Even though a tweaked version of the US$700 billion rescue plan was passed in the U.S. Senate Wednesday, markets still dropped, with the S&P/TSX composite plunging 814 points—mostly due to a huge decline in commodity stocks—while the Dow lost nearly 350 points.
Avery Shenfeld, a senior economist at CIBC World Markets, says there’s still a lot of uncertainty around whether or not this will survive in the U.S. House of Representatives. “I don’t think this bill passing is certain,” he says, even though many in the financial industry are cautiously optimistic that it will go through. “I think at this point there’s a guessing game going on whether enough members of the House are prepared to switch sides.”
Shenfeld says Thursday’s market volatility is just reflecting that uncertainty, though many in the industry are still worried that even if the rescue plan is implemented, American and global economies are still at risk.
With a few more bells and whistles added to the package—deposits up to $250,000 are now guaranteed (as opposed to $100,000) and some tax breaks have been included—it’s expected the plan will move from the House to President Bush’s office this week. If it doesn’t, expect more market turmoil.
“We’d see further pressure on equity prices and more concern about stability of the U.S. financial system,” says Shenfeld. “There will be an initial relief in markets, but it’s not going to quickly wipe out lingering concerns about the economy itself.”
While industry watchers are hoping the stimulus package will help markets and turn the economy around, Shenfeld says it’s unlikely this measure alone will fix all the damage. “They’ll likely have to do something more to stimulate consumer spending in 2009,” he explains. “When we come back after the American election, we’ll see another fiscal stimulus package of tax cuts and government spending initiatives.”
James Cole, senior vice-president and portfolio manager with AIC, says the U.S. would be better off in the long run if the rescue plan fails. He thinks the plan puts taxpayers at risk, and that it “serves to prop up a system, the mortgage securitization market, which has demonstrably failed.”
He adds that the mortgage securitization market should be allowed to “die the death it deserves. It will be painful in terms of short-term reduction in mortgage credit availability, but good in the longer term for reducing the systemic risks, which are plainly evident now.”
Instead of the rescue plan, Cole thinks the SEC should reinstate the uptick rule—a regulation that requires short sale transactions to be entered at a value higher than the price of the previous trade—and stop focusing their attention on shorting. “It can be done at the stroke of a pen by the SEC at no cost to anyone,” he says. “Bans on shorting are not a sustainable policy, and it’s also not fair. You can’t short financials, but still short commodity stocks. That’s where hedge funds are playing in their spare time now.”
Even if the uptick rule is implemented again, and if the rescue package passes, the economy won’t return to any sort of normalcy until the housing market corrects itself. Shenfeld says housing prices need to find a bottom before things can turn around.
“Housing prices need to stop falling and new buyers need to be able to get financing,” he explains. “The concern is that without this package or some substitute alternative, the banking system would not be in a position to provide people mortgages.”
Luckily, Canadians don’t have to worry too much about banks turning away home-buyers in search of a mortgage. Still, because Canada’s a heavy export nation, we’re affected by what happens down south. As a result, the passage of the rescue plan could help Canada’s markets as well. “Anything Washington does to improve the economic climate stateside will help Canada,” says Shenfeld.
He adds that Bank of Canada’s rate cuts have already helped our economy, and that we need to “resist calls on government to cut spending in the near term to meet some arbitrary deficit target.”
As for investors, Cole reiterates what many managers and advisors have been saying over the last few weeks: now’s a good time to buy. “There are a lot of companies with no credit risk—they don’t extend credit and don’t rely on credit — that are very attractively valued right now,” he says.
“Could they get cheaper tomorrow?” he asks. “Yes, so I’m looking out at five years of very attractive rates of return with limited downsides. In bear markets, things tend to get cheaper than you think.”
Cole points to the third quarter of 1998 to explain why now is a good time to buy. Back then investors had similar fears of a worldwide economic slowdown, and the S&P/TSX dropped 32%, the biggest quarter decline in the index’s history. “It proved to be a great buying opportunity, because the world did not end,” he says. “The sun is going to shine tomorrow and people are still going to keep driving.”
For this fund manager, who runs the AIC Canadian Balanced Fund, the Canadian Focused Fund and the Dividend Income Fund, the market volatility has resulted in great buys, though he can’t get more specific than that. He says he reduced some positions in financials and sold some businesses outright, which meant he was holding about 25% of his portfolio in cash.
“I have been investing some of that cash in recent days,” he admits. “I had cash going into this, and I’m gradually getting that to work.”
Filed by Bryan Borzykowski, Advisor.ca, craig.sebastiano@rci.rogers.com.