The Stealth Bull Market

MarketWatch’s Mark Hulbert says that, while the market has continued its upward trend in the past few months, sentiment remains quite low among market-timers — and that’s good news for stocks.

As of Thursday, the shortest-term market-timers tracked by Hulbert’s Hulbert Financial Digest, on average, recommended that investors be 19.4% in stocks. “Though that may strike you as surprising, it is precisely what contrarian theory would suggest: The bull market is climbing a wall of worry,” Hulbert writes.

In addition, Hulbert says the last time that the average recommended equity exposure among those newsletters was as low as it is today was in early July, when the Dow Jones Industrial Average was almost 2,000 points lower than recent levels. “That’s amazing, because the usual pattern is for advisers to become more optimistic and exuberant as the market rises, just as they tend to become more dejected and pessimistic as the market declines,” he says. “In other words, the bull market since July has had no net impact on the sentiment among market timers. Call it a stealth bull market, if you will.”

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Gabelli Says “Plain Ol’ Stock Picking” Still Works

In an interview with CNBC, GAMCO’s Mario Gabelli says the way to make money in a fairly flat market is by going back to “plain ol’ stock picking” — and says that the “new normal” will look a lot like the old normal.

“It’s not the new normal — it’s the way it used to be” until the financial sector blew up, Gabelli says. He adds that he expects “the strong will get stronger,” citing firms like Goldman Sachs and JPMorgan. And he also is on the lookout for companies that will go through what he terms “financial engineering”. (Thanks to valueinvestingpro for posting this video.)

“High-Quality” Picks from the Gurus

In the past two days, two of the most successful gurus I follow — GMO’s Jeremy Grantham and Gotham Capital’s Joel Greenblatt — have said that they are seeing a lot of value in “high-quality” stocks, as opposed to the junk-type stocks that have led the recent market surge.

In his third-quarter letter, Grantham says that U.S. “quality stocks (high, stable return and low debt)”, are now trading at “genuine outlier levels” compared to the rest of the market after the junk rally. “In our seven-year forecast the quality segment has a full seven-percentage-point lead over the whole S&P 500, or 9% over the balance ex-quality,” he says.

Greenblatt, meanwhile, told Yahoo! TechTicker that his “magic formula” approach seems to be finding more values in high-quality stocks than in junk-type stocks

With Grantham and Greenblatt’s comments in mind, I scoured my database for stocks that pass one or more of my “Guru Strategies” (each of which is based on the approach of a different investing great), and which could also be considered “high quality”, using Grantham’s definition as a basis. Among the specific criteria I used to define “high quality”:

  • earnings per share have increased in each year of the past five-year period, with average annual EPS growth of at least 10%;
  • a current ratio (current assets/current liabilities) of at least 2.0, to target stocks with good liquidity;
  • debt/equity ratios no greater than 40%;
  • market caps of at least $250 million, and share prices of at least $10, to focus on better-known firms.

Here are ten of the top stocks that meet all those criteria:

Guru-Strategy Approved "High-Quality" Stocks

Guru-Strategy Approved “High-Quality” Stocks

Greenblatt: High-Quality Appears to Offer Most Value

Hedge fund guru Joel Greenblatt says that he thinks the best values in the stock market are probably now in the “high-quality” area, as opposed to the junk stocks that have led the recent rally. And, he says he’s not too concerned with potential inflation — or deflation, for that matter.

Greenblatt, who uses a purely quantitative formula to pick stocks, tells Yahoo! TechTicker that he doesn’t like to predict where the broader market will go. But he does say that stocks with poor fundamentals got hammered last fall and in the early part of 2009, and have then surged back during the rally. Higher-quality stocks, meanwhile, fell less during the plunge, and have risen less in the rebound. “A lot of those are available at attractive prices,” he says of the latter group.

Greenblatt’s two-step “magic formula” is a value approach that often delves into unloved areas. “What you’ll find is that [the formula] comes up with companies that people always think there’s a problem with,” he says. Investing in one or two of these firms is thus risky. But if you buy a broader portfolio of them, the risk is dispersed. “That’s why you really have to buy a basket of 20 or 30,” says Greenblatt

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Guru Strategy Rating Changes: South American Firms on the Move

Each week, I take a look at which stocks my Validea.com Guru Strategy computer models have newfound interest in, and which they have soured on. Here’s a look at some of the stocks that my strategies have upgraded or downgraded today. As you’ll see, several South American firms are among the movers.

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Arnott: Think Deep — Value, That Is

Rob Arnott of Research Affiliates says that the recent rally has taken away from the attractiveness of many areas of the stock market, but he remains very high on beaten-down value stocks, which he says are still priced near Armageddon levels.

“What we’re seeing is value priced as if Armageddon isn’t right next door; but it might be three or four doors away,” Arnott tells Canada’s Globe & Mail. “And the growth side is priced as if the troubles are over and it’s back to the races. That doesn’t make sense.”

Indeed, the price-to-book value of stocks in the Russell 2000 value index is now less than half the level of the Russell growth stocks, notes the Globe & Mail’s Brian Milner. Normally, the value discount is about 30%.

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Grantham Expects “Painful” Pullback in 2010

In his third-quarter letter to clients, GMO’s Jeremy Grantham offers a scathing critique of a myriad of groups whose actions (or inactions) led to the current economic climate — from regulators to homebuilders to CEOs to politicans — and says the stock market is now 25% overvalued and due for a tumble. He also reiterates his belief that U.S. “quality” stocks are the place to be, and that an emerging market bubble is looming.

“Fair value on the S&P [500] is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers),” Grantham writes. “This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real [annual gains] down by more than 3% a year.” Corporate profit margins and price/earnings ratios have also risen significantly above fair value, he adds.

Grantham sees a pullback in late 2009 as unlikely, with low interest rates, lots of money being pumped into the economy, the promise from the Federal Reserve of further help in case of future problems, momentum, and the herd mentality driving stocks higher. “Price, however, does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors.

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