Well, so much for the Big Bazooka. Through last week, European banks had only borrowed €82.6 billion of the €400 billion that ECB President Mario Draghi had pledged to make available via his Targeted Longer-Term Refinancing Operations (“TLTRO”).
If you need a refresher, you can re-read “Draghi’s Big Plan,” which I wrote in June. But here’s the abbreviated version: Draghi’s TLTRO program allows Eurozone banks to borrow at next to nothing—0.25% or less—over four years on the condition that the funds be used to make loans to small and medium-sized businesses. TLTRO and a separate ECB plan to buy asset-backed securities were intended to expand the ECB’s balance sheet by about €1 trillion. Draghi’s plan would have stopped short of full-blown quantitative easing—or using central bank funds to buy government bonds on the open market—but it would nonetheless have injected a flood of liquidity into the Eurozone capital markets.
This, along with comparatively cheaper pricing, was a major reason for my bullishness on European stocks.
Draghi has publically insisted that the €82.6 billion take-up is in line with his expectations at this stage, but the market has been a little less than impressed. And the ABS program has yet to really get started.
Should any of this come as a surprise?
Not to any sane person who has been watching the ECB operate over the past two years. Nothing moves fast in the Eurozone. I expect the second iteration of TLTRO, scheduled for December, to have greater participation, as banks will have had more time to get comfortable with the terms and assess their borrowing needs. With loan demand still tepid, it might not be realistic for the ECB to loan out the entire €400, but I expect them to get awfully close. It’s hard for banks to turn down free money with few strings attached.
I also expect that the ABS purchase plan to eventually account for several hundred billion euros. Between the two, €500 billion to €750 billion in ECB balance sheet expansion becomes doable by the end of this year or first quarter of 2015. But that is still shy of Draghi’s stated intent to expand the balance sheet by €1 trillion. My bet is that he makes up the difference with a quantitative easing program of sorts. He’s been dropping hints about “doing more” for months now. My assumption is that he is simply waiting for bad economic data to lower political opposition from Germany.
And on that count, Draghi may soon get his way. Inflation in the Eurozone remains far too low for Draghi’s comfort. Last month’s reading came in at 0.3%, far below the ECB’s 2% inflation target. And the Eurozone economy is showing more signs of stalling; the purchasing managers’ index, leading indicator of economic activity, slid to a nine-month low in September, to 52.3. In France, the figure fell to 49.1. (Anything below 50 shows outright contraction.)
In the bad-news-is-good-news world of central-bank-driven markets, all of this points to one thing: Eurozone quantitative easing.
What does this mean for us?
Let’s think back a few years. When the Fed started its quantitative easing program, the economy was not healthy. The recovery was still in its early stages and could have easily reversed; it’s easy to forget that with the hindsight of multiple years of expansion and raging bull markets.
I see a similar scenario unfolding in Europe. Europe has its own set of unique problems, and it is not an exact apples for apples comparison. But the end result is the same: a ton of freshly-printed central bank cash is about to be dumped into an inexpensive and under owned equity market.
Action to take: Buy shares of the Cambria Global Value ETF (GVAL) and plan to hold for 12-24 months. Use a 20% trailing stop.
GVAL is not a pure play on Europe; it has significant exposure to emerging markets as well. I’m fine with that. Emerging markets are, by and large, very attractively priced, and I expect the flood of liquidity coming out of Europe to spill over into emerging markets.
