The UK markets are demonstrating how the central bank QE is distorting the market and why QE stimulus doesn’t work as well as expected.
The Brexit vote has cause the bank of England to inject billions into the British economy. Its more than the low billions inject on the Friday after the vote because the Bank has dropped the capital adequancy rules on banks releasing #120 billion of potential lending.
Don’t expect to see that lending on main street.
That money goes straight into the stock market in a giant carry trade.
This is at the core of how QE works or rather to some doesn’t work. The money only slowly leaks into the economy via a trickle down from asset price inflation.
This is a que for the illinformed to rail against QE. Meanwhile they sit in overpriced real estate and think they are canny property investors, all the wshile as QE artificially supports a property boom/bubble.
Stocks and real estate are the recipients of QE and the money from that leaks into pensions and inhertitance and general asset based wealth. That is why it doesn’t create inflation. It is not cash in the pocket, it is money with very slow velocity.
QE is a ‘pit prop’ to economies not a flashing neon light saying ‘spend, spend, spend.’
So back to the UK QE.
POW!!!! Up goes the FTSE and guess what, it’s the carry trade dividend paying mega caps that have rocketed.
The banks and their associates have taken this zero interest money and stiuck it into highly liquid dividend paying shares.
Here is the give away:
(Nation Grid share price)
Why would BP and Shell explode just twhen oil has taken a 10% drop. The answer fat dividends.
(BP)
(SHELL)
QE up in smoke (BATS)
Why?
Well if the government gives you billions at 0-1% why not take a risk and make 3-4% profit on blue chip dividend stocks. That’s 3 billion in profits going begging.
Clearly the flaw to this strategy is when you do a carry trade you don’t want to lose capital. So you hedge. This is one reason why Banks and Brexit dogs have been hit so hard and not come back. You buy the strong and defensive dividend payers and you short the weak.
It will of course be more complicated than that but the result are the to be clearly seen.
So what to do.
That’s tricky because this move is at the whim of central banks.
A low pound will give the UK a burst of inflation, so low interest rates might be under pressure in due course, though as inflation is now a long lost friend, a low pound burst of inflation might be waved away.
If this Brexit QE has legs then the FTSE will run and ultimately drag up the small caps. This would be crazy, but the old laws no longer apply in this new monetary world.
What is extremely interesting is what will happen to the house builders? After the Brexit panic subsides, there will be all the QE money sploshing around looking for a carry trade with fat security attached. Easy money equals rallying house prices.
That should mean at some point the house builders will turn and snap back.
I’ll be watching for that.
Meanwhile keep an eye on China. Its been a long time since China went into recession, when it comes out the whole world will rally. China is the new America and becomes stronger every western trade deficit. When the China tide turns the good times will role.
…but, but what about the US presidential election?
We are going to have to learn to lap up volatility.
Its all down to Yellen, Carney, Drahgi and Kuroda.