October 17, 1996

The main feature affecting North American investment markets over the last month was the announcement made on Friday, October 4 that US non-farm payrolls fell 40,000 in September instead of rising about 175,000 as expected. This diminished the likelihood that the US Federal Reserve Board would raise interest rates this year. Reflecting once more that inflationary pressures remain in check, long term Canada bonds rose to a 19 month high, to yield 7.43%, while long term US treasury bonds rose to a 2 month high to yield 6.74%. On that day, stock markets soared, with the Dow Jones Industrials average nudging 6000 and the TSE 300 index set a new high of 5416.

In this period under review, long term US treasury bonds ended October 16 trading at a yield of 6.84% compared with 6.95% on Sept 13. The year's high was in February at 6.09%. Long Canadas closed at 7.33%, a marked improvement from the 7.78% yield on Sept 13. Two year maturing US treasury notes traded at a 5.88% yield on Oct 16 compared with 6.11% a month ago. The Bank of Canada cut its prime rate on two occasions, now standing at 3.75% vs 4.25% a month ago. Canadian chartered banks will have to follow through, since the prime lending rate remains at 5.75%.

Meanwhile, North American stock markets continue to perform strongly. The Dow Jones Industrials average closed at a record high on Oct 16 at 6020.81, up from the then record high of 5838.52 on Sept 13. At this level it trades at 18.3 times improving, trailing earnings to yield 2.1% in cash dividends. The S&P's Composite Index closed at 704.42 on Oct 16 (its record high was 708.08 earlier in the week) compared with 680.54 on Sept 13, and now trades at 22 times earnings to also yield 2.1%. The TSE 300 index closed Oct 16 at 5481.00 (its high earlier in the week was 5495.91) and trades at 21.3 times earnings to now yield under 2%, i.e. 1.95% in cash dividends. This compares with 5243, 20.3 times and 2.04% a month ago.

As long as rates of inflation remain low, spending by governments remain curtailed and, hence, interest rates stay low, equity markets remain an attractive option, particularily if corporate earnings continue to increase. Inflation as measured by the Commodity Research Bureau index remains steady, 244 on Oct 16 vs 246 on Sept 13. Bond markets should remain at current levels over the next 3 months and selective stocks should continue to do well. There is no question that once inflation rears its ugly head, one shoud make for the hills, but it is difficult to see a change in direction of the current components of inflation, such as in wages and government spending.