It has been more than six years since the credit crisis and still the central banks of Europe and Japan continue to distort financial markets with their vast bond-buying programmes and zero (or negative) interest rate policies. There is little sign that their resolve will change soon.
In Europe, while the improvement in sentiment and business surveys has been impressive since ECB president Mario Draghi’s quantitative easing programme was confirmed in January, inflation is still in negative territory, with unemployment at more than 11 per cent. In Japan, economic growth returned in Q4, but an even larger bond purchase programme may yet be needed if Prime Minister Abe and Bank of Japan governor Kuroda are to hit their 2 per cent inflation target.
So, will interest rates ever ‘normalise’? Yes, eventually, but my hunch is that central bankers will get more active before they get less so. The latest candidate is China, where economic growth has been fading and there is mounting evidence of a backlash from the anti-corruption campaigns that have damaged business investment. Against this backdrop, the government looks to be prioritising growth again, and this means easier money.This implies even more liquidity and further upward moves in local asset prices.
China ‘A’ shares (buyable only by domestic investors and strictly qualified international institutions) have rallied by an extraordinary 89 per cent in a year, and some of this liquidity seems to be spilling over into Hong Kong-listed Chinese equities (‘H’ shares), where valuations are lower and yields higher.
In Europe, the ECB’s QE programme now appears to be a lot more potent than the original brew and is having a powerful effect on asset prices. The original purchases by the Federal Reserve and Bank of England just about mopped up the flood of bonds issued to fund the large 2009/10 budget deficits; now you find the ECB buying bonds in volumes vastly greater than their governments are actually issuing.
Deficits have declined or even turned to surpluses in parts of Europe (in Germany, for example, the 2014 budget surplus was €18 billion and rising), but still the Bundesbank/ECB have bought €11.1 billion of German government bonds in just the first month of the programme.
In short, while central banks are already forced buyers of any newly issued bonds, they must also buy large volumes from the investment portfolios of insurance companies, ETFs, mutual funds and foreign governments. These investors are left to redeploy the proceeds rapidly. If equities are chosen to replace the bonds purchased, then there often seems to be a preference for local markets, and buyers seem to favour liquidity and yield.
In Japan, Shinzo Abe’s ‘Three Arrows’ to revive growth (fiscal stimulus, monetary easing and structural reform) require the central bank and government to act in concert to magnify the policy impact. As part of the third Arrow, Abe has sought to make the Tokyo stock market more attractive by ‘guiding’ Japanese companies to increase their returns to shareholders, and to improve governance and transparency.
A series of companies are lifting or formalising dividend pay-out policies (giant conglomerate Japan Post recently announced that it would raise the group’s dividend pay-out ratio to more than 50 per cent, from around 25 per cent in recent years), while pension guidelines are being simultaneously altered to increase equity holding limits. While these ‘distortions’ or changes are highly welcome, this sort of directed policy has huge implications for stockholders.
Meanwhile, the removal of years of market distortions and ‘managed’ supply in the oil markets is set to trigger windfalls for oil consumers and a round of opportunistic M&A. It appears increasingly clear that Saudi Arabia (in public) and the rest of the Gulf (more privately) acknowledge that the era of Opec tightly managing oil market supply is now over. Saudi has not been shy to increase production: in the US, drilling (rig counts) has fallen by almost 50 per cent since June 2014 as shale operators pull back dramatically, while in Saudi Arabia (according to the Financial Times) the rig count has actually climbed.
With aggressive central banks and interventionist governments impacting asset prices, we at Sarasin anticipate further divergences in country, currency and commodity returns, with the QE programmes now centred in Europe and Japan being particularly effective. Put simply, then, political and policy distortions are rife across global markets; fortunately, so are the asset allocation and thematic opportunities they offer to global investors.