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Finding value in the current market

If you're having trouble reconciling the idea of short-term opportunity in the stock market with the many big-picture issues still facing the economy, you're not the only one.

I'm a fan of author Jason Zweig (who wrote the book we excerpted our Feb 2008 — The High Cost of Fear — cover article from). He's usually pretty insightful. His recent article titled Wall Street's Clearance Sale Leaves Few Bargains details how so far in this market rally, the junky stocks are the ones that have risen the most, while the high-quality stocks haven't done as well. The tone is pretty pessimistic, wondering "But after this big and fast a bounce, how much upside can be left?"

Interestingly, he then turns to Jeremy Grantham to answer that question. (You'll recall that we've talked a fair amount about Grantham's views on the market recently.) Again, the context is basically this: the market has rallied a huge amount, the stocks that have rallied the most aren't really very good companies, and any good values that did exist seem to be pretty much gone now.

So where can a value-conscious investor turn?

Mr. Grantham regards "high-quality blue chips" as the only bastion of value in today's market. He cites companies like Coca-Cola, Johnson & Johnson, Procter & Gamble, Wal-Mart Stores and Microsoft as offering "high, stable returns with very little debt."

Dividends average better than 3% for this group; if "everything merely returns to normal" over the next few years, Mr. Grantham expects these blue chips to be able to return 11% to 12% annually after inflation.

That's the punchline of this relatively pessimistic article?

Think about this with me for a second. Here's another way to rephrase that calculation: If everything "merely returns to normal", these bluest of blue chips would be expected to gain roughly 50% over the next three years. (Assuming a modest 3% annual inflation.)

Hello? Anybody out there NOT interested in an additional 50% gain over the next three years or so? Anyone think that isn't a big enough prize to be worth playing for?

Now granted, Grantham may be all wet and the exact opposite could happen. The point really isn't to debate his view of how this is going to play out. I was just struck by the dissonance between the article's tone and the example cited. I think it's an illustration that the author, like most of the rest of us, probably feels torn about this market. Conditions obviously aren't that great, yet there still seems to be opportunity in stocks.

It's hard to reconcile. But then again, it always is during/after bear markets.

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