Weekly Wrap-Up November 2-6, 1998

Closing Numbers

The North American bond markets were buffeted this week. Investors moved funds out of fixed income securities and back into the equity markets, as many believe that the worst of the global economic melt-down is behind us. Or is it just the eye of the storm? Flight from quality trades have been taking place for the past several weeks as confidence in markets outside of the United States has taken hold of the global financial community, thereby taking the lustre off of the security offered by US Treasuries.

Supply also helped the band market underperform on the week. The US quarterly refunding program brought the US Treasury to the market for a total of $US 38 billion in new bonds of 5 year, 10 year and 30 year tenure. The Bank of Canada also came to market with $CDA 2.3 billion 10 year bonds, which were much more warmly received than the US 10 year bond. As well, many corporate bond deals were successfully priced and launched over the week. Many institutional clients, who were motivated sellers of corporate bonds three weeks ago, are now driving spreads on these securities tighter as they attempt to get bonds back into their portfolios.

Corporate bonds trade at a basis point spread above government securities. In times of investor distress these spreads widen out dramatically, due to the illiquid nature of these securities relative to government bonds. As sentiment turns, spreads move tighter as investors try to buy corporate bonds for their portfolios. Corporate bonds are currently out-performing Government securities as an asset class.

Several European central banks lowered their short-term rates, following the two moves by the Federal Reserve Board and the Bank of Canada. Over the week the central banks of Spain, Portugal, Sweden, and Denmark lowered their short-term rates by 25 basis points, while the Bank of England lowered rates 50 basis points. This move has made investors question whether the Federal Reserve Board will lower rates again at it's next meeting, November, 17. Many believe that there is a powerful psychological component to the next Fed meeting - A rate cut will continue to provide stability to the markets, while leaving rates unchanged will send a disruptive wave through the markets.

Mid-term Congressional and Senatorial elections in the US added to the market uncertainty. The relatively strong showing by the Democrats allowed President Clinton to claim a form of victory. This has presented the possibility that the Republicans will leave the President to serve out his term without an impeachment hearing. The real message in this election was sent by the electorate who are clearly tired of the US government's sexual witch hunt and want the politicians in Washington to focus on the issues of education, health care, security, etc.

Politics has not been forgotten about in Canada. The Province of Quebec faces an election campaign for the balance of the month, with voters casting their ballots November, 30. This, of course, is old news. A simple reminder that this is once again being pitched as a Federalist versus Sovereigntist battle. Until the politicians in Quebec realize that there are serious issues to tackle such as health care, education and welfare reform, combined with controlling the Provincial debt, there will be no joy in Quebec. The election campaign is taking on the mud slinging qualities of a US election. May the best muckraker win.

Believe it or don't, but economic data is making a come back as an important factor in the way the markets are behaving. This is new after several months of trading on pure emotion and momentum. The economic data released in Canada this week saw building permits drop 4% in September; international reserves rise $CDA 572 million in October through the issuance of several foreign currency denominated bonds; department store sales rise 2.3% month-over-month and 4.7% year-over-year; help wanted index was unchanged; employment increased 57,000; the unemployment rate dropped 0.2% to 8.1%. In the US personal income grew 0.2% in September; consumption rose 0.5%; leading indicators were unchanged; factory orders rose 0.4%; National Association of Purchasing Managers survey indicated a 1.1 point decline to 48.3, with the manufacturing component dropping 5.5 points to 53.5 (a reading below 50 is supposed to represent an economic slow down.); initial claims rose 10,000 to 312,000; non-farm payrolls showed a 116,000 new jobs were added last month, leaving the unemployment rate at 4.6%

What all this information and activity meant for the bond markets was a sell-off. The Canadian 30 year long bond added 15 basis points over the course of the week to close at 5.65%. The US bond market fared much worse as the combination of supply and technical trading levels compounded the damage. The US 30 year Treasury bond added 29 basis points on the week to close at 5.44. The Canada/US 30 year spread narrowed to 21 basis points, 14 tighter than the close last week. (A basis point is 1/100th of a percent.)

The North American equity markets benefitted from the nervousness in the bond market, posting strong gains on the week. The interest rate cuts by European central banks reinforced the belief that stability is returning to the international markets, and a global recession will be averted. Mid-term US elections also added to the equity markets' exuberance, as the stronger than expected showing by the Democrats has allayed fears of impeachment hearings against President Clinton. Federal Reserve Board Chairman, Alan Greenspan, eased fears of a global credit squeeze in comments he made in a speech he made mid-week.

The positive tone in the equity markets over the past several weeks has meant that corporations are looking at the relatively cheap valuations of potential takeover targets. The acquisitions announced the previous week fueled investor speculation of further merger activity this week, and the market did not disappoint. To aid with this speculation, Poco Petroleum announced it would buy Pan East, a deep gas well firm in Canada, Empire announced it's formal acquisition of Oshawa Group, the Caisse in Quebec is bidding for control of Cambridge Shopping Centres, and Hammerson is rumoured to be selling it's Canadian real estate assets to OMERS.

The result of renewed exuberance in the equity markets saw the major North American exchanges all post strong gains. The Toronto Stock Exchange added 209.63 points, or 3.38%, to close the week at 6417.91. The TSE has risen more than 20% off the lows established October, 5. In New York, the DJIA added 383.36 points, or 4.46%, to close 25 points shy of 9000, at 8975.46. The S&P500 added 3.85% and the Nasdaq rose 4.81%. Interesting to note that with the recent rally, the equity markets are trading at higher P/E multiples than December of 1996. (It must be noted that the Greenspan 'irrational exuberance' comment was directed at the Japanese equity markets and not at the North American markets.) Does anyone else out there believe the potential for future double digit earnings growth may be somewhat limited in the current international economic environment? The eye of the storm?

With the markets focusing once again on economic data and corporate earnings, the next several weeks will be interesting for the markets. If the calm holds, the equity markets could test old highs, while the bond market could suffer from asset re-allocation in favour of equities. The linchpin in this is the potential action that the Federal Reserve Board will take at its next meeting November, 17. A rate cut will signal to the markets that the Federal Reserve Board wishes to prevent a credit and liquidity squeeze. If no action is taken, the market could face a return to the flight-to-quality, as perception that the Fed is unprepared to continue to support the international economic recovery positions the US as a safe haven for capital.

Next week is a short week with the Memorial Day Holiday in the US, and Remembrance Day in Canada on Wednesday. Both countries pay tribute to those who made the ultimate sacrifice so that we may now live in relative peace. At 11:00 am November 11, pause for one minute to remember those who served. Good trading.

Weekly Wrap-Up Archives

The Markets Page

The Financial Pipeline Homepage