I broke my leg playing judo back in 1998 and had to use crutches for about 2 months. Although they were difficult to get used to, after a few weeks I became quite adept at using them — to the point of being able to keep up with the rush-hour crowd.
It’s a strange comparison, but that is how I view the FTSE 100 in relation to quantitative easing — QE. The market is doing OK as is, but take away the stimulus — both from the Bank of England and now the European Central Bank — and I fear we’d be left with something of an uncomfortable silence in the market.
With or without you
Do you remember the “taper tantrums” of 2013? That was the market’s way of saying to the-then chairman of the US Federal Reserve, Ben Bernanke, “don’t take away our stimulus!”. The market was hooked. As the US economy has improved, the stimulus has been wound back, but the markets have continued to creep higher.
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The difference of course is that the economy is in better shape. So, relatively speaking, the US economy is receiving an enormous amount of stimulus (‘zero’ benchmark rate) relative to what would otherwise be warranted under such conditions. It means Wall Street can still walk around with its chest puffed out.
If interest rates were to start rising in the US, you would likely see a swift and dramatic exit from equities and into the bond market or cash.
Either way the market is ‘stuffed’. It can’t maintain its current altitude because extreme policy can’t last forever, and it won’t do well on its own, without stimulus.
For better or worse
The Europeans have seen how much fun Wall Street has been having over the past couple of years and now they want in on the action too.
Yesterday the ECB officially announced that it will buy €60bn worth of assets — public and private sector securities — per month. That’s more than markets were hoping for. The bank promised to print money until at least September 2016.
What’s the purpose? To stimulate the economy and achieve that wonderful little thing called inflation — it increases asset prices and helps dissolve debt. Straight from the lips of ECB president, Mario Draghi, the programme is designed to, “increase the lending capacity of banks“.
So far it’s had the effect of producing a mild rally in Europe’s major share markets and seen the euro drop to an 11-year low against the dollar.
That’s all for the better, right? Maybe not.
The sugar high
There’s nothing wrong with a bit of chocolate. It tastes great. You can’t, however, run a marathon on the stuff. The latest stimulus from the ECB, and the on-going £200bn in stimulus from Threadneedle Street, both provide the sugar for the market.
The marathon for the Eurozone is achieving fiscal balance for periphery states, competitiveness, productivity, inflation and economic growth. The marathon for Britain is achieving fiscal balance, higher real wages, longer working hours, and growth in the construction, manufacturing and export sectors.
So you see, when you put it like that, it’s hard to understand why the market would keep rallying under normal circumstances (ie, without any stimulus). Yes, the whole point of QE is to achieve economic growth, but we know from the experience in both Japan and the US that it is by no means a straight-forward process. Frankly, I think the market would fall, potentially quite dramatically, without QE.
Need more convincing?
Just look at the metrics: give or take a few points, the FTSE 100 yields 3.5%. The 10-year gilt, on the other hand, yields just 1.5%. That’s a direct result of ‘unnatural’ central bank asset purchases. Yesterday’s move simply deterred more investors from looking at the debt market, but that doesn’t mean the share market magically looked any better based on fundamentals.
Back in October, the stock market had a P/E of around 12.5. Since then the market has rallied. Today it has a P/E of 15.6. The average P/E for the market is around 14. Given the state of the economy, and the recent rise in the ‘attractiveness’ of the FTSE 100 as a direct result of Euro QE, it’s this Fool’s view that the market could be out of its depth.
