December 15, 1996



The fun began on December 5 when Federal Reserve Board Chairman Alan Greenspan mentioned that stock market levels may be getting ahead of real expectations. He may have been reflecting two thoughts, one, that a rapidly increasing stock market can have some influential factor on inflation and, two, concern that an excessive switch by investors into equity funds from fixed-income funds might hamper normal government funding patterns. In any event, it caused volatile conditions in both the stock and bond markets. This volatility was most manifested in the Canadian bond market when on Dec 5 long Canada's dropped $45.60 per $1,000 bond, pushing yields up 45 basis points and forcing the Cdn $ lower. In fact at the end of the day, the C$ was trading at 73.69 down 20 basis points, but also 1.5 cents lower than on Nov 8 when the Bank of Canada last cut its interest rate.


On the economic front, pretty well all the news was positive for both equity & bond markets. On Friday Dec 6, US non-farm payrolls for November were announced as up 118,000 vs expectations of a 170,000 increase. US unemployment rate rose to 5.4% from 5.2% over the month and average hourly wage rates, reflecting an increase in the minimum wage, rose 0.8%. On Dec 11, the Producer Price Index for November came in at up 0.1%, well below expectations. On Dec 12, the Consumer Price Index for Nov rose a modest 0.3% while Retail Sales for November declined 0.4%. All these figures would normally have been bullish for both markets.


US long term bonds ended Dec 13 trading at a 6.58% yield compared with 6.46% a month ago. During this period, they did trade as high as 6.35% but still below the 6.09% yield recorded in Feb 1996. Long Canadas closed Dec 13 at 7.14%, quite a come-down from the 6.73% yield of a month ago, but better than the 7.33% of 2 months ago. Two year maturing US treasury notes on Dec 13 yielded 5.76% not much changed from the 5.67% a month ago. Canadian 2 year bonds corrected to a 4.24% level from 4.02% last month. The Commodity Research Bureau index held quite steady at 243.75 vs 242.57 on Nov 15, mirroring economic data.


A stock market correction appears to be in place. The Dow Jones Industrials average stood at 6305 compared with 6348 on Nov 15 after trading as high as 6548 during the month. At this level, it trades at still a reasonable 18.2 multiple to trailing earnings to cash yield 2.09%. The S&P's Composite Index at 729 on Dec 13 compares with 738 a month ago, after having traded as high as 762 during the last month to trade at 20.2 earnings and yield 2.05% on cash dividends. The TSE 300 index closed at 5707 on Dec 13 down from the 5871 level of Nov 15, and down from its recent high of 6019. At its current level, it trades at the equivalent 23.1 times earnings to yield 1.9%.


While fundamentals continue to appear positive, investor sentiment has turned cautious. It is this newsletter's opinion that the current correction could take the Dow down to the 6100 level, the S&P to the 700 and the TSE to the 5400 mark. If the consumer decides to really go on a shopping spree this important Xmas season, a jump in retail sales could add to more volatility, on the downside.


This month's THE PICK will, as was the case on June 15 and last December 15, be a report card on specific stocks mentioned since August 28, 1995.