More than $12 trillion was erased from the market value of equities this month, accounting for about one-third of the total value wiped off stocks this year, as almost $680 billion of write downs and losses by banks triggered a freeze in credit markets.
Stocks in Canada and around the world dropped sharply with Canada dropping more than 8% yesterday or 43.3% from its high in June. The TSX would need to jump by more than 76% to recoup its previous high. Typically, the biggest gain posted by a bull bear is in the 12 months after the bear market ends. Canadian stocks and the Canadian dollar have hit 4 year lows.
You will notice that the majority of stock market losses are posted in the last hour of trading. The $U.S. hedge fund industry has more than $2 trillion in assets. Hedge funds typically borrow money to leverage their investment exposure. These hedge funds typically borrow money from Japan and then invest around the world. With global stocks and other investments down, these hedge funds are now selling in order to cover their margin calls on the loans that they received (from companies like the bankrupt Lehman Brothers), repaying their Japanese loans (this is the reason why you are seeing significant price appreciation in the Yen) and then buying U.S. dollars in order to repay any additional margin they have in the U.S. or repaying their investors as the hedge funds wind down (think about how much these hedge funds lost when you margin or leverage up investments that are down 40 to 60% plus an additional 20% loss on the currency). The majority of hedge funds have an October 31 year end thus, there is some urgency to winding down these investments. This is creating the forced selling that you are seeing in the last couple of weeks (or selling into strength). This event is also referred to as a massive global deleveraging.
However, I’m still an optimist (a disgruntled and frustrated optimist).
The MSCI World is trading at 10.5 times reported earnings, near its lowest valuation since 1995 when Bloomberg started following the data. The MSCI World Index has added 2.1% this morning snapping a two-day 8.4% drop. A company like Alcoa Inc. (one of the companies in the Dow) is traded at the lowest price to earnings ratio on record. In short, we will see bargain hunting materializing once the global deleveraging has been completed (buyers have been well conditioned to wait until prices drop further since there are more forced sellers sitting on the sidelines). The index of companies from 23 developed countries has fallen 28% in October, its worst month on record, as central banks and governments worldwide bailed out banks and cut interest rates to stabilize the banking system and tried to avert a deep recession or depression.
Their efforts are working as the futures on the Chicago Board of Options Exchange (CBOE) show an 100% chance/odds the Federal Reserve (Fed) will lower its target overnight rate by at least 0.50% tomorrow to help increase bank lending and spur economic growth (the interest rate cut could be higher).
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 that 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. The ‘path of least resistance’ for the stock market will be to go up and not down over the long-term. In the long-term if consumers, business, government and countries exchange goods and services there will be opportunity for profit (based on mutual benefit) and that will translate into positive price appreciation for stocks based on current valuations.
Peter Lynch once said that you cannot predict the next 10% move up or down in stock markets but you can predict the next 100% move which is up. I did not think that we would test the October 10th intra day low again around the world and we didn’t around the world but we did in Canada (based on forced selling). However, we did break the October 10th low based on technical factors and not fundamentals factors.
Things are bleak within the economy, credit markets and capital markets – it is frustrating and painful and there is no quick fix but eventually we will experience some positive news and remerge. Little by little we will make progress.
Wilfred Vos Bcs, CFP, FMA, FCSI, CIM, CFA, MBA, DMS, CBV
SVP & Partner
