January 17, 1997

Strong equity markets, firm bond markets and low interest rates in North America over the last year have been primarily a function of low rates of inflation. So naturally, over the last month, December 15/96 to January 15/97, the watch was on for any signs of inflation. The key indicators, as usual, are the Producers Price Index, Consumer Price Index, employment figures, inventories and commodity prices. During this period, continued government fiscal responsibility was evident and corporate downsizing continued (with an increasing flavor toward mergers). On balance, the stats came out positive, but there are enough deviations to cause concern. In chronological order, the US December Producer Price Index came in at up 0.5%, higher than expected and US nonfarm payrolls showed an increase of 262,000 vs expectations of 180,000. Business inventories in November showed a smaller rise than expected which opens the door toward possible re-ordering at higher cost price down the road if demand is still there. There were increases in the price of crude oil and natural gas. So much for the negatives. On the positive side, The US Consumer Price Index showed an increase of only 0.1% for December which, combined with retail sales being up 0.6% , together, speaks well. The Commodity Research Bureau Index at 242.47 on Jan 16/97 compares with 243.75 on Dec 15 and 242.57 on November 15. Markets zeroed in on these positive elements and, hence,continued to behave well. One wonders, however, if an aura of complacency may be setting in. Perhaps retail sales over the holidays will have proven to be higher. On January 16, jobless claims came in at 323,000, below the market consensus of 355,000 and Federal Reserve Board of Philadelphia Governor Meyer was suggesting a possible interest rate hike may be in order. It is now this newsletter's view that the Federal Reserve Board will increase interest rates following the Feb 4-5 Federal Open Market Committee (FOMC) meetings.

US long term bonds ended January 16 trading at a 6.82% yield compared with 6.58% Dec 13 and 6.46% on Nov 15. Long Canadas closed at 7.35% compared with 7.14% a month ago. Two year maturing US treasury notes yielded 5.97% vs 5.76% on Dec 13 while Canadian 2 year bonds actually improved to yield 4.03 % on Jan 16/97 compared with 4.24% on Dec 13/96.

Stock markets continued to set new highs. The Dow Jones Industrials average stood at 6765 on Jan 16 compared with 6305 on Dec 13. At this level it now trades at 19.5 times trailing earnings compared with 18.2 times a month ago and yields slightly less than 2 % on cash dividends. The S&P's Composite Index at 770 compares with 738 a month ago to trade at 21.4 times earnings compared with 20.2 times on Dec 13. Dividend yield is 1.95% compared to 2.05% a month ago. The TSE 300 index closed at 6104 compared to 5707 a month ago to trade at 25.1 times earnings compared with 23.1 last month. Market expectations are obviously based on an expanding rate of growth in corporate earnings. The price of gold on Jan 16/97 at 353.80 compares to 370 last month.

In summary, while there was some deterioration in the bond market ( and this may be seen as an indicator to the future direction of stock markets) equity markets continue to show strong momentum on the upside. Reminds one of the old saying: don't fight the tape. Nevertheless, it is this newsletter's view that more indicators will show up inflation and that there will be one hike in interest rates in the US. If these happen, it would not be unusual to think of a 10% correction in North American stockmarkets and a return to the $380 level for gold. Such a scenario would constitute a correction within a continuing bull market. Not much wrong with a 6100 Dow Jones and a 5400 TSE. Creating some base building would be healthy for the market.

This month's The Pick section will review some previously mentioned small-cap stocks, paving the way to the coverage of additional companies in the next month, February, edition.