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Stocks in for tough week on concerns that Euro spending cuts will slow recovery

TORONTO - Stock markets are in for more selling pressure next week and gold will likely get a further lift as investors focus on the huge price to be paid for dealing with the European debt crisis.

TORONTO - Stock markets are in for more selling pressure next week and gold will likely get a further lift as investors focus on the huge price to be paid for dealing with the European debt crisis.

Fears the debt crisis will continue for months and years have got investors worried that a resulting slump in Europe — the world's biggest economy — will undermine the global recovery and weaken demand for everything from coal and minerals to grain, oil and machinery.

Those are the kinds of things Canada exports to the continent and other parts of the world, and there's fear the Canadian economy could take a hit.

"It's just the grim reality that European growth is going to struggle for probably years given the enormous task at hand," said Doug Porter, deputy chief economist at BMO Capital Markets.

Gold could also move further into record territory this week as investors wonder about the long term viability of the euro and the inflation pressures arising from huge government bailouts.

Gold hit a series of record closes last week and hit a record intraday high of US$1,249.70 on Friday.

"What we’re seeing is a classic safe haven bid," Porter said.

"When investors look around the world, at various investing instruments, whether it's the US dollar or the euro or the yen, none look particularly appealing at this point and I think gold is shining just by being one of the least ugly investment prospects out there among currencies anyway."

In trading last week, markets were initially positive after a nearly US$1-trillion rescue package was launched by the European Union and the International Monetary Fund.

The package was hammered together amid a report that French President Nicolas Sarkozy threatened to pull his country out of the euro zone unless other members agreed to help Greece. The aid alleviated concerns that debt-plagued countries would be effectively shut out of global bond markets because of exorbitant interest rates.

But by Friday attention was fixed on the fact that the aid comes with tough strings attached that mean countries needing assistance will have to radically cut their deficits through tough austerity measures.

And those cuts will come at the expense of European growth.

"It really takes a significant amount off the GDP growth rates (for those countries)," said Pat McHugh, senior portfolio manager at MFC Global Investment Management.

The Toronto market finished the week up 2.75 per cent last week. But that only made up around two thirds of the amount lost the previous week as traders fretted about inaction by the European Union in dealing with a Greek debt crisis that threatened to bleed over to other countries running huge deficits such as Portugal and Spain.

Spain and Portugal last week announced moves to get their huge deficits under control through rising taxes and cuts to public sector worker pay.

But investors also wonder if governments have the political will to make those cuts stick over a period of years.

Greece has already been racked with huge demonstrations and strikes.

"If push comes to shove, are we going to be seeing riots in (other) countries as well?" asked McHugh.

"I think a reasonable man would be thinking, yeah. So at least from an emotional perspective, there is going to be some more bad news. So in the near term, the markets aren't expected to do much."

While gold is soaring, oil could see further sharp declines, partly on demand worries but prices have also been depressed as investors move into that other classic safe haven, the U.S. dollar.

Crude fell 4.65 per cent during the week, following a slide of more than 10 per cent the previous week.

Worries about the global effect of a slowing European economy are also likely giving the Bank of Canada a reason to think about when to hike interest rates.

There has been much speculation that the central bank could raise rates from the current 0.25 per cent level as early as June 1 "but I don't think the debate is closed on that front yet," said Porter.

"I think the last thing they want to be doing is tightening monetary policy in the face of a severe financial storm."

Porter doesn't believe that the bank would want to postpone making an upward move, noting that the bank wants to begin raising rates as soon as "reasonable."

"When they hold interest rates close to zero, it does potentially lead to an increase in speculative activity because basically they are lending money below inflation," he said.

"So for a borrower it's almost like you're getting free money and there is the temptation to speculate in other assets like real estate. And I think they're worried about some real distortions in the economy from leaving rates so low for so long."