Hello and welcome to the May episode of Monthly Market Insights. I'm Phil Attreed, Barclays Head
of Wealth Specialists. And once again, I'm joined by Will Hobbs, our Chief Investment Officer. Now,
it appears we're set to remain in a relatively disorientating period for
the world economy and for the investment markets that reflect what is a rapidly evolving outlook.
Central bankers are raising interest rates in a way that we haven't
been seeing for decades as the battle obviously against inflation has stepped up several notches
in recent months. So much so that actually many are now warring about
any forthcoming or the next recession. So we're talking a little bit about that today,
Will, also the latest on Ukraine and obviously the evolving situation with China's Covid
outbreak as well. So maybe we start with the central bank piece. We've had Bank of England
and the Fed raising interest rates this week. You're even seeing interest rate rises drawn
nearer in Europe as well. Will, have we learned much new from this information over this week or so?
It's a good question, Phil, a good starter for one as they say. I mean,
you're right and your introduction just saying, viewing as you and I know well,
we've said this before but viewing markets through the prism, viewing the world through the prism of
capital markets is a disorienting experience at the best of times and these are not they.
But from a central banking perspective, let's start that like you say. In the US there was
a bit of a very, very short-lived relief that the central bankers didn't go with the 75 basis point,
they just went with the 50 basis point rise. That point alone illustrates how far we've travelled
in terms of rate expectations so far this year. It continues as a result to be a horrible period for
government bond investors, traumatic even, really a change in what most government bond investors
have experienced in the last few decades. In the US you are likely to see more coming
as well. There are still more 50 basis points rate hikes expected and as we've been discussing
on Word on the Street, there are maybe some signs in the US that inflation is peaking a little bit.
Certainly you are going to see over the summer some incredibly muscular forces
trying to drag inflation back towards the ground a little bit. It's certainly those,
as we lap those, the effects of those stimulus checks that should be a significant
influence pulling inflation forces down. However, the big question really at the
moment is, amongst bond investors and central bankers a little bit is: to what extent will
the US central bank accept slightly higher than previously seen inflation in order to
avoid crashing the economy. And this like you say, it's the other big market narrative at the moment.
Are all these interests rates are they going to run the economy into the sand, US and global?
And I know we're humble enough not to make any hard predictions here. But are we
seeing any chances of the next recession evolve, is that something that you and the
investment team are looking at, thinking about? We hear lots of seemingly credible commentators
talking about how it's unlikely that we can avoid a recession given both the interest rate
rises that we've had but also those that many are obviously predicting in the months ahead.
Yes, one of the many lessons you might take from the last few years you and I is that you
don't want to get too busy rubbernecking the political and economic accidents in the road
ahead. What will be will be and investment markets don't always behave as you might expect in those
circumstances. And anyway at the moment, the point we'd make to clients, as you know, is that
your eye line should be well above the next recession if it's a year away, let's say.
But I think on this point specifically, yes, interest rates are a very blunt tool and usually
do come with lots of unintended consequences. So, some indication of that could be seen in the fact
that actually since the 1980s, that was when you saw the so called Volker shock. So Paul
Volker, the legendary central banker in the US, tamed inflation by raising interest rates to 20%.
Now since then, actually you've seen that there's not much of the co-movement that you might expect
or much of the relationship you might expect with regards to interest rates and inflation.
You might expect as interest rates rise, inflation falls because that's the intention
of interest rates. They're meant to slow aggregate demand and re-plug aggregate demand into aggregate
supply, the available supply in the economy and so get price pressures under control a little bit,
get everything travelling in equilibrium. But actually you find weirdly that inflation
and interest rates have often travelled in the same direction for periods of time.
So you can find that rising interest rates comes with rising inflation. Now the point here again
is a little bit of humility because what you can find is that interest rates can for a
load of reasons affect both demand and supply and therefore the relationship is really complicated.
I think what you're seeing at the moment in the US, that's the other thing to bear in mind is it's
not gentle. This is not the interest rate rises we've become used to in the last few decades.
This is something the Federal Reserve is trying to engineer a materially tighter kind of monetary
backdrop in quite a short space of time. Demand for everything has to cool quite rapidly, workers
included. So you should see unemployment rise and those kinds of things. So yes,
there are risks and there's many very garlanded names talking about the risks of a recession.
But as an investor, I guess the key point we get to and I'm sorry, waffly long answer as usual but
the key point what we do as investors. Now, I think there’s probably two things. One,
and again, this is the point we've made before but this is where the word “recession” is not that
useful. It's similar to “cake” or “dog”. There's many types of dogs and cakes
some friendly some less so on both cases and it simply doesn't tell us that much useful for an
investor because the word refers to such a broad range of experience from the economic horrors
of 07/08 to recessions, which don't really even have a name because they're statistical only.
We could take some consolation from the fact that the worst recessions in the past have
tended, not always, tended to be preceded by a build-up in economic success. And therefore
you need the purgatory forces of a recession to come along and correct those imbalances.
That's not the case that we see right now. So actually which gives you, on to your second
point, the US and this is remember the motor for, the keystone for the world economy,
the most important capitalist economy by a mile. The US enters this period still in really very
robust health with lots going for it particularly the private sector companies and businesses.
The balance sheet health is sensational so, you have got a lot going for it.
But it's a complicated time for investors. There's no doubt about that. And what you're
seeing in the bond market at the moment, which I think is so interesting is that you're seeing
investors suddenly start to look at compensating longer term lenders to the government for a bit
more risk of inflation, which is an important moment, I think. Sorry long-winded answer but okay
don't worry, focus on other stuff.
I’ll remember the analogy anyway, the cake and the dog analogy.
The two things on my mind!
How is the situation maybe a bit different in the UK and for Europe?
Yes, it's a lot different in the UK and Europe. Some of that strength is just not there,
particularly in the UK. The latest data points in Europe, the services sector is still showing some
sort of recovery from the Omicron blows. But the problem there of course is you're seeing in the
last couple of weeks is this gas supply story. There is still the potential for that to be
cut off and that would plunge the European economy into economic darkness for a short while.
The damage would be most grievous on those sectors that are most reliant,
so paper industry and so on, on gas supplies, and you're seeing accelerated plans to try and
wean the economy off that Russian gas reliance. And in the meantime, you're seeing this debate go
on, you've seen the discussion about the currency that Russian companies want to be paid in and
this debate about, it's been taking up Poland and Bulgaria in the short run.
So, there is that concern that could really change things quite quickly. In the UK,
we've had the Bank of England this week. And I mean it's interesting, but
the market had been expecting quite a lot of the Bank of England in the months ahead
and you and I discussed this on Word on the Street and other media over time, the team
have long believed that the market is being too optimistic or expecting too much of the economy
in the idea that it can take so many rate rises without swooning, without aggregate demand really
plunging and that is proving to be the case today. So you've seen an interest rate rise from a very
conflicted Monetary Policy Committee. It's not of one mind at all, but you've seen that and the
market is burying Sterling because what you're seeing across the bond market is that the market
has taken out one rate hike so far but that is really in deference to the idea that the
UK economy is too weak at the moment and for the next few months ahead to be able to take
much in the way of the rate rides as you're going to see or should see, or likely see in the US.
And in the UK and Europe, whereas you are seeing a peak or potentially a peeking inflation in the US,
that peak looks to be a bit further away in the UK, you're seeing the regulator is going
to give us another gift sadly, particularly the poorest households towards the end of the year,
so you're not going to see a peek in inflation in all likelihood until much later on in the year.
And you've got this very tough summer ahead in terms of real disposable income with
these, oil and energy prices really sapping the consumers’ strength. So tough times ahead for
the UK. There's no doubt about that. And that is why you're seeing very different market reactions,
but happily, although obviously we're vested in the UK economy doing well, the team is
necessarily dispassionate so far that's been a good position in portfolios to be underweight
in Sterling relative to G10, its G10 peers, and that's making money for the portfolios today.
And to complete the global picture, we shouldn't forget China. It's been a very tough period for
China year to date we've seen the first material Covid outbreak since the beginning of 2020 there,
the economy was already fairly wobbly. So are there any concerns of worsening there and what
that might mean in terms of knock-on effects?
Yes, it's a good question, Phil. There are some
very welcome signs that this current wave of Covid is peaking, many may be a little bit wary
maybe understandably of the case data, but if you look at mobility statistics and real-time data,
you can see some improvement suggesting that some of the lockdowns are easing.
The economy is far from out of the woods though as we've been saying, the problems
highlighted by the property market blow up of last year, the Evergrande affair, they remain, and you
are still seeing and will likely see for some time yet snap lockdowns as China's policymakers
continue to battle this much more transmissible variant. I think that's the main thing.
But China is just not as important for the world economy in its capital markets than the US,
and we all want China to do well, we all want the world economy to do well. But it's just less
important from an investor's perspective. The other point to make here just from a
portfolio perspective is that we are actually underway EM (emerging markets) equities relative
to DM (developed markets) equities. So again, China's plight is being a little bit helpful,
even though we are necessarily dispassionate but that again has been helping portfolio performance.
And I suppose lastly on that point, are there any particular changes to positioning that you
and the team are considering amongst all of what we've just talked about?
Yes, the main one that's been put on this month has been, actually we've taken out
a net overweight to developed equities and replaced it with a relative value
trade between development market equities and emerging market equities.
So your overall package of positions in the Tactical Asset Allocation (TAA)
is probably slightly negatively tilted in terms of bad news being better than good.
But not materially so but as we entered this period we thought that strong directional views
are probably not the way to go and so have moved into that relative value area a little bit more.
The other one, which we're watching very carefully obviously, is that open Sterling position.
It's now moved, some distance from where we put on the trade so it's just one to watch. I think
there's a lot of data coming up; there's a lot of stuff happening in the world economy in the coming
months, outside of the unpredictable unknowns of Ukraine, you've got giant forces pushing
and pulling the global economy. You've got this central bank context we have not seen for decades.
So it is a really interesting time to be an investor obviously and this is where the team
does their best work, so that's the good bit. But otherwise, we must hope that the various
people suffering the various blows around the world economy from Financial to
Healthcare that's something we hope moves on quickly and we get to better times.
And of course your reference to being slightly negatively tilted assumes that a client is already
fully invested. So, it's absolutely not suggesting that we should be negative. But that actually
that's a negative tilt to a normal position.
Phil, that's a very good point to finish off
on because obviously the size of the positions relative to your overall asset allocation, the
Tactical Asset Allocation is tiny. We could only necessarily muster small confidence in those kinds
of views, really it continues to be the Strategic Asset Allocation that you need to take solace in.
That's where it's got diversified commodities and all sorts of
other assets to be able to smooth your journey and that continues to do pretty well in the current
backdrop, but that's really where the meat and drink of your portfolio returns is.
The TAA just looks to provide a few class-A cherries, let’s say.
Fantastic. Thanks. Useful as always, Will, and thank you to our viewers
and listeners for joining us today. If you would like to keep in touch with our views
over the course of the next month, please do check us out on our podcast Word on the Street.