Last week, we highlighted a troubling Reuters article, which we classified as a quiet "trial balloon" to set the stage for an ECB launch of stock purchases. As Reuters put it, the ECB may soon be forced to follow the Bank of Japan's example and buy equities as part of any expanded stimulus programme. Reuters recapped the familiar problem: "The European Central Bank could run out of eligible bonds for its 1.7 trillion euro bond-buying scheme, meaning alternative options are on the table should it decide to loosen policy further to lift growth and inflation across the bloc. Analysts say these could include large-scale share buying, a policy that the BOJ has already adopted after it started purchasing equity exchange traded funds (ETFs) for its own quantitative easing scheme six years ago."
Overnight, the WSJ doubled down on this "warning", writing that central banks have become some of the biggest investors in bond markets. Now some in the financial markets think stocks should benefit more from their largess. The amusing spin came when the WSJ cited "some economists" who say the European Central Bank, which meets Thursday to decide if it should expand its current bond-buying program, should invest in equities. The reason - one we have discussed for years, and which Reuters touched upon last week - "It is running out of bonds to buy."
While certainly redundant, the WSJ observes that "a move by the ECB into equities would have big implications for Europe’s stock markets." Well yeah: with equities becoming risk-free, it would mean prompt all time highs as a completely price-indescriminate buyer would now be on the verge of nationalizing yet another market, and crushing all the fundamental signals that link corporate health, the economy, or underlying industry dynamics with risk asset prices.
The prospect of billions of euros flowing into equities could prop up prices, much as ECB bond purchases have done for debt securities. The signaling effect from the ECB’s unlimited money-printing power may also limit downturns in equities.
Stock purchases don’t appear to be on the near-term agenda. But ECB officials haven’t ruled them out, and the idea could gain steam if they continue to undershoot their 2% inflation target.
As we first explained in early 2015, the ECB would merely join such other central banks as the BOJ and SNB in openly monetizing equities (as opposed to the hidden stock purchases by entities such as the NY Fed which does so however using Citadel as a momentum-igniting intermediary when the US stock market is in danger of tumbling). The Czech central bank has been buying stocks since 2008. Israel’s central bank also holds stocks. In fact, the SNB has been buying stocks for over a decade "to diversify" its massive foreign-currency holdings. They now account for 20% of reserves, the resultof an unprecedented buying spree in the second quarter as first reported on this site:
Another big stockholder is the Bank of Japan. It had ¥10.182 trillion (about $98 billion) in individual stocks and exchange-traded funds as of Aug. 20, in terms of book value. It roughly doubled the pace of its annual ETF purchases to ¥6 trillion on July 29, 2016.
The SNB holds only foreign stocks, because buying overseas assets is supposed to weaken the strong franc. To avoid stock-picking, it mirrors broad stock indexes. The bank employs external experts to advise which companies should be excluded due to red flags such as arms dealing or environmental damage. The Japanese buy domestic equities as part of a more traditional stimulus program.
And while the ECB may not go ahead and announce equity monetization imminently, it may have no choice: "The obvious reason for the ECB to buy equities is they have almost run out of German bonds to buy,” said Stefan Gerlach, chief economist at BSI Bank and a former deputy governor of Ireland’s central bank. "The basic idea is that the central bank can put essentially anything on its balance sheet and there is no reason to be straight-laced about this.”
The good news is that once the ECB starts buying up European stocks, it would have a far bigger selection. "Equities offer a deep pool of assets. The market capitalization of listed eurozone companies was $6.1 trillion at the end of 2015, according to World Bank data."
Meanwhile the push is on, and the think tanks are already on board. First up, the Peterson Institute:
“I don’t see a reason not to do this,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics. “It isn’t obvious to me why a central bank wouldn’t always want a diversified portfolio, including equities.”
That a member of a think tank just said that it is not obvious to him why a central bank should not buy equities - at a time when even central bankers lament that collapse in fundamentals and market logic due to central bank intervention - is so idiotic we won't even comment on it. So here is what else he said:
Mr. Gagnon suggests a more aggressive approach, pointing to the success of Hong Kong’s central bank in supporting the economy during the late 1990s Asian financial crisis by buying around 10% of the Hang Seng Index. That move sparked a 40% rally in stock prices within two months, and the index more than doubled over the next 18 months.
Which, of course, Mr. Gagnon sees no problem with.
Not everyone has completely lost it: "some economists also worry that by purchasing only public and private bonds, central banks may fuel bubbles in rate-sensitive sectors such as housing."
ECB stock purchases “would be justified: European equities are undervalued, while there is a bubble—that the ECB continues to inflate—in bonds,” said Patrick Artus, chief economist at French investment bank Natixis, in a research note.
Just ignore the bubble in equities, please.
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With this full court press already in play, it is likely only a matter of time before Draghi does announce an expansion to the ECB's QE, one which will see the central bank a buyer of last resort in government and corporate bonds, as well as equities, thereby distorting all three key capital markets.
There is some hope that the only adult left in the room, Germany, will put a stop to this insanity before it is too late: "it would also raise the prospect of having Germany’s Bundesbank taking on the risk of Portuguese or Greek stocks. Germans are already deeply wary of the ECB’s bond buys and negative-rate policy."
Sadly, just as the Bundesbank rolled over in its opposition to both forms of bond purchases, so it will ultimately cave when it comes to the monetization of stocks.
Finally, while this is good news for stock bulls, as equities will have yet another artificial support, the question is what happens if and when the time comes to sell: after all, the only reason to buy stocks when central banks are in the market is to frontrun them. Which does miracles to PE multiples on the way up, however once the selling begins, especially in an illiquid market where the central bank itself has soaked up the bulk of the liquidity, it would mean an immediately bidless market as everyone rushes to the other side of the boat. Conveniently, that particular scenario is not one any current traders will have to worry about: while central bankers are notoriously experienced when it comes to buying, their selling skills have been and remain "optional."