The ECB QE package – a total of over €1.1tn - was much larger than initial market expectations of €500bn to €600bn. Mario Draghi also left the door open for the monthly bond purchases of €60bn to be continued beyond next September’s notional end-date. This is, on the margin, positive for European equities and fixed income - notably the Eurozone's peripheral countries – whilst being negative for the Euro.
Yesterday’s price action confirms this with EUROSTOXX Index up 1.7%, Spanish 10Y bonds gaining 14bps and the Euro -1.9% against the USD.
We’ve been pointedly underweight European markets for a while now, but there are 4 developing reasons – independent of yesterday’s ECB move - for being less underweight European equities:
1. ECB's accommodative monetary policy is starting to filter into the real economy via lower borrowing costs.
2. There are signs of a pick-up in the credit cycle, as a result of stronger household loan demand and a recovery in corporate lending, as well as reduced disparity in lending between countries.
3. The sharp fall in the Euro from the highs last year helps the EU's competiveness and is a tail-wind for EPS, especially when compared with the headwinds faced in the three years to ‘Q3 2014 created by a strong Euro. UBS thinks certainly thinks so, and suggests that Q1 EPS could be boosted by as much as 6% from the currency 'swing' YoY. The Germans will certainly be big beneficiaries, even if they are reluctant participants in the QE process.
4. Lower oil prices will boost real consumption decently. Markets have so far focused mainly on the negative implications of lower oil prices, but not on the positive aspects of this “global tax cut” equivalent.
Short-term, the EU economy will remain feeble, deflation fears will continue, EPS forecast revisions will remain the worst of any equity region and could eventually imply negative equity returns in '15. The political construct of the EU/Euro could also be tested by rising support for euro-sceptic parties in countries with elections this year (in Greece – this Sunday – Portugal and Spain), and in the UK as an important non-Eurozone member.
However, much of this could now be in the price, and as a consequence, European equities look like they could be a better 2015 story than was first thought – once you’ve hedged out the currency risk - provided that European politicians start following the ECB's lead and embark on long overdue reforms (something they've avoided doing). If they don't, there's not much more that the ECB can do.
However, although QE might have a limited effect in real terms, there’s no doubting that markets love it. It’s also worth noting that the ECB’s move comes in a week in which we've seen the PBOC inject around RMB400BN into China’s banking system (offsetting last week’s clumsy crackdown on margin lending by stockbrokerages), unexpected rate cuts by the Reserve Bank of India and the Canadian Central Bank and a shift in the consensus on potential Fed rate increases to 'lower for longer' (2016 anyone?). In Japan, the BOJ has also extended its QE from the original end-March end date and modestly boosted the 2 programmes it uses as part of its QE. This global wave of central bank created liquidity is equity and fixed income friendly.
Overall – the basic point is this.
If 2013 was a year of low yield for fixed income, 2014 a year of no yield, 2015 is shaping up to be a year of negative yields. By comparison, equities look like the only game worth playing.
Steve & Justin
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