There's Still Value in This Market

07/02/2013 6:30 am EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

While the market's meteoric rise has taken many stocks beyond buying range, Kelley Wright of Investment Quality Trends says bargains remain out there.

"The trend is your friend, until it isn't," is an old Wall Street adage. As to the state of said trend, it has definitely been to the upside for an extended period.

How long this long-term trend will persist is anyone's guess, but all indications are that it is entirely dependent on the Fed maintaining its current monetary policy.

If the kneejerk reaction we're witnessing at that ever so slightest hint that the Fed may be contemplating a change is a preview of things to come, it might be prudent not to be standing in front of the exit, unless you are comfortable with experiencing severe bodily harm.

Interest rates on ten-year and 30-year Treasuries—not to mention mortgage-backed securities—have risen to levels we have not seen in a while.

One of the Fed's reasons for Quantitative Easing (QE) was to buoy the housing market. The policy has accomplished this goal to an extent, as much of the backlog of houses has been snapped up by speculators, and in some areas of the country housing prices have risen considerably. However, many banks are still carrying a large number of foreclosed homes, and the housing industry has still not recovered as much as the Fed would like to see.

Another intent of QE was to increase employment. The policy has not been as effective. It is curious why serious studies by well-regarded academics and economists—which provide empirical evidence that although monetary policy can improve general economic conditions, it cannot induce employers to hire additional labor—have largely been ignored.

Margin debt on the New York Stock Exchange rose to $384.4 billion in April, eclipsing the record $381.4 billion reached in June 2007. For only the third time in history—the 2000 market peak, the 2007 market peak, and now today—margin debt exceeds 2.4% of GDP. One result of all this borrowed money is that asset prices (stocks) are much higher.

Due to massive deficit spending, record low interest rates, and cutting costs to the bone, corporations are more lean and mean than almost any previous period, and their balance sheets are absolutely pristine. Corporations are generating so much cash it is sloshing around as in a bucket. The end result is that dividends and share repurchases have risen significantly.

One tiny area of concern is that the Dow Utilities have taken a beating, and historically, a downturn in utilities has been a precursor to a downturn in the broad market. Of course this could just be a kneejerk reaction by the market to the recent rise in interest rates, which generally doesn't favor interest-sensitive stocks like utilities.

The dividend yield on the Dow Industrials has dipped to around 2.35%. According to the Dividend Yield Theory, 10% above and below Undervalue and Overvalue is considered a standard deviation. A 2.20% dividend yield on the Industrials would fall within that 10% standard deviation.

Considering all the above, what is the enlightened investor to do? For those who wish to add to their portfolios, there are still a well-diversified collection of stocks that offer good current value in the Undervalue category. With an appropriate investment time horizon to ride out any corrections in the broad market, these stocks are suitable for investment consideration.

What remains to be seen is in a rising interest rate environment, with persistently high unemployment, will there be sufficient investor demand and disposable income to maintain the current uptrend in stocks without the tailwind of continued cash infusions by the Federal Reserve.

Every dog has its day and every cycle runs its course. This time will be no different.

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