Market Outlook December 4, 2010

Bond values have continued their slow descent, while stock prices have moved higher. Unsurpisingly, the 5-year mortgage rate has fallen back to 5.19% from 5.44%, the same level it was at before the short-lived jump. Inflation, and inflation expectations, are both a little above the midpoint of the Bank of Canada’s band from 1% to 3%, at 2.4%. If this continues to rise, it will act as a brake on the economy. However, the American government continues to apply stimulus and I expect the recovery to continue it’s rocky path.

There’s really no such thing as a high-yield savings account right now. The best rate I see is 1.2% interest per year. That’s really low, and provides a negative real return (after inflation). Further, the current rate on Government of Canada 10 year bonds is 3.57%. With inflation expectations of 2.38%, the expected real return is 1.17%. No wonder I don’t believe this is a good time to buy bonds. Stocks, with a P/E of 19.42, provide an expected real return of 5.15%. Based on this, stocks provide a much better expected return than either bonds or cash at the present time.

Add to that the momentum of the stock market versus the bond market. Bonds have fallen back, and are at the same level they were at five months ago. Stocks can’t seem to stay down, turning in the highest weekly close since prior to the market crash in 2008. If I had to guess, I would think this will continue until into the spring. I eventually expect the market to blow past the 15,000 top is made in 2008, although it may be a couple of years yet. I’m buying stocks.