Comment & Analysis

What now, Dow Jones (news) ? Without a doubt, the big question confronting investors is whether the stock market has bottomed, with the Dow Jones industrial average recently up some 7% in just eight days after tumbling 36.79% from its record closing high of 14,164.53 on Oct. 9, 2007.

Many analysts may beg to differ, but some savvy strategists assert that indeed the market hit bottom on Nov. 20, 2008, when the Dow finished the session at 7,552.29, its lowest closing since Mar. 14, 2003.

It isn't surprising that investors on the whole are still very skeptical, if not dead set against putting one more dollar into equities because of the devastation of the market, with global financial crises and a deep recession battering stocks.

But whether or not shares have reached a low, investors should recognize that the new year and the forthcoming massive spending from President-elect Barack Obama's recovery proposal bodes well for the market. The ambitious program, set to begin in February, should lift investor and public confidence across the nation. The plan will bolster the economy with huge outlays and should help persuade financial institutions to unlock credit they have restricted so far, helping to boost business spending once again.

Cheap Blue Chips

Certainly there will be doubters, but already many asset managers have been snapping up stocks they expect to appreciate as a result of the Obama program. Some, such as those of companies expected to benefit from infrastructure rebuilding, already have taken off. For instance, since Dec. 20 shares of heavy equipment maker Caterpillar (CAT) have jumped 49%, while tractor maker Deere (NYSE: DE - news) 's (DE) stock has leaped 40%. Steel industry shares also have suddenly boomed: AK Steel (NYSE: AKS - news) (AKS) has jumped 106%, Allegheny Steel (ATI), 88%; Nucor (NUE), 85%; and U.S. Steel (X), 88%. Predictably, shares of companies that supply construction aggregates such as sand, gravel, and stone also have bumped up strongly: Vulcan Materials (NYSE: VMC - news) (VMC) climbed 70%, and Martin Marietta Materials (NYSE: MLM - news) (MLM) 73%. Even so, some analysts believe these sectors have the potential to go higher.

But investors should not be blind to other value opportunities the savaged market provides, largely as a result of enormous government intervention in the financial, auto, housing, and mortgage sectors.

The temptation is for investors to be very conservative in their investments and "wait for the right time" to invest, notes George Putnam, editor of The Turnaround Letter, who says many are even "considering abandoning stocks forever." With the annual return of the S&P 500-stock index down 6% since the beginning of the decade, that doesn't surprise Putnam. But he says this is exactly the wrong time for investors to pull away.

"We believe the stock market will post a strong rebound in the not-too-distant future," argues Putnam. With the market's huge decline in 2007, many blue-chip stocks of the highest quality are trading at discounted levels not seen since the 1990s, he notes.

Indeed, Putnam and other bulls recommend that investors have the courage to pick up high-quality stocks now trading at 30% to 50% off their 2007 highs. But in these still financially fragile times, shareholders should focus on companies with a record of steady earnings growth, strong cash flow, and leadership in their respective markets. And in most cases, a company should have a clean and healthy balance sheet and ample free cash flow to fund healthy dividends.

Robust Yields

Putnam recommends 14 top-quality stocks that have fallen by more than 30% in 2008, all leaders in their industries that he figures would make "good foundation" stocks for almost any portfolio.

Among them: AT&T (T), a dominant telecom player with free cash flow of $14 billion and generous dividend yield of 5.9%; Bank of America (NYSE: IKJ - news) (BAC), which has grown rapidly through acquisitions, including its purchase of Merrill Lynch (NYSE: MER - news) , and will likely benefit from further turmoil and consolidation in the banking sector. BofA cut its dividend to conserve capital but it still provides an attractive yield of 9.2%.

Other picks from editor Putnam: Berkshire Hathaway (BRK.B), Warren Buffett's principal investment vehicle, which owns operating companies and a vast investment portfolio worth at least $65 billion; General Electric (NYSE: GE - news) (GE), a global powerhouse whose brands are leaders in markets ranging from jet engines to light bulbs and entertainment, and which provides a substantial yield of 7.8%; and Microsoft (NASDAQ: MSFT - news) (MSFT), the largest independent software company with strong cash flow, a cash hoard of $20 billion, and a yield of nearly 3%.

A Snap Back in Earnings?

One sign of a market floor: Stocks have rallied in the past couple of weeks even while investors digested a lot of unnerving news, notes Jeff Kleintop, chief market strategist at LPL Financial Services. The unpleasant news included dismal earnings reports by Goldman Sachs (NYSE: GS - news) (GS) and Morgan Stanley (NYSE: MS - news) (MS), as well as the unfolding details of the alleged Ponzi scheme by Bernard Madoff. The volatile bottoming process is likely to extend into 2009, he says, but he recommends that investors try to profit from it.

Kleintop's most likely scenario for 2009 is that the financial panic that began in September 2008 will subside early in the year, allowing markets to normalize by mid-2009. He believes the government's intervention policies will begin to take hold by then. He notes that evidence of a sharp rebound in market sentiment started showing up in late 2008 and early 2009.

If his bullish scenario holds true, Kleintop sees stocks rebounding as both earnings and valuations snap back as a mountain of cash returns to the capital markets. The S&P 500 will close the year at about 1,365, he forecasts. The powerful market rally would likely be led by the consumer discretionary, information technology, and financial sectors.

Biotech Promise

Eric Wold, director of research at investment firm Merriman Curhan Ford in San Francisco, recommends seven stocks for 2009 that are leaders in solar energy, TV and film technology, biotech, and pharmaceuticals.

Among them: Energy Conversion Devices (NASDAQ: ENER - news) (ENER), one of the best-positioned solar companies, whose strong balance sheet and healthy order backlog should make it a major player in the industry; Gilead Sciences (NASDAQ: GILD - news) (GILD), whose position as leader in HIV therapeutics and in the cardiovascular field makes it a biotech staple for any investor; Imax (NASDAQ: IMAX - news) (IMAX), a pioneer in developing large-format theater systems with 320 theaters operating worldwide; Regeneron Pharmaceuticals (NASDAQ: REGN - news) (REGN), which Wold describes as an exciting biopharmaceutical company developing a proprietary set of "antibody-like" compounds with implications for multiple diseases; and Exide Technologies (NASDAQ: XIDE - news) (XIDE), a global supplier of lead acid batteries in automotive and industrial markets.

With all the turmoil and devastation investors had to bear in 2008, it is difficult to envision the market marching upward again. But after a correction, no matter how severe, a stronger market eventually emerges. The stock charts of the Dow and the S&P 500 index in each market cycle bear this out. The savvy investor rolls with the punches.