Weekly Wrap-Up November 16-20, 1998

The North American markets were dominated by the activity of the central banks this week. All eyes were focused on the Federal Reserve Board FOMC meeting Tuesday. The 25 basis point cut, the third cut in seven weeks, reinforced the belief that the worst of the global turmoil is behind us. The Fed rate cut was matched by the Bank of Canada. As a result, investors bet that a low inflation environment, with strong consumer demand will continue to drive corporate earnings. The assets which out performed this week were equities and corporate bonds.

The North American bond markets' only concern this week was the Federal Reserve Board's meeting of the FOMC. Mr. Alan Greenspan's announcement that the Fed would lower short-term interest rates a further 25 basis points was confirmation that the Federal Reserve Board is interested in signalling it's intention to maintain a stable, liquid market. The rate cut was widely anticipated, and priced into the market. The Fed's move to lower rates allowed the Governor of the Bank of Canada, Gordon Thiessen, to lower Canadian short-term interest rates by 25 basis points as well.

In Canada, pundits are talking about the Canadian market's underperformance vis-a-vis the US due to the Quebec provincial elections. The televised debate between the three main political parties was supposed to be the event at which a knock-out blow would be delivered. However, the political leaders managed to do little to win new votes, or lose those votes already committed. The next government in Quebec will be headed by the separatist Parti Quebecois, lead by Lucian Bouchard. The only question which remains to be answered is how many seats. This outcome provides Quebecers with two options; i) telling the rest of Canada that they might separate ii) telling Lucien Bouchard that they do not wish to have another referendum on Sovereignty in the near future. The Quebec election should be a non-event for the markets.

The only significant international issue this week was the lifting of the moratorium imposed by the Russian government on debt payments initiated August 17. This left Russian debtors, primarily banks, exposed to approximately $US 5 billion in debt to be settled or renegotiated. With a further $US 3.5 billion in forward currency transaction exposure, it could be quite some time before any creditor sees these payments. The question which is raised by this is - How healthy is the Russian financial system, and how many of its 1500 banks will survive?

There were a host of economic data released this week which had little impact on the market due to the overwhelming importance placed on Tuesday's FOMC meeting. In the US industrial production decreased 0.1% in October; capacity utilization dropped 0.4 to 80.6%; headline CPI rose 0.2%, with core inflation rising 0.2%; real earnings rose 0.4%; housing starts rose 7.3%; building permits rose 9.9%; the international trade balance declined $US 1.9 billion to $US -14 billion for the month of September; business inventories rose 0.6%; the Philadelphia Federal Reserve Survey indicated a drop of 8% in business activity in the region. In Canada new motor vehicle sales rose 5.3% in September; manufacturing shipments rose 0.1%; inventories rose 0.8%; unfilled orders rose 1.1%; new orders declined 2.4%; the international trade balance was $CDA 1.6 billion with exports down by $CDA 170 million and imports up by $CDA 110 million; CPI rose 0.4%, with the core up 0.2% for a year-over-year increase of 1.0% and 1.4% core; wholesale sales grew 0.7%, with wholesale inventories up 1.0%; retail sales rose 1.1%, with the ex-auto figure growing 0.8%.

Also of note on the economic front was the Bank of Canada semi-annual review of the Canadian economy. In his statement, Governor Thiessen indicated that the Bank was lowering the predicted growth rate of the Canadian economy for next year to between 2.50% and 3.25%, down from 3.50%. The OECD also lowered its forecast of Canadian economic growth to 3.0% in 1998, 2.4% for 1999 and 2.9% for 2000. It is interesting that while Mr. Thiessen indicates that the reason for the mitigated growth figures stems from the global economic slowdown and continued weakness in commodity prices, he is far more aggressive in his growth projection that private forecasters.

The Government of Canada 30 year long bond added 1 basis point this week to close at 5.50%. In the US, the Treasury 30 year long bond finished the week 3 basis points lower at a yield of 5.22%. The Canada/US 30 year spread has moved 4 basis points wider to 28 basis points. The liquidity that the central bankers have been injecting into the market has had a material affect as many corporate, provincial and municipal deals were priced over the course of the week. As with the previous three weeks, corporate bond have been outperforming the government bond market. (A basis point is 1/100th of a percent.)

The North American equity markets waited patiently for the Fed to drop interest rates, then rallied into the week's end. News of the Fed, and Bank of Canada, rate cut was initially received with a "buy the rumour, sell the news" mentality, but as the week progressed the bulls re-emerged as the dominant force in the market. It is worth noting that the rally has been restricted primarily to the largest, and most liquid of the blue chip stocks. Investors are still concerned about a possible flare up in the economic turmoil which plagued the markets in August and September.

The Canadian equity markets were aided by stronger than expected earnings reported this week by the Toronto Dominion Bank and the Royal Bank of Canada. Analysts had been predicting disastrous earnings as a result of the large percentage of the Canadian Banks' earnings which are provided by their brokerage and securities divisions. The past quarter was hardly a barn burner for trading and underwriting revenues. Even with the market turmoil both of the banks which reported this week managed to post profits on the north side of $CDA 1 billion, with the Royal Bank boosting profits by 9% over last year.

However, the troubles at Livent Inc. managed to hold back the markets run. After trading was resumed this week, following suspension on August 7, the stock dropped from $CAD 10.15 to 0.45.

The tech heavy Nasdaq was aided by the Amazon.com share split. After announcing a 3 for 1 stock split, shares of the on-line book seller rose $US 27.375 to $US 180.625. The 17.86% increase in share price helped the Nasdaq outperform the other North American indices over the past week.

The equity markets have done a tremendous job recovering from the lows set this year. In Canada the TSE set a record high close of 7822.25, on April 22, 1998. By October 5, the market had lost 31.78%, and sat at 5336.15. At the close this week the TSE had added 186.17 points, or 2.94% to close at 6522.26. The TSE has added 22.23% from its October low, yet is still 1299.99 points shy of its record high. The DJIA dropped 19.26% from its high of 9337.97 on July 17, 1998 to the year to date low on August 31 of 7539.07. The Dow is well off the bottom, and only 178.42 points shy of the record high. The DJIA closed the week up 239.96 points, or 2.69%, at 9159.55. The S&P500 added 3.36%, and the tech heavy Nasdaq rose 4.34%.

With the major economic numbers reported for the month, and the Fed and Bank of Canada lowering interest rates, there is little hype for the market to trade on. If the international markets continue to behave themselves, look for economic fundamentals to return to the forefront as market drivers. Next week will see quiet flows in the US market, and Canadian by association, due to the US Thanksgiving Holiday Thursday. Many desks will have skeleton staffs on as senior traders stretch the break into a long weekend. Good trading.

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