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: Despite recent fits and starts, this rally is 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.
And yet the market has been on a tear, with the S&P 500 climbing by more than 30% from its March lows. Even the financial sector has joined the fun, pacing the market in fact over the last three months with double-digit gains.
Black hole sun
This particular mirage is a mesmerizing doozey, with the likes of Goldman Sachs and Morgan Stanley rocketing to gains in excess of 70% so far this year. And all 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. 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 good reason, too: Investors in "junk" bonds in particular are being handsomely compensated for levels of default that aren't likely to materialize. And thanks to exchange-traded funds like iShares iBoxx $ High Yield Corporate Bond (HYG), investing in the asset class couldn't be easier or, perhaps, more profitable, too.
The iShares ETF -- whose portfolio is currently stuffed with debt issued by veritable household names such as Limited Brands
And speaking of equities …
For my money, savvy types looking to re-enter the market would be Foolishly wise to focus on cash-flow kings with tremendous long-haul track records of success and beaten-down share prices.
The Foolish bottom line
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This article was originally published on May 4, 2009. It has been updated.
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 and the Fool own shares of iShares iBoxx $ High Yield Corporate Bond. Chesapeake Energy is an Inside Value recommendation. The Motley Fool also owns shares of Chesapeake Energy. You can check out the Fool's strict disclosure policy right here.