Equity Markets Could Get a Boost if Central Banks Started Buying
By BRIAN BLACKSTONE and TOM FAIRLESS
Updated Sept. 5, 2016 2:00 p.m. ET
Central banks have become some of the biggest investors in bond markets. Now some in the financial markets think stocks should benefit more from their largesse.
Some economists say the European Central Bank, which meets Thursday to decide if it should expand its current bond-buying program, should invest in equities. The reason: It is running out of bonds to buy.
A move by the ECB into equities would have big implications for Europe’s stock markets, which have been rocked by a series of shocks this year, from volatility in China to Britain’s vote to leave the European Union. The prospect of billions of euros flowing into equities could prop up prices, much as ECB bond purchases have done for debt securities. The signaling effect from the ECB’s unlimited money-printing power may also limit downturns in equities.
Stock purchases don’t appear to be on the near-term agenda. But ECB officials haven’t ruled them out, and the idea could gain steam if they continue to undershoot their 2% inflation target.
Some central banks already invest in equities. Switzerland’s central bank has accumulated over $100 billion worth of stocks, including large holdings in blue-chip U.S. companies such as Apple and Coca-Cola.
If the ECB decides to raise its stimulus by extending its current bond program, as many analysts expect, fresh questions will be raised about how it will continue to find enough bonds to buy. The bank is already purchasing €80 billion ($89.2 billion) a month of corporate and public-sector bonds to reduce interest rates across the eurozone. Its holdings of public-sector debt reached €1 trillion last week, the ECB said Monday.
ENLARGE
With a key policy rate already below zero, ECB officials hope that buying bonds with freshly printed euros will reduce interest rates further. But policy makers face a practical constraint: The ECB is running up against self-imposed limits on how much of a country’s bonds it can hold.
“The obvious reason for the ECB to buy equities is they have almost run out of German bonds to buy,” said Stefan Gerlach, chief economist at BSI Bank and a former deputy governor of Ireland’s central bank. “The basic idea is that the central bank can put essentially anything on its balance sheet and there is no reason to be straight-laced about this.”
Advertisement
Equities offer a deep pool of assets. The market capitalization of listed eurozone companies was $6.1 trillion at the end of 2015, according to World Bank data.
Until the financial crisis, policy makers mostly steered growth and inflation by tweaking short-term policy rates, which in turn influenced longer maturities.
When policy rates approached zero, central banks in the U.S., the U.K., Japan and the eurozone turned to bond purchases to reduce long-term interest rates. Buying equities would likely yield some of the same effects in terms of encouraging consumption and investment through higher household wealth and lower cost of capital.
“I don’t see a reason not to do this,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics. “It isn’t obvious to me why a central bank wouldn’t always want a diversified portfolio, including equities.”
Partly to address political concerns, the ECB has set limits on the amount of a country’s government bonds it will buy. Analysts say it could run up against those limits soon in markets such as Germany, particularly if its quantitative-easing program extends beyond the targeted March 2017 end date.
Some economists also worry that by purchasing only public and private bonds, central banks may fuel bubbles in rate-sensitive sectors such as housing.
ECB stock purchases “would be justified: European equities are undervalued, while there is a bubble—that the ECB continues to inflate—in bonds,” said Patrick Artus, chief economist at French investment bank Natixis, in a research note.
The Swiss National Bank has purchased stocks for over a decade to diversify its massive foreign-currency holdings. They now account for 20% of reserves. Another big stockholder is the Bank of Japan. It had ¥10.182 trillion (about $98 billion) in individual stocks and exchange-traded funds as of Aug. 20, in terms of book value. It roughly doubled the pace of its annual ETF purchases to ¥6 trillion on July 29, 2016.
Economists have been split over the costs and benefits. Some say that Japan’s capital market can no longer accurately price the value of stocks; too much BOJ money has flown into some specific companies. Others say it has helped prop up share prices, thus producing “wealth effects” to help the economy fight deflation.
Mr. Gagnon suggests a more aggressive approach, pointing to the success of Hong Kong’s central bank in supporting the economy during the late 1990s Asian financial crisis by buying around 10% of the Hang Seng Index. That move sparked a 40% rally in stock prices within two months, and the index more than doubled over the next 18 months.
The SNB holds only foreign stocks, because buying overseas assets is supposed to weaken the strong franc. To avoid stock-picking, it mirrors broad stock indexes. The bank employs external experts to advise which companies should be excluded due to red flags such as arms dealing or environmental damage. The Japanese buy domestic equities as part of a more traditional stimulus program.
The Czech central bank has been buying stocks since 2008. Israel’s central bank also holds stocks. In contrast, the Federal Reserve’s charter doesn’t authorize it to buy equities.
There are risks, given that stocks tend to be more volatile than bonds. For the ECB, it would also raise the prospect of having Germany’s Bundesbank taking on the risk of Portuguese or Greek stocks. Germans are already deeply wary of the ECB’s bond buys and negative-rate policy.
Another downside is the signal that central banks may send when they buy and sell. “Buying equities in principle is riskier. I think central banks are philosophically unhappy to do this,” said BSI Bank’s Mr. Gerlach.
—Takashi Nakamichi contributed to this article.
Write to Brian Blackstone at
brian.blackstone@wsj.com and Tom Fairless at
tom.fairless@wsj.com