Weekly Wrap-Up November 9-13, 1998

Closing Numbers

The North American bond markets exhibited life early in the week, only to stall as investors and traders wait for the Federal Reserve Board meeting outcome Tuesday November, 17. The diminishing likelihood of impeachment in the US, and a political gaff or two by Quebec's separatist Premier, Lucien Bouchard, provided the impetus for the bond markets to hold in as other financial assets had a difficult week generating any momentum. Traders had little in the way of market sentiment to use as a guide as this week's trading session was solemnly interrupted by Remembrance Day ceremonies in Canada and Memorial Day services in the US.

The saber rattling going on between Washington and Bagdad provided a small flight to quality trade early in the week. This suited many securities dealers in the US who had to bid on $US 38 billion the previous week during the US quarterly refunding operation. The rest of the week was rather lack-lustre. Even the trickle of economic data did little to help excite the market.

The IMF and Brazil agreed on a $US 42 billion loan package to help stabilize the spreading Asian contagion. The deal will attempt to bolster the Brazilian real, and help stabilize the liquidity crisis the country's financial markets had been facing. The downside to the deal is that the tough austerity measures which the Brazilian government will have to impose will surely push the staggering Brazilian economy over the brink and into recession. Should this occur, the end result could be the very devaluation of the Brazilian real that the IMF and world community is trying to prevent. This bail-out package is aimed at protecting the US financial system, as many US financial institutions have much larger exposures to Latin and South America than they do to emerging markets in Asia or Eastern Europe. Should the Asian contagion infect the Latin and South American economies, the global economy could be in dire straits.

The Japanese announced yet another in a long list of stimulus packages aimed at dragging Asia's largest democratic economy out of recession. Many pundits have pointed out that the $US 181 billion proposed stimulus plan is simply a re-packaging of previous proposals and there is nothing new for the Japanese economy. The time frame under which the proposed package would be implemented is difficult to gauge, indicating that the effectiveness is not readily evident.

Russia announced that the moratorium placed on foreign currency denominated debt obligations to the West would be lifted. This implies that those financial institutions which had been unable to collect on debts owed to them by Russian companies may now attempt do so. This also means a potential collapse of what-ever is left of the Russian banking system. One Russian official estimated that as many as 50% of the country's 1500 banks would fail over the near-term.

All this meant that the investment world is focused on the Federal Reserve Board meeting on Tuesday November, 17. The Fed has indicated over the past several months that the main fear for the US economy is not the threat of inflation, but rather a slow-down in growth as a result of the drag put on it by the recessions in other economies. The question is - With the equity markets up 18% off their bottoms, and investors providing liquidity to the markets again, will the Fed ease short-term interest rates a further 25 basis points, after easing 50 basis points in the past 6 weeks? Many believe the answer to that question is no, thereby temporarily supporting the bond markets, and providing a cap on the equity markets.

On the economic front, very little significant data was released this week. In Canada, the new house price index for September dropped 0.1%. In the US, wholesale inventories rose 1.2% in September; non-farm productivity rose 2.3% in the third quarter, unit labour costs rose 1.7% over the same period; mortgage applications declined 6.6%, and mortgage refinancing dropped 20.4%; jobless claims rose 12,000 for the week ended November 7; retail sales rose 1% in October, with the ex-autos component rising 0.5%; Producer's Price Index rose 0.2%, with the core (ex- food and energy) up 0.1%.

The end of the Remembrance shortened trading week found the Government of Canada 30 year bonds yielding 5.49%, 16 basis points lower on the week. In the US, the 30 year Treasury bond finished the week at 5.25%, 19 basis points lower. The corporate bond markets continued to outperform the Government markets, but not by the same degree as the last two weeks. (A basis point is 1/100 of a percent.)

The North American equity markets drifted lower over the week as investors wait for the Federal Reserve Board meeting on short-term interest rates November, 17. Lower interest rates mean a more robust economy and greater consumer confidence, thereby producing strong corporate earnings.

In Canada, the banks held the market back, as the sector reports quarter-end and year-end earnings next week. Given the turmoil in the financial markets, and the lack underwriting business being done by the brokerage arms of the banks, many believe that earnings may disappoint. The IMF-Brazil deal did provide some support to the sector into the end of the week. Anything that mitigates the risk of a devaluation of the Brazilian real will benefit those financial institutions with exposure to the Latin and South American markets.

The TSE finished down 81.82 points, or 1.27%, to close the week at 6336.09. The DJIA finished lower on the week at 8919.59, off 55.87, or 0.62%. The S&P500 finished lower by 1.34%, while the Nasdaq eased back 0.46%. The Nasdaq was aided by the Internet sector, which saw TheGlobe.com rise over 800% after being issued this week. Hype helps, but do the cash-flows support the valuation the market is giving it?

Next week brings some interesting economic data as well as the all important FOMC meeting of the Federal Reserve Board in the US. The equity markets worldwide would love to see the Fed cut short-term interest rates by a further 25 basis points. Consequently, this would allow the Bank of Canada to match the Fed's move. A rate cut would support and fuel the equity markets, to the detriment of the bond markets. A policy decision which left interest rates unchanged could very well introduce some valuation concerns into the equity markets, as investors question the growth prospects of corporate earnings in a stable interest rate environment. Good trading.

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