FIRST QUARTILE ECONOMICS

Capital Markets Weekly

Friday, January 16, 1998

Financial markets have developed a sense the worst of the Asian debacle is over, in terms of the impact on global market volatility. With Japan announcing more steps to support economic growth, the Japanese stock market rebounded by 7% last week and this in turn spilled over to generate positive gains in North American equity markets. Gold rebounded by $11 while commodity prices generally, as measured by the CRB Index, rose by 2.4% on the week. Against this background, the TSE 300 rose 2.3% with a sharp 14.7% rise in the gold sector and a 6.0% rise in metals stocks. Even so, U.S. stocks rose by a greater magnitude with the S+P 500 up 3.6% on the week.

The better tone in equity markets has begun to fuel concern that the rally in long bonds is over. Yields on long term U.S. Treasury bonds rose by 11 basis points last week after breaking below trendline resistance going back to market peaks in 1993 and 1996. Just a week earlier, the U.S. fixed income market was priced in a manner that implied the next monetary policy move by the Federal Reserve was a reduction in interest rates instead of the uptrend the market has long been bracing for. This expectation has been tempered in recent days.

For Canada, the C$ remains in a soft mode but at least has lost some of its impact on interest rates. The C$ is in a zone that is probably close to maximum weakness over the near term. Specifically, major support is in place around the 1.45 U.S. area (69.96) which would marginally break the over-hyped record low of 69.13 (1.4465) set in 1986. However, just because the currency may not have much further room to fall, there is no visible force on the horizon that suggests a quick return to some kind of uptrend. On Wednesday, the November trade surplus will be reported and will be studied for any sign the current account deficit rise of the past year may begin to reverse soon. Indeed, the best thing that could happen to the C$ would be signs of economic weakness since that at least would point to a stall in import growth if not an outright decline.

In this overall environment, there is some risk financial market participants will begin to believe that bargains abound in equity markets and that the North American economy is safe from any meaningful impact from Asia. Against this background, near term rebounds in equity prices should be viewed with suspicion since nothing has really changed for the better other than market psychology. The underlying economic scenario of somewhat slower growth with unmeasurable deflationary forces at work will still result in a further deceleration in domestic inflation rates in 1998. This continues to highlight the merits of fixed income investments generally in 1998.

I remain in the camp that bonds will outperform equities generally in 1998 and that any low risk entry point back into equities awaits late 1998.

Friday , January 16 , 1998.

By Frank Hracs -First Quartile Economics

Weekly Archives

Capital Markets Weekly, January 9, 1998

Capital Markets Weekly, January 5, 1998

Capital Markets Weekly, December 19, 1997

Capital Markets Weekly, December 12, 1997

Capital Markets Weekly, December 5, 1997

Capital Markets Weekly, November 28, 1997

Capital Markets Weekly, November 21, 1997

Capital Markets Weekly, November 14, 1997

Capital Markets Weekly, November 7, 1997

Capital Markets Weekly, October 31, 1997

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