You Can Still Make Money – Even in This Market

By GREGORY ZUCKERMAN

Carnage in financial markets and worries about global economies have produced a new wave of nervousness among investors. But the turmoil also is creating something else -- bargains for investors with courage to do some buying of beaten-down shares.

An impressive triple-digit stock-market rally last Wednesday was wiped out Friday, when a disappointing report on the U.S. job market put a further dent in confidence.


Tim Foley
.The Dow Jones Industrial Average plunged below the psychologically important 10000 mark during Friday's frantic trading. Similar performances were logged by the Nasdaq Composite and the Standard & Poor's 500-stock index.

Amid such market volatility, few analysts say investors should jump into the market with both feet. European economies and currencies are under heavy pressure, and worries are growing that the global economic recovery is sputtering. If European governments are unable to make headway cutting debt and improving growth, the nervousness could affect other markets.

But, despite all the negatives, the U.S. economy is showing signs of strength. Corporate profits have been rising for five consecutive quarters; nonfinancial profits were up 6% in the past quarter. Construction and manufacturing data have been impressive lately.

"Having initially been driven by the financial sector in the early stages of recovery, profit growth has now broadened," says Peter Newland, an economist at Barclays Capital. "Indicators suggest that momentum is building, supported by healthy wage and profit growth."

The economy appears to be growing at an annualized, inflation-adjusted rate of at least 3% this quarter, amid impressive retail sales and industrial-production figures. That's respectable, though not robust, growth.

"Our baseline scenario is that events in Europe will not impact the U.S. economy in a meaningful way," says Morgan Stanley economist David Greenlaw.

Housing on the Mend
Housing seems to be stabilizing -- pending home sales rose 6% in April following a 7.1% increase in March and an 8.3% gain in February. Some of the improvement is due to the recently expired home-buyer tax credit, but tumbling mortgage rates could be another shot in the arm for the housing market.

Investors have dumped stocks and purchased Treasury bonds, seeking safety, which has helped push 30-year mortgage rates well below 5% -- sparking a surge in mortgage refinancings.

Though May's employment gains were disappointing, some say better times are ahead. "The labor market is the last puzzle piece that will likely fall into place next," predicts Jack Ablin, chief investment officer of Harris Private Bank in Chicago. "Temporary hiring is off the charts and given its tight relationship with the job market, we expect permanent job growth to follow close behind."

Just as important, stocks have been beaten down, so they now appear reasonably priced. The price/earnings ratio for companies in the S&P 500 index is 13.3 based on expected earnings for 2010, suggesting stocks are attractive, some analysts say.

."It is rare that investors are offered such violent and quick corrections in an environment that is fundamentally improving," says market strategist Mike O'Rourke. Mr. O'Rourke is among those who argue that market pressure is forcing nations in Europe to finally take dramatic steps to curb spending and rein in debt.

Some savvy investors, including Warren Buffett, David Tepper and Larry Fink, have issued more upbeat pronouncements in recent weeks, in part because Europe finally seems to be addressing its debt problems.

Europe Troubles 'Manageable'
John Paulson, a hedge-fund manager who scored $20 billion of profits in 2007 and 2008, in early May told his investors that "the outlook for 2011 could be very strong," and that housing prices could rise as much as 10% next year. In Mr. Paulson's view, the troubles in Greece and other European nations are "manageable" and won't be much of a drag on U.S. growth.

That's not to say a newly invigorated bull market is around the bend. Europe's difficulties will mean somewhat lower U.S. exports. Interest rates should remain low for the foreseeable future, but heavy government spending, which has helped boost growth, is unlikely to continue apace amid scrutiny over high levels of government debt.

Instead, investors who have little in the market should use the recent selloff as a reason to edge back into certain stocks, some analysts say.

"This is an environment in which most investors are underexposed to U.S. equities although they offer the best combination of growth and safety for a global investor," says Mr. O'Rourke.

The best strategy is to stick with large, "high quality" companies, which trade at cheaper valuations than their smaller peers and could hold up better if the market has another downdraft. In fact, the 100 largest stocks in the S&P 500 trade at a P/E multiple of about 12.6.

Goldman Sachs is a fan of tech titan Broadcom, biotech giant Amgen and Consol Energy, a coal producer that's also a favorite of George Soros's hedge fund.

Many larger tech stocks are cash-rich and have little debt, making them stable picks in rough markets, analysts note. Some also recommend health-care shares, partly because they trade at an average P/E multiple of just 11. Larry Robbins, who manages hedge fund Glenview Capital, recently recommended health-care-related companies McKesson, Express Scripts, and Life Technologies.

"If 2000 was the peak of irrational exuberance, with investors paying for companies without earnings, today has to be the era of irrational pessimism," argues James Paulsen, chief investment officer at Wells Capital Management, who recommends shares of companies in the technology and basic-materials industries.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com