One mantra has overridden everything else for the past five
years. It has proved even the most astute bears wrong and made
money for anyone with a dime in the markets.
Don't fight the Fed!
Stocks have jumped every year since 2009 -- and every year
pundits say we are due for a major correction. Subpar job growth
and annual GDP growth under 2% cannot possibly support asset
prices, they say, and a slowing China can't pick up the
And every year they are wrong.
Why? Because for the past five years, we have had the most
influential central bank in the world saying they've got a
monetary defibrillator... and they're going to keep shocking the
economy until it jumps back to life.
The economic resuscitation has been in the form of more than
$3 trillion pumped into the system.
While the general economy may still seem to be on life
support, asset prices have more than doubled since the Federal
Reserve began its assorted quantitative easing (QE) programs.
As Fed winds down its historic monetary support, I can't help but
wonder: What's next for stocks? Fortunately for investors, it
looks like the game will be the same -- but instead of "Don't
fight the Fed," the next slogan will be...
Don't fight the ECB!
About two years after President Mario Draghi told the markets
he would do "whatever it takes," the European Central Bank is
about to give the market a shot of adrenaline. At its June
meeting, the ECB said it would initiate another round of cheap
loans, up to $544 billion to regional banks. The loans will have
four-year maturities and cost just 0.25%.
Beyond its assorted loan programs, the ECB has lowered rates into
negative territory, giving banks an extra incentive to increase
lending rather than sit on cash. If even this were not enough,
the International Monetary Fund recently urged the ECB to
initiate an asset purchase program as well.
The Government's Shell Game -- With Money Under Every
While the new ECB's loan program may do no better at
kick-starting the economy than the Fed's program did here in the
U.S., one sector is almost guaranteed to benefit. J.P. Morgan
estimates that only 5% of the original loan program actually made
it into the economy, with the rest used by the banks to buy
sovereign debt and retire costlier loans.
Banks were able to borrow more than $1 trillion at a rate of
just 1% to buy bonds with yields two or three times higher, and
the ECB said nothing.
Now, the banks are getting an even better deal
with a longer loan at a lower rate
For example, under the new program, a bank could borrow at
0.25% and buy Italian 10-year debt yielding 2.9%. Unless you
believe that Italy will default, that is a 2.6% riskless return.
That is the risk-free scenario, but it gets better.
A strengthening economy across the European Union may actually
see the banks increasing loans (as the program intends), which
could see even higher profits. While the region's economy may not
be growing as fast as in the U.S., the downside risk has been
greatly diminished. and there's a good chance that banks will put
more of the new targeted loan program to work.
While American depositary receipts (ADRs) of European banks
are limited, investors can still cash in on the new market
Deutsche Bank (NYSE:
is one of the largest banks in the region, with a market cap of
$36.2 billion. The bank is global in operations and so may not
benefit as much as other strictly regional banks though 30% of
2013 revenue was from retail and business clients. Shares
increased 19.0% in the first year of the ECB's three-year loan
However, shares have plummeted 26% during the past six months
on allegations of market manipulation and a proposed capital
raise. That pullback means DB may now be an especially good
value. Shares trade for less than half book value (0.47 times, to
be exact), compared with the industry average of 0.9 times.
iShares MSCI Europe Financials Sector Fund (NYSE:
holds positions in more than 100 financial institutions across
Europe, many of which are not accessible as ADR shares to U.S.
investors. The fund holds its largest exposure to U.K. banks
(31.3%) but diversifies the rest of the holdings across EU
members. The fund jumped 36.2% in the year after the ECB's first
loan program, but it has fallen 4% in the past six months. Shares
pay a biannual dividend with the June payment doubling the
distribution from the previous year. The average price-to-book
ratio is relatively expensive at 1.3, but book values are likely
to improve on the new round of ECB funding.
Risks to Consider:
Despite increasingly easy money from the central bank, the
eurozone is still only expected to post GDP growth of about 1%
this year, which could make it difficult for financial companies
to generate long-term profits.
Action to Take -->
The ECB is again handing out virtually free money to the region's
banks and permitting them to make nearly riskless money in the
carry trade or generate higher profits on loans. Take advantage
of that generosity ahead of the rest of the market for a
potential pop in shares.
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