It's time for investors to face reality: until housing prices stabilize and the rate of unemployment shows real signs of improvement, the stock market may start disappointing investors going forward. After a 50% rally in less than six months, Mr. Market is going to want to see real signs of economic strength.
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Not All Profits Are Created Equally
So far, what little profit companies are reporting is a result of cost cutting measures. At some point, a business will have trimmed as much as it can. Businesses will then have to rely on making money the old fashioned way: by selling to customers.
Unfortunately, consumers today aren't interested in buying things with a carefree attitude anymore. If the purchase is discretionary, it goes down the list of priorities.
Time for the Old Timers to Shine
You would think that a market upswing would have been especially kind to the larger quality blue chip names that have been around for decades and possess balance sheets strong enough to survive economic setbacks.
Luckily for investors, the stocks your grandpa loves have actually underperformed during this rally. That means while other smaller cap stocks have seen their shares go up multifold, top shelf businesses have not followed suit.
Look at the Procter and Gamble Company (NYSE:PG). Year to date, shares are down nearly 15% while the S&P is up 10%. It's strange to me that a company that sells detergent, toothpaste and toilet paper is underperforming while companies selling more discretionary items are up over 100%. Even Johnson & Johnson (NYSE:JNJ) - 2008 notwithstanding - which has grown sales at over 10% per annum for decades is flat for the year. And both P&G and JNJ yield over 3%. (For more. check out Battered Stocks That Bounce Back)
While a stock can go up in price theoretically forever, Mr. Market won't continue to shower his good graces on companies that are unable to hold their own. In recessions, very few companies can. Those with the best shot at doing so are the names most familiar to us.
For example Wal-Mart (NYSE:WMT), the one retailer that is certain to weather the storm better than any other retailer, is down for the year, while discretionary retailer Pacific Sunwear (Nasdaq:PSUN) is up over 150%. Going forward, these names as well as others like Kraft Foods (NYSE:KFT) and pharmaceutical giant Pfizer (NYSE:PFE) will like provide investors with market beating returns while providing an incredible margin of safety relative to other equities.
Value is Found In the Least Populated Areas
Look around and other first rate businesses are underperforming. The risk/reward ratio for participating in these companies today is as good as it gets. Momentum seeking investors are abandoning them in pursuit of the quick gains found elsewhere. Such an investment approach is a recipe for disaster. (For further reading, check out The 3 Most Timeless Investment Principles and The Value Investor's Handbook.)
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