The U.S. just added another export to its long list of innovations it has gifted the world. This time it’s good ole’ American-styled monetary stimulus which it first invented in the wake of the 2000-03 financial meltdown, and then refined into a new-and-improved formulation in the aftermath of the 2008-09 financial crisis.
The latest adopter of the U.S. stimulus playbook after Japan is the European Union, whose central bank just yesterday unveiled its new plan to a highly expectant audience:
The ECB has “decided to launch an expanded asset purchase programme, encompassing the existing purchase programmes for asset-backed securities and covered bonds,” ECB president Mario Draghi announced yesterday. “Under this expanded programme, the combined monthly purchases of public and private sector securities will amount to €60 billion.”
This is entirely reminiscent of the U.S. central bank’s stimulus program whereby it purchased $85 billion per month of similar type securities and bonds.
Just what kind of an effect is Europe’s plan expected to have on its economies? If they’re using the same playbook as the U.S. recently used and perfected, investors might expect the same stellar results coming out of Europe as we have been enjoying back home… namely a stock market that just doesn’t want to quit.
Indeed, Europe seems to be sitting right where America was some five years ago – at the start of a marvellous bull run with years of life ahead of it.
The Scope of the ECB’s Plan
Let’s first get a sense of what the ECB has committed itself to:
Its purchasing program which began last November with the monthly purchasing of asset-backed securities and select corporate bonds of key European companies has now been expanded to include monthly purchases of “euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions” – which all together “will amount to €60 billion” each month “until end-September 2016”, Draghi read from the ECB’s press statement. Multiplied out, it works out to approximately €1.08 trillion worth of euros pumped into the European economy.
That’s a pretty sweet deal for its now 19-member economies, with the recent joining of its newest member Lithuania announced at the start of yesterday’s news briefing. But what makes the deal even sweeter is that it is open-ended:
The program “will in any case be conducted until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term,” the statement promised.
In other words, although the current intent is to run the program until September of 2016, the European economy’s progress will dictate if the program is to be terminated or extended at that time.
How is the ECB going to determine if its economy needs more stimulus or not?
“… until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term,” the statement informs.
And where is the European Union’s inflation rate at present? Far below that 2% target, as graphed below. In fact, it is currently at -0.10%, meaning deflation. At present, prices are falling, and wealth is eroding.
To achieve that 2% level of inflation, of course, prices and property values need to strengthen, which means the euro needs to weaken. And the fastest way to achieve that is to keep interest rates as low as possible (currently at 0.05%) and to pump truck-loads of money into the economy. As per the rules of supply and demand, the more you have of something in circulation, the cheaper it becomes.
A Euro in Freefall
The plan is working already. Within minutes of the reading of yesterday’s press release the euro started plunging, and has continued to fall well into today for a current drop of 4.5 cents from $1.163 to $1.118 USD as of this morning, for an erosion of some 3.869% in just the last 24 hours.
Over the next 18 months until the proposed end of the ECB’s program in September of 2016, it is more than likely the euro will lose the remaining 12 cents standing between it and parity with the U.S. dollar.
This, of course, would have an opposite effect on stock markets, since more money in circulation makes it easier and cheaper to obtain and borrow, helping corporations raise a great deal of capital through bond sales while having to pay ultra-low interest for it.
Sure enough, on the back of yesterday’s announcement, the U.K.’s FTSE 100 index rose 0.891%, France’s CAC 40 index rose 1.786%, and Germany’s DAX index rose 1.953%.
We should note that the United Kingdom has not adopted the use of the euro currency. Hence, ECB stimulus measures will have a greater impact on euro currency users than it will on the U.K. However, continental Europe is the U.K.’s largest trading partner, and any improvement on the south side of the English Channel will spill-over onto its northern shores.
The Birth of its Very Own Bull
Investors would give anything to be teleported back in time to early 2009, when the U.S. stock market hit bottom and started what has by now turned out to be a six year climb of more than 200% almost straight up. Yet the ECB may have just handed us a second chance. And unlike the U.S. Federal Reserve’s stimulus program, this one comes at no expense to American taxpayers.
It stands to reason that if the U.S. Fed’s stimulus programs helped fuel this monster bull run we have been enjoying in America, that the ECB’s adoption of a similar stimulus program will soon clone a twin bull with the same genetic stamina over in Europe. Yet we might be surprised at which countries present the better opportunities.
In the graphs below we note the performance of the main stock indices of the U.S., U.K., Germany and France from 2000 until present. The basic pattern is the same, each having experienced two peaks in 2000 and 2008 which were more-or-less at the same level for each index (noted in blue). Let’s call these “pre-stimulus peaks”.
In the case of the U.S.’s S&P 500 index, monetary stimulus lifted the index to well above its two pre-stimulus peaks, currently sitting about 33% higher. How do the three major European indices compare?
Currently, the U.K.’s FTSE 100 is trading very slightly below its two previous peaks, Germany’s DAX is some 32% above its two pre-stimulus peaks, while France’s CAC 40 is some 26% below its two pre-stimulus peaks.
Naturally, given that Germany’s economy has been the strongest in the Euro-zone, the DAX would for good reason already be well above its pre-stimulus peaks. But the ECB’s new program of €1.08 trillion will certainly lift it much higher.
Yet France may provide the greater potential in percentage terms, given that it is still well below its pre-stimulus peaks, just as America was the beginning of 2009. The pattern “could” repeat for France as it did for America, where stimulus lifts its stock market not only to its pre-stimulus peaks but well beyond.
As a token symbol of that potential, since the major indices hit their recent bottoms this January 6th, where the S&P 500 has gained 3.15%, the U.K.’s FTSE 100 has gained 7.06%, Germany’s DAX has gained 11.68%, and France’s CAC 40 has gained 13.38%. France is already in the lead.
While the road to recovery for Europe is expected to be long and arduous, investors may at present be sitting on the opportunity of a generation. We have seen what central bank easy-money policy has done for America’s stock markets. We are now about to see it happen all over again in Europe.
Who says the stock market doesn’t give second chances?