Insights & Advice

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Stocks Are Heading Higher

We hit the top of my trading range on Friday (S&P 1416) before quickly retreating. So far this market bounce off the lows has increased in vigor as we moved higher. Since the second re-test of the market bottom (S&P 1270) back in March, the bulls have been pushing this huge ball of worry relentlessly up, up and up a slippery slope of foreclosures, bad earnings and nasty economic surprises. I am confident the S&P 500, Dow and NASDAQ will forge higher. How much higher? Assume 5 to 6% additional gains from here before we run into trouble. I think that is enough upside to add a bit more money here.

Investors obviously approved the Federal Reserve Bank’s quarter point rate cut and their statement afterward gave everyone what they wanted. Worried about recession? The Fed had a few soothing words. They promised to “act as needed to promote sustainable economic activity.” If instead, you were expecting a pause because more rate cuts will fuel an already ascending inflation rate, don’t worry, be happy, the Fed promises to “continue to monitor inflation developments carefully.”

The bond market is betting that Wednesday’s rate cut will be the last we’ll see this cycle. I happen to agree—barring another meltdown from left field. So where does that leave the investor who has been hiding out in money market funds or government bonds waiting for the markets to bottom? Right now these instruments are yielding less than 3% while tax -free funds are yielding less than half of that. I talked to one client about that.

“But I’m protecting my capital,” protested the client this week.

“No way,” I argued, “not with real inflation north of 6% and going higher. Your principal is being eroded every day it sits in cash. Net, net—you along with every other investor in this predicament are losing your shirt while at the same time thinking you are preserving capital.”

So what’s an investor to do? For those who are still worried about the economy or the volatility of the markets, my advice is to take a look at corporate and high yield bonds, income funds as well as preferred stocks. Right now, you can double or even triple your money market returns in these instruments. The smart money is already scrambling to buy these investments because they believe the credit crisis is on the wane.

“But aren’t they riskier than money markets?” asked my client.

“Yes, but the risk of rising inflation and lower money market rates trumps the risk of the market in this case,” I argued.

I’ve looked at several high yield and income mutual funds priced around the $7-8/share range since the beginning of the year. Their price during that time of big declines in the market has fluctuated no more than 12 cents in one case and 25 cents up and down in another while yielding between 5.5% and 8.2%. I believe even risk averse investors could bear that kind of volatility.

One final note on commodities and the markets, I believe that the present pullback in commodities is simply a correction in a bull market. Look to buy metals, energy and agricultural commodities on the way down because choosing a bottom in these volatile investments is practically impossible. As for stocks, we still have room to run on the upside, possibly as high as 1500 on the S&P 500 but for right now I would be happy with another fifty points.

Posted in A Few Dollars More, At the Market