Weekly Wrap-Up August 10-14, 1998

Closing Numbers

The North American bond markets diverged as the flight-to-quality trade included dumping Canadian bonds to buy US bonds. The turmoil in Asia and Russia has spilled over into the Canadian fixed income markets, as the Canadian dollar required concerted intervention by the Bank of Canada in order to stem to Lonie's fall. Canada significantly underperformed the US on the week due to guilt by association.

The Asian markets continued to trade weaker on the week, as the depth of the Japanese economic problems become more apparent. The recession in Japan is worsening, as MITI reported that the economy is in it's worst slump since the end of the Second World War. Currency concerns surrounding international investors confidence in the yen caused the Bank of Japan to do some significant 'moral suasion' through-out the week in an attempt to keep speculators from running the currency.

Financial guru George Soros waded into the realm of foreign monetary policy, suggesting that the Russian government should devalue the rubble in proportion to the decline in oil prices. That would suggest a 15-20% drop in the value of the rubble. The Russian central bank spent some of its IMF $US defending the currency this week.

Of note is the Hong Kong Finance Authority's step aimed at keeping confidence in the former British territory's currency, markets and economy. There was buying by the central agency of both Hong Kong dollars on the international markets and of equities on the Heng Sang, causing a greater than 8% rise in that market on Friday. This is the first time in recent memory that the markets of Hong Kong have been defended in such a manner. It should be noted that the real estate bubble in Hong Kong has all but collapsed and there is little in the way of fundamentals supporting the economy at present.

On the economic front this week, the numbers indicate that the North American economies may be feeling the thin edge of the Asian slowdown wedge. In the US, non-farm productivity dropped 0.2%; retail sales dropped 0.4% in July, rising 0.5% ex-autos; PPI was up 0.2% in July, with the core up 0.1%; business inventories rose 0.1%; industrial production declined 0.6%; capacity utilization dropped 0.7 to 80.5%. In Canada, housing starts declined 6.5% in July; new homes price index was up 0.1% to 100.1; new vehicle sales declined 3.1% existing home sales dropped 0.3%; composite index for June rose 0.3%.

All this financial uncertainty translated into a weaker bond market in Canada, while the US benefitted from the continued flight to quality trade that has prevailed for the past couple of months. There is little chance of the US long bond breaking significantly lower in yield (sub 5.50%) until the Federal Reserve Board calls for an ease of monetary conditions. That is not likely at present. The Canadian market saw the opening of a new 10 year bond, while the US market saw supply come in the 3 year, 10 year, and 30 sectors of the curve. The corporate markets in both Canada and the US are losing their liquidity as spreads widen out versus the underlying Government bonds.

The Canadian 30 year long bond significantly underperformed the US long bond on the week. The Canadian long bond added 7 basis points, to close the week at 5.68%. The US 30 year Treasury bond shed 4 basis points on the week, closing at 5.59%. The Canada/US long bond spread has moved back into positive territory closing the week at +9 basis points. Two weeks ago the spread closed at -14 basis points, indicating that the Canadian long end has underperformed the US by 23 basis points.

The North American equity markets found no joy in Muddville. The TSE hitched its wagon to the troubled Canadian currency, while still feeling the impact of the global equity melt-down. The resource dominated Canadian economy has been significantly impacted by the slow-down in demand from the emerging markets in Asia. Exporters and companies competing with Asian importers are in jeopardy of missing their earnings projections by a significant margin. Second quarter earnings of many companies already reflect the reality of a slow down in demand, while third quarter results will show the Asian contagion is spreading to others.

Against the backdrop of concern surrounding the potential decline in demand for goods and services produced in North America, earnings warnings and increasing business inventories left little for the equity markets to do, except drop like a rock. The TSE shed 343.58 points, or 5.17%, to close the week at 6297.51. The DJIA dropped 2.01%, or 173.02 points, to finish the week at 8425.00. The S&P500 dropped 2.45%, while the Nasdaq slipped 3.06%.

The continued concern over Asia, and the financial reforms required there to bring about a healthy economy, the emerging financial instability in Russia, and the high valuation levels in the North American equity markets indicate that volatility will continue to prevail in the stock markets - globally. The fixed income market in Canada will require a period of sustained stability in the Canadian dollar before a rally will emerge in it. The US bond market is in range trading mode, and will require the Fed to say "ease" before it breaks significantly lower. It should be noted that most of the 'pro' desks are operating on the premise of selling strength, as opposed to buying dips. Good trading.

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