Weekly Wrap-Up January 25-29, 1999

The equity markets were the star performers of the week as concerns over Latin America and China hurt the bond markets. Earnings surprises and merger activity continue to drive the equity markets, while the Internet sector lottery rolls on.

The North American bond markets were little changed over the week. Continuing strength in the equity markets combined with low inflation and strong economic data keep bonds range bound. Concern over the economic health of Latin America and a possible devaluation of the Chinese currency prevents the markets from selling off, while the ongoing strength of the stock markets prevent a sustained rally.

Brazil maintained its prominence this week as the real continued to devalue relative to the $US. Intervention by the central bank, the passing of an austere budget supported by the IMF and belief that there has been an over reaction to the economic weakness in the region provided some support to the Latin American markets by weeks end. However, there is still a long way to go before these economies are standing tall again.

As an indication of this poor posture, the central bank in Mexico indicated that it would take a tougher line on inflation over the next year, at the expense of short-term economic growth. The bank has set 13% as the target inflation rate for next year. If the bank applies too much monetary constraint, there may be an economic drag on the economy which could push it towards recession, as many Latin American countries are already experiencing.

China continues to deny the rumours running wild in the financial markets that it intends to devalue the yuan. If that occurred many of the other Asian economies would be forced to further devalue their currencies, causing a further decline in economic activity in an already depressed region. This would further exacerbate the problems facing the region as exemplified in Hong Kong's 20% year-over-year decline in retail sales. The Asian consumer does not appear to be very confident at present.

On the economic front, several important pieces of data were released in both Canada and the US this week. The numbers point to stronger than expected growth, with continued low inflation. In Canada, GDP grew 0.4% month-over-month, while the year-over-year figure showed an increase of 2.7%. In the US, existing home sales rose 3.1% in December, for an annualized increase of 13.5%; business investment rose 7%; durable goods orders rose 1.9%, and 2.8% ex-transportation; consumer consumption rose 4.4%; exports rose 18%, while imports rose 16%; fourth quarter GDP grew 5.6%, for an annualized rate for 1998 of 3.9%; the price deflator rose 0.8%. Clearly, the North American economy continues to grow at an above trend rate, while maintaining a low level of inflationary pressure. The global disinflation that is being experienced will continue to hold down price pressures in the North American economy.

As a result of the economic concerns stemming from Latin American and China, and the strong economic data released this week, the bond markets had little conviction or momentum. With the strong economy, traders would like to sell bonds, as concerns over long-term inflation would erode the value of a bond. Yet, with the economic concerns of Latin America and China, no trader wants to sell too many bonds in case a strong flight-to-quality bid emerges.

In Canada the Government of Canada 30 year long bond shed 4 basis points over a quiet week of trading to yield 5.22%. A large supply calender of corporate and Provincial issuers has made it difficult for investors to move the market higher, as the new issues must be digested by the markets. Air Canada (rated BB - below investment grade) brought a deal this week at 200 basis points over Government of Canada bonds. This deal was clearly targeted at retail investors, as the bonds were priced very expensive relative to institutional deals (BBB - investment grade bonds are available at +235 in the same maturity). In the US, the US Treasury 30 year bond added 1 basis point to yield 5.10%, Supply in the two year sector was met with a ho-hum attitude, as investors looked to more US supply next week. The bond markets are in a range bound environment and are unlikely to break into lower yields with the Federal Reserve Board and the Bank of Canada on hold for further interest rate cuts. (A basis point is 1/100th of a percent.)

The North American equity markets continue to be driven by speculation on which of the Internet companies will be the winning lottery ticket for investors. There has also been a slight return to fundamentals as strong earnings reports have been released which provided a bid to the markets. Merger and acquisition activity continues to dominate the headlines as well in the equity markets.

This past week Ford announced that it will buy Volvo's automotive division for $US 6.9 billion; TRW announced its bid of $US 7 billion for Lucas Varity; Yahoo! announced its planned merger with GeoCities for $US 3.6 billion. All of these deals had a positive impact on the markets this week, particularly the Yahoo! deal. Those sexy Internet stocks continue to be where the hot money is. Technical day-traders are dominating the Internet sector.

The TSE managed to post what would normally be considered a strong performance on the week adding 2.06%. The Toronto market finished up 135.65 points at 6729.56. The US markets continue to move higher, with the Nasdaq posting three record high closes and the S&P a record high close to end the week. The DJIA added 238.16 points, or 2.61%, to close at 9358.83. The S&P500 added 4.44% to close at 1279.64, and the Nasdaq added 7.14% to close at 2505.89. Beware those companies with no positive cash flow.

Next week brings the all important employment reports in both the US and Canada. As well, the US Treasury will be tapping the bond markets next week for a couple of different terms. As a result there could be a little weakness in the bond markets. Look for corporate issuers to be ready to come to market quickly on opportunity. Good trading.

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