Chris Kuflik - ScotiaMcLeod Montreal

The markets wild gyrations over the past two weeks have been historical and unnerving for many investors. The questions on many investors’ minds reminded me of a Jackson Brown song “Running On Empty”. Are we headed for a repeat of 2008?

Let me begin by stating that we do not believe that the global economy is running on empty. Uncertain investors, reacting to each and every bit of news from the US and Europe as it hits the wires, are driving the fear. In addition, the major news outlets have sensationalized the market sell-offs and have only increased the panic factor for investors. Lastly, the program computer trading which follows the panic has greatly increased the magnitudes of the swings.

Yesterday, what was aptly referred to as a “perfect storm” brought the sellers back out in force, resulting in the first extremely sharp down day in more than a week. Some of the ingredients that came together to form yesterday’s storm:

1) The Wall Street Journal reported that U.S. regulators are closely watching the health of European banks.

2) Morgan Stanley cut its growth estimate for the global economy in 2011, now expecting 3.9% growth instead of 4.2%.

3) Manufacturing activity in the US Mid-Atlantic region showed a sharp drop in activity.

4) Weekly US jobless claims increased by 9,000 and moved back up over the 400,000 level. Existing home sales were weaker than expected.

Investors were also considering comments from two members of the Federal Reserve’s Open Market Committee (FOMC). Charles Plosser and Richard Fisher both dissented from the most recent Fed statement that promised low interest rates for another two years, and both have said the Fed shouldn’t take action for the purposes of supporting the stock market but rather based on economic conditions. That led to uncertainty over whether any sort of meaningful “QE3” will be enacted. Ironically, Plosser said the economy may not need additional stimulus and that he hasn’t reduced his growth expectations for 2012. Both were critical of the way Washington has dealt with debt problems, and Fisher said the uncertainty over fiscal and regulatory policy has caused businesses and consumers to sit on the sidelines.

While the major risk is a financial crisis sparked by the problems in Europe, the global situation now is much different than it was in 2008 when the U.S. crisis impacted the world. Banks are now well-capitalized. The ECB has shown, through their one week loan of 500 million Euros to an undisclosed European bank that, rather than have the risk of a run on a bank, which happened to Lehman Brothers in 2008, that they will support and prevent this from occurring. Sovereign debt problems, though very serious, are far easier to solve than unwinding the tangled subprime credit crisis that weaved its way into most corners of the global economy.

The last piece of negative news affecting the markets was the Thomson Reuters / University of Michigan Consumer Sentiment Survey. The widely watched measure of consumer confidence plunged in August to the lowest level seen since May 1980.  Many were expecting the indicator to drop modestly from 63.7 in July to 62.0 in August;

but it came in at an astonishingly low 54.9.Major declines in consumer confidence are usually seen as a very bearish sign for the markets.  Remember, about 70% of US economic activity is driven by consumer spending; and when consumers are fearful about the economy, they tend to keep wallets safely in their pockets. However, August's steep drop might mean something different for the markets this time around.

Contrast this consumer confidence number with the fact that retail sales rose more than analysts were expecting in July.  According to the US Census Bureau, retail sales jumped 0.5% from June's levels and increased by 8.5% year over year. It may not look like much of an upside surprise, but it was the biggest retail sales increase in four months. The decline in consumer confidence, possibly caused by the intense media coverage of the US debt ceiling debate is actually a very bullish signal. In the past when consumer confidence had fallen to extreme levels, the market mounted huge rallies.  In 1980 when consumer confidence plunged, the S&P 500 turned quickly and rose 36%. More recently, after consumer confidence plunged in March 2009, the S&P 500 bottomed and then soared 105% over the next two years.

During the decline in the markets, for every seller of an equity there is a buyer. Legendary investor Warren Buffett on a PBS interview last week made the following comment, “Last Monday, we spent more money in the stock market buying than any day this year.” In addition, Vickers Weekly Insider, which measures the ratio of selling to buying on the part of corporate executives, reported that there were approximately three buys for each sale last week. This was the highest level of buying in thirteen years. You should note that the last time insiders bought more than they sold was in March of 2009.

While we do not believe that we are running on empty nor do we expect a repeat of 2008, the “all clear sign” has not appeared yet. We expect that the market will remain volatile and will retest the lows registered last week. Should these levels hold, we expect higher markets in the fall. Please note that 2012 may be another story. Currently, we are compiling a long list of potential purchases to redeploy our cash. Security selection will be paramount.

Please feel free to share this commentary with someone you feel could benefit from its contents.

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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