"Markets have gone up too much, too soon, too fast."
-- Nouriel Roubini
Professor 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 nearly 70%, and the S&P 500 has jumped 62%. Healthy companies like Halliburton
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 may be 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. Also, as 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. Just a few days ago the Fed surprised banks by raising the rates on short-term loans. Would investors really be throwing their money into risky dividend stocks like Vector Group
(NYSE: VGR)if they could earn 5% or 6% 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 First Solar
You can try to play it safe and look for dividend-paying stocks that have some possibility of appreciating in price. However, even steadfast, previously reliable stocks like Diageo
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.
A few months ago our team recommended Exelon
During a time when many companies were undeservedly beaten down, Exelon kept trucking along, paying its hefty 4.7% dividend and not missing a stride. Trading for less than an 11 price-to-earnings ratio, Exelon sports an operating margin north of 25% and has consistent positive returns on equity. In addition, the company tramples its competition in every category from gross margins to net income. With a forward P/E of 10.5 and a pretty substantial competitive advantage, Exelon seems like a great value stock.
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This article was originally published Nov. 5, 2009. It has been updated.
Fool contributor Jordan DiPietro owns shares of First Solar. Exelon and Pfizer are Motley Fool Inside Value recommendations. First Solar is a Rule Breakers selection. National Oilwell Varco is a Stock Advisor pick. The Fool's disclosure policy is trading dirt cheap.