PHIL ATTREED: Hello and welcome to this the September episode of Monthly Market Insights. I'm Phil Attreed, Barclays Head of Wealth Specialists.
Once again, I'm joined by Will Hobbs, our Chief Investment Officer, as we try to unpack what's been happening in the investment world and what our investors can hope for in the weeks and months ahead.
So, of course, Will, it has been a challenging and reflective few weeks from many perspectives both here, of course in the UK, but also in the world's financial markets as well. So, from the investment team's perspective, what's the latest read on the state of the world economy?
WILL HOBBS: Yes, you're right on all counts, Phil, it's been exactly as you describe. With regards to the world economy. I'm afraid the news is still tricky, still challenging. This is still very much all about the battle to restore price stability. What I mean by that, what we mean by that is really trying to bring inflation back to heel and what it will take to do so.
So, a lot of what we're seeing at the moment if you remember back to the start of the year, the world economy entered, particularly the US economy, which is really where all the capital markets’ weather comes from, the US economy entered this year going at freight train pace. That very quickly became apparent that it was going too fast, that aggregate demand was swamping the ability of the economy to supply that demand.
The same story is happening elsewhere as well with slightly different details. And so central bankers have been trying to slow the economy and they've been raising interest rates extremely sharply by much more than market participants had expected. That makes for a very difficult capital markets backdrop.
The big questions really are now as we record are: how much short-term damage a central bank is going to have to do in order to bring inflation back to heel to restore that medium-term outlook? And when do we think the moment will come when they stop raising interest rates by such gigantic increments?
And the answer to the first one is: increasingly they'll have to do a little bit. The chances of a so-called soft landing, the US economy avoiding recession, are getting a bit slimmer. And in terms of when the Federal Reserve will pivot to a slightly less aggressive interest rate raising stance?
The answer is probably not yet. And so that makes for a very difficult capital markets backdrop; you're finding bond yields still rising, stocks still struggling.
There was a moment earlier in the summer when investors thought they saw the moment when central bankers would return to nurture mode, but unfortunately that was an illusion, a mirage. So yes, difficult times ahead still but at least the economy has begun to slow, I guess. It sounds like an odd thing to say in the current context, but there we go.
PA: Of course. therein lies the challenge for investment markets trying to price in both future risks and opportunities into different asset prices. But what are you and the team I suppose most worried about from the perspective of shorter-term investment returns?
WH: Yes, I mean. We're always worried about lots of things, that's our job to worry about stuff and to try and find where markets are worrying too much, where they're too optimistic, where they're too pessimistic, and try and profit from the difference on behalf of our many treasured clients.
But in a way, the thing that we're still worried about is really that inflation outlook. And remember that inflation remains a nebulous and hard-to-pin-down foe. It’s still poorly understood. If it wasn't, we wouldn't be in this situation, so ignore all those who are telling you exactly what comes next on that front.
And yes, I think the debate at the moment in the US in particular and this is similar elsewhere in some ways is that how high are interest rates going to have to go in the short term? And how big is the recession? Can we avoid a recession? And I guess that's the thing that keeps us up at night a bit.
There’s one aspect of the US economy, which is interesting which is that you're at the same level of unemployment that you were in 2019 roughly speaking, but the big difference is the number of open positions and how firms are competing for the very few people who are left looking for work and that is creating upward pressure on wages.
And that in terms is, if you look at the latest inflation print in the US, you can see that actually some of the wage-sensitive services type categories, they're the ones that you're seeing inflationary pressures build. So that's the big concern of the moment is: how far are central bankers going to go in order to necessarily restore inflation back to that 2% target?
Those arguing that we should not worry so much about inflation, look to Turkey as the contemporary example. There you’re seeing extremely unorthodox monetary policy experiments where the leader feels that cutting interest rates is the answer to inflation. It's not totally without substance: lower interest rates can help the supply factors so that can help beat demand. But that's just not how it works, unfortunately, in reality.
That’s really why we need to restore price pressures to more manageable, predictable levels, and that's really been the success of the last few decades and why we need to get back to in some ways from an inflation and central banking perspective. But it's going to be tough yards ahead. I think that's been our message for most of this year in some ways and that's what we're positioned for in portfolios, for things to get a little bit, for the macroeconomic environment to darken further a little bit.
PA: Yes, it all does sound a little painful in the months ahead and of course that provides some pretty good headlines as well. And those headlines provide very little to cheer, both over the summer and months ahead.
So, the question we often get back to is: why would you be looking to put money to work in investments even in a diversified portfolio right now, particularly in an environment where there's an expectation of higher returns on cash as interest rates start to rise?
WH: Yes, it's a very, very fair question. And I think I'd answer a number of ways. Yes, it can feel like nominal interest rates are risk-free, whatever they are at in the particular geography you're looking at and whatever time frame you're planning to lend to the government to or whatever other institutional or company. However, the first point to make is that that is part of the opportunity set that we incorporate into multi asset class funds and portfolios that we provide.
We take into account higher interest rates and how that affects, when we take each pound, dollar, or euro of our clients’ precious savings how we allocate it between the asset classes and that's part of the consideration is: what are the returns available in each particular space?
So, thinking about the available interest rate, that's something that's already incorporated into our thinking. I think the risk is that your double counting what we're already doing to a certain extent. Now, the other point which I think is probably the more important one is that interest rates, they do provide certain security, reliability, dependability, in nominal terms not in inflation-adjusted terms obviously.
In quite a lot of countries real interest rates are still not meaningfully beating inflation, so in real terms their savings are still going nowhere or they're still getting eroded by inflation.
But also, what you're missing out on is that call option on future human productivity, which is really about what the rest of your multi asset class funder portfolio is about: the ownership of companies and lending to companies and all those other areas which we really try and give the right level of access to because that is what drives really your inflation-beating returns over the longer term.
And in our opinion that call option on future human productivity, that's pretty attractively priced at the moment. Do we think there's going to be more productivity? Yes, of course, that is the big story, I think and the thing to remain focussed on in these very difficult moments, which is that we are very plausibly in the interregnum between the ICT revolution (the famous economist David Bloom pointed this out) and the wonders of the artificial intelligence revolution to come.
You've got to be in it to win it. So you can't just access all that wondrous productivity, the returns from that wondrous productivity, via interest rates, you need or just lending to governments or companies and so on. You need to have some ownership of companies and with that comes some risks, but over the longer term, we think that's really important to be able to take that risk with your long-term savings because it exposes you to the wonders of humankind.
I know we see a lot of humankind’s darker sides published on the media headlines you just talked about, but the real longer-term story, which is evident over several hundred years, thousands of years, is that restless innovation and capacity to change our surroundings for the better mostly, and to profit from, so to both drive change and to profit from it. That is the big advantage. I think that you can confer having not just exposure to interest rates but having exposure to stock ownership and other areas that we specialise in.
PA: Great. Thanks, as always, Will, for the insights. Thank you, our listeners for joining us. And if you would like to hear more between now and the next Monthly Market Insights, please do seek us out at our regular weekly podcast Word on the Street.