2007 was a volatile year for most equity stock markets around the world. Major North American stock indexes reached record highs in July, sustained major losses in August, recovered strongly in September only to plunge again in October. By the end of the year, most indexes had recorded only modest gains. Gold continued to challenge past nominal highs as fears of inflation combined with general distrust in the financial system drove demand.

Since August 2007, investors have experienced a marked increase in equity market volatility compared to the experience of previous years. It began with the problems in the US. sub-prime mortgage market, which started in the fall of 2006, worsened in 2007 and by August 2007 had become a global financial crisis.

The onset of the crisis in sub-prime mortgage lending sent shockwaves through various other segments of the financial system due to worries over the likely impact of an expanding credit crunch on the overall economy. Global stock markets saw a sharp fall as the sub-prime problems started to emerge. From mid-June to mid-August, the FTSE and Dow indexes lost nearly 10% and 6% respectively, while the Asian markets, Kospi and Nikkei indexes lost 16.5% and 16.3% respectively. What started as a credit crisis morphed into a liquidity crisis as it had become apparent that a large number of banks around the globe had invested in illiquid collateralized debt obligations constructed on residential mortgage-backed securities.

Liquidity infusions by central banks worldwide to assuage a credit crunch did not improve the global equity market sentiments which continued to stay negative and only appeared to recover after the US Fed cut its discount rate by 0.50% in August, by 0.25% in September and again by 0.25% in December. The Bank of Canada also cut rates for the first time since April 2004, lowering them by a quarter-point to 4.25% in December 2007. The Bank of England followed with a reduction of their key interest rate by 0.25% while the European Central Bank decided to keep its key lending rate unchanged.

In an unusual move, the US Fed announced in December that it was co-ordinating with other central banks, including the Bank of Canada, the European Central Bank as well as the Bank of England, to deal with the global credit crunch that followed the US sub-prime mortgage crisis. The US Fed said that it was creating a "temporary auction facility" to make funds available to banks (in amounts in excess of tens of billions of dollars) and was also setting up lines of credit with other central banks that could be used for additional resources.

The year 2008 started right where 2007 left off. The modest gains of 2007 were uniformly wiped out across almost all indexes in January of 2008. As major US financial institutions began to disclose their unprecedented losses for the fourth quarter of 2007, fear gripped investors as the full scope of the damage attributed to the Asset Backed Commercial Paper (ABCP) markets was realized and equity prices were slashed indiscriminately.

The world’s largest banks have reported a staggering $146 billion from the combined asset writedowns and credit losses stemming from the US sub-prime mortgage market. Merrill Lynch & Co. Inc. and Citigroup Inc. led the pack with a combined $50 billion of writedowns in the third and fourth quarters of 2007. Both had to look to foreign private equity funds from the Middle East and Asia for a fresh capital injection. Many other blue-chip financial institutions have also reported billions of dollars in mortgage losses and writedowns and were forced to replenish their capital with foreign equity.

On Monday, January 21, 2008 (a holiday in the US), stock markets around the world posted their heaviest one-day losses since 2000. The Fed pre-empted Tuesday’s opening with an emergency 75 basis point cut to restore confidence. It then made another 50 basis point cut the following week at its scheduled meeting, dropping rates to 3%, almost half of its high of 5.25% six months prior. The Fed has made it clear that it will make all necessary adjustments to its monetary policy to stave off a recession, but if and for how long it can hold off an economic slowdown is still uncertain.

Worldwide equity markets lost a combined $5.2 trillion dollars in the month of January 2008. Stock market volatility is expected to remain in the months to come as concerns about the economic fallout from the global credit market turmoil continues to rise. Investors should retain a defensive, high quality portfolio with a focus on stable earnings and reliable dividends.