If you had €1 trillion to spend, do you think you could spark some inflation in your economy? The European Central Bank (ECB) certainly did. A trillion euros is a lot of money. A thousand billions, or a million millions. It’s almost impossible to comprehend how much money that is. Interestingly, one trillion euros is approximately equal to Australia’s gross domestic product: that is, the sum of all revenues generated throughout the entire Australian economy over the last twelve months.
So over the last year or so, the ECB has spent around €1 trillion buying bonds in a hope to spark inflation. The idea is, by blasting the bond market with an additional €1 trillion in demand, bond prices go up and bond yields come down. The lower bond yields make it easier and cheaper for corporates and households to borrow. The hope is that borrowings increase to fund new investment and consumption – the key drivers of any economy.
So here we are, one year later. As illustrated on the chart below, ECB assets have increased by €1 trillion; and yet, market-implied inflation expectations have barely moved. On the one hand, this raises questions over the efficacy of the bond-buying program. On the other hand, we have no idea what inflation expectations would have done absent the €1 trillion program.
From an investment perspective, Montaka is staying away from European financials. Low demand for credit and a stubbornly flat yield curve are not great conditions for financials. Furthermore, asset risks exist around the potential break-up of the European Union due to a “Brexit” scenario or an immigration crisis. (For more on this idea, see here).
Montaka does see opportunity in non-financial equities, however. Particularly those with relatively clean balance sheets. You see, with the ECB set to buy corporate bonds for the first time tomorrow, there will be an enormous opportunity for European corporates to issue bonds at extremely low yields to buy back stock. This is financial engineering for sure. But so too is the ECB’s €1 trillion quantitative easing program. For the last six years, the saying amongst equity investors in the US has been: “Don’t fight the Fed.” The same may well now apply to the ECB.
Andrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.