November 27, 1997

This edition will cover the period from October 16, 1997, the date of the last report, to November 21. Over this period, the economic news from the US front, on balance, was good : moderate growth with surprisingly few signs of inflation. On Oct 17, US housing starts for Sept came in at the annual rate of 1.5 million, up 7.9% from the depressed figure of 1.35 million of August. This was vs an expectation of 1.43 million, so bearish for interest rates & bonds. On October 23, Asian stock markets came tumbling down 10% in reaction to drops in their currency values and fears that their banking structures were vulnerable. Gold lost over $2 an ounce to $317 on word that the Swiss National Bank proposed to sell 1400 metric tonnes of gold reserves for purposes other than currency stability. This led to a flight into bonds. On Oct 24, long Canadas increased in price, going from a 6.32% yield to 6.26%, and US longs went from 6.43% to 6.34%. On Oct 27, gold went down to US$310 and the flight out of international stock markets into bonds continued. Long Canadas went to 6.15% and then to 6.02% on Oct 28, while 30-year US treasury bonds went to 6.24% and to 6.13%. On Monday October 27, stock markets finally cracked. The DJIA produced the worst 1 day loss in history, down 554 points and overnight the Hong Kong stock market came tumbling down 14%. All other international stock markets began tumbling as well. Gold, in sympathy, began some recovery back up to $315. The Bank of Canada began to talk about increasing rates in order to stem the drop in the Cdn $, which in just a few days had dropped in value to US$1.4134 down from 1.3855. Oct 28-29 saw recovery in stock markets and funds flowing back into equities from bonds. Federal Reserve chairman Greenspan expounded that the currency crisis in Asia and the decline in equity markets worldwide were more or less the catalyst to the natural correction to take plce in an overheated stock market. On November 6, the Bank of England surprised markets by raising rates by 25 basis points to 7.25% from 7.00%. On Nov 7, Canada announced its unemployment rate was higher than expected at 9.1%. In spite of the continuing weakness in the Cdn $, this news relieved pressure to hike interest rates in Canada. On November 7, the US unemployment rate was reported at 4.7%, lowest in 23 years. The same day, non-farm payroll for October was announced as an increase of 284,000, much higher than the expected 208,000. Hourly earnings in October rose 0.7% indicating some wage inflation pressure. Interestingly, these latest two figures did not produce a negative effect on the bond market. Long term Canadas traded up to yield 6.03% and US long term treasuries traded to yield 6.11%. On Nov 12, the FOMC met and did not introduce interest rate increases. On November 14, October retail sales in the US came in down 0.2% vs expectations of an increase of 0.3%. The US Producer Price Index came in up 0.1% as per expectations. These good figures sparked a rally in the bond market. US long term bonds traded up to yield 6.08% and long Canadas broke the 6% yield to trade up to 5.96%. On Monday Nov 17, the Japanese Nikkei stock index posted an 8% gain (4th largest ever). This gave rise to a 4.6% rise in the Hong Kong Hang Seng index. These rises were based on hopes that the Japanese government would intervene to support the economy. On November 18, the US Consumer Price Index came in at plus 0.2% versus an expected rise of 0.3%. The year over year increase in CPI of 2.1% was the smallest since February 1987. On Nov 18, the Prime Minister of Japan denied that public funds would be used to help their ailing banking system. So the Nikkei lost 5.6% that day and another 5.3% the next. On Nov 20, the Japanese PM reversed his decision, and the Nikkei gained 3%. On Nov 19, US housing starts for October were reported 1.4 % higher than September at an annual rate of 1.53 million vs expectations of 1.47 million. The US trade balance deficit widened to $11.1 billion vs an expected 10.1. Neither of these stats had an effect on the bond market. On Nov 25, the Bank of Canad increased its bank rate by 25 basis points to 4.00% in the hope that it will halt the slide in the Cdn $. This compares with the Fed discount rate of 5%. Canada's short term rates are lower than in the US and it will probably take a bigger jump than that to reverse the direction of the C$. B of C is hesitant because of the high unemployment rate in Canada.

US long term bonds ended November 26 trading at a 6.04% yield, never quite breaking through the 6.00 level, a significant improvement from 6.36% on October 15. Long Canadas closed at 5.96% after having traded as high as 5.91%, compared with 6.23% on October 15. Two year maturing US treasury notes yielded 5.73% on Nov 26, not that greatly changed from the 5.78% on October 15, while Canadian 2 year bonds yielded 4.60% on November 26 after having traded as high as 4.39% compared with 4.49% on Oct 15.

Stock markets behaved in very volatile fashion and went through somewhat of a correction.. The Dow Jones Industrials average stood at 7795 on November 26, down 3.3% from 8058 on October 15, and down 5.6% from its all time high of 8259 in early August. At this level it now trades at 20.1 times trailing earnings compared with 21.1 times on Oct 15 and yields 1.75% on cash dividends, compared with 1.66% on Oct 15. The S&P's Composite Index at 952, is virtually unchanged from the 966 level of Oct 15 and down only 3.5% from all time high of 986 is trading at 23.4 times earnings unchanged from a month ago. Dividend yield is unchanged at 1.60%. The TSE 300 index closed at 6505 on November 26 down 8.8% from the 7129 level of Oct 15 and 10.0% from the all-time high of 7223 on October 7, to trade at 22.7 times trailing earnings compared with 24.2 a month ago. Dividend yield is 1.67% compared with 1.50% a month ago. The TSE has suffered from weak performance in the Gold sector and more recently from profit taking in the oil & gas service sector. Stock markets appear to be still reasonably priced in terms of value in a setting of low inflation and moderate growth. Dividend yields are historically low but combined with moderate capital appreciation relating to growth in earnings, stocks still compare favourably with fixed term investments.

A word about gold: This letter's view that we had seen the low in gold price at US$315 in July has indeed turned out to be wrong, as evidenced by the current price of US$296. However, the laws of supply and demand suggest that gold continues to be a rare commodity and should trade at higher prices. A more realistic price target over the next 6 months may very well be $335/ounce as opposed to the $370 level mentioned in this newsletter's report of October 15/97.

This edition's section of The Pick will mention two new companies for the first time.