The ECB just announced that it’s cutting interest rates from 0.75% to 0.5%.
This is a cut of 33.33% of the existing rate and will likely, beyond the symbolic, do little.
The intense desire of Central banks to drive down borrowing costs is borne out of their fear of deflation establishing a hold on member economies.
European governments have been dragooned by the Germans into enacting austerity measures and cutting back spending causes fiscal drag(hi), banks are reducing their balance sheets (lending less) and citizens are paying off debt (spending less), all these reduce growth in economies which will, if not counteracted, reduce profits and taxes.
The negative interest rates (the cash yield is less than inflation so assets held in cash are falling in value) are therefore used to encourage (force) money out of cash and into assets such as bonds, real estate, commodities and equities.
If this takes place the benefit is that more demand produces a rise in prices, which encourages more people out of cash thus creating upward momentum.
We wrote over a year ago of our expectation that gradually money would rotate from cash to bonds and then to bond proxy equities. The types of equities that investors have embraced over the last year are predominantly multi nationals with predictable earnings, low volatility, strong balance sheets and high dividends. So sectors such as consumer staples, telecoms, pharmaceuticals, commercial property REITS and utilities have enjoyed demand and now sit at historically elevated price to earnings ratios.
The distortions in markets caused by the residual fears of 2008 and the subsequent central bank responses (zero rates and QE) are significant.
The smart money is now focused on cyclical equities such as Technology and Industrials as well as recovering Financials. Russia is interesting as it is is hugely cheap (but can you invest in it?) China is out of favour and commodities have sold off a lot.
The clever money is willing to buy the ‘out of favour‘ because it knows that certainty comes with a heavy premium, but that doubt offers a discount.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.