Why won’t this rally die?
As we pass through government turbulence and a mediocre earnings season, it seems investors are more willing than ever to float listlessly into the sun.
Defying recent history
This market is definitely defying recent history--and expectations.
Since 2008 the stock market had been wildly volatile and earnings were largely undervalued. That’s changed, today the P/E ratio of the S&P 500 is very rich at 18 and volatility has plunged as the VIX toils near 13. Last year it touched 45.
You know what they say about “the calm;” what follows it can get pretty messy.
What’s really driving this market higher?
Theory: the Fed is "QE-crazed" and bond rates are so low that large investors have to buy stocks.
You should expect this trend to continue and you should actually find some comfort in it. There’s a tangible reason why stocks are overbought after all, and its reason enough to believe that they'll continue to soar.
Stocks rising baselessly=scary.
Stocks rising because they’re the “best of two evils”=better.
There's simply no alternative to stocks right now. The bond market is "unhealthy" and under constant assaults by the Fed; the government wants investors buy stocks.
With record low interest rates you can’t win in bonds, and just imagine if those interest rates creep up! Then you’ll be getting hammered in the short-term (low returns) and long-term (plummeting values)—stay away!
Dow 14k—a stock pickers playground
When the market is overvalued but still forcing you into stocks; smart stock picking matters.
Here’s your Dow 14k game plan:
1). Sell "extended rally" stocks--now
You don't want to be the last one holding the hot potato. Overvalued markets push stocks like salesforce.com, inc. (NYSE:CRM) higher and higher--until they don't.
As the chart below illustrates, salesforce.com, inc. (NYSE:CRM) meteoric rise in share price--including a near 60% rise this year--has little causal relationship to the company’s actual performance (diluted EPS).
Salesforce is really a wonderful company, but it's dangerous in this market. Even if the company meets all of analysts’ expectations over the next year it would only be growing at rate of 25%--not 60%.
And if it starts to miss its lofty expectations (even slightly), it'll get ugly--just ask Apple Inc. (NASDAQ:AAPL) shareholders.
The fact is the stock is trading at such a ridiculous premium based on speculation that its "tomorrow" will be much better than today.
At some point, cautionary voices will surround salesforce.com, inc. (NYSE:CRM) and it's reasonable to expect that it will (eventually) trade closer to its earnings.
And even if we project a ridiculous forward multiple, say 30x, we would still come to a price of just $58--even if salesforce.com, inc. (NYSE:CRM) hits all expectations for 2013.
2). Adopt a “yield appreciation” strategy
Overvalued markets demand that you start playing defense. Bonds aren’t paying but you may also be feeling “nervous” in stocks, so buy high dividend payers—a hybrid between the two. You’ll get regular income while staying in the healthy market. And if the market sells-off high yields will grow and offer a “yield appreciation” safety net as a “bottom” in these stocks is quickly established by new investors chasing the accelerating yield.
3). Buy Quality
The only way that this “yield appreciation” strategy works is if the dividend is safe. The best way to determine if a business is high caliber is by tracking return metrics (ROE or ROA) and profit margins. Many companies’ juice earnings by cutting costs or expanding recklessly, only top businesses can earn a high return and charge more for their products or services.
It’s simple; businesses that earn high returns on investment are highly unlikely to cut their dividend.
These stocks meet these criteria (high yield + high ROE + high PM)
|Microsoft Corporation (NASDAQ:MSFT)||3.30%||22.62%||21.20%|
|Altria Group, Inc. (NYSE:MO)||5.26%||94.15%||15.98%|
|The Coca-Cola Company (NYSE:KO)||2.75%||26.52%||18.63%|
|KLA-Tencor Corporation (NASDAQ:KLAC)||2.84%||21.97%||22.23%|
4). Feel free to send me a "thank you" letter