The situation certainly doesn’t rival the old MadTV sketches for entertainment value, but a diminished sense of optimism is sapping momentum across the financial markets this morning. The US dollar has run out of velocity ahead of tomorrow’s expected downward revision to first-quarter growth numbers, losing altitude as market bulls hedge themselves against a potential reversal.
Here in Canada, investors are also girding themselves for disappointment when first quarter gross domestic product numbers land tomorrow. The loonie is flirting with a critical resistance level in the mid-1.20’s, after the Bank of Canada’s distinctly dovish outlook knocked the currency down a few pegs earlier in the week. In its rate decision, the Bank effectively put a ceiling on the exchange rate, saying, “The Canadian dollar has strengthened in recent weeks in the context of higher oil prices and a softer U.S. dollar. If these developments are sustained, their net effect will need to be assessed as more data become available in the months ahead”.
Euros are trading at essentially unchanged levels, with yesterday’s recovery now an indistinct memory. The common currency and European equities had posted gains yesterday after Greece’s officials said that they were drafting a deal with creditors that would open the door to a bailout, but the IMF’s Christine Lagarde yelled “Opa!” last night, saying, “We are all in the process of working towards a solution for Greece and I would not say that we already have reached substantial results”. This continued a long-running series of exchange rate setbacks, with positive announcements from Athens repeatedly reversed by French and German pragmatism – suggesting that market participants should view these as Trojan horses when they are reported in the media.
Indexes in Shanghai and Shenzhen are in freefall after a number of securities firms announced plans to tighten margin requirements, potentially limiting the flow of cash into overheated markets. Both bourses have exploded upward over the last year, with investors betting that policymakers would continue efforts to pull investment and lending activities out of the shadows and onto exchanges, while pouring stimulus into the financial system.
Unfortunately, retail investors have borrowed trillions of yuan in the process. Margin leverage on the freely-traded market float has risen to unprecedented heights, arguably well above the levels that presaged the 1929 crash in the United States, raising fears that relatively unsophisticated participants and the wider financial system could be left with devastating losses when the smoke clears.
Overall valuations still appear reasonable in an international context, but there are legitimate reasons to suspect that further weakness is in the offing. Chinese investors remain broadly inexperienced relative to their Western peers who have been exposed to the ups and downs of stock prices for generations. After almost four decades of continuous economic growth, very few remember that markets don’t always go up. These are perfect conditions for those who would take advantage of naiveté – and for a surge in volatility.
In short, over the coming days, market participants should remember that low expectations are the secret to happiness”¦
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