MIKE SEGAR
This is a week of hearts over minds, where investor sentiment will determine the market's course rather than hard economic data and government policy.
There is both a lack of fresh economic news due this week and a heightened sense of fear among investors, setting the stage for another volatile week of trading.
In Canada, investors will have one eye on the latest fallout from Europe's financial crisis and another on the June 1 meeting at the Bank of Canada, which may or may not jack rates for the first time in almost two years. With the global economic recovery looking less stable, traders last week were reducing their bets on a rate hike, even as retail sales surged by 2.1 per cent.
In the U.S., the markets are coming off their biggest drop in a year last week, and although investors were somewhat startled by the ferocity of the selloff, they showed enough confidence to buy back in ahead of the weekend, powering a Friday afternoon rally.
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Technical analysts point to a key moment last Thursday as a bad omen for markets this week and beyond. The S&P 500 ended below its average closing price during the previous 200 days, which some analysts consider a technical sign that stock markets are likely to fall further. In addition, the benchmark gauge of U.S. stocks fell more than 10 per cent off its recent high, putting the market into official correction territory and generating more talk about the arrival of the bear.
Adding to the negative sentiment, prices for commodities, which are fundamental to any recovery, have fallen back close to their levels a year ago when the economy began to reignite.
It's quite possible that today's communications technology, and the ubiquitous nature of financial data that goes along with it, is feeding into the drama of world financial events this cycle, says Roland Chalupka, chief investment officer and portfolio manager with Fiduciary Trust Co. of Canada. But the speed with which crises unfold on the markets is really no faster than in previous cycles and the level of risk equity investors incur these days is actually on par with what they carried years ago, he says.
In markets like today's it is essential for investors to have formulated a long-term investing strategy and to stick with it. "I really don't know of anyone who makes money trying to time the market, except for high-frequency traders," he says.
Here are some points to help calm investor angst, courtesy of Avery Shenfeld, chief economist with CIBC World Markets. Canadian employment and retail sales have risen sharply, real gross domestic product outlook for the first quarter is close to 6 per cent, corporate earnings have exceeded expectations both here and in the U.S., companies are raising their dividends, falling oil prices will boost consumers' spending power, Japan's GDP exceeded 4 per cent for the second quarter in a row and Germany posted a 4-per-cent rise in industrial activity.
"While you weren't looking, there has been some good news from that trivial economy known as 'the world excluding Greece, Spain, Portugal and Ireland'" he wrote in his weekly report Friday.
Stocks
Did the problems of the Greek sovereign debt crisis wash ashore in the U.S. causing more damage to the S&P 500 than to Europe's bellwether companies?
"The actors at the centre stage in the Grecian Tragedy interestingly enough haven't been suffering the most lately," said Peter Buchanan, an economist with CIBC World Markets Inc. In May, the euro zone stocks as measured by the STOXX 50, a capitalization weighted index of 50 blue-chip stocks, have performed better than the S&P 500 after lagging for much of the year.
The relative weakness in North America reflects worries over the V-shaped global recovery, the weaker U.S. job claims and concerns over the U.S. financial reform bill, Mr. Buchanan said.
"I don't think the U.S. can be totally isolated [from Europe]" he said. Europe accounts for about 15 per cent of U.S. corporate profits.
The silver lining for Europe is the downdraft in the euro, which should help competitiveness, although the need for fiscal restraint will slow growth, economists say.
North American energy stocks were hit by the slump in oil prices over the prospects of slower growth stemming from Europe's sovereign debt problems. Oil is trading at about $70 (U.S.) a barrel down from $89.15 (U.S.) on May 3. That selloff could also reflect concerns over the proposed U.S. financial regulations restricting futures trading, Mr. Buchanan said.
The S&P 500 before Friday's rally was down 10.9 per cent in May, compared with an 8.5-per-cent decline in the STOXX 50.
Currencies
The rush to the safety of the U.S. dollar is a sign of panic by investors fearful of another credit crisis, but this is not déjà vu, strategists say.
Worrisome to many is the doubling of the three-month U.S.-dollar London Inter-bank Offered Rate (Libor), which measures the interest rate at which banks are willing to lend to each other. It is now up to almost 0.5 from 0.25 in early March, but still well below the 4.82 level it reached in October, 2008.
Libor today is an indication of rising worries over potential contagion effects such as the possibility of derivatives exposure to Greek debt at the banks.
"I do think the panic is in excess of the problem," said Eric Lascelles, chief economic and rates strategist with TD Securities Inc. Interest rates in Greece and Portugal remain elevated but are down massively from where they were, although the euro and commodity prices remain under pressure, he said.
"This is not really a repeat of what we saw in 2008 and 2009," said Stewart Hall, a currency and fixed-income strategist with HSBC Securities Canada Inc. "The crisis is relatively well understood - it's a sovereign debt problem. We know who has what exposure to whom and the interconnectedness in the industry." That is quite unlike the massive leverage and repackaging of sliced-and-diced securities in the mortgage-backed securities crisis, he said.
The difference in rates between three-month Libor and risk-free three-month Treasury bills is 35 basis points, compared with 463 points in October, 2008, he said. (A basis point is 1/100th of a percentage point.)
Commodities
The broad-based selloff in commodities as a result of fears over slower global growth and the rise in the U.S. dollar has sent the Commodity Research Bureau index down over 14 per cent from its highs earlier this year.
Commodities have been hit by both the European sovereign debt crisis and efforts by China to slow its growth.
"Commodity prices are now barely above year-ago levels when the North American economy was still in recession," said Douglas Porter and Benjamin Reitzes, economists with BMO Nesbitt Burns Inc.
And high commodity prices have been a key driver of the Canadian economy. "The Canadian dollar has yet to fully respond to this pullback in commodities supported by its status as a relative safe harbour and the prospect of independent Bank of Canada rate hikes," they said. "If commodity prices continue to break lower, the previous near-unanimous view that the loonie is poised to power through par would come under severe pressure."
Major Chinese stock indexes are down over 20 per cent on a year-to-date basis. "Oil and copper [are]both cracking below their 200-day moving averages, while the energy, materials and technology sectors have slid to the bottom of the leader board in the past month," said BMO Nesbitt economist Robert Kavcic.
But commodities are volatile and the price swings reflect the changing of sentiment by investment funds, said Patricia Mohr, vice-president of industry and commodity research at Bank of Nova Scotia. "Actual supply and demand conditions or the physical trade may often be quite different," she said.