Markets soared to new highs again on Thursday, as the European Central Bank (ECB) President Mario Draghi stated they are prepared for unconventional policy tools “if needed” to beat ultralow inflation. While interest rates were left at record lows, Draghi hinted that ECB’s balance sheet would be propelled to Mar 2012 levels.
This will require ECB to pump in 1 trillion euros into the Eurozone, which has been struggling with deflationary spiral and recession threats. Thus, creation of electric money, or as we call it ‘quantitative easing,’ policy is in the offing.
The ECB’s plans on boosting the balance sheet also come after what the Bank of Japan (BoJ) decided recently by stepping up asset purchases, and what the US Federal Reserve concluded.
European shares gained significantly yesterday as did the US benchmarks. Meanwhile, the euro slumped to a 26-month low against the US dollar, and European bond yields dropped. As additional monetary stimulus is introduced, the economy’s currency plummets. This in turn makes exports cheaper, leading to gains for the country whose currency has undergone devaluation.
Is This Just an Echo?
Draghi’s comments were probably not new and the ECB has been criticized with the term “continued inaction” for long. Draghi, on his own, had made similar indications earlier. In September, Draghi had suggested increasing the size of the balance sheet, but the comment irked some of his colleagues. The ECB had reduced rates and announced new stimulus measures in September. ECB had announced it will start purchasing asset-backed securities and covered bonds issued by Eurozone banks. This was criticized by some members as being a rushed affair.
Draghi had not outlined the scale of such purchases then. He also indicated that the new stimulus measures were not taken in one voice by the ECB. "Some were in favor of doing more, some were in favor of doing less," he added.
What’s New?
However, Draghi’s assurance of aggressive monetary stimulus measure was part of the ECB’s official statement and the balance sheet target was finally included in it. Draghi was very specific this time, even citing ‘Mar 2012’ to be the key month when ECB’s balance sheet boasted 3 trillion euros.
The difference the statement made this time is that it refuted allegations of the absence of unanimity among the council members. The official statement; carrying approval signature from the ECB’s governing council members, had the balance sheet target included in it for the first time. Investor mood were boosted this time as they are optimistic that the ECB will be in action now, shrugging criticism of “inaction.”
The council meeting this time was termed as “one of the best’ by Draghi himself. He also said: “Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.”
The unanimous council’s decision in fact juxtaposes with BoJ’s board members having differential views. Four of the BoJ board members voted against the proposal to expand monetary stimulus while five were in favor of the move. (Read: What Bank of Japan Stimulus Means for U.S. Stocks)
Why Europe Needs It?
"The Governing Council has tasked ECB staff and the relevant Eurosystem (central bank) committees with ensuring the timely preparation of further measures to be implemented if needed," Draghi said. Given the state of the region’s economic health, stimulus measure will be a much-needed catalyst.
As for the inflation rate, it was just 0.4% in October. This is far behind the ECB’s target rate of about 2%. Moreover, the Eurozone’s GDP stagnated in the second quarter. This came along with a 0.2% contraction in Germany’s economy and Italy sliding into recession. (Read: Eurozone Recovery Stalls in Q2)
Also recently, IMF believes the Eurozone faces a 1-in-3 chance of slipping back to recession in the near future. Weakness in the Eurozone also led the IMF to downgrade its global economic growth forecast this year for the third time. (Read: Germany Intensifies Eurozone's Recession Woes)
Not a Complete Smooth Sailing
However, skeptics see certain hurdles for ECB. The weakness in euro may be short-lived, according to them. Also, some experts are of the belief that the ECB is way behind other prominent central banks in its move to beef up the balance sheet. The ECB may find it difficult to lap up government bonds.
Also, experts foresee some ‘fundamental disagreements’ to continue within the council. In fact, not having the additional 1 trillion euros pumped into the system would have still meant that the ECB was moving toward the ‘soft target.’ Purchasing sovereign bonds may also face political obstacles.
Reuters reported that sources close to the ECB told them that ECB’s ‘plan to buy private-sector assets may fall short and pressure is likely to build for bolder action early next year, firstly moving into the corporate bond market’.
3 Stocks to Buy Now
Most European stocks traded higher following ECB’s statement. On this side of the pool too, investors cheered the much-needed clarity that Draghi provided. The Dow and S&P 500 finished at record highs on Thursday. Investors can boost their earnings by cashing in the opportunity provided now, and can buy the following 3 stocks that carry favorable Zacks Rank.
UBS AG (UBS): The company serves private, institutional and corporate clients worldwide, as well as retail clients in Switzerland. The business strategy is centered on pre-eminent global wealth management businesses and universal bank in Switzerland.
Recently, UBS AG reported third-quarter 2014 net income attributable to shareholders of CHF 762 million ($834.2 million), improving from the prior-year quarter earnings of CHF 577 million ($619.1 million). The results were driven by elevated net interest income (up 21% year over year) and increased net fee and commission income (up 12% year over year).
UBS AG currently holds a Zacks Rank #2 (Buy). It carries a price to earnings ratio (P/E) of 11.67. The current year growth estimate stands at 60.5% as compared to industry growth estimate of 8.6%.
Shire plc (SHPG): This is a biopharmaceutical company catering to diverse medical needs through research and development, manufacture, sale and distribution of pharmaceutical products.
The company reported third-quarter 2014 earnings (excluding special items and amortization) of $2.93 per American Depositary Share (ADS), up from $1.83 per ADS in the year-ago quarter and beating the Zacks Consensus Estimate of $2.47.
Quarterly revenues increased 31.7% to $1.6 billion, beating the Zacks Consensus Estimate of $1.5 billion.
Shire plc currently holds a Zacks Rank#2. It carries a P/E of 18.79x. The current year growth estimate stands at 40.8% as compared to industry growth estimate of 8%.
Mallinckrodt plc (MNK): The company is involved in drug development, manufacturing, marketing and distribution. This includes both branded and generic specialty drugs, active pharmaceutical ingredients and agents used in diagnostic imaging. Mallinckrodt has a large generics portfolio with a focus on pain management drugs.
Mallinckrodt currently holds a Zacks Rank #2 (Buy). It carries a P/E of 13.36x. The current year growth estimate stands at 39.6% as compared to industry growth estimate of 20.4%.
Bottom Line
It is crucial for investors to be watchful while investing in a region which is combating many economic hurdles. However, picking the right stocks may help investors gain in the near term. While the Organisation for Economic Cooperation and Development has urged the ECB “to do whatever it takes” for reviving the economy, we should get more insight in December when the ECB updates the economic forecasts and releases new quarterly outlook.
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