Market Outlook November 12, 2010

Bond yields, long and short, are up about 0.10%, while the posted mortgage rate is down about 0.10%. There has been a lot of talk about the second round of economic stimulus in the United States. At the same time, China is trying to manage the pace of their economic expansion and avoid an asset bubble. These are two diverging views of economic potential in the world. With bond values falling in Canada, it seems that we are benefiting either from our trading partners other than the US, or that our economy is well positioned (producing natural resources) to benefit from this particular environment. While interest rates continue to be relatively low and the winter shopping season is upon us, it seems likely that our economy will continue to recover.

Bonds and stocks both dropped in value over the past week. But while stocks dropped about 1.3%, they are up almost 5.0% over the last two months and over 13.5% since January. The momentum of stock returns still appears to be intact. Bonds, on the other hand, are at about the same level they were in early 2010. To add further context, the yield on bonds is around 3.5%, less than 1% higher than the 2.6% yield on stocks. In the current environment, bonds have provided some safety, but no real return. Stocks have provided a roller coaster ride, up in early 2010, up and down over the spring and summer, then up again during the fall. At present, however, stocks have far outpaced bonds, and that relationship doesn’t look like it will change in the near term.

The P/E of the stock market has dropped to 19, down from 22 earlier. This as the market value is rising, the reason being that earning have increased over the last year. In fact, earnings have improved over 40%, indicating that the economy is recovering, future earnings look even better and current prices are more reasonable than they would have This may not seem particularly cheap, but recall that it is based on past earnings. If future earnings can be expected to be much higher, the forward P/E would appear less expensive. Still, the market is probably fairly valued, without being over- or under-valued at this time. If the choice is between cash, bonds and stocks, the best returns are likely to be produced by stocks over the coming year.appeared six months ago. In fact, current market levels are now discounting earnings growth of around 25% going forward. There is room for more increase in market values of stocks. However, since I’ll be investing a lump sum sometime during the next couple weeks, I wouldn’t mind seeing the market level fall and build a base before continuing upward.

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