Markets Weekly podcast – 21 August 2023

Henk Potts (HP): Hello. It’s Monday, 21st August 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 with 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, and the impact of, Artificial Intelligence on companies, the economy and, of course, investors. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead. 

Now, risk assets remained under pressure last week, and bond yields surged as investors reacted to the relentlessly deteriorating economic data from China, the latest inflation and labour market reports in the UK, and concerns that the Fed hiking cycle could be extended, as US consumer spending continues to defy gravity.  

The MSCI global equity benchmark index generated its biggest weekly loss since March. European stocks were down for a third straight week. The STOXX 600 was down 2.3% last week, hitting its lowest level since 10th July. The European index is now down 4.9% so far this month. Cyclicals and companies with exposure to China have come under pressure. Leading laggards include basic resources, autos and industrials. 

Over on Wall Street there was a similar picture. The S&P 500 was down. In fact, it fell 2.1% last week. Technology mega-caps continued to lead the declines there. 

All the excitement’s really around fixed income. Ten-year Treasury yields rose above 4.3%, in fact they got close to their highest level since November 2007. That movement was mirrored in European fixed income markets. Ten-year gilt yields hit 4.75%. German bund yields topped 2.7%.  

In currencies and commodities, the dollar hit a two-month high against a basket of currencies at the end of last week, while oil posted its first weekly loss since June. And gold traded below $1,900 an ounce and has declined for four straight weeks and is back to its lowest level since March. 

The stronger US dollar makes the precious metal more expensive for non-dollar-denominated investors and buyers, and rising bond yields creates greater competition for a zero-interest-bearing asset. 

Now, on the macro side, the relaxation of COVID-19 restrictions at the start of this year in China was expected to lead to a rapid rebound in its economy and there was, you have to say, some early evidence of that, but the recovery has certainly lagged expectations as structural issues continue to infringe upon momentum.  

Officials are clearly worried that the world’s second-largest economy could miss its official 5% growth forecast for this year, and have now stepped up their policy response. In July, activity data continued to show a significant broad-based deterioration across consumption, investment, production and the property sector. The labour market, as we know, has also weakened. The urban jobless rate rose to 5.3%. Now, authorities are no longer publishing the youth unemployment rate, but we know it’s been running above 20%. 

Credit growth has fallen to a record low, deflation has been registered and concerns about the disruption in the property sector have grown after bellwether developer Country Garden missed coupon payments, and Evergrande filed for bankruptcy protection in the United States.  

Now, in response, the People’s Bank of China has been lowering the rate on its loans. The one-year loan rate fell by 15 basis points to 2.5%, the second reduction we’ve seen since June and the biggest reduction since the start of the pandemic. Short-term policy rates were also cut by 10-basis points. At the start of this week, China modestly lowered its one-year loan prime rate, but left its five-year loan rate, which is used to price mortgages, at 4.2%. They have been cutting policy, easing their stance, but not using the big bazooka that some economists have been calling for. 

In terms of the policy outlook, well, we expect the central bank to deliver another 10 basis points of cuts to policy rates in both the fourth quarter of this year and the first quarter of 2024, and another 25 basis point cut to the reserve-requirement ratio in the first quarter of next year. 

Market reaction, well, pretty predictable you have to say. Asian stocks, as you’d imagine, have been under pressure. The yuan has fallen to its weakest level since November. In fact, the currency’s tumbled around about 6% during the course of this year, making it the worst performing Asian currency after the Japanese yen. 

In terms of the growth outlook for China, well, given the absence of a sustained recovery in consumption, the ongoing pain that we’ve been seeing in the property sector and declining external demand, well, it will all encourage us to reduce our growth forecasts further. We now think China will grow at 4.5% during the course of this year, so, missing that 5% target level, and 4% in 2024. 

Moving on to the UK, where the focus has been on the latest inflation data and, of course, the labour market report. Starting with inflation, where July CPI moderated to 6.8% year on year, that was versus the 7.9% registered in June, driven by falling energy prices and the impact of the reduction in the Ofgem price cap. Food inflation has softened from the recent peak but still remains elevated.  

However, policymakers, I think, will still be concerned by the acceleration that we saw in core inflation, which rose to 7.4%, due to an increase in pricing pressures for services led by housing, travel and transport. 

Helping to offset some of the impact of those price pressures has been wage growth. Now, UK wage growth accelerated to its strongest pace on record, which dates back to 2001, in July. Average earnings, excluding bonuses, rose 7.8% in the three months through June, compared to a year ago.  

Whilst higher wages are alleviating some of that cost-of-living crisis, there is a concern that the impact that pay growth will have on inflation expectations, and, in turn, policy. Although, beneath those headlines of pay growth numbers, there are signs of an easing of labour market demand, which could help to alleviate some of those future pressures. The unemployment rate, for example, rose to 4.2%. That’s the highest that we’ve seen since July 2021 and up from 3.5% in August 2022. 

Inactivity rates in the UK have been normalising. Vacancy rates actually fell. They fell 66,000. Openings have now fallen for 13 consecutive months, although still remain above that one-million mark. We do see the UK unemployment rate modestly rising over the course of the next 18 months, getting up to around about 4.5% at the end of next year. 

What does that mean in terms of the policy impact? Well, despite the improvement in price pressures and hopes of it easing the labour market conditions, the Bank of England’s not yet, we think, in a position to declare cessation of hostilities with its battle with inflation. We estimate that UK inflation will remain above that 2% target through the course of 2024 and, therefore, expect a further quarter-point rate increase at the Monetary Policy Committee’s 21st September meeting, but that could actually be the last in this hiking cycle. 

Moving on to the US, where the latest retail sales data shows the mighty consumer continues to spend, the value of purchases increased 0.7% in July. May and June’s estimates were also revised higher. Sales increased in nine out of the 13 categories last month, including sporting goods, clothing outlets and restaurants and bars. Amazon’s Prime Day promotion boosted sales of the online retailers, which surged 1.9%, representing the strongest month this year. 

Demand continues to benefit from historically low levels of unemployment, pay growth, which we know is now starting to outstrip inflation, and a reduction in savings rates. But despite that resilience, we still would expect future demand to moderate as debt-servicing costs continue to rise, savings built up during the course of the pandemic are eroded and the unemployment rate starts to pick up.  

We think that, actually, private consumption growth, which, remember, is the backbone of the US economy, will average just half of 1% during the course of next year, thereby weighing on overall growth prospects in 2024. We still expect the US economy to flatline during the course of next year. 

So, that was the global economy and financial markets. In order to discuss the potential impact of the Artificial Intelligence (AI) revolution, I’m pleased to be joined by Luke Mayberry, Investment Analyst with Barclays Private Bank. 

Luke, great to have you with us today. Why don’t you get us started by giving us a brief overview of what AI is, and why everyone is talking about it in 2023? 

Luke Mayberry (LM): Hi, Henk. Thanks for having me. So, in a nutshell, Artificial Intelligence is the term used to describe a machine’s ability to perform human-like cognitive functions, such as learning and interacting. Put very simply, it works by using algorithms and statistical models to analyse large amounts of data to make predictions or decisions. 

In recent years, AI has increasingly become part of our daily lives in ways many of us may not even realise. For instance, it’s a technology that powers everything from voice assistants such as Siri and Alexa, to personalised recommendations on Amazon. AI as a concept has been around for decades, but that gained global fame when a company called OpenAI launched a chatbot called ChatGPT, which immediately experienced revolutionary growth. It set the record for the fastest-growing user base for an app, reaching 100 million users within two months. 

To put that in some context, it took Instagram two and a half years to reach that user base. This basically sparked intense competition among tech companies, such as Google and Apple, to develop and deploy similar tools and, since then, it’s got a lot of people talking about how AI could radically alter how we live and work. 

HP: OK. We know there’s a great debate amongst analysts about what AI will mean for companies, particularly, of course, the impact on productivity. What are your current predictions? 

LM: Well, AI enables intelligent automation means that companies can streamline operations by handling repetitive tasks and allowing employees to focus on more complex jobs. We’re already witnessing many companies embracing AI. For instance, in manufacturing, AI-powered robots are taking care of repetitive tasks with amazing precision. Which significantly improves efficiency and reduces the risk of errors.  

In the customer service industry, you’ve got chatbots and virtual assistants who are able to give instant, precise responses. And even in healthcare, it is being used to analyse medical images and data, helping to detect diseases faster and make inpatient-care more accurate. 

As the technology advances, we will likely see almost all industries using AI in some way. In fact, in a McKinsey report, it found that around 70% of companies are likely to adopt at least one type of AI technology by 2030.  

This leads me on to a question which a lot of people are asking, will I lose my job to AI? Well, a recent Goldman Sachs study, which made the headlines, estimates that roughly two-thirds of US occupations are exposed, to some degree, to automation by AI. So, while it’s true that some routine and repetitive tasks may be automated, potentially leading to job displacement, you have to remember new roles will also emerge as companies will need skilled individuals to develop, manage and maintain these systems.  

When we talk about the jobs that are most likely to be exposed, studies point to customer service, legal and engineering, which are likely to see the greatest gains in efficiency, and, therefore, these jobs are most at risk. The key is to focus on upskilling and reskilling the workforce to align with the changing job landscape. This way, employees can transition into roles that require more creativity, critical thinking and emotional intelligence, areas where for now humans outperform machines. 

HP: Luke, market participants are very excited about gaining exposure to the companies that have an AI component. In some cases, you have to say even when that link looks rather tenuous. Many people, therefore, have drawn the comparison with the AI frenzy to the dotcom bubble. What are your views on that? 

LM: Yes, well, the rally which we’ve seen from large US tech companies this year has been pretty remarkable, and they’ve been a driving force for the vast majority of S&P 500 gains year to date. This has led to stretched valuations for several of these AI-themed stocks. And, like you say, a lot of commentators have drawn comparisons of what we’re seeing in the US equity market with the internet boom we saw in the early 2000s. And while there are similarities in equity market behaviour, we do believe there are several reasons that set these two cycles apart. 

There’s no doubting that some valuations are stretched. However, on average, we are still way off the PE ratios achieved during the early 2000s. For instance, in March 2000 the Nasdaq 100 had a PE ratio exceeding 90, whereas today it stands just above 30. The other big difference between now and back then is that the current AI rally is being propelled by established mega-cap tech companies with considerably more stable earnings and stronger balance sheets. This is very different to 1999, when the rally was driven by investors flooding into newly listed public companies with no actual path to profitability. 

Finally, in my opinion, the biggest difference comes down to commercialisation. The landscape in the early 2000s was a lot more uncertain and I think it’s safe to say that AI’s commercialisation is significantly more rapid and immediate. An IBM study from last year backs this point up well, when it found that 35% of companies reported using AI in their business and 42% are exploring AI. People and companies are using it now and the growth is clear to see. 

HP: OK. What are the key takeaways for investors and how can investors gain exposure to AI? 

LM: Well, as the advantages of AI to businesses become more apparent, we predict that there’ll be a rise in corporate investment. This surge in investment is likely to positively impact AI-related stocks as companies seek to enhance their operational efficiency and, therefore, could provide investment opportunities to investors.  

While there’s no doubt that AI will have a significant impact across almost all industry sectors, anticipating the barriers to AI adoption may be more difficult to predict. For instance, ethical concerns raise the potential for companies to face a backlash, so this is something which investors certainly need to bear in mind. 

In terms of getting invested in AI, investors have the opportunity to gain exposure by investing directly in the large-tech companies that, like I mentioned earlier, are already utilising AI. Another option is through broader technology funds and ETFs that offer substantial exposure to both established tech giants and the smaller companies poised to benefit from the long-term growth in robotics and AI.  

Now, when it comes to getting direct exposure to AI, that is a bit more challenging as many companies in this field are not mature enough to be listed. However, private markets can be an avenue to get invested in these newer AI start-ups. 

HP: Well, thank you, Luke, for your insights today. It will certainly be fascinating to see how that AI revolution plays out over the course of the coming months and years, particularly the impact on productivity, but also what the developments are likely to mean to the economy, society and, of course, investors. 

Let’s move on to the week ahead, where the focus will be on the Jackson Hole Policy Symposium, where Fed chair Jerome Powell is expected to give an updated assessment of economic conditions in the United States on Friday, which should, I think, highlight some of that recent resilience that we’ve been talking about, but he’s likely to fall short of providing specific rate guidance given the raft of key datapoints that are likely to be distributed over the course of the coming week, ahead of the FOMC September meeting. 

On the data front, markets will await Thursday’s durable goods figures in the United States. We expect a significant 5% month-on-month decline in new durable-goods orders in July, more than unwinding June’s 4.6% jump. The downswing almost entirely reflects new orders in the volatile non-defence aircraft category, with new orders reports from Boeing showing a normalisation of aircraft orders following June’s surge.  

Excluding the volatile transportation numbers, we expect new orders to move down two-tenths of 1% month on month, consistent with the ongoing weakness in the ISM manufacturing orders report. 

In the UK on Wednesday, we expect August’s composite PMI to largely move sideways. We forecast a 50.9 print, versus the previous index measure of 50.8. We think services should be supported by the boost to household incomes from the fall in energy bills in July, offsetting a drag from deteriorating labour market conditions. Given that manufacturing is already very subdued, we do see some scope for a slight pickup there to around 45.5. 

With that, we’d like to thank you once again for joining us. I hope that you’ve found this update interesting. We will, of course, be back next week with our next instalment but, for now, may I wish you every success in the trading week ahead.