So Much for Those Green Shoots

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I'm having a hard time taking all the recent economic optimism seriously -- and apparently, given his performance Monday, so has Mr. Market.

For one thing, those "green shoots" everyone has been talking about seem to be withering fast:

• Applications for mortgage refinancings -- which had been trending up for a while -- may have peaked in April. May numbers were significantly lower.
• At 9.4%, the unemployment rate is at its highest in more than 25 years.
• Gas prices are back up -- a lot.
• Americans are responding not by spending money to stimulate the economy, but rather by paying down debt at a record rate, and saving more, too.

In other words, we still look stuck in a vicious cycle. And this isn't just an American issue -- recent economic reversals in Japan, China, and Germany point more toward an ongoing global recession than a recovery.

So why did the market rise 40% in the last three months?

People want to believe
As the study of behavioral finance has shown us, the markets are hardly ruthlessly rational machines. But they are a fascinating place to study human psychology. In this case, I think people could only take so much bad news. Once the specter of economic Armageddon started to fade even a little bit, people jumped right back in. Folks wanted to believe that the worst was behind us.

It may yet turn out that the worst is behind us. But going from "terrible" to "really bad" doesn't constitute a recovery.

So how do we make money in this?
The easy answers -- at least from my perspective -- are these:

• There's almost always value somewhere in the market. Buying good companies when they're selling at a discount to their intrinsic value gives you a lot of upside potential with (hopefully) limited downside risk.
• Buying stocks with solid dividends gives you some level of nearly assured return (like buying a bond), together with the benefits of owning a stock, which is more likely than a bond to appreciate in value over the long term.

The benefit of both of those approaches is that they both ease concerns about the market's short-term gyrations. Value-priced companies aren't as likely to decline a whole lot, and even if they do, it's easier not to worry about them when you know that they're already a bargain. And when you reinvest dividends, a market downturn can actually work to your advantage, as your reinvested dividends buy more shares.

Combining these approaches can give you the best of both worlds. It does take some digging to find stocks that fit both criteria, but they're out there. Take a look at these stocks:

Stock	CAPS Rating	Price/Book Ratio	Dividend Yield
Compass Diversified Holdings (Nasdaq: CODI)	*****	0.60	15.9%
Coca-Cola (NYSE: KO)	****	5.37	3.4%
Fairfax Financial Holdings (NYSE: FFH)	****	0.99	3.2%
AT&T (NYSE: T)	****	1.49	6.6%
3M (NYSE: MMM)	*****	4.23	3.3%
France Telecom (NYSE: FTE)	****	1.50	8.8%
Kraft (NYSE: KFT)	****	1.66	4.5%

Now, I haven't done full due diligence on all of these, so consider them starting points for research, not formal recommendations. But there are definitely some intriguing ideas here. Compass, for example, sports a dividend yield that seems too good to be true -- but Motley Fool CAPS members clearly think there's something worth investigating there.

Still, look before you leap
With dividend stocks, careful research is necessary to answer the big question: Will they keep paying? In a major recession, finding that answer requires more than a look at the balance sheet. Is their revenue sustainable? You'll need to do more reading and thinking to decide.

Likewise with value: Some stocks are cheap because they're really not worth much. Metrics like price-to-book ratios are only as accurate as the asset values on a company's books. They can be very misleading if the real value of those assets is much different.

Moreover, good value stocks don't always have the lowest valuations. There's a good argument to be made that Coke and 3M, with P/B ratios of about 5.4 and 4.2 respectively, are both value-priced at the moment, because the true (and immense) value of those companies' brands, distribution networks, and so forth aren't fully reflected in the "book value" calculation.

I've made good money with both the dividend and the value approaches over the years. Looking for stocks that are both value-priced and pay a sustainable dividend can be a particularly effective approach when you want to stay invested in stocks while playing a bit of defense.