"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 lows last March, the MSCI World Index (ACWI) has climbed nearly 70%, and the S&P 500 has jumped 62%. Otherwise healthy companies 3M
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 says, "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 rather than later. Would investors really be throwing their money into dividend stocks like Copano Energy
(Nasdaq: CPNO)if they could earn 5% or 6% with CDs like they could in 2006 and 2007? Copano pays out more than it has free cash flow or earnings -- not exactly a comforting fact considering it can cut its dividend if it has more pressing obligations (especially if you're counting on its 8.9% dividend yield!).
This is no time to snooze
OK, so what can you do?
You can look for growth stocks like The Knot
You can try to play it safe and look for dividend-paying stocks that have some possibility of appreciating in price. However, even a previously reliable, steadfast company like JPMorgan Chase and General Electric cut their dividends in the past. As operating margins continue to erode, in addition to a mere 3% market share of the smartphone market, Motorola was forced to cut dividends amidst the financial panic. Even in this recovering environment, it’s scary to rely on a single source for your dividend payments.
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. 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
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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This article was originally published Nov. 5, 2009. It has been updated.
Fool contributor Jordan DiPietro owns shares of Exelon and General Electric. 3M and Exelon are Inside Value picks. The Knot and Open Table are Rule Breakers selections. The Fool's disclosure policy is trading dirt cheap.