BUSINESS

THE BULL IS BACK

CASH-STARVED COMPANIES RUSH TO ISSUE STOCKS AS LOW INTEREST RATES HEIGHTEN MARKET DEMAND

DEIRDRE McMURDY May 3 1993
BUSINESS

THE BULL IS BACK

CASH-STARVED COMPANIES RUSH TO ISSUE STOCKS AS LOW INTEREST RATES HEIGHTEN MARKET DEMAND

DEIRDRE McMURDY May 3 1993

THE BULL IS BACK

BUSINESS

CASH-STARVED COMPANIES RUSH TO ISSUE STOCKS AS LOW INTEREST RATES HEIGHTEN MARKET DEMAND

If the stunning increase in Kenneth Barnes’s business is any indication, the Canadian stock market is on a roll. Barnes specializes in organizing so-called dog-and-pony shows—elaborate presentations where companies issuing new stock try to drum up sales interest among investment brokers and such large institutional clients as pension fund managers. Barnes, now, is even busier than he was during the investment boom that broke six years ago. Trading volumes on the Toronto Stock Exchange, after a laggard performance during the recession, have recently returned to the frenzied levels before the stock-market crash in October, 1987. Now, the cash-starved Canadian companies that have survived those lean years are rushing in aggressively to take advantage of the renewed public demand for stocks. In March alone, Canadians bought more than $1 billion in domestic equity mutual funds, compared with $305 million worth in March, 1992. Foreign investors have bought a record $15.5 billion in Canadian stocks and bonds over the past three months. As a result, Toronto-based Barnes is now stage-managing two major presentations a month—twice the number he did in the expansionist market in the first three quarters of 1987. “The market is way ahead of 1987 in many ways,” he said. “Appetite is strong but it’s an educated palate and investors are very choosy and price-conscious.”

The underlying reasons for the stampede into stocks are clear. Since the short-lived turbulence surrounding the constitutional referendum last fall, the prime interest rate has steadily declined to its current level of six per cent, the lowest since 1973. As a result, fixed-income investments, including treasury bills and guaranteed investment certificates, which offer returns pegged to those rates, have become significantly less attrac-

tive. At the same time, the near-collapse of Canadian commercial real estate markets has eliminated a traditionally strong rival for investment dollars.

In part, Canadian equities are also benefiting belatedly from the depth and three-year duration of the domestic economic recession. In the United States, the recovery and the corresponding increase in stock-market prices and trading volumes began almost two years ago. The Toronto Stock Exchange 300 Composite Index is still about 12 per cent below its pre-crash peak set in August, 1987, while in New York City, the Standard & Poor’s 500 Index is already about 30 per cent above its 1987 crest. That means that Canadian companies that improved productivity and lowered costs to survive the recession are now perceived to be relative bargains.

As those diverse elements converge, they have contributed to a profound psychological shift on the part of investors. When that finally happens in an economic cycle, demand tends to rapidly gain momentum and jolt languishing stocks forward. Said Donald Dillistone, a technical stock analyst in Winnipeg with Richardson Greenshields of Canada Ltd.: “People are now terrified of missing any gains in the market and they’re scrambling to outguess one another on the next hot spot.” The fact that first-quarter corporate earnings have been relatively unspectacular indicates that investors are still betting on companies’ future, rather than actual, performance. So far, only resource commodity producers, which export lumber or natural gas to the United States, have seen their profits rise sharply. The market, however, appears to be anticipating a broader improvement. Said Leon Tuey, an independent Vancouver-based portfolio manager: “You don’t make money looking in the rearview mirror. Market activity is based on what people bet is going to happen.” Compared with those of other major industrialized countries, Canada’s economic prospects appear to warrant the current level of enthusiasm. And even though the country’s business and political communities are in the throes of a public-debt crisis, in-

vestment industry analysts report that foreign investors are displaying strong interest in Canadian stocks. In February, according to Statistics Canada, foreign investors spent $9.1 billion on Canadian bonds and $965 million on stocks—the highest amount since just before the 1987 crash.

Canada’s popularity is rooted in forecasts for growth in the gross domestic product by about 3.5 per cent for 1993. That compares with estimates of so-called negative growth for Germany and growth of about one per cent for Japan this year. As well, central banks in both of those countries have steadily reduced their interest rates in a bid to prevent their respective economies from slipping further—making equity returns in Canada’s recovering economy even more attractive. On April 22, the Bundesbank in Frankfurt surprised international markets by dropping its influential discount rate, for the

third consecutive time, to 7.25 per cent from 7.5 per cent. In Japan, the central bank rate has dropped six times since July, 1991, to its present level of 2.5 per cent.

Despite the recent surge of confidence in Canada’s prospects, however, it is increasingly apparent that the severity of the recession has led to some fundamental changes in the economy. Those changes, in turn, are contributing to an unusual pattern of recovery. A study released last week by the Confer-

ence Board of Canada in Ottawa noted that while optimism has rebounded in business circles, the average Canadian remains gloomy. Said Paul Darby, the board’s director of forecasting: “Domestic demand is far below its usual level at this point in a recovery cycle.”

According to Darby, unemployment rates of about 11 per cent, continued corporate layoffs and growing concerns about major tax increases and public program cuts have dramatically curtailed consumer spending. Even though debt as a percentage of disposable income has steadily decreased, seasonally adjusted retail sales figures for February show a 0.7-per-cent drop from the previous month to $15.9 billion. And housing starts, which strengthened to an annual rate of 170,000 units last fall, fell to a 150,000-unit rate in March.

Another key difference in this post-recession period is the role played by government. For the first time since the Second World War, economic health is not being restored by government spending and the corresponding expansion of credit or money supply. Indeed, both federal and provincial governments are mired in

severe debt crises that inhibit them from playing their past role in kick-starting the economy with capital spending programs.

However unfamiliar the economic landscape may now look—especially in light of the number of companies that have disappeared or dramatically restructured—Tuey says that the market remains fundamentally unaffected. “Every cycle is different, but the chain of events never changes and human nature never changes,” he said. According to Tuey, the key to understanding markets lies in the scrutiny of central bank policy—whatever variables may be present. “Whenever the economy slumps, central banks ease up on interest rates and that pumps up the market,” said Tuey. “It’s like a law of nature.” And in such a cyclical and volatile business, Mother Nature is as sound an indicator as any.

DEIRDRE McMURDY