Market Outlook August 8, 2011

What a tumultuous week! After dropping nearly 5% last week, stocks dropped another 5% this week. I even saw in a news article that someone suggested this could be the start of another waterfall decline like September 2008. The market index broke below its 200-day moving average and the decline affected almost all stocks. At the same time, economic data came in worse than expected. For example, Canadian GDP is just 2.2%, although the Bank of Canada plans to leave rates unchanged, probably for another year. Not surprisingly, bond prices jumped as investors fled to safety. The yield on the Canadian 10-year is as low as it has been, except for a brief period on November 2010, since the depths of the market crash in March and April 2009.

Second quarter earnings reports are underway and some companies have reported less positive news than expected. Most of the companies I own will report in the next two weeks. My fair value estimate for the market has risen slightly, and given the current low market price, it is only discounting future earnings growth of 14.5% over the coming 12 months. Logically, then, this is a much cheaper time to buy than two months ago.

But who wants to buy into a dropping market? What if it keeps going down? If you can’t stomache further drops, don’t buy in now. I don’t see any solid indication that this correction is over. Bonds have far better momentum than stocks, and anyone building a portfolio of stocks and bonds should be overweight bonds at this point. For those who are a little more creative and are rotating between asset classes, gold (IGT) remains the place to be. I am certainly happy to have been in gold over the past couple weeks. I only regret that it wasn’t a larger portion of my portfolio.