This epic central-bank-easing-driven global stock bull is starting to be strangled by the very central banks that fueled it. This week the European Central Bank made a landmark decision to drastically slash its quantitative easing next year. That follows the Fed’s new quantitative-tightening campaign just getting underway this month. With CBs aggressively curtailing easy-money liquidity, this stock bull is in serious trouble.
The US flagship S&P 500 broad-market stock index (SPX) has powered an incredible 280.6% higher over the past 8.6 years, making for the third-largest and second-longest bull market in US history! The resulting popular euphoria, a strong feeling of happiness and confidence, is extraordinary. So investors brazenly shrugged off the Fed’s September 20th QT and the ECB’s October 26th QE-tapering announcements.
That’s a grave mistake. Extreme central-bank easing unlike anything witnessed before in history is why this stock bull grew to such grotesque monstrous proportions. Without QE, it would have withered and died years ago. Central banks conjured literally trillions of new dollars and euros out of thin air, and used that new money to buy assets. This vast quantitative easing inarguably levitated the world stock markets.
QE greatly boosted stocks in two key ways. Most of it was bond buying, which forced interest rates to deep artificial lows nearing and even under zero at times. This bullied traditional bond investors looking for yield income into dividend-paying stocks. The record-low interest rates fueled by QE were also used to justify extremely-expensive stock prices. QE aggressively forced legions of investors to buy stocks high.
The super-low borrowing costs driven by QE’s crushing downward pressure on interest rates also unleashed a vast corporate-stock-buyback binge unlike anything ever witnessed. Corporations borrowed trillions of dollars and euros to use to buy back their own stocks, boosting their stock prices. QE both enabled and provided the incentives for this anomalous extreme financial engineering, indirectly levitating stock markets.
Stock traders’ apparent belief over this past month that the Fed starting to reverse its QE through QT and the ECB greatly slowing its QE will have no meaningful impact on QE-levitated stock prices is absurd. The simultaneous reversal and slowing of QE in the States and Europe is a hellstorm relentlessly bearing down on hyper-complacent traders. It’s the financial equivalent of a Category 5+ super-hurricane, a juggernaut.
This Thursday the ECB announced it is slashing in half its ongoing QE bond monetizations from their current €60b-per-month pace to €30b per month for the first 9 months of 2018. After that the ECB’s QE will likely cease entirely, since it is running out of available bonds to buy because the ECB’s total QE has been so vast. That means ECB QE will collapse from €720b this year to €270b next year, a radical 62.5% plunge!
The idea that stock markets won’t miss €450b of ECB bond buying next year is ludicrous. The ECB has been monetizing bonds continuously with at least a €60b-per-month pace since March 2015. That will make for colossal total QE from then to December 2017 exceeding €2040b, growing to over €2310b by September 2018. €60b per month falling to €30b for most of next year and then likely zero will have a huge impact.
At current exchange rates, that €450b drop of ECB QE from 2017 to 2018 translates into $530b. That is likely enough all alone to tank global stock markets reliant on aggressive central-bank QE like crack cocaine. But add that on top of the Fed’s first-ever quantitative tightening now getting underway, and 2018 will see the greatest central-bank tightening in history. How can that not drive an overdue stock bear?
I discussed the Fed’s new QT campaign and likely market impact in great detail a month ago right after it was announced. While the Fed’s own QE bond buying formally ended in October 2014, it held all those bonds on its balance sheet until this month. Starting this quarter, the Fed is allowing $10b per month to roll off as they mature. That effectively destroys the money created to buy those bonds, removing QE capital.
$10b per month isn’t much initially, but the Fed is slowly ramping that to a target of $50b per month by Q4’18. The math is simple. Total Fed QT in 2017 will only run $30b, a rounding error relative to the vast size of QE’s trillions of monetized bonds. But in 2018 that Fed QT will add up to $420b. Add that to the $530b of ECB QE here in 2017 but not coming in 2018 due to the taper, and markets face $950b of CB tightening!
Can the world’s two most-important central banks collectively withdraw almost a trillion dollars of liquidity in 2018 alone without blowing a gaping hole in these lofty stock markets? Not a freaking chance! And 2019 looks even worse. Total ECB QE will likely run at zero, down from €720b this year. That translates into $850b. And the Fed’s QT will run at its terminal full speed of $600b annually. That adds up to $1450b!
So on top of 2018’s $950b less of ECB QE and new Fed QT compared to this year, 2019 faces another $1450b of collective tightening from the Fed and ECB relative to 2017. That means $2.4t of central-bank liquidity that exists in this record stock market year will vanish over the next couple years. I can’t imagine a more-bearish omen for excessively-large QE-inflated stock bulls than such a vast reversal of CB flows.
