Market Outlook April 25, 2011

Inflation jumped to 3.3% year-over-year. I think this was unexpected, although given my personal experience with gas prices and what I’m hearing about food prices, it seems reasonalbe. Inflation leads to higher interest rates, which slows down economic activity. Although the Bank of Canada left their prime rate unchanged at their last meeting, it now seems more likely that they would raise it at their next meeting. Rising interest rates would impact bond rates, which are already a little lower. This scenario could even lead to a market correction or a mid-cycle slowdown.

Momentum still strongly in favour of stocks. The last six months have been very positive for stocks. The last two months, however, haven’t really provided much growth. The market moved up, then down, then up, then down, resulting in sideways movement. Future results are likely to derive from company earnings reports. This is the end of April and the old saying “Sell in May and go away” might apply for the summer. I’ll be watching closely over the next couple weeks.

The market still appears to be fairly valued. Given the P/E of 19.99, it doesn’t appear that stocks are undervalued. But if the economy continues to grow at the current rate, stocks are likely to provide a very reasonable return from this level. There are many problems that should have triggered a market correction already, if markets were overvalued. The natural and nuclear disasters in Japan, the bailout for Portugal and the debt in the US have all been in the news recently. However, companies seem to be able to continue reporting profitable financial results.