Weekly Wrap-Up September 21-25, 1998

Closing Numbers

The North American bond markets benefitted, again, from the flight-to-quality trade which have pushed US Treasuries and Canadian long bonds to record low yields. While in the past several weeks the turmoil has come from emerging market concerns, this week the impetus came from a source much closer to home. The Long Term Credit Management LP (LTCM) was bailed out of virtual insolvency by a syndicate of lenders. The survival of LTCM is in the best interests of the institutions involved in the rescue package. Orchestrated by the New York Federal Reserve Bank, the deal is reportedly worth $US 4 billion. This size of bailout could save many emerging market countries from default. However, due to the nature of the LTCM holdings and leverage, the failure of LTCM would send a chaotic wave of destabilizing activity into the markets. Not to mention what it would do to the balance sheets of some of the largest US financial institutions.

As the third quarter comes to a close, watch for more bad news management from the major trading houses and banks in both Canada and the US. Remember what was written here several weeks ago about the nature of the financial sectors' exposure to derivatives and emerging market debt, well add hedge funds to the list as more prepare to report this quarter.

After the Japanese government reported last week that there had been agreement on a package designed to rescue the Japanese financial sector, the deal came unraveled this week. The deal which emerged, was one of political expediency derived quickly in an effort to show the rest of the global financial community that the Japanese were attempting to mend their broken financial sector. However, on the eve of Prime Minister Obuchi's meeting with US President Clinton there was nothing left to discuss, except - What were the Japanese authorities proposing to do now? The situation is still festering and the open sore is not likely to heal without some tough medicine.

At a time when the world needs strong leadership, the only country in a position to show that leadership is the US. Unfortunately only two of the three pillars of strength have any credibility left. Treasury Secretary Rubin, and Federal Reserve Board Chairman Alan Greenspan provide the fiscal and monetary authority required, however, the political strength necessary to bring about stability is lacking. President Clinton had more of the same added to the pile as the video tape testimony given to the Grand Jury was released to the public this week. The President's greatest crime does not appear to be his transgression, but rather that he allowed himself to get caught. The global markets need to receive some political guidance, and the President appears unable at present to remove himself from the scandal. The markets are going to be worse off for it.

In a testimony to the US Senate budget committee this week, Fed Chairman Alan Greenspan held out the possibility of a US cut in interest rates sooner rather than later. Mr. Greenspan cited the need to "bring the existing instabilities to a level of stability reasonably shortly to prevent the contagion from really spilling over and creating some very significant further difficulties for all of us". Many took this to mean that the Federal Reserve Board will cut US short-term interest rates at the next FOMC meeting Tuesday 29, September. This would allow corporate profits to be bolstered, and give the Bank of Canada the opportunity to lower short-term rates.

Once again the economic data released this week had little effect on the markets. Capital markets are trading on an emotional basis globally. In the US, durable goods orders dropped 0.3% to +1.9%, ex-transportation they dropped 2.1% in August; second quarter GDP grew at 1.8%, the weakest quarterly growth in three years as corporate profits declined for the first time in over 10 years; personal income rose 0.5%, while personal spending rose 0.6% in August. In Canada retail sales rose 1.4% in July, corresponding with advances in consumer credit since the third quarter of 1996, while weekly earnings growth, which rose 0.5%, lags consumer spending growth; composite index was unchanged at 207.3; net foreign investment in July rose $CDA 1.4 billion. Can the consumer continue to keep the economy afloat if spending continues to grow faster than wages? Can you say personal bankruptcy? The consumer may soon find that they are tapped out on credit.

In the bond markets both the US Treasury market and the Canadian bond markets set record low yields on the week. The Government of Canada 30 year long bond set a record low close yield of 5.36% earlier in the week, before finishing better by 5 basis points at 5.37%. The US 30 year Treasury bond closed the week at a record low yield of 5.12%, better by 3 basis points on the week. The Canada/US 30 year bond spread narrowed 2 basis points on the week to close at 24. (A basis point is 1/100th of a percent.)

The North American equity markets put on a brave face in the frontal assault waged on them by the global market place. The possibility of the Federal Reserve Board cutting US short-term interest rates at next Tuesday's FOMC meeting allowed the equity markets to show some signs of life. However, it should be noted that without the help of the New York Federal Reserve Banks $US 4 billion bail-out of LTCM the markets would be in considerably worse shape. The foundations of the financial sector are beginning to show signs of weakening and the Fed may attempt to sure them up with a rate cut.

The TSE showed some signs of life this week aided by gold and oil, as the commodities markets attempt to put in a base. The Toronto Stock exchange added 75.32 points, or 1.31%, to close the week at 5846.72. The DJIA added 1.69%, or 133.11 points, to finish the week above 8000 at 8028.77. The S&P500 added 2.42%, while the Nasdaq added 4.80%. The big board's gains in New York are misleading as there was little in the way of market breadth. Approximately 9 stocks rose on the week for every 10 that declined. From a technical point of view, this is not a strong turn around for the market.

It should be noted while the commodity markets appear to be a all time lows in $US terms, this is not the case for countries which import commodities priced in US dollars. Imagine the cost of a bushel of wheat in Indonesia, where the rupiah has dropped over 40% versus the $US. Wheat still looks expensive from the emerging markets' point of view. Hungry nations will do desperate things to feed their populations.

Next week brings the FOMC meeting Tuesday, when the Fed is widely expected to cut interest rates. The only question in many market participants minds is by how much. The US is attempting to re-inflate its economy to stabilize the global capital markets. This appears to be what the Japanese did in the late 1980's and early 1990's to help out the Americans before the Japanese speculative bubble burst. As well US non-farm payrolls will be reported Friday next week. If the Fed eases rates on Tuesday, the payrolls number will likely be a non-event regardless of it's size. More volatility lies ahead as more trading desks, investors and hedge funds have to admit their losses. Good trading.

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