Markets Weekly podcast – 29 August 2023
Central banks and behavioural finance
As many of us return from our summer breaks, Alex Joshi, our Head of Behavioural Finance, examines the key considerations that may be on investors’ minds during the remainder of 2023. He also explores the psychological impact of news events such as the revolution in AI and economic uncertainty in China. While podcast host Henk Potts discusses the latest announcements from the US Federal Reserve, AI-focused corporate earnings, and deteriorating manufacturing data.
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Henk Potts (HP): Hello. It’s Tuesday, 29th 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 some of the key behavioural finance areas investors should be thinking about as they return to their screens after the summer holiday. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
It was a turbulent week for markets, which were buffeted by the conflicting forces of weaker economic data that appeared to reduce pressure on central bankers, and the vigilant message that emerged from the Jackson Hole Policy Symposium.
Meanwhile, investors also had to digest quarterly results from Nvidia, the poster child of the AI revolution. Volatility was the name of the game as equities gyrated with the news flow. Stocks finished in positive territory last week, and were up yesterday, but struggled to meaningfully regain the significant losses racked up so far this month.
On Wall Street, the S&P 500 was up eight-tenths of 1% over the course of last week. It was up six-tenths of 1% yesterday, but is still down 3.4% this month and on track for its biggest monthly decline since December 2022.
A similar picture’s been playing out in Europe. The STOXX 600 rose seven-tenths of 1% last week, and nine-tenths of 1% yesterday. It’s also down 3.4% in August.
Nvidia’s results were billed as the make-or-break moment for artificial intelligence. Despite the massive hike, the chipmaker managed to smash consensus expectations and offered an upbeat outlook. Its shares and, in fact, technology shares, rose immediately on the update, but they couldn’t hang on to the gains as investors have started to appreciate that the AI revolution is not about one earnings report or, indeed, one company, no matter how well they’re placed to provide the infrastructure that’s likely to lead the development.
Now, the Jackson Hole Policy Symposium, as we know, the heady mix of central bankers, economists, academics and market participants. This year, they debated the structural shifts in the global economy. Whilst the group considered long-term issues, including elevated government debt levels, the green transition, deglobalisation and of course, AI for markets, the focus was on Jerome Powell’s keynote speech.
The Fed chair used the opportunity to reiterate the view that the central bank is prepared to raise rates further if appropriate, and intends to hold policy at a restrictive level until they are confident that inflation is moving sustainably down towards its objective. So, very much appearing to play into that higher-for-longer narrative while also hinting at a policy pause in September.
In terms of market reaction, most yields along the US Treasury curve rose at the end of last week, particularly the rate-sensitive two-year bonds. The ten-year finished the week at 4.25%.
How do we see the US inflation profile and path of policy playing out? Well, US inflation, as we know, has been moderating at a rapid rate. The consumer price index was 3.2% year-on-year in July. That compares to a peak of 9.1% in June 2022. Future easing may be harder to come by, but we forecast the US CPI will slow to 3.1% in the fourth quarter this year and average 2.4% in 2024.
In terms of the path of policy, well, the US Federal Reserve has ratcheted up interest rates by a full 5.25 percentage points since March 2022. The current range of 5.25% to 5.5% is the highest that we’ve seen in more than two decades. We forecast one more 25-basis point hike in November, making the terminal rate for this cycle 5.5% to 5.75%.
Now, on the data front the focus last week was very much on the raft of PMI reports on both sides of the Atlantic. Remember, these surveys are seen as a good guide to future activity and can be used to identify changing economic trends before they show up in other data series. The latest readings show a significant deterioration in activity. To remind you, a reading below 50 separates contraction from expansion.
Starting in Europe, the composite PMI printed at 47 in August. That’s down 1.6 points from July, and below the Bloomberg consensus expectation of 48.5. Most notably, there was a significant drop in services, which softened into contraction territory. Manufacturing, you have to say, stabilised but still remained in the doldrums, printing at 44.7.
The European composite index has now contracted for four consecutive months. New orders further weakened. Expectations of future output were also more pessimistic. The European PMI has also pointed to a weakening of labour market conditions and persistent price pressures.
The employment indicator declined to 50.3. The composite input price index gained 2.1 points to 56, its first month-on-month increase in 11 months. The uptick was supported by both manufacturing, which I think likely reflects the increase in wholesale commodity prices, and services, which increases concerns that it could filter through to wage pressures.
In terms of the UK, well, the July composite index dropped into contraction territory at 47.9. Both manufacturing and services were weaker than expected. In terms of the breakdown for manufacturing, it showed weaker industrial output. Firms, as we know, are currently relying on the backlog of orders which are being run down, and the slump in new orders suggests levels ahead will be registering a significant shortfall. As in Europe, labour market conditions appear to be easing, but unlike on the continent, price pressures in the UK are also easing.
Turning to the US to finish off, the flash PMI showed that the acceleration in the service sector weakened. Factory output continued to fall. Companies reported that demand is looking increasingly lethargic in the face of high prices and rising interest rates. Responses indicated that output could fall into contraction in the coming months and job cutting is likely to be implemented.
Meanwhile, cost pressures have regained some momentum as the rate of input price inflation quickened on the back of greater fuel, wage and raw material costs.
What do we take from the latest surveys? Manufacturing is clearly an area of global weakness. Recent data shows that the level of new orders continues to be very poor. The rebuilding of inventories remains low, and producers are dealing with a scarcity of workers and rising labour costs.
And services is now starting to come under pressure. Demand is showing signs of fading as savings are further eroded, debt servicing costs rise, and unemployment starts to pick up.
The reading, I think, adds to the evidence of a broad-based slowdown ahead, but continued to fall short of an outright recession.
So, that was the global economy and financial markets last week. Our guest today is Alex Joshi, Head of Behavioural Finance for Barclays Private Bank, and we will discuss the importance of being clear on one’s own investment goals and not getting swayed by others.
Alex, great to have you with us today. You spoke to us recently about the importance of reflection on past decisions as a way to improve future decision-making in part by identifying and overcoming our own individual behavioural biases.
On this theme of good decision-making as investors return from their summer break, what should they be keeping in mind as they face the rest of this year?
Alex Joshi (AJ): Hi, Henk. Good to be back with you. So, as we look forward to the rest of the year there are lots of question marks about a multitude of factors, as you’ve just discussed, like terminal rates, growth, China, the Ukraine war, AI boom, so there’s the prospect of much uncertainty going into Q3, Q4 and beyond.
And one simple, but key, thing to keep in mind for the rest of the year, but across all periods of time, as an investor is that investors should be clear as to why they are investing, better said, the game that they are playing, and recognise the uniqueness of that in the context of the market and also market commentary.
So, we refer to investors very much as one homogenous group. However, this is far from the case. As we know, markets are made up of many different individuals, all with different goals and horizons.
So, if we take a running example. Let’s imagine one’s running a marathon. We have set a pace and time and are just focusing on running to that. Now, let’s imagine a few kilometres in, you see people coming past you extremely fast. The question is would you run at their pace? Probably not, as you’ll most likely do a couple of kilometres which may be faster, but then you can drop off and there’s a big risk of then not finishing.
And that’s very similar with investing. Market participants can be playing very different games. If we think of a university endowment fund on one end, and on the other extreme, we think of day traders. And then on market commentary, for the investor seeking to protect and grow their wealth over many years, if not decades, then it’s long-term data that is the most important.
While short-term news flow can appear to be important, as it affects portfolio valuations today, much of it can be unhelpful when sticking to a longer-term investment goal. So, for investors holding diversified portfolios, much of the news will be noise.
So, investors have to be careful about stories that appear to be on the surface very significant but might not be directly relevant to one’s own portfolio.
HP: Alex, what is it about stories that investors should be really careful of?
AJ: Yeah. So as human beings we have a natural preference for simpler narratives. However, given the complexity of markets that we all understand, the simpler answer, in many cases, can be too much of an over-simplification. You know, when individuals look back at the past, we all create stories about why certain things happened which help us to make sense of the world, make it appear more understandable, you know, in some way.
However, the reality is that the world is far more uncertain than many realise. Additionally, history can be misleading, not least because lessons learnt a few decades ago may be less relevant in today’s times, given structural changes in how people and businesses operate.
One simple example, just take the internet, you know, the advent of the internet is just one example of how life today differs very significantly from that in just the ‘90s. And the further back you go, the higher the likelihood that one is examining a world which no longer applies to the present day, and the more general your takeaways should be.
Then, as a result of, you know, this draw towards simpler narratives, the way investors behave can be driven by biases, and we’ve spoken about them many times here, you know, such as the confirmation bias, when we seek out and pay closer attention to data and stories that confirm one’s own held beliefs, or, say, over optimism, you know, being overly optimistic about their beliefs. And in a market that is driven largely by sentiment, this is particularly important to be aware of.
So, it’s therefore important for investors to look beyond today’s headlines and simple narratives to the impact of events for one’s own individual portfolio.
HP: OK. If the name of the game is, indeed, long-term investing, what kind of stories should investors be listening to?
AJ: Yeah, so as I said at the start, you know, long-term data is the most important. So, while short-term news flow can appear to be important as it affects the portfolio today, you know, much of it can be unhelpful when you think about longer-term goals.
Now, let’s take an example for a long-term investor being swayed by the actions of those with much shorter-time horizons, so, start checking your portfolio daily, where the probability of seeing a gain or a loss in a portfolio has a probability which is, you know, approximately a coin flip.
Well, then that investor is going to have an elevated perception of the riskiness of investing and, obviously, this has implications on decision-making. Whereas, if we look at the data, the probability of seeing gains in a portfolio increases significantly as one extends the time horizon being considered.
So, let’s think about changes in the probability of achieving positive returns for equities, whether that’s on the S&P 500 or the MSCI World, when holding them for periods of up to 15 years. And this is the chart which is going to appear in next week’s edition of Market Perspectives.
So, the probability is approximately a coin flip for one day. So, you know, 50% probability of seeing positive returns if you look at the portfolio on a daily basis. If we extend that out to five years, that probability is approximately 80%. If we go out 10 years, this rises to approximately 90%. And if we go out to 15 years, well, that probability is approximately a 100% probability of seeing gains in a portfolio.
So, for a long-term investor, the odds are stacked in your favour by staying invested through both good and bad times, though, of course, you know, nothing is guaranteed. And so this is the key point that I made at the beginning, which is that for each individual investor, an important aspect of investing success is recognising your own individual goals and time horizon, and then not being swayed by the actions and behaviours of others who may be playing completely different games to you.
HP: Well, thank you, Alex, for your insight today. It’s great to step back from the day-to-day melees of the market to consider our decision-making process and put it in the context of the time horizon, indeed, in which we’re operating over.
Let’s move on to the week ahead, where the focus will be on eurozone inflation on Thursday, the US employment report on Friday.
For EU inflation, we expect the August print to be unchanged from July. We look for a rise of six-tenths of 1% month-on-month, 5.3% year-on-year, as rising energy prices due to the increase in crude prices and the regulatory electricity hike in France should be largely offset by disinflationary pressures coming through from core goods and food prices. For the core level, we look for inflation to moderate by 0.2 percentage points from July, to print at 5.3%.
Moving on to the US labour market, where we expect the numbers to remain robust. In fact, we forecast the economy to have created 200,000 jobs in August, which would represent a modest increase from the 187,000 recorded in July. Forecast that average hourly earnings will match July’s pace of up four-tenths of 1% month-on-month to 4.4% year-on-year. We should note, of course, that wages are now outstripping the rate of inflation, and we look for the unemployment rate to cut to 3.6%.
With that, I’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.
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