Sell the Rally, Buy These Winners

10/24/2011 11:06 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

The market has priced in good news, but stocks like McDonald’s and Bed Bath & Beyond don’t need a boom to keep running, writes senior editor Igor Greenwald.

Things have been going so well of late, it’s too bad the math doesn’t add up.

The market’s not the hysterical wreck it was at the start of October, nor can it look forward to another month of endearing earnings news. So, chances are, this magic beanstalk of a rally is mostly done.

It’s served a welcome reminder that the US economy is in better shape than Europe’s or Japan’s. The corporate cream is still rising to the top, on the shoulders of the anonymous millions churning the milk to keep from drowning.

Europe is about to throw a trillion or so euros at its money problems, and a particularly generous squint might suggest that’s enough. China has the capacity and every incentive to kick its own banking and real estate woes down the road.

The US economy likely managed to grow at a 2.5% annual rate in the third quarter, despite the frights and shocks dispensed by Washington and Wall Street, figures released this week should show.

Retail sales have held up better than anyone had a right to expect. Auto sales have been strong, as the cars and trucks financed at 0% in 2001 to 2003 start to show their age. Multifamily housing starts were up 51% to the highest level in three years in September, spurred by rising rents and falling rates.

If this is how the economy performs with its political and financial underpinnings in grave doubt, and with businessmen supposedly paralyzed by fear of red tape, how much might it boom once these real and imagined drawbacks recede? That’s the promise rally participants have been buying, and it’s just possible to imagine pension managers thinking this way.

Hedge funders suffering from performance anxiety will just be happy to have padded their returns ahead of the redemption window. And many—perhaps most—individual investors are refusing to take their chances in a casino increasingly dominated by computers trading at incomprehensible speeds.

Unfortunately, the penny-pinching all the rage in Europe and the US is very likely to drag recent growth rates south, and the private sector is not going to make up for the public thrift.

We learned on Friday that McDonald’s (MCD) prices will soon be rising for the third time this year, alongside the health-care costs for many Wal-Mart (WMT) workers. The drive-thru diners and part-time greeters will need to churn the milk of corporate kindness that much faster just to stay afloat.

Merrill Lynch warned overnight that the US credit rating could face more downgrades if the congressional budget negotiators remain stuck. And while that won’t stop the Chinese from buying US bonds, it could ensure that the temporary payroll tax cut and unemployment aid that have bolstered growth will soon go away.

Europe is insisting on austerity from Italy very much along the line of the demands that have turned Greece into a basket case. The EU’s economists, working alongside the International Monetary Fund’s, concluded Friday that the cuts forced on Greece have only succeeded in running up its debts, requiring much steeper writedowns. That, in turn, will swallow up precious public resources that won’t be available to prop up Italy or Spain.

Those countries badly need a devaluation that can’t happen while they stick with the euro. As growth falters, doubts about debt repayment will only grow, notwithstanding the partial insurance guarantees the Eurozone is promising.

So public policy continues to opt for retrenchment over growth, and in the US as well as Europe, the screws are set to tighten automatically next year without an imminent change of heart by politicians. What’s more, the recent resilience of financial markets makes it less likely that the austerity proponents will come around before it’s too late.

That’s a lot of risk to be shrugged off by a market that’s already come a long way in a short time, especially as focus shifts from corporate windfalls to the political wrangling.

The best way to finesse all that risk is with strong, steady stocks in clear uptrends that figure to do well even in a recession and financial panic. I remain partial to the likes of McDonald’s (MCD), Bed Bath & Beyond (BBBY) and TJX Stores (TJX), which are keeping pace with the market on good days and holding up extremely well during bad ones. There are still double-digit yields and dirt-cheap earnings multiples out there.

But Italy and China and the supercommittee are out there as well. The bankers’ math still doesn’t add up. And so long as that holds true, it doesn’t make sense to chase a market that’s not going to run away.

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