North American Markets closed up more than 400 points today or close to 4% after the Federal Reserve Board announced a firm commitment to keep interest rates low until mid-2013. This is a big relief following a wild day and large drops yesterday and last week.
This week’s descent is triggered by the Standard & Poors downgrade of the US credit rating from AAA to AA+. Two other credit rating agencies decided to keep the US rating to AAA. This was the first time since 1917 that the US credit rating was downgraded. The downgrade is controversial and thought to be unnecessary for a wealthy nation which can easily raise taxes to meet debt payments .
The markets reacted wildly yesterday. We are currently experiencing a crisis of confidence shown across the world. The European Central Bank stepped in and is reported to be buying back bonds from financially troubled Spain and Italy. A third round of Quantitative Easing (QE3) is expected from the US. These measures are put in place to help economies deal with the debt and confidence issues.
Is this bad for your investments? Yes, but only to a degree. These problems will not disappear or be fixed quickly. We are likely to see further wild days ahead and a slower recovery. A recession is possible but unlikely because of the positive indicators I have discussed in previous blog posts which remain true.
David Graham of CIBC World Markets said last week and I quote: “Please remember that while the governments (US and some Europe) are poor, the vast majority of companies are stockpiling cash. During the worst of the recession, they cut costs, diversified revenues and accumulated cash . Now most companies are in better shape than most governments. A Moody’s investor service report last week showed US non-financial companies sat on 1.2 trillion in cash and short term liquid investments at the end of 2010. The total has only grown since. But it’s not just the balance sheet strength. The earnings season tech darling Apple Inc and Intel Corp blew past analysts’ expectations and big consumers names like Coca-Cola and MacDonald’s continue to grow rapidly. The S&P 500’s forward earning yield which is the reverse of price earning ratio is 9%. that means that the earning per share are expected to be about 9 % of the share price, a hefty return considering that US Treasuries return next to nothing. Yet investors continue to shed stocks, even if the alternative is 2% on GICs.”
Canadian financials, which have strong balance sheets and are considered defensive stocks, are currently yielding between 3.5% and 4.8%. On the US side, 22 of the top 30 Dow stocks pay a dividend yield better than the 10 year US Treasury.
Markets are overreacting based on fear, not facts. Don’t get caught up in the irrational frenzy. Stay calm and read the following especially, “The do’s and don’t for investors in the market” article.