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In Focus

Weekly market insights

Our weekly investment publication

Welcome to the latest edition of In Focus

In Focus is our weekly investment publication where we try and look beyond the noise of the present, and provide context for the longer term investor.

The publication includes a market report covering the week’s developments along with the latest perspectives from our Chief Investment Office.

The main articles focus on engaging topical issues with contributions from across our investments team including Behavioural Finance, Asset Allocation, Portfolio Management, and Manager Selection.

  • From the Chief Investment Office

    Brace! Brace!

    This week, we look at some of the recurring client questions around the economy and markets, and explain why some of the nervousness might not be warranted.

    1. What is the latest on the world economy after the data deluge of the last few weeks?

    We think the best way to view the outlook for the world economy (and its constituent parts) is as a range of possible paths. The team here is constantly updating the relative likelihood of these potential paths as new information and data becomes available.

    The central, most likely, batch of futures are best labelled ‘muddle through’. Here, inflation continues to unevenly subside, allowing central bankers in the US and Europe (including the UK) to begin cutting interest rates by the summer. Under this scenario, US growth slows a bit from the box office pace of last year, while Europe recovers, amidst the fading effects of some of the blows shipped in the last couple of years.

    On either side of that benign cluster of futures are some that could be classified either melt up or melt down. For the melt up, you can imagine rapid and broad take-up of the breathtaking advances in the technological frontier. Growth accelerates. Not just in the US, but more broadly as the breakthroughs in areas ranging from AI to Biotech to Solar, jumpstart productivity growth.

    We probably need less help in imagining the melt down scenarios, given our natural dispositions. However, perhaps this could come from a US commercial property bust rippling up the financial pipes to US regional banks, and beyond. Certainly, our in-house recession indicator remains elevated (Figure 1).

    Figure 1: Recession still ahead?

    Our in-house recession indicator is still suggesting elevated risk of imminent downturn.

    Source: Bloomberg, Barclays. Chart data from 1990 to 2024.

    The news flow and data of the last few weeks have not materially changed how we relatively handicap that range. Part of this is down to the fact that the statisticians in the US have been wrestling with the effects of their domestic winter storms. January data in particular look very lumpy, with some of that warping blurring February’s read as well.

    But from what we can see, the US economy still looks in decent shape and we are starting to see some welcome signs of life in cyclical indicators outside of the US. There are also proliferating practical examples from the world of business finding productive use for those aforementioned new technologies.

    2. So, are the major central banks still on target to start cutting cycles by the summer?

    Investors have latched on to a comment by President Lagarde of the European Central Bank (ECB) last week, where she pointed out that in terms of scheduled data releases, they “will know a little more in April, but a lot more in June.” That joins the latest data and central bank commentary pointing to mid-summer as the starting line for rate cuts at the Bank of England, European Central Bank, and the US Federal Reserve (Fed).

    Again, it is worth trying to think probabilistically here. There are certainly some scenarios where there are no rate cuts in the US this year. One interesting perspective here is the degree to which the experience of the 1970s weighs on today’s cohort of central bankers.

    These are decision-makers with a perhaps understandable eye on posterity. The tattered reputation of Arthur Burns, in the eyes of some the worst-ever chair of the Fed, and the man most responsible for letting inflation out of the bag during his time in the chair, may be influential.

    Premature easing of monetary policy is widely seen as one of the cardinal sins – it was one of the IMF’s seven stylised facts from 100 years of inflation shocks under the title ‘premature celebration’.

    So, even though this latest inflation shock looks ever more plausibly to be on the way out, central bankers in Europe and the US will likely want to be extra sure before beginning rate cuts. That is unless you see a significant swoon in the economic data.

    3. What does that all mean for the positioning of the multi-asset class funds and portfolios?

    Here, there are a few points to make.

    First, the last month has seen a bounce, both relative and absolute, in small and mid-cap stocks relative to large cap, in non-US (particularly Japan and Europe), and some of the less loved equity sectors including financials and materials. There is some fundamental grounding in this – the beginnings of an upturn in some of the cyclical data outside of the US could be important.

    In that core macro scenario outlined above, where the US economy continues to muddle through, you should see some of that macro heat help warm the rest of the world – that may make for a more inclusive market, broadening beyond the high-flying tech stocks known as the ‘Magnificent 7’.

    Second, our book of tactical, short-term positions is relatively flat at the moment. There will be periods like this, and we are instinctively against macho positions for the sake of them! The team is continuing to generate plenty of ideas of course, but it’s just that many of them are not making it through the necessarily rigorous gauntlet to final implementation.

    Third (and most self-servingly), the balance of those muddle through and melt up scenarios described above, would suggest this is a very attractive time to be invested (albeit never risk-free). If you are, ever more plausibly, in the foothills of the fourth industrial revolution, then you really do not want to be frozen out sitting in cash or short rates.

    Those higher short rates are part of the appeal of investing in diversified fashion at the moment, admittedly – higher yields helping higher overall expected returns. However, the main attraction is stocks as a gateway to human productivity just before it gets a major upgrade.

    Yes, there are some areas of overvaluation, and yes there are some names at the top which may even as we speak be birthing their own nemesis, as with Eastman Kodak and the digital camera.

    However, stocks in aggregate do not look intimidatingly priced and as the example suggests, there is plenty of democratising potential in this new batch of technologies starting to come online.

    The long-term case for investing remains robust, even if the short-term economic outlook looks uncertain. For more information, see our recent article: Why (on earth) invest now?

  • Quarterly deep dive

    Welcome to our quarterly deep dive. In this issue, we consider three possible scenarios for 2024, and explore the equity and fixed income asset classes in more detail.

    Article 1: What could 2024 look like? 3 possibilities

    In thinking about the year ahead for investors, the most helpful framework is to explore a range of possible outcomes. Here, we look at three such outcomes, and focus on the US economy, which will continue to set the beat for the rest of the world’s capital markets.

    Outcome 1: Boom

    The long-expected fourth industrial revolution is finally taking shape. We are already seeing some tangible signs in US productivity and other data.

    Under this scenario, the US economy not only refuses to buckle under the interest rate rises of the last couple of years, but actually continues to accelerate. Key here are continued brisk improvements in the reliability and functionality of the incoming technological frontier. In generative Artificial Intelligence (AI), this could be a realisation of the exciting advances in co-pilot tools, for example.1

    In this situation, inflation returns painlessly to target as extra demand coming from positive real wages is met by a more productive corporate sector. Interest rates (real and nominal) would likely trend at a higher level than seen in the years running up to the pandemic. 

    Outcome 2: Muddle through

    While coincident data is speaking of continued resilience in the US2 and indeed much of the global economy, leading indicators remain soft (Figure 1). The implication remains that a slowdown is still in the post. Under this scenario, the US and global economy do indeed slow as more of the interest rate rises enacted make it through to the wallets of customers and businesses. 

    Figure 1: A slowdown still ahead?

    Leading indicators such as the ISM survey point to a slowdown still ahead.

    Source: FactSet, Barclays. Chart data from 31/12/1997 to 29/9/2023.

    However, the slowdown is mild. The early cycle strength of private sector balance sheets is part of the mitigant, as is some continuing fiscal largesse from many of the world’s governments. Central banks begin cutting interest rates by the end of the first half. Real and nominal interest rates settle at a higher level than pre-crisis, thanks to a healthier private sector balance sheet mix, but only marginally. 

    Outcome 3: Bust

    This is ever the easiest scenario to imagine, conditioned as we are by gloom-hungry social and other media. Here we find that the effects of interest rates have simply been delayed not cancelled. Commercial real estate is one of the cracks that widens alarmingly, with over $100bn of commercial mortgages due to refinance this year. The stress feeds on up into US regional banks among other creditors.3

    The worsening economic situation in the US and elsewhere provides the operating space for right wing populists to take command in the US presidential and European parliamentary elections. 

    Some thoughts on the world outside of the US

    While the US economy remains the most important for the world’s capital markets by a distance, there will be other areas to focus on. China’s unfinished residential property crash is one such.

    So far, the economy has been protected to a degree by the backlog of unfinished developments. This has allowed builders to continue working on existing projects even as sales and new construction starts plunged lower (Figure 2). This remains a tightrope walk for policymakers, buffeted by heavy and unpredictable crosswinds. 

    Figure 2: Unfinished China property crash

    China’s economy has been protected to a degree by the backlog of unfinished developments despite sales and new construction starts plunging lower.

    Source: Bloomberg, Barclays. Chart data from 31/12/2013 to 31/12/2023.

    War, and all its attendant horrors, continues to rage on Europe’s eastern front. The continent’s economy should be helped by the continued ebbing of inflation, with the region’s central bankers likely able to ease policy rates in the first half of the year.

    The ebbing of inflation should continue to boost consumers’ inflation-adjusted wage growth. The democratic exit of Poland’s Law and Justice Party last year should provide some succour to those fearing inexorable decline into populist mess.

    There remains a gloomy consensus on the outlook for the economy, as there was last year and the year before.  However, the UK is now most of the way through choking down its jump in mortgage rates, and positive real wage growth could be more important than acknowledged here too.

    There is plenty that policymakers can do to help jumpstart the UK’s sluggish productivity growth,4 but the arrival of this new batch of technologies may provide some helpful impetus. 

    Conclusion

    Much like every year, it will be the things that weren’t forecasted at all that will dominate market pricing. This is a year where democracy is again on trial. However, the reminder from us is that the global economy is perfectly capable of doing its own thing, defying both stump box rhetoric and even implemented policy. That ‘own thing’ is most of the time, growth.

    More often than not, we find a bit more output for a given set of input of workers and equipment. This process is fuelled by the invention of new technologies and how we incorporate these into our lives. Happily, it is this often quite resilient trend, rather than the noise and bombast of the political sphere, that dictates the long-term returns from investments.

    There will be plenty of short-term distractions in the months ahead, and market volatility is to be expected. However, the long-term case for investing remains compelling, and that’s what truly matters against the backdrop of the three potential outcomes referenced above. 

    Article 2: What’s the outlook for equities in 2024?

    Why do I want to own equities at all?

    As usual, the act of putting your hard-earned savings to work in stock markets feels risky. Recessions, both economic and democratic, seem imminent (or may already be here in the case of the latter).

    This uninviting geopolitical and economic context is made worse for investors by the apparent insouciance of stocks. Even after a ragged start to the year, high stock market valuations in the US in particular seem out of kilter with reality.

    Besides which, many investors will point to the nominal returns now available in bond markets – more on that in the next article – and say that these (equity) risks are simply not worth taking. If I can get mid-to-high single digit returns from lending to some of the most reliable creditors on the planet, why would I buy a seemingly delusional stock market?

    The strategic reminder…

    The single most important fact to consider is the incoming fourth industrial revolution. Yes, bond markets offer more than risk-free return for the first time in a long time. However, what they don’t offer is the upside to further industrial transformation.

    This call option on future human productivity looks particularly attractively priced at the moment, primarily because the incoming technologies are finally promising something meaningful. Equities, more than bonds, offer investors a slice of this revolutionary action.

    But…

    Last year belonged to seven gigantic companies – the so-called ‘magnificent seven’. For many it will be hard to look beyond these modern titans. They already seem to have this incoming batch of technologies, and the future revenue streams which they bring, sewn up. While they appear expensive according to various metrics including price-to-earnings (known in short as P/E), if we incorporate the growth expected of them, then the froth all but disappears.

    There are risks here though. There is a growing threat from anti-trust and competition authorities for a start. Consumer prices are no longer seen as the only place where monopolistic behaviour shows up. Increasingly there is the realisation that aggregate productivity can also suffer when allowing industries to concentrate around one or two winners.5

    A scan of the history of major technological breakthroughs would also preach caution. The ultimate winners are often found a long way from the initial excitement.6 There is democratising potential in the current expansion of the technological frontier too – the toolkit that would help level-up the playing field for smaller businesses with some of those titans is starting to look compelling.

    The answer?

    Boring and mealy-mouthed though it may seem, the answer is to make sure that you are well-diversified in both sectoral and geographic terms. There are certainly worlds where the ‘magnificent seven’, and other similar firms, continue their jaw-dropping run of the last several years.

    These are companies that have certainly earned a degree of monopoly profits by dint of their excellence. However, there are also worlds where many of the factors that have enabled their multi-year trouncing of the competition (in share price and other terms) fall away and even reverse.

    Investment conclusion

    In our multi-asset class funds and portfolios, we tend to try and keep a foot in some of the dustier, less fashionable, corners of the stock market at all times. This means that, even when European stocks have been beaten handily by their US brethren for every year of the last decade (Figure 1), we maintain some exposure. The same goes for emerging markets and some of the other more unloved areas. 

    Figure 1: US vs European equities

    Returns from US stocks have beaten those from Europe most years this last decade.

    Source: FactSet, Barclays. Chart data from 31/12/2010 to 29/12/2023.

    The popularity of these spaces will wax and wane according to a range of different (many unpredictable) factors, from regulatory to economic. These trends can go on for years at a time and thus can begin to resemble eternal truths to our infuriatingly myopic industry.

    However, if past is prologue, a smoother investment journey can be enjoyed by those investors who carefully blunt the forces of price momentum within their multi-asset funds and portfolios. Broadly speaking, equities remain the workhorse of a well-diversified portfolio or fund and have an important part to play in 2024. 

    Article 3: What’s the outlook for fixed income in 2024?

    After a period of aggressive interest rate hikes by central banks around the world, inflation has fallen sharply, but without a substantial drag to the employment sector or severe hit to the US economy.

    Looking ahead to 2024, investors have many reasons to be optimistic about the fixed income universe:

    • Starting yields are high in both nominal and real (adjusted for inflation) terms.
    • Global supply chain disruptions have eased considerably, nominal wage growth has declined from record high levels, and commodity prices have also declined steadily.
    •  Lastly, global central banks (with the exception of the Bank of Japan) are in the process of transitioning away from aggressive tightening, to a phase of policy easing. In other words, interest rates should start falling across the board.

    Against this backdrop, let’s consider three potential scenarios that could face bond investors in the coming months. 

    Scenario 1: Economic boom

    Not only does the US avoid a recession in this scenario, but growth dynamics prove to be better than expected, which leads to somewhat higher inflation than the central bank target of ~2%.

    A composite of coincident US economic growth indicators (Figure 1) points to resilient real gross domestic product (GDP) growth slightly above 2% for the first quarter of 2024. Whether the conditions for this level of growth could be sustained  throughout the year, or whether there’s a further reacceleration, remains a tall order.

    However, there is a ‘risk’ (even if unlikely) of this scenario becoming a reality, driven by continued demand for employment, resilient household consumption7 and rising real wages. 

    Figure 1: Coincident measures of US economic growth suggest Q1 2024 US real GDP growth will be slightly above the long run average of ~2%

    The figure shows a composite of US economic growth measures.

    Source: Barclays, US Regional Federal Reserve Banks, Bloomberg. Chart data from 30/01/2004 to 31/12/2023.

    By using annual US retail sales growth as a proxy for consumption (consumers mostly spend from what they earn), investors can currently see the level is close to the average seen since 2000. US wage growth shows that despite the normalisation over the last year, wages are still rising at levels consistent with healthy economic activity.

    There is also evidence to show that US business dynamism is on the rise again after multi-decade declines. A surge of a similar magnitude took place in the 1990s, which was followed by a period of tremendous economic growth and productivity gains in the US.8

    Scenario 2: Muddle through

    In this scenario, US and global growth in aggregate remains anaemic, but escapes a severe economic contraction.

    Central banks are likely to cut interest rates in an effort to normalise monetary policy (maintain the desired level of restrictiveness as inflation falls). After all, in the view of central bankers, restrictive monetary policy has been successful and is close to achieving its objective of bringing down inflation to target (Figure 2).

    The attentive reader may question how much of the decline in inflation is attributable to central bank policy versus other factors. In reality, it’s difficult to know for sure. Central banks, and borrowers, will welcome the progress either way.

    Figure 2: Annual CPI inflation is heading towards central bank inflation target

     

    The figure shows annual changes in inflation since 2013 for the US, UK, Eurozone, and Japan.

    Source: Barclays, Bloomberg. Chart data from 31/12/2013 to 30/11/2023. *This measure excludes energy and fresh food.

    Scenario 3: Economic bust

    The US economy tumbles as the lagged effects of restrictive monetary policy start to blunt wider economic activity.

    In this scenario, bond yields decline the most, driven not only by precautionary interest rate cuts to tweak monetary policy, but also a reduction beyond current market expectations for 2024 (Figure 3) to soften the blow and aid the economic recovery from the prevailing slump/recession. This scenario would be a return to the countercyclical monetary policy seen by central banks post-2000. 

    Figure 3: Level of interest rate cuts implied by swap markets by December 2024

    The figure shows market expected changes in central bank policy rates by December 2024.

    Source: Barclays, Bloomberg. Chart data from 13/01/2023 to 10/01/24.

    The US employment market has historically strengthened at a slow pace, and deteriorated at a much faster pace. For example, since the 1950s, it has taken between 12 to 30 months for the unemployment rate in the US to rise from a local trough to a new peak, but it has taken between 11 to 110 months for the opposite to occur.

    There was a gradual, and orderly softening in demand for employment in 2023 as the US economy was normalising from its pandemic-related distortions. Looking ahead, we may see a more abrupt fall in demand for labour as corporates face historically tight credit conditions, higher debt refinancing costs, and the risk of slowing customer demand.

    In an attempt to bring down inflation, there is also a risk that central bankers remain too cautious in their decision-making, and allow interest rates to remain restrictive for too long, resulting in a more severe economic hit.

    Lastly, it is worth highlighting a note of caution when it comes to credit. Spreads – in other words, the difference in yield between government and corporate debt of comparable maturity – have tightened substantially over the last year and remain vulnerable to a reversal. However, this downside risk is somewhat mitigated by the relatively high coupon payments investors can lock in.

    Investment conclusion

    In summary, the outlook for fixed income appears brighter than it has been in a long time. Current valuations are attractive when compared to history, inflation is slowing, the US (the global growth engine) is showing signs of exhaustion, and the path of least resistance for most central banks seems to be skewed towards interest rate reductions rather than increases.

    However, as often remarked in previous notes, the key to successful investing lays in firstly, being invested over the long term, and secondly, having a diversified portfolio which performs reasonably well in all weather conditions, irrespective of where the economic cycle may be. 

    Fixed income exposure is, of course, a key ingredient to such a portfolio, complemented by stocks, credit, and alternative asset classes, such as commodities. What is different this time around, is the potential opportunity to receive more bang for your buck from your fixed income allocation, something which is currently reflected in our portfolios through a tactical overweight in developed markets (excluding Japan) government bonds.

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This document has been prepared by Barclays, for information purposes only. Barclays does not guarantee the accuracy or completeness of information which is contained in this document and which is stated to have been obtained from or is based upon trade and statistical services or other third party sources. Any data on past performance, modelling or back-testing contained herein is no indication as to future performance. No representation is made as to the reasonableness of the assumptions made within or the accuracy or completeness of any modelling or back-testing. All opinions and estimates are given as of the date hereof and are subject to change. The value of any investment may fluctuate as a result of market changes. The information in this document is not intended to predict actual results and no assurances are given with respect thereto.

The information contained herein is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. The investments discussed in this publication may not be suitable for all investors. Advice should be sought from a financial adviser regarding the suitability of the investment products mentioned herein, taking into account your specific objectives, financial situation and particular needs before you make any commitment to purchase any such investment products. Barclays and its affiliates do not provide tax advice and nothing herein should be construed as such. Accordingly, you should seek advice based on your particular circumstances from an independent tax adviser. Neither Barclays, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of or reliance upon this publication or its contents, or for any omission. Past performance does not guarantee or predict future performance.

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