August 7, 2010 Market Outlook

Interest rates have fallen back slightly. This makes the yield curve steeper, which improves the profitability of banks and helps them to continue lending. Bonds have risen somewhat in value, while the stock market advanced.  The market is back where it began the year, a little under 11,800. Although the market has corrected twice (7% drop during January and 9% drop through May and June), stocks are currently climbing. There seems to be a floor around 11,100 and a ceiling around 12,200. We may or may not see lower prices this year, but stocks are less expensive than a few months ago. This is probably a good time to buy quality investments.

A very short note about Manulife Financial (MFC). Manulife reported earnings that were surprisingly bad. The market seems to have over-reacted, by dropping the price of MFC shares 10% in a single day. The loss was not due to negative cash flow, it was due to accounting, based on the cost of guarantees related to the value of variable annuities (there may be more to it, I haven’t read the report). The market was low at the end of June (as noted above), but has already risen significantly. One reason that this may be a good thing, is that many companies with bad news like to get it all out at once. When things are going well, they want to minimize bad news. But when there’s unavoidable bad news, they will often release all the bad news together, to get it out of the way. Going forward, comparisons will be much more favourable. This is a quirk of public reporting.

Stock valuations are based on expected future earnings. Because the economy is uncertain and earnings reports are not complete, it’s difficult to forecast earnings. (Similar to forecasting the weather, in my opinion.) If earnings continue to come in strong, the stock market level will be justified and may present a good buying opportunity. If, on the other hand, the economy deteriorates and earnings fall, stock prices will also fall.