Go Long and Strong for 2006

Although the current year-end rally almost seems too easy, I do think that the seeds of it come from a solid wall of worry, which is why I believe it is going to stick and even continue well into next year (admittedly with bumps along the way).

Here is the wall of worry as I see it:

• "The housing bubble is over." Every day The Wall Street Journal has another article on this. Is it over? Does this even affect stocks or the consumer? Nobody really knows.

• "The yield curve is inverting." I've written in the past how this does not necessarily lead to a recession. Rather, it could end up leading to very quick short-term rate declines, which would be a huge boost to the market.

• "Mortgages are going to pop higher next year." A lot of banks used low-interest mortgages to entice refinancers. The low interest gets higher after a few years. Starting next year, these higher rates could affect the consumer. The flip side is that corporate spending is starting to really kick in.

• "S&P 500 companies are not spending their cash on growth." This is the best one. Investors are actually worried because companies are using cash for buybacks and dividends instead of fueling growth. As one prominent mutual fund manager put it, "Companies no longer see prospects for growth. They can't figure out how to grow, so they are giving their money back."

If corporations really didn't see any prospects out there, then I have news for you: They wouldn't be handing over their cash, they'd be shoring up their balance sheets and waiting for the tough times to come. But they aren't doing that, because the tough times are not coming next year. Or maybe even the year after. Analysts expect there to be almost 15% year-on-year earnings growth in 2006 for the S&P 500. Let's say they are wrong by 60% and its only 5% growth. That's still outpacing the broader economy.

So why give back the cash and not use it for growth?

The enormous increase in productivity in the 1990s is now only beginning to be felt in corporate America. Corporations are outsourcing, downsizing and using fewer plants and less equipment per unit of production.

So why not use it for marketing? Well, thanks to Google, customer acquisition costs are falling dramatically as companies switch from broad TV advertising to very specific, pay-per-performance advertising on the Internet. Ford, for instance, is moving as much as 10% of its advertising budget online for the first time. Internet advertising until now has just been an experiment. This graphic from eMarketer is telling:

Marketers have given up on traditional media and would rather pay for customers than for the generic "branding" campaigns they've been scammed into by the ad agencies.

Perhaps the biggest concern people have is a combination of all of the above -- that in 2006 we are certainly heading toward a recession, perhaps even a depression if you believe all of the hype out there.

The one contrarian play I can think of is to throw what the great quarterback Y.A. Tittle would call "The Bomb" and go long and strong for the 30%-plus rally that could happen in 2006 on the S&P.

---

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

Interested in more writings from James Altucher? Check out his newsletter, TheStreet.com Internet Review. For more information, click here.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.