Will Christmas come early for financial markets?

2nd November 2015

Anthony Rayner, co-manager of Miton’s multi-asset fund range, looks at the possibility of an early Christmas present for investors from central banks…

In the main, economic data continues to disappoint and so, in true Pavlovian style, expectations are building for an early Christmas present from some central banks.

Stepping back from this circular interplay, the wider picture is troubling: despite Herculean efforts over a number of years to boost economies around the world, growth concerns remain.

Of course, this is not just an issue for the world central banks, it is an issue for society and politicians: the “social contract” itself is under pressure.

In many Western democracies, the lack of balanced economic prosperity has been leading voters to question the traditional political systems, characterised by moves to more extremist parties.

Similarly, in countries like China, the authorities are fully aware that without sufficient economic prosperity, the acceptance of the one party system will also come under increasing scrutiny.

The ability to increase growth rates seems central to maintaining the political status quo. Bearing this in mind, it might seem at first sight strange that it’s central banks, not Western politicians, that have done most of the heavy lifting.

Central banks have used everything in their traditional tool set, and much beyond, in an attempt to facilitate self-sustained economic growth.

They might not have succeeded and there might be unintended consequences, but they have tried.

Turning to politicians, the evidence is less compelling. Structural reform has in many cases been much slower than expected but it’s often a ‘no pain, no gain’ option, one to which the political cycle is not very forgiving.

Meanwhile, the debate around fiscal policy has been paralysed by political ideology, something which monetary policy was much less constrained by.

So, if we assume that monetary policy and fiscal policy have not worked, either we have to change the policy mix or admit expectations are beyond reality.

In terms of expectations, the question was side-stepped in the pre-crisis boom, as credit filled in the gap between reality and expectations. However, since then, politicians simply have not broached the topic: promising less is unlikely to be a vote-winner.

In terms of changing the policy mix, a material change in either monetary or fiscal policy seems some way off from the current consensus.

That said it appears to be increasingly accepted that monetary policy hasn’t worked or is becoming less effective or, even worse, is making markets more unstable.

If this becomes consensus, the debate can move on to a broader set of solutions. In the meantime, if a material divergence between the expectations and the reality of economic prosperity continues, social contracts across the world will remain under pressure.

And it is not just social contracts that are being tested, for example, scarce growth questions ‘contracts’ between creditors and debtors, between trading partners and within regions such as the eurozone.

What does this mean for financial markets? In the absence of better growth data, or a change in the policy mix, investors are left hoping that central banks will throw markets some festive easing.

For our portfolios, our base case of low growth continues to dominate our broadly defensive positioning across a range of investments.

We have less conviction than we have had in the past that these investments can benefit from more QE (Quantitative Easing).

Our pragmatic approach keeps us focused on protecting against losses while allowing us to capture potential rises, emphasising the importance of remaining flexible.

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