It’s fascinating how financial markets seem only able to focus on a small number of issues at a time. We call this the market narrative, the story the market is focused on at any moment in time. It’s also interesting how the narrative that explains past events can change. 
An example is last year’s market weakness and recent recovery. At the time, most of the talk surrounded the trade dispute with China and its expected impact on economic activity and inflation. As the year progressed, the sell-off hastened, culminating in a particularly weak December and changes in European, US and Chinese monetary policy.
Subsequently, equity and bond markets have rallied substantially, erasing much of the losses from the latter part of 2018.The narrative is now ‘QE forever’ and there’s nothing to worry about. Now, the narrative around the 2018 year-end collapse is that it was all about quantitative tightening (QT) rather than global trade.
The true substance behind these somewhat conflicting explanations of stock market moves will never be known, but we can put some data points around them. In the trade war, tariffs were introduced on a limited number of goods such as steel and washing machines, but the threat of more impactful broadening of tariffs was delayed, pending the ongoing negotiations. However, the mere threat of tariffs appears to have impacted investment intentions in China, where confidence has taken a knock, if the Purchasing Manager Indices are to be believed.
Some anecdotal evidence of companies aiming to move production out of China and Chinese companies feeling less confident supports this, although it may be the case that businesses were already moving from China as Chinese labour costs continue to rise. In the US however, there’s little evidence of any widespread impact from the trade wars, unsurprising given the relatively low proportion of the economy dependent on trade. The narrative around the trade war has shifted from unfair undercutting of US industries to intellectual property rights.
Evidence of the impact of QT and its subsequent reversal is also anecdotal. There is very good data from the US and Europe on central bank bond buying but it’s much harder to ascertain the degree to which this has impacted the prices of other assets, and few people now believe that it has any meaningful impact on the real economy.
What we do know is that the Fed suggested it would be slower to raise rates and retained the right to introduce further QE, and the ECB has introduced a further round of its targeted longer-term refinancing operations, its equivalent of QE but via the commercial banking sector.
Once announced, the ECB’s action had a negative impact on markets, in sharp contrast to the reaction to the Fed’s January change in tone. The ECB’s approach is, by its very design, harmful. By giving the banks, effectively, free money with which they can only buy their domestic government bonds, it creates a risk-free profit opportunity and a huge disincentive to lend to the real economy. This is arguably the cause of Europe’s ongoing poor growth and, in the longer term, makes the banks, basically, arms of the state.
In China, the situation with monetary policy is less clear. There’s some emerging evidence of increased bank lending and bank reserve requirements have been loosened, suggesting a more accommodative policy stance.
Overall, the narrative of easier money supporting asset prices has been accepted by markets, reversing last year’s story of an economic slowdown driven by the twin factors resulting from the trade wars, economic activity and inflation.
The tougher question now is where to next, and this is very much dependent on the evidence that continues to emerge. If economic and corporate data continues to deteriorate, then no amount of free money can save an over-indebted business with declining earnings, and we will need to see the prices of many assets (both bonds and equities) materially lower. If, on the other hand, activity reaccelerates, the zombies will be saved to fight another day. Our approach is to avoid those companies most exposed to the downside, whether because of excessive debt or very high valuations, and to further reduce the risk in our bond elements of our portfolios. What we do like is businesses with good quality and growing revenues with relatively less cyclical business models.
David Jane is manager of Miton’s multi-asset fund range. The views expressed above are his own and should not be taken as investment advice.