Are you tired of the snow yet? How about all the volatility in the markets ? Spring is coming, even if it doesn’t quite look that way just yet. Unfortunately for investors, relief may have to wait a bit longer.
So what exactly is going on in the markets? You can sum it up in one word : uncertainty. And as you know, uncertainty is the one thing markets really do not like.
Ever since last summer when the first sub-prime shock waves began to reverberate throughout the financial world, investors have been in a reactive mode, responding to a regular barrage of news, both negative and positive.
On the negative side, in addition to mounting losses in the banking sector and a deepening worldwide credit crunch, there are growing concerns that an economic slow-down in the US could turn into a recession. What’s more, with the cost of oil at an all time high, there is talk of a return to the dreaded “stagflation” of the seventies (that is sluggish economic growth combined with high inflation and unemployment). None of these possibilities bodes well for corporate earnings, which is what drives stock market prices.
Turning to the positive, there are several factors to consider. Central banks are working together to address the liquidity crisis created by the sub-prime fall-out. In the US, the Federal Reserve has consistently demonstrated it is prepared to use all the tools in its bag to keep the financial sector afloat and stave off any potential economic downturn in the US.
On the economic front, the jury is still out as to whether or not the US is actually in a recession. Our own Canadian economy remains strong, primarily buoyed by demand for our natural resources. All signs indicate that the global economy also continues to fare well. This has lead to a belief among some observers that the world is no longer as dependant as it was on the US economy and is, hence, less vulnerable to any economic downturn in the States.
Finally, in the markets today, stocks are trading at reasonable prices overall. In fact, as investors have been re-pricing risk in the aftermath of sub-prime, a lot of quality assets have been hurt despite strong fundamentals. In other words, a lot of babies have been thrown out with the bath water – and of course, that spells buying opportunities! We see this in particular in the banking sector and housing-related industries. As well, in Asia and other international markets, strong economic growth prevails despite very poor stock market performance. So if you were wondering what has happened to the value of your international equity funds of late, there’s your answer.
All in all, there is evidence of a slowdown in the US, but as yet no real indication of either a protracted recession or a return to stagflation. That said, there remains a great deal of uncertainty and ultimately that is what markets are responding to. Investor sentiment is now down to levels comparable to other periods of market turmoil such as the aftermath of 9-11. History shows that when investor sentiment reaches these kinds of lows, the rebound is not too far off.
So the turn around will come as certainly as will the arrival of spring. The only real question is when. For now, as long as the full extent of the sub-prime fall-out remains to be seen and uncertainty on the economic front persists, we can expect continued stock market volatility. In the meantime, sticking to your investment strategy, and adding to your holdings where possible, is the best way to turn this volatility to your advantage. As Warren Buffet, one of the most successful investors of our time has said, “The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long term values.” (Source: Warren Buffet Speaks, Janet Lowe, Wiles & Sons 1997)
