Morningstar Insights: Don’t Get Caught by These 10 Behavioral Pitfalls

Successful investing requires a rare ability to overcome one’s own psychological weaknesses–but you have to identify them first.

Successful investing is hard, but it doesn’t require genius. In fact, Warren Buffett asserted that it’s not so much raw brain power you need, but temperament “to control the urges that get other people into trouble in investing.”

As much as anything else, successful investing requires something perhaps even more rare: the ability to identify and overcome one’s own psychological weaknesses.

Over the past several decades, psychology has permeated our culture in many ways. In more recent times, its influences have taken hold in the field of behavioral finance, spawning an array of academic papers and learned tomes that attempt to explain why people make financial decisions that are contrary to their own interests.

Experts in the field of behavioral finance have a lot to offer in terms of understanding psychology and the behaviors of investors, particularly the mistakes that they make. Much of the field attempts to extrapolate larger, macro trends of influence, such as how human behavior might move the market. In this article, we’d prefer to focus on how the insights from the field of behavioral finance can benefit individual investors. Primarily, we’re interested in how we can learn to spot and correct investing mistakes in order to yield greater profits.

Following are 10 of the biggest psychological pitfalls.

1. Overconfidence

Overconfidence refers to our boundless ability as human beings to think that we’re smarter or more capable than we really are. It’s what leads 82% of people to say that they are in the top 30% of safe drivers, for example. Moreover, when people say that they’re 90% sure of something, studies show that they’re right only about 70% of the time. Such optimism isn’t always bad. Certainly we’d have a difficult time dealing with life’s many setbacks if we were die-hard pessimists.

However, overconfidence hurts us as investors when we believe that we’re better able to spot the next  Amazon.com (AMZN) than another investor is. Odds are, we’re not. (Nothing personal.)

Studies show that overconfident investors trade more rapidly because they think they know more than the person on the other side of the trade. Trading rapidly costs plenty, and rarely rewards the effort. We’ll repeat yet again that trading costs in the form of commissions, taxes, and losses on the bid-ask spread have been shown to be a serious damper on annualized returns. These frictional costs will always drag returns down.

One of the things that drives rapid trading, in addition to overconfidence in our abilities, is the illusion of control. Greater participation in our investments can make us feel more in control of our finances, but there is a degree to which too much involvement can be detrimental, as studies of rapid trading have demonstrated.

2. Selective Memory

Another danger that overconfident behavior might lead to is selective memory. Few of us want to remember a painful event or experience in the past, particularly one that was of our own doing. In terms of investments, we certainly don’t want to remember those stock calls that we missed much less those that proved to be mistakes that ended in losses.

The more confident we are, the more such memories threaten our self-image. How can we be such good investors if we made those mistakes in the past? Instead of remembering the past accurately, in fact, we will remember it selectively so that it suits our needs and preserves our self-image.

Incorporating information in this way is a form of correcting for cognitive dissonance, a well-known theory in psychology. Cognitive dissonance posits that we are uncomfortable holding two seemingly disparate ideas, opinions, beliefs, attitudes, or in this case, behaviors, at once, and our psyche will somehow need to correct for this.

Correcting for a poor investment choice of the past, particularly if we see ourselves as skilled traders now, warrants selectively adjusting our memory of that poor investment choice. “Perhaps it really wasn’t such a bad decision selling that stock?” Or, “Perhaps we didn’t lose as much money as we thought?” Over time our memory of the event will likely not be accurate but will be well integrated into a whole picture of how we need to see ourselves.

Another type of selective memory is representativeness, which is a mental shortcut that causes us to give too much weight to recent evidence–such as short-term performance numbers–and too little weight to the evidence from the more distant past. As a result, we’ll give too little weight to the real odds of an event happening.

3. Self-Handicapping

Researchers have also observed a behavior that could be considered the opposite of overconfidence. Self-handicapping bias occurs when we try to explain any possible future poor performance with a reason that may or may not be true.

An example of self-handicapping is when we say we’re not feeling good prior to a presentation, so if the presentation doesn’t go well, we’ll have an explanation. Or it’s when we confess to our ankle being sore just before running on the field for a big game. If we don’t quite play well, maybe it’s because our ankle was hurting.

As investors, we may also succumb to self-handicapping, perhaps by admitting that we didn’t spend as much time researching a stock as we normally had done in the past, just in case the investment doesn’t turn out quite as well as expected. Both overconfidence and self-handicapping behaviors are common among investors, but they aren’t the only negative tendencies that can impact our overall investing success.

4. Loss Aversion

It’s no secret, for example, that many investors will focus obsessively on one investment that’s losing money, even if the rest of their portfolio is in the black. This behavior is called loss aversion.

Investors have been shown to be more likely to sell winning stocks in an effort to “take some profits,” while at the same time not wanting to accept defeat in the case of the losers. Philip Fisher wrote in his excellent book Common Stocks and Uncommon Profits that, “More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason.”

Regret also comes into play with loss aversion. It may lead us to be unable to distinguish between a bad decision and a bad outcome. We regret a bad outcome, such as a stretch of weak performance from a given stock, even if we chose the investment for all the right reasons. In this case, regret can lead us to make a bad sell decision, such as selling a solid company at a bottom instead of buying more.

It also doesn’t help that we tend to feel the pain of a loss more strongly than we do the pleasure of a gain. It’s this unwillingness to accept the pain early that might cause us to “ride losers too long” in the vain hope that they’ll turn around and won’t make us face the consequences of our decisions.

5. Sunk Costs

Another factor driving loss aversion is the sunk-cost fallacy. This theory states that we are unable to ignore the “sunk costs” of a decision, even when those costs are unlikely to be recovered.

One example of this would be if we purchased expensive theater tickets only to learn before attending the performance that the play was terrible. Since we paid for the tickets, we would be far more likely to attend the play than we would if those same tickets had been given to us by a friend. Rational behavior would suggest that regardless of whether or not we purchased the tickets, if we heard the play was terrible, we would choose to go or not go based on our interest. Instead, our inability to ignore the sunk costs of poor investments causes us to fail to evaluate a situation such as this on its own merits. Sunk costs may also prompt us to hold on to a stock even as the underlying business falters, rather than cutting our losses. Had the dropping stock been a gift, perhaps we wouldn’t hang on quite so long.

6. Anchoring

Ask New Yorkers to estimate the population of Chicago, and they’ll anchor on the number they know–the population of the Big Apple–and adjust down, but not enough. Ask people in Milwaukee to guess the number of people in Chicago and they’ll anchor on the number they know and go up, but not enough. When estimating the unknown, we cleave to what we know.

Investors often fall prey to anchoring. They get anchored on their own estimates of a company’s earnings, or on last year’s earnings. For investors, anchoring behavior manifests itself in placing undue emphasis on recent performance since this may be what instigated the investment decision in the first place.

When an investment is lagging, we may hold on to it because we cling to the price we paid for it, or its strong performance just before its decline, in an effort to “break even” or get back to what we paid for it. We may cling to subpar companies for years, rather than dumping them and getting on with our investment life. It’s costly to hold on to losers, though, and we may miss out on putting those invested funds to better use.

7. Confirmation Bias

Another risk that stems from both overconfidence and anchoring involves how we look at information. Too often we extrapolate our own beliefs without realizing it and engage in confirmation bias, or treating information that supports what we already believe, or want to believe, more favorably.

For instance, if we’ve had luck owning  Honda (HMC) cars, we will likely be more inclined to believe information that supports our own good experience owning them, rather than information to the contrary. If we’ve purchased a mutual fund concentrated in healthcare stocks, we may overemphasize positive information about the sector and discount whatever negative news we hear about how these stocks are expected to perform.

Hindsight bias also plays off of overconfidence and anchoring behavior. This is the tendency to re-evaluate our past behavior surrounding an event or decision knowing the actual outcome. Our judgment of a previous decision becomes biased to accommodate the new information. For example, knowing the outcome of a stock’s performance, we may adjust our reasoning for purchasing it in the first place. This type of “knowledge updating” can keep us from viewing past decisions as objectively as we should.

8. Mental Accounting

If you’ve ever heard friends say that they can’t spend a certain pool of money because they’re planning to use it for their vacation, you’ve witnessed mental accounting in action. Most of us separate our money into buckets–this money is for the kids’ college education, this money is for our retirement, this money is for the house. Heaven forbid that we spend the house money on a vacation.

Investors derive some benefits from this behavior. Earmarking money for retirement may prevent us from spending it frivolously. Mental accounting becomes a problem, though, when we categorize our funds without looking at the bigger picture. One example of this would be how we view a tax refund. While we might diligently place any extra money left over from our regular income into savings, we often view tax refunds as “found money” to be spent more frivolously. Since tax refunds are in fact our earned income, they should not be considered this way.

For gambling aficionados this effect can be referred to as “house money.” We’re much more likely to take risks with house money than with our own. For example, if we go to the roulette table with $100 and win another $200, we’re more likely to take a bigger risk with that $200 in winnings than we would if the money was our own to begin with. There’s a perception that the money isn’t really ours and wasn’t earned, so it’s OK to take more risk with it. This is risk we’d be unlikely to take if we’d spent time working for that $200 ourselves.

Similarly, if our taxes were correctly adjusted so that we received that refund in portions all year long as part of our regular paycheck, we might be less inclined to go out and impulsively purchase that Caribbean cruise or new television.

In investing, just remember that money is money, no matter whether the funds in a brokerage account are derived from hard-earned savings, an inheritance, or realized capital gains.

9. Framing Effect

One other form of mental accounting is worth noting. The framing effect addresses how a reference point, oftentimes a meaningless benchmark, can affect our decision.

Let’s assume, for example, that we decide to buy that television after all. But just before paying $500 for it, we realize it’s $100 cheaper at a store down the street. In this case, we are quite likely to make that trip down the street and buy the less expensive television. If, however, we’re buying a new set of living room furniture and the price tag is $5,000, we are unlikely to go down the street to the store selling it for $4,900. Why? Aren’t we still saving $100?

Unfortunately, we tend to view the discount in relative, rather than absolute terms. When we were buying the television, we were saving 20% by going to the second shop, but when we were buying the living room furniture, we were saving only 2%. So it looks like $100 isn’t always worth $100 depending on the situation.

The best way to avoid the negative aspects of mental accounting is to concentrate on the total return of your investments, and to take care not to think of your “budget buckets” so discretely that you fail to see how some seemingly small decisions can make a big impact.

10. Herding

There are thousands and thousands of stocks out there. Investors cannot know them all. In fact, it’s a major endeavor to really know even a few of them. But people are bombarded with stock ideas from brokers, television, magazines, websites, and other places. Inevitably, some decide that the latest idea they’ve heard is a better idea than a stock they own (preferably one that’s up, at least), and they make a trade.

Unfortunately, in many cases the stock has come to the public’s attention because of its strong previous performance, not because of an improvement in the underlying business. Following a stock tip, under the assumption that others have more information, is a form of herding behavior.

This is not to say that investors should necessarily hold whatever investments they currently own. Some stocks should be sold, either because the underlying businesses have declined or their stock prices greatly exceed their intrinsic value. But it is clear that many individual (and institutional) investors hurt themselves by making too many buy and sell decisions for too many fallacious reasons.

We can all be much better investors when we learn to select stocks carefully and for the right reasons, and then actively block out the noise. Any temporary comfort derived from investing with the crowd or following a market guru can lead to fading performance or inappropriate investments for your particular goals.


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BlackRock Commentary: Energy shock spurs Europe’s recession

 Wei Li, Global Chief Investment Strategist at the BlackRock Investment Institute together with Alex Brazier, Deputy Head, Beata Harasim, Senior Investment Strategist and Nicholas Fawcett, Macro Research, all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points:

Energy shock: We think the energy crisis will spur a recession in Europe. The ECB is trying to fight inflation without recognizing the costs. We prefer credit over equities.

Market backdrop: The ECB raised rates by a record 0.75%. We think the ECB will keep raising rates through year-end until the economic effects of the energy crunch are clear.

Week ahead: All eyes are on U.S. CPI inflation for signs of further easing, especially core inflation. We expect inflation to cool but still settle above pre-Covid levels.

The energy crunch will drive a recession in Europe, as we’ve argued since March. The crisis has worsened since then as Russia has halted gas supplies. Plus, the European Central Bank (ECB) isn’t acknowledging how it will crush activity further by trying to fight high inflation, in our view. We think the ECB will wake up to this reality sooner than markets expect – but not before it inevitably faces a severe recession. We remain underweight equities and prefer high-quality credit.

Europe’s energy squeeze

Europe’s efforts to wean itself off Russian energy have triggered a price surge that’s been amplified as Russia cuts gas supplies. The European Union is now spending nearly 12% of its GDP on energy, making the crisis worse than the 1970s oil shocks. See orange line in the chart. That’s not the case for the U.S, a net energy exporter (yellow line). It’s hard to see any relief for Europe in the next couple of years, with rationing on the horizon, in our view. Winter may cause demand to surge, slashing stockpiles. Countries are rushing to cushion pressure, especially on households. Germany plans to collect excess profits from energy providers and cap prices. EU energy ministers have called for similar policies. The UK has a sizable plan to pay energy suppliers the difference between a new capped price and the price they would have been able to charge.

The euro area policies are much smaller than those in the UK or for Covid-19. That reinforces why the energy shock will drive a protracted recession lasting several quarters in Europe, in our view. The ECB is set to make things worse: Like the Federal Reserve, the ECB hasn’t acknowledged the damage it must do to growth to fight this inflation, even after it hiked a record 0.75% last week. The ECB is instead responding to the politics of energy-driven headline inflation, we think. Its new forecast for modest growth next year is already stale by not accounting for recent events like Russia cutting off gas supply. We see the ECB’s downside scenario of a -0.9% contraction as more likely. The euro sliding to 20-year lows against the U.S. dollar reflects deteriorating growth and terms of trade from higher energy prices, in our view.

European Central Bank view

The ECB will also have to contend with fragmentation risks – and perhaps put into practice its anti-fragmentation tool for peripheral debt spreads. Italy’s economic fundamentals have worsened in this shock, with the shift to a current account deficit amid its heavy debt burden. That’s more likely to feed volatility for Italian bonds, even if the coming election likely results in a center-right government that won’t be very antagonistic to the EU.

We think the ECB will keep up its aggressive rate hikes through the end of 2022 but then stop once it sees the economy taking a major hit. Year-end rates will likely stand somewhat short of current market rate expectations, in our view.

Bank of England view

Unlike others, the Bank of England (BoE) has been clear that bringing inflation down to target would require a deep recession. The UK’s fiscal plans wouldn’t change that, in our view. The measures are just another example of governments responding to the politics of high inflation. The subsidies may slow headline inflation and cushion the recession blow in the near term. But they can’t solve the imbalance of low supply relative to demand – and in fact block the fall in demand required to reduce inflation. Limiting the hit to real household incomes reduces the growth drag the BoE would have expected. That implies the BoE will keep hiking rates to get demand back in line with supply but not as much as markets expect, in our view.

Our bottom line

European stocks aren’t priced for the deep recession we expect. Excluding commodities, European earnings growth estimates are too optimistic, we think. We stay underweight European and most developed market stocks. We prefer investment grade credit as yields better compensate for default risk. We’re neutral European government bonds and have a modest overweight to UK gilts with a preference for short-dated bonds due to markets pricing in an overly hawkish rate path.

Market backdrop

Volatility persists across markets – underscoring the new regime of heightened macro volatility. The ECB hiked rates a record 0.75% and cut its growth forecasts last week. Yet the ECB’s new growth forecasts still don’t reflect the deep recession we expect from the energy shock and higher rates. We see the ECB jacking up rates through year-end but then stopping as the economic toll from the energy shock and rate hikes becomes clear.

The focus this week is on whether U.S. core inflation is slowing further or staying at elevated levels. The consensus sees the core CPI holding fairly steady, up by shelter costs, even if headline inflation likely cools on lower gasoline prices. The Bank of England policy meeting previously set for Sept. 15 has been rescheduled after Queen Elizabeth’s death.

Week Ahead

Sept. 12: UK GDP data

Sept. 13: U.S. CPI data

Sept. 14: UK CPI data

Sept. 16: China retail sales; U.S. University of Michigan survey


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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 12th September, 2022 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Global equities rallied into the end of last week, with the MSCI World Index closing up 3.0%, while the S&P 500 Index closed up 3.7%, the STOXX Europe 600 Index closed up 1.1%, whilst the MSCI Asia Pacific Index closed near flat, down just 0.03%. With sentiment extremely bearish, equity markets are susceptible to bear-market squeezes like the one we saw last week.

Headwinds persist and volatility remains, and investors seem to be looking beyond the immediate issues that have been weighing on stocks, giving the market short-term, risk-on moves higher. In terms of themes last week, focus was mainly on the European Central Bank (ECB) announcement on Thursday. Energy was also in focus as European leaders looked to take more serious action to protect consumers and businesses. In terms of equity fund flows, Europe recorded its 30th consecutive weekly outflow. Meanwhile, US equity funds saw their largest outflow in 11 weeks.

ECB hikes rates by 75 basis points (bps)

On Thursday, the ECB announced that it would raise interest rates by 75 bps to 1.25%. A 75-bps hike represents the largest ECB hike in history. Inflation in the eurozone had surged to 9.1% in the year to August, so the ECB was under pressure to act. Before the announcement, the market was split between a 50 bp or 75 bp hike, so there was room either way for a small shock. With the announcement, ECB President Christine Lagarde stressed that “policy rates remain far below levels that ensure return of inflation to 2%” and that further hikes “over the next several meetings will likely be appropriate to slow demand and avoid persistent upward pressure on inflation expectations”. Any further hikes would be dependent on data.

This did represent a shift in rhetoric around the reasons for hiking rates. Previously, the ECB had said that rates hikes would ensure “that demand conditions adjust to deliver its inflation target in the medium term”. With the language a little more forceful, this could be taken as a hawkish signal to investors.

In terms of projections, the ECB revised up its inflation expectations significantly. The ECB now expects inflation to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024, up from 6.8%, 3.5% and 2.1% respectively projected back in June. Yet, the ECB does not anticipate a recession, reducing the gross domestic product (GDP) forecast to +0.9% for next year, down from +2.1% in June’s projections. There was no clear message on quantitative tightening in the statement, so it’s expected that the ECB will continue to reinvest the principal payments from its purchase programmes. PEPP reinvestments will continue at least until end-2024, and flexibility will remain. Lagarde advised that rates are the appropriate policy instrument at this time. On Friday, the Financial Times reported that the ECB has agreed to start discussions on shrinking its balance sheet in early October.

Given the hawkish tilt to Thursday’s announcement, equities sold off nearly 1% afterward, but soon recovered ground to finish the day higher. The euro closed the week back above parity versus The US dollar. Attention now shifts to what the ECB does next. Reports towards the end of last week indicated that there was growing support for a further 75 bp hike in October. As mentioned, Lagarde said she expected the ECB to hike over the next “several” meetings. At the moment, the market is pricing in roughly 145 bps cumulative over the next three meetings. Given that the ECB has a history of hawkish surprises this year, this seems a little low, in our view.

European energy market

Last week started with an announcement from Gazprom that there would be an indefinite shutdown of Nord Stream 1. This was on the back of a scheduled shutdown which commenced on 31 August. Russia blamed European sanctions for the decision to cut off supplies, and European equity markets started last week firmly in the red, selling off nearly 2%. Yet, despite Nord Stream supplies being cut to zero, European Union (EU) governments announced impressive gas builds last week, using supplies from Norway and North Africa. The EU is currently at 83.6% capacity, Germany is at 88%, whilst France gas reserves are at 93.8% of capacity. These announcements raise hopes that Europe should be able to get through winter without running out of gas. Note, the EU imported 40% of its gas requirement from Russia last year, which has fallen to 9% in 2022.

However, there is an inevitable knock-on effect, and attention shifted firmly last week to financial support for consumers. EU energy ministers met on Friday to try to produce a consensus resolution, but there was little concrete action. A price cap was not agreed upon, but does remain a possibility. However, it was stressed that a cap, even temporary, may threaten supply— so it comes with risks. The delegates also stopped short of calling for a mandatory reduction in energy demand and said that more work was needed to measure the impact of capping prices.

There was a headline last week suggesting that there was a proposal for an EU price cap of €200 MWH for non-gas electricity; however, this was not confirmed. Separately, Germany is considering taking direct action to avoid a wave of insolvencies through the winter.

In terms of action, the UK’s new Prime Minister, Liz Truss, announced a plan to freeze annual consumer energy bills for two years at £2,500. This replaces the prior decision by the regulator, Ofgem, to raise the energy price cap to £3,549 from £1,971. The plan, which may cost as much as £150 billion (6.5% of GDP), gives UK consumers protection over the next two years, UK retail stocks rallied last week after that news. The decision will also have a material impact upon inflation expectations in the United Kingdom, with inflation now likely to peak at current levels.

Many of the banks revised their inflation and GDP forecasts last week.

Week in review

Europe

European equities rallied into the end of the week to close up 1.1% overall. It was a poor start to the week, with the market opening lower on Monday on the back of news of the Nord Stream 1 shutdown. US stocks drove the late-week move higher after an initial selloff following the ECB announcement.

Outside of that, focus was on Friday’s EU energy meeting, and, in the United Kingdom, Liz Truss was appointed as the new Prime Minister following a lengthy leadership contest. Sentiment remains bearish although there is some encouragement for consumer stocks that European governments look to be protecting the public from the worst of energy inflation.

In terms of sectors, basic resources were strong last week, recovering most of their losses from the previous week. Commodities rallied into the end of the week on the back of property support measures in China/Hong Kong. Banks were also higher last week on the higher interest-rate environment, with many of the more rate-sensitive banks outperforming. In terms of the laggards, oil and gas stocks underperformed last week amid lower oil prices. It is difficult to pin down a driver of the underperformance on a week where we had OPEC cuts, China lockdowns and more chatter on windfall taxes.

Also, telecommunications closed the week down, with a little reversion at play as the sector has been one of the outperformers year-to-date. There was also a report that German consumers are displaying a reluctance to accept price hikes by mobile-phone companies, which dampened sentiment.

United States

US equity markets snapped a three-week run of declines and saw some decent gains last week, with the S&P 500 Index, DJIA and Nasdaq all rising. In terms of catalysts, a pullback in the US dollar after months of strength helped change sentiment. In addition, there is also some expectation that this week’s US Consumer Price Index (CPI) data could see another decline, so there is anticipation that we may have seen peak inflation. From a technical standpoint, the S&P 500, Nasdaq and Russell 2000 indices are now all back above their key technical 50-day moving averages.

From a central bank perspective, there was a lot of focus on the ECB’s actions. However, Fed Chair Jerome Powell did make a speech where he stuck to the hawkish message from Jackson Hole, Wyoming. He stated: “We need to act now, forthrightly, strongly as we have been doing. My colleagues and I are strongly committed to this project and will keep at it.” He said that the goal for the Fed is to have economic growth below trend for some time, to reduce pressure on the labour market from adding to recession concerns. This saw US year-end rate expectations increase to about 3.88% vs. 3.67% previously.

Sector performance was positive across the board with the materials and consumer discretionary names the best performers.

Looking to US macro data, the latest Institute for Supply Management (ISM) non-manufacturing survey picked up. The August ISM services component came in stronger than expected at 56.9 vs. 56.7 previously, suggesting that the US economy has maintained strong underlying momentum, despite high inflation and rising interest rates.

Asia

It was a ”game of two halves” this week in Asia, with the MSCI Asia Pacific trading lower on Tuesday and Wednesday, only to rally back on Thursday and Friday, tracking the S&P 500 Index in the United States to close the week basically flat. The rally in equities came after the US dollar fell last week after reaching its highest level since 2002. Comments from Japanese authorities indicating concern about the level and pace of decline of the Japanese yen helped trigger a wave of profit taking in the dollar.

Japan’s equity market closed the week higher after the government announced new measures to help the country cope with rising inflation, whilst the yen fell to its lowest level in 24 years, prompting fresh comments from officials. The 10-year bond yield fell to 0.23% from 0.24% at the end of the previous week.

The government announced a new relief package, due in October, to help the country cope with rising inflation. The package includes cash handouts to low-income households as well as measures to keep some commodity and food prices at current levels. Prime Minister Fumio Kishida stated that it was the government’s priority to protect both households and businesses from the impact of higher import prices due largely to the war in Ukraine.

Authorities issued their strongest warning yet on the weakness of the yen, a few days after the ECB raised interest rates by 75 bps. On Friday, the yen fell back below 142.50 after earlier touching as high as 145. Japanese officials said that they would take action to prevent “excessive, one-sided” moves in the exchange rate. It is unclear yet what steps authorities will take to arrest the decline in the yen, although Friday saw the largest appreciation in the currency in a month.

On the macro front, GDP expanded at an annualized rate of 3.5% in the second quarter, higher than expected. The easing of  COVID restrictions boosted the economy, which encouraged business spending and private consumption. While Japan’s economy has now regained its pre-pandemic size, there are some expectations that growth may slow due to the ongoing COVID-19 pandemic, supply chain disruptions impeding production, rising prices, and global economic uncertainty. Data this week in Japan includes  machine tool orders, the Producer Price Index (PPI), industrial production and trade figures.

Mainland China’s equity market also had a solid week, closing higher last week as better inflation data and expectations of further policy support prompted buying. Chinese inflation fell (despite expectations of a rise) which raised hopes of a cut in lending rates. PPI was also lower than expected, while new loans came in lower than expected.

Attempts by Chinese authorities to jumpstart the economy have been hampered by China’s “Zero-COVID” policy and by weakness in the property sector. Property shares rallied last week on hopes of more easing of home purchase restrictions including the potential removal of curbs and tax concessions for property transactions.

This week, China’s President Xi Jinping is expected to make his first foreign trip in more than two years. He is expected to travel to Kazakhstan and Uzbekistan, where he is due to meet with Russian President Vladimir Putin on the sidelines of the Shanghai Cooperation Organization.

China’s currency strengthened on Friday after being under pressure for the past three weeks. Earlier in the week, China cut the amount of foreign exchange that domestic banks must hold in reserves, a move seen as an effort to bolster the yuan. Financial institutions will be required to hold 6% of their foreign currency deposits in reserves starting 15 September, down from the current 8%, according to a People’s Bank of China statement.

Looking ahead, China is bracing for a typhoon this week. In a week where macro data including retail sales, industrial production, property investment and property sales figures will be reported, China is expected to keep its medium-term lending rate unchanged at 2.75%.

Hong Kong’s equity benchmark closed the week slightly lower. Stocks slumped for the first four days of the week amid growing concerns about the economic fallout from wider lockdowns in China and growing tension between US and China on tech exports. However, stocks snapped the losing streak and logged a strong rally Friday ahead of the long weekend, as a government report showing slower inflation in China helped boost the outlook for more monetary easing to shore up the economy. Chinese real estate developers ended the week strongly, with smaller creditors of embattled Chinese property firms increasingly turning to court to obtain payments. Chip makers struggled after reports that the White House is considering moves that would restrict US investment in Chinese tech firms, while later in the week, President Xi called for a stronger effort to pool nationwide resources to advance key technologies.

On the COVID-19 front, Finance Secretary Chan said that the city needed to raise its vaccination rate further to allow Hong Kong to re-open its borders. His comments came after press reports said that suicide rates of children under the age of 15 hit a record high in Hong Kong last year.

The week ahead

The death of Queen Elizabeth II at the age of 96, the longest-serving British monarch, has set into motion a lengthy period of national mourning and preparations for her state funeral. The Bank of England has postponed the interest-rate decision scheduled for 15 September (this will now be held on 22 September).

Elsewhere, markets will be focused on US inflation data for August, after price growth decelerated more than forecast in July. President Xi Jinping will make his first foreign trip in more than two years, as noted.

Key Events

Monday 12 September: UK Monthly GDP, UK Manufacturing & Industrial Production

Tuesday 13 September:  German, Spanish, and US CPI

Wednesday 14 September: UK CPI & RPI

Thursday 15 September: US Jobless claims, US Industrial and Manufacturing production

Friday 16 September:  Eurozone CPI

Calendar

Monday 12 September

  • UK Monthly GDP
  • UK Manufacturing & Industrial Production
  • Italy Industrial Production

Tuesday 13 September

  • UK ILO Unemployment & Claimant Count Rate
  • Germany CPI, ZEW survey expectations
  • Spain CPI
  • US CPI
  • US Federal budget

Wednesday 14 September

  • UK CPI & RPI
  • Eurozone Industrial Production
  • US Core PPI

Thursday 15 September

  • France CPI
  • Italy General Government Debt
  • Eurozone Trade Balance
  • US Jobless claims
  • US Industrial & Manufacturing production
  • US Financial accounts

Friday 16 September

  • UK Retail sales Inc Auto Fuel
  • Eurozone EU27 New Car Registrations
  • Spain Labour Costs
  • Italy Trade Balance Total
  • Eurozone CPI
  • US State employment
  • US Total net TIC flows


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What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 25 July 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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