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The Effects of ECB QE

The European Central Bank (ECB) just announced its plan to expand its balance sheet with over 60 billion euro’s a month starting in March 2015 up to September 2016. In total this should expand the ECB balance sheet by over 1,148 trillion euros, which is more than the market was anticipating. The obvious effect of today’s announcement is that the combined central bank balance sheets will expand at an accelerated rate (Figure 1). The combined central bank balance sheet expansion, will be much larger than what was the case in 2014. In effect this will flood the global financial system with even more cheap money.

Figure 1: Combined central bank balance sheet expansion set to accelerate (Source Deutsche Bank)

The effects of today’s announcement will be profound and far-reaching. In the following paragraphs we will summarize the expected consequences of today’s ECB announcement and more importantly how investors can capitalize on this.

Effect on European stocks

Looking at the historical effects of previous QE announcements in the US, UK and Japan, we can conclude that the effect of European QE will be quite positive for European stocks. On average the absolute performance of local equity markets in reaction to central bank QE ranges between 3%-7%, over a three month time period, after the initial announcement.

Figure 2: Performance of US, UK and Japanese equity markets, 3 months after QE announcement (Source: Deutsche Bank)

Because of this we can assume a comparable return for European equities over the next three months. We suggest the following trades for investors on a 3 month time period: 

  1. Buy Euro Stoxx 600 Index trackers.
  2. Buy German DAX Index.
  3. Buy Dutch AEX Index.

Another equity strategy investors can use to capitalize on ECB QE is by buying specific sectors, which historically have tended to benefit the most from central bank balance sheet expansion. An analysis conducted by Deutsche Bank shows that so-called cyclical sectors have historically benefitted the most from comparable central bank actions (Figure 3)

Figure 3: Historical QE sensitivity and relative outperformance of equity sectors, 3 months post QE announcement (Source: Deutsche Bank)

Due to this strong historical precedent we suggest the following trades for investors, on a 3 month time period:

  1. Buy European Financial Services sector stocks (e.g. Allianz and ING)
  2. Buy European Automakers stocks (e.g. BMW and Daimler)
  3. Buy European Bank stocks (e.g. Societe Generale and Deutsche Bank)

Effect on individual countries and sovereign bonds

Although ECB QE, will benefit Europe as whole, there will be significant differences between the benefits individual nations will feel. Although much of this will be dependent on the exact details of how the ECB will implement its QE program, we can generally assume the following: 

1. ECB QE, will be more advantageous for high-debt European periphery countries, who are implementing long-term structural reforms versus high-debt countries who are more reluctant to implement painful deficit reducing measures.

2. ECB QE, will have stronger benefits for Europe’s “Inner-Core” countries such as Germany and the Netherlands versus “Semi-Core” countries such as France and Belgium.

The relative advantage a country feels from ECB QE, will have significant impact on the relative performance of European sovereign bond markets. The expected impact of today’s announcement on European sovereign bonds is summarized in the following table (Figure 4)

Figure 4: Expected market impact of ECB QE on individual European sovereign bond markets (Source: Credit Suisse)

We suggest the following trades, on a 3 month time period: 

Periphery plays:

  1. Long Spanish 2 year bonds
  2. Long Portuguese 3 year bonds

“Inner-Core” vs “Semi-Core” plays:

  1. Long 10 year German Bunds versus short 10 year French bonds
  2. Long 10 year Netherland bonds versus short 10 year Austrian bonds

Possible effect on Gold prices

As was noted in the introduction of this article, the aggregate amount of Global liquidity is set to increase sharply in 2014. This could have significant effects that might benefit an inflation hedge such as Gold. 

Firstly, on a global level central banks are injecting a massive amount of liquidity at a time, when markets are already flooded with cheap money. The aggregate injection of the announced ECB and current Bank of Japan (BoJ) stimulus will be massive. In total this will amount to roughly $360 billion dollars per quarter, which is much higher than the average quarterly amount injected in 2014 (Figure 5)

Figure 5: three-month rolling average of central bank liquidity injections (Source: Fidelity Worldwide Investments)

Secondly, ECB QE will put a cap on European sovereign bond yields, while simultaneously increasing inflation, as a result of this real interest rates in Europe are likely to decrease. Looking at historic correlations, Gold has always benefitted from declining real interest rates (Figure 6)

Figure 6:  Gold vs real interest rates (Source: Fidelity Worldwide Investments)

As a result of these two factors we see an opportunity to buy Gold, with a price target of US$1400. In this way, an investor could anticipate for risks of decreasing real interest rates within the EU.    

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Simon Waslander

Simon is the CEO and Editor-in-Chief of Foresight Investor. He has been following the markets passionately for over 7 years.

This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions.

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