OTTAWA — While it may be shocking to those whose livelihood depend on the financial markets that potential investors are sitting on $45-billion worth of cash at the moment, there are some very good reasons for the current state of affairs. And they are not all included in the report citing that figure put out this week by CIBC World Markets.
That report, written by Benjamin Tal, an economist with the investment bank, talked about investors seeking a safe haven from market volatility by taking their money out of stocks and putting it into bank accounts or super-safe investments such as government savings bonds and treasury bills.
Mr. Tal put this down to risk aversion on the part of Canadian investors and warned that they were missing out on “billions of dollars in potential investment gains” by building up what he called “excess liquidity.”
Well, one man's “excess liquidity” is another man's “prudent savings.” It all depends on whether you are an investment bank, whose revenues depend on people continuing to buy and sell securities, or an ordinary investor concerned about not losing your shirt.
For there is more going on here than a sudden onset of conservatism on the part of Canadian investors. To Mr. Tal's risk aversion should be added two other factors: a loss of trust in financial markets in general and a loss of confidence in the economic future.
Since the scandals involving Enron, WorldCom and the like at the turn of the century (which wasn't that long ago, after all), small investors in Canada have been subjected to a steady flow of bad news that has served to undermine their trust in financial markets. True, some of the events occurred mostly or even entirely in the United States, but blanket media coverage ensured that the message from each was heard in Canada.
And what were those messages? With Enron and WorldCom, where management fiddled the books and accountants did not catch the fraud, investors learned that supposedly reputable companies could not be trusted, even if their accounts carried an outside firm's seal of approval.
That was followed by the market-timing scandal involving mutual funds in the U.S. and Canada in which preferred investors were allowed to trade funds after the deadline passed for most other investors. The message here was that the rules are not the same for everyone.
Following close on the heels of that debacle came an increased focus on the massive amounts in salary and other compensation that boards were giving chief executive officers. Here, shareholders learned that the boards that were supposed to protect their interests were giving their money away hand over fist.
And then came the asset-backed commercial paper crisis, in which it became perfectly clear that many financial advisers employed by financial institutions and brokerages did not have a clue about the products they were urging on investors.
It has not helped that in Canada it takes years, if not decades, to bring those accused of white-collar crime to trial. Witness the spectacular collapse of Bre-X in 1997, where a case involving minor charges only concluded last year. Or, the alleged fraud at Livent in 1998, with the trial of the accused delayed until this month.
There are some who will argue that some of these events, including Enron and WorldCom, happened so long ago that they could hardly be affecting investors' decisions today. That might have been the case if they had faded away, but these and other scandals at that time were of such magnitude and caused such long-lasting suffering among investors that they continue to be cited in news reports, endlessly refreshing investors' memories.
And the negative impression they have left extends to other companies, according to Peter Darke, who teaches marketing at York University. He and Jennifer Argo, a professor of marketing at the University of Alberta, did a study, called When you can't count on the numbers: corporate fraud, generalized suspicion and investment behaviour.
One of their findings, says Mr. Darke, is that knowledge of fraud in one company affects an investor's opinion of another, unrelated company, even though the investor is not aware that this is happening. “People learn to generalize their suspicions,” he says.
The cumulative effect of this is to make the markets look like a dodgy place to put your money, where the rules depend on the size of your pocketbook, and wrongdoers may go unpunished.
Companies and market participants will say that this is an unfair characterization and that most companies are honest and most markets operate fairly. That may be true, but it's not the impression left by the unrelenting media coverage of negative news. The fact that a small percentage of executives are guilty of malfeasance will always make a better headline than the fact that the vast majority of them are not.
The other compelling reason for investors to sit on their cash at the moment is uncertainty about where the Canadian economy is heading. With economic growth in the U.S. slowing, there are growing concerns about how much of that pain will be felt in Canada. Here, the banks have had a hand in undermining public confidence, with each seemingly trying to outdo the other in predicting when Canada will enter a recession.
“Apart from malfeasance in the marketplace, which I'm sure has an impact for some investors, economic uncertainty is causing people to be more reluctant than in the past to invest in the marketplace,” says Darrell Bricker of Ipsos-Reid, the polling firm. “It wouldn't be that surprising that they are sitting on a lot of cash, given that they are uncertain about the economic times and uncertain about what a good investment would be.”
The lack of trust in the marketplace is not an incurable condition. Companies and market participants are taking steps and could do a great deal more to make themselves more accountable to investors. Indeed, one of Mr. Darke's other findings was that when a remedy is put in place, such as the Sarbanes Oxley Act in the U.S., and it is perceived by investors to be effective, it helps restore investor trust.
As for economic uncertainty, it will eventually resolve itself when economic growth in Canada moves decisively up or down.
Until then, who can blame investors for dusting off their old piggy banks? It certainly seems like the most rational choice.
© The Globe and Mail
