Pro Perspectives 8/19/19

August 19, 2019

The most important news last week, didn't come from the President's twitter account.  It didn't come from China.  It came from the mouth of an ECB governing council member. 

Olli Rehn, voting ECB member and the central bank head of Finland, was vying for the head job at the ECB earlier this year.  He didn't get it.  It went to the IMF chief, Cristine Lagarde. 

Last week, Rehn laid the groundwork for the ECB to roll out another big stimulus round in September. 

Remember, as we discussed last week, the catalyst for the melt-down in global bond markets was the one-two punch from the ECB and the Fed back in December.  The ECB officially quit QE.  Days later, the Fed hiked again, into an ugly decline in the stock markets, and, moreover, Jay Powell said their quantitative tightening program was on “auto-pilot.”  This sent a clear message/reality check to markets that (at least a portion of) the $14+ trillion in global liquidity that the big three central banks have pumped into the world — that promoted stability and little to no inflation – was getting sucked out. 

With that, we now have the ECB, importantly, heading back to the QE business.  And it may involve outright buying stocks.  

Let's take a look at how that might impact German stocks.  As you can see in the chart below, the DAX remains 14% from the record highs that were made in early 2018 (German stocks have been in drawdown for 17 months) …

The Bank of Japan has been in the business of buying Japanese stocks for a long time.  But under the Abe plan, it has become a key tool in the massive QQE program at the Bank of Japan since 2013.  With the BOJ involved in stocks, it reduces the risk premium in the stock market.  And in a world of zero interest rates, the lower risk in stocks is an incentive for capital to chase the higher potential returns of stocks. The idea is that it ultimately drives demand and inflation in the economy. 

How has it worked out for Japanese stock prices? 

Here's a look at the chart …
As you can see in the chart, the Japanese stock market has doubled since the BOJ started in 2013.  During the same period, U.S. stocks have about doubled too (not unrelated).

But after six years of outright buying ETFs, the BOJ is now the top shareholder in 55 of the 225 companies in the Nikkei 225.  And they own more than 75% of the Japanese ETF market. 

It has worked for stock market investors.  But many would argue it hasn't worked for the economy.  Growth in Japan has run about 1% annualized over the period.  And inflation, a little less.  But Japan's asset purchases (including stocks) have been a big contributor to what has been feeble global economic recovery, rather than a global depression.  We will see next month if Europe has been forced to follow Japan’s lead (buying stocks). 

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