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Europe’s Policies Pay Off

By Benjamin Shepherd on February 4, 2016

While there have been some ups and downs – which will likely continue given the increasing volatility – Europe has generally done well for us in our portfolios.

Most of our European stocks have performed better than the broader market, even as they continue to pay steady dividends. That consistency is exactly when you want in these turbulent times, and our American holdings have done even better.

One common denominator between America and Europe has been unconventional monetary policy. Here in the United States, while the Fed didn’t resort to explicitly negative interest rates, it stuck to a zero-rate policy for years and bought roughly $3.5 trillion of assets by the end of 2015.

Not only did that help prop up both our stock and bond markets, its quantitative easing (QE) program also generated nearly half a trillion dollars for the U.S. Treasury between 2009 and 2014. Ironically enough, QE helped to reduce our deficit even as the value of the S&P 500 more than doubled and bonds skyrocketed.

Thanks to Europe’s political structure – sovereign states responsible for their own domestic budgets but beholden to a regional central bank – the European Central Bank has had to be more aggressive about its QE program. While is now making massive monthly asset purchases amounting to more than $67 billion, the ECB was one of the first to resort to negative interest rates; i.e., making depositors pay the central bank interest for holding their money.

The idea is that negative rates will not only make credit cheaper for companies and households, they will also force banks to lend, since any return on their money is better than paying the central bank to hold it. Sub 0% rates have the added benefit of devaluing a nation’s or region’s currency, making exports more cost competitive.

There’s a lot of debate about just how effective these unconventional monetary policies have actually been, especially it’s tough to prove that conventional monetary policy would have been as effective when you’re only talking theoretically. Neither the U.S. or Europe has fallen into an outright depression though, nor investors have made a quite a bit of money off of unconventional monetary policy.

Japan began its own QE program in early 2013 and expanded it in late 2014. While its political geography isn’t nearly as complex as Europe’s, it faces its own unique set of challenges which has made it difficult to revive its economy. It suffers from high government debt, a dependence on imports and a rapidly aging population and resultant shrinking workforce, all of which makes it tough revive a sagging economy.

It also made it virtually inevitable that the Bank of Japan would resort to even more unconventional policy, implementing its own negative interest rates last week. There’s been the usual grousing about the potential for unexpected consequences, which isn’t completely unjustified since Japan’s debt-to-GDP ratio is more than 230%, but stock markets around the world responded enthusiastically to the news. Even our own S&P 500 ended the day up 1.6%, despite there being little other news that day.

None of this is to say unconventional policy is necessarily good economic policy. Just as we can’t really say what would have happened if central banks hadn’t gone all asymmetric in their war against economic decline, we don’t know for certain what will happen from here. Economics are dismal for a reason.

What we do know is that unconventional policy has been pretty good for investors so far, so we’ll take our breaks where we can get them. And that means riding the unconventional wave since the Bank of Japan isn’t likely to be the last to take more drastic measures.


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