Friday, 23 January 2015

QE: Super Mario says "jump" and Eurozone equities say "how high?"

Mario Draghi did it again.

Let's quantify and keep it simple:

1. EZB's QE programme will start in March 2015 and run for at least 19 months, until September 2016, inclusive

2. The ECB will buy EUR 60bn of Eurozone government bonds, ABS and covered bonds on a monthly basis. Almost EUR 1.1trn on a cumulative basis over the 19-month period

3. EUR 1.1trn account for:

a. Approx. 12% of Eurozone's government bonds outstanding nominal value

b. Approx. 19% of Eurozone's total stock market capitalisation

c. Approx. 25% of Eurozone's free-float stock market capitalisation

d. Approx. 33% of Eurozone's blue-chip free-float stock market capitalisation (DAX, CAC40, FTSE MIB, IBEX35,....)

So, the question of the day is: where will banks, pension funds, mutual funds & Co invest the proceeds from the disposal of Eurozone government bonds to the ECB? 

Answer: with Spanish 10-year government bonds yielding less than 1.4% and Italian's less than 1.6%, covered bond yields back to pre-2008 levels and the same applying to corporate bonds (incl. high-yield) the excess liquidity will end up in the Eurozone stock market. Assuming that the overwhelming majority of it - let's say 80% - will flow into the most liquid stock market segments (blue-chips), it means that approx. 25% of Eurozone's major stock market indices free-float will be bought up by the direct participant in ECB's QE. And the pricing effect will unavoidably trickle down to small and mid-caps.

For the sake of comparison, FED's QE3 announced in September 2012 and which run until October 2014 accounted for approx. 12% of US' total stock market cap (vs. 19% for the Eurozone). The S&P 500 rose 50% over the period. The US stock market was more expensive then than the Eurozone stock markets are today (on a CAPE basis: USA/S&P500 21.5x vs. Germany 20x; France 16x, Spain 12x; Italy 11x, Austria 9x, Portugal 8.5x, Greece.....3x).

Conclusion: Super Mario is giving you a late Christmas present. To take it up you just have to buy Eurozone stocks. 

Belated Merry Christmas everyone!

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