Central banks are turning on the stimulus tap


Stay pro-risk and stick to “quality” stocks; our “Quality Play” theme has registered strong outperformance since our initiation.
Chief Investment Office27 Nov 2019
Photo credit: AFP Photo


What happened?  

Sharp rebound in risk assets; more than meets the eyes. Risk assets have undergone substantial rebound since 2 October, with the S&P 500 Index up 8.8% and the US high-yield corporate bond spread narrowing 28 bps. The oft-cited reasons for this rebound are:

(a) Troughing global macro momentum

(b) Receding US-China trade tension

Without doubt, these are all plausible explanations. The ISM Manufacturing, for instance, has made a tentative rebound from 47.8 in September to 48.3 in October. On the political front, the GeoQuant United States Political Risk Score Index has fallen from 36.1 to the current level of 35.6, suggesting an easing of geopolitical uncertainties.

But we have to put things in perspective. The latest rebound in macro indicators is only in the early innings and besides, they are coming on the back of sharper and earlier deterioration. Given the strong risks assets rally, we believe there is another factor driving markets higher and that is – the return of central banks’ liquidity. 

What does this mean?

Back to “risk-on”; Fed and ECB balance sheets in expansionary mode. Both the US Federal Reserve and European Central Bank (ECB) have turned on the stimulus tap again. The Fed announced it will purchase USD60b of Treasury Bills per month until 2Q20 while the ECB has also resumed the purchase of Eurozone government bonds at the pace of EUR20b per month starting November for “as long as necessary”.

The latest development has since triggered a spike in the combined balance sheets of the Fed, the ECB, and the Bank of Japan. From January to August, the size shrunk by USD39b per month on average. But in September and October, the balance sheets registered an average monthly expansion of USD130b (Figure 1).   

What should you do?

Stay pro-risk; Stick to “Quality” plays. Barring a sudden deterioration in the US-China trade negotiation, we expect global equities to grind higher in the remaining weeks of 2019 as fundamentals gradually turn the corner. The return of monetary accommodation is another factor underpinning our optimistic view.

To recap, back in 2Q18 CIO Insights “Mind the Bends”, we published a thematic piece titled “Quality Play” – advocating investors to buy quality stocks with strong balance sheets, strong market positioning, and attractive earnings outlook. The strategy has panned out well. Using the MSCI ACWI Quality Index as proxy, the theme has gained 20.2% since 2Q18, outperforming global equities by 8.2%pts.  .

Figure 1: The return of central banks’ largesse

Source: Bloomberg, DBS

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