Why the Dow Likes Bad Economic News

To any ordinary person, the recent movements in the stock market don't make much intuitive sense. Today, for instance, news that weekly jobless claims rose and revised U.S. GDP figures were weaker than expected would lead most non-investors to expect the stock market to decline. Yet in the upside-down world of Federal Reserve monetary policy, investors have taken bad news for the economy as good news for the markets, in the belief that a longer period of Fed intervention through quantitative easing and low interest rates will boost the stock market. At least for now, the Dow Jones Industrials (DJINDICES: ^DJI  ) are reflecting this recent trend, gaining 63 points by 10:45 a.m. EDT, marking a turnaround from yesterday's triple-digit losses. The broader market is also higher, showing that the phenomenon applies beyond the Dow.

When the Dow's movements don't make sense, it's more important to focus on fundamentals in your investing. For instance, Caterpillar (NYSE: CAT  ) has struggled recently because of its high exposure to the slowing Chinese economy, and that has held the stock back despite the Dow's record run. Yet with an attractive valuation of just 11 times trailing earnings, Caterpillar offers a margin of safety even if the reductions in future earnings estimates that we've seen recently continue. You'd have to see substantial further deterioration in the global economic environment before Caterpillar's stock would look expensive at these levels.

Tech stocks have also offered attractive values to investors willing to take on the risk of turnaround projects. Both Intel (NASDAQ: INTC  ) and Cisco Systems (NASDAQ: CSCO  ) trade at below-market multiples, in large part because of concerns about heightened competition among big tech companies and a transition toward broader offerings throughout the IT space, rather than niche segments of the market. Investors fear that Intel won't be able to diversify beyond its PC-chip dominance and that Cisco will lose its place atop the networking space while failing to get a foothold in broader IT services. Yet low valuations -- Intel and Cisco trade on respective P/Es of 12 and 13.5 -- discount their current business prospects far more than appears justified, even given concerns about low IT spending levels throughout the industry.

Beyond the fundamentals, though, news plays an important role in short-term stock movements. Outside the Dow, microturbine producer Capstone Turbine (NASDAQ: CPST  ) soared 8.8% after receiving its second large order in the past week. After getting word of a purchase from real-estate and investment firm Related Companies on Tuesday, Capstone got an order today from Southern California Gas to buy three of its C65 uninterruptible power-source units for use at the gas company's data center. Given the relatively small size of the business, which sports sales of only about $122 million over the past year, orders like this have a material effect on Capstone and also draw the attention of other prospective buyers.

The overall lesson, though, is not to let the Dow's Fed-affected moves confuse you. By keeping focused on the long run, you'll avoid drawing bad conclusions from the market's short-term jumps and plunges.

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