Markets Weekly podcast – 15 April 2024
US inflation and behavioural finance
15 April 2024
What are the psychological implications of investing when markets are at an all-time high? Tune in as Alex Joshi, our Head of Behavioural Finance, delves into the emotional biases that could impact investment decision-making when markets remain buoyant despite a predicted economic slowdown.
Meanwhile, host Henk Potts examines crude oil prices, US inflation and the latest announcement from the European Central Bank, amongst other things.
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Henk Potts (HP): Hello, it’s Monday, 15th April 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 emotional challenges that investors face when stock markets trade at near record levels. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
We know that risk assets have been propelled ever higher over the course of the past few months by the ‘Goldilocks’ narrative of contained geopolitical tensions, rapid disinflation and expectations that aggressive rate cuts would be forthcoming. Well, last week investors got hit with a dose of reality, as Iran launched an attack on Israel, US inflation indicators remained elevated and economists were forced to slash their Fed rate-reduction projections.
There was widespread reaction to these factors across financial markets, particularly in commodity markets. Crude prices spiked and gold hit new record highs. So, on Friday, Brent traded about $92 a barrel, that’s the highest that we’ve seen since October last year. The surge has been driven by concerns that the conflict could escalate to include other major Middle Eastern oil producers.
Lower levels of exports coming from Iran? Well, we should remember, of course, that Iranian oil is already subjected to US and European sanctions. However, exports have risen by some 50% during the course of last year, to around 1.3 million barrels per day, the large majority of that, of course, going to China. We also know that Iran has threatened to close the Straits of Hormuz. That’s a major shipping route that accounts for around 20 million barrels today of seaborne crude.
Gold topped the $2,400 an ounce mark for the first time. The precious metal has advanced around 18% so far this year. Remember, that’s on top of that 13% increase that was registered in 2023, continuing to be supported by central bank purchases and investor demand.
In terms of stock markets, well, they did retreat from near record levels. In fact, the S&P 500 was down 1.6% last week, that’s the biggest weekly decline that we’ve seen since the end of October last year.
In Europe, the decline was less dramatic, it has to be said. The STOXX 600 fell three-tenths of 1% over the course of the week. There was a broad-based flight to safety towards the end of the week. Safe-haven currencies rallied, so the traditional Japanese yen, Swiss franc and US dollar, all trading higher. In fact, the dollar hit a year-to-date high in late trading on Friday.
When we come to government bonds, yields on long-term US debt have now staged their biggest two-week increase in six months. The 10-year Treasury yield rose by 12 basis points over the course of the week and finished at 4.49%.
Markets will be watching the military and the diplomatic developments very closely in the coming days but there are some reasons, I think, for hope of restraint, after Iran said it would not carry out further assaults in the absence of a strong reaction from Israel. The US wouldn’t support, they said, an Israeli counterattack against Iran. President Biden, as we know, has been working over the course of the weekend on a diplomatic solution with some of the G7 leaders.
So, I think investors are very much in wait and see mode. As we see this morning, crude has been trading a little bit lower. European stock markets are in positive territory. One sector we could be focusing on, of course, is the defence stock. They’ve been trading to the upside. US futures are also higher this morning as well.
Let’s return back to that macro picture. The big number, of course, last week was that US CPI print. Headline inflation in March came in at a stronger-than-expected 3.5% year on year, reflecting higher energy prices.
Perhaps of more concern for policymakers, was the core reading. Now, we know this strips out the volatile food and energy components. That came in at a surprisingly robust 2.8%, which was the same number we saw in February.
Price pressures have been driven by increases in core services inflation. We particularly see that shining through in areas such as transportation, medical care and insurance.
So, where are we in terms of US inflation expectations? Well, I think taking into account the recent inflation report, the high-frequency data that we monitor, along with the overall stronger-than-expected level of activity in the US economy, it’s perhaps no surprise that we have revised up our US CPI forecast. We now see core CPI being at 3.3% at the end of this year, before easing through the course of 2025 and finishing around 2.6% at the end of next year.
Now, clearly, this will have a significant impact in terms of the path of policy we expect for the United States. We know the FOMC has already expressed concern about the sustainability of inflation getting back towards that 2% target. And as such we now expect a single rate cut during the course of this year, so looking for a 25-basis point reduction in September and thus the fed funds target range finishing the year at 5% to 5.25%.
Now, we do see further scope for rate reductions in 2025. The target range forecast being at 4% to 4.25% at the end of next year.
So, sticking with that monetary policy theme, the other major event of the week, of course, was the European Central Bank meeting on Thursday, where projections were announced. Disinflation and lacklustre levels of activity encouraged the central bank to change its rate guidance. It said that it would be appropriate to cut rates. Underlying price pressures, its updated forecast and the impact of previous rate increases increased the confidence that inflation was closing in on that 2% target level.
To remind you, euro area inflation has decelerated from a peak of 10.6% back in October 2022 to 2.4% in March.
In terms of European Central Bank expectations, as we know, it kept its policy rates on hold, but at the press conference President Lagarde indicated that a few members already favoured cutting borrowing costs, but they agreed to rally to the consensus of the large majority of the governors. They felt they needed more data which, as we know, will be available before the June meeting.
The European Central Bank does remain data dependent and has not fully committed to a rate path, but we maintain the view that the cutting cycle will start with a first 25-basis point policy rate cut in June, followed by successive 25-basis point cuts at each meeting until January 2025, when the deposit rate should reach that terminal level of 2.5%.
Now, we should appreciate there is, of course, a case to be made for a slower rate-reduction cadence. We think this should be driven by the elevated US inflation that we have been seeing, but also a weaker euro, particularly the gap between the US and euro rate grows, which could, of course, increase imported inflationary pressures. We also think there could be less urgency, as rates are returned back to more neutral levels.
So, that was the global economy and financial markets last week. In order to discuss the investment backdrop and the emotional challenges investors face when stock markets appear to be at elevated levels, I’m pleased to be joined by Alex Joshi, who’s Head of Behavioural Finance with Barclays Private Bank.
Alex, great to have you with us today. Let’s start off. Is it not counterintuitive to invest when markets are hitting all-time highs, while a slowdown in economic activity is still forecast?
Alex Joshi (AJ): Hi, Henk. Good to be back with you, and I think a very timely question. I think what I’d say is very simply that markets regularly hit all-time highs. If we think about the S&P 500, and we think about where it’s ended up at the end of the month over the last few decades, from 1950 up until the current day, the S&P 500 has actually ended a month at an all-time high roughly a quarter of the time.
That being said, you know, as human beings we can expect a reversal when things go up, meaning we have a tendency to expect that they’re going to go down. And why is that? Well, it’s something called the gambler’s fallacy. Imagine we’re playing roulette and we’ve had a few spins that landed on red, then the expectation is that we’ve seen a few reds, well, surely, the next one must be black. If we think about investing and we think about markets ending a month on a high, and assume that’s a heads, say, when we’re flipping a coin, a few heads in a row and you might expect that the next one is going to be a tail.
However, that is not necessarily going to be the case. We have a tendency to expect the law of large numbers, where things will tend to those averages, to apply to small sample sizes, and that is not always the case.
HP: OK. Let’s try and think about the data. Is there anything that we can draw upon which highlights the subsequent impact on investing at higher levels?
AJ: Good question. So, of course, equities have rallied significantly since their October lows and many investors will ask, have the gains already been had and have they missed the boat? And obviously history does show that the subsequent returns from high valuations are low. However, if we think on a more holistic level, investing around highs doesn’t necessarily mean you need to impair the ability to reach the goals.
We did a bit of analysis and we looked, from the year 2000 up until the present day, at the returns you’d expect from investing on any given day. So, we looked at one-, three- and five-year returns from getting invested on any given day. And then we compared that to investors that would only invest at an all-time high to compare the differences. And, actually, when you look across that, the differences are very small.
You know, it’s very difficult to draw any firm conclusion, but one is the importance of timing the market and not market timing. If you compare over one, three and five years, in most cases that five year is going to be far higher than it is in one. And so, I think, the importance is to remember that the long-term drivers, being economic growth, human ingenuity and technological progress, and keeping that in mind.
HP: Certainly those long-term perspectives are really important when it comes to investing. Let’s try and broaden out the conversation a little bit though. What can we expect next for equity markets, Alex?
AJ: Good question. And obviously when asked a question like this we typically look back at history to see what has happened and we think about the current market environment. Today, it’s interest rate cuts which is on the minds of investors and so we’ve looked back to see what are the impacts of recent rate-cutting cycles? What happens subsequently to equity market performance?
And looking at the US and looking across various different cycles, the picture that comes out is very mixed. It’s nuance that is important here. We find very large dispersion. In some cases, markets have rallied quite significantly and in others they haven’t, you know, they’ve fallen.
And what seems to be most important for that is what is the health of the US economy at the moment of the rate cuts? And that is going to be the key issue here, is as rates start falling, as we begin that cutting cycle, what is the state of the global economy at the beginning, during and after? That is going to be the likely determinant for equity performance.
HP: OK. So, what are the key takeaways investors should be focusing on at the moment?
AJ: So, I think it’s very simple. It’s the importance of getting and staying invested. It’s something that we repeat time and time again, which is that volatility is part and parcel of the investment journey. We’ve looked at intra-year declines versus calendar-year returns multiple times and we can see that, for any listeners that want to look into the Market Perspectives article, that markets can have bad weeks, months or years, but history shows that the value of equity markets has risen over time.
Of course, there are things you can do to position yourself in the shorter term. We can think about hedging. We continue to talk about the importance of diversification. And, you know, there is never a perfect time to invest, at least in the absence of hindsight. Nonetheless, we believe that getting and staying invested does provide investors with the chance of, you know, achieving those long-term goals of protecting and growing wealth.
HP: Well, thank you, Alex, for providing some context for the current investment environment and, of course, reiterating the importance of focusing on long-term goals.
Now, let’s move back to the week ahead, where the focus will be on today’s US retail sales number and Wednesday’s UK March inflation report. The retail sales numbers will give us a snapshot of the strength of the mighty US consumer, where we’re projecting a solid three-tenths of 1% month-on-month increase in retail sales, as demand continues to bounce back from the sharp declines that were registered in January. We also believe that longer-term demand should be supported by both income and wealth dynamics.
In the UK, we project that headline inflation will moderate. We think it’ll come in at 3.1% year on year in March, helped by an easing of food, alcohol and tobacco prices. We think that the core reading is also likely to decelerate. We’ve got it coming in at 4.1%.
With that, I’d like to thank you once again for joining us. I 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.
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