By Scott Ronalds

The manager of our fixed income funds (Connor, Clark & Lunn) prepares a Financial Markets Forecast every year that addresses the outlook for the economy, inflation, monetary policy, market valuations and extreme technical conditions in order to set the framework for their portfolio strategy.

The Forecast is a tool that CC&L uses to help guide their thinking. They make it clear that no prognostication will be totally accurate. In fact, CC&L are sure to be wrong in certain aspects of their outlook and stand prepared to adjust their thinking as circumstances change.

I found their commentary on the U.S. housing market particularly interesting. CC&L reports that the market is still a mess, with home sales, building permits, new starts and a heightened level of foreclosures all pointing to a sector of the economy that is still in deep trouble. A scary stat – 25% of all U.S. homeowners (15 million) have negative equity in their homes (i.e., the value of their mortgage exceeds the value of their house). Yikes! To make matters worse, mortgage rates have started to rise (up 0.7% over recent lows) and are forecast to move higher throughout the year.

On the brighter side, the manager notes that housing starts are only averaging half the level required to keep up with population growth, affordability is the best it has been in 30 years, mortgage servicing costs are attractive, and the price-to-rent ratio suggests that owning is preferable over renting.

All said, CC&L expects the U.S. housing market to decline modestly in 2011. This is not to suggest that investors should steer clear of the U.S. stock market, however. CC&L points out that the consumer is slowly making a comeback, the outlook for corporate profits remains good, corporate America is sitting on piles of cash and stock valuations are attractive relative to historical levels.

There’s no denying the mess in the American housing market. Some value hunters would argue, however, that there’s no sector more ripe for the picking. From where I’m sitting in Vancouver, it's hard not to agree. A ‘starter home’ (read: tear-down) on a standard size lot in the west side of the city is regularly fetching $1.2 million (typically with multiple offers). That would buy a whole block in most parts of Arizona. Something seems out of line. For investors with a healthy tolerance for risk, a long time horizon and a good pair of boots, this may be a mess worth getting a little dirty in.