Market Outlook: February 28, 2011

Interest rates, surprisingly, have fallen over the course of the last week. Bond prices, which move inversely, have risen, probably in response to increased volatility in the stock market. Whether the stock market is fluctuating more is due to geopolitical events, technical resistance or fundamental factors including earnings results is a matter of debate. Economic indicators continue to be fairly positive, with unemployment down and profitability up. But results are not uniform across all companies in all sectors. It is interesting to note that through the market dip and rise of the last week, much of the change in the index was due to the movements of a few large names. This is reminiscent of what happened on the TSX in summer of 2008. I’m not suggesting that a crash is imminent, only that reviewing the movement of the index doesn’t tell the entire story.

Last week was a short week in the stock market, with markets closed on Monday. Prices fell about 2% between Tuesday and Thursday, before mining and energy stocks advanced enough to recover almost the entire market value. Seeing that the market level is still over 5% higher than a month ago, it seems like a reasonable pause. In contrast, bonds have risen and fallen slightly, but produced very little change in value over the last year. Stocks have been a far better investment, and seem poised to continue. A somewhat slower pace wouldn’t be at all surprising, however.

As earnings reports have been released, the fair value of the market appears higher. Certain companies have beaten expectations. At the same time, earnings may be 20%, 30% or even 40% higher than a year earlier. The fact that the market value is a little higher than what seems to be “fair value” is less worrisome because the market is is recovery. However, the pace of economic expansion and profit growth cannot continue indefinitely at this level. There may be some resistance around 14,000 on the TSX, since it spent much time around this level throughout 2007 and part of 2008. It will be interesting to see if the market can move much higher before correcting or moving sideways for a time.