Central Bank Heroics

The many reminiscences on the passing of Margaret Thatcher have contrasted her decisive radical economic policies with the consensus-building ineffectiveness of today’s political leaders. But since the 1980s, the nature of political and economic power has evolved. Governments in Europe spent the 1990s passing on responsibility for monetary policy to independent central banks. Over the last decade they binged on fiscal stimulus until they ran out of money.  Little wonder today’s politicians look so feeble with so few policy options. By contrast, central banks with unlimited access to money via the printing presses have never been more highly regarded.  It is the central banker – rather the politician – who is the hero of our time.

The importance of the recent announcement from the Bank of Japan that they would double Japanese monetary base by the end of 2014 through asset purchases of ¥7trillon per month ($70bn or 1.4% GDP) is difficult to overstate¹. This compares with the $85bn per month (0.5% GDP) which the Federal Reserve is printing (indefinitely and until US unemployment falls to an acceptable level)². We can see on Table 1 (Global Quantitative Easing) that at the end of 2012 the Federal Reserve had done $2,650bn of asset purchases (64% of all QE worldwide). The additional QE announced by the Bank of Japan equates to $1,334bn (a huge 32% increase in the amount of global quantitative easing). Indeed including the additional $296bn of QE done by the FED year to date (but not counting its future purchases) we can see that the amount of global quantitative easing announced year to date has increased by 39% to $5,803bn (a figure equating to 16% of the US, European and Japanese economies combined).

Table 1: Global Quantitative Easing³

N.B. All figures in US$bn. ECB asset purchases through SMP were sterilised and therefore may not be considered full QE. UK and Japanese figures assumes purchases announced which may not yet be undertaken.

Although QE is not a panacea for the anaemic global growth environment, it has been a mistake to underestimate its positive effect on asset prices, thus avoiding a dangerous deflationary debt spiral in the real economy. After cutting yields on cash to near zero, central banks have focused on pushing down bond yields through outright purchases and repo activity. The Bank of England for example owns 39% of conventional gilts and 30% of all UK debt outstanding⁴. In the Eurozone, the LTRO by which the ECB provided over €1trillon of additional liquidity⁵ (expanding the ECB balance sheet to 30% of Eurozone GDP) dramatically reduced the amount of European bank bond issuance, thus driving down yields. During 2012 for the first time ever (or at least since a sophisticated corporate bond market began in the 1970s) the average European corporate bond (as well as government bond) yielded less than the average European equity. Today, over 50% of all European companies yield more than the average corporate bond⁶ (compared to the long term average of only 12%). It should therefore not be a surprise that the “hunt for yield” has finally arrived in the stock-market. This makes us cautious on betting against equities as an asset class.

Effect of Monetary Stimulus

The outlook for corporate profits, however, remains difficult. Aggregate European corporate profits in 2012 fell by 5%⁷. Excluding banks, profits were flat. Leading economic indicators do not currently suggest that economic growth in 2013 will be significantly different to 2012. As with last year, the average European company will struggle to advance their earnings in 2013. Our response to this is to generally invest in above average companies able to generate profit growth despite anaemic economic growth. We see some earnings upgrade potential in a few unique industries but we largely expect to make returns from our stocks delivering forecast earnings growth with the absence of value in bonds and cash protecting against a de-rating of valuation.  Central bankers, the heroes of our age, are also the equity investors’ best friend.

Barry Norris
Founding Partner & Fund Manager
26th April 2013