Bullish, But Four Reasons for Caution

In addition to misguided government interventions, the market has three other negatives that make me more cautious than I might be based on just valuations. First is the real estate market. Prices continue to decline. September saw another year-over-year decline of 9% in home prices. There was an unexpected pick up in sales of 2.7% that cheered some to the prospects for the market. At the risk of dumping cold water on the cheerful, sales are still 33% below year ago levels. There is still an inventory of over 10 months supply and I expect that to grow as foreclosures continue to surge.

The second problem is unemployment. While the current 6.1% level might be manageable, we are seeing layoff notices every day. No sector seems to be safe from cutbacks. We are even seeing fairly widespread municipal government cutbacks. The job destruction in the financial companies alone seems likely to continue for some time to come.

The final problem is earnings. Unemployed consumers in danger of losing their homes are highly unlikely to flock to the malls and spend money. It will be a dismal fourth quarter. I do not think the market is properly priced on earnings expectations. According to my copy of Barron's this week, the S&P 500 is still at 17 times earnings. We should still see multiple contraction and falling earnings, a combination that leads to lower overall prices.

I said last week that the growing number of cheap stocks was making me closer to cautiously bullish than my previous outright bearish stance of most of the year. That is still true, but the key word is cautious. The wholesale dumping of stocks caused by the hedge-fund deleveraging and mutual-fund redemptions has created incredible bargains.

The prices of companies like Ashland (ASH - commentary - Cramer's Take) and Cleveland Cliffs (CLF - commentary - Cramer's Take) is almost ridiculous. I am a buyer.

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At the time of publication, Melvin was long Darling International, Ashland, Cleveland Cliffs and CBS, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.