Weekly Wrap-Up August 2-6, 1999

The North American bond markets finished the week in rough shape. After chopping around in anticipation of the employment data at week's end, the bottom fell out of the market. A combination of economic and supply driven factors took any wind out of the bond market's sails. Concern over the timing and magnitude of the next Federal Reserve interest rate hike in the US is mounting. The Federal Reserve Board next meets on August 24, and it is widely anticipated that the Fed will raise rates again. The equity markets were generally weaker due to the increased fears of interest rate increases. Through-out the week the equity markets showed signs of weakness. The bull market is feeling tired and topish as investors from Europe and Asia sell the US stock market and buy Asian and European markets.

The North American bond markets finished the week in rough shape. After chopping around in anticipation of the employment data at week's end, the bottom fell out of the market. A combination of economic and supply driven factors took any wind out of the bond market's sails. Concern over the timing and magnitude of the next Federal Reserve interest rate hike in the US is mounting. The Federal Reserve Board next meets on August 24, and it is widely anticipated that the Fed will raise rates again.

Another interest rate increase should come as no surprise to the North American markets. The Federal Reserve Board Chairman Alan Greenspan has stated that the liquidity that the Fed injected into the market in August - October last fall is no longer required, and that the Fed is looking to unwind the liquidity it has provided. With a total of 75 basis points of rate relief last fall, and a 25 basis point increase in June, that leaves the Fed with another 50 basis points to go just to get back to flat.

While the global press continues to write of the robust turn around occurring in the Japanese economy, it is worth noting that Japanese unemployment is at 4.6%. This is the highest it has been since 1955 when statistics began to be collected. The number of unemployed is expected to rise as more companies restructure in an effort to become more competitive. As well, the Japanese reported that auto sales decreased 13.9% on a year-over-year basis in July. This is the 28th consecutive decline. This data hardly reflects an economy which has turned the corner.

Elsewhere in the world, the July manufacturing survey out of Euroland indicated that the common currency zone is experiencing strong manufacturing performance. A combination of easy monetary conditions provided by the European Central Bank and the Bank of England are helping to fuel the resurgence of consumer demand in Europe.

Economic data in North America was sparse, but very important to the markets. In Canada, the unemployment rate rose 0.1% to 7.7% as an increase in the number of people looking for work pushed the unemployment rate higher. After several months of stagnant job growth, the economy produced 40,000 new jobs (equivalent to approximately 400,000 new jobs in the US economy). In the US, NAPM numbers revealed that the prices paid by purchasers were up again. This would normally have sent the market into a tail spin, however many investors held the opinion that the primary reason for the increase was due to crude oil prices. US productivity increased 1.3% in the second quarter compared to an increase of 3.6% in the first quarter; while unit labour costs rose 3.8% in the second quarter, up from the 0.8% increase in the first quarter. This is not a good sign, as the Fed is concerned with the effect of tight labour markets on the inflation picture in the US. If wages rise faster than productivity, then costs will eventually be passed onto consumers. The US non-farm payrolls number of 310,000 new jobs, versus 210,000 estimated, hit the market hard. The combination of productivity, unit labour costs, and employment numbers have spooked the markets. Concern over another increase in interest rates by the Federal Reserve Board now has the bond and equity markets nervous.

The bond markets on both sides of the border had to digest a significant amount of supply over the past several weeks. This week in the US, two corporate issues amounted to almost $US 10 billion in new supply. Wall-Mart issued $US 5.75 billion and Fanny Mae issued $US 4 billion, these are large deals even for the US market. As a result of the economic data and supply, the bond markets sold off. In Canada, the Government of Canada 30 year long bond added 9 basis points to close the week at a yield of 5.93%. In the US, the US Treasury long bond added 5 basis points in yield to finish the week at 6.16%. The Canada/US 30 year spread has narrowed into 23 basis points from a wide of 43 basis points. Over the past several weeks the Canadian long bond has underperformed the US long Treasury by 20 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets were generally weaker due to the increased fears of interest rate increases by the Federal Reserve Board. Through-out the week the equity markets showed signs of weakness. The bull market is feeling tired and topish as investors from Europe and Asia sell the US stock market and buy Asian and European markets. The US non-farm payroll numbers added to the concern of another interest rate increase by the Federal Reserve Board.

As interest rates increase, the cost of money which companies can borrow at increases. At some point the marginal cost of money (interest rates) will be greater than the value added to the firm of borrowing that money to increase production, or continue to fund current production. As a result, returns to equities will drop and the multiples which equities are currently trading at will have to come more in line with future earnings expectations.

On the mergers and acquisitions front, the two major deals for the week had little to no impact on the market as a whole. In the US, Dow Chemical announced its purchase of Union Carbide for $US 11.6 billion. In Canada, Toronto Dominion Bank (TD) announced its intention to purchase Canada Trust for $Cda 7.85 billion. This deal is likely to receive the approval of the Minister of Finance, where the proposed bank mergers earlier this year did not. TD has been more forth coming with the Department of Finance. The merged entity will not be dominant in any one market, thereby allying any fears the Competition Bureau may have.

In Canada, the TSE lost 202.23 points, or 2.86%, to finish the week at 6878.80. In the US, the DJIA posted a positive close at 10,714.03, up 58.88 points. The S&P500 and Nasdaq were not as fortunate, posting negative returns of -2.14% and -3.43% respectively. The Nasdaq is now over 10% below its recent high, the generally accepted level of a market correction. That does not necessarily mean that the market is poised to rebound.

Next week brings more supply to the bond markets, as several corporate and provincial issuers are looking to tap the markets. As well, the US Treasury plans to auction a total of $US 37 billion in bonds. Supply and economic data, along with a healthy does of interest rate concern will drive the market next week. Good trading.

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