Market Outlook October 22, 2010

Surprisingly, interest rates have fallen slightly. Interest rates are already low, however central banks are keeping money supply loose in order to continue to stimulate the economy as it recovers. The recovery is not guaranteed, although it seems to be underway. For that reason, it makes sense to maintain the availability of money until the velocity picks up again. Another effect is that inflation expectations are higher. This implies that rates should rise, bringing us closer to the end of a bull market (although, in reality, not very close yet).

I am also surprised to see that stocks and bonds both have positive momentum. However, the momentum of the stock market is much greater than that of the bond market. The stock market is almost certainly the place to be right now. There still seems to be quite a bit of risk aversion from investors, making stock-based investments a contrarian choice. Corporate earnings are still rising, many beating expectations, which raises the fair value of the stock market. Stocks still appear to be at the high end of reasonable value, given past earnings. But accounting for the fact that the economy is in recovery mode, it seems reasonable to expect earnings to continue to grow, and stock values to continue to rise.

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