Markets are very jittery and like a “yo-yo” they can snap down, up, down and up at a moments notice and lately, without justification, simply on investor sentiment. These are interesting and unprecedented times and we are making history.
Yesterday, in the United States, it was the second-biggest point gain ever for the Dow and the S&P 500 (and the largest percentage gain). These point advances were surpassed only by the rally on October 13th of this month but the indices are still down approximately 18% (in $US dollars) for the month. This means there is opportunity for investors as stocks recoup their most recent losses with time. The Toronto Stock Exchange followed behind and posted a gain of more than 7% erasing the majority of the losses posted the day prior (this volatility is a 5 standard deviation event – it really, at least in theory, should not or could not happen).
A very positive tone continues to persist in international stock markets today and the futures market would suggest another good day in North America today as investors go bargain hunting (based on valuation). We are due for a relief rally based on the significant declines that we have seen in stocks.
Investors are convinced that central banks worldwide will cut rates even more, potentially by as much as 1% in the United States to bring the overnight rate down to ½ or 1%. Japan could also be cutting rates – if that is actually possible. Investors have bought up stocks that had been driven down to their lowest prices in more than five years (10 if you don’t count dividends).
The Federal Reserve is expected to cut its benchmark fed funds rate by at least 0.50% but tumbling commodities prices and weaker consumer spending are slowing inflation. This slower consumer spending officials have described as a “significant concern” at their last scheduled meeting in September. In turn, dropping interest rates by as much as 1.00% this afternoon is a real possibility (at least that is what equity markets are partially hoping for) but I think a more conservative approach would be to cut once today and once again in December at their next scheduled meeting.
As mentioned, the big catalyst (news to hit the wire) for the late day surge was a huge drop in the Japanese yen. It has appreciated significantly in the last two weeks – as result the Canadian dollar is stronger this morning and apparently the Bank of Japan may cut interest rates later this week. Since everything appears to be working backwards in this current investment environment any sign of relief and a reversal back to the norm (less currency volatility, less forced liquidation of hedge funds or margin calls via the Japanese Yen etc…) is a very welcome sign of relief by equity investors.
Big oil companies gave the Dow its biggest boost after British major BP Plc reported a record quarterly profit which beat investor expectations. Exxon Mobil and Chevron both rose more than 13% in the Dow. The other interesting story will be the potential merger between GM and Chrysler and the acquisition of VW by Porsche (and that short squeeze). VW was actually valued as the most expensive company in the world based on market cap.
As mentioned previously, with current stock valuations (price to earnings, price to book, price to cash flow etc….), the belief that central banks and governments around the world are going to be successful in fixing credit and financial markets and the gradual return (this is not a short-term fix) of investor confidence and stability, you would probably want to be more of a investor than a seller in equities. In addition, we are seeing the credit markets ‘thaw’ as interest rates for corporate lending are starting to inch down slowly but persistently, suggesting that confidence is coming back into the system and that money is starting to flow within the system again.
I am an optimist based on valuation and government intervention but I also believe that we are in and will be in a recession. Economic news will be bleak (unemployment rising, residential real estate prices dropping and a drop in consumer spending) but the ‘bleak’ news will slow and will eventually bottom. Conversely, equity markets have already factored in a significant amount of bad news and forced selling and thus, equity markets will rebound and advance before the economy bottoms and starts to recover.
Little by little we will make progress. In the interim, stay diversified, but if we can’t make money in equities in the next 3 to 5 years I just don’t know when you will be able to. As it stands now, things are very over sold and the price-to-earnings ratio (valuation of major indices) has not been seen in decades, if ever. Expect volatility but that will also subside with time.
Wilfred Vos Bcs, CFP, FMA, FCSI, CIM, CFA, MBA, DMS, CBV
SVP & Partner
