August 21, 2010 Stock Market Outlook

Past inflation is currently a little below the Bank of Canada’s target. It has increased from 1.0% to 1.8%, but inflation expectations remain very close to the 2% target. There is still room for the economy to grow before the central bank should become worried about overheating. That would generally indicate that interest rates should also remain low, which is the case. It is easier for the economy to grow in an environment with low borrowing costs, and the expectation is for continued economic growth. The pace, however, remains uncertain.

The housing market continues to appear weak, with magazine covers beginning to question the possibility of a US-style meltdown. This may indicate a turning point, as the journalists are usually the last to notice. They 5 year mortgage rate is down again, making houses slightly more affordable. That should support house prices and keep them from falling too far. In contrast to our southern neighbours, the job market is relatively stable and personal bankruptcies haven’t increased.

Bonds and stocks have both strengthened over the past week. Bonds still have more momentum, with prices rising and yields dropping. Further, stocks don’t look particularly cheap based on the most recently reported earnings. However, most earnings reports beat analyst expectations and positive surprises often buoy stock prices. Buying stocks now would probably represent good value, but will not provide a smooth increase in value going forward.