Markets Weekly podcast – 10 July 2023

Henk Potts (HP): Hello. It’s Monday, 10th July 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 how investors should be positioned for the rest of this year. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead. 

It was a nervous start to the second half of the year, as investors spent the week trying to reconcile the strong performance from risk assets that’s propelled global equities more than 20% above their October lows with the deteriorating economic backdrop, and the prospect of higher peak rates as labour markets remain robust and the battle against inflation continues into the third quarter. 

Last week’s soft PMIs, the weakening consumer activity in China and Europe, and the solid US employment data highlighted the dilemma. In terms of equity performance in Europe, stocks had their worst week since the middle of March. The STOXX 600 was down 3%. Over on Wall Street, where there was a shortened trading week due to the holidays, the S&P 500 fell 1.2%. The Nasdaq was down nine-tenths of 1%. 

In commodity markets, Saudi Arabia continued with its press to stabilise crude prices by constraining supply, as demand concerns continued to develop. The Kingdom said it would prolong its one million barrel-per-day production cut for a further month. Russia also said it would cut production by 500,000 barrels per day in August. Brent was up around about 4% last week, trading at around $78 a barrel this morning but is still down 27% over the course of the past year. 

In terms of the outlook, well, demand is still pretty hard to predict, it has to be said, and is likely to be determined by the shape of the recovery in the global economy, but also the depth of the slowdown that we’re seeing in advanced economies, particularly the manufacturing picture. But constrained Opec+ supply, weak US production growth and low inventories should help to support prices. 

In terms of gold, rising bond yields have been creating greater competition for the precious metal. Investors have been reducing their ETF holdings. In fact, they’ve reduced them for 14 straight days. Total gold held by exchange-traded funds is down 1.6% year to date.  

The price of gold has fallen for four consecutive weeks, trading back to around $1,915 an ounce this morning. Gold is off around 7% from those near record highs that were achieved in May, but it’s still up 4.8% year to date, and, for us, continues to be a really important portfolio diversifier. 

Now, moving on to the macro side, where the focus was on the deluge of ISM PMI reports from the US, China and across Europe. These surveys, I think, are a really useful guide to future business conditions. We’ve been expecting a weakening of activity and that certainly shone through in some of the latest reports, starting with the US, where manufacturing activity fell for an eighth straight month, to its weakest level in three years.  

The Institute of Supply Management’s manufacturing gauge fell to 46. That’s the weakest since May 2020, down from 46.9 a month earlier. The weakness was across all the major components, including production, employment and new orders. In fact, only four of the 18 industries in the survey reported production growth last month. New orders have now contracted for 10 consecutive months, and the backlog of previous orders is starting to be run down. Low levels of inventory build also suggest future weakness. 

On a positive note, price pressures have been fading and supplier delivery times have been shortening as global supply chains continue to improve. 

What do we take from the report? Whilst the reading is still above those low 40s, which would be consistent with an outright recession, factory production has clearly weakened. We anticipate a further decline in activity in the coming months, which will weigh on growth prospects. 

In Europe, the final composite purchasing managers’ index slumped to 49.9 in June, from May’s 52.8, the index falling below that 50 expansion line for the first time since December. The survey showed manufacturing activity declined in all four of Europe’s major economies. The 43.4 reading was the lowest since the pandemic, and the services PMI dropped to 52 from 55.1. 

Moving on to China, where the services purchasing managers’ index declined to 53.9 from 57.1 in May. The reading suggests that robust recovery in demand for services, since the abandoning of COVID-19 restrictions at the end of last year, is starting to lose momentum. The easing of household consumption growth, coupled with the ongoing weakness in the housing market, slumping exports and deflation risks, have been increasing pressure on the authorities to deliver a comprehensive policy response. 

Now, the People’s Bank of China has already cut policy rates, but we expect further easing in the coming months. We also expect a 25-basis point cut to the reserve requirement ratio, the amount of cash that banks have to hold, in the third quarter of this year and Q1 of 2024. We expect mortgage rates will be cut between 60 and 80 basis points and anticipate there’ll be an increase in the lending programme to support infrastructure investment. 

Beyond the PMIs, eurozone retail sales fell 2.95% year-on-year in May. The annual comparison has now fallen for eight consecutive months. Eurozone consumers have been reducing their spending on goods. Disposable incomes have been impacted by persistent elevated levels of inflation, and higher credit and mortgage repayments. 

Households are also increasing their savings rates. That’s due to the higher rates offered by the banks, but I think also as a precaution due to that economic uncertainty. 

Finishing off with the US labour markets, where the figures, you have to say, were a little bit mixed. Markets were bracing themselves for another consensus-busting nonfarm payroll figure following that blowout ADP number, but policymakers were probably comforted as the data showed US employers added fewer jobs than expected last month.  

In fact, the US economy created 209,000 jobs. Remember, consensus was around 230,000. The figure was the first below consensus for around 15 months and there was also a downward revision to the prior two months. Although the hawks will continue to point to the fact the unemployment rate ticked down to 3.6%, which is close to a five-decade low, the participation rate remained unchanged at 62.6%, which is still below that pre-pandemic level of 63%, and actually average hourly earnings accelerated. They rose four-tenths of 1% month on month, 4.4% year on year. 

When we look at the US labour market, we forecast that payrolls will continue to weaken and actually turn negative in the second half of this year, and the US unemployment rate will start to rise. In fact, we’ve put it at 4.2% at the end of this year, providing some of the slack the Federal Reserve, the US central bank, has been looking for. 

So, that was the global economy and financial markets last week. In order to discuss the investment outlook for the rest of this year, I’m pleased to be joined by Julien Lafargue, Chief Market Strategist with Barclays Private Bank. 

Julien, great to have you with us today. We published our Mid-Year Outlook in June, which offers our views on the economic outlook, how investors should be positioned across asset classes, with a deep dive into both equities and fixed income, along with some important pieces of research that analysed the question of de-dollarisation, biodiversity risks and how investors should be using behavioural finance techniques to improve their decision-making process. 

So, if anyone hasn’t read the Mid-Year Outlook, watched the webcast or, indeed, attended one of our live events, what would you say were the key messages? 

Julien Lafargue (JL): Well, thanks very much for having me back on the podcast, Henk. Well, if someone hasn’t done any of those things, first, I would probably ask them why, and encourage them to take a look at the document at least. I think, you know, there’s a lot of good content in there, as you mentioned. And I think the main message, really, from that publication and the events that we held around it, I would say, are twofold. 

One is, in the short term, I think it’s important to recognise from an investment perspective that things have changed, and that the opportunities that we see today may not be the same as they were, you know, 12 months ago. And this is something that we first highlighted in our full-year Outlook, back in November, including the importance of revising the fixed income exposure. 

It's fair to say fixed income hasn’t necessarily been a star performer on a year-to-date basis, but we continue to see it as a much more attractive asset class at this particular point in time for the medium term. 

The second point is, when it comes maybe to the medium-term picture, is the fact that, although a lot of people are telling us that you know, equity markets are overly expensive, we do have, still, a conviction that equities should form part of any diversified portfolio over the medium term.  

It’s true that valuations may not be as attractive as they’ve been in the past, although they’ve been more expensive than that, but the reality is a lot of the upside that we expect to see, and we’ve published our Capital Market Assumption, as well, that looks out to the next five years. Where we do see the upside coming from is from the earnings-growth potential and we don’t see any reason why, whether it’s US, European or global, equities should not be able to provide decent earnings growth in the years to come. 

So, fixed income in the short term, equities in the long term or medium term, but overall still a very strong conviction that one needs to be diversified in the current environment. 

HP: Julien, now that you’ve had an opportunity to discuss the outlook with many clients across Europe, what were the main questions that they were asking you? 

JL:  Well, we actually got quite a few questions, a very engaged audience across all the events that we hosted. There were very specific questions, sometimes different from one city to the other, but I think one of the main topics that kept coming back is the one around artificial intelligence. This is not something that we necessarily cover in our Mid-Year Outlook, but it’s definitely something that has caught the headlines and raised questions.  

We know that a lot of the performance on the US equity market, in particular, on a year-to-date basis, has been driven by a handful of stocks, and those all share the same characteristic, which is an exposure to artificial intelligence as a broader theme. 

And I think the questions coming from clients on artificial intelligence were twofold. One is, you know, is this something that I, as an investor, should look into and be invested in? And, second, is what are the longer-term impacts you see, maybe more from a macroeconomic perspective, on the back of this AI revolution?  

So, maybe, you know, starting with the market angle. Yes, it’s true that a very little sample of companies have done extremely well, and they have this AI angle to them. Is this overdone? Maybe it is a bit in the short term. I think we have to recognise that AI is not something that was invented in November, when ChatGPT came to the fore and people finally familiarised themselves with AI, it’s something that has been around. It is accelerating, and, like any other technology, you tend to have breakthroughs that drive adoption at a much faster pace than in the past, but we would temper the optimism around that. 

It is clearly a very exciting new trend, but it may take a while for this to translate into any kind of material impact for the companies, whether it’s a positive impact or negative impact, whether companies are able to generate more profit because they are exposed to AI or because they integrate AI within their business model to maximise efficiencies, or if some business models might be threatened by AI, making them redundant, basically. 

So, in the short term, we do think that this is a space that will continue to grow. This is definitely a space where we want to be exposed over time, but I think you need to be mindful of that. You shouldn’t chase the hype, I would say, and maybe wait for a bit of consolidation, I think.  

We’re going into earnings season now. Maybe we’re going to get a better understanding. I still expect many management teams to mention AI, but we are hopefully going to get a better indication as to what the real impacts are, where the real winners are, because, really, apart from a couple of companies, at this stage it’s difficult to understand what the impact could be. 

HP: Julien, sticking with that AI theme, do you think the role of investment strategists will be replaced by artificial intelligence? Will AI be running money for clients at some stage? 

JL:  Well, I’m not sure. Maybe. You know, I think back to my point around the fact that AI has been around for a while, many investment managers, including Barclays, have integrated AI technology in part of their business. We do have, internally, robot advisers that will help generate investment recommendations based on several factors. So, this is again not something that is brand new.  

I think, also, we have to recognise that in many businesses, not just investment or banking, there is still a strong desire, and a necessity, to have that human touch and human understanding. So, it might help in some aspects of the job and might replace some aspects of the job, but I don’t think it’s going to really get rid of us, hopefully, not in the very short term. 

But that is a very interesting point, and the second thing that we were discussing with clients is what are the implications around, you know, the bigger macro picture. And I think, in the same way that it is hard today to really understand what will be the impact at a company level, it’s hard to understand what will be the impact at the macroeconomic level. 

It could be that this AI revolution is a headwind for the macroeconomic landscape, at least at the beginning. Why? Because maybe jobs will be destroyed, maybe because companies will have to invest massively in that space, trying to build out capacity. That may reduce profit, that may motivate them to pay less to their employees. There are a lot of question marks in the shorter term. 

In the longer term, on paper it could be very beneficial. We know that productivity growth has gone nowhere for many years now, and maybe this is the catalyst that we needed to finally see some productivity growth, especially in developed economies. 

But it’s a very fascinating topic, one that I think needs to be analysed deeper, and we’re definitely spending time on that with the rest of the team. You know, we’ll probably come out with some kind of thoughts in the coming weeks. All I would say is, the reality is that nobody knows what the ultimate impact will be. But it will definitely have an impact, and this impact will vary depending on each sector and each company. We just have to wait and see a bit before we get a better picture. 

HP: Yeah, I think that makes a lot of sense. In reality, it’s most likely to enhance people’s roles, their ability to fulfil them in a much more efficient way, help us to manage risk in a better way, help us to become far more efficient. So, it’s going to be an interesting development not only, I think, for financial markets, but as you say, the broader economy as well. 

Moving on, as we’ve spent time with clients over the course of the past few weeks, you do get the sense that they are nervous about the immediate future, particularly that disconnect between the strong equity markets, that we saw in the first half of the year, and the deteriorating economic backdrop, and the impact of higher peak rates. What would you say were the main areas of concern? 

JL: Well, I think, you know, compared to our views I think we’ve received a limited amount of pushback. I think one reason for that is simply that we’re not coming out with a view that the markets are going to collapse 20% or increase 20%. I think, maybe, the concerns or the pushback were centred around our more constructive views over the medium term. A lot of people still remain sceptical about the upside potential for equity markets, not just in the short term, but in the medium term.  

I think the concern comes mainly from the fact that we are at this pivotal point when it comes to central bank policies, the fact that debt loads across the world have increased meaningfully on the back of COVID and all the stimulus that came with it, and people are just concerned that the growth that we’ve seen, whether it’s from a market-value or from a market-capitalisation standpoint, ie the upside in equity markets that we’ve experienced in the past few years as well as the macroeconomic, the GDP growth that we’ve been able to achieve over the last 10 years or so, that is probably not repeatable in this new, post-COVID world where inflation is a topic again. 

I think this is a very valid concern and we have addressed that, we have accounted for that. If you look at our Capital Market Assumption, we are forecasting lower growth, going forward. This is to account for the fact that in the world where there is more debt going around, that typically reduces the potential growth. We are also expecting slightly higher inflation, going forward. So, we are accounting for that, but we also realise that whether it’s the human race or companies, they have this incredible ability to adjust to whatever new normal they’re faced with. 

So, we do think that the short term is going to be quite challenging as we go through this adjustment period, but even if we live in a world where loss is lower and where inflation might be slightly higher, we don’t think this is going to completely change the face of markets, really. And that’s why we do think that investors should stay invested as they diversify. 

HP: OK. Let’s finish off with that theme. If you had to summarise the biggest risk, but also the opportunities, for investors in the second half of the year and beyond, what would they be? 

JL: Well, I think, you know, the risk that we can think about, that we can sort of measure, that we can hedge, I think for me the biggest risk is really the geopolitical risk. It’s a risk maybe more on the medium term, and we said that when the events started in Ukraine, those things can be very disruptive in the very short term for markets. But history shows that, again, back to this resiliency and this capacity to adapt, that the impacts tend to be lasting for a short while, but not forever.  

And I think this is what we need to keep in mind, because geopolitical tensions are unlikely to go away and we’re probably going to see a further flashpoint and we could see further volatility on the back of that. It’s very difficult to hedge against those risks. We don’t necessarily know where they’re going to come from and in what form. So, really, the only thing to do is to be diversified. 

The other main risk we see, we have this rather constructive outlook when it comes to the macroeconomic picture and, you know, we could be wrong and we could be heading into a much more severe slowdown, if not recession. This is what a lot of the pushback we received was pointing to. Again, in this case, you know, some people have said, well, I’d rather be in cash, and that brings me to also an opportunity, cash is great, maybe in the very short term and especially nowadays that you’re getting paid to have your cash sat in a deposit account or maybe in a money-market funds. 

But the reality is, cash has never been a successful investment over time. It barely compensates for inflation. In fact, our Capital Market Assumption shows that real rates are going to remain negative for the next five years, so by being in cash for a long period time, you’re effectively guaranteed to lose money. And I think it’s important for people to recognise that, and to realise that locking those yields now that we have access to and that we haven’t seen in maybe the last 10 years, shouldn’t be done with cash, it should be done, maybe, with mid-term or medium-term maturity bonds.  

That, to us, is where the real opportunity is and, by definition, the opposite is that people just waiting in cash feeling good about it, but they might wake up, you know, six months or 12 months from now when rates are closer to 3%, they’ll have this reinvestment risk and the market might be, you know, up another 10% and then what do you do? So, that’s definitely one.  

And the other one is, in terms of opportunity, I would say, is the fact that markets have been driven by a very narrow leadership is actually, for some people, a concern. For us, it’s a great opportunity. It means that there is still a lot of upside potential and if they haven’t participated in any kind of rally so far this year, and where valuations are still relatively reasonable and, therefore, for stock pickers, this is a great environment.  

It was a great environment in the first six months of the year. Well done if you picked the stocks that had some AI exposure to it. It will probably still be a great opportunity for a stock picker in the second half of the year as well. Maybe some of the names that were left behind will play catch-up. 

HP: Well, thank you, Julien, for your insights today. As we’ve been discussing, it’s a challenging backdrop for investors, but certainly interesting to hear your views on how to navigate that political and economic uncertainty and where those potential opportunities lie. 

Let’s move on to the week ahead, where the focus will be on the US inflation report, where we anticipate the moderation in price pressures will continue into a 12th straight month in June. We expect headline CPI to rise three-tenths of 1% month on month, the annual rate to decelerate to 3.1% year on year, helped by base effects, flat energy prices and only a modest increase in food inflation. 

On the core reading, we look for 0.3% month on month, and 5% year on year, which would be 14 basis points lower than in May, driven by lower used-car prices, but core services and housing, we think, will maintain its recent rate. Those figures out, of course, on Wednesday. 

With that, we’d like to thank you once again for joining us. Hope 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.