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Thursday, September 22, 2016 1:26
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DOUG By Guest Blogger Doug Rowat

Now that I’m a regular contributor here, I’ve noticed a few popular trends in the comments section. Four in particular: 1) all government data is false, 2) all election polling data is rigged in favour of left-leaning candidates, 3) central banks only harm markets and the economy and 4) many blog dogs live interesting lives after about 9 pm.

For those who believe points 1) and 2), you probably feel that North America is already deep in recession and Trump’s guaranteed to be the next president. Build your portfolios accordingly. Let’s tackle point 3).

Central banks maintaining abnormally low interest rates combined with their massive asset purchases may very well result in negative consequences. However, kicking cans down roads is what always happens with economies. Recessions are rare (only 11 in the US since WWII) and we spend too much time worrying about them. Waiting in the fetal position for an impending global recession is unproductive. What I care more about is central banks’ short- and medium-term effect on equity markets.

First, does central bank stimulus actually affect market direction? Absolutely. Let’s look at some examples. The best example, of course, is the US Fed’s massive US$4.5 trillion quantitative easing (QE) program. Quantitative easing, by the way, is an indirect form of economic stimulus that provides liquidity and capital to banks, which promotes lending, and suppresses bond yields because bonds are often the assets that central banks purchase as part of their capital-boost. Lower bond yields, of course, make equity markets comparatively more attractive. The Fed’s QE has not only helped the US economy recover following the credit crisis but has lifted the S&P 500 about 9% annually, including dividends, since QE began in 2008. The correlation between QE and US market direction is an almost perfect 97%.

US Federal Reserve Assets vs S&P 500


Source: Turner Investments, Bloomberg

The Bank of Japan has taken similar action also adding hundreds of billions to its balance sheet, which has also sent the Japan equity market soaring. The stimulus has been less effective this year in part because of the rise in oil prices (Japan produces more earthquakes than oil, so sharp oil price increases often hurt their markets), but the Nikkei 225 is still up about 10% annually including dividends since the BoJ’s stimulus program began in earnest in 2009.

Bank of Japan Assets vs Nikkei 225


Source: Turner Investments, Bloomberg

And finally, the Bank of England has similarly been purchasing assets at breakneck speed, having just kicked it up a notch following the Brexit scare by adding GBP60 billion (C$104 billion) to its QE program (the Bank also lowered its benchmark interest rate, just to be safe). The FTSE 100 is up almost 12% annually since stimulus began in 2009 and 10% since the Brexit vote in June.

Bank of England Assets vs. FTSE 100


Source: Turner Investments, Bloomberg

So, where do we stand now? The Fed, of course, finished with its QE experiment in October 2014 and so far, while sometimes a bit shaky, the US economy is standing firmly on its own two feet and the S&P is up about 10% since the stimulus ended. Consensus forecasts a reasonable 2.2% GDP growth rate next year and I believe that the US market will continue to chug along without requiring more QE. The other major central banks aren’t working within countries that have the same economic strength as the US and are therefore continuing to purchase assets.

While they frequently tease the media by suggesting that their stimulus programs will shortly end, I bet they don’t. Below are the consensus GDP growth forecasts for 2017 along with current inflation rates:

  • Japan: +0.7%, -0.4%
  • UK: +0.6%, +0.6%
  • Eurozone: +1.3%, +0.2%

Anemic. And in each instance, well below the long-term averages. Battling slow growth and low inflation, central banks will likely continue their asset purchases, which, if history is a guide, will push their country’s equity markets higher. We run a global portfolio at our practice, so what central banks around the world do matters to us. Do emergency-level interest rates and ballooning central bank balance sheets pose problems down the road?

Of course. And at some point the global economy will drop faster than Hillary Clinton on a hot day in New York. But I have to work with what’s likely to move equity markets higher on a more immediate basis—that being continued stimulus. Global growth, as we see it now, will be slow, but not negative, so we’ll worry about the next major global recession later. Thankfully, the helpful commenters here will tell you exactly when that will happen; so relax, they have it all timed perfectly.

But enough about central banks, on to point 4): what’s Smoking Man up to tonight…

Doug Rowat,FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

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