First, what really concerns me is that interest rates have fallen lower than I have seen them. Going back to the crisis of 2008, interest rates have not been lower (and they were far higher before the market crash). In fact, I have data back to 2001 on Government of Canada bonds (10 year, 3 year and real return), and this is the lower yield quoted for bonds. The 10 year yield 2.49%, a ridiculously low rate; the 3 year yields just 0.93%. What does it mean? Governments can borrow cheaply, and we’re certainly not at the top of the economic cycle. It means that bond prices are really high, even higher than last time (early 2010) I recommended against buying bonds. In fact, prices are 7.8% higher now than when I wrote that post. (For context, the TSX is exactly flat over the same period, and gold is worth 50% more).
So even though bonds didn’t look attractive 18 months ago, they were a better investment than the stock market. That continues to be the case, although it appears that may reverse next month. When that happens, it will be time to take profit from bonds and start buying stocks again. In fact, in a portfolio diversified between more asset classes than just stocks, bonds and cash, real estate (XRE) appears to have the best momentum. I sold IGT and bought XRE last week (Tuesday morning, unfortunately). XRE performed better than other asset classes over the course of the week, and I will continue to own XRE this week.
My fair value estimate for the stock market rose again this week, although the market price dropped slightly (less than 0.5%). The market now appears to be quite undervalued (almost 6%). Although momentum doesn’t yet favour stocks, the market appears to be attractively priced.
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.
Not good. That’s basically the market outlook, summed up in two words. The fact that I’m summing up my market outlook in two words shows that I’m tiring of watching the market. But the market doesn’t care whether or not I’m ready for some good news, the bad news just keeps rolling in. I don’t see bad economic news, because corporate earnings appear to be holding up. Rather, it’s uncertainty and a lot of “what if” followed by negative scenarios. While that certainly translates into lower stock market prices, it also means that the market will turn, not on company performance improvement, but on sentiment improvement, which can be quicker, but also more volatile.
Given three weeks of negative stock market performance, stocks appear much less attractive than bonds. That was already the case, but it is even more pronounced than at any time since early October. That doesn’t mean the outlook for the economy isn’t good (it may or may not be), but that the prevailing attitude toward equity ownership is negative. A traditional portfolio should remain underweight stocks and overweight bonds. A more adventurous portfolio should focus on owning gold (IGT).
The stock market appears more undervalued now, at 7.5% below my fair value estimate, than it has in recent months. Corporate earnings are supportive of a stock market value between 9,600 and 16,000, depending on outlook. The mid-point is 12,400, with the market level at 11,500. It could always go lower, but it appears cheap at the moment.
Volatility remains persistently high, closing the week at 32. I’m less concerned by the level, but more concerned by the fact that it is not trending downward. Stocks lost more than 3% this past week, moving the market valuation to a level where it appears undervalued. I had thought that stocks would continue their recovery on a fairly smooth trajectory, but that has not been the case. The market seems to be predicting corporate profit growth of less than 0% (-0.87%) over the next 12 months.
Bonds continue to have the greater momentum, and a portfolio that is balanced between stocks, bonds and cash should still be overweight bonds. Among all asset classes (that I track), gold (IGT) continues to present the best prospects. Other assets sometimes have a couple weeks of growth, only to reverse direction and give back the gains.
While I’m not ready to commit money to equities by selling gold, the market looks cheap. Investors who are patient, with a long time horizon, or who don’t mind watching their investments go down before going up, may be wise to buy now. The markets have already made a low on Oct 4 (of just under 11,200) and seem to have reversed course and begun the recovery. There are plenty of bargains, for those with the stomache for them.
I had hoped for better. I was really hoping that after September and October ended, the high volatility and negative stock market performance would end also. Historically, the period of November to May has been relatively strong for stock markets. That doesn’t mean that they turn on a dime, switching from negative to positive as the calendar turns from October to November. But volatility remains somewhat elevated (between 30 and 35, where 20 is normal during a bull market), likely due to uncertainty around the situation in Europe in general and in Greece in specific.
Another sign of the prevailing lack of optimism is the fact that the stock market is discounting 12 month earnings growth of just 3.1%. Remember a year ago when they were discounting earnings growth of 30% and 40%? I suggested at the time that it was possible, and a few companies have achieved it. But not all companies have enjoyed continuous economic growth, and there is still much uncertainty about what the next 12 months will bring. This translates into P/E compression, which explains why some companies, such as the banks, are trading with relatively low P/E ratios (under 12) and high dividend yields (near 5%).
Stocks ended the week lower in value than they began the week. The negative return impacted the momentum, where bonds continue to hold favour. In fact, gold (IGT) continues to offer the best momentum out of the asset classes I watch. Others continue to be positive, but gold appears the most favourable.
Last week I was relatively optimistic, but the stock market is 1% lower this week. It doesn’t look like it’s headed down, but it doesn’t appear to be in recovery mode yet, either. Actually, the market dropped almost 4% between the close on Oct 31 and the open on Nov 1. The climb since then has been steady, which is exactly what seasonality would predict.
Momentum this week has continued to improve, but is still not greater for stocks compared to bonds. In fact, bond yields fell quite a bit over the past week, as investors looked to bonds for a safe haven. Bond values rose more than 1.6% over the past week. In a portfolio split between stocks and bonds (and cash), bonds continue to appear more favourable. Asset rotation, however, continues to prefer gold (IGT), with small caps, then emerging markets, showing well.
The economy looks less certain than in the past. This isn’t new news, of course. Newspaper headlines continue to magnify every problem and hiccup. On balance, that entails far less risk than ignoring the problems, while headlines encourage everyone to invest in the latest hot pick. Inflation, at 3.2%, is higher than the Bank of Canada’s target band between 1% and 3%. Even inflation expectations have crept up over 2%, which is worrisome. At least the term spread is steep enough to be profitable for banks.
The stock market continues to appear slightly undervalued. My fair value calculation gives a range between 9,800 (extreme pessimism) and 16,400 (extreme optimism). The upper range continues to rise as earnings are reported. The market value was near this upper limit while the market recovered from the 2008-2009 crash, but is currently very near the mid-point. I think that it optimism will need to become widespread before the market produces very good growth.
Happy Halloween! Nothing scary here today. A week or so ago felt like the bottom of the market. Interest rates have risen, back to levels last seen in July. In fact, stocks have also returned to the level they were at in July. The market trend seems to have reversed from downward to upward.
The reversal can clearly be seen in the momentum calculations. Momentum for bonds turned negative (just barely), where they have had positive momentum since late May, just after the stock market first turned down. All other asset classes: large cap and small cap stocks, emerging market stocks and real estate have turned positive. Gold (IGT) continues to produce the best momentum, but emerging markets are close behind. I will continue to own gold for the coming week.
According to my calculated estimate of stock market fair value, the stock market is right in the middle of fair value. Earnings reports are not universally positive, but corporate earnings are supportive of higher stock market values than what we experienced through all of October. During the recent correction, the market appeared to be undervalued, and during the bull market before that, it appeared to be overvalued. It will be interesting to see if it returns to “overvalued”, providing an opportunity for profit. Typically, November to May is a profitable period in equity markets.