Markets Weekly podcast – 11 December 2023
Central bank options and behavioural finance
What steps could investors take to lessen the emotional discomfort of short-term market volatility? Tune in as Alex Joshi, our Head of Behavioural Finance, explores some of the key findings from our ‘Outlook 2024’ report. Topics include the role of diversification and the importance of staying invested over the long term. Meanwhile, podcast host Julien Lafargue reflects on the most recent US jobs data, interest rates in the major regions and US inflation.
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Julien Lafargue (JL): Welcome to a new edition of Barclays’ Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and today, again, I will be your host.
As usual, we will start by reviewing last week before moving on to our guest segment. And this week, I’m very pleased to be joined by Alex Joshi, Head of Behavioural Finance here at Barclays Private Bank, to help us look into 2024 and make better investing decisions.
But before we talk about all those biases that are impacting us, let’s look at last week. And it was a pretty busy week from a data perspective. It was a very solid week from a market perspective. In fact, the S&P and the Nasdaq both set new fresh year-to-date closing highs on Friday, and this came as a result of a lower yield, in particular in Europe.
The dominant market narrative has been, and will remain, increasing confidence about a soft or a no landing economic scenario with the Fed and other central banks possibly starting to cut rates in the first half of next year. And as I mentioned, from a data perspective, we had another round of Goldilocks economic data this week, and this has helped to continue to support this narrative of a soft or no landing.
The main release was in the US, and this was the November nonfarm payroll. Those rose by 199,000, much ahead of the consensus. The consensus was looking for 175,000.
Meanwhile, we’ve had other positive data coming from the US in the form of the October JOLTS report, which showed a larger-than-expected decline in job openings, and the November ISM services index, which remained fairly stable at 52.7, that was up 0.9 points versus the previous month.
If we focus for a second on this US jobs data, there is a lot of noise in this data at the moment. Just to give you an example, the household survey, which is another survey running parallel and that is used to calculate the unemployment rate in the US, this particular survey showed that the US economy added 747,000 jobs in November, and that compares to the 199,000 that are mentioned, a number that is based on the establishment survey.
And this makes it very hard to come up with a definitive view on the state of the US labour market. That said, we would expect the situation to deteriorate eventually, if only because this is what the Fed will tell us it would do.
Talking about the Fed and what to watch for this week, I’ll recap all the events, but I think it’s worth mentioning the three central banks that we’re going to hear from later this week. So, we’re going to start with the Fed on Wednesday, followed by the ECB and the BoE, the Bank of England, on Thursday.
All three central banks are expected to keep interest rates unchanged, and we do expect them to maintain a rather hawkish bias, pushing back against what have been easing expectations from the market. In fact, markets have started to price in earlier and earlier cuts going into 2024, something that we’ve discussed previously and we don’t think central bankers are too keen with those easing in financial conditions. So, clearly, we could expect some volatility around those meetings as central bankers push back against market expectations.
Talking about volatility, I think this is maybe the right time to transition to our guest segment. Alex has been helping us and helping our clients dealing with this volatility throughout the last couple of years and Alex contributed, of course, to the ‘Outlook 2024’ that was recently published, and specifically the behavioural finance article of Alex.
It was very interesting. You addressed nine key questions on the minds of investors, and I thought that today we could maybe dive a bit deeper into a few of them.
But, firstly, first welcome to the podcast and maybe tell our listeners why do we think it’s worthwhile having a behavioural finance chapter as part of our ‘2024 Outlook’.
Alex Joshi (AJ): Hi, Julien. Good to be back with you. So, yeah, I think a neat example to answer this question is, if we take Harry Markowitz, the pioneer of modern portfolio theory, he was once asked about his own investment allocation and he said, “My intention was to minimise my future regret, so I split my contributions 50:50 between bonds and equities.”
So, this is a guy here who’s the pioneer of portfolio theory doing an even split between equities and bonds, very much because psychology was driving his behaviour. So, whilst creating an optimal investment strategy and portfolio is a financial optimisation problem, psychology plays a significant role in the success of an investment journey.
So, you know, whilst finance is built on models of rational agents that seek to maximise utility, the daily decisions of investors are influenced by emotions like fear or grief. And, in fact, history is littered with episodes where non-financial factors or animal spirits as they’re called drove markets.
So, by taking into account psychology, I believe that we can better understand investor behaviour to improve one’s investment approach. You know, we as humans, are all prone to behavioural biases and as we’ve discussed before, biases they’re systematic deviations from rationality. And these can both, you know, impair decision-making and actually, ultimately, drag on returns and so, for that reason, I think it’s very important that psychology is part of the investment discussion.
JL: Right. So, over the last few weeks on this podcast and in other meetings we’ve discussed our outlook for 2024, what we expect. And one thing that we’ve been mentioning time and time again is the risk that we see on the horizon, and I think behavioural finance is a great tool to help us prepare for those potential risks. So, in your opinion, how do you think investors should look at all those risks that we see on the horizon?
AJ: Yeah, a great question. So, you know, of course, as you said, you know, in the ‘Outlook’ we outlined the risks that we see for economies and markets in the context of an expectation of a slowing macro picture and, you know, firstly, I recognise that thinking about risk can be disconcerting to certain investors.
So, for investors that are concerned about risks, I think the starting point is to consider putting hedges in place. And a core satellite approach, you know, where you’ve got a satellite portfolio or, you know, hedges that complement a core portfolio, this can make it easier to stay invested. You know, in the past, we’ve discussed the importance of, you know, staying invested. And, you know, we believe that this may be preferable to a binary situation of being in the market when you’re optimistic about prospects and being out of it when you’re pessimistic.
And so a core satellite approach, you know, allows for both protection against risks, but also the capitalisation of opportunities because it shouldn’t just be, you know, a discussion about the downside.
However, you know, the market impact of risk events can be unpredictable and there’s, you know, the potential for risks that haven’t been considered, you know, so unknown unknowns. And one pre-emptive action that an investor can take in this case is to hold a well-diversified portfolio.
You know, it’s very simple advice that investors hear time and time again, but it’s extremely important to own a mix of asset classes, sectors and regions as it’s one of the few ways to both protect and capitalise on unexpected events. And in the ‘Outlook’, we’ve obviously spoken about the importance of diversification beyond the traditional 60:40 portfolio, talking about private assets, for example.
And I guess the final point is to say that diversification, you know, it can help dampen volatility as we all know but, as a result of that, it can also protect the investor from the emotions that some of this volatility can bring about. So, as well as doing well from a financial perspective, we should also think about the emotional benefits because a well-diversified portfolio, what it does is it provides the building blocks for clear and rational decision-making, which can make it easier to overcome some of these more difficult periods on the investment journey.
JL: If people are bored hearing us talking about diversification all the time, there is one thing that I keep hearing all the time when I speak to investors is the fact that the outlook, especially now but, again, I hear that almost every single time, the outlook isn’t certain and it feels very uncomfortable investing right now because, you know, this or that could happen or this or that could take a turn for the worst. So, I think this is where behavioural finance can add a lot of value. What, in your mind, should an investor do when they feel that investing feels uncomfortable?
AJ: Yeah, a great question. So, I’ll start with a very simple statement, which is that investors earn returns on their invested capital for taking risk and higher risks typically yield higher expected returns. So, therefore, to earn returns over and above, you know, the so-called risk-free rate, it’s necessary to accept the discomfort that comes with volatility and uncertainty. Now, in the face of that, investors have three options.
So, the first is you can accept this cost, you know, the cost of discomfort and earn the long-term returns that will typically be associated with the returns profile of the assets that they’re holding. So that’s option one.
Two is, you know, if you feel uncomfortable is to say, OK, hold assets, you know, with lower associated volatility and accept, you know, lower expected returns. So, this may reduce that discomfort, but then may also affect an investor’s ability to reach their long-term goals. So that’s option two.
The third is to try and earn the returns whilst avoiding paying the price by, say, attempting to time the market. However, you know, as we’ve discussed many times in the past, we believe that this is a difficult sport, can also prove costly, and in investing, you know, just like in life, humility is essential.
So, in the face of, you know, accepting the costs and earning returns, you know, holding assets with low volatility and getting lower returns or attempting to just avoid it all together by trying to time the market, which is very difficult, you know, I’d make the point which is that volatility is uncomfortable, but will not necessarily stop an investor from reaching their goals if they can see it through. And if we just take 2023 as an example, you know, as you’ve mentioned here already, you know, November has seen stellar returns for both equities and bonds and it’s been a strong overall 2023, and this is despite a whole raft of issues which are facing investors, right? And this happens time and time again when investing.
Events happen that in the short term, potentially, can seem quite dramatic and potentially derail an investor, you know, from their investment path, but those that can see it through, that can see beyond that, typically are going to be rewarded. And so that’s what I would say to investors that are seeing this uncertainty and volatility that this is part and parcel of the investment journey.
JL: Yeah, and my answer to that question would have simply been, well, you know, you shouldn’t invest if you feel good about it, probably because the best-case scenario is already priced in, so you should always feel uncomfortable when you’re investing simply because you are taking a risk.
Anyway, last question from me and then I’ll let you go. 2024, we rely heavily on you internally and externally to help us make the most of the opportunities that we see and trying to keep our biases at bay. How do you think investors can gain that edge in 2024?
AJ: So, in what looks to be a year which will test the resolve of investors, it’s going to be timeless investing principles combined with strong behavioural resolve, which can improve the odds of success. And so, a robust investment process, which leads to a well-diversified portfolio of quality companies should provide solid foundations to generate appropriate returns over the medium term.
But for this to happen, an investor must be able to hold that portfolio during challenging times. And that’s because of something that I address in the article in another one of the questions, which is that throughout history, in spite of disruptions, the long-term drivers of growth of markets which are, you know, human ingenuity and technical advancement, these continue on in the background and, despite the short-term risks that we see on the horizon, you know, longer term, we don’t believe there’s a reason for this to change.
So, if we go into next year, it’s critical for investors to have an awareness of their own behavioural proclivities, putting a plan in place to limit their impact can make it easier to stay the course, and a trusted adviser can provide a valuable outside perspective to help navigate the challenges ahead.
So, it’s, you know, strong foundations for clear and rational decision-making, which maximise the chance of being able to mitigate risks and capitalise on opportunities, and this should give investors an edge in 2024 and beyond.
JL: Excellent. Well, look, I’m sure we’re going to have you back next year because it’s pretty certain that the world is still going to be very uncertain and so we’ll need your wisdom to help us, guide us through all this uncertainty. But thank you very much for all you’ve contributed this year. I’m looking forward to have you back next year.
But, before we conclude, a quick look at the events ahead for this week. We mentioned the three central bank meetings. So, the Fed’s going to be on Wednesday, the ECB and the BoE on Thursday. Alongside that, we’re going to have a very important release in the US on Tuesday, so prior to the Fed meeting, and that will be the US inflation figure, which might or might not influence what the Fed decides to say. And we will finish up the week with the US retail sales, that’s still going to be on Thursday before we get the European Flash PMIs on Friday to give us a glimpse as to how the European economy is going to enter 2024.
So, another very busy week ahead and a week that we will debrief next week when we get together for the last podcast of 2023. But, in the meantime, as always, we wish you all the very best in the trading week ahead.
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