July 15, 1996

Investors in North American markets continue to be fearful of signs of inflation. This fear is manifested in wild swings in both the bond and stock markets. These variations tend to be even more dramatic since a high degree of investing is done through pooled funds so that any change in asset allocation, be it type of investment (cash, fixed income, equity) or sector (high-tech, resource, defensive) tends to exacerbate such swings. Yet, what has taken place in the real world over the last month is almost an exact replica of what has occurred over the last 5 months. When on Friday July 5 US non-farm payrolls came in at plus 239,000, the unemployment rate dropping to 5.3% from last month's 5.6% and hourly earnings registering a 0.76% increase (a 9 cents leap vs 3 cents last month) markets went into panic mode. Long term bonds came off nearly 3 points to yield 7.18% and the Dow Jones tumbled 115 points, all in a shrtened trading day. However, at week's end the other key economic trends once more pointed out that there still remains slack in the economy. The June Producer Price Index was reported up 0.2% and retail sales for June were actually down 0.2% against a 0.8& increase in May. Unfortunately for the stock market, this relatively good news came out at the same time as downward revisions in earnings for quality high-tech companies Motorola, Hewlett-Packard and Digital Equipment. In general then, current sentiment among investors has turned bearish and there is evidence of less money flowing into managed funds, some evidence of asset location into bonds from equities and even some redemption out of funds altogether. Sector allocation is confusing. First, there was cashing in of venture precious-metal funds followed by reduction in the technology sector.

Long term US treasury bonds after having moved down to yields as high as 7.19% ( not quite as low as the 7.22% recorded in June) recovered to the level of 7.03% on July 12, compared with 7.09% a month ago. Long Canadas closed at 8.08%, a real improvement over the 8.23% yield a month ago. Two year maturing US treasury notes remained steady at 6.28% over the month while 2 year Canadas improved to 5.98% compared with 6.12% last month, continuing the trend to lower than US rates in the short area. This again puts pressure on the Bank of Canada to lower rates.

In spite of the wild variations, North American stock markets continue to trade at relatively high levels, with Canadian stocks now performing somewhat better than US. The Dow Jones Industrials average at 5511, trading below its high of 5778, trades at 17.8 times generally improving earnings to cash yield 2.3%. The S&P's Composite Index at 646 (year high of 680) trades at 19 times earnings to yield 2.3% on cash dividends. This compares to last month figures of 666, 19.6 and 2.2%. The TSE 300 index was actually up over the month to 5041 (year high 5248) to trade now at a 19.4 p/e ratio and yield 2.1%. This compares to last months' figures of 5030, 19.1 and 2.1%

Focus in the minds of investors will continue to be on inflation, particularily on the important wage component. The Commodity Research Bureau index closed at 251.58 on July 12, up from 249.19 a month ago., but the increase appears to have been caused mainly by the rise of certain grain crops due to scorching dry weather. If gold is really a measure of anticipated inflation, it certainly is not acting that way. Closing price on July 12 of $384 (as measured in a stronger US dollar) is unchanged from a month ago. In general, the North American market is continuing to attract international investment as a result of stable conditions, relatively low inflation and a moderate growth rate.