Equity markets went into another deep slide Monday, posting the biggest single-day losses in more than two years, amid gathering fears that the world economy is headed back into recession.
Investors were already on edge after Standard & Poor's cut the U.S. government's triple-A credit rating on Friday and the European Central Bank decided to take extraordinary measures to stem the growing crisis in the euro zone, and they began selling stocks as soon as the markets opened for the week of trading. A selloff that started in Asia and Europe gathered momentum in North America.
Even U.S. President Barack Obama's afternoon statement that the world's largest economy would tackle its debt problems with "a renewed sense of urgency" did not halt the panic. By day's end, the S&P/TSX composite index was down 491 points, or 4 per cent, its biggest decline since June, 2009. U.S. markets fared even worse, with the S&P 500 index plunging 6.7 per cent for its worst day since the 2008 financial crisis.
For some, the sudden, sharp drop in equity prices – Canadian stocks are down 13.5 per cent since July 22 – is bringing back fears of a replay of the vicious bear market of three years ago that left few investors untouched.
That period was marked by the failure of huge financial institutions that collapsed seemingly with little warning. Others were merging to save their hides. Companies like American International Group Inc., believed solid only weeks before, were revealing huge losses on complex investments, forcing governments to bail them out. Companies far removed from the financial sector couldn't borrow. There were real fears that it was the end of finance as we know it.
It's natural to ask, with stock markets in Canada and the U.S. plunging day after day in an accelerating dive, if we are on the doorstep of such a cataclysm again. But many think the answer is no.
What's at play now is "massively different," says John Schumacher, a co-founder of Toronto-based hedge fund company East Coast Fund Management Inc. and a former co-chief executive officer of Bank of Nova Scotia's securities business.
Financial markets are genuinely concerned about Europe's ability to pay its debts and, most of all, fear that major economies like the U.S. are falling back into recession.
That's all bad, but there remain significant differences between now and the deep financial crisis of 2008. Then, markets were not just falling; some of them were shutting down. Credit became extremely difficult to get; with no access to funds, companies stopped making things and consumers stopped buying them. Economic growth tanked.
"The overwhelming emotion in the market is the fear of fear," Mr. Schumacher said. "There isn't anyone who isn't worried about 2008 coming back, and it's such an overwhelming emotion that most people can't think through the fact that the same factors are just not in place."
This time, however, financial markets are still functioning. Share prices are slumping, but there's no sign that creditworthy companies have lost the ability to borrow. No banks are on life support for a lack of liquidity. Instead of markets causing a recession, they are reflecting fears about one.
That's no comfort to investors watching their retirement savings shrink, but it's a fundamental difference.
"A lot of the problems have really been worked through and what we're dealing with is not balance sheets full of toxic crap [such as subprie mortgages] but instead just a really tepid recovery," Mr. Schumacher said.
That is not to say that financial markets are going to be a fun place to be any time soon. Governments in developed countries are focusing on cutting spending, leaving little cash for stimulus projects. In that environment, every hint of slowing growth – and there are many – is troubling to buyers of stocks. They know that there is unlikely to be another government spending boom to help them out.
The result is that "signs of slowing growth appear to have a nastier edge," Dominic Wilson, chief markets economist at Goldman Sachs Group Inc., said on a conference call with clients Monday.
But there ought to be more resiliency in the financial system this time, especially in North America, thanks to the lessons learned and the focus of regulators on lowering risk by forcing banks to use less borrowed money in their businesses, some market watchers say.
Canada's banks remain solid and spent recent weeks stashing away extra cash raised in bond issues and cutting back on risky positions, while cutting back dealings with counterparties that they deemed risky.
Senior bankers are cautious and perhaps a bit depressed about the outlook for their business, but they are far from terrified.
The American banks that survived the 2008 crisis, while in some cases dealing with the after effects, are in large part in better shape to withstand a storm. According to Goldman Sachs, the biggest U.S. banks – Citigroup Inc., Bank of America and JPMorgan – now have 35 per cent of their assets in liquid holdings that could quickly be converted to cash in a pinch, up from 27 per cent prior the financial crisis.
They are also less dependent on short-term borrowing for the cash they need. During the crisis, they relied on markets for funds to run their business, borrowing every day from investors. Now, more of their funds come from deposits, which are less fickle.
One wild card remains European banks, and whether they have the wherewithal to withstand losses on bonds issued by struggling European governments.
But Canadian bank officials interviewed in recent days believe that while there are signs of stress in the financial system, especially in European banking, it's nothing like 2008. That's also evident in market measures, such as what European banks are paying for loans from other banks. While the rate for such loans is up, it's well short of where it was three years ago.
"European banks are in awful shape, but it's not a surprise to anyone and they have access to funding to get them through this from central banks," Mr. Schumacher said.