PHIL ATTREED: Hello and welcome to the December 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 and we're going to be exploring what's going on in the world of investing.
So, Will, we've certainly seen more volatile markets this month than investors have probably been used to now for some time; the Omicron variant alongside an apparent change in tone from US central bankers in particular are clearly the main culprits but what are the team's views at the moment?
WILL HOBBS: I think, Phil, the experts have long warned us that this pandemic, the variant sting in this pandemic's tail could be a shock to markets at some point and that certainly proved to be the case a little bit so far.
Certainly the emergence of the Omicron variant is part of that volatility story you're talking about. The data we have on Omicron in terms of this is very young, it's very new and so we don't have many data points which means that the story those data points are telling is volatile and shouldn't be listened to too closely just yet.
We just need more evidence basically but in terms of epidemiological gossip, if there is such a thing, most experts seem to be saying that in terms of transmissibility, it does look like Omicron is at least as transmissible as Delta if not more so, so this will continue to be a variant of concern. That means there is a danger that it will out compete Delta essentially.
But on the potentially more positive side then, like I say it's incredibly tentative don't take this too strongly, the incoming information they have at the moment is that it could be a little bit milder in terms of disease than severity versus Delta. Vaccine efficacy information is coming over the next few days and weeks; we'll get more information on this but again the inferences people are drawing from hospitalisation data, the age cohorts of people being hospitalised, is suggesting that the vaccines are going to provide some kind of protection.
So the current view here is broadly speaking that there is going to be a hit to certain types of activities, it will impede normalisation, but it won't cancel it all together. And I think that's the important point. So you're looking at shifting timings of certain things but not necessarily something yet that investors should get too het up about.
The central bank debate is interesting at the moment maybe just to me but there's some interesting bits about it. The fact is that if you're thinking about how to measure the degree of generosity from the central bankers, you've got to look at monetary policy in real terms i.e. adjusting for inflation.
Now if you look at this, viewed from this angle you can see what's happened over the last couple of years is that monetary policy became very generous right in the teeth of 2020 but actually since then the economy has recovered really briskly.
You're looking at the unemployment, everything, thanks to policymakers' support you've seen a really very sharp recovery in activity and so on. However, basically because inflation and expected inflation has been moving higher, faster than the market's expectation of normalising interest rates and monetary policy, the actual monetary medicine we've been delivering to the economy has been getting stronger, as the economy has been getting better. So that is something that central bankers are looking at and you can expect that it won't stay the case for long.
We suspect that next year is going to be about normalising those real interest rates a little bit.
PA: And of course markets and investors and experts are having to get used to this new newsflow and obviously the reaction that we've seen from investment markets and individual assets is, whilst a little bit more volatile, there's not been of any of the kind of magnitude that we saw last year at the peak of Covid.
But it does seem like oil and cryptocurrencies like Bitcoin are probably most notable just for the sheer violence of the movements that we've seen in those in particular.
WH: Yes, you can link a supply story here in a sense. I think, oil if you talk to the experts in this space, they would argue that oil prices almost immediately or very swiftly incorporated the darker scenarios associated with the Omicron variant.
So I saw one analyst suggesting that if you look at front-end pricing and inferred the barrels of oil of demand that you were taking out of that demand inferred by that price move, then essentially you're assuming three months with plane free skies.
Now there are a lot of moving parts here, you can't really say it so precisely; I'm just trying to give you an idea of the scale of the pullback.
I think there are others though pointing to other things to take into account. Now I'm speaking about: it's shale oil's budgeting season right now and what that tends to mean is that, if you think about it, these guys are trying to make a profit like everybody and they're looking at the oil price and saying, 'with my slightly higher costs of production should I think about that particular geology or reopen that well' or so on.
And so to a certain extent in OPEC, it might be in their interest to have slightly lower or more volatile oil prices around this time that's just one potential input.
The point there I think is about investing in supply and this is a key story with regards to all of commodities to be honest or many commodities, which is that particularly the old economy, the less green ones. Not only has that space provided very poor returns over the last several years, decade even, and that has made attracting new investment quite difficult but also our environmental objectives have made it quite difficult to attract new investment into the space.
Now the reality is that we know we're going to need some fossil fuels and some of that stuff to get to that cleaner economy and we need to access it as cheaply as possible. That story probably still stays with regards to commodities a little bit or at least the upside case.
With regards to Bitcoin and again it's a kind of supply story isn't it to a certain extent, which is: the attraction of Bitcoins and other coins with a finite supply built into their algorithm, what's the attraction of that relative to money which is under the control of central banks and various other political actors let's say. Not that central banks are political but you can see what I'm saying about, other kinds of authorities.
The big worry about or the big thing that Bitcoin was answering is: don't debase my money, don't print lots more money and therefore devalue the value of something in my pocket and Bitcoin was supposed to be in part an antidote to that.
Now the point about what you're seeing, what I just mentioned with regards to the outlook for real interest rates as some are speculating, that if Bitcoin and other assets have prospered in a world where liquidity or capital was abundant and cheap and real interest rates were falling, then what happens if that world is reversed?
That now you have central bankers talking a little bit about what real interest rates need to head up and that capital needs to get a bit less cheap, how does Bitcoin do in that? So there's lots of stuff going on in this; it's not easy to characterise as one narrative but I think real interest rates is a really important story to look forward for a lot of reasons and a lot of assets.
PA: Quite. Referencing that point about central banker generosity in particular, next year should, as you say start to see central bankers maybe removing that proverbial punch bowl a little bit more, so basically getting a little less generous.
Interest rates also there's certainly expectation that they should start to rise with quantitative easing support being wound in a little, what should we expect by way of investment market response to that kind of environment?
WH: I think it's a fair question, Phil, we don't want to be too confident here. I think the people are making comparisons and pure valuation between stock markets now and stock markets in the late 1990s before they went 'pop' quite viciously with the tech bubble.
Now yes, in absolute terms, that's true but I think the point that everyone makes all along the while is that the relative story is very different. So nominal interest or long-term interest rates, the discount rate, the risk-free rate of return, whatever you want to call it, they were 6% in the late 1990s, there are there abouts. You look at them now, the 10-year yield is less than 1.5%, so in real or nominal terms the comparison with interest rates is entirely different.
But I think our point would be that interest rates, stocks have scope to absorb higher real interest rates, but what it might well do is change the leader board. So which areas of the market prosper versus those which don't.
There are some other points to make as well and I think with regards to your outlook, it's not all of this stuff. You want to be able to separate it out and say: 'Well this leads to this and that leads to that'.
But as we know they all interact with each other in complicated and sometimes unexpected ways – think about your near-term and your long-term outlook as the broad edges of the stream and everything else is possible in between and at the bottom, less positive area.
You could say that maybe Omicron is a blow that further or more permanently darkens our approach to saving and investing or how we think about risk more generally and you get that story of pandemics past where consumers and businesses are just a little bit more conservative for a longer time and that's long term. It's deflationary even if we don't know what happens in the near term with inflation and Omicron because of what it might do to important supply countries and so on.
But on the upside as we've said that there is this productivity story, which is particularly interesting at the moment.
Just look at the Healthcare angle and advances in how Healthcare is dispersed but also treatments, vaccines, we really could be on the cusp from what you hear from some experts in the space of breakthroughs that have the chance to transform the lives and productive potential of a much larger slice of humanity and this again to me is part of a kind of growing evidence locker that points to how productivity and innovation happens and happens on a sustainable basis.
And this is the big question of all economists and economic historians and anyone besides it's 'the' question basically: how does productivity happen and why does it continue?
And there's the pessimistic case which you and I have discussed a lot which says that: look at the long sweep of human history, the thousands of years of human history where nothing much happens, and then you get this little blip of productivity which is the outlier they will argue.
From the 18th century to now that's the outlier and actually we're just about to return to those thousands of years of stagnation from this fact and they point to this story.
However, to me I think, from my little perch, that might misunderstand or risk misunderstanding the nature of why productivity happens.
And I think the more attractive story to me anyway is that actually the reason why you get millennia of stagnation followed by this pickup is that knowledge, the type of knowledge that we needed to accrue, not just instincts, but knowledge that explained the world and the universe around us.
The causal power of this kind of wave of knowledge, building wave, it required a couple of things: (A) Ability for us to be able to codify it and write it down so that we can build on it and not go backwards but (B) it was about finding the ability to use that knowledge profitably, how to do and it just took a while for that causal power to gather.
But once it has gathered, its power is almost infinite; its limits are not knowable from our little standpoints right here. And I think the point that's really important though is not just the codification of that knowledge but the thing that really changes and sets it off in the 18th century and still today is the idea of error correction, our ability to be on the wrong path but for people to criticise and to find a better way and to look to find a better path, or how to error correct.
And that is difficult, that required the scientific revolution to happen and that is a key part of that build-up of that explanatory or propositional knowledge that has taken us far. Sorry I'm on the same rant again but it is important.
PA: Absolutely, Will, but moving away from history to the present day, I guess playing devil's advocate as well: aren't we at risk here?
So the technological advances that we've seen in just this last decade or so particularly around things like social media, have they not allowed us to retreat into little microcosms, little echo chambers that essentially actually reduce the opportunity collectively to error correct as you say, as we become more homogeneous in our views?
WH: Yes, Phil spot on. This crisis and not just the policymaker response of asking us to go behind locked doors, but also the technological response, we've been driven further into these kind of little citadels of agreement. I agree entirely.
And that is essentially the opposite, the antithesis to error correction to be able to put us into the framework where we can actually see stuff. And I think the point about this is that whatever answers we may have or think we have for the world around us as it stands, those answers will need to evolve to fit, to your point, what happens the unknowable aspects of the future.
And history proves that the tradition of criticism is central to that ability to error correct. I'm not talking about the anonymous bile that seems to prosper on much of social media but the idea of evidence-based challenge, the kind that is not distinct from civilised debate.
And in a sense you can think about the liberal democratic model, is seen by some as the political version of our error-correcting capability. The bet is essentially that democracy, it limits the damage, or it assumes that the damage that can be done from an electorate, the ever-changing whims of an electorate is significantly less than the damage that could be done by the whim of an individual unchecked by the power, by the threat of deselection. And that's basically the bet. But if you look in the year ahead, there are risks.
Populations can go for options that are not in their interests in a sense that's always the risk. But over time democracy has proved good at that even; it weeds out the worst selections rather than permanently optimising for the best ones. You can look out for the French elections on that obviously.
But on the other side two of 2022's big threats are with regard the territorial mores of a different governance model: the straits of Taiwan and the Ukrainian border or two areas where we hope that self-interest and logic would prevail. But there are risks there.
PA: I guess those are certainly some of the risks, aside from what we've already mentioned earlier on, that we may well face ahead in 2022. But what about some of the positives that we might also benefit from as we look to next year?
WH: Well from the economic standpoint, there's plenty of positive dry powder on the side-lines. Still businesses are running very low stockrooms so there's a huge inventory build that is set to help the economy at some point next year.
There is also the prospect of those excess savings that many people have talked about. Now in various countries, they're skewed differently in terms of who actually has these excess savings, but that's again something that could be quite forceful in pushing the economy forward over the coming year.
And also the reality over the course of next year, we will see the oral treatments for Covid ramp up and that could be a significant, hopefully final blow for this pandemic. I'm not saying that we're not going to live with the coronavirus for some time, this latest coronavirus, for some time. But that we could start to see a more meaningful return to normality as those Covid pills start to spread around the world.
Those are all positive things and the other side I would say is: take some pride where you can on the fact that accumulated scientific knowledge when met with the right incentives led us to these incredible healthcare solutions of the last two years, which have taken us into a completely different place to where we would have been if the context was the same healthcare context that you had in the 19th or 18th or any other century.
That does show, it illustrates some of the technological capabilities and I would say that we are entering the fourth industrial revolution. I think that's the point and that for investors tends to be a pretty good time to be invested, even if the wider society can be a little bit turbulent.
PA: Absolutely, healthcare innovation being one of those investing for innovation themes that we spoke of over the summer months and wrote numerous articles as well.
Will, as we head into the end of this year, thank you again for your insights, and thank you also to our viewers and listeners for joining us.
If you would like to hear more from us over the course of the next month or so ahead of the next of these episodes, please do seek out our weekly podcast Word on the Street, where we share our latest views on developments. Otherwise, Will and I look forward to being back with you in early 2022.