As if 7 straight days are not good enough, things are looking like they will continue for an 8th day today. In North America it will be a little touch and go but that hasn’t stopped the market in the past! It is very clear that things can go in either direction pretty quick and stock markets continue in a very volatile state.
Yesterday, Canada’s main stock index closed higher after a surprise move by the U.S. Federal Reserve to revive the U.S. economy bolstered investor confidence and risk appetite.
The Federal Reserve promised to pump an additional $1.15 trillion (yes that is trillion) into the U.S. economy in an aggressive move to battle a deep recession, partly by buying government bonds for the first time since the 1960s. The Fed or FOMC concluded a two day policy meeting yesterday and the U.S. central bank said it would:
1. “Increase the size of the Federal Reserve’s balance sheet by purchasing up to an additional $750 billion (but this could be as high as $1.45 trillion) of agency mortgage backed securities (this could assist in cleaning the banks balance sheets of toxic or bad assets but we will have to wait and see)”;
2. Continue to purchase agency debt, adding up to $100 billion this year; and
3. Finally admit that it will purchase “up to $300 billion of longer-term Treasury securities over the next 6 months” to bring down borrowing costs. This goes back to a program called “Operation Twist” that ran from 1961 to 1965.
Having pushed overnight rates virtually to zero, the Fed has turned its focus to flooding stressed credit markets with cash in the hope of restarting lending and restoring growth (banks with excessive cash on their balance sheets will eventually make a loan) a policy that the Fed leader Ben Bernanke has dubbed “credit easing.”
The decision caught many investors by surprise and jolted markets which have already been jolted by many negative events over the last year and some recent positive comments from various individuals of influence. The price of U.S. government bonds rose significantly after the announcement with yields enduring their biggest single day drop since 1987. In turn, yields on government debt are less than 2.5% on the very long end. The interest rate on a 30 year mortgage in the U.S. fell to around their lowest levels on record (about 4.5 to 4.75%).
The Bank of England’s recent success in pushing interest rates down by buying government debt may have been a factor in the U.S. central bank’s decision. By driving down yields or interest rates on debt, the Fed hopes to lower a very wide array of interest costs for consumers and businesses (pay less interest and you can afford to buy stuff or keep what you have).
Some investors said the action would be inflationary, and warned of the downside risks. Stock prices jumped higher, while the U.S. dollar dropped by a considerable margin (Canadian dollar gained) on the news.
The Fed also said that interest rates would stay low for “an extended period,” a more explicit promise to stay on hold with interest rates for a prolonged time than has been suggested in recent months.
Bernanke said on Sunday (on the television show 60 Minutes) that repairing the tattered financial system was necessary to secure a recovery for the U.S. economy, which has been stuck in recession for more than a year.
The Fed pointed to worsening prospects for the economy and that the near-term outlook is “weak” and that stimulus measures should lead to a gradual resumption of growth. While the Fed has gone to extraordinary lengths to try to get credit flowing, the economy is still very weak. U.S. gross domestic product (GDP) shrank at a 6.2% annual rate in the 4th quarter, the deepest contraction since early 1982, and economists expect a decline of 5% or more in the 1st quarter of this year. The unemployment rate, which has already hit a 25-year high of 8.1%, is expected to climb through the year.
The news sparked an instant rally in North American equities and brought Toronto’s key index to its highest close since February 13th. Earlier in the day the index had fallen by as much as 3%. The S&P/TSX composite index rose 0.81%.
The financials index, which accounts for about 33% of the total index rose 1% and is now up 29% in just over a week. That has helped lift the TSX off the 5 year low it hit earlier in the month. Some investors believe that the upside momentum is very strong but a pull back could come to fruition after such a large gain.
In the United States, shares of financial companies and home builders gave the market some of the biggest gains as investors bet that the Fed’s move would kick start lending. Bank of America (BofA) shares jumped 22.3% to $7.67 (Citigroup is now trading at $3 up from $0.97 less than 2 weeks ago).
The Dow Jones industrial average gained 1.23%, the Standard & Poor’s 500 Index gained 2.09% and the Nasdaq Composite Index gained 1.99%. The rally in stocks was another step forward in the bounce off of 12-year low reached earlier this month. The S&P 500 index has risen 17.4% from its current bear market low on March 9th. The S&P Financial index gained 10.1% on the day and is up considerably from their recent lows.
After the closing bell, Oracle Corp. reported stronger than expected quarterly results and said it would pay its first dividend to shareholders. The stock rose 5.9% in extended hours trading, helping to set a positive tone for this morning. This morning stocks climbed, sending the MSCI World Index to the longest stretch of gains since 2006. The index gains are led by banks and raw material producers which are the past years worst performers. Gains in Standard & Poor’s 500 Index futures were limited after U.S. stocks.
Regards,
Wilfred Vos Bcs, FMA, CIM, CFP, FCSI, DMS, CBV, MBA, CFA
SVP & Partner
