Weekly Wrap-Up August 17-21, 1998

Closing Numbers

The North American bond markets experienced a continued 'flight-to-quality' trade over the course of the week. While the equity markets did better at the beginning of the week, asset allocators moved some funds out of the bond market. Once the bottom began to fall out of the equity markets, the rotators shovelled money back into the bond market.

In Canada, the Supreme Court ruled that the Province of Quebec was not legally permitted to separate from the rest of Canada unilaterally. The Court's opinion covers the potential separation question from both a domestic and international frame of reference. Both the Federalist and Separatist camps felt that the ruling legitimized their stated positions. The Supreme Court did not rule on how a separation would be negotiated, what a clear majority vote consisted of, or who would be responsible for the clear wording of any future referendum question.

This news was overshadowed in the market by President Clinton's action against reported terrorist bases operating in Sudan and Afghanistan. The attacks were in response to the US embassy bombings earlier this month. While all agree that there must be a firm stance taken against terrorist activities in all there forms, many question the timing of the attacks from a political perspective. Has any one seen 'Wag the Dog'?

Aiding the continued market volatility were significant economic events on the global stage. In the Asian markets, concern over the over all health of the Japanese banking system was reinforced with the Long Term Credit Bank requiring a reported $US 5 billion to prevent default on its current obligations. As well as Okura Securities filing for bankruptcy protection. The firm has had significant bad debts on its books related to the collapse of the real estate market, and was unable to fund the short fall. The move brings about the third largest bankruptcy in Japanese post-war history.

Russia contributed its share of fuel to the fire. President Yeltsin announced Monday that the ruble will be allowed to float in a wide band associated with the $US. This came after the President indicated that the ruble would not be devalued and the economy was recovering. The ruble almost immediately dropped to the bottom end of the newly defined trading band, amounting to a de facto 30% devaluation of the currency. Let us not forget that finance czar, George Soros, indicated a week ago that the Russian currency should be devalued a minimum of 20% to account for the depressed value of oil on the world market. Oil is one of Russia's largest export commodities.

Oil, oil every where and nary a drop to give away. With the depressed nature of the global commodity markets, particularly oil, the Venezuelan government is making noises about devaluing its currency. While it has come as little surprise to many finance types that the Asian markets have had their currencies devalued, and few were surprised when Russia finally officially recognized what the money changers on the streets of Russia had been practicing for some time, the possibility of a true devaluation of what is considered a relatively stable economy so close to the American market have raised many an eyebrow. This contributed significantly to the rally experienced in the bond market into the end of the week.

Economically, there were several releases which indicated parts of the economy are growing at a healthy pace, while the rest of the economy seems to be slowing with little sign of inflation present. In the US, CPI for July rose 0.2%, with the core up 0.2%; international trade deficit for July was $US14.15 billion; housing starts rose 5.7%; building permits were up 4.0%. In Canada, the international trade balance for June rose to $CDA 1.54 billion, as exports rose 0.1% and imports declined 0.8%; CPI for July rose 1.0% year-over-year, with the core up 1.3% year-over-year, while the month-over-month figures showed the headline figure unchanged with the core up 0.2%; retail sales for June were down 1.7%, declining 2.0% with the automotive component removed; manufacturing shipments declined 2.9%; inventories rose 1.3%; unfilled orders rose 1.5%; new orders declined 2.0%.

The Canadian bond market experienced a positive week due to the strength of the 'flight-to-quality' trade. The Government of Canada 30 year long bond shed 4 basis points to close the week at 5.64%. The US 30 year Treasury bond closed the week at 5.46%, better by 13 basis points. The Canada/US spread continues to move deeper into positive territory, closing the week at +18 basis points. This spread will continue push wider until the $CDA can stabilize. The Canadian dollar set a record low close versus the $US Friday at $1.5418. (A basis point is 1/100th of a percent.)

The North American equity markets continue to experience significant volatility related to the the global economic instability created by Asia, Russia and now Latin America. While the markets managed to put in better prints during the early part of the week, the majority of it was on rumours, rather than news. The banks and financial services helped pull the markets higher as expectations for strong quarterly results were widely anticipated. With the release of the earnings statements, many banks reported poor earnings from their brokerage operations, and expectations of depressed earnings going forward related to non-performance of foreign loans and reduced interest rate spread income. This did little to help support the equity markets.

Firms with exposure to commodities prices, demand from Asia, or Russia, or Latin America felt the markets' sting. The recent market strength was thinly based with little in the way of market breadth. With only a few large, liquid stocks in play, it takes very little to get the ball rolling down hill. The banks started it, export driven firms jumped on broad and the computer and technology sector greased it up. While thin gains were reported south of the border, there was some significant work done on Friday afternoon by traders and investors alike to drag the markets back into positive territory. Nothing could help the beleaguered market in Toronto.

The TSE failed to recover Friday due to the continued weakness in the Canadian dollar. The TSE closed down 3.23 points on the week, at 6294.28. The DJIA finished the week stronger by 108.65 points or 1.29%, at 8533.65. The positive close was the result of a stunning recover from down nearly 300 points Friday. The S&P500 added 1.74%, while the Nasdaq managed to hang onto a 0.41% gain.

Look for more volatility next week. Monday should help set the tone. If the markets open poorly in Asia, then a continued drop in prices should occur as fear turns to panic and investors begin to capitulate. The bond markets should benefit from the continued 'flight-to-quality', while spreads in the corporate bond market push wider in sympathy to the decline in equity prices. Good trading.

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