Weekly Wrap-Up December 7-11, 1998

The general strength exhibited by economic fundamentals over the past two weeks prevented bonds from doing better even as large cap equities underperformed due to future earnings concerns. Further central bank interest rate cuts in Europe continue to point to the negative impact the Asian flu is exerting on the global economy. With no mega-merger news, and the beginning of tax-loss selling prior to year end, bonds continued to be the asset of choice. Many investors are being caught by the hype of internet issues, the Nasdaq set two record high closes on the week. Beware companies with no cash flows.

The North American bond market rallied on the week, as concerns over inflation and future corporate earnings provided a bid. In Canada, a week $CAD and supply in the 2 year sector of the curve prevented the market from doing better. While in the US, gains made early in the week were eroded by the looming spectre of impeachment.

The Bank of England began playing catch-up with its continental neighbours this week as short-term interest rates were cut 50 basis points. The move is the second cut in as many months, bring the cumulative cut to 75 basis points. Overnight rates in England now stand at 6.25%. Last week the majority of the countries participating in the EU all cut their interest rates in an effort at convergence prior to the formal adoption of the Euro. However, it should also be noted that economic growth is slowing across Europe, and Britain recently reported some anemic economic data, indicating a slow down is underway, with the potential of moving towards North America.

Bank of Canada Governor, Gordon Thiessen, addressed a conference in British Columbia this week on the state of the Canadian economy. Comments from Mr. Thiessen indicated that he does not believe the Canadian economy is headed for a recession. Stronger than expected growth in the US will continue to help the Canadian economy grow. He indicated that consumer and business spending on capital goods will spur growth next year.

The Russian Duma passed an acceptable budget reform bill this week, freeing up more of the IMF economic rescue package. And President Boris Yeltsin managed to leave his hospital room long enough to fire several senior aids, who had recently made negative comments regarding Mr. Yeltsin's health. This display was surely made as a political signal of who is still in charge. After the siteing in the Kremlin, Mr. Yeltsin returned to convalescing.

Brazil, where the IMF, World Bank and United States have drawn an economic line in the sand in an effort to stop the domino effect of collapsing international economies, passed some economic reforms this week. While the reforms are not completely in line with the conditions of the bail-out package, there are growing signs of a willingness to compromise in the political arena, in an effort to secure the financial assistance. The road to reform is a long and tough one.

Economic data this week indicate an economy with little signs of inflation, again. In Canada, capacity utilization in the third quarter was 83.5%, down 0.6%; housing starts declined 6.5% in November; the new house price index rose 0.1 to 100.2 in October; new vehicle sales dropped 10.9% in October. In the US, the current account deficit grew by $US 4.6 billion, to a record 61.3 billion; jobless claims rose by 1,000 to 314,000 for the week ending December, 5; wholesale inventories declined 0.2% in October; Michigan sentiment index declined 2 points to 100.7; Producers Price Index fell 0.2%, with the core rate up 0.1% in November; retail sales rose 0.6%, with the ex-automobile component rising 0.4% in November. Continued record growth in the US current account deficit, the negative savings rate in the US, and record high stock market valuations may point to trouble in the New Year as consumers begin to realize that they are not as wealthy as they believe, and retrench.

Bonds on both sides of the border rallied this week, although some gains were given back Friday on the stronger than expected retail sales figures in the US. The Government of Canada 30 year bond shed 4 basis points to close at 5.21%. The Bank of Canada auctioned $CAD 3.5 billion new 2 year bonds this week. After a significant amount of cheapening up of that sector of the yield curve the auction went relatively well. Although, it is believed that with year-end fast approaching there was little demand from institutional accounts and that the dealers took down most of the new supply.

In the US, the US Treasury 30 year long bond shaved 2 basis points to yield 5.02%. The US long bond managed to drop below 5% this week, but gave back those gains on expectations that the Federal Reserve Board Chairman Alan Greenspan will not lower US short-term interest rates at the next FOMC meeting December, 22. The Canada/US long bond spread was tighter by 2 basis points this week, at 19 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets were hurt this week by commodity prices and concerns over future corporate earnings. The global commodity market continues to experience weakness as demand for base products remains soft. Supply continues to outstrip demand. Large companies, such as Coca-Cola, Union Carbide and Proctor & Gamble announced that their quarterly earnings would not meet analyst expectations. As well, there were indications that future corporate earnings quality of exporters and large multinationals would deteriorate further as demand overseas continues to wane. Are current valuations really justified by future earnings?

The Toronto Stock Exchange lost 80.28 points over the course of the week to close down 1.27% at 6258.76. The TSE was hurt by concerns over commodity prices - as oil traded below $US 11 per barrel, a weaker Canadian dollar, and the potential contents of Finance Minister Paul Martin's report on bank mergers to be released Monday morning. All the whispers indicate the answer is - No. The Dow lost 194.38 points, or 2.16%, to close the week at 8821.76, on the back of weaker earnings projections by the large US exporters. The S&P500 lost 0.87%. While the Nasdaq set two record high closes this week and added 1.31%. The record high on the Nasdaq, set Wednesday, is 2050.42. The continued strength of the Nasdaq has been predicated on investor enthusiasm for Internet stocks.

Caveat Emptor. It is very difficult to rationally value a company with no earnings, no real assets - except the ones that ride up and down in the elevators each day, and is rallying on a story. Who is to say what the stock is really worth, but before you buy anything be sure you understand the company, the industry, where the cash flows are generated, and consult your financial planner.

Next week brings more inflation data in the US. This should indicate that the demon - Inflation - is still well over the horizon. Also, note that the market is going to behave in a very odd manner over the next two weeks as tax-loss selling takes hold. Investors looking to lock in capital losses to offset their capital gains my be playing some games over the short-term. Good trading.

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