Market Outlook: February 7, 2011

Please excuse the lateness of this post. I was sick for a couple days, which reminds me that money really doesn’t matter much if we don’t have our health.

Last week, I worried that markets have risen very quickly, and I suggested that it would be reasonable to expect either a correction or at least a sideways trend over a period of time. It seems, however, that economic metrics have come in better than expected, and the current market level appears justified. Interest rates continue to rise, causing bond values to fall. Rates generally rise as the economy strengthens, moderating growth. Business cycle theory suggests that we probably have another year or two of growth before we experience either a mid-cycle slowdown or a real recession.

The stock market posted a new high at the end of the week, relative to the past few months. This renewed momentum coincides with a drop in bond prices, giving a clear edge to the stock market at present. Based on the prior reported earnings, the market seems to have exceeded the range of fair value. In order to justify the current prices, earnings would need to increase by 34% over the coming 12 months. That is possible, but seems much less likely than it did a year ago.