Market Update 1-23-15

European Central Bank Announces Quantitative Easing:

 

As expected, the European Central Bank (ECB) announced on Wednesday its pledge to purchase government bonds in an asset purchase program worth approximately €1.1 Trillion ($1.3 Trillion),  more than €500 Billion more than originally expected.  The plan is to purchase €60 Billion a month until at least the end of September 2016, though they left the option open to continue beyond that point.  This is all being done in an effort to increase the amount of euros in circulation with the goal of staving off deflation. 

 

ECB President Mario Draghi stated the monthly bond purchases will begin in March and will likely be compromised of €45 Billion of sovereign debt, €5 Billion of bonds issued by European institutions and agencies, and €10 Billion of asset-backed securities and covered bonds.  The markets reacted favorably, sending European stocks moderately higher, while also sending the value of the euro lower. 

 

The ECB program is modeled after the U.S. QE bond buying by the Federal Reserve which has been credited with jump-starting the U.S. economy after the 2008 financial crisis.  The Eurozone economy likely grew at approximately 1% last year, economists estimate, after emerging from recession in 2013. The biggest challenge for the ECB is that the program is much more challenging to carry out in the fragmented Eurozone, with 19 member states that do not always agree.  Economically strong nations, such as Germany and the Netherlands, have voiced some opposition to the program in the past.  They fear that if struggling countries such as Spain and Italy defaulted on their bond payments, German and Dutch taxpayers would get stuck with the bill.

 

For 20% of the bond purchases, the ECB agreed to share losses among Eurozone nations. That strategy is backed by economists who fear interest rates in debt-racked countries will spike if they’re forced to absorb all the losses on their bonds. But, in an apparent concession to Germany, individual nations will have to bear losses for the remainder of the purchases.

Other recent ECB measures to stimulate growth have been largely ineffective. They include offering cheap bank loans and making banks pay to park their money at the central bank to prod them to lend more.  While the American economy saw resurgent expansion in the third quarter — growing 5% — the major European economies of Germany, France, Spain, Italy and others have seen little growth since the financial crisis began in 2008.

Germany has a hard time taking on risk due to the financial mismanagement of other European countries that have let entitlement programs run out of control in the past.  They want more structural reforms in some southern European nations, such as Italy, Spain and Greece. Germany also harbors entrenched historical fears of inflation and has been reluctant to endorse monetary policy that could lead to rising prices.  Germany is hypersensitive to inflation risks because they have suffered through terrible bouts of inflation in the past.  In the Weimar Republic immediately following World War I, the US dollar and the German mark were very close in value.  Hyperinflation then took hold and by November 1923, one American dollar was worth 4.2 Trillion marks (yes, that’s Trillion with a ‘T’).

 

Big Election in Greece Sunday:

 

On Sunday, Greece will vote to elect all 300 members into its Hellenic Parliament.  This is especially important because Greek lawmakers were asked to elect a new president in December.  However, after three attempts, they failed to agree on a new President.  As a result, Greece must hold national elections to vote for all 300 seats in its Hellenic Parliament.  The newly elected Hellenic Parliament will then decide on the next president.  Current polls show the Syriza party as the favorite to win.  The Syriza Party has long opposed the Greek Bailout plan and it is believed that, if elected, the end result will be Greece’s exit from the Eurozone.  However, the big unknown is whether the Syriza Party would have enough control to form its own government.  There is a chance that, after Sunday’s election, there will be no clear majority and a second round of national elections may be required.

 

Switzerland Removes Swiss franc peg to euro:

 

Switzerland delivered quite a shock to the markets on Thursday, announcing they will no longer “peg” the Swiss franc to the euro, which had previously been set to 1.20 Swiss francs to euros.  This move was unanticipated and sent the Swiss franc into a trading frenzy, appreciating as much as 41% against the euro.  Swiss stocks fell on the news, as an appreciating Swiss franc means Swiss exports become more expensive to foreign nations (and therefore less attractive).  This is a big deal to the Swiss economy as nearly 72% of its GDP comes from exports.  Interest rates were also lowered from -0.25% to -0.75%.

 

It is important to remember that Switzerland began the currency peg in 2011 during the euro crisis.  At the time, what looked like the imminent end of the euro made people want to move their money to the safety of Swiss banks (since Switzerland is not part of the euro).  These incoming deposits began pushing the value of the Swiss franc higher, making exports more expensive to foreign nations.  To combat this, the Swiss national bank adopted a “peg” of 1.20 Swiss francs for each euro, meaning they would control how much money gets printed to ensure this peg would remain intact.  As the Swiss National Bank saw the appreciating currency as inevitable, they decided to take action sooner rather than later.  It is very likely this will lead to further deflation within Switzerland.

 

Corporate Earnings Looking Strong, But It’s Still Early:

 

Earnings season has gotten off to a good start.  Though the number of companies that have reported is still small, as of early this morning, 79% of the S&P 500 companies that have reported their earnings have exceeded projections after analysts reduced their estimates.  General Electric (GE) was the most notable earnings announcement that took place this week.  GE earned $0.56 per share, beating the $0.55 average that analysts were expecting.  GE attributed this to growth in its industrial segment, especially in infrastructure.  The company continues to “wind down” its reliance on the financial side of the business, as they are in the process of spinning off GE Capital.  Even with the drop in oil prices, GE only lowered its profit forecast for 2015 by 5%, better than analysts anticipated.

 

Next week is a big week for corporate earnings releases.  A few of the companies set to report next week are Microsoft (MSFT), AT&T (T), Apple (AAPL), Freeport McMoran Copper (FCX), Procter & Gamble (PG), Boeing (BA), Qualcomm (QCOM), Blackstone Group (BX), Ford Motor (F), Google (GOOG), Visa (V), and Chevron (CVX).   Next week should be very telling for the direction of the economy as we listen to the guidance from each of the companies.

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