Buy With Central Banks Is U.S.-Japan Lesson for ECB QE ScenarioSimon Kennedy
If central banks are buying, it pays for investors to join in.
That’s the lesson from quantitative-easing episodes in the U.S. and Japan, which hand investors a template to follow should the European Central Bank begin its own asset-purchase program.
While few experts see that happening this year, let alone when policy makers meet June 5, economists at Societe Generale SA are among those predicting otherwise. They anticipate 300 billion euros ($408 billion) of purchases before the end of the year, split between asset-backed securities, the euro area’s jointly issued crisis bonds and some other private assets. BNP Paribas SA and Citigroup Inc. also reckon the ECB will be hoovering up government bonds before 2015 starts.
Behind such bets is the suspicion that ECB President Mario Draghi will have to do more than cut interest rates and provide liquidity for banks if he is to counter what he calls “the potential for a negative spiral” in inflation. A report scheduled for release tomorrow will show inflation slowed to 0.6 percent in May, just a third of the ECB’s target, according to the median forecast of economists surveyed by Bloomberg News.
So how should investors react if the ECB finally starts buying assets? Societe Generale analysts looked to the U.S. and Japan for clues. They found three patterns in both the Japanese purchase of asset-backed securities from August 2003 to September 2006 and the three rounds of quantitative easing deployed by the Federal Reserve from November 2008 to now.
First, QE triggered a reallocation from bonds to equities, In Japan, that proved enough to push up the MSCI Index Japan by 76 percent over the three period during which the bank spent 3.8 trillion yen ($37 billion).
In the U.S., the Standard & Poor’s Index 500 rose 36 percent in the first wave of buying until March 2010, 24 percent in the second round from August 2010 to the following June and 29 percent in QE3 since September 2012, Societe Generale strategists Alain Bokobza and Gaelle Blanchard said in a report last month.
Second, 10-year bond yields were pushed higher, to the tune of 71 basis points in Japan and a cumulative 212 basis points in the U.S. over their respective quantitative-easing periods. While that may sound counterintuitive if the central banks are buying bonds, the resulting spur to economic growth and inflation boosted long-term yields, according to Bokobza.
Third, QE supported the banking sector. Japanese bank stocks improved strongly once the BOJ started quantitative easing, reducing the sector’s credit risk after bad loans had hurt their balance sheets. In the U.S., the buying helped stabilize the share performance of banks.
Such a blueprint has Societe Generale making some early recommendations if Draghi’s ECB follows the BOJ and the Fed.
Investors should bet on euro-region equities to outperform rivals elsewhere. In the U.S., industrials and consumer discretionary stocks did better than the market in every QE episode, while consumer staples, utilities and telecommunications systematically underperformed.
The stocks and bonds of crisis countries such as Greece and Spain and maybe even less-infected France should do well as asset purchases supports their equity markets by aiding economic activity.
It’s also worth preparing for the banking outlook to turn more positive, with Societe Generale favoring Credit Agricole SA, BNP Paribas and Unicredit SpA.
All that’s needed now is for Draghi to start writing checks.