Is QE a Cure-All?
Pacific life fund advisors, June 2016
International equities may post positive U.S. dollar returns this year, but Pacific Funds portfolio manager, Max Gokhman, is paying close attention to unconventional policy tools, like negative interest rates and corporate bond purchases, which may cause the European Union some adverse side effects.
Central Bank Impact on International Equities
Investing in international equities requires an understanding of the economic growth and currency movements for each country in which you are invested. Today, the direction of currencies and economies is largely dictated by central banks. We will illustrate this using Europe as an example.
The European Union is still struggling to recover from a recession that ended in 2013. Early in 2015 Mario Draghi, president of the European Central Bank or ECB, announced that he would attempt to heal the region’s economy with a treatment that proved highly effective in the U.S. – quantitative easing, or “QE” for short. QE is when a central bank purchases government securities to lower interest rates and increase the money supply.
So far the European Union or, “the patient,” is responding well to treatment. We can see how the ECB balance sheet grew as it began buying assets last March. The private banks could then lend their proceeds from these sales to consumers – and we indeed saw a sharp uptick in household credit right after QE began. As consumers spent this money, the economy should continue to pick up steam as we’ve seen Gross Domestic Product (GDP) growth accelerating after March 2015.
That’s good news, but let’s not forget the currency component. In 2014 and 2015 the EURO STOXX, a broad index of Eurozone companies, was positive, but the return for U.S. investors in U.S. dollars was negative. The difference was due to the currency impact. Central banks play the dominant role in driving currency movements as cutting rates and buying bonds negatively impact a country’s currency. The combination of the Federal Reserve ending its QE stimulus, while the ECB was ramping up its own QE pushed the U.S. dollar up by roughly 27% over this period, relative to the Euro and this decimated domestic returns for European stocks.
What does this mean for U.S. investors, investing in international equities today? So far in 2016 we have seen the Federal Reserve slow down its plan for interest rate hikes and the U.S. dollar has subsequently fallen, which may forestall the adverse currency impact that dominated international stock returns over the last two years. Meanwhile, global central bankers’ efforts to revive their economies appear to be working. Thus, international equities may post positive U.S. dollar returns this year, however, we are paying close attention to make sure that unconventional policy tools, like negative interest rates or corporate bond purchases, do not cause the “the patient” any adverse side effects.
This video is provided by Pacific Funds. These views represent the opinions of Pacific Life Fund Advisors, not Pacific Funds, and are presented for informational purposes only. These views should not be construed as investment advice, the offer or sale of any investment, or to predict performance of any investment. The opinions expressed herein are based on current market conditions, are as of May 19, 2016, and are subject to change without notice.
Pacific Life Fund Advisors LLC (PLFA), a wholly owned subsidiary of Pacific Life Insurance Company, is the investment adviser to the Pacific Funds. PLFA also does business under the name Pacific Asset Management and manages certain funds under that name. Pacific Funds refers to Pacific Funds Series Trust.
All investing involves risk, including the possible loss of the principal amount invested. Investments in foreign markets are subject to regulatory, political, economic, market, and other conditions of those markets, which can make these investments more volatile and less liquid than U.S. investments. Currencies and securities denominated in foreign currencies may be affected by changes in exchange rates between those currencies and the U.S. dollar. Currency exchange rates may be volatile and may fluctuate in response to interest rate changes, the general economic conditions of a country, the actions of the U.S. and foreign governments, central banks, or other political or regulatory conditions in the U.S. or abroad. Interest rate changes, or expectations about such changes, may cause the value of debt securities to fluctuate. Equity securities tend to go up or down in value, sometimes rapidly and unpredictably in response to many factors including a company's historical and prospective earnings, the value of its assets, general economic conditions, interest rates, investor perceptions and market liquidity. There is a risk that the determination that a stock is undervalued is not correct or is not recognized in the market.
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