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Gurdgiev: 2 new bubbles are expanding

Friday, July 04 13:58:37

The stage is being set for a substantial bubble to emerge in European equities valuations to parallel an already established bubble in sovereign debt valuations.

That's according to prominent Irish economist and blogger, Constantin Gurdgiev, who added that some positive but also some "very risky" decisions were made by the ECB at its landmark June meeting.

In an interview with Jorge Nascimento Rodrigues editor of Portugal's Janela na Web, he said that the cut in rates and the announcement of new TLTROs will have limited effectiveness.

"Mario Draghi paired the direct measures with two rather radical policies innovations: the abandonment of sterilisation of the SMP and the negative deposit rates. The first one is aiming to support interest rates reductions with concrete increases in liquidity supply, alongside the TLTROs. The latter one is designed to create incentives for the banks to price down the risks in the interbank funding markets. Both are supposed to re-enforce each other to break the vicious cycle of fragmentation in the credit markets, whereby surplus liquidity created in the Northern European economies remains trapped in their banking systems without flowing to the Southern economies," he said.

Mr Gurdgiev added, however, that much more is needed to unblock the flow in the system, including money-printing (QE). " Instead of much-anticipated start of an outright QE, the ECB opted for a scatter-gun approach of showering the credit markets with complex, seemingly disconnected policies."

The core concern, following on the foot of the June meeting, is that new measures will simply act to stimulate financial markets valuations and sovereign debt prices without trickling down into the real economy, corporate capex (capital expenditure) and hiring, he added.

"This concern is real. Since H2 2011, European Stoxx 600 index dynamics diverged from the underlying companies earnings per share (EPS) momentum as sustained gains in equities prices coincided with steady declines in EPS, as mentioned by Wolf Richter of, based on data from FactSet [see the chart in this link]. EPS of the 600 of Eurostoxx at 29 July 2011 was 26.27 euros; at 5 May 2014 lowered to 23.65 euros, based on data from FactSet. At this stage, it is hard to imagine how reduced cost of new lending (as opposed to legacy debt burdens) can support EPS momentum reversals. At the same time, we can expect improved funding costs in the banking sector to stimulate leverage and demand side for equities. The stage is being set for a substantial bubble emerging in European equities valuations to parallel already established bubble in sovereign debt valuations," Mr Gurdgiev concluded.