The Worlds Biggest Deals

The World’s Biggest Deals: Now Central Banks Buy Stocks

by Samuel Kraigwest

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. – BusinessWeek

Here’s a story that is not getting as much attention as it deserves.

Central banks are starting to purchase equities directly. Not just in the US but around the world. This is a direct result of the more activist policies that central banks are now pursuing. The rationale for central banks used to be that they existed as a buyer of last resort for the financial industry and banks in particular. But now central banks seem to exist to assure the solvency of an economy. They don’t serve an industry anymore – they serve the sociopolitical and economics needs of the larger nation-state.  This is a radical change of mission but not one that people seem to have noticed especially.

But it is incredibly important. In the modern era, delinked from gold, central banks can print as much money as they want. Hypothetically speaking this means they can buy as many stocks as they want. Central banks have thus gone from a non-entity in the stock market to a potential deciding factor. Here’s more from the Businessweek article:

“In the last year or so, I have spoken with 103 central banks on diversification,” Gary Smith, London-based global head of official institutions at BNP Paribas Investment Partners, which oversees about $649 billion, said in a phone interview. “If reserves are growing, so are diversification pressures. Equities are not for every bank tomorrow, but more are continuing down this path.”

Managers of banks’ assets are looking for alternatives to holding government bonds after efforts to stimulate growth from the Federal Reserve, the Bank of Japan and the Bank of England helped send yields near to record lows. Central banks’ foreign- exchange holdings have increased by about $8.5 trillion globally in the past decade, exceeding levels needed for day-to-day currency administration …

“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. Even so, the risks of owning shares are the same as ever, he said in e-mailed comments.

Currency reserves among the world’s central banks climbed by $734 billion in 2012 to a record $10.9 trillion, according to data from the Washington-based International Monetary Fund. That’s about 20 percent of the $55 trillion market value of global stocks, data compiled by Bloomberg show.

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.”

Logical or not, this needs to be noticed and internalized by those who are active in the market. Again, central banks are not institutions – previously the largest market players. Central banks have virtually unlimited resources and from an equity perspective, direct buying can be a game changer.

What are the downsides? Well, even unlimited buying of equities cannot force stock markets up forever, especially if the buying obviously delinks stock markets from the underlying economy. Separately, as distortions become obvious, central banks will come under pressure to justifying their practices and perhaps slow or cease buying in some instances.

This could have quite negative effects on stock market averages. Even leaving aside (and we will) the market justifications for these kinds of actions, central bank buying in stock markets may be quite destabilizing. But if this trend continues, and it seems that it will, then regardless of the justifications or seeming necessity, it is one more factor that investors will have to take into account, perhaps the biggest of all.

Samuel Kraigwest is longtime commenter on the markets who grew up in the US but now travels the world in search of promising investments and the ever-elusive “best martini.” Kraigwest is also a contrarian investor who uses all of his life experience and investment knowhow to communicate the hard-truths of 21st century global speculation. Please visit the following address for a no-risk sample of a global newsletter with which he is involved.  https://secure.viscountmedia.com/order/sales_nigel3.html