Keeping one's perspective in life-and-death situations is usually easier said than done. When it comes to nearly-life-and-death, like rapidly falling stock markets, perspective is no less important. The current nose-dive in the Canadian stock market - down 7.7% this month - comes against a backdrop of a global bear market where major indices are down somewhere between 10% and 25% on a year-to-date basis (versus only a 3.4% decline YTD in Canada, the best performance of OECD countries). Not that knowing somebody else is losing money makes the sting of a declining stock portfolio any easier to handle, but it does help keep us realistic in our expectations. As Alan Greenspan once said, ''It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress,'' and neither can the Canadian stock market. Let's take a step back and look at the underlying drivers in this current market downturn...

With global stock markets tanking over the first half of the year, investors gravitated towards what was 'working', and more often than not that meant commodities, both the physical goods, and the stocks. As we talked about a few weeks ago (Commodities are the new T-bills - June 20th), commodities have become the (somewhat counter intuitive) asset class of choice in our low growth/high inflation world. This meant a flood of capital came out of traditional sectors, namely financials, and was poured into commodities. Over the course of 2008, crude oil and natural gas have risen 30.6% and 25.7% respectively, while copper is up 18.0%, gold has climbed 10.5%, and the overall CRB Commodity Index has rallied 15.2%. Despite this surge in prices, commodity stocks have lagged behind markedly, with the Materials sub-index up just 6.3% this year and Energy sub-index only 3.0% higher. As we discussed a few weeks ago in Oil UP, Natural Gas UP, Energy Stocks DOWN... HUH?? - July 4th, there comes a point when commodity stocks no longer price in current commodity prices... in essence the stocks are 'saying' that they don't believe that these commodity prices are sustainable. Unfortunately, while the stocks are no longer participating on the upside, they don't seem to have any trouble going lower when commodities decline.

At the other end of the spectrum, the banking and brokerage debacle has at the very least taken a breather. After falling roughly 50% over the past nine months the US financials are showing some signs of life after some not-as-bad-as-expected earnings reports, some short-covering, and some hope that the Federal government will continue to throw cash at the mortgage market in an attempt to sidestep a housing meltdown (see Fannie, Freddie and the Seven Stages of Grief - July 18th for more on that topic). The result has been funds flowing out of the commodity sectors and back into financials in hopes of buying in at the bottom, or at the very least, not missing a rally in that group. Incidentally, it was just over a year ago that the highly-tanned and immaculately coiffed ex-Countrywide Financial CEO Angelo Mozilo took to the airwaves warning of a looming disaster in the real estate market.

Couple the above two points with the fact that recent US economic data and corporate earnings have been largely as-expected or better-than-expected and you find yourself in a situation where investors are reducing their risk-aversion and are starting to look at stocks that have been crushed over the past several months: consumer staples, technology, pharmaceuticals, etc. Once again, investors are selling commodities and commodity stocks to fund this sector rotation.

Alright you say, I get it... energy and materials stocks are on the wrong end of this stock market reshuffle, so does that mean that the great commodity bull run that started back in October 2001 and shifted into 5th gear in August of last year (right around the time of Mr. Mozilo's pronouncement) is now over? Not likely. Even if it advances at a decelerating pace, the emerging economy infrastructure build-out that has powered this multi-year rally will continue, and the commodities consumed in that build-out will continue to see historically strong pricing. In the near-term, volatility is inevitable, and some of the laggard sectors mentioned above may take a turn leading equity markets, but the longer-term story is intact.

See, I told you so.

In other news...

Think you're feeling the inflation pinch these days? While it may cost a few more dollars to drive to the cottage and your local latte maker may point to rising milk costs as he hikes the price of your morning coffee by 25 cents, at least you don't live in Zimbabwe. After years of economic catastrophe and governmental breakdown, Zimbabwe's inflation has lost all sense of normalcy and currently sits at 12.5 MILLION PERCENT. With that in mind, the government is in the process of introducing the $100 Billion Dollar bill. If you're interested you can always buy one of these novel bills on eBay.