End of LTRO = end of equity rally 2012?

February 17, 2012

This year’s global equity rally is unlikely to survive the end of the ECB’s liquidity injections, warns HSBC.

World stocks have jumped 10 percent since the start of 2012, emerging markets are up 15 percent and the index of top European stocks has gained 8 percent. These gains, HSBC says, are almost entirely down to the European Central Bank’s end-December refinancing operation, or LTRO, that injected $500 billion to ease banks’ liquidity worries. The tentative improvement in the U.S. and global growth picture along with beaten-down stock valuations added only limited ammunition to the rally, the bank says.

The findings of HSBC’s analysis? First, past episodes of quantitative easing — Japan in 2001-2004 and the United States, Britain and the euro zone after 2008 –  provided a significant fillip to equity markets.  U.S. stocks rose an average 6 percent, UK stocks by 8 percent and euro zone markets by 15 percent in the three months following the post-Lehman QE rounds, though in Japan the gains have been short-lived. Second, unexpected changes in monetary policy produced a larger impact on stock prices than the continuation of a previous policy.

And when QE stopped, the effect on stocks was immediately negative. HSBC found:

The periods when the Fed halted QE and allowed its balance sheet to shrink (in August 2009, June to October 2010 and July to October 2011) were all periods of weakness for the stock market.

The ECB is gearing up for another LTRO round in two weeks time. But it will not come as a surprise to markets and there are no plans for more.

HSBC concludes:

That implies that the positive impact of the LTRO will peter out by the end of this month. The direction of equity markets after that will be down to more conventional factors: the resilience of economic growth, earnings and developments in the saga of European debt. …Given other worries, we remain cautious on global equity markets.

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