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Jittery investors have four reasons to worry

Stocks are selling off across North America and around the world. Trader Michael Hagis works on the floor of the New York Stock Exchange June 11, 2013.

Richard Drew/AP

Investors are growing nervous, and stocks are selling off across North America and around the world. In Toronto, the S&P/TSX index has slid 2.9 per cent over the past five days, while in New York the S&P 500 index has ground lower over the past month.

Four major worries, spanning governments, central banks and the performance of companies themselves, appear to be weighing on equities. They are:

Tapering talk

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Federal Reserve Chairman Ben Bernanke hinted three weeks ago that the U.S. central bank could soon taper off on its massive purchases of government bonds and mortgage securities. The purchases have flooded stock markets with new cash in recent years, and investors worry that present stock prices may not be sustainable without Fed stimulus.

When the Fed ended its first round of stimulus, known as quantitative easing (QE), major global stock market indexes tumbled by more than 10 per cent within three months, says Colin Cieszynski, a senior market analyst at CMC Markets. The pattern repeated itself at the end of QE2, Mr. Cieszynski adds, although he doesn't believe the conclusion of the current QE3 will deliver quite as strong a blow.

"This time around, central banks appear more likely to withdraw slowly rather than go cold turkey, so we may not see as sharp a falloff, but we could see volatility for some time," he says.

Market strategists cannot agree on exactly when the Fed will apply the brakes. September appears to be the earliest likely date, which suggests that investors will have plenty to worry about for months to come.

Japanese jitters

Japan's central bank has followed the Fed's lead and is attempting to jump start its own moribund economy with a flood of stimulus. The Bank of Japan wants to double the country's monetary base in a bid to lift inflation to 2 per cent in two years and break Japan out of its deflationary funk.

In response to the new policy, the Nikkei 225 soared to a high of 15,627 points in May, up from 8,661 points in November when stimulus began. But then investors began questioning whether cheap money alone would be enough to fix years of economic malaise in Japan. They dumped Japanese equities, sending the Nikkei to a close Tuesday of 13,317 points.

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On Tuesday, global markets were hopeful that the Bank of Japan would accelerate the stimulus flow to dampen the recent volatility, but the central bank made it clear it would not try to smooth out the turmoil.

Instead, the central bank of the world's third-largest economy tried to focus observers on early gains, saying an increase in both government and consumer spending boosted economic growth to a healthy 4.1-per-cent pace in the first quarter. "The negative reaction to the Japanese decision indicates that markets need more and more stimulus to justify current levels, leaving stocks highly vulnerable to a correction," Mr. Cieszynski warned.

Slowing earnings growth

A growing chorus of negative financial guidance from the world's biggest companies is adding to the jittery market climate.

At the start of the year, analysts had forecast that the companies in the S&P 500 index would grow their earnings at a year-over-year pace of almost 9 per cent this quarter. Today, expectations are for only 3.5-per-cent growth, according to S&P Capital IQ.

Of course, part of the slide can be blamed on equity analysts, who are often overly optimistic at the start of the year, then trim their forecasts to match reality. So it's useful to also look at what the companies themselves are saying, and on that point the data shows a similar trend.

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Of the 108 members of the S&P 500 that have issued guidance for the current quarter, 76 released negative guidance, 19 positive and 13 in line with expectations. The resulting negative-to-positive ratio of 4 is almost double the 10-year average of 2.1, according to S&P Capital IQ.

The Chinese backdrop

China's galloping growth and seemingly insatiable appetite for raw materials has helped to drive markets – especially resource-oriented exchanges such as Toronto – to hefty gains in recent years. Today, economic data from the country are pointing to slowing growth, with potentially serious repercussions for the commodity-fueled markets of countries such as Australia and Canada.

China posted a sequential decline in economic growth in the first quarter. The latest data for May suggest the country is headed for a further decrease this quarter. Exports rose by just 1 per cent last month, compared with a gain of nearly 15 per cent in April.

Even more troublesome, imports in May actually decreased by a fraction, compared with a gain of almost 17 per cent in April. The swing could signal trouble ahead for the government's policy of making consumer spending the engine of economic growth.

The International Monetary Fund forecasts that the Chinese economy will expand by about 7.8 per cent this year. That rate would represent the slowest pace since 1999. One of the most ominous signs to observers is that China is boosting credit as growth slows: The economy appears to be requiring more credit to produce each renminbi of economic expansion.

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