"Markets have gone up too much, too soon, too fast."
--Nouriel Roubini
Prof. Roubini, known for having predicted the economic crisis, proclaims he's cautious in the near term because of a weak economic recovery. George Magnus, economic advisor at UBS, agrees, saying, "This recovery is entirely dependent on the unprecedented largesse of governments and central banks ... the recovery is built on very short-term foundations."
This doubt about the economy is all well and good, but one only needs to look at the recent stock market recovery to find some seriously optimistic expectations.
We must be dreaming
Since the March lows, the MSCI World Index (ACWI) has climbed by 74%, and the S&P 500 has jumped 63%. Healthy companies like 3M Company (NYSE:MMM) and Hewlett-Packard (NYSE:HPQ) have rebounded more than 100% during that time, and bedridden stocks like AIG have been able to secure whopping 350% gains. Bulls are pointing to a fast, V-shaped recovery that will mirror the quickness of our slide into recession. Could a full recovery really be this immediate?
There goes the alarm
The short answer is no -- this can't be as prompt a recovery as some believe. Here are three reasons why I believe this rally is a castle made of sand:
- Deleveraging: Household balance sheets are fundamentally linked to property busts, which often take years to play out. People will continue to spend less and consume less as they realize the reduced worth of their assets. This is the ultimate hurdle as the economy struggles to grow, since consumer spending accounted for 70% of the economy in recent years.
- Government spending: Unfortunately, it seems as though our tax dollars have been behind much of the rally. Bears point to the fact that car sales slowed after the Cash for Clunkers program ended, and home sales will probably become sluggish when the first-time buyer tax credit extension expires next year. Also, as the threat of inflation increases, and the public becomes more concerned with the ballooning of the Fed's balance sheet, government spending will slow. Magnus states, "If you don't have credit growth operating, it is hard to sustain spending while unemployment is still rising." In other words: Let's not count on the government to get us out of this mess.
- Interest rates: Central banks worldwide have kept interest rates as close to zero as possible, which has increased the flow of capital into the stock market. But many people believe low interest rates (cheap money) are one of the reasons we got into this fix and think the Fed will have to raise rates sooner than later. Would investors really be throwing their money into inconsistent and risky dividend stocks like World Wrestling Entertainment (NYSE:WWE) if they could earn 5% with CDs like they could in 2006 and 2007?
This is no time to snooze
OK, so what can you do?
You can look for growth stocks, companies like Cell Therapeutics (NASDAQ:CTIC) that operate in difficult and often unpredictable industries but that could generate great returns. But despite the market surge, Magnus argues, "the economy doesn't really go anywhere." Translation: This may not really be a great time for growth.
You can try to play it safe and look for dividend-paying stocks that have some possibility of appreciating in price. However, even steadfast, reliable stocks like General Electric (NYSE:GE) and Dow Chemical (NYSE:DOW) have had to slash their dividends. It's difficult to know which dividend stocks you can count on in a turbulent market.
The smart move is to follow in the footsteps of investing gurus like Benjamin Graham, Warren Buffett, and David Dodd. In any environment, good or bad, there will always be undervalued stocks -- the tricky part is finding them. Our analysts at Motley Fool Inside Value are constantly finding great companies that are selling below their true value. These companies are operating profitably, are trading cheaply, and have responsible and reliable management. In fact, many exhibit strong growth and pay a dividend -- so we can have the best of both worlds.
Our team recently recommended Apollo Group (NASDAQ:APOL), the national provider of adult educational services. Apollo, through its subsidiaries, offers bachelor's, master's, and doctorate degrees -- and through its flagship University of Phoenix, it carries the label of largest private university.
At a time when unemployment is in the double digits, many adults are trying to find cost-effective ways to enrich their resumes, and higher education often fits the bill. The company has a rock-solid balance sheet, with a paltry 11% long-term debt-to-equity ratio, and it has increased revenues and earnings by double digits over the past five years. Trading at a reasonable price-to-earnings ratio, this company seems to be well worth it -- making it a great value stock.
I can't lie -- in these uncertain times, our team has picked a few stocks that haven't turned out as we would have liked. But since inception in 2004, our picks have returned more than seven percentage points over the S&P 500, and we continue to work hard to bring you only the best of the best. Our analysts not only provide you with their recommendations, but they also tell you at what price to buy and at what price a stock is no longer a bargain.
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Jordan DiPietro owns shares of General Electric and Apollo Group. Apollo Group and 3M are Motley Fool Inside Value recommendations. The Fool's disclosure policy is trading dirt cheap.
