BONDS
The spread or difference between the yield on 10-year and two-year Canadian government bonds has narrowed dramatically, or, in the parlance of bond traders, the yield curve is flattening.
"This is significant as it suggests that a shift in sentiment is under way," said George Davis, chief technical analyst for RBC Dominion Securities Inc.
The spread has been widening or in a "sustained long-term steepening phase since 2007," Mr. Davis said. But that appears to have ended in January with the yield curve forming "a double top" at around 230 basis points before its plunge to about 190. (A basis point is 1/100th of a percentage point).
The increasingly bearish view of the bond market, as traders speculate on the likelihood of rising short-term interest rates, is also being reflected in the recent rise of the Canadian dollar. The yield on a one-year Government of Canada treasury bill this month soared 30 per cent to 0.841 per cent - the highest level in over year - from 0.645 per cent.
However, in the short-term, the direction of financial markets is much more problematic. Traders should keep an eye on U.S. equity markets to determine the direction of the loonie and bonds, Mr. Davis said. In the short-term, both the Canadian dollar and equity markets such as the S&P 500 are overbought and weakness in U.S. stocks should result in a weaker loonie as investors become more risk averse, he said. That would be bullish for bonds.
"You have to be more cautious for a price correction based on overbought valuations," he said. "Therefore, watch stocks for clues."
COMMODITIES
Pulp prices are soaring as demand remains strong in the face of production constraints.
The price of northern bleached softwood kraft pulp has soared 39 per cent to $880 (U.S.) a tonne in February from $635 in May, said Christy Chen, an economist responsible for industry and country analysis for BMO Nesbitt Burns Inc.
"Higher prices provide Canadian producers, who are contending with high production costs and weak balance sheets, an opportunity to restart idle mills and generate more profits," Ms. Chen said. "Prices are expected to move up further after Chile's massive earthquake last month, as about 8 per cent global market pulp capacity resides in Chile and about 85 per cent of Chile's capacity is located near the earthquake's epicentre."
In addition to the Chilean earthquake, pulp shipments from Finland are being hurt by recent strikes in the transportation sector, said Brian Topp, forest products analyst for Maison Placements Canada Inc. Canadian producers will also benefit from a likely shutdown for maintenance of U.S. pulp producers, he said.
Although there is growing demand for pulp from Asia, mills now closed will restart and the other constraints to production are only temporary, he said.
"At best, they [Canfor Pulp Income Fund and SFK Pulp Fund]are holds, but I have no expectations of them outperforming," he said. "Ultimately, there is too much pulp for the basic underlying demand."
The units of Canfor Pulp yield 11.5 per cent. The units closed last week at $12.48 up from a 52-week low of $1.30.
STOCKS
Portfolio strategists with Barclays Capital, the investment banking arm of Barclays Bank PLC, are looking for a significant drop in the S&P 500 during the second quarter, "but would treat any major pullback in share prices as a buying opportunity."
They forecast the index will increase 9 per cent in 2010. "We favour defensive over cyclical sectors because of turn in leading indicators, a reversal of analyst earnings estimate revisions, and compelling valuations," they said.
"Our favourite measure of earnings growth momentum, the net revisions, is rolling over at a high level," said Barry Knapp, the head of U.S. equity portfolio strategy with Barclays Capital. The indicator measures the number - but not the magnitude - of analysts increasing estimates less those decreasing estimates.
"Falling net revisions implies that significant positive surprises may be harder to come by this earnings season with less encouraging implications for equity returns," Mr. Knapp said.
In other words, the consensus earnings forecasts are too high, which could lead to disappointments.
The net revisions indicator shows that earnings estimates are still moving higher, but generally the rate of change is slowing and it is close to an inflection point, he said. "This at least partially explains why the U.S. equity market did not move higher during an earnings season in January (fourth quarter 2009 reports) that by most traditional measures was strong."
Other impediments for equities during the second quarter, in addition to the earnings reporting season, are the March employment report in early April and the U.S. Federal Reserve meeting in late April, he said.