Market Outlook December 18, 2010

Bond yields have fallen by a small amount at the short end. Other interest rates have remained steady. There is no real expectations that interest rates will rise significantly over the next half-year. This easy money is supportive of the economy, but it may be having an unintended consequence. Bank of Canada governor Mark Carney is fretting that individual Canadians may be carrying too much debt. My personal debt-to-equity ratio is a little over 50% (including my house and investment assets), but I’ll be bringing it down to around 36% in the new year by selling an asset that’s encumbered with debt. I’m doing my part. What can you do to reduce debt?

Because inflation is moderate and interest rates are low, the likelihood of a bear market seems relatively low. The economy is definitely not overheating to the point that the central bank will try to cool it by raising rates. They seem concerned though that any rise in rates might have a more severe impact than in the past, given high debt levels. I remain fairly optimistic in my outlook for the coming months.

Stocks seemed to take a rest over the course of the last week, ending just a little lower than where they ended the week prior. As might be expected, bond prices rose slightly. Having said that, stocks still have pretty good momentum, which looks like it might continue through the end of the year. The TSX may not be undervalued, but it looks like it could go over 13,600 before being overvalued. The current P/E ratio of 19.26 inverted implies a real earnings yield of 5.19%. Add to that inflation of 2.4% (currently), and you get an expected return on stocks of 7.59%. If earnings remain constant and the next year provides a 7.59% return, stocks will provide an acceptable investment return that is highly unlikely to be matched by bonds.