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Putting off recession for another day?

5 March 2019

Since the injection of QE markets seem to be stuck in a repeating cycle: Eat, sleep, rave, repeat, says David Jane, manager of Miton’s multi asset fund range.

Since the global financial crisis, now over a decade ago, monetary policy worldwide has been re-invented with a new set of tools characterised by the catch all term of QE. At their instigation, having been brought up in the era of traditional monetarism, many commentators suggested that the likely outcome of money printing would be inflation. However, quite the opposite has occurred, and the economy and markets now seem to be stuck in a repeating cycle: Eat, sleep, rave, repeat.

At its introduction, QE was seen as an emergency measure in which central banks could inject vast amounts of liquidity into the financial system, thus having the twin effects of encouraging greater risk taking by banks and financing governments’ ballooning deficits. It is arguable whether private sector leverage has been healthy in this cycle, given that investment expenditure has been muted and corporate debt growth has been for buybacks and leveraged buyouts (LBOs) rather than expansion; this is most likely one of the reasons why inflation has been muted.

QE has arguably allowed the economy and financial markets to follow a smoother path. At each occasion where expansion has appeared threatened, further rounds of QE have been enacted, enabling markets and economies to quickly recover. Central bankers might now be thinking they have superpowers, able to avoid recessions simply by mentioning the possibility of more free money going forward.

Reality is quite different. There must be an upper bound to the amount of debt the world economy can sustain. Even with near zero interest rates, companies will fail if they have little or no equity to absorb the bumps on the road. We can see significant amounts of distress in various companies and sectors despite the currently low levels of rates. The same may not be true of government debt where new debt can now just be issued directly or indirectly to the central bank, but in the private sector there must be an upper bound to leverage.

The question that will need to be answered in the near term is whether the change in tone from the US Federal Reserve, and the apparent injection of further liquidity from China, will be sufficient to underpin markets over the coming months and revive economic growth expectations, which appear to have taken a material knock lately. If that is the case, then markets can repeat the pattern for yet another round, building on the current recovery into a sustained rebound and further economic growth, putting off a recession for another day.

We continue to avoid being over-committed at this stage as it remains unclear from the economic data that the trick has been successful as of yet. We are avoiding areas which will suffer most in the event of a downturn in markets and the economy, while maintaining a material equity weight in areas that are able to thrive even if a recession looms. In fixed income we continue to reduce our corporate bond exposure, partly through maturities but also sales, building more liquid and diversifying government bond exposure for preference.

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