The U.S. House of Representatives has voted in favour of the Emergency Economic Stabilization Act of 2008, more commonly referred to as the Wall Street bailout package. The move is being greeted as a positive step in stabilizing financial and credit markets. The plan needs time to work, and for investors, that means patience and likely more short-term volatility.
The bill, which has ballooned from four pages to about 450 pages since the House last voted on it on Monday, was passed by a vote of 263 to 171. The bill was quickly signed into law by President George W. Bush, who has been a strong vocal supporter of the bill.
The Senate passed the bill on Wednesday, with a vote of 74 to 25.
The bill authorizes the use of up to US$700 billion in government funds to take bad mortgage-related debts off the balance sheets of many financial institutions.
This does not provide a solution to what has been described as the worst financial crisis since the Great Depression. Observers point out that, if successful, the act would put a floor on the crisis, rather than actually solve it. Only time will tell if that floor will hold.
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“First and foremost, people have to forget the notion that this is a silver bullet. It’s an important step in coming up with a long-term solution. But something like this takes a long time to implement. The government will have to buy the impaired loans from banks around the U.S. Then they inject the cash and the banks start lending money,” says Bob Gorman, chief portfolio strategist for TD Waterhouse. “The initial impact will be psychological in a positive sense, because there will be some impending improvement in the credit situation. The actual flow of cash will take some time.”
Peter Drake, vice-president of retirement and economic research at Fidelity Investment Canada, notes that economic troubles in the U.S. and Canada are likely to continue. The bailout merely prevents matters from getting worse.
“I’m not saying markets are going to settle down overnight. We still face a period of slow economic growth and recession — we may have started one in the United States and likely in Canada. What that means as we take a mid- to long-term view is we are going to see markets that are more stable. We will see a better economy, probably not a great one, but a better one than you would have seen if this bill didn’t go through,” he says.
Drake says he’s seen a lot of financial hiccups in his years in the industry as an economist and strategist, and the causes of this one may be just as severe as the 1987 stock market crash or the oil price shock of 1973. He’s optimistic that government institutions are better able to deal with this crisis than they would have been during those crises.
“In the 1973 correction, I was energy economist and there was a big increase in oil prices, although puny by today’s standards. That raised some questions back then, and no one was quite sure how they would get answered, but they did get answered,” he says. “In comparison with happened in 1973 and 1987, government and central banks do seem to be better equipped to do something about it. Our economies today are better equipped to deal with this sort of thing. I’m not denying there will be economic damage but I think it will be less than we’d have had even 20 years ago if this had occurred.”
From an investor’s standpoint, there will likely be more bullish calls on gold and hard commodities, due to the volume of American dollars that are going to flood the market to cover the bailout. But Gorman warns against investors running toward gold.
“What we have seen historically is if the U.S. dollar goes down, gold goes up and vice versa. The likelihood is, in the not-distant future, we are also going to see European interest rates going down, and the decreased difference between the European rates, which tend to be quite high, and the American rates, will serve to buoy the U.S. dollar,” Gorman says. “The U.S. dollar will tend to be stronger than it has been. That would likely be a headwind for the price of gold here. That may seem a little counterintuitive but we already saw the price of gold come off a lot the other day; I think it is vulnerable here in the near term.”
Gorman also believes that the commodity-heavy TSX will likely continue on the decline it was on before the worst of the financial crisis hit.
“The Canadian market has greatly outperformed the U.S to a large extent on the back of higher commodity prices. One of our big themes for 2008 is that you’ll start to see rotation of leadership from the cyclical in commodities to the less cyclical as the worldwide economy starts to slow and commodity prices drop off as result. We’ve seen that with a vengeance since the end of June—the TSX has had a very tough time,” he says. “The Canadian dollar has also been sliding versus the U.S. While both of the markets are probably probing the depths here at this stage of the game, the correlation between the two may not be exact, and the Canadian market may have a little bit of a tougher time here based on its commodity stocks in the near term. As an investor you want to be on both sides of the border at this point, not solely based in Canada.”
 | Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com |