Stock markets around the world fell sharply again yesterday and they continue to fall this morning (the MSCI World Index is down 2.5% in local currency). After concerns about an economic recession, falling commodity prices and gloomy corporate earnings pushed buyers onto the sidelines.
Yesterday, the Federal Reserve (Fed) announced their latest tactic to end the credit crisis, saying it could lend up to $540 billion to buy certificates of deposit (COD’s) and commercial paper (CP’s) from money market funds, which have struggled to liquidate their positions at fair value.
Governments and Central Banks around the world have now promised nearly $4 trillion to guarantee bank deposits and in many instances have bought interests in struggling financial institutions, in an attempt to restore calm and order to credit markets after the most severe financial crisis since the Great Depression.
Although, these massive capital injections, bailouts and interest rate cuts (Bank of Canada dropped interest rates a further 0.25% yesterday morning) appear to have gained some traction after weeks of doing nothing, we have a long way to go. Interest rates for intra bank lending and business lending have dropped by 1.3% but are still 0.70% higher than they should be thus, we are about 2/3rds of the way there.
The U.S. dollar rallied to a two year high against a basket of major global currencies (although, the Canadian dollar dropped to 80 cents this morning, levels not seen since 2005). This is driven by several factors, including repatriation of capital back into the U.S. from emerging markets (risky investments), falling commodity and stock prices, banking stress, expectations that other Central Banks will cut interest rates more aggressively than the Fed (they can’t really do that much more) and hopes for a U.S. government fiscal stimulus package boosting its own economy (making the U.S. a more attractive place to invest). This trend will likely continue in the short-term but is clearly not sustainable over the long-term (in short, expect to see FX volatility increase over time).
Investors are cutting profit forecasts as losses and write downs related to financial crisis have topped $660 billion. Analysts have cut profit forecasts for companies in the S&P 500 and now expect earnings to decline by 5% in 2008, according to estimates compiled by Bloomberg. Since the index is down more than 30% the valuations have certainly contracted significantly more. Wachovia, which is being bought by Wells Fargo, did report a $23 billion dollar loss and the banking companies are certainly accounting for the bulk of those declines.
In the short-term there will be no shortage of ‘things to worry about’ and we will see the ‘domino’ effect starting to take hold as companies or countries previously not impacted by the sub-prime mortgage fiasco begin to be impacted by the ‘credit freeze’ of the last 4 weeks. Companies and countries will have a hard time refinancing their debt (Iceland and Argentina are struggling as countries). In addition, not all companies will achieve their respective earnings targets (although, Apple did exceed expectations last night and the stock rallied by 12% this morning – we see if those gains will hold).
Things will continue to be volatile as recession fears increase in the short-term. Let’s face it – irrespective of the technical facts we are in a recession, but the politicians like to ‘beat the data until it confesses to something that supports their campaign.’ The Chicago Board of Options Exchange (CBOE) VIX index (measure of fear or volatility) is still trading above 53 (it hit a high of 56 yesterday) which is still very, very high and thus, investors are still expecting big price swings in either direction in the short-term.
Stay diversified, stay the course, but the new reality in the short-term will be volatility. Medium to long-term investors will be rewarded based on current valuations and the assumption the governments and Central Banks will take the required steps to unfreeze credit markets and ‘pull’ the global economy out of a recession at some point. There are no short-term solutions but failure is really not an option.
Wilfred Vos Bcs, CFP, FMA, FCSI, CIM, CFA, MBA, DMS, CBV
SVP & Partner
