Will the recent rally continue? Or is the stock market overheated after a 65% surge?
I have no idea -- and frankly, I don't care.
Here's why you shouldn't care, either
Of course it would be wonderful to be able to forecast stock gyrations, deftly jumping in and out as the market ebbs and flows. But unfortunately, it simply isn't possible to accomplish such a feat on a consistent basis, and investors' attempts to anticipate the market's short-term movements only cost them money in the long run.
According to a study from Dalbar Inc., the S&P 500 produced an 8.35% annual return from 1988 through 2008. However, the average equity investor realized an annual return of just 1.87% over the same period thanks to the adverse effects of market timing. That means an investment of $10,000 in 1988 would have grown to $49,725 over the past two decades if left untouched. But investors who panicked at market bottoms and chased returns as the market rose would have only $14,485 today.
This problem has become so widespread that in 2006, Morningstar introduced an "investor return" measure to illustrate the impact of investors' timing their purchases and sales. Not surprisingly, a recent Morningstar study found that investor returns trailed fund returns over the past five years in each of the 14 mutual fund categories that Morningstar tracks.
Still not convinced that trying to time the market is a bad idea? One final example should drive the point home. Thanks to big bets on Goldman Sachs (NYSE: GS ) , Mosaic (NYSE: MOS ) , and PotashCorp (NYSE: POT ) , Ken Heebner's CGM Focus Fund was the best-performing equity mutual fund of the past decade. But while CGM Focus posted an 18% annual gain over the past 10 years, the average investor in the fund lost 11% a year!
So rather than obsess over which way the stock market is headed next, heed these wise words from investing legend Peter Lynch: "Market timing is speculating and it rarely, if ever, pays off."
What does pay off?
"I don't believe in predicting markets," Lynch wrote in his classic One Up On Wall Street. "I believe in buying great companies -- especially companies that are undervalued and/or underappreciated. … Pick the right stocks and the market will take care of itself."
That strategy worked pretty well for Lynch, who posted 29% annual returns during his 13 years at the helm of Fidelity's Magellan Fund (sadly, most Magellan investors realized much lower returns during Lynch's tenure due to their attempts to time the market).
But Lynch famously focused on consumer-facing companies whose products he enjoyed, like Taco Bell (now owned by Yum! Brands (NYSE: YUM), Hanes (NYSE: HBI ) , and Chrysler (now owned by the U.S. government). With unemployment at a 26-year high and the U.S. consumer on the ropes, where should investors look to find the right stocks today?
The right stocks
That's the question I posed to Jeff Fischer, lead advisor for Motley Fool Pro. Like Lynch, Jeff and his team don't get swept up in trying to forecast short-term market movements. Instead, they seek out companies with sustainable competitive advantages, significant recurring revenue, diverse customer bases, strong free cash flow, and healthy balance sheets. Here are two picks that Jeff believes will serve investors well whether the stock market heads up, down, or sideways:
A blueprint for success
The American Civil Society of Engineers estimates that the U.S. must spend $2.2 trillion over the next five years to repair aging bridges, dams, transportation, and wastewater systems. Jeff believes this will be a boon for a number of infrastructure companies, including Autodesk (Nasdaq: ADSK ) , the dominant player in the design, construction, manufacturing, and engineering software market.
Although new business has been hard to come by recently, Autodesk can count on steady recurring revenue from the 1.7 million users enrolled in the company's maintenance program. And Jeff isn't worried about those end users jumping ship: Autodesk's software is the industry standard, and any employer switching to a competitor's product would need to retrain their designers and engineers. To top it off, the company boasts a rock-solid balance sheet, with $960 million in cash and zero long-term debt.
Healthy as a horse
Concerns over the shape of potential reform have hampered the health-care industry, but Jeff sees value in Medtronic (NYSE: MDT ) , the world's largest independent provider of medical technology. Medtronic produces a broad array of medical devices, including pacemakers, heart valves, artificial discs, and insulin pumps.
Although medical device manufacturing is a competitive industry, Medtronic keeps a leg up on peers thanks to a commitment to R&D and a history of innovation. The company is the market leader in five of its six divisions (and it's the No. 2 player in cardiovascular offerings). That dominant position, combined with favorable demographic trends and consistently high margins, should make Medtronic a long-term winner, regardless of the stock market's short-term direction.
The Foolish bottom line
Rather than worry about which way the stock market is headed next, investors would be better served by emulating Peter Lynch and finding strong companies that are undervalued and/or underappreciated. To learn more about Jeff Fischer's strategy for identifying such businesses at Motley Fool Pro, simply enter your email address in the box below.
Editor's note: Contrary to reporting in a previous version of this article, Hanes is not owned by Sara Lee. The Fool regrets the error.