Markets Weekly podcast – 9 May 2022

Henk Potts (HP): Hello. It’s Monday, 9^th May 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 first-quarter earnings season. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Risk assets maintained their forceful downward trajectory last week, as central bankers warned of a more intense pace of policy tightening as they struggle to curb multi-decade high inflation, even if it comes at the cost of activity and employment. Stagflation fears drove down equity prices and pushed bond yields higher.

It was a volatile week in equity market trading characterised by dramatic swings and heightened uncertainty. Truly a rough week for European equity markets as energy-supply concerns pressured growth prospects. The STOXX 600 in Europe fell 4.5%, its biggest weekly decline since the start of March. The S&P 500 fell to its lowest level in around a year on Friday, which knocks up five straight weeks of losses, which is the longest losing streak since June 2011. The index is now 14.4% below its 52-week high that was achieved on 4^th January.

In terms of bond markets, 10-year Treasury yields settled at 3.12% on Friday, the highest close since November 2018 and near their highest level in more than a decade.

The dollar continues to strengthen, the dollar index hitting close to a 20-year high last week, as political and economic uncertainty boost demand for the world’s reserve currency. The dollar index up around about 8% year-to-date.

Crude prices are on the rise once again. Trading up over the course of the past week, Brent back to $112 a barrel this morning as EU officials proposed a phased embargo on Russian oil over the course of the next six months. The US said it would buy back oil for its strategic reserves. Meanwhile, OPEC+ only ratified a small monthly increase as members struggle to raise production levels to meet their previous commitments.

But, as we know, it was central bankers that were the key market drivers over the course of the past week. As expected, the Federal Reserve raised rates by 50 basis points, its biggest increase in more than two decades, and announced that the balance sheet run-off would start in June.

The half point increase pushes the Fed’s funds target range up to 0.75% to 1%. Fed chair Jerome Powell’s comments in the press conference dismissed speculation that the Committee had been considering 75 basis point hikes, and helped market participants who were looking for clues as to the rate of future hikes by saying 50 basis points, and likely the Committee’s baseline in the next couple of meetings.

So we’ve adjusted our policy forecasts to reflect that. We now look for half of 1% increases in June and July, followed by 25 basis point increments at each of the meetings through January 2023. This would put the terminal rate for the cycle at 2.75% to 3%.

The FOMC continued with the tune that the US economy is well placed to handle tighter monetary policy despite that first-quarter contraction, which was primarily driven, actually, by weaker external demand, strengthening private consumption expenditure, and fixed investment encouraged the Fed to say that downside risks have diminished.

Labour markets, of course, continue to remain robust in the United States. Friday’s employment report showed another solid increase in job creation. The US economy created 428,000 jobs last month versus the estimate of 380,000. That matched the March increase. We’ve now seen 12 straight months of gains above 400,000. April’s gains were driven by strong hiring in leisure and hospitality.

In terms of the unemployment rate, well, that held steady at 3.6% but it’s getting closer to those pre-pandemic lows. Average hourly earnings rose 5.5% year-on-year, which is helping to offset the erosion in household purchasing power, although, of course, will continue to be a concern for policymakers.

If you’re looking for an area of disappointment, well, it came, of course, in the form of the supply of labour. The participation rate eased back to 62.2%, which is still below the pre-pandemic level of 63.4%, but the rate of workers aged 25 to 54 slipping once again.

The Fed, as I said, also formally announced that it would allow its holdings of Treasuries and mortgage-backed securities to decline. The cap from June to August was set at $47.5 billion. It then increases up to $95 billion by September. According to Bloomberg data, the announced pace of the balance sheet run-off will see the Fed’s portfolio approach its pre-pandemic level size by the time that we get to 2024.

The upgraded pace of policy tightening suggests the Fed, I think, will wait for tangible evidence inflation is under control, and perhaps more than that starting to come down, before taking its foot off the tightening gas.

In contrast to the Federal Reserve, the Bank of England’s assessment of economic conditions was far more gloomy after forecasting that inflation could creep into double digits, and warned the UK economy faces a prolonged period of stagflation. Despite the faltering growth profile, the MPC still felt compelled to hike rates by a further 25 basis points up to 1%, which is the highest since 2009.

In terms of highlights, from those new forecasts they’re saying inflation to climb above 10% in October due to another 40% increase in energy price caps, and said GDP growth would decelerate to 1% in the fourth quarter of this year. Unemployment, they’re suggesting, will continue to drop but then climb to around 5.5% by the time that we get through 2025, perhaps most importantly saying that output would shrink by a quarter of 1% through the course of 2023.

We think given the Bank of England are now clearly much more concerned about the level and the persistence of inflation, second-round effects on wages, rising inflation expectations can expect that tightening cycle to continue. Looking for a hike of 25 basis points at both the June and the August meeting, putting the bank rate at 1.5% by the time that we get to the summer.

Our economic outlook for the UK, well, I think after enjoying one of the strongest recovery rates in the developed world in 2021, the UK economy looks set to stall over the course of the next 18 months, with surging inflation, higher interest rates, and the rising tax burden all expected to take their toll on growth prospects.

So let’s move on. In order to discuss the key messages that we’ve been seeing from the first-quarter earnings season so far, I’m pleased to be joined by Dorothée Deck, our Cross-Asset Class Strategist with Barclays Private Bank.

Dorothée, a pleasure, as always, to have you with us. Let’s delve into the earnings season. What have been your main takeaways so far?

Dorothée Deck (DD): Thanks a lot, Henk. So we’re now approaching the end of the earnings season with close to 90% of the companies having reported in the US and almost two-thirds in Europe. So this earnings season has been a particularly important one to watch, given the current market uncertainty and the growing concerns around a slowdown in activity, high and persistent inflation, the ongoing supply-chain disruptions, and also the impact of the war in Ukraine.

So the key message is that earnings have been robust. They have surprised positively in the US and in Europe, by 4% and 10% respectively. Revenues have also come in ahead of expectations in both regions, but to a lesser extent, suggesting that margins have surprised positively. And this is an important point because coming into the reporting season there were a lot of concerns about companies’ ability to pass on higher input costs to their customers.

So, it turns out that margins have declined on a year-on-year basis, but less than feared by analysts. The proportion of companies beating earnings forecasts has been 78% in the US and 66% in Europe, both above their 10-year averages. Now, in terms of actual earnings growth, earnings reported so far are up 8% in the US, versus last year, and up 10% in Europe, very much helped by the energy sector. So if we exclude the energy sector, earnings would have been up only 2% in the US and down 6% in Europe.

HP: OK, Dorothée, so which sectors have delivered the biggest positive surprises and which have disappointed the most?

DD: So the picture varies by region. In the US all sectors have surprised positively with the exception of consumer discretionary, which has missed by 32% even though two-thirds of the companies in that sector have exceeded expectations, and this mainly reflects the miss from Amazon. The sectors that have surprised most positively in the US include materials and healthcare, followed by consumer staples. They have reported earnings 8% to 9% ahead of expectations. Otherwise, energy and industrials have been broadly in line with analysts’ forecasts. 

In Europe three sectors have missed expectations, real estate, utilities, and energy, by 32%, 8%, and 2% respectively. The most positive earnings surprises have been reported by communication services, with a 42% beat, followed by consumer discretionary 30% ahead, and materials 23% ahead.

HP: Well, thank you Dorothée. It’s interesting to get the breakdown from a sector perspective. We know the earnings season is important for the numbers that are delivered but also in terms of the outlook. What have we learnt from the management statements?

DD: Yeah, so as always during the earnings season investors are watching very closely how companies have performed in the most recent quarter, but they’re even more interested in the companies’ outlook statements and any guidance management can offer on future growth prospects.

So if we look at company transcripts a number of interesting trends emerge. Companies have generally become more cautious on the growth and inflation outlook. The health of the US economy is not questioned yet, but companies worry about the impact of the COVID related lockdowns in China on global demand and supply chains. They also mention the geopolitical uncertainty, which further exacerbates the pressure on input costs and commodity shortages. And when talking about margins their objective has shifted from margin expansion to margin preservation.

EBIT margins remain close to all-time highs, at 12.7% globally for nonfinancial companies, so going forward the market will be focusing on how those margins evolve. It will become increasingly important to differentiate between the companies that have pricing power and can protect margins in the face of higher input costs, and the ones that don’t and earnings predictability will be rewarded.

In terms of dividend policy on share buybacks, those haven’t changed much across sectors with most companies maintaining their existing policies and few announcing new programmes.

And the last point I would highlight is that the proportion of US companies revising earnings guidance higher has declined materially versus the previous four quarters. So approximately 40% of US companies have been guiding higher in the first quarter, down from over 60% in each quarter last year.

HP: OK, Dorothée, let’s try and bring this together a little bit. Taking into account what we’ve heard in terms of the first quarter earnings, bringing in those outlook statements coming through from management teams as well, where does that leave the full-year earnings forecasts?

DD: So, given the more cautious company outlooks, we expect earnings estimates to come down modestly this year. At the index level earnings estimates have generally gone up since the start of the year, so we expect some reversal of that outside of the commodity driven sectors. In the past four weeks the energy and materials sectors have seen a significant increase in earnings estimates both in the US and in Europe. So, for example, for energy EPS forecasts have increased by 12% in the US, 9% in Europe, and for materials EPS estimates have increased by 5% in both regions.

In contrast, EPS forecasts for communication services in the US have been revised down by 6% in the past month alone. So the good news is that following the recent market correction a lot of this already seems to be reflected in the price. On our numbers US and global equities are now discounting flat earnings growth this year which seems conservative. It compares with bottom-up analysts’ forecasts of 10% earnings growth this year.

However, there are significant differences across regions, with European equities now discounting a 5% to 10% decline in earnings this year compared with bottom-up analysts’ forecasts of an 11% increase in earnings. So the market is much more pessimistic about the earnings outlook for Europe than the US.

HP: Well, thank you Dorothée for your insight today. We know investors have become increasingly concerned about the macro environment and, therefore, there’s even greater focus, I think, on that earnings picture, which continues, I think, to provide support for stock markets.

Let’s move on to the week ahead, where the focus will be on the US on Wednesday and Thursday, when we get the latest CPI and PPI prints. We estimate that inflationary pressures declined on the energy side, while price pressures in core held largely firm. We expect CPI to have risen 0.18% month-on-month or 8.1% year-on-year in April. We expect core CPI to have risen four-tenths of 1% month-on-month, coming in at 5.9% year-on-year.

We expect final demand producer price pressures to have softened somewhat relative to March, led by smaller increases in food and energy prices. For headline PPI, for example, we expect an increase of eight-tenths of 1% month-on-month in April, meaning 11% year-on-year. And for PPI ex food and energy, we look for an increase of six-tenths of 1%, or an annualised rate of 8.8%.

In the UK, the focus will be on the first-quarter GDP release on Thursday. We expect GDP in March to grow by three-tenths of 1% month-on-month. In line with the strong high frequency data and PMIs, we believe the service sector was still enjoying momentum related to the post-COVID rebound in March, despite higher inflation. We expect industrial production to print weaker, given signs already seen in the March PMIs that the conflict in Ukraine was starting to have an impact on the sector.

Construction may print strongly, in part unwinding some of the weakness that we saw in February that was related to stormy weather hitting activity. Barring any revisions to the previous month, this print will be consistent with a 1.1% quarter-on-quarter outturn for Q1, although risk, as we know, continues to remain to the downside.

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.