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.

Market Outlook December 12, 2011

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