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ECB QE Doing Opposite of Objective

Chart In Focus
June 09, 2016

I like to say that there are only 2 fundamental factors which matter for the overall stock market:

1. How much money is there?

2. How much does that money want to be invested?

Change either of those, and the market will move up or down.  But 2016 is showing us a perverse version of that.  We are in opposite-world now. 

The Fed has backed away from the QE game, and is wishing it could find a sufficient excuse to start normalizing interest rates.  But the rest of the world is heading into the world of negative interest rates, such that banks are contemplating expanding their vaults to hold cash in lieu of holding negative-yielding government and corporate bonds.  The idea is that pumping all of that extra money into the banking system should help lift the financial markets, and thus the actual economies of the countries involved.

This presumption of how market physics work persists in spite of the evidence indicating that it actually does the opposite of the intented effect.  This week’s chart shows that the correlation between Germany’s DAX Index and the size of the ECB’s balance sheet is at best non-existent, and perhaps more accurately it is a roughly inverse correlation. 

When the ECB started expanding its balance sheet in earnest back in early 2015, Germany’s stock market responded by moving downward.  This makes no sense according to the popular theory that more money means higher stock prices.  But after a while it is time to revise the hypothesis in light of sufficient data. 

There is a correlation is between ECB assets and gold, but with a twist.  The size of the ECB balance sheet correlates better with gold as priced in euros.

ECB assets versus gold priced in euros

It is not a perfect correlation, but it is a pretty good one for the overall trend.  The implication is that if Mario Draghi insists on continuing the ECB’s QE program, and running his continent’s banking system into the ground, then gold is likely to be the main beneficiary.  The European economy and stock markets, not so much. 

Tom McClellan
Editor, The McClellan Market Report

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