Why Monetary Stimulus Is Proving Less Effective



The tailwinds abated

Much of the stock market gains in 2012 and 2013 were driven by multiple expansion on the back of aggressive monetary stimulus. Between the market low in 2011 and the end of 2014 the price-to-earnings ratio on the S&P 500 expanded by over 40%. Put differently, as central banks, including the Fed, embarked on an increasingly aggressive series of monetary experiments investors responded by consistently paying more for a dollar of earnings. However, since 2014, QE has ended and monetary stimulus by other central banks, notably the Bank of Japan and European Central Bank, is proving less effective in stimulating asset prices, outside of European credit.

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Market Realist – Monetary stimulus less effective in Europe and Japan

In the wake of the economic (IJH) (IWF) slowdown, the Federal Reserve used several rounds of quantitative easing to propel the economy. From 2010–2013, the Fed induced liquidity worth around $2 trillion into the Market by buying government bonds and mortgage-backed securities.

Higher liquidity in the Market led to a sharp rise in equities (IWM). Forward PE (price-to-earnings) of the S&P 500 (SPY) jumped from 12.7x at the end of 2011 to 17.2x at the end of 2014.

Japan’s monetary easing

Other central banks also initiated a slew of measures to propel their economies. However, they had very limited success. The Bank of Japan has long been trying to achieve a 2% inflation target to propel the Japanese economy to a higher growth trajectory. Despite the quantitative and qualitative monetary easing with a negative interest rate, the central bank hasn’t been able to arrest declining inflation.

When Japan’s central bank launched a massive stimulus program, core inflation fell 0.4% in May 2016 from a year earlier. It was the largest fall since April 2013. The central bank is likely to lower its inflation target for fiscal 2016 to 0.0%–0.5% from 0.5%.

ECB stimulus

Similarly, the ECB (European Central Bank) launched several measures to boost the economy (IEV) and enhance inflation to a target level of around 2%. It expanded its massive bond-buying program to $91.5 billion per month from the earlier $68.7 billion. It also decided to acquire corporate bonds.

Additionally, the ECB cut its main refinancing rate to 0.0% and its deposit rate to -0.4% to spur the economy. The ECB is also encouraging banks to lend to the private sector.


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