Interactive Investor

Ken Fisher: Quantitative Speaking

11th December 2014 12:25

Ken Fisher from ii contributor

Don't believe what you've read about Mario Draghi's latest move: He didn't put a lump of coal in your Christmas stocking when he punted on quantitative easing (QE) last week. That decision was a gift for markets and euroland's economy.

Draghi has hinted at broader QE for months. In October the ECB launched QE-lite, buying asset-backed securities and covered bonds, but those markets aren’t big enough to add €1 trillion to the ECB's balance sheet - the alleged target. Most expect more and foolishly hoped Draghi would announce sovereign bond buying last week, but all he said was, maybe next year.

Most coverage calls this a disastrous delay, dooming the eurozone to deflationary depression, 1930s-style (and cratering Britain's export market, making you suffer too). Not so! It is QE itself that would create deflation - almost for sure! Not prevent it! Full-scale QE would be an anchor around Europe's neck.

The reality of QE has always been reverse of the theory. As I've written for years, QE wants to goose growth by boosting banks and making borrowing dirt-cheap. Central banks buy bonds or other long-term assets from banks, pay for them in out-of-thin-air reserve credits, and expect banks to lend off those reserves many times over, stimulating the broad quantity of money.

Theory vs reality

The purchases reduce long rates, supposedly making borrowers more eager. That's the theory! Reality? When short rates are held near zero, lowering long rates reduces the spread  - effectively banks' gross profit margin (short rates are banks' funding costs, long rates are their revenues). Smaller profits make banks less keen to lend, so they don't. Reserves stay on deposit at central banks, lending reels, and the broad quantity of money (M4, M3 or M2) sinks. America endured this during five years of QE. You lived the nightmare in Britain until late 2012. Now QE is whacking Japan, in its third recession since 2009.

Observers say QE is only a matter of time, believing Draghi's pledges to re-evaluate "early next year" and assuming the only road-block is inflation-shy Germany. Maybe! But central bankers' words are unreliable. They often say one thing - often what they think people want to hear - then do another. Fed transcripts from September 2008 document Ben Bernanke implying certain language in the Fed's policy statement was intended as marketing spin.

Draghi is arguably the master of central bank marketing spin. All sound and fury, little to no substance. Symbolism! When he said he'd do "whatever it takes" to save the euro in 2012, markets oohed and aahed at his power. But he didn't do a thing! The programme he announced wasn't used once. Just words. Symbolism. And it worked for him.

Britain doing great

Same goes for his "early next year" QE pledge, which followed promises the ECB "will do what we must" to raise inflation. More big words! But actions speak louder than words, and his actions of nothingness suggest this pledge may be empty. Which is great! Europe has problems, but it is overall growing. The Conference Board's Leading Economic Indexes for Germany, France, Spain and the full eurozone are in choppy uptrends, implying modest growth continues looking ahead - but growth nonetheless. Yes, Italy and Greece are acting Italian and Greek. But overall modest growth. It isn't a crisis. Britain is doing great. Price gains, though low, are positive - particularly if you strip out falling oil prices (which is positive). Core inflation, which excludes energy and fresh food, has stabilised lately. M3 money supply is rising. Growth isn't gangbusters! But Europe doesn't face a deflationary doom spiral.

Draghi knows all this. He knows the numbers are better today than when he started jawboning about QE in June, with GDP up more and core prices stabilizing. Anything could happen, but if past actions are a guide, it wouldn't shock if he didn't do full-fledged, sovereign bond-buying QE next year either. That's great! Eurozone yield curves will be free to steepen, freeing banks to lend more and actually boost the quantity of money.

Get ready with these stocks

My tip: QE-obsessed eurozone sentiment is way too low. When the masses believe disaster looms, slow uneven growth is a big positive surprise - just what stocks love. False fears are bullish, and it is a whopping falsehood that the eurozone can't survive without QE. Own these stocks now to be ready:

Pimco's volatility from Bill Gross' exodus knocked the bejeebers out of its German parent, Allianz - too much, overblown and out of all proportion to scale for the world's biggest, best insurer. It's now at book value, 0.6 times revenue and 12 times my 2015 earnings estimate, with a likely 3.2% dividend yield. Buy it.

EMC isn't European, but as a globalised tech firm, it benefits from a stronger-than-expected Continent. EMC is the most complete provider of IT infrastructure like storage, data protection, analytics, virtualisation and security used across enterprise data centers and public cloud environments. Growth is near-certain for years to come, yet it's priced market like at 2.6 times revenue and 13 times my 2015 earnings guestimate, with a 1.5% dividend yield.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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