Market Outlook July 4, 2011

After a strong week in the stock market, momentum has swung back in favour of stocks. If an investor were balancing their portfolio between stocks, bonds and cash, it would no longer be time to overweight bonds. It would be time to return to the default proportions, possibly overweighting stocks. For an investor rotating between a number of asset classes, the momentum is clearly in favour of real estate (XRE). This week, I will be selling my gold ETF (IGT) to buy the real estate ETF (XRE).

The likelihood of a bear market remains moderate. Interest rates on government bonds have jumped, as investors have sold bonds and purchased stocks. Economic indicators seemed to be more favourable over the past week, encouraging investors and speculators, who have chosen to take on greater risk. Surprisingly, inflation was reported at 3.7% as at the end of May (year-over-year). This is far above the Bank of Canada’s target range of 1-3% and it’s above the inflation expectations shown by the spread between nominal and real return bonds. It will be interesting to see if this lasts. It will also be interesting to watch the announcement the next time the Bank of Canada sets their prime lending rate.

The TSX has jumped quite a bit over the past week, about 4.0%. It is still a little under the top end of my fair value estimate. And now that it has momentum in its favour, it looks like a good time to invest. No one know what the summer will bring, but it seems very likely that, barring a large jump in interest rates, the stock market will end the year higher than where it is now.