Phil: Hello and welcome to the April episode of Monthly Market Insights. I'm Phil Attreed, Barclays' Head of Investment Consulting and today Will Hobbs our Chief Investment Officer and I will reflect on the first quarter of the year and we'll also take a look forward to what might lie ahead. So Will, let's start with a few thoughts on 2021 so far. How would you characterise what's been I suppose quite an eventful start to the year really?
Will: It has been eventful and it's eventful outside my house as well, Phil, because they've literally just decided to start trying to put scaffolding up next door, so forgive the background noise. But I think the point is that we've had a very strong start to the year for stocks, diversified commodities, and an accelerating sell-off in core government bonds, gold and some of the superstars of the crisis in investment terms. Now the driving force here, we've discussed before you and I, it's two things really: The main central thing is a sharp improvement in the outlook for global growth but this is driven by two main things so far this year: one, you've seen a very sharp drop off in infection rates around many countries, now part of that is down to successful vaccination campaigns; the other bit is that there has been more and much bigger stimulus than had been priced into markets. And to give you a sense of how big the upgrade is, if you look at the US economy for instance and look at what was expected at the beginning of the year in terms of US output growth for 2021, it was just below 4% that's now nearly 6% in terms of consensus expectations so there's been a big growth upgrade and that has played through into capital markets in the way that we just described.
Phil: Quite. I mean it certainly has been a very strong start to the year for stock market building on I suppose what was a, to be honest, quite a staggering recovery from March's volatility back with the first instances of the Covid lockdown. One thing I suppose that has maybe surprised me a little bit is how resilient continental European stocks have been, what's proving to be a worsening of the situation in the region. What's your take on that?
Will: Yes, certainly the recent experience of continental Europe has been less favourable than US and UK, both in terms of infection rates and indeed the vaccine newsflow. Now the good news here is that case counts seem to be in the process of peaking, even in Paris which is one of the hot spots at the moment. You are also seeing an acceleration, much against the news headlines, you're seeing an acceleration in vaccination rates as well, which is very welcome. More broadly though I'd make a couple of points. So the first thing is, I think this is a media trap to a certain extent, but we need to be aware of trying to make too much out of the successes and failures of vaccine distribution as investors around the world. There are surely lessons to be learned here but it's also worth remembering that a year ago, the talking heads were prospecting for meaning in the very different case counts and economic outcomes seen around the world at the time in the opening exchanges of the pandemic. Then it was the UK that compared unfavourably. Then as now we would warn of the desire to derive lessons and judgment prematurely. This pandemic has certainly exposed some strengths and weaknesses in the broader design of many countries from societal to institutional. However, we will need time to distinguish between luck, both good and bad, and actual design flaw to the extent that such things can be seen as design flaws. Now the other point to remember from a purely investment perspective, I think is just remember that when you're buying an index or a company, you're not just accessing this coming year's profits. You're actually accessing all of future profits supposedly or our estimation of that mountain of corporate cash flows that might lie ahead of you. Now the point about that is that if you have some slight slippage in the vaccination campaign, for example, that represents more of a chip out of that massive cash flow mountain than anything more substantial. So you wouldn't expect a gigantic share price reaction to these slight slippages in reopening timetables.
Phil: Quite and I know that you've often highlighted that a good degree of higher profile data, I suppose both economic historically but also now Covid data, it's quite backward looking in nature by the time it's actually published and so rather than being useful as insight for future investment decision making. With that in mind, we've also spoken a little bit about inflation in last month's edition. We've done a pretty detailed Word on the Street podcast on that subject too. But do you think markets are maybe in danger of this type of extrapolation when it comes to inflation – so if the anticipated spike inflation comes that I think some forecasters are putting out there, do you think that it could unnerve the market or does the team maybe see it more likely that markets will look through, they'll take that in their stride, and look through to the other side if what I mean?
Will: It's a very interesting question, Phil, I mean we're certainly entering an interesting period for markets, I think I think you're right. And like you say inflation should pick up quite sharply in months ahead. In some part that's a function like you say of lapping the slump in inflation in price pressures that we saw in the onset of the crisis. The actual central bankers are telling us to relax, that they see some inflation coming but they see it as transitory; that they see it as a bump in the road rather than anything more permanent. But there are some credible voices warning of slightly more dangerous times from inflation. So for instance Charles Goodhart, formerly of the Bank of England’s Monetary Policy Committee, he co-authored a book where they look at some of the driving forces behind the disinflationary trends of the last few decades and they argue that a large part of it's to do with a combination of globalisation and demographics. What I mean by that is essentially China's accession to the world economy provided a mass of, a huge labour supply shock, so a gigantic amount of labour which is among many other causes seen as taking away labour market bargaining power in the developed world. Now their argument is that that labour market supply boom is gone and actually you could start to see it reverse in coming years and that actually just as the central bankers move to something called an average inflation targeting regime, because they've got so frustrated with trying to generate some inflation, they're becoming more accommodative in sense, that actually underneath, the slow-moving economic forces are actually moving towards a more inflationary environment. So there are threats out there; we've got to be aware. But I think we go back to that same point we always make which is inflation forecasting should be a low conviction activity. The Bank of England expressed this statistically at the moment, the confidence interval of their two-year inflation forecast is twice as wide as normal, so they see a one-in-three chance that inflation will be either above 4% or below 0% on a two-year horizon. That gives you some sense of that uncertainty. But I think the main message from us is keep an open mind, I think.
Phil: And I guess the point that you and JP and the team would be making is that by design, for those invested with us, the portfolios that we're managing, the multi-asset class funds that we're managing for our clients as well, they should be robust to both of those worlds that you point out, the one where inflation is suddenly a problem and also the one where potentially disinflation persists has also been talked about.
Will: Yes, I think that's exactly correct, Phil; you've spent too much time with us. We're deliberately doing the opposite of organising our assets as a macho bet on a single vision of the future. You need to be able to, the point really is you're trying to generate the maximum possible returns in a variety of macroeconomic paradigms not just a continuation of the recent past but the multitude of paths ahead that exist and will always exist and that is the point about diversified investing to a certain extent.
Phil: And it's not just me spending too much time either. Just to finish on there was actually a point of challenge actually from a client that we were with just the other day, challenging I suppose our views around future productivity, which you reference quite regularly. She'd actually come across an article referencing Robert Gordon, he’s a US economist known for his pessimism on the topic of productivity, I know that well, Will. But the argument there being that humans maybe have actually discovered and fully exploited most of the important inventions already out there. This of course goes against what the client had been hearing from you on a number of these calls and podcasts that we do. But of course if that were to be true, then a lower growth future of course could mean lower returns for a diversified portfolio as well. Some thoughts on that challenge?
Will: Yes, thank you, Phil. I'm loathe to go up against the big heavyweights in the economics world like Robert Gordon. But I there are lots of views here and I think it is really important as you say, productivity is literally everything when it comes to portfolio returns over the long term, so if that we are in a new world where all of the inventions have been done, exploited, and so on then you could, you should expect much lower returns from a diversified portfolio, I mean much, much lower. So Gordon’s pessimism like you say is based on the idea that the game-changing inventions of the past, like electricity, what's called general purpose technologies, they're behind us. Now the idea on top of this, he's not all alone in saying this, so the idea that good ideas are actually getting harder to find is backed up by some interesting work from some other academics, other equally famous academics who looked at declining returns of research and development since the 1930s. Now, however, what often is a very nuanced take on the subject in the original academic piece and Robert Gordon’s is a very nuanced take in a way, it can lose some of that nuance when it hits the media and the conclusions are simplified to a certain extent. Now to show how finely balanced they are, actually there's some recent work on the productivity story in the US in the 20th century trying to tell the story overall, because what Robert Gordon would argue is that productivity is very much weighted to the first half and afterwards you find this slow decline. And actually some revisions of the statistics show a much smoother line and that actually the great inventions of the past may have contributed less to measured productivity than the likes of Robert Gordon would argue. And the point there is that the sources of productivity are more diversified, more various than some have previously argued, and less centred on the need to come up with the great new, the electricity of today or the various other ideas. Now from my perspective, even if you were to go down that route, to argue that none of quantum computing, AI, all major breakthroughs in those subjects will remain elusive to us for kingdom come, I think that seems unrealistic or unrealistically pessimistic. The other thing, I think there's a couple of final really important points to make with productivity, which I think just slightly answer the question. The one, the central input into this story is us, not me, probably more likely you, but us as in humankind and the more of us there are the better life gets is the inference. Now there are really interesting multi-disciplinary studies looking at the first industrial revolution and the causes of the first industrial revolution. And there's no one answer here, there's a multitude of answers. But there's an increasingly growing or there's a growing argument that actually the birth of the industrial revolution lies in a surge in nutrition in the 1730s, a series of bountiful harvests and basically a generation is born in Britain which then comes to be the great inventors which change literally the history of the world. And some are pointing to that very direct link between well-fed, well-educated humans and the ability to innovate and generate new inventions. There's loads more I can say on that, I won't bang on about it but it's a really interesting subject and I think that's one thing. And you can go down the Stephen Pinker side and say: look in the bottom billion people there are, if genius is evenly distributed, there are a million people of genius level IQ. Now that becomes so important to grant those parts of the global population, education, opportunity and the ability to have those ideas. And you could argue even that the smartphones that we're using to record this, half the adult population something like it has a smartphone. You've essentially put the means of production into everyone's hands. I think it's very unlikely that no one's going to think of anything positive to do and we could all just spend our time being rude to celebrities and playing Candy Crush but I think others will use them more vitally. And the other thing I think is just like I say, the second point is really about focusing less on the big inventions, the big, famous, sexy inventions that we've all talked about the electricity, the computer chip, and so on, and a following surge in productivity. And actually the closer you look, the more it looks like just myriad inventions coming across all sorts of interlocking areas. So it's much less of that stop-start process and more a continuous process of innovation. There's loads more to say on it but I won't. But I think the major point to make is that I can't get too depressed about the future of productivity at the moment. I find it quite difficult to given all that I've read and all that I think I know on this subject. So I would challenge that and I do think that future returns are well based on the future of human innovation and productivity.
Phil: Well I have to say I much prefer living in Will's optimistic world and the better returns to portfolios that potentially that brings as well. Thank you as always, Will, for sharing your thoughts today. Thank you also to our viewers and our listeners for joining us. And if you would like to hear more from us before the next Monthly Market Insights, please do seek out our weekly podcast Word on the Street where we share all of our latest views on worldwide market developments. Otherwise, Will and I will be back with you next month.