I realize the market is a discounting machine -- with investors collectively trying to anticipate future events and price shares accordingly -- but let's face it: This rally is getting ridiculous. Wall Street is on a bender (yet again), and the shiny, happy future it seems to be looking forward to overlooks the fierce grimness of now. It's a mirage, at least in the near term. Maybe the midterm, too.
You may be right; I may be crazy
Still, it's worth pondering just how much longer this particular bout of irrational exuberance might last. If the market can make it here, after all, it can make it anywhere.
Unemployment is high and poised to climb higher; GDP has famously fallen off a cliff; and the much ballyhooed news that consumer spending rose during the year's first quarter (hurrah!) evaporated on contact with even just casual analysis. January produced virtually all the quarterly gains; February was flat; and March actually saw consumer spending decline. (Boo! Hiss!)
And yet the market has been on a tear, with the S&P 500 climbing by some 11% during the month of April alone. And guess -- just guess -- where the bulk of those gains have come from? Why, from financial stocks, of course, with the sector posting a 22% rise over the period.
Black hole sun
This particular mirage is a mesmerizing doozey, with the likes of American Express (NYSE: AXP ) , Wells Fargo (NYSE: WFC ) , and Capital One (NYSE: COF ) rocketing to gains in excess of 30% over the period. And this despite the fact that the black hole at the center of our financial galaxy remains, with toxic assets sucking liquidity out of the credit markets just about as fast as government largesse can pour it back in.
That, however, is a temporary "solution" (right, elected officials?). And unless someone pulls a rabbit out of a hat soon, the latest Treasury-floated TARP initiative -- a public/private partnership that socializes risk while privatizing reward -- seems likely to die an ignominious death. Gallingly, it may be the banks themselves that shoot this one down.
And why not? Our apparent willingness to prop 'em up into perpetuity has yet to be seriously challenged, which explains the financials rally. Rumors of profitability have been greatly exaggerated (thanks in part to mark-to-dream-on accounting), but when the U.S. taxpayer is your compulsory patron, it is, as the kids used to say, all good. Indeed, we might as well call it rational exuberance.
With that as a backdrop, it's worth asking whether financial-stock multibaggers can be far behind, even from their currently inflated levels. Based on its closing price last Thursday, for example, seemingly beleaguered AIG (NYSE: AIG ) would be a 10-bagger by returning to "just" $11 a share, a price it exceeded as recently as last September.
Don't get me wrong: I don't believe such a rocket-shot would be warranted, at least not based on fundamentals. Indeed, I'm among those who believe that the financial sector should return to its former lack of glory, becoming a comparatively much smaller slice of the market's pie chart, complete with permanently shrunken market caps for former big boys.
Between now and that smaller, shabbier future, though, there may be money to be made, largely by speculators betting that the financial sector will essentially become a government entitlement program -- albeit one that puts up with little of the pesky regulatory oversight that attends, say, Medicare or Social Security.
For those who prefer to invest rather than speculate, there are far smarter ways to proceed -- and to align your portfolio with what a sustained market recovery will probably look like. As shell-shocked investors return to equities, they'll likely do so judiciously, newly aware of the benefits of bonds, for example. And for the equity sleeves of their portfolios, a focus on cash-flow kings with tremendous track records of success -- and beaten-down share prices -- will be in order.
IBM (NYSE: IBM ) , Apple (Nasdaq: AAPL ) , and Oracle (Nasdaq: ORCL ) , for example, have those first two attributes in spades. But they're on my watch list (rather than in my portfolio) because I think their valuation profiles will become more attractive when our dead cat finally touches down back here on planet Earth.
The Foolish bottom line
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Shannon Zimmerman runs point on the Fool's Duke Street and Ready Made Millionaire services, and he runs off at the mouth each week on Motley Fool Money, the Fool's fast 'n' furious podcast. A fresh edition of MFM hits iTunes each Friday, and you can listen by clicking here. (Link opens iTunes.) Shannon doesn't own any of the stocks mentioned in this article. Apple is a Motley Fool Stock Advisor recommendation. American Express is a Motley Fool Inside Value pick. The Fool owns shares of American Express. You can check out the Fool's strict disclosure policy right here.