Market Outlook December 5, 2011

The stock market surged this week, rising over 5%. To put that in perspective, two weeks in a row like that would provide a year’s worth of return (10% growth). But coming after four negative weeks in a row that together saw the market fall -9%, this only starts to repair the damage. Stocks continue to display negative momentum, indicating that the market is not prepared for a sustained upward trend. The VIX, at 27.52, has fallen below the range of 30-35 where it has spent the last few months. This is the first positive sign that the market may continue to rally into the end of the year.

Bonds also rose on the week, despite the fact that they normally move opposite to stocks. The price, when it isn’t influenced by interest rates, which have held steady for months now, responds to shifts in supply and demand. My guess as to why stocks rose and bonds rose slightly at the same time would be that investment managers were moving money from cash (equivalents) to stocks, without selling bonds. For a portfolio balanced between cash, bonds and stocks, I still suggest that bonds appear to be the most dependable holding. For those willing to take more risk, real estate (XRE) now shows more momentum than gold. I will be selling my gold ETF (IGT) and buying real estate (XRE) instead.

Despite the impressive stock market rally of the past week, the market still appears to be undervalued. In fact, my fair value estimate for the market rose, also. This means that even without any earnings growth, the coming year should provide a reasonable 5% – 10% of market growth, as pessimism fades and optimism returns. That’s not a prediction, but from this market level, it’s a possibility. From my experience, the market tends to appear overvalued as long as optimism reigns, as it did from late 2009 to early 2011. While there is always a risk that the market could fall further, it seems more likely that the bad news is factored in and good news will result in positive performance.