Weekly Wrap-Up December 21, 1998 - January 1, 1999

The last two weeks of the 1998 were dominated by the equity markets, particularly Internet related stocks. The bond markets went through a bit of a roller-coaster ride, on very thin trading and unsupportive news out of Japan. Overall, this year saw the Toronto Stock Exchange lose 3.2%, while the American exchanges all posted strong gains. Currency and commodity related concerns prevented the Canadian markets from keeping up with their southern neighbours.

The North American bond markets see-sawed over the past two weeks in very thin trading. The Federal Reserve Board's Open Market Committee meeting on December 22, resulted in no decrease in the Federal Funds rate. The result was a market which perceives the Fed to be on hold for the next several months as the affects of the three rate cuts between the beginning of October and the middle of November take hold. Alan Greenspan, Fed Chairman, has shifted the Fed's policy stance to neutral from accommodative reinforcing the markets belief. The financial stability and confidence which the Fed's rate cuts have provided to the international market place will allow the global market a reprieve from the turmoil experienced in late fall. However, it should be noted that there are still some significant structural problems with the global financial system which will keep the economies of Asia and Russia from regaining their footing in the near-term.

On the international scene there were a couple of significant developments which impacted the world markets. Most noteworthy of those was the announcement by the Bank of Japan and the Japanese Ministry of Finance that the two organizations would not be participating in the Japanese bond market to the same extent as in previous years. This news came in the face of the Japanese government's announcement that the most recent recovery package announced would be one third funded by an increase in bond issuance. Finance Minister Kiichi Miyazawa stated that the Trust Fund Bureau would discontinue outright purchases of Japanese bonds (JGB). Supply and demand imbalance, remember ECO100. This did little to support the global bond market in the week prior to Christmas, as JGB futures almost went limit down on the futures exchange. Bad for bonds. But this may be good for the Japanese economy as a positively slopped yield curve may help the struggling banks through gap lending. On the downside the Japanese trade surplus decreased, indicating that the export sector which had been performing relatively well, may be stumbling. A weaker $US as a result of the introduction of the Euro, could exacerbate the Asian problem, as their exports increase in price.

In Brazil, the government is planning to raise corporate taxes in an effort to generate an additional $US 5 billion in revenues in order to satisfy IMF guidelines securing the Brazilian financial rescue package. While this is beneficial in the short-term, securing IMF loans, in the long-term there are questions raised as to the cost to the economy through decreased hiring, decreased capital expenditures on plant and equipment, and decreased foreign direct investment due to higher taxation.

The continuing troubles in Russia, both economic and political, manifest themselves in Russia's default of a $US 362 million payment on $US 26 billion in Soviet-era debt. This was widely expected, however the event reinforces market perceptions that the Russian central bank cannot print its way out of debt.

Economic data was virtually non-existent over the holiday shortened trading sessions. Of note the final revision for US third quarter GDP came in at +3.7%, revised down 0.2%. The implicit price deflator rose at a 1% annualized rate.

The statements out of Japan caused the most harm to the bond markets in the week prior to Christmas. As a result of the sell-off in Japanese bonds, the Canadian and US markets both suffered. Some of the initial selling was attributed to profit taking, however, the majority of the move was on thin volumes. The holiday shortened session between the Christmas break and New Years saw fund managers putting cash to work in order to appear fully invested for year end. Over the two week period Canadian 30 year bonds added 6 basis points to yield 5.24%. In the US, the 30 year Treasury bond added 8 basis points to yield 5.09%. The Canada/US 30 year bond spread has narrowed to 15 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets continued to move higher into year-end. The stock market has been fueled by the buying frenzy related to internet stocks. The continuing momentum based buying of internet related stocks, or companies announcing plans to build a web site, indicates there to be little rhyme or reason to the market. AOL, the platform/search engine which has made the internet a no-brainer for so many users, now has a larger market cap than GM, Pepsi-Co, or Gillette. Think about it. Remember last year when a certain restaurant chain sponsored by several Hollywood celebrities had a market capitalization equivalent to something outrageous like $US 80 million per restaurant. What's it worth now?

The key to any investing is understanding the security which is being bought, and all the cash flows associated with it. Many of these internet companies have no cash flows, and are trading on a story, some hype and a lot of momentum. It is concerning when internet day-trading chat rooms have more effect on a security than economic and financial fundamentals.

The TSE was up 2.08% over the Holiday season closing at 6485.94. Over the course of the 1998 trading year the index lost 3.2%, or 213.5 points. Commodity, currency and the liquidity crisis concerns all weighed heavy on the Toronto Stock Exchange. In New York, the mood was much brighter at year end. The DJIA added 3.13% over the last two weeks of the year, closing at 9181.43. The S&P500 added 3.46%, setting 4 record highs, closing at 1229.23. While the Nasdaq added 5.06%, closing at a record high of 2192.69, one of five record high closes in the final eight trading sessions of the year. Over the course of the year the DJIA added 16.1%, the S&P 500 added 26.70% and the Nasdaq added a stellar 39.6%. Can these double digit returns continue? Is there an economic slowdown brewing in North America?

Next week brings a full trading session back to the markets. It also brings into existence the introduction of the Euro. The new European currency takes over as the trading currency for the eleven member EU on January 1, 1999. The physical exchange of notes does not occur until January 1, 2001, with full conversion scheduled for January 1, 2002. As well, the economic data to be released this week includes the ever important non-farm payrolls report in the US. As well, look for corporate bond issuers to line-up to bring more debt issues to market. Will any sensibility return to the tech stocks, only the market will tell us. Can you say speculative bubble. Good trading

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