Weekly Wrap-Up October 27-31, 1997

Closing Numbers

The North American bond markets lost touch with economic fundamentals, continuing to be caught up in the volatility generated by the global equity markets this week. The debt markets, which traditionally set the tone for the equity markets as a proxy of long term economic expectations, diverged from this traditional role taking on the role of bastion of quality and stability in the security markets. The flight to quality continued on the week as such traditional safe harbours during volatile economic times as gold, have lost their lustre, the North American bond markets have become the store of value. As equities sold off world wide, so too did the North American bond market rally. And when the equity markets managed to recover their footing, the bond markets stumbled. However, by the week's end there could be no question as to the asset class which carried the week - bonds.

Federal Reserve Board Chairman, Alan Greenspan addressed the Congressional banking committee this week. As usual the Fed Chairman's words were cause for the financial community to sit up and listen, particularly since the Fed FOMC will be meeting November, 12. Mr. Greenspan re-iterated that the central bank cannot be complacent regarding inflation, and that the recent performance of the US economy has been encouraging. The Fed Chairman also indicated that the equity sell-off on Grey Monday may be an aid to the US economy's six and a half year expansion, bringing stock values closer to being in-line with economic fundamentals.

There was some significant economic data released on both sides of the border this week, which may help to determine the health of the two economies. The US released the Employment Cost Index, which is a key economic measure for the Fed. The index indicated that the cost of labour increased a benign 0.8% last quarter, which was as the street expected. US Durable Goods orders declined 0.6% month-over-month, ex-defense it fell 0.3%, and US Q3 GDP rose 3.5%, with 3.2% expected. The price deflator - a proxy measure for inflation - rise a mere 1.4%. The rise in the price deflator is the smallest quarterly increase since 1964. Another release of interest in the US this week was the Fed Beige Book. The Beige Book is the information which the Fed Governors will interpret prior to the next FOMC meeting, November 12. The release indicated that there are few signs of wage pressure in the US, while moderate to strong economic growth is reported in most areas.

In Canada, the numbers point to an economy which is not experiencing any inflationary pressure, growing at a moderated pace after posting some strong numbers in July and August. The Industrial Producers Price Index (IPPI) declined 0.2%, with raw materials down 2.2%. Canadian GDP was unchanged, month-over-month. This was a relief after the previous month's release indicated that the economy grew 0.8% in that month. Another increase of that magnitude would have put the Canadian economy's expansion in the +5% area, on a yearly basis. At present it is estimated to be growing at 4.8%.

Supply came to the markets this week as both the US Treasury and the Bank of Canada came to market on behalf of their respective governments. The US Treasury auctioned $US 15bil 2 year notes which met with modest demand on a day that the bond markets were losing ground. As well, the US came with $US 12bil 5 year notes with an incredibly average 2.25:1 bid to cover ratio. In Canada, the Government re-opened the 8%/27, coming to market with $CDA 1.2bil, to bring the total issue size to $CDA 9.6bil. The issue met with strong demand coming at an average yield of 6.09%, and closing 4 basis points to the good at 6.05% the day of issue.

With the turmoil demonstrated in the international currency markets, the Canadian dollar was not immune. The beaver buck set a 2-1/2 year low this week, as the Bank of Canada worked hard at defending the currency. As soon as the Bank of Canada had left the market the currency gapped down to set the new low for the last couple of years. The implications are that the monetary conditions in Canada have eased as a result of the weaker currency, and once the dollar has stabilized, the Bank of Canada may be forced to hike short-term interest rates in order to return to a neutral policy stance, from one which has become accommodative.

On the week the long bond in Canada shed 17 basis points to close at 6.01%. This is the lowest close for the Canadian 30 year bond since it was first issued in 1990. The bond also set an intra-day low yield of 5.96%. The US Treasury 30 year bond closed the week 13 basis points stronger at 6.15%. The Canadian long end outperformed the US long end as the Canada/US long spread moves to -14 basis points, a 4 basis point improvement by the Canadian issue. (A basis point is 1/100th of a percent.)

The North American equity markets were welcomed to Halloween early this year, as the weakness of the Asian equity and currency markets continued to have a spill-over effect. At the outset of the week, the Hang Seng index had shed 23.8% of its value in six trading sessions. In October, 1987, the DJIA lost 22% of its value in one day. Grey Monday was the largest single day point loss on the DJIA. The TSE reported it's largest single day loss in 134 years. However, on a percentage basis the moves were not nearly as destructive as the move seen back in 1987. The 554.26 point decline Monday on the Dow represented a 7.18% decline in relative value. The TSE shed 434.25 points, or 6.17%. The market used the background noise of the Tiger economy meltdown to stage the correction that every one has been waiting for. The only exchanges which did not sell-off Monday were in Fiji, and Mongolia!!!

Monday saw the DJIA use the circuit breaker safety features established by the exchange after the October 1987 crash in an effort to calm the fears, and nerves, of investors. Trading in New York was first halted once the market traded down 350 points. Traders, investors, and analysts then had half an hour to collect themselves and consider the recent move, and whether it was over done. Once trading began again, traders had done nothing but write sell orders in the half hour they had to themselves. It did not take long for the Exchange's circuit breakers to be thrown again as the market reached down 550 points. The market did not re-open for trading. It was the first time the New York exchange had been closed early since the assassination of President Kennedy. Toronto closed early as well, on its lows for the session.

The volatility begun on Monday proceeded unabated throughout the week, with the markets having a strong day Tuesday and Friday to narrow the loses exhibited on the week. Not a single North American exchange was completely immune from the global sell-off in equities. The overvalued nature of the equity market had precipitated the sell-off which occurred. Investors had been expecting a correction, and needed a reason to initiate it. The meltdown in Asia was as good as any. Fed Chairman, Alan Greenspan indicated in his address to Congress that the sell-off in the equity markets was a sign of a healthy market and may actually aid the US economic expansion. The aid Mr. Greenspan is referring to is the psychological effect which the perceived personal wealth erosion may have on domestic consumers, limiting near-term expenditures, and there-by slowing the economy.

As the week progressed, the Latin American exchanges and currencies came under pressure. This further exacerbated the flight to quality which the bond markets experienced whenever the equity markets fell down. Concerns over the impact on imports from the Asian countries whose currencies have been hammered, concerns over the effect of decreased demand in the troubled Asian economies on domestic exports, concern over the effect of the diminishing growth of sales in the economically expanding Pacific Rim, all contributed to the sell-off in the North American markets. Other issues for investors to consider are the possibility of the Chinese devaluing their currency, and of the effects of any bad loans made by Japanese banks to firms in the Asian countries adversely effected by recent events. Japan's economy is in bad enough shape without having to worry about the banking system deteriorating.

On the week the TSE outperformed the dogs in an underperforming market. The Toronto exchange lost 2.72% of its value, or 191.11 points to close at 6842.38. The DJIA was the dog of the North American markets, shedding 3.54%, or 273.33 points to close at 7442.08. The S&P 500, and the Nasdaq also lost about 3% on the week. Volumes were heavy this week, with both the Nasdaq and the DJIA posting 1 billion plus share days for the first time.

Next week brings a host of economic indicators, and the markets one week closer to the November 12, FOMC meeting. The US market will get to see the NAPM report, personal income, vehicle sales, manufacturing orders, wholesale trade, and the non-farms payrolls number. All of these indicators may have relevance to the market, or none of them may, depending on whether the markets start to trade on fundamentals, or continue to trade off of the psychological fears of the equity markets. Look for more of the same, with a considerable amount of volatility thrown in for good measure. Good trading.

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