FIRST QUARTILE ECONOMICS |
There was a bit of an air pocket for stocks on Wednesday and Thursday amidst bond market weakness (S+P 500 down 1.6%), but all was recovered and more on Friday with a 2.0% daily gain to yet another record level. During the past eight weeks the S+P 500 is up 14.5% from the intra-day low in the week of January 9. This is a pretty solid run but is losing momentum. In the first four weeks of the rally, the S+P 500 rose 9.8% and is up a mere 4.7% in the past four weeks. A crude extrapolation implies potential for no more than a 2.5% gain over the next four weeks, still not bad but getting more treacherous.
In a potential hint of a global equity market stall ahead, the Hong Kong Hang-Seng Index fell 4.9% on the week (undoing a fraction of its prior 45% rebound). As pointed out in the chart in last weeks letter, the HS is at technical resistance to further gains and the resistance line held perfectly. On balance, the global equity market as calculated in the USD MSCI Index fell by 0.3% on the week and also bounced off trend channel resistance this past week.
U.S. BONDS: Treasury futures put in another 2 1/4 point range on the week and declined a net 3/4 points. Support was broken early in the week, 6% equivalent on cash 30-year Treasuries, and some follow through declines emerged to the 6.07% range. In a ludicrous move, bonds reacted overly negatively to a marginal rise in the February Purchasing Managers' Index report released on Monday, and then began to price in on a bearish employment report.
The employment report was indeed ultimately on the bearish side with a 310,000 job gain (four months in a row of 300,000 plus gains is very seldom seen) but bond prices eventually rose 5/8 points on the day to close just above 6.0%. The futures chart is equally indecisive with a weekly close right on the previous support line but it appears the uptrend channel from last summer remains intact.
I believe this is as bad as the data gets for bonds this month. The manufacturing employment component fell as did the average workweek and overtime hours. This adds up to a likely flat Industrial Production report ahead following a zero gain in January. As part of the reporting this past week some key high-tech companies warned of earnings disappointments this quarter and this has to be the start of a several quarter string of stagnant earnings for a lot of companies. Hiring plans will soon move into reverse.
At this stage, the market has priced in perhaps a 60% chance of a Fed tightening by mid-year versus essentially zero probability a few weeks ago (based on Euro-dollar futures). Despite the apparently strong economic data, June Euro-dollar futures actually closed up on a week-to-week basis so the degree of Fed tightening expectations is extremely fluid and subject to rapid revision.
I continue to expect a successful re-visitation of the January low of 5.69% on 30-year Treasuries in the next couple of months and a follow-through move to at least 5.50%. Note the break of cash oil prices below $15 B/L this week. Inflation has still better days ahead in 1998 and a rising U.S. dollar will reinforce the trend.
Core CPI inflation should ease below 2.0% within a few months (from 2.2% yr/yr presently in January) while the overall CPI could be close to a 1.0 % yr/yr pace by mid-year. Somewhere in there the market will be back to pricing in an eventual Fed ease and that will probably represent the definitive opportunity to drastically reduce durations, take some profits and switch to cash equivalents.
CANADIAN EQUITIES: The TSE 300 rose by 1.3% on the week and broadly outperformed the U.S. indices. Metals and minerals rose an unlikely 5.3% on the week in defiance of the tentative outlook for global economic growth ahead. Despite new recent lows in oil prices, the Oil and Gas sector fell only 0.1% on the week while Pipelines fell the most at 1.7%.
CANADIAN BONDS: Domestic bonds held in well in the short end as the currency improved but five years and out moderately underperformed the U.S. market. Accordingly, the domestic yield curve steepened about 18 basis points from 2 to 30 years.
If a little Canadian dollar strength could hold the short end in so well while the U.S. market overall was relatively soft, it is likely the CAD strength I expect ahead should tend to steepen the curve further. In addition, if the U.S. dollar rises a few percent ahead, this will translate into a tighter stance in the domestic Monetary Conditions Index which will lead to general conclusions in the market that Bank of Canada rate hikes for 1998 are done.
On that logic, there is perhaps 25 basis points of potential rally in 2-year Canadas ahead while 30-year Canadas (in line with the U.S.) may very well have around 50 basis points of yield decline through mid-year.
COMMODITIES: Oil prices moved below $15 B/L and are through multi-year trendline support. This is no great surprise with newfound stability in the Middle-East and the global oil glut.
Some people think oil can get as low as $12 B/L but in any case this scenario has a few more months to play out before OPEC eventually bites the bullet in mutual desperation and cuts production.
U.S. DOLLAR: The dollar is building up for a powerful near term break out against the DM and then the Yen. German officials continue to signal steady interest rates for the balance of the year while the Japanese Ministry of Finance is pre-occupied with raids, scandals and suicides that are making it tough to craft any near term economic support packages. Indeed, everything the MOF has announced lately has been geared to keep the Japanese economy from sliding into outright recession as opposed to promoting economic recovery.
The best technical scenario for the dollar is versus the DM as several weeks of action have been capped by the downtrend line from mid-1997. I believe this resistance will soon give way and usher in a surge towards 1.90 DM by late Spring. There is no reason to think the Yen will remain stable and a similar percentage gain in Dollar/Yen is expected, eg. towards the 132 Yen level.
CANADIAN DOLLAR: CAD was confined to technical ranges during the past week. Weakness was limited to 1.4290 while strength was capped at 1.4150. Still there was a net gain of 0.5% on the week to a constructive close of 1.4182 (70.51).
The main news of note was the resignation of Quebec Liberal leader Daniel Johnston on Monday which immediately delayed any potential provincial election until the Fall and a subsequent Separation referendum into1999. Talk of Jean Charest (leader of the federal Conservatives) running as Liberal leader in Quebec then kept the improved currency tone alive as polls suggest the Liberals could defeat the PQ in the next election.
Economic data early in the week proved mixed as December GDP rose 1.0% versus a decline of 0.2% in November, but Q4 GDP decelerated to a 3.0% annualized gain versus 4.1% in Q3. After strikes, Q4 GDP rose about 3.4% but still the excessive momentum of the economy through 1997 appears to have cooled. At one level this is bad for the currency since it means domestic interest rates have no fundamental reason to rise further in 1998. However, slower domestic demand will help temper imports and allow for some more recovery in the trade surplus. Technically, fundamentally and politically there is room for the CAD to drive toward the 1.3900 range in the months ahead, as projected here last week.
Monday, March 9, 1998.
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