Weekly Wrap-Up July 13-17, 1998

Closing Numbers

The North American bond markets exhibited the opposite reaction one would have suspected from the political uncertainty now present in Japan, they sold off. The unwinding of the 'flight-to-quality' trade began in earnest last week. Many players took the news out of Japan and Russia as positive for both markets and sold North American bonds to buy European and Asian securities.

The Japanese upper house elections on Sunday resulted in a stunning lack of confidence placed in the ruling Liberal Democratic Party, leading to the resignation of Prime Minister Hashimoto, and his whole cabinet. Many market players took this to mean that the Japanese are truly committed to financial reform, however, the leading candidate to replace Hashimoto has already been painted with the same brush, and is said to have little in the way of 'leadership' quality. Is this the start of the Japanese economic reforms necessary to bring the economy, and the region out of recession? Or is it the set-up to political and economic uncertainty resulting in the continuing saga – Asia III, the Meltdown Continues?

Russia's $US14.5billion bailout package by the IMF helped to restore faith in the European markets, and particularly to the Deutschemark. Had the Russian economy deteriorated further, there was some serious concerns regarding the German banking systems exposure to the ruble. A substantial portion of the Russian economic engine is supported by loans from German banks. If Russia collapses economically, the German financial system could be at serious risk. Much of the political and economic risk which has been inherent in the bond markets of late may have been overdone, however, if Russia fails to get its economic house in order, and Japan fails to undertake real financial reforms, the bond markets will surely respond with a return to the flight to quality, particularly if the North American economies continue to show slowing, non-inflationary economic activity.

Economic data indicated that the economies of both Canada and the US are experiencing non-inflationary growth, at a declining rate. In the US, retail sales grew 0.1% in June, with core ex-autos up 0.1%; CPI rose 0.1%, core up 0.1% with annualized inflation for the first 6 months of 1998 running at 1.4%; business inventories dropped 0.1% in May; industrial production slowed by 0.1% in June; capacity utilization dropped 0.4 to 81.6%; international trade balance recorded a $US 15.75billion deficit, primarily due to decreased exports as a result of Asia. In Canada, manufacturing shipments in May were -0.1%, inventories were up 0.6%, unfilled orders rose 1.1%, new orders dropped 0.4%; new vehicle sales rose 1.1%; existing home sales rose 9% year-over-year; CPI ran at +1.0% year-over-year, core up the same, month-over-month data showed headline inflation rose 0.1% in June, with the core inflation rate declining 0.1%; wage settlements averaged +1.7% in June, a 0.4 decline from May; the international trade balance posted a $CDA 1.67billion surplus, as exports were unchanged and imports dropped 1.9%. The concerning news out of this weeks' numbers was the trade balance and retail sales figures. Both numbers indicate that the consumer is not as strong a participant in the economy as was the case earlier in the year. A continuing drag by Asia on the North American economy could see a series of flat to negative economic growth figures. This all points to the next move by the Fed to lower interest rates and makes it incredibly difficult for the Bank of Canada to raise rates to defend the Canadian currency. Look for the Canadian dollar to get worse before it gets better.

The Canadian 30 year long bond finished the week at 5.55%, up 10 basis points on the week. The US 30-year Treasury bond closed the week 13 basis points higher, at 5.75%. The Canada/US 30-year spread stands at -20 basis points, moving further back into negative territory. The sell-off was rumoured to be fueled by the Chinese central bank selling US Treasuries to buy European securities. Add to that the thin trade and technical nature of the bond market at present, and the markets could do little but drift higher. Look for bond friendly comments out of Federal Reserve Board Chairman Alan Greenspan to help bonds do better next week.

The North American equity markets had one of the strongest weeks in quite some time. The DJIA, S&P500, and the Nasdaq all finished in record territory this week, as the markets shrugged off the political uncertainty in Japan and focused on better than expected earnings announcements from many US players, particularly high quality high-tech firms.

The DJIA, S&P500, and Nasdaq all posted three recorded high closes throughout the week including a record high close for the week on Friday. The high-tech stocks, particularly those with economic links to Asia did better on better than expected earnings reports emerging from the US market. Many companies are beating street analysts' estimates for the previous quarter earnings figures. The Canadian major market, the TSE, continues to suffer from it's exposure to natural resource based companies. Continuing weakness in the Canadian dollar has also caused concern for the TSE as foreign investors' fear that their returns will be adversely affected by the declining dollar. Canada's export based resource sector faces a great deal of exposure to the economic situation in Asia, which is not helping the TSE much.

The TSE posted an anemic 0.39%, or 28.59 points, to close at 7418.31. The DJIA, on the other hand, managed to gain 2.55%, or 232.23, to close at a record high 9,337.97. The S&P500 added 1.93%, while the Nasdaq was up an impressive 3.38%.

Next week brings Federal Reserve Board Chairman Alan Greenspan's semi-annual Humphrey-Hawkins testimony on the state of the US economy and monetary policy. As well, the elections on Friday of Japan's new Prime Minister may provide for the makings of true economic change in Japan, or more of the same optimistic talk, with no credible action. Both events could significantly affect the direction of the markets in North America. Good trading.

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