Weekly Wrap-Up November 23-27, 1998

The North American market was driven by the spectre of merger mania this week. More than $US 30 billion in corporate takeovers drove the US equity markets to new record highs. The fixed income markets followed along as strong currencies, combined with falling commodity prices, leaves inflation off the radar screen. The excitement associated with the merger activity gave a spark to the US Thanksgiving holiday shortened session.

The North American fixed income markets continued to show signs of strength as decreasing commodity prices and continuing positive economic data indicates that the current environment is inflation friendly. With no red flags visible on the international horizon, the positive tone established in the bond market over the past several weeks continues to be evident.

The Quebec provincial election (Monday 30 November, 1998) is expected to go to the pro-separatist Parti Quebecois, headed by the current Premier, Lucien Bouchard. In previous election campaigns, a separatist government would have represented significant market risk to international investors. At present there is little mention of it in the financial press. Most investors are not concerned about a separatist government, but about a possible referendum vote. The Quebec electorate have made it clear through-out the election campaign that they are not interested in separation. The only way Premier Bouchard will get the "winning conditions" he is looking for before holding another referendum is if a very emotional issue arises which he can lever into separatist sentiment. Otherwise, look for a fiscally responsible government attempting to deal with big deficits, and bigger debt.

The international scene provided little activity this past week for the markets to be concerned about. The OPEC ministers met for their annual winter conference. Little was done, or expected to be done, to stop the slide in oil prices. Statements coming from the OPEC nations indicated that before any new quotas could be established to lower the output of oil by the cartel, full compliance with current quota levels must occur. As well, the second largest member of OPEC, Venezuela, is going into Presidential elections in December. This means the government is unlikely to agree to any further cut backs which would limit its ability to export oil. Russia continues to grapple with its Soviet-era debt burden. The country must renegotiate $US 70 billion in debt, and deliver a "realistic budget" before the IMF will release a further $US 22.6 billion in loans. With the failing health of President Yeltsin, and a lack of resolve elsewhere in the government, do not look for quick solutions to the continuing economic woes in Russia.

There was a a number of economic releases this week. In the US final third quarter GDP was +3.9%; chain-weighted price index was 0.8%, unchanged form the second quarter; corporate profits declined 1.8% in the third quarter; durable goods orders dropped 1.7% in October; consumer confidence rose 6.7 to 126; personal income rose 0.4% in October; personal consumption rose 0.5%; existing home sales rose 2.1%; the help wanted index declined 1.0 to 87. In Canada net foreign investment in September was $CAD -6.2 billion in September, a change of $CDA -15.8 billion; industrial products price index rose 0.7% in October; raw materials price index dropped 0.3%; the composite index rose 0.1%; average weekly hours earnings dropped 0.2% in September; average hours worked were unchanged.

It is interesting to note that the US consumers' spending outstripped their earnings for a second month. A negative savings rate cannot be maintained. The buoyant markets generated by Fed policy setting lower interest rates will eventually lead to a consumer pull back as savings must be replenished. Does the US consumer have an exaggerated sense of wealth?

The bond markets in both Canada and the US rallied in relatively quiet markets. The US Thanksgiving holiday, Thursday, meant most trading desks in the US were closed early Wednesday, all day Thursday, and only had skeleton staffs on Friday - most senior traders took an extra long weekend.

Thin markets, with positive momentum allowed for a bullish close on the week. In Canada, the Government issued 5 year bonds which were well received. TransCanada Pipelines came to the market for $CAD 350 million long bonds. The initial advertised minimum issue size of $CAD 150 million for the deal was well priced and had some demand left as 90% of orders were granted. TransCanada traded as wide as 160 basis points in the first week of October, and were issued at 105 basis points this week. The market sentiment has swung in favour of corporate bonds on equity market exuberance. Many market participants questioned the size of the deal. A deal that was $CAD 250 million would have been healthier for the corporate bond market as more demand would have been left unsatiated and provided strong support in the secondary market. TRAP... the issuer that investors love to hate ... remember September.

Fixed income markets in both Canada and the US rallied into the close of the US Thanksgiving holiday shortened week. The Government of Canada 30 year bond shed 9 basis points to close the week yielding 5.41%. The US 30 year Treasury bond closed the week at 5.16%, rallying 6 basis points. The Canada/US long spread narrowed 3 basis points to close the week at 25 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets experienced something not seen since the middle of July, new record highs. Hard to imagine the equity markets being at such lofty levels when a mere 5 weeks ago there were not any 'Bulls' to be seen. Corporate merger mania has set the markets ablaze.

The merger activity includes Tyco International's acquisition of AMP Inc. for $US 11.3 billion; Deutsche Bank's $US 9.7 billion purchase of Bankers Trust; Siebe PLC paying $US 5 billion for BTR; AOL paying $US 4 billion for Netscape; rumoured talks of a merger between Siemens and Newbridge Networks; announced talks between Exxon and Mobil - which would create the world's largest oil company. Corporate financial officers seem to believe that assets are cheap, and economies of scale are important. Size matters.

All this activity drove the DJIA to a record high close on Monday of 9374.27, the S&P 500 to 1188.21 and 1192.33 Friday, and the Nasdaq to 2016.44 - also a record high close. The TSE, however, did not benefit from the merger mania in the US. Toronto gave up ground on the week as banks, financials, and oil & gas gave up ground. The banking sector was hurt by the run-up in value it experienced last week through earnings announcements by the Royal Bank and Toronto Dominion Bank. The resignation of Barclays PLC CEO Martin Taylor, and his announcement that investors should be concerned about pre-tax profits took the shine off of the sector.

On the week the TSE underperformed it's southern neighbours. The TSE was down 53.94 points, or 0.83%, to close the week at 6468.32. The DJIA, after posting the record close on Monday, drifted sideways in thin volumes to finish the week up 1.83%, or 173.53, at 9333.08. The S&P 500 added 2.47% while the tech laden Nasdaq rose 4.58%, both closing the week at record highs. Given the negative savings rate in the US and significantly higher equity valuations, the markets may be getting ahead of themselves as the strong rally has been moving against the falling fundamentals in the market. There appears to be a gap in earnings expectations and the reality of the developing economic environment.

Next week brings the markets back from the long weekend in the US to a full trading week. The big news of next week will be the non-farm payrolls number Friday. Not because of any market sentiment towards another Fed interest rate cut, but because the market need an indicator of what traders should do over the short-term. Look for more corporate bond issuers to tap the market, as conditions for deals firm up and investors are not as afraid of corporate credits. Good trading.

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