The two key influences on asset performance remain monetary policy and politics.
Monetary policy has been a key feature since the financial crisis, with short term interest rates anchored at historical lows and asset purchase programmes being maintained by central banks.
One of the main objectives of this Quantitative Easing (QE) was to encourage borrowing to boost economic growth, but there is much debate about the efficacy of this policy.
What is more certain is that much of the liquidity that has been created has found its way into risk assets such as equities and corporate bonds; leading to valuations that, even if not necessarily expensive, can no longer be described as cheap.
Although QE is still being actively pursued by the European Central Bank (€60bn per month) and the Bank of Japan ($60bn per month), thus continuing to increase the amount of money in circulation, markets are more concerned about an imminent rise in the US benchmark Fed Funds interest rate, leading to a rise in the price of money, and what that might mean for financial assets.
Investors are mindful of the turmoil of the “taper tantrum” of 2013; when bonds and equities sold off as the Fed first floated the idea of ending its QE; although markets subsequently recovered strongly.
Those with longer memories, look back to the monetary tightening of 1994, which delivered sharp losses to bond investors and increased volatility for equities.
There are further concerns that the tightening of 1994 underpinned a strong dollar, which helped lead to the Asian crisis of 1997; so investors in emerging markets remain wary of a repeat performance.
Without wishing to appear insouciant, we remain less concerned about the medium term outlook, although continue to accept that short term volatility will remain a feature of markets.
Central bank heads have gone to great lengths to assure investors that interest rate rises will only be undertaken in the event that growth is robust, and even then they will monitor the effect and not commit themselves to a fixed agenda of further tightening.
We certainly appear to be a long way from the circumstances of the 1970s, ‘80s and early ‘90s, when central banks had to lean very hard against inflationary pressures and if anything, they would currently be prepared to accept the risk of higher inflation rather than the threat of outright deflation; owing to the high amounts of debt that remain in the global economy.
What is clear is that this transition from a period of concerted global monetary easing to one where not all central banks are rowing in the same direction will be tricky, both in terms of managing the policy and its effect on markets.
Another big transition is taking place in China, as the Communist Party attempts to reposition the economy from being one that depends on exports and infrastructure investment for its growth, to one that relies more on the domestic consumption of goods and services.
The competitive advantage of a cheap labour force migrating from the countryside to the cities is not what it used to be and much of the post-crisis construction boom was financed by local government debt, which is no longer sustainable. Meanwhile, the savings rate in China is estimated to be around 50% of Gross Domestic Product (GDP) and the government wants to persuade Chinese consumers to spend more of this.
Thus, the nature of China’s demands on the global economy is changing, and nowhere has this been more evident than in the lower demand for commodities, especially those related to construction.
Furthermore, President Xi Jingping’s crackdown on corruption has been longer-lasting and more pervasive than originally expected; damping demand for luxury goods.
Our belief is that these changes will eventually put the country’s growth on a more sustainable footing and that it offers considerable opportunities for patient investors.
Politics also reared its head again in Europe after a period of relative calm, with Greece trying to renegotiate the terms of its bailout. An agreement was eventually found which prevented an exit of Greece from the Eurozone, but the sustainability of the new bailout agreement remains uncertain.
