European shares are now poised to move higher in the wake of the ECB’s decision to alter monetary policy. The combination of lower deposit and refinance rates, in tandem with an increased quantitative easing program, should help catapult stocks. In September 2012, the Federal Reserve went to an open-ended bond purchase program which helped lift stocks, pushing the S&P 500 index higher by nearly 50% over the course of the next two years. The liquidity provided by the European Central Bank should be the catalyst that lifts stocks and increases inflation expectations.
Change in ECB Monetary Policy
On Thursday March 10, 2016 the European Central Bank announced a shift in their monetary policy in an effort to drive inflation higher by lifting assets prices. Not only did the bank lower its deposit rate by 10 basis points to -40 basis points, and reduce its refinance rate by 5 basis points to zero, but it also increased its quantitative easing bond purchase program by 20 billion euros per month to 80 billion from 60 billion.
The central bank also announced that it would look at four new long-term lending programs, and hold the bond purchase program in place to at least March 2017 from September 2016. The ECB also said they would add corporate bonds to the program. This is now a big deal for stocks as in many cases the alternative to stocks is corporate bonds which in many cases has a similar risk profile.
The largest beneficiaries of the bond purchase program and the change in monetary policy are the European Banks, such as Deutsche Bank. The banks benefit from actually getting paid to lend money to clients. Instead of keeping money at the central bank and receiving a negative amount for it, they can take money from the long-term lending facilities and receive income to get paid by clients to take lending risk. This is a mechanism to directly increase lending.
Another group that will directly benefit from the changes in monetary policy are corporations. If the ECB is now focused on purchase corporate debt, their actions will push yields in the corporate space down making borrowing in this area much less expensive. Not only will investment grade paper get stronger in demand but high yields debt in Europe will benefit as investors scramble for yield.
While all this is going on preferred stocks in Europe will begin to benefit, as investors generate a proxy for corporate debt. The yields on preferred stocks will in turn move lower, which should spill over into common stocks. As investors search for the best possible returns they will move down the risk spectrum and purchases of European common stocks should move to a premium. The further out the risk an investor goes, the more they will actually achieve in returns. This set up is similar to the set up achieved in the United States, which should provide a very strong backdrop for European stocks.
Investors and European Shares
Investors who are looking at stocks should understand there is an underlying upward bias to European stocks given the recent actions of the European central bank. Although individual stocks will likely experience volatility over the course of 2016, the upward bias should be higher as purchases of 80 billion Euros per month will be moved through the system.