The world’s capital markets have undergone incredible volatility in recent months.
During some weeks it seemed as if every second day there was a precipitous triple-digit drop and then a recovery of hundreds of points in the main market indices. A report on Greece’s debt default status would send markets plunging, and then some favourable comment on the U.S. labour market numbers, or some other vague bit of positive news, would cause a similar upward surge.
In aggregate, net declines in a number of these main market indices since early August have been around 15%. But factoring out the volatility, which is certainly a significant correction, these indices are still well up: 10%, or so, from where they were a year ago.
So what should we read from today’s market behaviour? Are we teetering on the edge of a financial abyss? I don’t think so.
Here is what James Altucher of Freakonomics had to say about a potential market meltdown when the volatility started.
“U.S. banks have a surplus of $1.3 trillion. They also make money for free by borrowing from retail consumers at checking account interest rates and then lending to the Fed at 3% (or whatever the day’s T-bill rates are). This is called “free money.” They’ve also increased commercial lending for seven months in a row. U.S. GDP has had eight quarters in a row of growth, and American corporations have $2 trillion in cash on their balance sheets. Also, this is very important: household debt obligations (rent/mortgage + car payments + credit card payments divided by income) are at their lowest since 1992. In 2008, this metric was at its highest since 1992. That’s a big difference. The consumer is healing.
“Companies are doing fine. Seventy-five per cent of the firms in the S&P 500 have beaten their earnings estimates. The S&P right now trades at 12x forward earnings versus the historical average of 15x. Oil prices have dropped dramatically since their highs of 2008. This is like one huge tax cut for the American public.”
But will Europe’s debt crisis plunge the world economy into chaos? I don’t think so. The European Financial Stability Facility (EFSF) has been set up with an overall rescue package of €750 billion, of which bonds guaranteed by member states for up to €440 billion can be loaned to member states in difficulty. That’s over $1 trillion. And you can bet the EU, if needed, will commit much more to save the Euro. Greece and other potential defaults are already priced into the market. And don’t forget that Japan has successfully managed a debt-to-GDP ratio worse than Greece’s for more than 20 years.
So with such emotion-driven volatility in the financial world, what is going to happen to all of the cash out there, and where can one seek to benefit from it?
There will be the sky-is-falling types who will cry out that we will soon witness the mushroom cloud, the train wreck, the destruction of the economy. Some of these prophets of doom will target the frightened, peddling products and investments designed to provide emotional comfort and the promise of financial protection to people fearful of losing it all. In this category, I also put those advisers who will sit on their hands and do nothing for their clients while still milking fees. I wish the regulators strength in preventing as many of these abuses as they can.
Many fund managers will realize that while the profits from heavy trading during this period of volatility are welcome, this is not a long-term, sustainable investment strategy. At some point, when the emotion is under control, investors have to take long positions again in something to enjoy any real growth.
The sooner, the better. •
