a period of volatility to pass.

And whilst that can help a little bit with the comfort, you’ve lost out on one of the key benefits of phasing in, which is that you may potentially benefit from a lower average entry price. And so that’s for someone with a good plan.

But it can become even more challenging, a period like this, for those that haven’t prepared for a bear market period. And by this, I mean investors who may have a less well-diversified portfolio. For example, who experienced higher portfolio volatility as a result and then obviously the emotional impacts of that are magnified.

During a period like this, emotions can cause us to overstate risks and ignore probabilities. So, salient examples of worst-case scenarios can overshadow their likelihood. There are typically lots of headlines that compare, you know, a period of falling markets with previous crises, you know, deep recessions, depressions etc. This is a concept called the availability heuristic, which is a mental rule of thumb where we end up overweighting news headlines which are more dramatic or emotive.

And so, the consequence is that many investors may take decisions for an environment that may be very short-lived because we extrapolate forward and believe that this is likely to continue indefinitely in the future and the reality is that, actually, these periods pass quite quickly.

JL: Now, and to conclude, can you help us understand how investors should think about bear markets?

AJ: So, I’ve got five points that I’d like to discuss, and the first is to not assume the worst. You know, we’re talking about bear markets, the word recession is appearing more and more in the news, but a recession doesn’t necessarily mean a crisis. As listeners of this podcast will have heard us say over the last few weeks, the view here is that volatility is here to stay and lower returns are expected, but we remain constructive on the outlook for the global economy. We stay broadly constructive over the next 12 months as we believe that the market has already priced in a slowdown and so it’s important to bear that in mind, because there are a lot of headlines that are very negative and we should remember that.

The second is the importance of keeping a long-term focus. And by that, I mean focusing on your individual long-term goals. All investors should be thinking about what it is that they personally are looking to achieve with their portfolio and use that as the lens through which to view market events and our reactions to them. You know, how does this event affect my ability to reach my, potentially, you know, long-term goals? And, you know, linked to that, how does the decision that I’m wanting to take as a result of market events also affect that goal?

The third point is to remember that a period like this is part and parcel of investing, and actually the long-term returns from equities would be significantly lower if it wasn’t for a period like this. Now, with the amount of data that shows this, I’ll pull out two data points here.

The first is, if we think about the S&P 500 and we think about calendar year returns, and so let’s take the period of 1980 up until the present year, and we look at calendar year returns versus entry year declines, so falls within a given year. Now, over this period, despite average intra year declines of 14%, which is very significant, in 31 of the 41 years, returns were positive and actually averaged 10.2%. And so, this adds weight to the statement that you’ll have heard us say many times before, which is that it's time in the market and not market timing which matters most for long term returns.

Now, every year Barclays produces an equity and gilts study, which has been running from 1899, and so that looks at the returns from equities versus government bonds and cash. And we find, over that period, if we were to take any two-year period, the probability of equities outperforming cash is 69%. If we extend that out to 10 years, well, that probability rises to 91%.

And so, you know, well, the reason I mention that there is if we believe, you know, in the long-term direction of markets, which we don’t believe have been significantly affected by what we’re seeing presently, then getting invested, you know, makes, a lot of sense and sooner rather than, later because of these costs of cash which can, you know, erode capital over time.

The fourth point is to think about the opportunities. You know, we’re talking very much about falling markets, protection etc., but it’s important to recognise that periods like this can provide a better entry point for those that are, you know, optimistic about the future prospects. And remember that opportunities can emerge during periods like this, and it’s those investors that have got, you know, the building blocks in place, a well-diversified portfolio for example, a plan for bear markets that have the composure to see through, an investor like this that can actually capitalise on opportunities during a period like this.

Now, the final point is it’s important to not make in-the-moment decisions, which are driven by how we feel presently. So, at a period like this, we become very short term in our thinking, we can extrapolate forward and believe that a period like this is going to continue indefinitely, and so it’s important to reflect on our decision-making from the outside. And I think dialogue with a trusted adviser that can help us and challenge us also is very important for seeing through a period like the one we’re facing now at the moment.

JL: Thank you very much for your insight, Alex, and to help us go beyond the numbers to better understand the market and our own psychology. Thank you.

And before we conclude, a few key items to put on your agenda for the week. Outside of the sea of Q2 communication, the big macroeconomic catalyst will be the FOMC decision on Wednesday. We expect the Federal Reserve to hike once more, potentially by another 75 basis points, although we would argue that the risk is probably to the downside this time around.

We will also get Q2 US GDP on Thursday and the first indication as to whether the US are already in a technical recession. Remember that Q1 US GDP was negative. Finally, we will get a slew of inflation numbers on Friday including the eurozone CPI for the month of July, the US Employment Cost Index for the second quarter, and the US PCE for the month of June.

On our side, we’ll take a break for a couple of weeks, but we will be back on 15th August, and until then we, well, first hope you get a chance to enjoy some time off and, of course, we wish you all the very best for the trading weeks ahead.