By Ray Turchansky
Edmonton Journal
Saturday, March 03, 2007

Also published in:

It was just last December when Scotiabank chief economist Warren Jestin offered a prophetic foreshadowing for investors.

Adrian Mastracci, fee-only portfolio manager at
KCM Wealth Management in Vancouver, says, "Let's remember that the best approach to the markets is to invest with our logical side of the brain, not the emotional side."

"Now we're dealing with a lot of players, some we don't even know," said Jestin. "What's the central bank governor of China thinking?

"When you take a chunk of the world that has not consumed before and bring them into the consumer market, you create tremendous opportunities and challenges. Liquidity is a very good thing, but at the end of the day if you see a sudden rush out the door in a country or an industry, you're going to see enormous swings."

Lo and behold, North American investors awoke this past Tuesday and watched in horror as the Dow Jones industrial average dropped 4.3 per cent at one point, the biggest drop since the World Trade Center was felled in September of 2001. The Toronto Stock Exchange set a single-day record with 615,234 trades, and took a 2.7-per-cent haircut.

Many people welcomed the pullback, saying that with both the Dow and S&P/TSX repeatedly setting record highs during January, a pause that refreshes had been in order. Yet this time there was no terrorist attack in the United States, no havoc wreaked on oil supplies in the Middle East.

Granted, during the day a U.S. government report came out saying the orders for durable goods fell 7.8 per cent in January and concerns continued to grow about sub-prime interest rate mortgage defaults. Furthermore, there was word that there might be an unwinding of the "carry trade," in which hedge funds in particular borrow money at near-zero interest rates in Japan and invest elsewhere.

But this week's retrenchment wasn't made in the U.S.A. or Japan. The avalanche had been set in motion hours earlier, in China. Richardson Partners Financial Ltd. explained the cause of this market belly flop:

"Triggering this sell-off was big news out of China, whereby the Chinese government approved a special task force to clamp down on illegal share offerings and investment with borrowed money. The two stock exchanges corrected by nine per cent on the news and that left the more speculative Shenzen market up only 28 per cent on the year."

CIBC World Markets chief economist Benjamin Tal made the astute observation that this just proves the United States "is no longer driving the bus" in the world of global economics and stock markets. China is now the elephant that catches a cold and causes the U.S. to sneeze.

TD Economics said the sell-off was set in motion by "a number of newly announced regulatory changes -- and heightened expectations for further changes -- which will improve the financial soundness of the domestic Chinese stock market." The report went on to say that the pullback was "not a reflection of underlying weakness or overheating in the economy, but rather was a result of the Chinese government taking the necessary measures to prevent the economy from just such a fate."

China's major stock market had shot up a whopping 130 per cent in 2006, reputedly a result of liquidity provided when the country allowed $230 billion US in non-tradable state-owned shares to be traded, which greatly increased investor access to Chinese equities.

As a result, a number of reports blamed this week's sell-off on a neophyte Chinese investment community that doesn't really understand capital markets and reacted in knee-jerk fashion to its government's announcements.

In truth, North American investors may be more experienced concerning capital markets, but are just as reactive as the Chinese. As Vancouver financial advisor Adrian Mastracci told clients after Tuesday's bailout: "Let's remember that the best approach to the markets is to invest with our logical side of the brain, not the emotional side."

Altamira Financial Services Ltd. said the global profit-taking had occurred "without regard to much of the context surrounding China's activity."

In fact, late this week there were stories about Chinese investors being startled that global stock markets had reacted so strongly to what they had perceived as a national matter.

TD explained: "The Chinese economy serves as a lynchpin in worldwide manufacturing production chains and it has also been driving commodity demand. Disruptions to either of these would have global implications.

"Since this week's developments should shore up the Chinese financial system and have little implications for the rest of the economy, these fears should subside."

If global markets now "turtle" when China moves to improve its financial market system, one shudders to think of the effect if anything major should happen to hurt that country's economy.

Apparently the Greyhound indeed has a new driver, who is the master of our financial fate, and captain of our capital soul.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.