A month ago, I thought that European QE would not have too much of an impact in the very short term. My reasoning was that the whole thing had been extensively flagged. Everyone knew the date (January 22nd) and the scope (the one trillion number had been leaked since last September). I had not heard a single voice airing doubts that QE would be launched. The only uncertainty was over risk sharing: would Mario Draghi cross the Rubicon? It was given a very low probability by market observers, and rightly so as the ECB chairman decided not to declare war yet on 80 million Germans. And here we are, a month later, up 7%! This reminded me why I pick stocks for a living and refuse steadfastly to take a market risk. I would be very poor at the latter.
For our fund, QE is an hindrance to manage in the short to medium term and a distant catastrophic outcome to be wary of. It is an hindrance because the surge of liquidity usually results in a rising cross sectional correlation in the market (lower discrimination among stocks) and reinforces casino-style behaviours ("stocks are going up any way, let's try to find out the fad of the month, the week, the day...."). We will keep on choosing stocks for our long book on their prospects to deliver better than expected earnings. Thanks to our more constructive view on economic growth in Europe this year, there are more candidates than at any point in time in the last three years. Diversification will help mitigate the risk that QE entails specifically for our short book.
At this stage, there is no need to brace for the inevitable backlash that this Eurozone QE will trigger. It is too distant an event and, though as dramatic as it will be, it is hard to see yet what shape and form it will take. However, inevitable ultimately it is. The instant mis-allocation of capital which is the inevitable consequence of distorting on such a grand scale key economic signals (exchange rates, the propension to save versus to consume, risk premia) will result in long terms damages. Inflating asset prices create bubbles, and a bursting bubble is not something which can be safely managed.
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