Weekly Wrap-Up November 30 - December 4, 1998

The North American markets were poised to react to two major events this week, neither of which had any material effect. The election in the Province of Quebec, and the US employment report were to have given direction to the market. Unfortunately, neither event provided traders, or investors, with the momentum necessary to move the market one direction or the other. The big news of the week came out of Europe, with almost all the central banks cutting interest rates in a precursor to the establishment of the single currency Euro on January 1, 1999. The bond markets benefitted from the central bank action.

The North American bond markets rallied this week, benefitting from central bank action in Europe, and a hint that all is not well in the international financial system. The Quebec election in Canada proved to be a non-event for the international markets, and the US non-farm payrolls number was taken as a backwards looking measure of economic activity rendering its market affect minimal this time around. Commodities continue to set new lows for the past 12 to 18 years, easing the fear of inflation, raising the spectre of deflation, and as a result increasing the likelihood of further central bank cuts in interest rate in North America.

In Canada, the separatist Parti Quebecois won the provincial election, as expected. The PQ, under the leadership of Premier Lucien Bouchard, emerged with a majority government, defeating the pro-federalist Liberal Party, lead by Jean Charest. Most noteworthy in the results was that, although the PQ managed to win more seats through-out the province, the Liberals actually secured a larger percentage of the popular vote. This has put the PQ's referendum agenda on sovereignty on the "back burner" as Premier Bouchard most now focus on establishing a responsible government and tackling the province's massive debt burden.

The Quebec electorate effectively exercised both options available to them. By electing the PQ, the population of Quebec has effectively kept the rest of Canada on its toes regarding the possibility of separation, while at the same time sending a clear message to the PQ that the electorate has no desire at present for a referendum. The only way that the PQ will achieve the "winning conditions" for another referendum on separation is if there is an emotional battle established based on constitutional matters between Quebec and the rest of Canada. One market uncertainty removed for the foreseeable future.

The central banks of Europe surprised the investment community this week when there was a concerted effort to ease monetary conditions in the majority of countries participating in the new European currency - the 'Euro'. The impetus came from the Bundesbank, which cut its repo rate by 30 basis points, to 3%. Immediately following the Buba move, the Bank of France, Spain, and Belgium matched the German over-night rate of 3%. As well, the Bank of Italy moved rates down to 3.5%, a 50 basis point cut. If that was not enough, Finland, Ireland, the Netherlands, and Portugal also cut rates, while Switzerland provided "liquidity" to the market. This move in interest rates helps to bring the monetary conditions closer to a level playing field for those countries participating in the new Euro currency. The move was not unexpected, but there had been very little in the way of timing signals from the Central Bankers.

The problems in the international financial system re-emerged this week, reminding every one that a quick fix is not possible. In Japan, JDC Corp. became the seventh construction and property company to file for bankruptcy this year; GDP fell 0.7% continuing the slide witnessed over the past four quarters; finance officials reported that the Japanese deficit would soon reach 9.8% of GDP. Brazil, which is itself in financial distress, currently has a deficit of 7% of GDP.

Brazil also stepped back into the limelight as the Parliament failed to pass pension and social spending reforms which would secure a further portion of the IMF and international rescue package loans. This caused the markets in Canada and the US to lose a significant amount of liquidity as swap traders, and spread product traders backed off their bids by 5-15 basis points. North American exposure to Latin and South America is approximately 10 times its exposure to Asia.

Russia continues to be a problem as there is little positive news coming out of the country. The talks this week between the Prime Minister and the head of the IMF were cool , to be polite. Little political will is present in the country as taxes cannot be collected, wages cannot be paid, and debt cannot be serviced. Look for the printing press of the central bank to be busy printing rubles. Inflation, and a devalued ruble will be the result, as witnessed by the drop of the ruble this week to approximately 20:1 versus the $US.

There were several economic releases this week which taken in the aggregate point to a slowing North American economy with the possibility on missing a recession. In Canada, third quarter GDP at market prices rose 0.4%; the implicit price index fell 0.1% in Q3; GDP at factor cost for September rose 0.1%; building permits dropped 7.9% in October; the help wanted index remained unchanged for November; employment growth for November was +103,400; the unemployment rate fell to 8.0%, down 0.1%. In the US, Chicago Purchasing Manager Index rose 2.1 to 50.1; National Association of Purchasing Managers Index fell 1.5 to 46.8 in November; construction spending rose 0.3% in October; non-farm productivity in the third quarter rose 0.7% to +3%; housing completions fell 1.3% in October; new home sales rose 0.8%; non-farm payrolls rose 267,000 in November; the unemployment rate dropped 0.2% to 4.4%; average hours worked remained unchanged at 34.6 hours; average hourly earnings rose 0.2% to $US 12.93.

It is interesting to note that in April of this year if Canada and the US had reported job gains of the magnitude reported this week, the market would have called for a tightening of monetary conditions by the central banks to ward off inflation. Now the market is calling the employment number a backwards looking indicator, and not relevant to the future prospects of the economy. Instead, the market is focusing on the layoff announcements over the past two weeks by major international corporations, including Boeing, Sears and the Canadian banks as an indication of future economic activity. Things that make you go Hmmm.

The North American bond markets continued their rally this week, as the international environment, inflation friendly economic reports, and central bank easing in Europe were all bond friendly. The Canadian 30 year long bond shed 16 basis points to close the week at 5.25%. The US Treasury 30 year long bond was 12 basis points stronger, closing at 5.04%. The Canada/US long bond spread narrowed 4 basis points to 21 basis points. Look for the spread to narrow next week, as a significant amount of supply is due in the US, but reverse the narrowing move after US supply is out of the way. The bond market is feeling "topish" and should reverse its recent gains over the near-term, unless the flight-to-quality trade returns.

The North American equity markets retreated from their record levels of last week, as concerns about the health of the international financial system, corporate layoffs and future earnings took hold of lofty valuations.

Boeing announced that a total of 48,000 jobs would be lost over the next three years, as decreasing demand targets the production of one airliner per month from the current level of three per month. This has negative implications for the company's earnings over the medium-term. It also had negative implications for shareholders, who saw the stock drop over $US 8 this week. In the past, a company announcing layoffs would see its share price rally as investors took the cost reductions in salaries as an indication of greater earning potential. Now investors are focusing on the fact that demand is dropping for the product, or service, thereby reducing the potential for greater earnings in the future. The mind-set of the market may be shifting back to economic fundamentals.

While the market came down from its merger-mania hangover of last week, there were still a couple of significant merger announcements. Exxon and Mobil announced their desire to merge. This union would form the world's largest gas company, controlling about 20% of the US east , and north-east region. Big. Not to be left out in the 'size matters' game, Total and PetroFina announced their intentions to merge. This deal would be worth approximately $US 10 billion. The announced deals did little for the price of crude oil, which posted a twelve and a half year low this week. Supply concerns, along with warm weather in the US north-east, continue to depress the price of crude. Intra-day trading saw crude get down below $US 10.85 per barrel this week.

The TSE did not benefit from the excitement hoped for by the restructuring of the Exchange's composite from 100 to 60 and a partnership with the S&P. Toronto lost 129.28 points, or 2%, to close the week at 6339.04. The DJIA fared worse as earnings concerns pushed the Dow lower by 316.94, or 3.40%, to close at 9016.14. The S&P500 lost 1.31%, while the Nasdaq lost 0.66%. The Nasdaq continues to benefit from the Internet sector's continued strength on hype. Lofty valuation levels are justified due to the fact that the Internet is the only area with earnings growth. Be careful of what the earnings are based on.

Next week brings supply to the Canadian fixed income market, as the Bank of Canada issues 2 year bonds. Look for the yield curve to cheapen up ahead of the auction, in order to entice investors to buy. If Brazil continues to make headlines look for the North American markets to become extremely nervous. There is little in the way of economic data to sway the market this week. Good trading.

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