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  1. Home
  2. / Investing
  3. / Stocks

The Day Ahead: Avoid the Hope-Fired Rally

There's too much risk here, and too little upside potential.
By BRIAN SOZZI Dec 18, 2012 | 08:00 AM EST
Stocks quotes in this article: BEBE, FL

"In making decisions under conditions of uncertainty, the consequences must dominate the probabilities." -- Peter Bernstein

Surely you must have various bedrock philosophies that you put into action when you're selecting stocks. One that I have in my mental arsenal is: "Find the facts, and develop a reasonable set of predictions off of them."

However, something tells me many investors lack useful rules of thumb. Instead, they prefer to draw lines on a black-hued chart or buy a stock because it was on a list of "Volume Leaders" on page 97. Hey, whatever floats your boat, I suppose. But, given the markets' crucial patch at the moment, it's important to focus on just a few investing principles. There is no need to ratchet up the level of confusion when corporate earnings are facing a murky path six to 12 months down the line. What we have are extremes on both sides of the equation, and the market is unequivocally confused and detached from any semblance of rationality.

Two fresh, simplistic principles come to me from the late investment philosopher Peter Bernstein:

"Financial markets are a bet on the future." (OK, this is not new to me; it's more of a helpful reminder.)

"Financial markets can't function without information."

Let's put these two inspirational messages to the test on items I observed Monday:

First, the S&P 500 is trading at 14.5x current earnings, as compared with the 16.4x average since 1954. This statistic leads investors to believe stocks are a screaming bargain. After all, corporate balance sheets are in fine standing -- income statements are another issue entirely -- the Federal Reserve is friendly and the international scene in 2013 should be different from what we saw in 2012. I say, yeah? This is a modest discount to an average compiled during an era of stronger growth -- because we in this post-recession period are living in a land of "sub-part growth." So does this S&P level factor in enough risk, given the impending new fiscal runway? Has the market looked forward to a period of deficit reduction and entitlement reform?

Second, the market ignored the December Empire State Index; what happened was exactly in line with the comments I made Monday morning. The key takeaway was that businesses have an expectation of pressured selling prices, which should trigger a basic thought that fourth-quarter reports may not represent the widely discussed earnings trough for the cycle.

I certainly comprehend traders bidding up the market after they've studied the faces of Washington elite. However, the market is essentially fabricating its own new information, developing a future that fits with its natural desire to send stocks higher. (The future is always brighter than the present, right?) I want you as an investor to understand this: Any announcement on fiscal policy will bring some form of harm to companies. Indeed, we will have long sought certainty, but with it a change in the dynamics of the economy.

So I continue to believe there is more risk to jumping into a hope-based rally than there is upside into year-end. Trust me, as soon as a fiscal-cliff deal is ironed out in any fashion, stocks will rally until the finer points of the legislation are appreciated. There will be ample opportunity to rebalance and reposition your portfolio for success in 2013.

Assorted Scribbles

● Specialty-apparel retailer Bebe (BEBE) came across my screen Monday. The company sported only meager moves in same-store sales and experienced clear holiday-season challenges, so it's of intrigue to me that the stock gained ground on very robust volume.

● What excites me on 2013: a chance for earnings-per-share estimates to be marked down at a less rapid pace than in 2012, with stabilization returning by mid-year. Remember that, in 2012, we have had to endure a prolonged stretch of reduced profit estimates.

● Was that an ugly chart on Finish Line (FL)? You bet. However, the stock is so cheap and the company in the process of many tech investments that could propel longer-term returns, so I have to ponder if it's a better bet in 2013, relative to the Street's current footwear retail favorite.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Sozzi had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Stocks

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