Weekly Wrap-Up September 20-24, 1999

The North American bond markets rallied, only reluctantly this week. The weakness displayed in the equity markets finally tipped the scale in favour of bonds. With such a limited reaction to the equity sell-off, the bond markets on both sides of the border appear to be driven by short covering as opposed to real buying. The strong Yen versus the $US, along with negative trade data in the US did little to add to the upside. The North American equity markets were a disaster this week for investors. On average the major exchanges lost 4.5% of their value over the course of the week. Many believe that this will mitigate the need for the Fed to raise interest rates at the next FOMC meeting October, 5. However, this is only a small percentage of the price inflation imbedded into the price of the major large cap equities. There is still more room for asset prices to fall. After all, there is not going to be 15% year-over-year growth in earnings for ever, is there?

The North American bond markets rallied, only reluctantly this week. The weakness displayed in the equity markets finally tipped the scale in favour of bonds. With such a limited reaction to the equity sell-off, the bond markets on both sides of the border appear to be driven by short covering as opposed to real buying. The strong Yen versus the $US, along with negative trade data in the US did little to add to the upside.

The Yen has been the predominant driving force in the markets over the past month. Much debate has been undertaken as to the best manner in which to manage the strengthening Yen. The Bank of Japan indicated that it would not increase the money supply in Japan in order to ease the Yen back to a more reasonable level. The climb of the Yen has not been curbed, and in one over night trading session the Yen rose 2% against the $US. Any export led recovery in Japan will be short lived if the Yen continues to strengthen versus the $US, leaving little possibility for a consumer aided recovery to develop.

OPEC helped their own cause this week. At a meeting of OPEC ministers, the group announced that it would not ease current oil production quotas until at least March 2000. As a result of this announcement oil is now trading at over $US24 per barrel. Oil had been as low as $US 11.55 during the winter months of this year.

The market was so focused on the US trade deficit and the continuing strength of the Yen that a speech given by the Bank of Canada Governor Gord Thiessen went unnoticed. Mr. Thiessen indicated that the Canadian economy was on track to enjoy strong growth, and that the economic conditions of Canada's major trading partners were recovering or already very healthy. This should have helped the markets in Canada, but due to the focus on the US, little attention was given to the comments.

The week was very thin on economic data, but what data was released was tell-tale. In Canada, retail sales rose 1.3% month-over-month in; the trade surplus increased to $CDA 3.17 billion. The increase in the trade surplus is related to cross-border trade with the US. In the US, the Federal Reserve Beige Book produced a benign reaction as all measures reported a strong economy with little signs of resurgent inflation. The big US economic data was the release of the US trade deficit figures, which rose to $US 25.2 billion in July from $US 24.6 billion in June. The US economy remains robust and consumer demand is on fire.

The bond markets are beginning to indicate that we are in a rising interest rate environment. Normally when the equity markets sell-off to a significant degree there is a flight-to-quality trade which occurs as investors bail out of equities and buy bonds. This is not the case this past week. The rally which occurred in the bond market was primarily a short covering rally. Real money investors are not chasing the market as it moves higher. In fact many accounts were seen selling into the rally to take profits. The Government of Canada 30 year long bond rallied 6 basis points this week to close at 5.83%. The US Treasury 30 year long bond shed 8 basis points on the week to close at 5.97%. This rally is not one to chase as yields will rise over the near-term as investors remain concerned about the rising spectre of inflation. (A basis point is 1/100th of a percent.)

The North American equity markets were a disaster this week for investors. On average the major exchanges lost 4.5% of their value over the course of the week. Many believe that this will mitigate the need for the Fed to raise interest rates at the next FOMC meeting October, 5. However, this is only a small percentage of the price inflation imbedded into the price of the major large cap equities. There is still more room for asset prices to fall. After all, there is not going to be 15% year-over-year growth in earnings for ever, is there?

The strength of the Yen continues to weigh on the equity markets. Investors are moving their holdings out of the US markets and into the Japanese markets. This in turn forces the Yen higher against the $US, and draws more investors into the strengthening Japanese equity markets. However, the higher Yen will hurt exporters in Japan, and result in decreased earnings, and hurt Japanese equities. A vicious circle.

The Dow has breached the technical level of 10,400-500. As a result, the market is now poised to move down to the 9600 level. This is only technical analysis, and not representative of market fundamentals. However, if you believe that the market is fundamentally overvalued at this point, then the technical picture adds weight to the bearish sentiment. It would appear that Microsoft President Steve Ballmer believes equities are over valued, as he indicated that large cap technology stocks, including Microsoft, are at excessive levels. Investors should be wary of earnings expectations and interest rate fears.

Over the week the TSE lost 298.95 points, or 4.23%, to close at 6763.38. The Toronto exchange is now up a mere 4.28% year-to-date, and is down 13.54% from its high of April 1998. The DJIA shed 524.30 points, a decline of 4.85%, to close at 10,279.36. The DJIA is now up 11.96% year-to-date, and down 9.24% from its recent high. The S&P500 lost 4.35%, to close at 1277.36. This leaves the S&P up 3.92% year-to-date, and down 9.97% from its highs this year. The Nasdaq lost 4.50% to close at 2740.41, leaving it up 24.96% so far this year, down only 5.08% from its high of two weeks ago.

Next week brings little in the way of economic data. All attention will be on the commodities and Yen to see if the rally in either is truly over. If the rally is sustained, look for the talk of inflation to rise again as the US will import inflation through higher priced foreign goods via the weaker $US. Good trading.

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