Markets Weekly podcast – 31 July 2023

Julien Lafargue (JL): Welcome to this new edition of Barclays Private Bank Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and I will be your host today as Henk is enjoying some well-deserved time off.

As usual, we will start by reviewing last week’s events before moving on to our guest segment. And, this week, Alex Joshi, Head of Behavioural Finance at Barclays Private Bank, will tell us why it’s so important for investors to take the time to reflect on our decision-making process.

But, first, let’s look at last week’s events. And it was a fairly busy week, probably in fact the busiest week of the year so far. We’ve had no less than three major central banks who were giving us an update, as well as a lot of earnings reports.

In terms of central banks, let’s start with the Fed. The Fed decided, as expected, to hike interest rates by 25 basis points, bringing the top range of the Fed funds rate to 5.5%. The meeting offered nothing really in terms of surprises. The big question on the market’s mind was whether the Fed was done after this hike in July, if whether there would be more hikes to come. And, on that front, what Chair Powell did was really to keep his options open. 

The Fed remains data dependent, will monitor the next couple of inflation prints as job reports going into the September meeting and only then a decision will be made. Encouragingly though, Powell acknowledged the fact that the US economy has been very resilient. In fact, the Fed staff doesn’t forecast a recession any more.

Where does that leave us? We believe that there could be, potentially, one more hike in November, another 25-basis point hike, but this is really dependent on the next couple of inflation reports and job reports. That being said, I think we can make the case clearly now that we are approaching fast the end of this hiking cycle in the US for sure.

Now, the other key element of last week was the vast amount of macroeconomic data that we got, in particular in the US, and really all this data reinforced the view that the US economy has been much more resilient than we expected, and that the market expected, specifically nine months ago. At this point, if you remember, everybody was expecting the US to be in recession by now, and this is clearly not the case. In fact, we got the second-quarter GDP figure from the US and it came in at 2.4% on an annualised basis. This was well ahead of the 1.5% the consensus had expected, in part, thanks to robust consumer spending.

So the US economy is doing well, and inflation is coming down gradually. This is what the June reading for the core PCI confirmed. Inflation printed at 0.2% month on month, that was down from May’s level. And on an annualised basis, core PCE is now at 4.1%, which is the softest annual reading since September 2021.

On top of that, we had a very good number on the consumer confidence side. In fact, it was at its highest level since mid 2021. We’ve responded increasingly optimistic about the labour market which was, again, reflected in the lower-than-expected initial and continuing jobless claim. 

Maybe the only negative news, so to speak, was the softer-than-expected new home sales in June in the US, with also downward revision to May’s numbers, but this is a part of the market that has been on fire recently, so some moderation is not necessarily anything to worry too much about.

So, in the US the picture is clear. Strong economy, moderating inflation, which leaves us in what people have started to refer to as a Goldilocks scenario.

Now moving on to Europe and the ECB, again, no real surprise there. The ECB hiked by 25 basis points, taking its deposit rate up to 3.75%. And similar to the Fed, the ECB left the door open for a pause or a hike, definitely not a cut, but the central bank wants all its options open going into the fall.

The statement, I think, that was the main change. The statement omitted the wording that said the policy will be brought to a sufficiently restrictive level and said that future decisions will ensure that key rates will be set at those sufficiently restrictive level.

The main takeaways were relatively dovish as leading indicators point to disinflation gaining traction in the region and, unlike the US, economic activity appears to be slowing. Now, policymakers still sounded divided on whether more rate hikes are needed. Our view here is the ECB is pretty much done unless we have a significant upside surprise to inflation readings between now and the end of the year. A pause in September seems very likely and another hike is a possibility, but one that we would assign low probability to.

Now, finally on to a bit of a recap of the earnings season. We are roughly halfway through. So far, as expected, it’s been relatively mixed. As some of the key themes that we’ve heard companies talk about during this earnings season, one is definitely a continued resilience on the consumer side, still more hints that there is this building disinflation wave. And also, interestingly, some report of loosening in the labour market. 

But, overall, the message has been one of cautiousness from management teams, which we believe is going to mean that earnings forecasts for 2023, at least for the second half of this year, will remain fairly stable once we incorporate the Q2 results.

Now, that’s it for last week. Now it’s time for us to move on to our guest segment, and as I said, we’re very pleased to be joined by Alex Joshi, Head of Behavioural Finance here at Barclays Private Bank.

So, Alex, summer is upon us and we thought it would be great for you to pass by and talk to us about the importance of taking time out for self-reflection regarding our own decision-making. So, let me start by asking you a fairly blunt question. Why is it important for investors to pause and reflect on their own behaviour and decision-making.

Alex Joshi (AJ): Hi, Julien, good to back with you. So, the summer break is a good time for reflection on business and investment decisions and performance, as well as thinking about positioning for the rest of the year. As well as reflecting on the impact of events that may have occurred, it’s also important to think about our own reactions to them in terms of decisions taken, but also decisions not taken and their impact. And the reason for this is the role that investor psychology has in driving markets.

As we all know, superior investment returns come from understanding the difference between how things are supposed to work and how they actually do in the real world, and a key input is psychology. So, if understanding investor psychology can help make sense of, and capitalise on, opportunities at the market level, then analysing decision-making at the individual level should also lead to better outcomes for the individual investor. And this is because of the use of heuristics and the resulting behavioural biases that can impact on judgements.

And, by the way, this also applies to those who may have their investments professionally managed because, in many cases, the decisions about whether and when to invest, and how much to allocate, can actually be far more consequential to long-term outcomes than the short-term optimisation of portfolios.

JL: So you mentioned, Alex, you mentioned heuristics and biases. What’s a heuristic that might be relevant in today’s market environment?

AJ: So, heuristics are mental rules of thumb that we use in our daily lives that can help us to simplify decision-making. A prevalent and relevant heuristic is availability. We overweight the importance of things which are more readily available in our minds, so things that are dramatic or emotive. 

So, for example, if I was to ask you if a random word is taken from an English text, is it more likely that the word starts with a K or that K is the third letter? Many English speaking people would immediately think of many words that begin with the letter K, so kangaroo or kale. But it takes a more concentrated effort to think of words in which K is the third letter so, for example, acknowledge or ask.

So, people overestimate the number of words that begin with the letter K and they underestimate those with K as the third letter.

Now, in investing we can overstate the importance of events happening today that make a lot of headlines and make decisions based on an expectation that today will continue to be the reality in the future. This can then affect asset allocation decisions and mean we’re not correctly positioned for the future as we become overly focused on the short term at the expense of long-term trends.

So, today if I think about the significant rise in rates that we’ve had this year, having this front of mind and not considering the future path of rates when it comes to decisions, say, about fixed income, the message that we’ve been hearing about locking rates or say mortgage decisions in the UK, in particular.

So, the key message here is the importance of keeping historical context when investing because whilst history never repeats itself exactly, it does rhyme.

JL: OK, great. Can you maybe give us a behavioural bias which is particularly prevalent, and how can we remove biases?

AJ: So, I’ll start with the second part of that question, and the reality is that, unfortunately, it’s very difficult to debias ourselves completely. But what we can do is have an awareness of them and put things in place to try and limit their impact such as decision-making rules or frameworks like making decisions by committee instead of at the individual level.

Now, in terms of biases, I’ll make reference to a few here that we do typically see together. So over optimism, over confidence and the confirmation bias.

The first two are pretty self-explanatory, but they can be exacerbated by the confirmation bias, which is where we seek data and narratives that confirm our own pre-existing views and beliefs. This can then impact on risk taking, also on asset allocation in terms of less diversification than is sensible, given one’s tolerance, composure, financial circumstances and goals. 

Artificial intelligence, I guess, is a good example presently if we think about the year-to-date rally in the context of investor sentiment for it and all the positive narratives that one can find about its future impact.

Remember, when sentiment is either very bullish or very bearish, we can see dramatic changes that then have big impacts on markets and that investors that are really bought into those narratives can be caught out.

So, the key message here is the importance of ensuring that you are critically evaluating your views and decisions, ensuring that you’re consuming balanced views and challenging your thinking for flaws or biases. So, for example, working with an external adviser to give you an outside perspective is very useful here.

JL: Right. So now to conclude, in practice, what can investors be doing over the summer break?

AJ: So, it’s all about thinking back to all the big decisions made, as well as those that were not made and reviewing their success. It’s easy to focus on things that we’ve done, but we sometimes spend less time thinking about the decisions that we didn’t take. So, that’s a starting point. 

Then, if we can identify times where there may have been some flaw in our judgement, it’s about thinking about what you can put in place to prevent a repeat of this in the future. And so putting rules in place is a very good way here.

Also, it should be an opportunity to get the right balance in terms of the information which is consumed. I think having a break from short-term news flow can be quite helpful to keeping a longer-term perspective, but then, at the same time, using the period to consumer more thoughtful, longer-term commentary and ideas such as, for example, a midyear outlook, as well as historical pieces for the broader historical basis to put current events and actions into context. And, together, this can help to overcome some of these biases that can make us more short term in our thinking when we’re wired into the daily news flow.

I guess in modern society, you know, it’s easier and faster, it’s seen as better, but when it comes to decision-making, slowing down every once in a while, introducing some friction into the decision-making process is no bad thing in the longer-term context.

JL: Excellent. Thank you very much, Alex. Really, really interesting insight and I think plenty of takeaways for investors as, hopefully, they take some time off over the coming weeks.

Now, before we wrap up, a quick look at the upcoming events. Probably the most important one, at least in the UK, will be the Bank of England meeting. The BoE is set to hike for another time. There is debate as to whether it’s going to be 25 or 50 basis points. The consensus seems to be leaning on 25 basis points this time around as a function of some encouraging sign on the inflationary front, although nothing to compare versus what’s happening in the US or even in the eurozone and, at the same time, a macroeconomic outlook that remains rather bleak. 

So, 25 basis points is probably the base case for this week on the BoE side. And we will hear from the Governor what’s coming next. Both the ECB and the Fed appear to be on a pause. It looks like the BoE could be, out of those three, the central bank that might keep pushing interest rates a bit higher for the time being.

Outside of the BoE, a few other important releases to be aware of. First, the US manufacturing ISM for the month of July and the US JOLTS report for June. Both will come out on Tuesday. That will be followed by the services ISM, again for July, which will be out on Thursday.

And the big event of the week, outside of the BoE, will be on Friday, with the US nonfarm payroll report for the month of July. And, again, this is going to be a key input into the Fed’s decision in September.

So it might be quieter, or feel quieter these days with the summer upon us, but activity in markets will remain busy, so we will be back next week to cover all those releases and more.

In the meantime, if you’re taking some time off, we wish you a very pleasant break. And if not, we’ll speak to you next week.

(end of recording)