Central Banks Wade Into Stocks

Readers may recall that we have frequently remarked that the fact that central banks have reportedly become fairly large net buyers of gold over the past two years was at best irrelevant and at worst a contrary indicator. What it never was and never will be, is bullish. There is some hope that it may not be a big negative signal, due to the fact that the central banks doing the buying are not the same ones that sold between $250 and $600 and because they only buy fairly small amounts. However, it sure hasn't been a positive signal so far. Central banks as a rule are the worst traders in the world.

It is therefore interesting that the latest central bank fad is apparently to buy stocks. They didn't buy stocks in early 2009, mind. They probably had to wait for the markets to 'look safe' or something like that.

Bloomberg reports:


Central banks, guardians of the world’s $11 trillion in foreign-exchange reserves, are buying stocks in record amounts as falling bond yields push even risk- averse investors toward equities.

In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bank and the Czech National Bank have boosted their holdings to at least 10 percent of reserves.


The survey of 60 central bankers, overseeing a combined $6.7 trillion, found that low bond returns had prompted almost half to take on more risk. Fourteen said they had already invested in equities or would do so within five years. Those conducting the annual poll had never before asked that question.

“I definitely see other central banks doing or considering equities,” said Jan Schmidt, the executive director of risk management at the Czech National Bank in Prague, which has built up stocks to 10 percent of its $44.4 billion in reserves since 2008.


Central banks’ purchases of shares show how the “hunger for yield” is changing the behavior of even the most conservative investors, according to Matthew Beesley, head of equities at Henderson Global Investors Holding Ltd. In London, which oversees about $100 billion.

“Equities are the last asset class standing,” Beesley said in a phone interview on April 18. “When you have dividend yields in excess of bond yields, it’s a very logical move.”


(emphasis added)

Good grief. Yes, it's only 'logical' to invest in the 'last asset class standing' – which means in translation: the one asset class that's recently been in an uptrend. We weren't actually aware that central banks had a 'hunger for yield'. Aren't they supposed to be out there 'fighting inflation'? Just kidding.

However, they are supposed to be the stewards of the currencies they issue, and it is not entirely clear why that suddenly requires them to pile into equities. One thing is certain though: it is an example of very interesting timing.


NYSE Margin Debt Back at Nominal Record High

Just as central bankers eagerly eye stocks as a means to 'diversify' their reserves, margin debt at the NYSE is finally back at its 2007 record high. It may well grow even larger this time around though, as the annual rate of change has not yet achieved a spike similar to those seen in 1999/2000 and 2007.

Still, in spite of rising stock prices, investor net worth has now been negative for more than three years (with a few brief interruptions). That's not as long as during the 1990s mania, but longer than the period preceding the 2007 peak. Naturally, investors have nothing to worry about, since it is well known that the DJIA is going to 36,000 next. Even if it is 'impossible to predict how long it will take'.



margin debt
NYSE margin debt is back at its 2007 peak. It may make an even higher peak this time around, but it would probably be a mistake to completely ignore this datum – click to enlarge.



But then again, mutual funds have seen large inflows lately, so surely they have lots of cash to deploy? Unfortunately their cash amounts to only 3.7% of their assets, 40 basis points above an all time low. The small wiggles that can be seen on the chart in recent months are likely the result of said inflows.



mufu cash
Mutual fund cash-to-assets ratio – it has never been as low as over the past three years – click to enlarge.



Surely that doesn't mean much though, since it hasn't meant anything for three years running. And besides, investors are bearish, so stocks can only go higher.



Consensus Inc
Consensus Inc. bullish consensus on stocks – click to enlarge.



OK, so some investors are bearish. But it isn't as if speculators were heavily long futures on speculative stocks, something like small caps, say.



A new record high in speculative net long positions on Russell 2000 futures – click to enlarge.



Enough already…who cares about these technicalities? Fundamentals are sound! Companies are throwing off oodles of cash!


corporate cash flow
Corporate net cash flows turn negative – click to enlarge.



That seems to leave only one thing: central banks are buying stocks and they know best!

We must admit that the above amounts to some extent to an exercise in cherry-picking of data. Not every stock market-related sentiment and positioning datum looks as stretched as the ones shown above. There are surveys like Consensus Inc. and Market Vane that are pretty much at the top of their historical range, but others like the Investors Intelligence survey look  less extreme. Speculators don't hold record net long positions in all stock index futures, but their long positions are nevertheless historically large in all of them (they are not far from records in most of them – and the records were all set within the past year).

Economic conditions are meanwhile at best middling in the US, and downright atrocious in Europe and Japan. China is growing, but less than it used to and it has a debt problem to boot (of course, everybody has a debt problem).



Either the stock market 'knows' something we don't – and we frankly don't think so, because it usually knows very little – or it is indeed rising on fumes. No doubt the fact that central banks continue to be 'accommodating', i.e., are printing gobs of money, currently lends support to stocks. One must however be careful with such simplistic cause-effect schemata. One could for instance ask, why is this additional money no longer lifting commodity prices? And how does the persistent bid enjoyed by 'safe haven' type government bonds jibe with rising stock prices? To be sure, warning signs like the ones discussed above have been noticeable for many months and this hasn't kept the rally from continuing. It was easy to underestimate its persistence, and may still persist for even longer. However, once even central banks are beginning to buy stocks, a few extra alarm bells should start ringing.

Oh well, at least stocks are cheap.



S&P 500 Average 12-Year PE
SPX, average 6 year and 12-year p/e ratio 1877- today (chart via our friend BC) – click to enlarge.



Oops! Sorry! : )



Charts by: Sentimentrader, St. Louis Fed, BC




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3 Responses to “Central Banks and Their Unerring Sense of Timing”

  • Jimmy, there won’t be any redemption cash problems. Those people will get out at the bottom.

    As far as the charts, the bottom one says all. They are all out there saying, stocks are cheap. Compared to what? The whole mess is in its current structure for a reason, that business conditions are in doubt. But, there isn’t a view of risk any more, despite the financial tragedies that have occurred over the past, especially the recent past. Dividend yields are part of the long term risk return on stocks and they are historically low, not high. If long term inflation is 3%, long term real growth 1%, dividends need to be 5% to reach 9%, the nonsense long term return on stocks. As the bottom chart shows, we have been in a historic bubble that is outside the bounds of anything else on the charts. That includes the bottom in 2008.

    Stocks are no different than any financial product, the long term return is established by the purchase price, not by the perceived future. There is over 100 years of data to look at what the future will hold on the broad market and its growth potential. The sizable returns have been made almost exclusively from periods of high dividends and low PE’s and never from peaks. Note the real return made from the 2000 peak in the SPX and even the Dow, which has outperformed, mainly due to timely splits and the replacement of corpses with live entities. The credit bubble influenced high level of corporate profits hasn’t eliminated the overvaluation, only put values on a more unstable slope, as outliers always return to the norm. Corporate earnings have reached almost double prior peaks in percentage of GDP and added to other factors, promise a huge fall in stock valuations. A return to normal would entail a loss of roughly 50% of corporate earnings across the board, not a welcome prospect. What won’t go on forever won’t. The rest of the economy no longer has the resources to support such a transfer of wealth or credit.

  • SavvyGuy:

    “I definitely see other central banks doing or considering equities,” said Jan Schmidt, the executive director of risk management at the Czech National Bank in Prague, which has built up stocks to 10 percent of its $44.4 billion in reserves since 2008.


    Monkey see, monkey do!

  • jimmyjames:

    But then again, mutual funds have seen large inflows lately, so surely they have lots of cash to deploy? Unfortunately their cash amounts to only 3.7% of their assets, 40 basis points above an all time low.


    So when everyone heads for exits at once- where will the redemption cash come from in a possible no bid market?
    No problem–Mutual Funds have forever had the same sort of “bail in” eg: Cypress type of clause that’s become the latest trendy fad across the world now-
    If selling freezes up in a crashing market- they can simply issue you shares “of the fund” in lieu of cash and then you will be allowed to watch your cash disappear from a different angle-

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