Morgan Stanley has mixed views on EBC’s QE

Although the bank predicts the European equity market might gain c. 8% over next 6 months from QE’s announcement, its economist are still scratching their heads regarding the ability to implement and the benefits of this kind of measures.

From a note entitled: « Implications of ECB QE for macro and equity sectors », dated Jan 19 (bold statements underlined by us):

« We expect the ECB to embark on sovereign QE despite considerable political concerns and legal obstacles at this week’s Governing Council meeting. On balance, we expect the ECB to announce government bond purchases of €500bn and private sector asset purchases of €100bn on Thursday. »

Well, we hear from other brokers that not much has to be expected from Jan 22, although the principle of QE should go in the open.

« For sovereigns, we think a workable compromise for the ECB would be a hybrid programme with a core component in which financial risk is shared across the Eurosystem, and an optional component relating to national central bank risk. We remain sceptical on the impact of sovereign QE because of the dissent inside the ECB, the potential political backlash, the legal uncertainties on government bond buying, and the Greek situation and its complex execution. »

Nothing new here, we know the Germans and some Nordic countries (the Netherlands) are not big fans of sovereign bonds purchases, because it’s a free lunch for countries that did not conduct any significant structural reforms in the pas (mainly France and Italy).

« As far as equity markets are concerned we do not believe that QE is already fully in the price for European equities and expect subsequent performance to be driven by whether investors perceive the ECB’s actions as ‘whole-hearted’ or ‘half-hearted’. In the event of the former, we expect Europe’s 12m PE to rise from 13.8 today up towards 15. The latter would likely see equities flat or down. »

Yes and the latter is a risk. But since not so many investors expect full blown QE, any positive surprise should do the trick. Remember, we have to wait after Draghi has spoken to see what other members of the governing council will declare.

« Our interest rate strategist team believe the actual purchases will be undertaken by the individual central banks in operations similar to SMP and covered bond purchases. Such a programme could be viewed as moderately disappointing, they argue, given current pricing, particularly if risk-pooling disappoints.

While our FX strategy team is bearish on EUR and sees QE as adding to the downward pressure, the pace of EUR decline is likely to be determined by the structure and extent of any QE announcement. In the case of relatively unconstrained QE, acceleration in the EUR decline would be expected and could even exceed the MS base case 1.12 forecast for year-end, putting the focus on our bear case projection of 1.00.

However, under the case of QE with constraints, which are viewed by the market as making the policy less effective, resulting in higher asset market volatility, the EUR is likely to be prone to a near-term corrective rebound and we would maintain our base case 1.12 EUR projection for year-end. »

Here’s a cool chart that reflects previous QE experiment on govies, forex and equities.

Source: Morgan Stanley

Source: Morgan Stanley

And for equities, here’s a look up of QE impact for stocks based on past experiences.

Source: Morgan Stanley

Source: Morgan Stanley

Some comments from MS’s strategist team:

« The table below ranks sectors by their 6M hit ratio – i.e. % of times that the sector outperformed when we measure the N6M average post QE announcement to the L6M average pre QE announcement. We then also show the % upside to the N6M average that our analysis suggests. While we should be careful about applying historical performance patterns too dogmatically (regional sectors can have different characteristics and the macro backdrops at the time of the QE announcements may have been different) we would note the following:

Bullish: Sectors in the below table that have a hit ratio of 50% or more and offer upside from current levels are: Autos, Industrial Goods & Services, Chemicals, Oil & Gas, Financials Services and Construction & Materials. Given the ongoing volatility in commodity markets we would focus on Autos, Industrial Goods & Services, Financials Services and Construction & Materials as sectors to overweight at this time.

Bearish: Sectors in the below table that have a hit ratio of 50% or less and offer downside from current levels are: Real Estate, Food & Beverages, Personal & Household Goods, Retail, Insurance, Technology, Telecoms, and Healthcare. Utilities has previously been the most consistent underperformer around QE, lagging the market on 5/6 occasions (the one exception was around Japan’s QE announcement in Apr-13).

Max/Min skew: The sectors with the most positive maximum-to-minimum skew are: Oil & Gas, Basic Resources, Financial Services, Banks, Utilities and Construction & Materials. The sectors with the most negative maximum-to-minimum skew are Real Estate, Telecoms, Food & Beverages, Technology, Healthcare and Retail. »

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