ECONOMY

Canada - In November, Canadian core CPI fell to only 1.6% on a year-over-year basis, and was flat month-over-month. The all-items CPI was up 2.5% year-over-year due to higher energy prices. The 3-month annual trend is now sitting at zero, and the 6-month trend at 0.9%. The all-items CPI had a 0.3% month-over-month gain due to rising gasoline prices and higher mortgage interest costs. There is now room for another rate cut by the Bank of Canada.

Canadian leading indicators were flat in November. The market had been expecting a small increase. This was the first time since July 2001 that the indicator did not advance. Only three of the sub-components were up. The big decliners were housing and durable goods. The housing sub-component declined by 0.9% month-over-month, while new orders declined by 1.3% month-over-month, following a 1.5% month-over-month decline in October. There were small increases in retail trade and business service employment.

This report suggests that Canadian economy is coming to a halt. Fourth quarter GDP will likely be quite soft.

In October, Canadian total wholesale sales increased by 0.5% month-over-month, much better than expected. In real terms, wholesale sales were up by 2.0% month-over-month, which was the biggest increase since May. There was an 11.3% month-over-month increase in the sale of lumber and millwork products. Sales of household products and motor vehicle parts also increased. Apparel and motor vehicles were both down.

U.S. - US new orders of durable goods for November were up 0.1%, much weaker than expected. Durable good shipments were flat due to weakness in both aircraft and electrical equipment. Core capital goods (non-defense capital goods excluding aircraft) fell by 0.4% in November, following a 2.9% decline in October. There are indications that the outlook for business investment in the US is not as good as had been expected. New orders of core capital goods have now fallen for two consecutive months, and have been negative on a year-over-year basis for 10 of the last 11 months. With consumer spending showing some slowdown, and business investment looking weaker than had been expected, GDP growth in the US is expected to be very modest for the first two quarters of the year.

The estimate today for Social Security and Medicare programs total government liabilities and unfunded commitments for future benefit payments promised are above $53 trillion, up from $20 trillion in 2000. This indicates the need for the creation of considerable amount of money to fund these commitments, which has to have an inflationary impact on the purchasing power of the dollar.

US housing starts fell to 1.19 million units in November. The mix in starts was skewed towards the lower-value multi-unit structures. The value-added of multi unit structures is only about 70% that of a single family home. The housing market continues to be out of balance and the bottom is expected at roughly 750,000 starts in 2009 or 2010. Inventory of homes is very high and will be worsened by rising foreclosures.

Building permits have fallen to their lowest level since mid-1993 and indicate considerably lower starts. Single-family permits are down 34% year-over-year, and are much lower on a three month annualized basis, being down 55%.

Ned Davis indicates that there is $48 trillion in overall credit market debt and $172 trillion in notional derivatives at US commercial banks. The leverage is such that this could cause a major crisis. Most of the damage is in the lower quality mortgage debt. The key is whether the mortgage debt crisis will spread to other sectors, which it seems to be doing. It is important to watch corporate bond yields. If the average corporate bond yields on Baa rated bonds moves down very significantly, it will show that the Fed's easing campaign is having some positive impact. To date, the Fed has lost some of its inflation fighting credibility, and because the housing bubble has not been cleared up, corporate securities have not followed the Feds lowering of its short-term rates.

The ISM non-manufacturing index slipped from 54.1 to 53.9 in December, but the decline was not as severe as had been expected. With new orders improving from 51.1 to 53.5 and employment from 50.8 to 52.1, the non-manufacturing index actually improved slightly from 51.8 to 52.9. The index seems to be at odds with the unemployment numbers that came out for December.

December job growth was much weaker than had been expected in the US at 18,000 net jobs created. Most job creation came from government, and the private sector lost 13,000 jobs. The unemployment rate increased from 4.7% to 5.0%, the highest level since November 2005. Construction lost 49,000 jobs, and manufacturing lost 31,000 jobs. The service sector gained 93,000 jobs, most coming from education and health services, as well as government. Professional and business services were up 43,000 jobs. Every single other category lost jobs. Average hourly earnings increase 0.4% month-over-month, resulting in year-over-year wage growth of 3.7%.

Inflation pressures are still increasing, but the economy is slowing, which puts the Fed in a very uncomfortable position. Employment is also a lagging indicator of growth, and therefore further weakness will likely be in store for the economy. Wage growth, meanwhile, continues quite strong.

November consumption of newsprint by dailies in the US fell 11.2 % year-over-year. Total consumption was down only 9.9% year to date as commercial printers had a 7% year-over-year increase in usage for the first time since March 2006.

Inventories have been reduced by 175,000 tonnes since the middle of the year. At the consumer level there is just 34 days supply, the lowest since 2002. This might possibly support a small price increase.

Offshore exports climbed just 2.2% year-over-year in November. Exports were around 196,000 tonnes, which is below the average of 221,000 tonnes in the previous six months.

International - There is a concern that farmers around the world will not be able to meet demand for wheat. Dry weather is threatening Argentina's crops.  Wheat is now above $10 a bushel for the first time, and has more than doubled in the past year. Rice, soy beans and corn are also up. Fertilizer demand has also increased and potash is expanding capacity to meet this demand.

China, through a subsidiary of China's State Administration of Foreign Exchange, manager of the world's largest foreign exchange reserves, has purchased very small stakes in three large Australian banks. They bought less than 1% in Australian and New Zealand Banks, Commonwealth Bank of Australia, and National Australia Bank.

MARKET

There was a short-term oversold condition which led to a bullish rally near the year-end. There should be some reinvestment demand early in the year; however it is doubtful whether it will produce much of an uptrend as there are too many earnings warnings already, and once companies start to report, expect considerable caution in their guidance.

The presidential election cycle also indicates potential weakness. In the average election year, the Dow, since 1900, has confirmed early year weakness followed by a strong rally into August. This basically confirms my view that the market will see a downtrend in early 2008 as corporate earnings are announced. Expect a good buying opportunity to present itself before the end of the second quarter.

Historically, once a trend develops for the election result the market reacts differently. If it looks like the incumbent party is going to win, the market goes higher. If it looks like the out party is going to win, the market normally goes down prior to the inauguration as it is expected that the party will raise taxes. This has been the pattern since 1900.

On a short-term basis, the market is likely to go slightly higher; but the market is not cheap based on earnings and dividends. Analysis of real dividend yields indicates that the market is overvalued and real dividends are at a very low level. On the basis of real earnings, yield stocks are overvalued, as is pointed out by Ned Davis in his analysis of the market over the last 25 years.

Sovereign Wealth Funds (SWF), formed by an increasing number of nations, are trying to get rid of dollars by buying stocks and hard assets. There is well over $2 trillion available at the present time. The United Arab Emirates have SWF of $875 billion on their own. Even Norway has $350 billion. The Saudis are planning a Fund in excess of $900 billion. These Funds are all going to be looking for assets around the world. The US looks to be up for sale as evidenced by chunks of Citigroup and Morgan Stanley being sold. The US government is not complaining about foreigners buying up their assets as they need the money.

In the US, stock prices have fallen, and in many cases, indicate very high yields. Several companies, especially in the financial area, are going to have to have significant dividend cuts to help maintain their capital bases. Dividend investors, both in the US and Canada, should look very carefully at high dividends, and make sure that there is adequate coverage through earnings and the capital positions of the company to maintain those dividends.

IDC Portfolio Management points out that a sharp rise in continuing claims for unemployment results in economic recession and a significant decline in the S&P 500. They also note that a similar recession, led by housing, occurred in 1990-91. Continuing claims for unemployment rose above 2.2 million in early September 1989 and above 2.4 million in July 1990. The S&P 500 peaked above 360 in September 1989, again in July 1990, and then declined to 300 by early October 1990 for a 15% correction.

Continuing claims for unemployment rose to a new cycle high in December 2007 at 2.76 million. An increase towards 3.6 million would forecast a decline in the S&P 500 from 1,420 on January 4, 2007 toward about 1,170 by April 2008, or a 17.5% correction. If claims rose to 3.2 million, it would be a mild recession, and would result in the S&P 500 dropping to about the 1,300, or an 8.5% further correction. These numbers are confirmed by Ned Davis if one looks at the charts.

The US financial sector remains in a downtrend mainly due to the mortgage crisis and its effect on the economy. This is now spilling over into Canada. Canadian banks seem to have a further downtrend. The positive on the Canadian banks is that their capital ratios remain stable (except possibly CIBC, depending on how much of a hit they have to take on asset-based commercial paper), and the dividends look safe.

The S&P 500 is down 11.8% since last summer, Dow Jones Industrials 11.84%, and the NASDAQ Composite 14.7%. The US financials entered a bear market quite early in 2007; however technology and other groups are now starting to enter their own bear markets.

The International Accounting Standards Board is considering requiring companies to create parallel financial statements to account for their exposure to off-balance sheet vehicles. The credit crunch crisis has prompted increased scrutiny of accounting practices.

On a technical basis, the TSX Index is in much better shape than Dow or the S&P 500. The resource, gold, and oil and gas sectors, as well as a strong utility base, offset weaknesses in other areas

Based on the Dow Theory, this is a bear market. The industrials violated their support levels to 12,743 and the transports to 4,366. A bear market only ends when stocks correct to much lower PE multiples and higher dividend yields. Investor sentiment becomes very negative. This likely takes a minimum of three months and possibly much longer. All the forecasters become very bearish. Newspapers carry bad news only. There should be some very dire statements about the end of the stock market. These always seem to occur.

Margins drop significantly as investors try to preserve their capital. Volume normally dries up as investors stop their selling and are too discouraged to buy. The averages go lower, bounce, and then test new low points. Initially when a bear market develops a dead cat bounce occurs, which sucks investors into buying stocks prematurely. A rally should occur anytime now.

Gold remains in a major uptrend and stocks are now behind bullion. As gold moves up, profitability increases significantly for the gold mines.

The Financial Times has been anti-gold for a great length of time, but they seem to have changed their stance as they indicate that gold is a new global currency. This would mean there are now three reserve currencies - the US dollar, the euro and gold.