MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING FRIDAY DECEMBER 19, 1997 (2)
FEATURE STORY
Dollar dips below US70›. Does Bank of Canada's hold on interest rate hike mean it's ready for weaker C$?
By David Thomas - Economics Reporter The Financial Post
The C$ tumbled below the psychologically important US70› level Friday, edging closer to its record low after the Bank of Canada opted against raising interest rates to give the ailing currency a boost.
The central bank's decision to hold off on another rate hike convinced several analysts it is ready to tolerate a weaker C$.
"The bank's line in the sand for the currency at US70› got wiped out, forcing a retreat further up the beach," said Avery Shenfeld, senior economist at CIBC Wood Gundy Securities Inc.
The C$ dropped as low as US69.71› during the day but later recovered some ground with the help of aggressive open-market support by the central bank.
It closed down US0.24› at US69.88›, close to its record low of US69.13›. It was the first time the C$ had closed below US70› in almost 12 years.
"I think a lot of perceptions were changed today," said Michael Gregory, an economist with Lehman Brothers Canada Inc.
"The feeling now is that the bank is probably not going to jump in to defend the C$ with more rate hikes."
Gregory said he still expected higher rates from the bank. But barring a huge slide in the C$, the moves are unlikely before February and will be to slow economic growth rather than shore up the C$.
"Short of the currency falling a couple of cents, I don't see the bank raising rates to defend the C$."
John McCallum, chief economist at Royal Bank of Canada, said the prospect of a C$ at under US70› should not be alarming or a sign of crisis.
"I don't think we should see the C$ as a sort of national virility symbol. If the real world circumstances change to give us a weaker dollar, that's not the end of the world."
The central bank began its course of increasing interest rates in the expectation an overheating economy at the end of next year would lead to inflationary pressures.
But the C$'s weakness and a possible global economic slowdown following the downturn in Asian economies have combined to throw the bank a curve ball.
The focus has shifted to boosting rates as a currency defence after the C$ came under fire in October.
The bank has raised interest rates 100 basis points since the end of September.
As for inflation, figures released Friday showed it fell to 0.9% for the 12 months ended September --- its lowest yearly rate in nearly three years.
The rate dipped below the bank's inflation target range of 1% to 3%. It is expected to edge up next month but the long-term trend is down from October's 1.5%, say economists.
"The low [inflation rate] has boxed in the Bank of Canada," said Sherry Cooper, Nesbitt Burns Inc. economist.
"This will make it tough for the bank to justify a further tightening move, thus putting renewed downward pressure on the C$."
A chorus of concern is growing that a policy of interest rate hikes to defend the currency will take a hefty toll on economic growth next year and should be abandoned in favor of a weaker currency.
CIBC Wood Gundy has forecast another 75 basis points in rate increases are warranted if the bank intends to keep the C$ above US70›.
This would knock 1998 gross domestic product growth down from about 3.5% to 2.8%, said Jeff Rubin, its chief economist.
Similarly, Merrill Lynch & Co. analyst Karim Basta recently revised his forecast for GDP growth in Canada from 3.5% to 2.8%, based in part on the negative effects of higher rates.
Both Rubin and Basta expressed concern the central bank's policy of interest rate increases to defend the currency was damaging since the inflation outlook may actually call for lower rates.
"With inflation running below the bank's stated objective and unemployment still stubbornly high, it would be crazy to punish domestic demand," agreed Jeoffrey Hall, a Canadian market analyst with Boston-based Technical Data.
INSIDE THE MARKET
Patrick Bloomfield
Fear an ever increasing factor
Sometimes one is lucky enough to get some things right. For instance, I have been suggesting for some months that bonds could give investors a better short-term bang for their buck than stocks.
That was indubitably proven in U.S. markets Friday, when the yield on 30-year U.S. treasuries dropped more than one-tenth of a percentage point below the 6% mark, as bond prices jumped and the major stock indexes tumbled.
There was more than enough depressing global and domestic news to add some further spookiness to the jitters of a "triple-witching" day, when trading can be influenced by the expiry of stock-related futures and options contracts in Chicago.
Quite apart from the mayhem on Asian and other world bourses, market players fretted over South Korea's chances of getting through the next few weeks without default, while the ripples spread from the move by Toshoku Ltd., a major Japanese food company, to seek protection from its creditors.
Meanwhile, back on Uncle Sam's ranch, there was a report that individual investors were disinvesting in equity mutual funds, instead of their recent unseemly rush to invest. In addition, corporate earnings concerns were heightened by the 20% second-quarter earnings drop reported by Nike Inc., breaking a long winning streak and reflecting marketing problems in North American and Asia,
With inflation a ghoul of the past, the concerns that hit stocks pulled money into the relative safety of bonds, though benefits enjoyed by the Canadian variety have been moderated by the Bank of Canada's need to keep short-term rates up to defend our buck.
This columns musings that the bear is now stalking North American stock markets were also lent strength. Sure, my rationale is still based more on mood than numbers. Come Friday, fear was near to replacing the greed of the recent past. And commentators in general were acknowledging that Asian flu has to be a negative for 1998 profit expectations. The second highest trading day on record suggested that the bulls were locking in profits accordingly.
But there were also some notable consolations. One was the rugged way the major U.S. market indexes clawed their back from there morning fall. Clearly, bargain hunters were also in evidence.
Then there was the relative strength of some tech stocks and small caps. Though the Nasdaq composite index took its knocks like the rest, it still held above 1500, and then came back at the end of the day. Semiconductors and Internet-related stocks were pockets of strength.
Keeping in mind that tech stocks are still purported to be the wave of the future, and that their ranks now include some of North American markets' worst walking wounded cases, they obviously bargain hunting targets.
IBM Corp., for instance, does not look particularly overpriced at a trailing price earning multiple of 17. On the other hand, the investment case might be a little harder to prove for the mighty Microsoft Corp., especially after Judge Thomas Penfield Jackson had a technician show him how to perform the simple task of disabling the company's Internet browser. (The software giant had been acting as if this could only be accomplished at the cost of disabling its whole Windows 95 operating system.)
Why are our Canadian markets being hit harder? One has only to note the symptoms of Asian disinflationary flu in gold and precious metals prices to answer that one. In addition, our valiant central bank's defense of the C$ is beginning to lift three-month treasury bill rates to a level where they can be an acceptable alternative to income generating stocks.
But bargains are also showing up here, too. The trick in the months ahead will be to find and buy them.
MARKET EYE
Of bulls, bears and tigers
William Hanley
We hate to leave you like this, but the entire Market Eye team is headed south on its annual Caribbean Mission of Mercy - Batteries Not Included. So this will be it for 1997, which will long be remembered as the year that came after 1996.
But we can't leave you without some random thoughts - stocking stuffers for the mind - about where the various markets are and where they might be going as we head into the new year. Incidentally and ironically, 1998 is the year of the tiger - Asian economies take note - in the Chinese calendar.First, the Western won. The US70› level is a crucial psychological level for the C$. It sank below that on Friday as the Bank of Canada, which is alternately wringing its hands and sitting on them as the loonie heads south, failed to act.
Seventy cents is a politically and socially charged barrier. Though the bank will hate to play Grinch, interest rates will have to be raised next week and maybe again the week after or very early in the new year to let the markets know a line has been drawn in the sand.
If the C$ is not buttressed now, hello US68›, bye-bye bond market, and next stop US66›. If it ever came to US66›, though, there would likely be widespread buying of Canadian assets at firesale prices, which in turn would probably boost the C$.
If we were not living side by side with the U.S., this US70› taboo would not be as strong. But when Canadians are confronted daily by the "number" like a running sports score, they take it very personally and emotionally.Which brings us to the domestic stock market, which investors are beginning to take very personally with seven more trading days left in the year. We hate to bleat and run, but it is now conceivable that the benchmark Toronto Stock Exchange 300 composite index could end up returning little more this year than what those poor souls are earning in - dare we say it? - GICs and term deposits.
The TSE 300 is now below its 200-day moving average, which may be telling us technically that the bear market has arrived, if only in baby form. On the other hand, it may be telling us a buying opportunity is at hand.
A Reuters survey of Bay Street analysts conducted Dec. 12 found that on average they were expecting a TSE 300 return of 17% in 1998. Forgetting for a moment that analysts are paid to be as bullish as they can possibly be, in that they are supposed to look for things to buy, not sell, Canadian stocks may start to look cheap very soon.
We must confess, however, that we have a hard time accepting that there are any compelling fundamental reasons that our resource stocks should suddenly come to life. Who is going to be buying the underlying commodities?The bear is stalking Wall Street, where bonds are looking the best bet for 1998, with some observers calling for a 5% yield on the 30-year treasury from around 5.9% now.
As of Friday, the benchmark Standard & Poor's 500 index was still up 27.8% on the year, with the Dow blue chips ahead 20.2% and the Nasdaq composite 18.1%. But the Dow still has not recaptured the heights of early August and the S&P is below the record of early October. Meanwhile, Nasdaq and its tech stocks clearly have relinquished the role of market leader and are in a bear market of their own.
All this, largely the result of the Asian crisis, does not bode well for U.S. stocks and, by extension, Canadian equities.
But remember, we went into the past two years not expecting to anywhere near match 1995's 35% S&P gain. After advances of 21% in 1996 and about 27% so far this year, few people have great expectations for 1998. Yet that, in the contrarian order of things, is something to keep in mind in this season of hope.
We'll be back in this space Tuesday, Jan. 6, when the view from the Street will have no doubt have changed again.
BUY - HOLD - SELL
AGF Management's Buy & Sell
North American franchise strength to the rescue
Sonita Horvitch - The Financial Post
Laura Wallace, vice-president and portfolio manager at Toronto-based AGF Management Ltd., is focusing on Canadian companies with a strong North American franchise.
Despite the uncertainty in Asia, the North American economy will continue to grow in 1998 albeit at a slower pace than in 1997. Wallace is the lead manager of AGF Canadian Equity Fund, a conservative growth fund with an emphasis on large capitalization stocks. She warned investors to expect sharp moves in both directions in the main North American stock indexes next year. "The events in Southeast Asia will continue to affect the North American capital markets, at least for the first half of 1998," she said.
The expected slowdown in Asian economies will reduce world and North American economic growth rates. Therefore 1998 North American profits will come under pressure. "These may be below the investment community's expectations." At current valuations, North American equities are sensitive to disappointments.
On a positive note, the southeast Asian slowdown will help to lessen inflationary pressures in North America, allaying fears that the U.S. Federal Reserve would have to raise interest rates in the light of the continuing strength seen in the U.S. economy. Another plus, from a flow of funds standpoint, is that international investors are likely to view North America as a safe haven. Canada's challenge will be to work its way through its currency weakness. One problem is that Canada is viewed as an exporter of resources, where prices are under pressure. "There is little acknowledgment of the growing significance of non-resource exports such asautos, auto parts and high technology," said Wallace.
In choosing companies with a strong North American franchise, Wallace is highlighting those active in retailing and communications, given the increase in consumer spending. She has added to her holdings in Sears Canada Inc. (SCC/TSE), which closed recently at $19.75 and has a 52-week trading range of $25.75 to $9.90. The stock was her pick in this column, May 6, at $14.90.
In the communications sector, her pick is Toronto-based Baton Broadcasting Inc. (BNB/TSE) $24.50 ($25-$6.90). The television broadcasting company's earnings should be strong in 1998 and 1999, she said. The company is under new management and advertising revenue should be strong, said Wallace.
The money manager is also favoring the print media sector.
Wallace has increased her holdings in the financial services sector. Her two favorites are Montreal-based Royal Bank of Canada (RY/TSE) $76.05 ($82.50-$46) and Toronto-based Toronto-Dominion Bank (TD/TSE) $53.95 ($55.25-$33.50). Wallace said both banks should show strong growth relative to their peers. Despite recent upsets in the equity market, she expects the fee-related business of the pair to remain strong.
Large Canadian high-tech companies have been the subject of downward earnings revisions. "But many of the mid-cap companies with a strong North American focus continue to offer good earnings visibility," said Wallace, who picked three favorites: Markham, Ont.-based Geac
Computer Corp. Ltd. (GAC/TSE) $46.75 ($48-$12.55), which sells, services and rents medium to large scale computer systems, Toronto based Leitch Technology Corp. (LTV/TSE) $40.75 ($45-$24), which makes and markets electronic equipment used by television broadcast facilities and Thornhill, Ont.-based ATI Technologies Inc. (ATY/TSE) $32.20 ($32.25-$15.65), which makes and markets personal computer
graphics and multimedia products.
Wallace has reduced her exposure to metals and minerals. "This sector is the most vulnerable to the slowdown in growth in Southeast Asia." These countries will sharply curtail infrastructure development in 1998. Wallace has sold holdings of nickel producer Inco Ltd. (N/TSE) $25.50 ($51.45-$24.25) and aluminum producer Alcan Aluminium Ltd. (AL/TSE) $39 ($55.70-$37.10).
Volatility marks Canada's high-tech industries
Canadian press
It's been a manic year for Canada's high-tech industries. Wild swings between elation and depression were commonplace as the rapidly changing information economy anointed some with riches while saddling others with debt.
It's an industry that has grown to become larger than fishing, forestry, agriculture and transportation combined. But it became notorious this year for its volatility and extreme shortage of skilled workers.
Gaylen Duncan, chief executive of the Information Technology Association of Canada, focuses on the rosey side of 1997.
"It was the year that high-tech emerged as the engine of growth for the economy," he says, ready with charts and graphs to prove it.
Indeed, the numbers are impressive. But the best way to see what's going on is to have a look at companies like Northern Telecom and Newbridge Networks.
In June, Nortel said it would spend $250 million over four years expanding its Ottawa operations and hiring 5,000 "knowledge workers" to meet demand for its telecommunications gear.
Nortel, based in Brampton, Ont., then announced plans to hire another 1,000 in Montreal. More than 1,000 jobs have been created at Nortel's Calgary plant in the last three years.
The company, which employs 70,000 worldwide, had revenues of $12.8 billion US last year and is Canada's biggest exporter of technology products.
Meanwhile, Newbridge Networks Corp., based in Kanata, Ont., said it needed another 4,000 new workers over four years to satisfy international hunger for its data network equipment.
Duncan says high-tech growth has been so rapid in the Ottawa area that it has more than offset the massive job cuts that have diminished the ranks of the federal government the last three years.
The booming demand for high-tech products is being fuelled by worldwide deregulation of the telecommunications industry and the so-called convergence of computers and other technologies.
But companies like Newbridge and Nortel have loudly lamented the fact that they can't find enough qualified applicants for all those new jobs.
In fact, the so-called skills gap in Canada amounts to about 30,000 unfilled positions, says Dan Potter, chief executive of the Information Technology Institute, based in Halifax.
"It's an acute problem," says Potter, whose private schools train university grads to work in the information trade.
The growth of Potter's business proves the point.
In 1995, he had one school in Halifax earning $2.5 million a year. The institute doubled its revenues in 1996, then tripled them to $15.7 million this year with four schools in Halifax, Moncton, N.B., Ottawa and Toronto.
Potter's students may be scrambling to keep up with job offers, but they'll have to choose wisely. The path to high-tech pot of gold was left littered this year with plenty of corpses and walking wounded.
Ottawa's Corel Corp., once the darling of Canada's software industry, was pummelled by a barrage of bad news. Poor sales of its well-known WordPerfect software drove the firm into the red for three consecutive quarters.
The company recently announced it expects to lose $95 million US in its fourth quarter alone, about $230 million US over the last nine months. Its stock plunged from a 52-week high of $10.95 to a new low of $2.54.
Indeed, technology stocks in general - even Nortel and Newbridge - showed a stunningly elastic nature this year.
"They were all over the map," said Patricia Croft, portfolio manager at Sceptre Investment Counsel in Toronto.
"They were a market leader at one point, but fell back as we began to come to grips with overproduction and supply. They were a Cinderella that turned sour."
Cheryl Nesbitt, analyst at Scotia Captial Markets in Toronto, agreed.
"There was huge volatility, right from the beginning."
Duncan of the Information Technology Association has a simple explanation.
"We're an emerging industry, and we're highly volatile because of the rate of change. What looks like a hot product on Monday sometimes ... doesn't even exist by Wednesday."
Several firms learned that lesson the hard way in 1997.
-In October, Ottawa software developer Fulcrum Technologies Inc. slashed 80 jobs and warned that it would lose $8 million in its third quarter after sales went into a tailspin.
-The assets of insolvent Gandalf Technologies Inc. of Kanata, Ont., were liquidated this year after the computer networking company finally succumbed to years of mounting losses. Unsecured creditors were owed $10 million US.
-Istar Internet Inc. of Ottawa was sold for $35 million to American Internet provider PSInet Inc. On its first day of trading in November 1995, Istar stock shot to $17.75, up 48 per cent - one of the biggest one-day climbs in the history of the Toronto stock market. After the PSInet bid was announced, its shares hovered just above $1.
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