Is Tencent Stock a Buy?

Does the 800-pound gorilla of China’s tech sector still have room to climb?

Jun 8, 2020


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Tencent (OTC:TCEH.Y) is one of the largest tech companies in China. It owns

• WeChat, the country's top messaging app; 
• the world's largest game publishing business; 
• China's second-largest cloud platform; 
• one of the country's largest video streaming platforms; and 
• one of its top digital payment platforms.

Tencent's stock has rallied more than 1,400% over the past decade as its gaming and advertising businesses expanded and it entered new markets. Is it finally time to take profits, or does the Chinese tech giant still have room to run?



1.  Keeping pace with shifting advertising trends

Tencent's advertising business, which generated 19% of its revenue last quarter, sells ads across

• WeChat, 
• the older QQ messaging platform, 
• its mobile ad network, 
• Tencent Video, and 
• other apps. 

The segment's revenue rose 32% annually during the quarter as

• e-commerce, 
• online education, and 
• gaming companies 

bought more ads throughout the COVID-19 crisis.

However, Tencent's ad business faces fierce competition from

• Alibaba's (NYSE:BABA) paid product listings, 
• online search platforms like Baidu (NASDAQ:BIDU), and 
• Gen Z-oriented platforms like ByteDance, which owns the viral short video app TikTok (known as Douyin in China).

WeChat's ecosystem of Mini Programs, which locks users into the app, also faces competition from similar walled gardens like

• Baidu's mobile app, 
• Alibaba-backed AliPay, and 
• Douyin's mini programs. 

WeChat's messaging service, which serves over 1.2 billion monthly active users, also faces competition from dating apps like Momo and Tantan.

To shore up its defenses against these rivals, Tencent needs to keep launching new apps -- which will cause its operating expenses to rise.




2.  The gaming unit is relying on overseas growth and investments

Tencent's gaming business, which generated 35% of its revenue last quarter, is still locking in gamers with hit games like

• Honor of Kings, 
• Peacekeeper Elite, 
• PUBG Mobile, and 
• League of Legends. 

Its revenue grew 31% annually during the quarter as people played more games throughout the lockdown period.


Tencent's stakes in overseas companies like

• Fortnite publisher Epic Games, 
• Bayonetta developer Platinum Games, 
• Ubisoft, and 
• Activision Blizzard 

also reduce its dependence on the Chinese market, which is hobbled by fickle censorship standards, tight playtime restrictions, and rigid licensing requirements.

That expansion also widens its moat against its top Chinese rival NetEase, which is gaining significant momentum overseas with its PUBG rival Knives Out.

Looking ahead, investors should expect Tencent's gaming unit to rely more heavily on overseas titles like Call of Duty Mobile, as well as increased investments in overseas developers and publishers.




3.  Countering Alibaba in the cloud and fintech markets

Tencent's fintech and business services unit, which accounted for 24% of its top line last quarter, generates most of its revenue from

• Tencent Cloud, China's second-largest cloud infrastructure platform after Alibaba Cloud, and 
• WeChat Pay, which shares a near-duopoly in the payments market with Alibaba-backed AliPay.

Revenue from this newer business rose 22% annually last quarter, but that marked a significant slowdown from its previous quarters. Tencent attributed the deceleration to fewer WeChat payments throughout the lockdowns, but it expects the business to recover later this year.

Tencent doesn't disclose its cloud profits, but it's likely unprofitable like Alibaba Cloud. Both companies will likely incur more losses in their cloud businesses, and use other profitable businesses -- like Tencent's ad and gaming units, and Alibaba's core commerce unit -- to subsidize the difference.

Therefore, the growth of the fintech and business services unit is a double-edged sword: It generates fresh revenue growth and diversifies Tencent's top line away from games and ads, but it will likely throttle its adjusted operating margin -- which declined annually from 43% to 34% last quarter.



4.   Is it the right time to buy Tencent?

Analysts expect Tencent's revenue and earnings to rise 22% and 17%, respectively, this year, as its strengths offset its weaknesses. That's a solid growth rate for a stock that trades at about 33 times forward earnings.

I own shares of Tencent, and I believe it's still one of the best long-term plays on China's growth. Tencent is also better diversified than Alibaba and Baidu, which still rely heavily on e-commerce sales and online ads, respectively.

The only near-term threat to Tencent is the legislative threat to potentially delist Chinese stocks from U.S. exchanges if they don't follow certain accounting rules. But top tech companies like Tencent, Alibaba, and Baidu will more likely reach a compromise with U.S. regulators instead of staging a full retreat to closer exchanges like Hong Kong. Therefore, Tencent remains a solid long-term investment, and it has room to run after its 30% rally over the past 12 months


https://www.fool.com/investing/2020/06/08/is-tencent-stock-a-buy.aspx

Market Timing: There are only two types of investors

There are quite long periods when the market falls and takes a long time to regain previous highs. 

How shall we judge whether you should try to take advantage of this?



Market strategies:  Dollar Cost Averaging versus Absolute Bottom Buying Strategy

Dow Jones Industrial Average Index from 1970 - 2020.  This is a period of 50 years which spans inflationary and deflationary cycles and which has seen several crises and crashes as well as bull markets.  It seems like a long and fair sample period.

Imagine that over this 50-year period there are two competing investment strategies. 

1. One is to invest an equal amount every trading day throughout the period irrespective of market conditions - the so-called dollar cost averaging.
2. The other strategy requires enough foresight for the investor to invest the same amount daily, but to stop investing when the market turns down and save the cash.  This money is only invested when the Dow makes a new bottom, hitting its low point in any period of decline (hence why it is known as an "absolute bottom buying strategy").

This is a somewhat more realistic example of how you might apply foresight, rather than measuring what would happen if you had such certainty about the future you were able to sell everything just before the market turned down and then buy it back at the bottom.


Outcomes

Over the 50-year period, the second strategy would have produced returns 22 per cent higher than the first.

It sounds impressive - perhaps a little less so when you break it down to a 0.4 per cent outperformance per year 

But think of the time and effort you would have to spend monitoring markets to get those calls just right.



Possibly foregoing any significant gains

Since March 2013, the Dow is up just over 150 per cent in total, averaging 13.3 per cent per annum. 

Imagine if you had acted on market fears and taken your money out of equities or stopped investing ahead of that performance. 

Should you risk foregoing any significant portion of that gain for a maximum upside of 0.4 per cent per year.




Anticipation

Nobody has perfect foresight:  

• wrong about the events and 
• wrong about the market's reaction to events

In reality, attempt to implement the second strategy will almost certainly cause harm to your net worth as nobody has perfect foresight.  In your desire to time the markets, you will stop investing, or worse, sell and take money out when you expect the market to go down and instead it goes up.

Think back to Brexit and Trump's election.  We were told by most commentators that they wold not happen, but if they did, the markets would plunge.  Not only were they wrong about the events but they were also wrong about the market's reaction to events.  The markets soared.



There are only two types of investors

When it comes to so-called market timing, there are only two sorts of people: 

1. those who can't do it, and 
2. those who know they can't do it.  

It is safer and more profitable to be in the latter camp.

There is a lot to lose and little to gain from market timing.

Reference:  The Financial Times

There is a lot to lose and little to gain from market timing.

There is a lot to lose and little to gain from market timing.

When it comes to so-called market timing, there are only two sorts of people

1. those who can't do it, and
2. those who know they can't do it.

It is safer and more profitable to be in the later camp.



What is market timing?

With the Covid-19 pandemic dominating the news and recent volatility on world stock markets, you may have heard a lot about market timing again. 

Advisers and financial commentators will probably not use that actual term.  What they will talk about is whether you should sell some or all of your equity investments because of the economic effects of the coronavirus and the subsequent effect on the market.

All of this what is termed "market timing" in the jargon of the investment trade - holding back investment or taking some or all of your money out of the market when you anticipate a fall.



Problem of this approach:  Can you anticipate the markets?

The word "anticipate" indicates the first problem with this approach. 

Most people whom I encounter take their money out during or after a fall - as they did in March. 

[They are doing the equivalent of driving whilst looking in the rear view mirror (or at best, out of the side window of the car).  You need to look out of the windscreen in order to have the best chance of driving safely.  The trouble with doing that in terms of the stock market is that the visibility is often so poor, it feels like driving in fog.]



Markets are second order systems

Such approaches to investment are almost all futile.  Markets are second order systems.  What this means is that in order to successfully implement such market timing strategies:

1.  you not only have to be able to predict events - 

• interest rates, 
• wars, 
• oil price shocks, 
• the impact of the coronavirus, 
• the outcome of elections and referendums - 

2.  you also need to know what the market was expecting,

• how it will react and 
• get your timing right.  

Tricky.



Reference: Financial Times

Know your Investment Profile

Your investment profile

Define your investment profile by identifying:
1.  Your goals and constraints
2.  Your risk ability and tolerance
3.  Your cognitive biases and their impact on your emotions.


Profiling:  everyone is unique

Differences go beyond the level of wealth and stem from:

• 1.  Age
• 2.  Education
• 3.  Phase of life
• 4.  Profession
• 5.  ...

Financial situation as the core of your profile

1.  A very wealthy person with relatively little planned expenses

• Will be able to take considerable investment risk, as you have enough funds aside to absorb potential losses.
• Will be said to have a "high risk ability"

2.  A person with limited wealth and a large part of his assets reserved for financial commitments:

• Can only take limited investment risk, as he lacks funds to cover potential losses
• Will be said to have a "low risk ability"

Ranking the objectives is also key

1.  List your objectives and rank them by degree of priority:

• Saving for retirement
• Providing for children's education
• Purchasing real estate objects

2.  Risk tolerance will be:

• High for less important objectives
• Low for important objectives

Investment horizon:  the longer, the better!

1.  The longer the investment horizon, the higher the risk ability

• .... as investments may recover from potential losses

2.  The shorter the investment horizon, the lower the risk ability

• .....  as investments cannot recover from potential losses.

3.  Unless you want to speculate ... but at your own risk!

Cognitive biases and the 3 steps in investing

Cognitive biases affect investment decisions when:

1.  Defining the investment universe

• Choosing which asset classes / securities are taken into consideration

2.  Constructing the optimal investment strategy

• Forecasting expecting returns and risk

3.  Adjusting and rebalancing the portfolio.

Cognitive biases:  defining the investment universe

When defining the assets universe you want to invest in:

• You tend to over-invest in local companies (home bias)
• You tend to overweight recent information (recency bias)

You should get out of your comfort zone and do extensive research on securities which may not necessarily be close to your home, nor provide readily available information.

Cognitive biases:  constructing the portfolio

When making forecasts:

• You may be influenced by recent data, which may not be relevant (anchoring bias)
• You tend to be over-confident (overestimating expected returns and / or underestimating risk)
• You tend to look for evidence which will confirm our beliefs and ignore information that contradicts them (confirmation bias)

Look for the black swan!

Cognitive biases:  rebalancing

When rebalancing the portfolio:

• You tend to overestimate the value of assets you own and underestimate the value of (similar) assets you do not own (endowment effect)
• You tend to sell winning positions too soon and hold onto losing positions for too long (disposition effect)

The right question to ask yourself

For example:  

You bought 1000 Nokia shares at 30 EUR.  The stock goes to 60 .. and then drops to 20 EUR.  The question to ask yourself is:

"If I had 20,000 EUR today, would I purchase 1000 Nokia shares?"

• If you answer "yes", then keep the position.
• If you answer "no", then sell it.

Conclusions

Before constructing a portfolio, you need to define your

• Objectives
• Risk ability and tolerance

You should be aware that you are influenced by cognitive biases which may lead to sub-optimal investment decisions.

You should try to adjust as much as possible for these biases.

KLSE Market PE 19.6.2020

Company	Mkt Cap (b)	Last Price	PE	DY	ROE
MAH	9.607	5.79	26.18	2.59	3.99
AMMB	9.404	3.12	6.06	6.41	8.47
AXIATA	32	3.49	37.89	2.72	5.42
CIMB	36.616	3.69	9.45	7.05	7.09
DIALOG	20.141	3.57	32.78	1.06	15.08
DIGI	33.744	4.34	23.7	4.19	228.88
GENM	15.855	2.67	22.36	7.49	3.78
GENTING	17.213	4.44	13.22	4.95	3.69
HAPSENG	21.411	8.6	18.38	4.07	15.6
HARTA	38.827	11.46	89.32	0.72	17.11
HLB	31.475	14.52	12.29	3.44	9.17
HLFG	16.203	14.12	9	2.97	8.82
IHH	47.477	5.41	86.15	0.74	2.46
IOI	27.34	4.35	66.82	1.84	4.58
KLK	23.826	22.04	56.91	2.27	4.07
MAXIS	41.683	5.33	28.4	3.75	20.86
MBB	86.334	7.68	10.23	8.33	10.82
MISC	35.175	7.88	-	4.19	-0.7
NESTLE	32.689	139.4	52.39	2.01	72.7
PBB	64.443	16.6	11.87	4.4	12.55
PCHEM	50.56	6.32	20.07	2.85	8.29
PETDAG	20.962	21.1	41.19	4.03	9.16
PETGAS	34.311	17.34	19.19	4.73	13.77
PMETAL	18.898	4.68	41.23	1.07	14.01
PPB	24.355	17.12	22.31	1.81	4.95
RHB	19.369	4.83	7.99	6.42	9.3
SIME	14.827	2.18	17.93	4.59	5.79
SIMEPLT	33.941	4.93	83.14	0.2	3.09
TENAGA	67.2	11.78	18.21	8.49	6.74
TOPGLOV	39.094	14.58	59.68	0.51	18.94
Company	Mkt Cap (b)	PAT (m0	DIV (m)	DPO	Equity (m)
MAH	9.607	367.0	248.8	0.68	9197.0
AMMB	9.404	1551.8	602.8	0.39	18321.3
AXIATA	32	844.6	870.4	1.03	15582.1
CIMB	36.616	3874.7	2581.4	0.67	54650.3
DIALOG	20.141	614.4	213.5	0.35	4074.5
DIGI	33.744	1423.8	1413.9	0.99	622.1
GENM	15.855	709.1	1187.5	1.67	18758.7
GENTING	17.213	1302.0	852.0	0.65	35285.7
HAPSENG	21.411	1164.9	871.4	0.75	7467.4
HARTA	38.827	434.7	279.6	0.64	2540.6
HLB	31.475	2561.0	1082.7	0.42	27928.3
HLFG	16.203	1800.3	481.2	0.27	20411.9
IHH	47.477	551.1	351.3	0.64	22402.3
IOI	27.34	409.2	503.1	1.23	8933.6
KLK	23.826	418.7	540.9	1.29	10286.5
MAXIS	41.683	1467.7	1563.1	1.07	7036.0
MBB	86.334	8439.3	7191.6	0.85	77997.2
MISC	35.175	-241.0	1473.8	-6.12	34428.6
NESTLE	32.689	624.0	657.0	1.05	858.3
PBB	64.443	5429.1	2835.5	0.52	43259.5
PCHEM	50.56	2519.2	1441.0	0.57	30388.2
PETDAG	20.962	508.9	844.8	1.66	5555.8
PETGAS	34.311	1788.0	1622.9	0.91	12984.5
PMETAL	18.898	458.4	202.2	0.44	3271.6
PPB	24.355	1091.7	440.8	0.40	22053.8
RHB	19.369	2424.2	1243.5	0.51	26066.2
SIME	14.827	826.9	680.6	0.82	14282.2
SIMEPLT	33.941	408.2	67.9	0.17	13211.6
TENAGA	67.2	3690.3	5705.3	1.55	54751.9
TOPGLOV	39.094	655.1	199.4	0.30	3458.6
KLCI	964.98	48117.0	38250.0	0.79	606066.2
KLCI 1503.19
Market PE	20.1
Market DY	3.96%
Market ROE	6.3%

Market P/B	1.59
Market DPO	0.79

Excellent comments on Margin of Safety by Warren Buffett

Warren Buffett explains Margin of Safety

https://youtu.be/hZQNnDHlQZQ

'Don't confuse day traders with serious investors'

'Don't confuse day traders with serious investors': Warren Buffett and Howard Marks will win over time, Princeton economist says

"I don't confuse day traders with serious investors," he said. "Don't be misled with false claims of easy profits from day trading."

The economist and author added that almost all individual traders suffer losses over time, highlighting three studies to support his claim:

• Active traders on Charles Schwab significantly underperformed a low-cost index fund over a six-year period.
• Less than 1% of Taiwanese traders consistently beat a low-cost ETF over a 15-year period, and 80% lost money.
• 97% of Brazilian day traders lost money, and just 1% earned more than the national minimum wage.

Malkiel also emphasized that savvy investors diversify and rebalance their holdings, manage their tax burdens, avoid trying to time the market, stick to their convictions, and use investment structures such as low-fee ETFs.

https://markets.businessinsider.com/news/stocks/warren-buffett-howard-marks-will-ultimately-beat-day-traders-malkiel-2020-6-1029321160

Unconventional Market Policy: Exit Strategy (8)

Special Operations

Overall, special operations other than the traditional repurchase agreements might be needed to sterilise the effects of unconventional policy measures at the appropriate time in the future. 

1.  One option would be to have the fiscal authority issue debt certificates to the market and deposit the proceeds with the central bank. 

• The switch in the ownership of government debt from the private sector to the monetary authority would alleviate the inflationary pressures arising from the additional liquidity. 

2.  Another option would be for the central bank to issue debt certificates itself, as the ECB for example can do according to its Statute. 

• In this way the central bank would essentially change the composition of the liabilities side of its balance sheet, moving away from excess reserves and towards less-liquid debt securities. 
• The effect, compared with government debt issuance, would in essence be the same.

Financial loss for the central bank

An important final element related to the exit strategy, but which should be considered carefully already when deciding to embark on unconventional measures, is that when the central bank sells the assets their value is likely to have declined considerably, given the higher rate of interest. 

This implies a financial loss for the central bank. 

The consequences for the financial – and overall – independence of the central bank should not be downplayed.

Unconventional Market Policy: Exit Strategy (7)

Getting the timing right in withdrawing additional liquidity

Getting the timing right in withdrawing additional liquidity is likely to be decisive in order to ensure a non-inflationary recovery. 

Generally speaking, the lower the reversibility of the non-conventional operations, the larger the risk of being behind the curve when the macroeconomic and financial market situation improves.

Indeed, to a large extent the speed of unwinding of unconventional measures would depend on their degree of reversibility. 

(A)  Some of the unwinding would happen automatically as central bank programmes become increasingly unattractive as financial conditions normalise. 

• For instance, many lending facilities provide liquidity at a premium over the main policy rate or with a high haircut applied to the required collateral, making interbank lending the more attractive option once normal lending activity among market participants is restored. 
• As a result, the central bank’s balance sheet would decline automatically as demand for its funds decreases. 
• As noted, the ECB’s current liquidity-providing operations imply an ‘endogenous’ exit strategy as banks would automatically seek less credit from the ECB when tensions in financial markets ease. 
• The speed of the reversibility would therefore largely depend on the speed of the resurgence of the financial system. 

(B)  In the euro area, the revitalisation of money markets is key to the ECB’s exit strategy and any future interest rate decision should therefore avoid a further disruption of money markets. 

• In this context, bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending. 
• This, in turn, could blur the important signals coming otherwise from the resurgence of interbank lending and the associated positive effect on the ECB’s balance sheet.

(C)  Obviously, the speed of tightening would also depend on the maturity of the assets bought by central banks within the framework of their easing programmes. 

• Differences in the maturity of assets will ensure that a tightening of the accommodative stance would come in gradual tranches. 
• This is important to avoid any abrupt tightening of credit conditions in the middle of the recovery. 
• At the same time, measures centered on assets that are longer-term in nature and less liquid could pose challenges to the future unwinding of these measures. 
• If market conditions were to improve faster than expected, an increase in the average maturity of the central bank’s portfolio would make it more difficult for financial markets to return to normal private sector functioning and would also heighten medium-term inflation risks.

Unconventional Monetary Policy: Exit Strategy (6)

How quickly should policy-makers reverse their policies? 

On the one hand, withdrawing liquidity in such large quantities will trigger a substantial contractionary monetary policy shock. 

The large size of many easing programmes will make it difficult to sell assets without a significant market impact. 

If it happens too quickly or abruptly, policy-makers risk choking off the economic recovery or imposing heavy capital losses on lenders. 

• For instance, in the corporate bond or commercial paper market, even small sales of securities by the central bank could cause spreads to widen considerably and to sharply tighten credit conditions for firms. 

On the other hand, with policy rates at record low levels and additional liquidity-providing measures adopted in so many countries, the possibility of inflation risks emerging sometime later is not something that can be excluded. 

• Retaining such exceptional policy measures for too long might aggravate the upside risks to price stability and sow the seeds for future imbalances in financial markets.

Unconventional Monetary Policy: Exit Strategy (5)

Reaction of the Financial Markets to the Start of Unwinding

This raises the question of the reaction that financial markets might have to the start of the unwinding of the direct easing measures. 

1.   How would markets react to the central bank starting to sell the government bonds it purchased under the direct quantitative easing policy? 

Such a start would signal presumably that the tightening cycle is close and could affect yields. 

2.  If the amount of assets to be sold is significant, this can have an impact on the market conditions of the underlying assets, possibly further depressing its price.

Unconventional Monetary Policy: Exit Strategy (4)

Unwinding of 'Credit Easing' Policies (Unwinding the Purchase of Corporate Bonds)

Measures taken through the purchase of corporate bonds aim to revitalise the flow of credit in certain market segments.

These measures are primarily designed to bypass the financial sector and to ensure that non-financial corporations still have access to external financing. 

Now, in theory, by stimulating longer-term investments and hence aggregate demand, these measures might induce inflationary pressures in the medium to long-term, independent of the functioning of money markets and lending by banks. 

The strength of this channel depends on the depth of the corporate bond market. 

• If policy-makers were to react to these inflationary pressures by raising interest rates pre-emptively while money markets were still weak, the consequences for the banking channel of intermediation could be severe. 
• If, however, markets were to function properly again, there would be no reason to postpone the unwinding of ‘credit easing’ policies to a date longer than needed. 

Taken together, this reasoning suggests that purchases of privately issued securities should be unwound before or at the same time as interest rates are raised back to normal levels.

Unconventional Monetary Policy: Exit Strategy (3)

What are the implications for the sequencing of unwinding conventional and unconventional policy measures? 

It means that non-standard measures that aim mainly at restoring the orderly functioning of money markets, such as supplementary longer-term refinancing operations or an extended menu of eligible collaterals, might have to be rolled back before interest rates are increased again.


Why?

(A)  First of all, because raising interest rates in an environment in which such unconventional measures were still judged to be necessary would risk undermining a sustained recovery by money markets. 

If concerns about the required and available amounts of short-term funding still prevailed among market participants, raising rates might reinforce these fears and could lead to further, unwarranted upward pressure on overnight rates. 

(B)  Second, supplying extra liquidity to the markets through non-standard measures while, at the same time, tightening monetary policy would send mixed signals on the effective monetary policy stance. 

Measures to alleviate the strains in money markets could in fact be seen as a continued easing of the monetary policy stance. 

(C)  Third, with non-standard measures such as the unlimited provision of liquidity still in place it might be more difficult for the central bank to steer the level of market rates consistent with its policy target. 

For example, a fixed rate tender with full allotment usually leaves the banking sector with a large daily liquidity surplus, which needs to be mopped up by additional fine-tuning operations towards the end of the reserve maintenance period in order to avoid a sharp drop in the overnight interest rate. 

This, however, causes extra volatility in the markets as well as large interest rate fluctuations that are undesirable from the point of view of an effective signalling of the monetary policy stance. 

(D)  Fourth, with markets still in need of additional non-standard measures, the pass-through of an increase in policy rates would probably be hampered. 

The orderly transmission of any monetary tightening would only resume once trust among market participants has had been restored and money markets were operating normally again. 

(E)  Finally, in any bank-dominated system of fund intermediation, in which the recovery of the economy largely depends on the soundness of the banking system, inflationary pressures that would require a tightening of monetary policy are likely to appear only when the banks take up their normal lending activity again. 

This, in turn, implies that non-standard measures should ideally be rolled back before interest rates were increased.

Unconventional Monetary Policy: Exit Strategy (2)

Most of the unconventional measures (quantitative easing and credit easing) put in place are designed to stimulate lending, to convince savers to hold risky longer-term assets.

The extremely low interest rates and ample liquidity aims at favouring borrowers and penalising lenders over the medium term.

The effectiveness of these measures mainly depends on the readiness of banks to go back to their main business of lending to households and firms rather than parking excess reserves with the central bank.



Problem of Exiting or Reversing

Prospects of rising interest rates may discourage private savers from purchasing longer-term assets, as a tightening of monetary policy inevitably implies a capital loss for those who bought these assets. 

An increase in policy rates – and in particular in the deposit rate – risks undermining banks’ incentive to re-engage in funding the private sector. 

Raising policy rates, or the expectation of such increases, when confidence is not fully restored could therefore be counterproductive.

Unconventional Monetary Policy: Exit Strategy (1)

EXIT STRATEGY

How and when do central banks need to unwind the extra monetary stimulus? 

Simple answers:

• when the economy rebounds and 
• inflationary prospects are back in line with the central bank’s price stability objective. 

Not Easy

Unfortunately, for a number of reasons, formulating an adequate exit strategy is not such an easy task. Why? 

Two choices that need to be made: 

• first, devising the right sequence for the phasing out of the conventional and unconventional monetary policy accommodation; 
• second, deciding on the speed at which the unconventional accommodation is removed.

To unwind unconventional monetary policy operations (in the case of quantitative easing and credit easing policies), 

• it normally implies selling assets outright, and in significant amounts. 

In the case of the endogenous easing measures, the unwinding happens automatically, since banks should naturally 

• reduce their demand for central bank money and 
• increase interbank lending as their situation normalises.

Reference:

https://www.ecb.europa.eu/press/key/date/2009/html/sp090428.en.html?fbclid=IwAR3l-HERTcR1afdIISMWCe0owxInfKY2zF5O5L4E-pfpADWdhAt4W6Z-Ux0

Conventional and unconventional monetary policy
Lorenzo Bini Smaghi,
Member of the Executive Board of the European Central Bank,
Keynote lecture at the International Center for Monetary and Banking Studies (ICMB),
Geneva, 28 April 2009

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),

GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing