Market Outlook: January 10, 2011

The yield curve has steepened, where short rates have remained more or less constant and long rates have risen slightly. A steep yield curve generally coincides with a strengthening economy. When the economy reaches a top and interest rates begin to drop at the long end, the yield curve will become flat and imply an increased risk of falling asset values. We don’t seem to be near that point.

Stocks have lost some momentum, although they still have far more momentum than bonds, which have lost ground over the last 2.5 months and are only slightly ahead of their value 10 months ago. There is a market effect called the January Effect which holds that as go the first five days of January, so goes the month of January and so goes the year (for stock performance). Is this a reliable effect, or is it a superstition? I believe that evidence shows this effect being reliable slightly more than 50% of the time. Optimistically, I only believe in it when it portends good performance. This year, the first five days in the market have been disappointing, whereas I expect relatively strong returns in the stock market this year.

With a P/E of 19.46, the stock market does not appear particularly cheap. This level implies a real forward return of 5.14%. This is far better than long government bonds, currently yielding 3.6%, which should provide a real return of 1.60%. There is no change in the apparent value of stocks, still appearing near the upper end of fair value range. The market will still require improved earnings to be supportive of rising prices. Seeing that we await fourth quarter reports from the majority of companies, there may be some delay since many companies take longer when reporting fourth quarter earnings, depending on the work of their auditors. We may not get a good sense for the economic performance of companies until March. In the meantime, investors are making deposits to RRSPs and TFSAs, which increases the demand for investments. I will watch with interest to see whether funds are flowing into fixed income, balanced funds or equity funds.


3 thoughts on “Market Outlook: January 10, 2011

  1. I wonder if there’s an “RRSP effect” that sees a runup in canadian stock values at the end of february (and maybe even some currency effects from people investing in other international funds). That would be interesting to see, but probably not big enough to plan around 🙂

    Do you know if people are following a similar yearly pattern with TFSAs? There seems to be absolutely no benefit to this, but then again forgetting your RRSPs for 11 months doesn’t make sense either.

  2. The RRSP season may be a contributor to the January effect, here in Canada. The strongest season for stocks tends to be November to May, even outside of Canada. I doubt there’s a currency effect, however, that’s large enough to notice. Canada is only about 4% of the world-wide investment market (whereas the US is close to 50%).

    My experience with TFSAs is that those with cash will often deposit it in January to get the maximum tax shelter. However, many people are moving investments from open (non-RRSP) accounts to TFSAs in-kind (without selling them), so there’s no effect on market prices. I also hold that TFSAs are great for young people and retirees, but make little sense for anyone with a mortgage. If most people agree, there may be a low participation rate. I would be interested to see a number about this.

  3. Based on the number of people who reportedly haven’t thought about holding investments in a TFSA, I wouldn’t count on a large number of people comparing the net after-tax benefit to paying down their mortgage 🙂 Then again in a few years once more financial planners have incorporated them maybe they’ll push people towards a couple of more common uses.

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