Places to Hide in a Rocky Market

I heard a top-notch market analyst say recently that she is a big believer in not trying to anticipate the end of the world. I am in that camp.

The markets are pretty cheap now. The 1,953 stocks in the MSCI World index are now valued at 14 times profits, the lowest since at least 1995, according to a data review by Bloomberg. Europe's Stoxx 600 has a price-to-earnings ratio of 10.7, the cheapest since at least 2002.

We are just on the cusp of true globalization. Once we clean out the excesses, the markets will be poised for the next leg of a strong market run. We'll likely have to wait for that run for a bit, but it will happen.

Before I tell you the ideas for the stocks to consider retreating too, a broad-zoom perspective is in order. The U.S. spent only 16 months of the last 25 years in recession. That’s a significant improvement over prior periods. Many analysts say we are in a recession right now, but even figuring out whether we are or not will take a few quarters. If we are, the typical recession since World War II has lasted 10 months on average, according to the National Bureau of Economic Research. Given the massive size of the housing and subsequent credit bubble, it will likely last longer than ten months. How long is anyone’s guess.

A look at the stock market performance during 11 recessions dating back to 1945 by Sam Stovall, chief investment strategist at Standard & Poor’s, found that the S&P 500 fell 26%, on average, from the months leading up to a recession to the recession lows. The S&P study found that when 10 of the last 11 recessions were over, in the ensuing six months stocks rose on average 12.1%.

The fear of course is that the Federal Reserve has guided the market from one asset bubble to another, from the tech bubble to the housing bubble to now the credit-market bubble. And that cutting rates again keeps the asset inflation party going. The fear is legitimate.

The recession of 2001 was over by November of that year, but still the Fed cut rates down to zero and held them there for three years, in a now unsubstantiated fear of deflation. The real fear was asset inflation which is what we’re dealing with now.

The debate now is that aggressive interest rate cuts could shorten the duration or severity of a slowdown. I still say printing too much money is a key danger, as too much money chasing too few good asset ideas creates one bubble after another and ignites inflation.

Keep in mind that the next asset bubbles are in emerging markets, which is why pinning the blame for the downturn in Monday’s trading on solely the U.S. brings to mind the saying I always keep in my hip pocket, “a conclusion is where the mind comes to rest.”

The benchmark indices of India, Brazil, Turkey and Indonesia all soared more than 40% last year. In China, the Shanghai Composite Index just about doubled, rising 97% in 2007. Monday’s 5.1% drop still had the Shanghai composite up more than five-fold in the past three years.

We knew China was in bubble-land when we saw PetroChina’s market cap soar to $1 trillion last fall, an amount worth almost twice as much as ExxonMobil, a sum roughly equivalent to the entire Brazilian economy, an amount worth substantially more than the combined economic output of the five founding members of the Organization of Petroleum Exporting Countries.

But it was absurd for anyone to think there was any rationality to this market valuation in the up until now hermetically sealed Middle Kingdom. China’s largest oil and gas distributor had listed only 13% of its total shares, with the remaining 87% held by China National Petroleum Corp., the holding company owned by the Chinese government. The tiny shares floated went largely to mainland investors largely restricted to investing only in shares of companies on the mainland. Only just beginning to understand how to value stocks, faced with rising health costs their government won’t cover, and largely restricted from investing outside their borders, you can see why local investors in China are piling pell-mell into the stock market there.

Consider this too: Goldman Sachs has already warned that central bankers in emerging markets are gunning the printing presses to calm local populations, for political reasons, to appease the powers that be who, well, want to keep their crablike grip on power. Goldman says the money supply in emerging markets grew an average 21% over the past year. China’s M3 measure of broad money rose 20%, Russia’s money supply grew 51% and India is up 24%. Goldman also says the entire world’s money supply is growing faster than the rate of GDP growth, and that it is growing at its fastest rate in decades, in real terms. A warning all central bankers need to take heed of.

So what to do? You’ve likely heard it said that you should value companies, not the stocks, and I agree.

I’m still crunching the numbers on a bunch of long ideas I’m getting from the bears in the market. Here’s who they like so far, more later: Exelon Corp, Weatherford International, Dry Ships, Valero and Tesoro. Michael Markowski, founder of stockdiagnostics.com, is following the cash metrics and likes the stocks below.

Markowski’s pretty good—he was early calling the problems at Sears, saying back in 2002 that this stock would go south. And in September of last year he was raising Perkins Diner-sized red flags that the financial stocks were going to see bad times. Here are the Cash King’s picks: Adobe Systems, Applied Materials, Cisco Systems, Citrix Systems, Intuit, Oracle, Paychex and Qualcomm.