A Quantitative Easing Rally
Stocks recovered ground last week thanks to the announcement of a bigger-than-expected quantitative easing (QE) package from the European Central Bank (ECB). In the U.S., the Dow Jones Industrial Average rose 0.92% to close the week at 17,672, the S&P 500 Index advanced 1.58% to 2,051, and the Nasdaq Composite Index climbed 2.65% to 4,757. Bond prices also rose, with the yield on the 10-year Treasury slipping from 1.83% to 1.79%.
Last week's moves support our thesis that central bank action outside the U.S. will help support international equity markets. Our theory on fixed income is different: Prices remain extremely expensive, in our view, suggesting that investors need to be even more selective within their bond portfolios.
ECB Did Not Disappoint
After enduring a rough start to the year, stock prices rose and volatility dropped last week. Investors were cheered by the ECB's QE package and an unexpected rate cut by the Bank of Canada. It was no surprise, but Brazil's central bank bucked the trend with a 50-basis-point (0.50%) increase in the country's benchmark interest rate.
All told, most of the credit for the rally goes to the ECB, which committed to monthly purchases of 60 billion euros in bonds with maturities ranging from 2 to 30 years until at least September of 2016. The size of the package, the open-ended nature of the commitment and the willingness to purchase longer-dated bonds all came as positive surprises to investors. About the only concession to the so-called hawks was the fact that 80% of the purchased bonds will be owned by the respective European central banks. This will limit the risk sharing between countries, addressing a major concern of German officials.
By itself, QE is unlikely to spur European growth, but it should go a long way in mitigating the risk of deflation and supporting European equities, particularly in peripheral countries, where stocks are already up sharply year-to-date. In fact, the positive response in the market was partly a function of fortuitous timing. The announcement came at a time when European indicators appear to be bottoming. For example, recent business surveys out of Germany have turned higher.
Similarly, Chinese stocks managed to recover from an early week tumble, their worst decline in years, thanks to better-than-expected economic data and optimism that the Chinese central bank will further ease monetary conditions. The lesson for investors is this: Foreign markets are facing several headwinds, but both the reality and hope for further monetary easing are helping to cushion international stocks.