What started as a brush fire in the U.S. subprime lending market now is spreading like a forest fire in Southern Europe — fast and furious. Global stock markets have more or less wiped out all of their 2007 gains, and then some, and everyone is wondering whether we have hit bottom.
The feeling I’m getting from talking to my industry contacts, as well as reading the financial press, is that investors have not been this worried since the aftermath of the tech bubble burst of 2000. The reason why everyone is so worried is the notion that, this time around, the trouble did not start in the stock markets. It started somewhere much more dangerous: with the supply of capital.
One of the prevalent ways of accessing capital supply is through credit. And while Canadians have received many assurances that our credit market is neither as weak nor as exposed to subprime lending as the U.S credit market, the fact remains that asset-backed market in Canada is still huge, to the tune of $35.0 billion! So far, only a few firms have announced their exposure to the troubled sector, such as Coventree Capital Group and Transat AT, but I’m sure many more will soon follow.
What the markets need right now is assurance from central banks on both sides of the border that measures are being taken to lessen the impact of the credit collapse on their respective economies. Unfortunately, the central banks are still assessing the situation, which is not delivering much faith to investors. This is resulting in panicked sell-offs, as we witnessed on August 28, 2007.
Probably the reason why the Bank of Canada is not rushing with announcements lies in the fact that fiscal and monetary policies, if miscalculated, can often do more damage than good. To avoid overshooting or shortchanging the landing, the Bank of Canada must assess properly just how exposed the Canadian economy is to the credit crunch, or rather, how much damage losses in the asset- backed market could actually inflict.
And while the Canadian economy has much more going for it than the U.S. economy does, we don’t live in the bubble. Before things get better, we will continue hearing discouraging news from our neighbors, such as weak housing market, foreclosures, renewals at higher and, for some, unattainable interest rates, and declining employment numbers.
With recession signals in the U.S. clearly flashing, Canada’s exports to our largest trade partner are bound to suffer a serious blow. When that is translated in the context of Canada’s stock markets, it means that the volatility is far from over. Surely, there will be as many bargain hunters as there will be jittery investors. The former will drive the market up, creating an illusion of recovery, while the latter will drive it down, dispelling the said illusion.
Historically, the months of August through October have been the most volatile and weakest in any given year. This year is not likely to be any different. The only sensible piece of advice anyone can offer investors is to focus on the long-term investment horizon and not get caught up in the short-term rollercoaster ride that, admittedly, is making everyone sick to their stomachs right about now.