As North American stock markets went into a steep nosedive on Aug. 4, portfolio manager Oscar Belaiche refused to panic. Surprised by how fearful investors had suddenly become, he buckled down and started buying.
From his perch in a Bay Street office tower, Mr. Belaiche and his equity investment team at Dynamic Funds were opting to play the contrarian card. This was a moment they had been preparing for. Through the course of July, as U.S. President Barack Obama and a dysfunctional Congress stumbled through rancorous negotiations to raise the debt ceiling, Mr. Belaiche had decided to stockpile some cash. He had a hunch that when a deal was reached, the result would not sit well with investors.
He was right. But even a seasoned money manager who lived through the Asian meltdown, the technology crash and the financial crisis of 2008-09 could not have been totally prepared for what was to come.
At about 8 p.m. on Friday evening, rating agency Standard & Poor’s dropped a bomb. Hours after traders had gone home, the United States, the world’s largest economy and the centre of the financial universe, lost its triple-A status.
The resulting uncertainty spread like a burning bush over the weekend. Because money managers could do nothing else, they worked through the myriad permutations of what could happen when the markets finally opened in Asia on Monday morning, or Sunday night on the east coast of North America. Working from home, Mr. Belaiche created a “shopping list” of stocks to buy if markets tanked on Monday. When they did, he and many other portfolio managers sprung into action.
By the end of trading on Friday afternoon, the S&P/TSX composite index had posted its best week in more than a year, up 3.1 per cent. But the path there involved stomach-churning volatility. In the U.S., the Dow Jones industrial average, which ended the week with a small loss, moved more than 400 points four days in a row this week – a record. Over all, most major equity markets are down at least 10 per cent off their recent highs; Germany’s benchmark DAX index has fallen nearly 20 per cent since July 7.
So far, investors have struggled to make sense of the freefall. It appears they haven’t been reacting to one specific event, but a mishmash of worries: the U.S. downgrade, Europe’s worsening sovereign debt crisis, a slowing world economy, even concerns about China’s prospects.
It is, Mr. Belaiche says, “the correction with no name.” But perhaps that’s because underlying all these factors is the fragile state of mind of investors, who remember the 2008 crash all too well and are fearful of a repeat.
“People are afraid of being afraid, the way they were in ’08 and ’09. That left a lot of scar tissue,” says John Schumacher, who now is a partner at hedge fund company East Coast Fund Management Inc. and a former senior executive at Bank of Nova Scotia’s securities arm. On Monday morning, as stocks began a downward spiral, Mr. Schumacher’s daughter sent him a text message. “Is it going to happen again?” she asked.
How and why the fear spread
For all the confusion around the day-to-day trading, no one can say the possibility of a correction never existed. Stocks markets have soared since Ben Bernanke hinted at a second round of quantitative easing during the annual Jackson Hole conference in Wyoming last August. Spirits were so high that not even a devastating Japanese earthquake could dampen the mood for too long.
Yet beneath the surface, the U.S. economy was beginning to stall and Europe’s debt problems kept flaring up. It became clear that Greece would need another bailout and systemic reforms, all of which would affect European banks that hold Greek debt.