Markets Weekly podcast – 16 October 2023

Julien Lafargue (JL): Welcome to a new edition of Barclays Private Bank’s Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist at Barclays, and I will be your host today. As usual, we will start by reviewing last week’s events before moving on to our guest segment.  

And this week, I'm very pleased to be joined by Alex Joshi, the Head of Behavioural Finance here at Barclays Private Bank, to talk about investors’ behaviour in the current context. But first, let's take a look at last week.  

It was a green week, the S&P finished higher for a second straight week. The NASDAQ was slightly lower, however. And there were a number of moving pieces. So, the Treasury rally was probably the key upside catalyst. And this was driven partly by a flight to safety from geopolitical uncertainty, as well as over-sold conditions that we pointed out previously.  

The ‘peak Fed’ narrative also got some support last week, as multiple FOMC officials said that the recent increasing yields had done some of the Fed's work for it.  

However, it wasn't all rosy and Treasury volatility popped up midweek after three disappointing Treasury auctions, reflecting both escalating fears around Treasury supply and the government deficit, as well as a rising term premium, something that we discussed with Michel last week.  

Now, the key macroeconomic data point last week was the US inflation data. And it was somewhat mixed. So, US core inflation was in line, but the headline surprised marginally to the upside. In terms of numbers, core inflation was 0.3% month on month and 4.1% year on year. This was down from the 4.3% recorded in August. At the headline level, inflation was 0.4% month on month and 3.7% year over year. Both those numbers were about a tenth higher than expected.  

Now, looking at the details and where this surprise came from, obviously oil prices, having been on the up for a while now, contributed to higher headline inflation, but a major contributor was also shelter.  

In particular, within shelter, as we know, rent costs are not necessarily going meaningfully higher, the key driver was hotels, which can seem strange, especially considering that inflation for hotels was running at an annualised pace of something like 50% last month, which obviously is not sustainable.  

Therefore, I think the conclusion on this US inflation reading is that the road from 9% to maybe 4% was pretty easy in the US, but the road from 4% to 2% is going to be trickier, and probably longer. However, we do remain on the right track.  

Now, lastly, the start of the earnings season last week gave investors the opportunity to focus on the micro economic development. We have only had a handful of companies reporting so far, but the key highlights for me were, first on the US banking side, we saw US banks clear a relatively low bar when it comes to expectations.  

They surprised positively thanks to an ongoing net interest income tailwind, and especially so for large money centres, which have the most deposit pricing power. They also saw healthy, at least healthier than expected, credit quality.  

A lot of people were expecting banks to take on a lot of provision, which hasn't been the case. And finally, good expense control. So that's on the positive side. On the negative side, we had a negative surprise from the luxury sector in Europe, with LVMH, which reported Q3 earnings revenue growth of 9%, missing the consensus by nearly three percentage points.  

And really, the weakness was coming from across the board. So, something that we want to pay close attention to, we know that luxury tends to be more resilient. But this is a warning sign from LVMH. Still, very good growth, but slowing growth.  

So, something to keep in mind as we go through the earnings season. And obviously, what has been top of mind for many investors in recent weeks, unfortunately, I would say is the geopolitical situation, which remains extremely tense in the Middle East.  

So far, markets have seen the events happening in Israel and Gaza as isolated. But the risk of the conflict spreading out to neighbouring countries, especially Iran, is real. And this could not only support oil prices in the short term, from a market perspective, it could also temper any optimism.  

Again, something that is a very fluid situation and that will probably stay with us for the weeks to come, though something we'll get back to in coming editions of this podcast. Our message, I think, remains relatively unchanged.  

As we pointed out last week, rates were bound to consolidate after the short move up in yields. And while we welcome this recent move lower, further volatility is likely. The Fed wants to keep monetary conditions tight enough and will probably change its narrative slightly, or at least adjust it, in order to make sure this happens.  

As a result, we expect markets to continue bouncing around until the end of this year. Now, in this context, let's bring out our guest Alex Joshi, Head of Behavioural Finance here at Barclays Private Bank, to discuss how people should think about markets and how they should think about their own behaviour in very uncertain times, like the one that we're going through at the moment.  

Alex, well, first great to have you back. I think, let's start at the beginning. And talking to clients on a very regular basis, one thing that I noticed is that many of them have watched this stock market rally from the sidelines, preferring to, in the context of such elevated uncertainty, remain in cash.  

For the first time in a while, I think that wasn't necessarily such a bad move in the sense that we're getting paid for holding cash. But cash is clearly the discussion of the moment. Should we stay in cash? Should we stop being invested? So, why do you think there is so much focus on cash?  

Alex Joshi (AJ): Sure, good morning and good to be back with you. So, I guess let's start with a reminder of the historical context. So, we've had over a decade of ultra-low rates after the great financial crisis and this bull market rally for many years.  

And then, you know, gone from historically ultra-low rates to months of consecutive increases in base rates as central banks have, you know, forcefully addressed the inflation issue.  

This has led to a change in environment. For many years, we heard about Tina, the acronym for ‘There is No Alternative’ to equities and we've now moved into, you know, what has been called this Tara environment, ‘There are Alternatives’. And so, of course, this has changed things in terms of the attractiveness of different asset classes.  

So, fixed income became attractive again, you know, after a long time, not speaking about it, it became a hot topic. And then at the same time, we've now got a lot of discussions about cash, you know, cash, term deposits, with some investors asking, you know, I think, a valid question, why risk capital if I can get high risk-free returns?  

JL: Yeah, I cannot tell you how often I've had this argument being put in front of me, trying to say that longer term, being invested, being in the market, is still, or should be, a relatively worse strategy.  

So, why do you think investors are actually still risking capital in this environment?  

AJ: Because it's not only about this present environment, but also the future environments that long-term investors will face. So, cash, of course, it provides comfort, but there are costs associated with it in terms of foregone investment returns but then also the erosion from inflation. Because whilst base rates are high today, so is inflation.  

So, in specific time periods, it can be quite attractive to hold cash. But, if we think a little bit longer term and we look at asset class returns, so if we were to look at asset class returns and their rankings year on year, what you typically see is a patchwork of very dispersed results.  

So, you'll see different asset class returns bounce around and it's quite difficult to predict in any given year what is going to be the best-performing asset class and what's going to be the worst. But one thing that you can see, when you look at this, is that cash returns are typically quite low over longer time periods.  

This is something that we see quite clearly in our Equity Gilt Study. So, our investment bank produces a report every year and this data goes back to 1899 until the present day. So, we've got close to 130 years data in terms of asset class returns and for the UK.  

And now over this extremely long period of time, what we do find is that over any two-year period, the probability of equities outperforming cash is 70%. But if we extend that out to a 10-year period, that probability rises to 91%.  

So, despite looking across different time periods, different rate environments, different inflation environments, the case is still strong for a long-term investor to hold equities over cash in this environment.  

But, of course, we are entering into a new environment. We're unlikely to go back to the same ultra-low rates that we've had in the past. And there is a lot of uncertainty ahead. You've alluded to it in your introduction.  

And so, of course, this leads to the obvious suggestion, which is for a diversified portfolio. And so, a diversified portfolio is important. And one of the things that we've said on this podcast in the past is the importance of going beyond that traditional 60-40 portfolio that historically has been a staple of investors. Our quant experts have spoken about the importance of introducing additional asset classes, like private assets, into the mix.  

JL: Yeah, it does feel a lot like investors these days, and to be fair it's hard to blame them, look at the news, they look at all this uncertainty, whether it's from a geopolitical standpoint or from a macroeconomic standpoint, and say, you know what, I understand to some degree that I may be leaving some money on the table, but it just helps me sleep at night to be in cash. And I don't feel that bad doing so because I get some interest on this cash, at least today, and that I think this notion of at least today is important to stress, because we don't think that rates will necessarily stay as elevated as they are forever.  

Do you feel when you talk to a client that there is this notion of comfort that is coming through?  

AJ: Yeah, absolutely. Because holding cash is not just something that you do for a financial reason. There's also the emotional reason. So, you have the financial reasons in terms of it makes sense for you at the time to be holding cash because of the uncertainty and volatility, and you don't want to have exposure to that.  

But then that's also very emotional as well. We don't like uncertainty. We don't like not knowing what's going to come next. And so, this leads to an argument which I think has weight, which is that an optimal allocation for an investor is not going to be optimal if you can't stick with it.  

So, at times it might be necessary to hold more cash if it makes you comfortable. Of course, from a traditional finance perspective, you might not be allocating your cash most optimally in terms of the mix of risk assets for the goals that you have over the long term.  

But if you're going to struggle to actually hold that portfolio, then actually it makes sense to have a bit more protection. However, I think it's extremely important to remember that this comfort does have costs. As I mentioned at the outset, these costs are in terms of foregone investment returns and inflation. And I think it's important for investors to recognise that successful long-term investing to some degree does require being comfortable with the uncomfortable.  

So, it shouldn't be a binary case of you're in the market if you're optimistic and you're out of the market if you're pessimistic, because there are costs to this. There's the costs of trying to time the market. And if you are overly cautious, holding too much cash, of course, this is going to have the potential to limit your upside potential.  

So, I think the key message for clients that are nervous and thinking about cash is the importance of being in the market, staying in the market to benefit from these long-term trends that we see when it comes to investing.  

But putting things in place to protect yourself, so putting hedges in place, following the approach of a core-satellite portfolio, where you have a core portfolio, which is generating the bulk of those returns.  

It's allowing you to protect and grow your wealth over time. But then on the outside, in the satellite, you can put things in place when you're feeling a little bit nervous, when there's something that you've got some concerns around, so that you benefit whilst also still being cognisant of the risks.  

JL: Yeah, and I think that is the key takeaway and the main message here is, well, first cash has to be a conscious decision. And as you mentioned, it can be for comfort, but we need to live with the cost that this has.  

But it doesn't mean that we're saying be invested and stay invested. It's not that cash is a bad thing. We just need to think about cash as an asset class of its own and manage it that way. We're not solely based on how we feel at the moment but based on how it fits within a bigger, more diversified portfolio.  

And I think that the key other point for me that I learned today is how important it is to be consistent. And having a plan but not sticking to the plan is as good as not having a plan at all. And I think the current environment is really testing investors as to whether they are able to stick to their plan, you've shown that many times in the past, that's the only way really to generate attractive return by compounding, is being invested and sticking to that plan.  

And thanks for coming today and helping us step back from the uncertainty that we have to deal with on a consistent basis these days, and remind us what is the right course of action when it comes to investing.  

We’ll definitely have you back. Thanks again, Alex. Before I conclude, I just wanted to bring your attention to a few things that will happen this week and that we should pay attention to. Obviously, earnings are going to ramp up this week and next.  

So, maybe investors will be focused a tiny bit more on the micro rather than the macro side for the next couple of weeks. However, there are still a few macroeconomic data releases that are worth keeping an eye on, first and foremost the US retail sales for September. Those will come on Tuesday.  

Then we're going to get the usual batch of Chinese data on Wednesday, including the Q3 GDP, the retail sales as well as the industrial production. Closer to home on Wednesday, we're going to get the UK CPI and in the US, the Fed Beige Book.  

We will end the week with a speech from Fed chair Jerome Powell at the Economic Club of New York, that will be on Thursday. So, with a lot of earnings coming up, we're going to have a lot to talk about next week. So, we'll be pleased to see you then. But in the meantime, we wish you all the best in trading in the week ahead.