March 15, 1997
The strong North American bond and equity markets of the last year came about in an environment of moderate economic growth combined with low inflation. The name of the game then became to watch out for inflationary trends that would ultimately spike interest rates and cause downward corrections to bond & stock prices. This newsletter was consistent in noticing, since August 1995, that stock markets were reasonably valued in terms of both interest rate structure as well as growth in corporate earnings. In December and January this letter pointed out some signs of inflation and in fact suggested in January that the Fed could very well elect to increase the discount rate following the Feb 5 FOMC meetings. Along came February economic figures and inflationary tendencies more or less vanished. Now in March we are once more witnessing some inflation. On Friday, March 7, it was announced that Feb non-farm payrolls had increased by 339,000, about a third more than expected. The US unemployment rate for Feb dipped to 5.3% from 5.4 in Jan. On Thursday, March 13 it was announced that US retail sales rose by a larger than expected 0.8% and that January retail sales were revised upward to 1.5% from the earlier reported 0.6%. This would be the largest advance since February 1996. And yet, these negative stats (re inflation) must be compared with some positive ones, such as a smaller than expected rise of 0.2% in average hourly earnings along with a 0.8-hour jump in the average workweek, all in February. Finally, the Commodity Research Bureau Index was up somewhat to 246.93 from 239.51 a month ago and 242.47 on Jan. 16. The next meeting of the policy-setting Federal Open Market Committee is set for March 25. After looking foolish with January's prediction, this newsletter will pass on the March guess.
US long term bonds ended March 14 trading at a 6.95% yield compared with 6.53% Feb. 14. Long Canadas closed at 7.19% compared with 6.81% but still better than the 7.35% on Jan 15. Two year maturing US treasury notes yielded 6.17% vs 5.77% on Feb 14 while Canadian 2 year bonds narrowed the gap to yield 4.49% compared with 3.97% on Feb 14.
Stock markets continued to be firm. The Dow Jones Industrials average stood at 6935 on March 14 compared with 6989 on Feb 14, after having touched 7067. At this level it now trades at 19.2 times trailing earnings compared with 19.7 times a month ago and yields 1.95% on cash dividends. The S&P's Composite Index at 793 compares with 808 a month ago, after having traded as high as 818, to trade at 20.5 times earnings compared with 22.5 times on Feb 14. Dividend yield is 1.91% compared to 1.87% a month ago. The TSE 300 index closed at 6198 compared to 6214 a month ago to trade at 22.5 times better trailing earnings compared with 23.5 last month. Market expectations continue to be based on an expanding rate of growth in corporate earnings. The price of gold on March 14 recovered to close at $352.60US compared to $346.40 on Feb 14 and to 370 in mid-December and continues to reflect the strong US $.
Until there are real and consistent signs of inflation bond markets should continue to trade at current levels. The stock market will most likely continue to be influenced by increasing corporate earnings. With low interest rates prevailing, merger and acquisition activities are on the rise. The large trading volume on North American markets continues to be generated by fund managers and pro-trading involving hedging and index package activities. In the Dec issue, this letter was calling for a healthy correction within a continuing bull market, to levels of 6100 on the Dow, 700 on the S&P and 5400 on the TSE. As a result of the impressive continued advance, these levels are now being adjusted to 6500, 730 and 5700, respectively.