Feeble inflation data and weak activity reads in manufacturing and services, coupled with Mario Draghi’s comments at the June meeting highlight that QE is certainly a policy tool of the future.
The question is how have markets responded to QE programs that have been implemented across the globe? There are three key examples of market reactions to QE which include the US, the UK and Japan. However, I will concentrate on the US and Japan as they provide perfect counter views of QE responses.
There is no doubting the response the US market has had to QE, after having been part of monetary policy from the Fed for just over five years now. The bull market rally has no doubt been sustained by the program and when you compare the expansion of the Fed’s balance sheet to the S&P, the correlation is near enough to perfect and has seen the US markets averaging 20% appreciation in price terms over this time.
However, what has been interesting from the US’ experiences is that earnings growth in the first year was flat to negative and took until the second year of the program to see earnings growth and a further six to nine months to actually see stretched multiples decline to more ‘normalised’ levels. The counter to this is that multiples had been punished in the GFC and were coming from a low base; the expansion in ‘09 and ’10 were certainly not what most market commentators would call stretched, for example when QE1 started the S&P was trading on a forward P/E of 10.1 times. In Europe however, the STOXX currently trades 14 times forward earnings – a possible limiting factor to the appreciation expected, based on the US response?
In the early 2000s, the BoJ undertook a program to try to break Japan out of is one and a half decades of deflation (which is probably a more comparable case considering the fear of deflation in the periphery). The initial reaction to the purchasing of Japanese government bonds (JGB) was optimism which saw the Nikkei up, however this was not sustained and the markets fell away as deflation was unable to be broken and earnings growth was unresponsive.
This is the fear around Europe; deflation once it takes hold is near enough to impossible to break out of. The lack of sustained growth since the lowering of rates, coupled with the persistent slide in inflation and the lack of earnings recovery in the banks particularly, could suggest the Japanese experience may be the outcome of a QE program in Europe.
However unlike Japan, Europe has acted swiftly in comparison, although nowhere near as decisive as the US or as quick Europe moved on monetary policy inside a year by dropping rates by 300 basis points. Japan took nine years to assume zero interest rates and almost 12 years to enact a QE program. Also the Japanese markets were trading on 23 times earnings, which is substantially higher than the European markets. However, the eurozone does have more characteristics to that of Japan in the early 2000s, rather than the US.
I reiterate that we don’t expect the ECB to adopt a QE policy this week, however if and when it does history shows that responses to these programs have been mixed at best; on current data Europe looks like heading the way of Japan rather than the US.
Ahead of the Australian open
Two pieces of data we will be watching from an Australian-centric point of view: the GDP print and Glenn Stevens’ speech. The expectations for second quarter GDP is 0.4%, down from 1.1% in the first, which will see year-on-year numbers coming in at 3% according to estimates, from 3.5%. Net exports and the performance of the non-mining space are the things to watch as the mining slowdown is sure to filter through.
Glenn Stevens’ speech will be interesting as he is speaking at a luncheon for the Committee of Economic Development of Australia; if there is Q&A he is likely to be pressed on the AUD, housing and future growth - things the market has being dying to hear.
We are currently calling the ASX 200 down seven points to 5651, however after reaching a six-year closing high yesterday on next to no major news, this could be easily reversed.