The recovery in markets has been remarkable. Having had its worst December since the Great Depression, the US market had its best January since 1987. The volt face by the US Federal Reserve has lifted the spectre of a continued programme of interest rate increases and the chatter on the Street is that even QT may be curtailed towards the end of the year. Despite the size of Trump's stimulative package, the economy appears to have been acutely sensitive to tightening financial conditions and the trade war is acting to complicate matters further.

The precipitous falls in economic numbers during Q4 appear to be stabilising and some of the more forward looking indicators have bounced, alleviating fears of recession. Having got perilously close, the Treasury yield curve is now some distance from inverting [although the overnight dovish Fed announcement has flattened the curve once again]. All this has allowed the VIX volatility index to return to more relaxed levels.

Europe too has avoided recession but the economic optimism emerging at the beginning of 2018 has completely vanished. Major economies such as Italy are in recession and trade affected Germany narrowly avoided one following the zero GDP growth print in Q4. There are bright spots such as in some of the eastern EU states and Spain isn't doing too bad. The French economy should pick up following Macron's €10bn sop in a failed attempt to quell the street protests. The pitiful performance of the region's economy must be depressing for the ECB which has only just turned off QE. Draghi has recently announced that rates won't be raised until the end of the year at the earliest and put in place further measures to encourage bank lending. We note that the European demographic outlook is not dissimilar to Japan's. It also shares an equally decrepit banking system. Yuck!

In the UK, the shambolic Parliamentary proceedings was more than enough to scupper any attempt of a dry January. Events over March have done nothing but encouraged more regular trips to the drinks cabinet. Some MPs too are fed up with the leadership direction (lack of) and have splintered to form a new party; despairing with a choice of the Tories and Brexit, or Corbyn and socialism. So far there has only been a trickle of MPs abandoning the main parties but this could turn into a torrent which would wash away the current party structure.

Investors have voted with their feet and the UK market continues to underperform. Note that since 2017, remarkably every part of the UK economy (business, household and government) has spent more than its income. The resulting swelling in the current account deficit is being increasingly funded by short term flows. Thankfully, on most PPP measures sterling is cheap and the nation's vast stash of foreign assets have appreciated in value as a consequence. In addition, the woeful lack productivity growth is a concern.

Brexit involves a journey into the dark and there is no guarantee that the necessary political compromise will end up with a rational outcome. This will leave the economy with a headache, banging like a brothel headboard. There seems little option but to maintain our underweight. Once the main political decisions have been arrived at, talented stock pickers should be in a position to once again identify the winners and losers within the market. At that stage, we shall look to switch from our passive UK holdings back into active funds.

It is not unprecedented to have a market fall of 20% without economies entering recession but it is unusual. The last time it happened was during the Russian/LTCM crisis in 1998. As was the case then, markets have been quick to recover although we are still a little shy of the September high. With the benefit of hindsight, we were wrong to hold off buying equities at the end of December as we considered. Our call that economies and earnings would struggle during Q1 was broadly correct but we misjudged the market's sensitivity to interest rate expectations. We have learnt that we are unlikely to see equities present themselves at bargain levels while the authorities reaction to any slowdown is to loosen policy speedily. We shall be less demanding next time we are presented with a similar opportunity.

It is difficult to see markets make much further progress from where they currently are (although a resolution to the trade issue would help). Earnings have been downgraded this year and so far markets just haven't cared. We suspect that there may be further downgrades to come and markets cannot indefinitely blithely ignore the deterioration. Markets remain far more concerned about recession than inflation. A revival of the latter cannot be discounted entirely and would come as a very rude shock. The maintenance of our cautious positioning is appropriate in these circumstances.