BUSINESS

THE BULLS ARE RUNNING

IGNORING GRIM ECONOMIC SIGNALS, NORTH AMERICAN INVESTORS PROPEL STOCK PRICES TO DIZZY NEW HEIGHTS

DEIRDRE McMURDY,JOHN DALY January 27 1992
BUSINESS

THE BULLS ARE RUNNING

IGNORING GRIM ECONOMIC SIGNALS, NORTH AMERICAN INVESTORS PROPEL STOCK PRICES TO DIZZY NEW HEIGHTS

DEIRDRE McMURDY,JOHN DALY January 27 1992

THE BULLS ARE RUNNING

BUSINESS

IGNORING GRIM ECONOMIC SIGNALS, NORTH AMERICAN INVESTORS PROPEL STOCK PRICES TO DIZZY NEW HEIGHTS

At first glance, few companies appear to have less appeal for investors than embattled Nova Corp. Battered by weak world demand for its petrochemical products, the Calgary-based company lost $250 million in the nine months that ended Sept. 30. It also replaced two of its senior executives recently and wrote down its assets by $675 million—an acknowledgment that falling chemical prices have reduced the value of the company’s holdings. But last week, as North American stock markets surged to new highs, Nova issued $240 million of new common stock—and investors snapped up the shares within hours. According to Frank Mersch, who invests money for Altamira Capital Corp., a Toronto-based mutual fund company, buyers are betting that an economic recovery will soon improve corporate profits throughout North America. “Perception and confidence are critical to the market,” said Mersch. He added: “Everyone is buying aggressively.”

Although there have been few concrete signs of an economic recovery to date, North American stock markets are clearly anticipating that the worst of the recession is over. In the past six weeks, the New York Stock Exchange’s bellwether Dow Jones industrial average has climbed by 13 per cent, closing last week at 3,264.98. The Toronto Stock Exchange 300 composite index, in turn, has climbed by 9.5 per cent, closing last week at 3,658.3. The wave of buying has been propelled by the continuing decline in North American interest rates, which has fuelled hopes of an economic upturn later this year. When a recovery begins, economists say, companies that have laid off workers and reduced production capacity should be well-positioned for growth. Said Larry Lunn, chairman of Connor, Clark & Lunn, a Vancouverbased investment firm: “The stock market generally tells you what the rest of the economy is going to do.”

The initial cause of the sharp climb in stock prices over the past month was the U.S. Federal Reserve Board’s unexpected decision on Dec. 20 to slash its discount interest rate by a full percentage point, to 3.5 per cent. That was the largest cut since 1981, and it sent an unmistakable signal to financial markets that the Bush administration is determined to kick-start the economy before the presidential election in November. The Bank of Canada, which has followed a similar policy in hopes of fuelling a recovery, last week lowered its own rate by 0.13 percentage points to 7.2 per cent—the lowest level in almost five years.

The drop in interest rates has led large financial institutions and individual investors to pull their money out of government treasury bills, term deposits and other investments that are pegged to current interest yields. Seeking higher returns, they have invested much of that money in stocks—sparking spectacular share price hikes in recent weeks. Declared Orest Ludwick, manager of the Winnipegbased Investor’s Growth Fund: “Billions of dollars are now looking for a new home—there has been a massive unleashing of capital.” He added: “Until it finds that home, the market will be driven forward.”

On Bay Street and Wall Street, investors are betting that good times are just around the corner

The market’s new momentum has already pushed up the price of high-quality bank stocks and other blue-chip equities. More recently, however, it is the so-called cyclical stocks, especially those in the hard-hit resources sector, that have posted the strongest gains. During a recession, when construction and manufacturing activity decline, those stocks slump along with the demand for products such as lumber, paper and metals. But when a recovery is in sight, prices in those sectors rise. Indeed, last week, metals and minerals shares were among the Toronto market’s strongest performers. Said Ludwick: “The strength of the cyclicals indicates a belief that the economy is turning.”

Share prices in high-risk areas like biotechnology have also shown surprising strength recently. According to Altamira’s Mersch, that phenomenon echoes the trend in the early 1980s, when high-technology stocks such as those of Mitel Corp. rose sharply on the theory that Canada was becoming “Silicon Valley North.” Said Mersch: “With surges like this in biotechnology, you know there is a lot less caution on the part of investors.”

The surge in share prices is an encouraging signal for the rest of the economy. Since the end of the Second World War, upswings in the stock market have been powerful indicators of broader recoveries. Jeremy Siegel, a professor of finance at the Wharton School in Philadelphia, said that U.S. stock markets have hit bottom and then posted a major rally eight times since the war. On average, the economy has followed the markets upward five months later. Noting that the current rally began in December, Siegel predicts that the economy will begin to rebound in April or May. Declared Siegel: “I think we are headed for a recovery.”

The prevailing optimism among stock-market analysts has created a glaring contradiction: as many investors see it, even the economic storm clouds have attractive silver linings. Recently, buyers have snapped up shares in companies that announced major layoffs, plant closures or other cost-cutting initiatives. Investors are counting on the austerity measures to make those companies more efficient when the economy recovers. Shares in New York-based Citicorp, for one, have climbed by more than $7 in the past month, despite reports that the bank suffered heavy losses in the fourth quarter of 1991.

Financial-services analysts said that Citicorp’s decision to cut costs by trimming management helped to convince investors that the company was returning to health after stumbling badly earlier in 1991. Similarly, shares in IBM Corp. jumped despite the company’s $3.2billion loss last year.

Some analysts claim that the market’s positive response to the spate of depressing economic reports was entirely predictable. Investors tend to prefer negative reports to lingering uncertainty because it helps them to identify the bottom in a downward economic spiral. Significantly, it was not until the end of 1991 that most major North American corporations revealed the full extent of the damage to their balance sheets. Said Ludwick: “Uncertainty is worse than bad news.”

But other experienced investors warn that the surge of buying over the past few weeks may be premature. Peter Anderson, senior vice-president of IDS Financial Services in Minneapolis, which administers more than $9.1 billion in pension fund assets, says that lower rates, by themselves, will not likely be enough to spur consumer and business spending. Said Anderson: “The assumption is that lower rates will translate into higher earnings. But we do not believe that is the case.”

He added that the rally has already pushed the prices of most stocks close to historically high levels relative to expected profits. As a result, Peterson said, he has sold close to $630 million in stock over the past two months.

Some money managers are even more pessimistic. Montreal-based Stephen Jarislowsky, for one, claims that the North American economy is heading for a depression. Jarislowsky, the 66-year-old president of Canada’s largest private pension fund management firm, Jarislowsky, Fraser & Co. Ltd., which administers over $12 billion in assets, says that inexperienced portfolio managers are caught in a wave of false optimism. “They do not know that, historically, there have been such things as deflation,” he said. “They all think it is another 1982. I think it is another 1932.”

Perhaps the only certainty at a time of conflicting signals is that it is risky to be firmly in the camp of either the bulls or the bears. Kim Shannon, an investment manager with Toronto-based Royal Insurance Co. of Canada, said that she is buying and selling cautiously to avoid being caught in a possible “bear trap”—a sudden market collapse. “You can’t predict the market at the best of times, but it’s especially easy to spook people when there is a mood of euphoria. These gains are anticipatory, and the downside could be nasty,” she said.

Until now, however, investors have been casting aside their doubts. And as stock markets continued their heady ascent last week, even the pessimists conceded that the surge of confidence could become a self-fulfilling prophecy—nudging the economy at least a little further along the road to recovery.

DEIRDRE McMURDY and JOHN DALY