Weekly Wrap-Up March 2-6, 1998

Closing Numbers

The North American bond markets underperformed the equity markets as concerns over the continuing strength of the economy re-emerge. Since Federal Reserve Board Chairman Alan Greespan made his Humphrey-Hawkins testimony a week ago, the bond markets have begun to price in the fear of inflationary pressures. The Asian contagion has not begun to manifest itself in a gradual slow down in North America. Instead, the economic data released this past week demonstrates a robust economy, and a shrinking labour force. These issues combined with the deteriorating technical picture in the bond markets saw fixed income securities sell-off this week.

Economic data this week continued to paint a picture of a strong economy with little signs of inflation. However, Mr. Greenspan's comments a week ago indicated that it is unlikely that the Fed will lower interest rates in the near future, and the central bank must remain vigilant with respect to inflation. This put bond bulls on their heels and allowed the bears to emerge from the woods.

In Canada this week, fourth quarter GDP was +0.7%; GDP at factor cost for December was +1.0%; the implicit price deflator was +0.1%; international reserves increased by $CDA 3.31billion; building permits declined by 9.9% in January. The majority of the building permit decrease for January can be explained by the ice storm which hit eastern Ontario and southern Quebec.

In the US, personal income rose 0.6% in January; personal consumption grew 0.4% in the same month; construction spending rose 0.7%; NAPM grew 0.9 to 53.3; new home sales grew at an annualized rate of 10.3% in January; factory orders grew 0.5%, primarily through aircraft orders. The number that the markets had been waiting for, February's non-farm payrolls was a stronger than expected +310,000 jobs, with January revised higher. The unemployment rate in the US decline 0.1% to 4.6%, tying a twenty four year low.

Supply in the US corporate market is adding to the selling pressure in the US, as fund managers sell Treasuries to make room for the new corporate issuance. The Canadian corporate supply has dried up after the first month of the year had the street worried about the flood of new issuance that was expected. As a result of the lack of corporate issuance over the past couple of weeks, the spreads on corporate bonds have been moving in. There is rumoured to be a lot of cash waiting in the wings to pick away at supply, so look for the spread narrowing trend to continue over the near-term.

The Government of Canada 30 year long bond added 15 basis points to its yield this week, to close at 5.93%. The US Treasury 30 year long bond sold off as well, adding 8 basis points to close the week at 6.02%. The Canadian bond market is underperforming the US as investors see most of the good news from a deficit and inflationary view point as already in the market, thereby leaving little reason for Canadian bond spreads to remain below those of the US. (A basis point is 1/100th of a percent.)

The North American equity markets interpreted the data released this week in a significantly different manner. The earnings warnings issued by Intel, and Motorola, as a result of their operations in south-east Asia only underpinned the strength present in the economies at home. This in turn lead to the perception that domestic firms with little exposure to the Asian contagion would be excellent candidates for improving earnings in the face of domestic economic strength. This was also true of the resource based stocks such as forestry and base metals. With the emerging belief that the raw materials sectors are putting in a bottom, and with continued strength in the manufacturing and construction sectors, the possibility for the cyclicals to play catch-up with the rest of the market is real.

Except for the gold market. The yellow metal had to deal with another central bank issuing a sell order. The Bank of Portugal indicated this week that gold had lost its "mythical quality" and there was little reason for keeping it as a government asset. As a result, the precious metal lost 1.5% of its value, or $US 4.50, to close the week weak at $US 294.60.

The TSE managed to outperform its US counterparts this week as the resource sector helped pull the Canadian exchange closer to a new record. Although the TSE has taken considerably longer to reclaim higher ground than the US and European markets, the fundamentals remain strong in Canada, and the market should be able to reach new heights in the near-term. Even with the TSE outperforming both the DJIA, and the S&P500 posted two record high closes this week.

The TSE closed up 93.12 points, or 1.31%, at 7185.61, not far from the old record high of 7209.85 set back in October. The DJIA closed better by 23.67 points at 8569.39, after seeing higher ground earlier in the week.

With the economic picture still robust, and the slate virtually clean with respect to inflation, the markets are poised to move higher. The long bond yields near 6% should draw conservative investors into the market, and pull fund manager money in off the side lines. Look for more defensive stock trading vis-a-vis corporate exposure to Asia over the near-term. Good trading.

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