Interest rates have moved very little since last week, but seem to be slightly reduced. The yield curve is positive, however, which is indicative that policy makers believe the economy is in expansion mode. An example of this was the Bank of Canada’s decision to leave rates unchanged. As the economy expands, rates will rise to keep the economy from overheating, until the point when the economy begins to cool again. For now, however, rates remain low with a greater likelihood that they will rise. Bonds, therefore, seem unattractive as an investment for growth.
Stock market momentum continues to be positive. Although stocks are lower than a week ago and momentum is lower, it remains positive. Because of the relative stability of interest rates, bonds have very little momentum at all. Stocks have been volatile lately, but the volatility has remained relatively restrained. Even though there are many worries, many investors probably expect the worst and, with the memory of autumn 2008 still fresh, are probably prepared for the worst. As long as these worries are accounted for in stock prices, the market is likely to get so far ahead of itself that it will require a 10% or greater correction.
The stock market is sometimes said to “climb a wall of worry.” Although the market has been moving sideways for the past couple weeks, it could have done much worse, given the events that we’ve witnessed. Between the political unrest in North Africa, the natural disaster in Japan and the financial uncertainty in Portugal and Ireland, there is lots to worry about. But investors must be relatively optimistic that the economic environment is at least supportive of the current level at which corporations are operating, if not supportive of improvement. For that reason, despite these many worries, the market has been able to support its relatively high valuation and continues to suggest it could go higher. We will continue to watch with interest the earnings reports that have started coming in for the first quarter of the year to evaluate whether or not companies expect to continue to benefit from economic recovery and stability.