August 15, 1996

All of a sudden, professional investors no longer seem to be spooked with fears of inflation. Is it possible that the close examination of fluctuations in non-farm payrolls has gone the way of the old infatuation with money supply (you remember M1, M2 ?). In any event, July Producer Price Index came in at no change from June's. The July Consumer Price Index was up 0.3%, stronger than expected, and retail sales in July in the US actually rose by 0.1%. The latter 3 sets of stats would, according to the scenarios prevalent over the last 6 months, normally be a negative to bond and money markets. Particularily so when combined with a relatively high US federal refinancing program. But such was not the case. Both the bond and stock markets put on their rally caps over the last month.

Long term US treasury bonds ended August 15 at a yield of 6.78% compared with 7.03% on July 12. Long Canadas closed at 7.79% compared with 8.08% over the same period. Two year maturing US treasury notes traded at 5.95% on August 15 vs 6.28% a month ago while 2 year Canadas improved dramically to yield 5.09% compared to 5.98% on July 12/96. Short term rates in Canada are now considerably lower than in the US. And, of course, the Bank of Canada finally cut its prime. There was even an improvement in the Commodity Research Bureau Index, closing at 248 on August 15, compared with 252 on July 12.

Meanwhile, the stock market donned its rally cap also & went to bat. The Dow Jones Industials average closed at 5666 on August 15 vs 5511 on July 12 ( 1996 high is 5778) and now trades at 17.8 times trailing earnings, unchanged from a month ago. The S&P's Composite Index at 662 contrasts with 646 on July 12 (year high is 681) and now trades at 19.4 times earnings (19 times a month ago). The TSE 300 index rose less, closing at 5073 vs 5041 a month ago, to trade at 19.8 times trailing earnings and cash yield 2.12%, compared with 19.4 and the same yield last month.

This editorial page has been consistent in its positive view of fixed income and stock markets over the last year. We still don't see much signs of the economy overheating and therefore we feel that inflation in North America will stay at low rates while the economy grows at a moderate clip. In such a scenario, stock markets offer sound investment value, particularily when measured in relation to corporate earnings. Additionally, the quality of earnings is high because of the lack of inflation affecting inventory and the lack of accelerated depreciation rates due to less capital spending, and hence earnings that are taxed at normal rates. However, markets will contine to be volatile because of the heavy concentration held by institutionalized pooled funds, most of which act in the same direction. This and hedging operations tend to make the swings more exagerated. Wouldn't it be a wonderful world if half the funds acted differently than the other half?

The attached PICKS chapter takes a look at an additional 2 junior gold explorers.