Black Monday’s long hangover

D'ARCY JENISH December 14 1987

Black Monday’s long hangover

D'ARCY JENISH December 14 1987

Black Monday’s long hangover


After months of speculation, the Royal Bank of Canada announced last week that it has found a partner in the securities industry. Other major banks and brokers began announcing mergers and partnerships almost a year ago, but the Royal’s tardiness has paid off, according to some experts. By striking a deal after the stock market crash of Oct. 19, the bank saved an estimated $100 million on its purchase of 75 per cent of Toronto-based Dominion Securities Inc. And other repercussions of the October crash continued to surface last week. Toronto-based Wood Gundy Inc., one of Canada’s oldest and largest brokers, announced on Dec. 2 that it has laid off about 150 of 2,100 employees. Meanwhile, fears of economic turmoil and possibly even a recession were heightened all week as a result of two major daily drops in stock market indexes.

The latest gyrations in the financial markets, according to most observers, revealed that investors remain nervous about structural economic problems such as the $194-billion U.S. budget deficit and world trade imbalances. Yet many economists still argue that volatile stock markets do not necessarily mean that the economy as a whole is headed into a tailspin. They note that inflation is under control, interest rates are stable and unemployment has dropped over the past year. The economy could still be badly hurt if it turns out that consumer confidence has been shaken by the stock market crash. But last week automobile manufacturers, whose sales are one good indicator of consumers’ willingness to spend, released November figures that showed domestic car sales up more than nine

per cent over November, 1986, and foreign car sales up 14 per cent. At the same time, Canadian retailers were confidently predicting a strong Christmas season. Said Elliott Wahle, president of Toronto-based Toys-R-Us (Canada) Ltd., a leading chain of children’s stores: “We are very bullish about Christmas.”

While the debate over the economic impact of the market crash continues unresolved, the Royal Bank-Dominion Securities deal culminates a year of dramatic restructuring in the Canadian securities industry. Since the federal and provincial governments loosened their rules on the ownership of brokerage companies last June, Canada’s five largest banks have either bought or formed partnerships with brokers. Two Canadian trust companies have also bought into brokerage firms, while six foreign banks or securities firms have purchased interests in Canadian brokers. But by being the last to buy, the Royal, Canada’s biggest bank, has struck the best deal.

The bank has offered approximately $385 million, or about $23 per share, for 75 per cent of Dominion Securities. But only one-third of the purchase price is cash. The remainder will be Royal Bank shares. Allan Taylor, chairman of the bank, said that the new partnership “will considerably broaden the range of our financial products.” For his part, Dominion Securities president Anthony Fell said that his company “will be responsible for all the securities activities for the Royal Bank worldwide.”

As part of the announcement, Dominion Securities said that its book value, or the historical value of the company’s assets minus depreciation, is about $10 per share, meaning that the Royal paid about 2Z3 times the stat-

ed value of the company. By comparison, the banks that bought brokers before the Oct. 19 crash paid as much as five times book value. Jeffrey Carney, financial services analyst with Merrill Lynch, said that the Royal could not have anticipated the market crash. But by holding out for a better price after the market declined, the bank struck a better deal, he said. “They probably saved themselves $100 million,” added Carney.

At the same time as the Royal BankDominion Securities deal was announced, senior executives at Wood Gundy were handing out layoff notices. And over the previous week Merrill Lynch Canada Inc. dismissed eight of its 380 brokers after their sales vol-

umes declined. Wood Gundy had hired about 300 new employees in the past year while the stock market was booming. But vice-chairman Edmund King said that now about 150 employees are being laid off. The layoffs will affect most departments in Toronto and branch offices across the country. Wood Gundy, King added, is merely responding to the decline in new share issues and stock market activity since the crash.

Meanwhile, the world’s stock markets continued to react to the upheavals that began on Oct. 19 when the New York Stock Exchange’s critical Dow Jones industrial average plummeted a record 508 points, or 22.62 per cent. On that day, known as Black

Monday, the Toronto Stock Exchange (TSE) equivalent to the Dow, its 300 composite index, lost an unprecedented 407 points—11 per cent. The TSE index was at 3,080 points at the beginning of November, and by Friday, Nov. 27, after a month of fluctuations of as much as 77 points a day, it was little changed at 3,086. Then, on Monday, Nov. 30, it skidded nearly 108 points, while the Dow dropped 77 points that day. And last Thursday both indexes dropped 73 points. At week’s end, Toronto was down 177 points and New York 144 points from the previous Friday.

Several conflicting trends appear to be contributing to the market volatility. Statistics Canada reported last week that net foreign purchases of Canadian stocks hit a record $2.8 billion during the months of July, August and September, the third straight quarter in which new highs were achieved. Since the crash, according to Wood Gundy executive vice-president John Plaxton, foreign institutional investors have been selling Canadian stocks because the Canadian dollar has fallen with its American counterpart against other major world currencies. At the same time, dozens of Canadian companies are moving into the market to buy back their own stock at reduced prices. “I think that the stock market will continue to react negatively,” added Milton Wong, president of the investment-management company M. K. Wong & Associates Ltd., based in Vancouver. “It is like tremors after an earthquake.”

But many analysts are now looking to the Christmas shopping season for a clear signal of where the economy is going. November and December are critical months for retailers. More than onequarter of all department-store and adult-clothing sales occur in those two months. And after posting record sales in 1986 many retailers, anticipating another boom year, committed themselves to large Christmas inventories long before the market crash.

Retail sales to the end of September, the latest figures available from Statistics Canada, jumped about nine per cent in Ontario and Quebec over the same nine months of 1986, and six to eight per cent in British Columbia and Atlantic Canada. In Alberta, Saskatchewan and Manitoba, sales were up three per cent. John Winter, a vice-

president of Toronto-based Clayton Research Associates Ltd., said that despite the Oct. 19 crash, sales appear to be normal across Canada. Winter added that a slight improvement in employment opportunities in Alberta since the start of the year could boost Christmas sales there. But elsewhere, he said, there have been no new significant economic changes that would stimulate greater sales over Christmas.

Even a proliferation of early December and pre-Christmas sales is not necessarily a sign of trouble, said Brent Houlden, a senior manager with the accounting firm Touche Ross & Co. in Toronto. Many consumers will not buy until they see price reductions, Houlden added. As a result, many merchants now make allowances for sales by starting the Christmas season with large enough price markups to accommodate reductions.

By the end of November the market crash appeared to have had little lasting effect on Canadian consumers. Said George Kosich, president of Hudson’s Bay Co.: “The crash has not affected our sales at all.” The company includes Simpsons Ltd. and Zellers Inc., which both posted 15to 20-per-cent increases in revenue last month over November, 1986, Kosich said, while Hudson’s Bay store sales jumped close to 10 per cent. But not all retailers reported similar results. Barry Slawsky, president of San Francisco Gifts Ltd., an Edmontonbased gift-store chain with 72 outlets from Vancouver to Thunder Bay, said that his November sales were down 20 per cent from a year earlier. By last week, he said, he was already discounting some Christmas merchandise.

In the United States, several leading analysts are predicting a fourto fiveper-cent increase in retail sales this month over December, 1986. “Black Monday has come and gone,” said Susan Schmierer, senior retail-trade analyst at Prudential-Bache Securities Inc. in New York, “and so has the risk of a major retrenchment.” If that proves to be an accurate reading of consumer confidence, the U.S. and Canadian economies—apart from their securities industries—may survive the crash of 1987 without a major economic catastrophe.