MARKET WRAP -5 / Weekend Investing Commentary-Reviews 12/11/98
Bay Street Beat: The Year Santa Forgot Bay Street
Canadian stock investors must feel as if they've been slighted by the man in red.
The traditional December "Santa Claus" rally looks likely to pass Wall Street and Toronto's Bay Street by this year, frightened off by a round of fourth-quarter corporate profit warnings and jitters about the U.S. impeachment hearings.
"If you look back at past Decembers, there has been a substantial number of Decembers that have done very well. But this year, I don't think it's going to be the case," said Fred Ketchen, senior vice-president and director of equity trading at ScotiaMcLeod Inc.
"Confession session at the end of the year is good for the soul. It's also lousy for the stock market."
Companies who expect their earnings to disappoint often use what traders refer to as "confession period" -- usually the last month of a quarter -- to lower analysts' expectations and lessen the impact of earnings disasters.
"Companies try to beat expectations but they have to lower expectations before they can beat them," said Robert Normand, chief economist and strategist, Levesque Beaubien Geoffrion.
"Maybe in January we will see that the fourth-quarter profits will not be very good for lots of companies."
On Friday, U.S. and Canadian markets were unsettled when the U.S. House Judiciary Committee approved three articles of impeachment. The articles, alleging perjury and obstruction of justice by President Clinton, go to the House of Representatives for a vote this week.
On the week, the Toronto Stock Exchange TSE 300 Composite Index was down 80.28 points, or about 1.3 percent, ending Friday at 6258.76.
Strategists do not see a major return to November's strength any time soon.
Triple-witching options expiry this week will boost volumes and volatility. In addition, as the December 22 policy-making Federal Open Market Committee draws nigh, the market will again be rife with doubts about whether the U.S. Federal Reserve will cut interest rates.
"If the Fed decides to wait and see the result of Christmas sales in the U.S. and just delay its cut...with all these bad earnings coming to the market, maybe we could see a weakening of the stock market before the end of the year," said Normand.
The erosion in commodity prices -- January Brent crude oil has dropped below $10 a barrel -- has been particularly worrying for Canadian market strategists who said the autumn rally was based on hopes that with stabilizing world economies, commodities would appreciate.
There are technical issues as well. Toronto's rally dwindled before establishing any clear break-out. Technical analysts, who study stock market charts as strategists probe the economy and market mood, believe that failure in the rally may signal further losses.
"Toronto has even failed to move above its 200-day moving average. That's very negative because if you can't get above your 200-day moving average it's like having a wall and having a sense that you can't climb over, having a fence with sharp barbed wire on top," said technical analyst Ron Meisels, president of P and C Holdings in Montreal.
"It fizzled out seriously below it."
Meisels said the TSE 300 may well need to sink to the 6,000-point level before investors will be compelled to bargain-hunt.
Experts high on bonds, low on stocks
BULLS Vs. BEARS
Monday, December 14, 1998
CAROLYN LEITCH - Globe & Mail
Market professionals predict Canadian bond prices will be higher six months from now, indicating they believe interest rates will head lower, according to the latest Globe and Mail Bulls v. Bears survey.
The survey also shows that experts expect equity markets in New York and Toronto to remain mired in the doldrums, in keeping with warnings last week about corporate profits.
Sixty-seven per cent of survey respondents forecast the price of the 30-year Government of Canada bond will be higher in six months, while only 7 per cent foresaw a lower price. That compares with 54 per cent calling for a rise and 29 per cent predicting the bond price will head south, in the previous survey two weeks ago.
The balance of opinion -- the bearish percentage subtracted from the bullish -- stands at 59.3, the most positive stance on bond prices in three months.
On Friday, the 30-year bond yield fell to 5.06 per cent -- a record low for the fourth consecutive day -- amid expectations that slowing economic growth will hamper corporate profits and prompt central banks to lower borrowing costs.
The outlook on stocks remains unenthusiastic. Those pundits calling for the Standard & Poor's 500-stock index to close higher six months from now strengthened marginally to 34 per cent from 28 per cent in the previous survey.
Those predicting a drop in the benchmark index edged down to 45 per cent from 48 per cent. That puts the balance of opinion at minus 10.4, somewhat less pessimistic than the minus 20.7 recorded in the previous survey.
In Friday trading, U.S. stocks were mixed, with Coca-Cola Co. joining the list of Dow Jones industrial average companies warning investors that profits will likely fall short of forecasts.
For the week, the S&P 500 fell 0.9 per cent, as the threat of impeachment proceedings against U.S. President Bill Clinton unsettled the markets.
The S&P 500 has risen 22 per cent since Oct. 8, when the market decline that began in mid-July slumped to its lowest level.
The experts' sentiment toward the Toronto Stock Exchange's 300-stock composite index remained steady.
Respondents looking for a rise in the Toronto market six months from now weighed in at 48 per cent, compared with 34 per cent who expect it to fall. Two weeks earlier, 52 per cent were optimists and 38 per cent were pessimists.
The balance of opinion stayed at 13.8 for both surveys. The percentage calling for no change, meanwhile, increased to 18 per cent in the most recent survey from the previous 10 per cent.
In last week's trading, the TSE 300 lost 1.3 per cent as the same dire outlooks that rattled U.S. markets unsettled Toronto.
T. Eaton Co. Ltd. joined the household names that dampened expectations when it said fiscal fourth quarter and year-end earnings will fall short of its estimates. Eaton said weaker consumer confidence and unusually warm weather hurt winter-clothing sales.
Experts also didn't change much in their opinion on the price of gold, with 42 per cent of respondents predicting a rise and 15 per cent forecasting a drop. That compares with 41 per cent expecting an improvement and 11 per cent looking for a decline two weeks earlier.
On Friday, the price of bullion ended the day at $290.85 (U.S.).
Bulls v. Bears is a proprietary survey developed by The Globe and Mail as an indicator of Canadian professional market sentiment. There were 29 respondents.
THE INVESTMENT PROS FIGHTS IT OUT
Every two weeks we survey money managers, strategists and advisers on where they expect financial markets to be in six months -- up, down or unchanged. Here is what they think this week.
The rest are neutral.
UP / DOWN
TSE 300.............48% / 34%
S&P 500............34% / 45%
Bond prices........67% / 07%
Gold...................42% / 15%
Wall Street Ahead - Profit Warnings And Impeachment
Wall Street, fearful the global economic turmoil has come home to roost after a raft of gloomy profit projections from multinational companies, is bracing for a new round of warnings even as impeachment proceedings threaten to unsettle the political environment.
In the past week, bad news from Dow companies ranging from aerospace giant Boeing Co. <BA.N> to drug maker Merck and Co. <MRK.N> to soft drink bellwether Coca-Cola Co. <KO.N> have eroded the confidence that fueled a furious blue-chip surge.
The approaching end of the fourth quarter means more such warnings are likely.
"We're in the warnings season, so there are a lot of announcements next week and everyone is scared stiff," said Hugh Johnson, chief market strategist at First Albany Corp.
Meanwhile, the impeachment process against President Bill Clinton is expected to dampen investor psychology.
The House of Representatives' Judiciary Committee voted Friday to recommend impeachment of Clinton, which will now be considered by the house of Representatives. A vote by the full House is expected late this week.
Around the same time as the expected vote, the volatility and activity on Wall Street will almost certainly rise with anticipation of Friday's "triple-witching" expirations of stock options and index options and futures.
Wall Street will also keep Brazil's attempts to mend its troubled economy within its field of vision, mindful of the jolt markets received when that country's legislature rejected reform measures linked to International Monetary Fund aid.
"The market is very reactive to Brazil," said Barry Hyman, chief market strategist at Ehrenkrantz, King and Nussbaum. "Brazil is a big exposure in terms of U.S. banks and it is also 20 percent of our export market."
In what should be the last big week of the year for initial public offerings, two new Internet darlings, InfoSpace.com <INSP.O> and Pacific Internet<PCNTF.O>, could turn red hot when they sell their shares to the public for the first time.
Elsewhere in the Internet sector, investors will look at comment accompanying results from CMG Information Services <CMGI.O>, the publicly traded Internet venture capital firm.
The company is viewed as something of an industry benchmark because it has big stakes in Lycos Inc. <LCOS.O> and GeoCities <GCTY.O> and investments across the Internet spectrum.
Analysts agree, however, that corporate earnings announcements will serve as the main guide. Last week, the Dow fell 194.38 points, or 2.2 percent to 8,821.76, weighed by gloomy projections from global companies.
"The way the global financial crisis shows up on our doorstep is when a company tells you sales and earnings will be lower than expected," said First Albany's Johnson.
In the oil patch, an area of weak earnings that has recaptured investor attention because of eye-catching merger deals, analysts meetings by Chevron Corp <CHV.N> and Shell/Royal Dutch<RD.AS><SHEL.L>, which rumored to be mulling a pairing, will draw attention.
The companies have declined to comment on the rumors but Chevron has said a discussion of merger and acquisition plans are not on the meeting agenda.
Markets Take A Rosier World View
After a months-long spell of global gloom, investors seem to be taking a brighter view of the world economic outlook as 1998 draws to a close.
While Wall Street has rallied strongly through the autumn, it isn't just the U.S. stock market that has staged an impressive comeback from the severe summer selloff.
Depressed foreign markets from Canada to China and Latin America have posted gains of 20 per cent or better in the last three months. Indexes of international and global stock mutual funds calculated by the research firm of
Lipper Inc. now show gains of more than 10 per cent since a year ago at this time.
"The worst may well be over for a battered and bruised global economy," says Stephen Roach, chief economist at Morgan Stanley Dean Witter & Co.
Roach and other analysts give much of the credit for the improved atmosphere to rescue efforts aimed at supporting countries troubled by debt and currency problems -- and to moves by the Federal Reserve, the Bank of Canada and other central banks to lower interest rates to boost economic growth.
"The Fed has lifted spirits with three consecutive interest rate cuts, which should limit the downside risk in the market," says John Manley, investment strategist at Salomon Smith Barney Inc.
Even the most optimistic observers temper their enthusiasm by noting that many of the big questions overhanging the markets during the summer have by no means been resolved. For instance, worldwide commodity prices have slumped again lately, stirring up renewed worries about deflation.
"Despite the restoration of more orderly conditions in the financial markets over the last six weeks, ominous threats to the U.S. economy persist," says David Resler, chief economist at Nomura Securities International Inc. in New York. "Indeed, deflation pressures have intensified."
Adds Manley, "Asia is still riddled with excess capacity and Latin America's economy is faced with a sustained period of zero or even negative growth."
A typical issue confronting investors right now is the decline of oil prices to some of their lowest levels in a generation.
This represents a boon to North American consumers, similiar to a tax cut, as it reduces people's outlays for gasoline and heating oil. However, notes strategist Jack Lavery at Merrill Lynch & Co., "Falling oil prices are not purely a boost to growth, but have negative consequences as well.
By depressing oil revenues for such countries as Russia and Mexico, "plummeting oil prices raise serious concerns about international financial fragility," Lavery says.
In Resler's words, "While falling oil prices help ensure that inflation will remain low, they also highlight a new set of risks. Oil producing regions and nations could succumb to the same fate that afflicted the Asian economies after their currency devaluations."
Even though worries like that persist, however, many analysts say the biggest fears of a few months ago have faded. "While parts of Asia, Latin America and Russia are facing significant economic weakness, on balance the global economic picture remains sound," says Edward Kerschner, chairman of the investment policy committee at PaineWebber Inc.
"The aggregate impact of global turmoil on U.S. companies is probably not as great as feared. While some U.S. companies are pressured by lower prices for their products, others are helped by lower costs.
"If the U.S. were to experience deflation in coming years," Kerschner argues, "it would be benign deflation driven by technological progress and accompanied by healthy economic growth."
The Week Ahead
"People are cautious. I think the market [Dow Jones Industrial Average] could go lower from here, perhaps testing the 8500 level," says Alan Ackerman, executive vice president at Reich & Co. Job cuts announced by companies such as Boeing (BA) and Johnson & Johnson (JNJ) have investors worried that more layoffs are on the way, he says. Meanwhile, worries are growing that the U.S. economy is headed for a recession, Ackerman adds. The possibility that impeachment hearings against President Clinton could start next year also have investors nervous.
Still, Friday's strong retail sales report indicates that a key part of the economy, consumption, is still growing. "The number was quite strong. It caused us to revise our consumer spending-growth forecast from 4.5% to 5.5% in the fourth quarter," says Gerald Cohen, senior economist at Merrill Lynch. Strong consumption and the rebound in the stock market from the September lows are offsetting a slowdown in industrial production, giving the Federal Reserve little reason to ease rates again when it meets Dec. 22, Cohen says.
Next week, a few economic reports are worth watching. Tuesday's report on the November consumer price index should show a rise of just 0.1%, mainly because of lower prices for food and energy, says Erik Aarts at ISI Group. LJR Redbook also reports weekly retail sales on Tuesday.
On Wednesday, the Commerce Department's report on housing starts should show a 2.1% rise in November from October to 1.73 million, predicts Aarts. The housing market continues to grow from last year, when housing starts were between 1.5 to 1.6 million. The Federal Reserve reports November industrial production and capacity utilization on Wednesday. Aarts sees industrial production declining 0.4% and capacity utilization falling to 80.5% from 81.8% in October
The trade deficit, which will be released Thursday, should widen to $14.7 billion from $14 billion in October. Thursday's Philadelphia Fed index, which gives economists a first glimpse of manufacturing activity in December, should improve to negative 10 from negative 14 last month, but it still shows that manufacturing continues to be hurt by slowing world economies, Aarts says.
Investors should brace for more profit warnings as the end of the quarter approaches. Retailers such as Bed, Bath & Beyond (BBBY), Best Buy (BBY), Circuit City (CC) and Costco (COST) are reporting quarterly earnings next week. On Wednesday, software maker Adobe Systems (ADBE) is scheduled to report earnings. Footwear maker Nike (NKE) is supposed to report earnings Friday.
The IPO calendar is quieter next week. Infospace.com, a provider of Yellow Pages and maps on the Internet, may try to go public next week after delaying it this week pending a review by the SEC of its prospectus. Other Internet-related IPOs next week are Pacific Internet, Singapore's Internet service provider, and Concur Technologies, a software maker.
The Earnings Mirage
Don't break out the champagne. It looks like the 4.5% S&P 500 earnings growth that Wall Street analysts are forecasting for the fourth quarter isn't the relief investors were hoping for. In fact, strip away the one-time gains and we may have another earnings shortfall, like the third quarter's 3.2% drop in S&P profits.
All the improvement may be due to special, one-time benefits that aren't likely to recur in the first and second quarters, says Chuck Hill, head of research at First Call. In other words, this so-called increase isn't really an increase at all.
Those one-time boosts include the lingering effects of the General Motors (GM) assembly plant strike. Despite the fact that the strike ended in July, ramping up production took a while. By the fourth quarter, lots were full and pent-up demand could be met. GM's earnings are expected to be up 23.7% this quarter. The auto maker's improvements alone will add 2% to S&P earnings, says Hill. That is not likely to happen again next quarter.
Another factor, he says, is that the dollar weakened against foreign currencies during the fourth quarter. That means that companies' overseas sales are suddenly worth more in dollars. That alone could add anywhere from 2 to 5 percentage points to overall earnings.
Add it all up and corporate earnings could be getting an artificial boost of 4% or more. That's why Hill expects things to get worse, not better, in the first and second quarters of 1999 as these one-time benefits evaporate.
Of course, you couldn't predict any of this by just looking at consensus S&P 500 estimates. Wall Street analysts are still predicting double-digit growth in the first half of next year (10.8% in the first quarter and 15.4% in the second). But we already know analysts' estimates aren't to be trusted. As usual, strategists are a little more realistic. Bear Stearns' Elizabeth Mackay is pretty much in the middle of the pack, forecasting earnings expansion of 5% next year.
Still, analysts and strategists agree on one thing: The sectors most at risk this quarter to report lousy earnings are pretty much the same ones that have been suffering all along from Asia's economic weakness. Commodity producers, such as oil, steel and metals makers, will continue to be hurt by both weak demand from Asia and Latin America, as well as falling prices caused by sharply priced imports.
Consumer nondurable makers, like Procter & Gamble (PG) and Coca-Cola (KO), are also suffering as once fast-growing offshore markets grow weak. "Pricing power is falling for companies and you're getting sloppy demand," says Lehman equity strategist Jeff Applegate.
Which companies will suffer next? Auto makers, like GM, which have managed to keep sales and earnings flowing may stumble as cheaper imports grab market share.
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