FINDING EQUILIBRIUM
Recent market slides have caught investors off balance, but don’t forget the growth that came before.
Is the worst over?
After a week of uninterrupted decline, the markets in Toronto and New York rebounded strongly on Wednesday.
Not so in China, where the rout continued, with share prices now down 22 per cent in four trading days.
They also fell again in Europe, but there was optimism in Japan and Korea, with rises of 3.2 per cent and 2.2 per cent, respectively.
It’s something we’re going to have to get used to as markets search for a new equilibrium. The worst may be over for Canadian stocks, which have been sliding along with the dollar since November over weakening prices for energy and commodities.
It also pays to remember that between January 2009 and the beginning of this week, the main Toronto stock index rose 55 per cent.
For U.S. stocks, the rally began in May 2009 and continued through July, making it the third-longest bull market on record. The Dow has risen farther and for longer, and so the readjustment may have a while to go.
While everyone is pointing a finger at China, Martin Feldstein, a Harvard economics professor and adviser to former U.S. president Ronald Reagan, argued in an article this week that the real culprit for this mayhem is the U.S. Federal Reserve.
Since the 2008 financial collapse, central banks, including the Fed, undertook an unprecedented experiment. They printed dollars by the trillions to stave off a global depression.
This artificially forced interest rates down to record lows, which stabilized the financial system.
The policy had the desired effect of shifting savings from banks and low-risk fixed-income investments into stocks. The hope was that, by increasing share prices, household wealth would also rise and so lift consumer spending.
The strategy worked. Faced with little or no after-inflation return on things such as guaranteed investment certificates (GICs), small investors have jumped into stocks.
Feldstein and others, including Yale economist and Nobel Prizewinner Robert Shiller, have noted that the flood of money into stocks has created inflation, taking the average price-to-earnings ratio of U.S. stocks to 30 to 50 per cent above historic averages. The priceto-earnings ratio is a measure used to determine the fair value of shares. It divides the share price into the annual profits per share.
Two moves by the Chinese government this week have set the stage for more trouble ahead.
On Sunday, China announced that pension funds managed by local governments will be allowed to invest in stocks for the first time, potentially channelling billions into the country’s markets. These pension funds will be able to invest up to 30 per cent of their assets in the country’s stocks, or $97 billion (U.S.). Previously, the funds could only invest in bank deposits and treasury bills
This is a prospect that no doubt thrills the average Chinese pensioner. Their life savings can now be used to help prop up asset prices that are so overinflated they’re collapsing.
On Tuesday, China cut its key lending rate by 0.25 of a percentage point to 4.6 per cent, its fifth rate cut since November. At the same time, it offered a disincentive to save by reducing savings rates by the same 0.25 per cent. So what does that mean for us? There’s no point in selling if you have a balanced portfolio of dividend-paying, high-quality stocks. They might still fall further and almost certainly will bounce around for a while.
Companies with a history or profits, dominant in their industries, that pay dividends in good times and bad, fall last and recover first. They’re usually household names and when ill winds blow they can withstand it. The reverse is true for low-quality, speculative stocks.
Corrections can be short or sharp or long and lingering. In both cases, prices bounce — a relief rally one day followed by big losses the next. News that would normally be seen as positive is ignored, while bad news is magnified beyond its real impact.
At some point, that changes. Until then, expect more volatility. Adam Mayers writes about investing and personal finance on Tuesdays and Thursdays. Have a questions? Reach him at amayers@thestar.ca.