September 6, 2002

North American stock markets continue to be building a base on top of the bottoms encountered on September 21, 2001 and on July 24, 2002.

The S&P/TSX composite index at 6480 is up 8.1% from the 5994 low of July 24 but still down 43.2% from its all time high of 11,402 in September 2000.  The Dow Jones Industrial Index at 8427 has recovered 11.9% from its low of 7533 on July 24 and is now down 28.3% from its all-time high of 11,750 on Jan 14, 2000.  At the current level, it trades at 21.7 times earnings of $388 to yield 2.22% on cash dividends of $187.  The S&P 500 index at 894 has recovered 15.2% from the 776 low of July 24 and is now 42.5% lower than its all time high of 1553 on March 23, 2000.   At the current level, it trades at 36.2 times indicated earnings of $24.70 to yield 1.76% on the $15.71 cash dividend.  The NASDAQ at 1295 is up 5.4% from its low of 1229 on July 24 and is now 74.8% lower than its all-time high of 5132 on March 9, 2000.   The Russell 2000 Index at 392 has risen 8% from its low of 363 on July 24 and is now down 35.2% from its all-time high of 605 in March 2000.

Looking at some world indices, London’s FTSE 100 Index at 4107 recovered 13.3% from the 3626 level of July 24, now down 22.5% from its year high and off 41.3% from its all-time high of 7000 in January 2000. Frankfurt’s DAX Index at 3486 has lost some ground over the last 6 weeks but, nevertheless, is up 6.7% from the July 24 low, yet down 35.5% from its year high of 5400 and down 56.4% from its all-time high of 8000 in February 2000.  Tokyo’s Nikkei-225 index at 9129 seems to be in free-fall, down 4% below July levels which, at the time, appeared to constitute a triple bottom and is now down 24% from its yearly high and down 56.3% from its high of 20,900 in March 2000.

The Bond Market gained investment favour over the last 6 weeks with bond prices increasing significantly while bond yields moved to 40-year lows.  10-year Canadas closed on Sept 6 at a yield of 4.94%, slightly off its best level of 4.90% the previous day.  This compares with 5.16% on July 26.  Two-year Canadian maturities traded at a 3.33% yield on Sept 6, its highest level being at 3.02% on Aug 7.  This compares with 3.21% on July 26.  In the US, both the long-term bonds as well as short-term hit their highest peaks on Sept 5.  US 10-year treasury bonds closed at a 4.03% yield on Sept 6, down from a 3.91% yield the day before.  This compares with a 4.38% yield on July 26.  US 2-year treasury notes closed at a 2.06% yield on Sept 6 down from the 1.94% yield of the previous day, yet up from trading levels of 2.21% yields on July 26.  It is becoming increasingly more difficult to imagine bonds trading at much lower yields than those prevailing.  A reversal to this strong bond market will occur only when there are real signs of strengthening in the economy causing loan demand and/or if there are signs of inflation prompting central banks to react accordingly by hiking interest rates.

The US Federal Reserve Board left the overnight bank-lending rate unchanged at 1.75% on Aug 14 for the sixth time this year.  The FOMC next meet on September 24 and this newsletter predicts that rates will remain unchanged.

The Bank of Canada on September 4 left the overnight lending rate unchanged at 2.75% and now looks forward to increasing the rate for the 4th time this year at its next setting on October 16.

The University of Michigan’s Index of Consumer Sentiment fell for the third consecutive month in August to 87.6 from 88.1 in July and 92.4 in June.

The Conference Board’s Consumer Confidence Index fell to 93.5 in August from 97.4 in July and 106.4 in June.

The Conference Board’s U.S. index of leading indicators fell 0.4% in July after falling a revised 0.2% in June and a restated rise of 0.6% in May.  The indicator is the Conference Board’s measure of the economy over the next 3 to 6 months.

Institute for Supply Management Index ISM (purchasing) fell to 50.9 in August, lower than the 53.1 in July and the 56.2 in June.  This is the weakest reading since the 49.6 in January.  However, anything over 50 is still in positive territory.

The US Trade Deficit narrowed slightly in June to $37.2 billion from $37.8 billion in May.  These are still high figures, but are now 2 months old.

US 2Q 2002 GDP grew at a 1.1% annual rate compared with the 5% rate of the 1Q (revised downward from the previously reported 6.1% annual rate).  It now looks like the rate of growth for 2002 w1l be about 2-½% to 3%.  In 2001 the US GDP increased 1.2%. 

Canada’s 2Q 2002 GDP grew at an annual rate of 4.3%, down from the 6.2% rate in 1Q.

US Nonfarm Payrolls increased by 39,000 in August to 130.8 million compared with a revised increase of 67,000 in July.  The available labor pool fell to 12.6 million from 13.2 million in July.  The percentage of the US population holding jobs rose to 66.6% in August.  US unemployment rate fell to 5.7% in August from the 5.9% rates in July and June. The number of unemployed was 2.8 million in August, down from the recent high of 3.1 million in June.  The service industry added 100,000 jobs in Aug bringing the total increase to 411,000 since February.  Manufacturing employment dropped by 68,000 in Aug, the 25th straight month of declines. Average weekly income rose to $505.36 ($14.82/hr) in Aug from $502.52 ($14.78/hr) in July.  Over the year, both the average weekly earnings and the hourly ones grew by 3.1%.

In Canada, employment increased by 59,000 in August but the unemployment rate remained high at 7.5%, an improvement from the 7.6% rate of July.  Nevertheless, this will most likely prompt the Bank of Canada to increase its overnight lending rate from its current 2.75% at the next scheduled meeting of October 16.

The US Consumer Price Index rose 0.1% in July, the same increase as in June.  So far this year, consumer prices are running at a 2.5% annual rate compared with the 2.7% annual rate in the same 7 months last year.

In Canada, CPI in July rose 0.5% over that of June and is 2.7% higher than July of last year.

The US Producer Price Index fell 0.2% in July, following a 0.1% increase in June.  This means that wholesale prices rose at an annual rate of 0.9% in the first 7 months of the year.

US Retail Sales rose 1.2% in July, following a 1.4% gain in June.

Housing starts fell in July by 2.7% to an annual rate of 1.65 million, after a 3.6% drop in June to a then annual rate of 1.67 million.

The CRB index continues to increase significantly now at 223 compared with 211 on July 26 and seems to be heading to the recent high of 235 in 4Q 2000 but still a good distance from the high of 264 in 2Q 1996.  Crude oil prices have moved up higher, perhaps on the perception that hostilities could take place in Iraq, causing delivery disruptions.  October oil closed at US$29.61 up from $26.58 on July 26 and traded as high as $30.32 on Aug 20.  Natural gas prices in the US trended higher as well closing at US$3.265/million BTU compared with $3 on July 26.  But, in a very volatile market it did trade, at one point, at a 3-month high of $3.617.  The recent high was $3.88/mmBTU on May 14 and the recent low was $2.79 on July 12.   Gold has been increasing in price as a result of open market purchases by some gold producers closing off forward sale hedges.  Also, prices reflect the busy period September to December when demand for gold is strong.  Prices closed at US$321, up from $303 on July 26 and appears to be ready to challenge the 2 1/2 year high of $331 attained on June 4.  The US dollar, over the last 6 weeks, has not varied much against the Euro, closing out at 1Euro=$0.9818 compared with $0.9880 on July 26.  The Canadian dollar, in relation to the US$, has been all over the map, closing at US64.14 cents, compared with 62.94 cents on July 26 and the recent high of 66.30 on June 26.

North American stock markets, while trading in very volatile fashion, may be simply reflecting economic conditions.  The economy slowed down significantly in 2001 and is recovering slowly and in fits and starts in 2002.  Bonds have been star performers and have drawn funds away from equities.  Stock price to earning ratios, which appear to be high from a historical viewpoint, may be merely reflecting the low interest yield prevailing in fixed income instruments, meaning that both markets are in sync.  From an emotional point of view, stock markets have held up remarkably well in the face of so many disturbing factors.  To many investors, the knockout punch was the corporate scandals and fraud forcing them to seriously question the concept of open market trading.  Some have fled and are now investing in real estate as an alternative to both stocks and low-income bonds.  The investment community has not helped matters by moving away from traditional investments in favor of new, synthetic type of instruments such as off balance sheet items, derivatives, index funds, etc.  The latest folly is the Toronto Stock Exchange going public in an IPO.  With $191 million cash on hand, it doesn’t need money, the proceeds of the issue will go to selling shareholders, those being stock-brokerage houses.  Those selling will be well rewarded with a price supposedly at 20 times earnings.  The TSE a growth stock?  The major players, i.e. the banks and strong indies such as Canaccord & Yorkton will vie for control.  In the after market, some of the major pension funds, such as the Caisse, Ontario Teachers, OMERS, etc. might join the fray.  Nothing created, no jobs added, simply another turn-off for the individual investor.  Fortunately, there are still some well-run companies whose shares trade at reasonable levels and where prospects for growth appear to be well defined.  This newsletter attempts to point these out to the reader in the ensuing section, LATEST PICKS.

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