Market Outlook: February 14, 2011

Interest rates have remained unchanged. The markets will not be able to take their cues from prevailing rates, and the interest rate won’t have an affect of the present value of money. However, after remaining steady for a long time at 5.19%, the five-year fixed mortgage rate has jumped to 5.44%. The cost of houses and, eventually, the cost of mortgage debt has increased. This leaves less money for other uses and acts as a brake on the economy. Depending on how many people have large mortgages and how many are either variable or up for renewal soon, this change in mortgage cost could have a material impact.

Surprisingly, stock market momentum over bonds has increased. The stock market finished the week about at the same level as the week prior. Bonds have hardly moved. The reason is that markets were lower 200 days ago, one of the time frames I compare for momentum. In this case, the unchanged market is better than the lower former market level. However, the change is small, and it indicates that stocks are still a better choice that bonds. Even though I was recently concerned that the market has risen too far too fast and is in “need of a break”, the market pushed to a a slightly higher level and remained there for a week. That’s not to say it couldn’t fall back, but it would take a few negative weeks in the stock market before bonds begin to appear more attractive.

We are in the midst of earnings announcements. I was worried that current stock market level has baked in a future earnings growth of about 35%. While this is still cause for concern, profit at GAP rose by 45%, as an example. Expectations have also risen, so it remains to be seen what the market reaction will be to “expected” good news. It seems more and more likely that the market will react more strongly to a negative surprise, perhaps initiating a small correction.


2 thoughts on “Market Outlook: February 14, 2011

  1. Profit levels can be hard to measure in percentage terms because they hover near (and sometimes below) 0. A company may lose 95% of its profit one year and then have it increase by 20x the next… just to get back to normal. 35% earnings growth for 10 years in a row is highly unlikely but for one year coming off some really bad circumstances it’s not that difficult.

    Some people measure average profits over 5, 10, or 20 years to see if the current level is in line with reasonable expectations, but there are still too many factors affecting that… I wonder if there’s some alternative method like creating a chart of cumulative profits over a 20-year period that would allow you to measure change correctly in percentages. If you did this a year with losses would look like a correction in the stock market rather than a 150% drop.

  2. Yes, that’s very tricky. That’s why I’ve only mentioned it, without trying to measure changes in profitability. During the early and mid part of 2009, it was much easier to envision a 50% improvement in profitability versus a 35% improvement at this point. Only time will tell, but I’m being a little more cautious than usual.

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