Is It Time to Bail Out of the Market?

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Europe's in crisis, the U.S. economy is stagnant, and unemployment is anchored around 9% -- time to bail out of the market, right?

And, Jim, you say, Bloomberg just reported that the number of shares sold short is approaching Lehman levels. That must mean that the market is bound to head lower, surely?

Wrong.

In fact, with valuations at near-record lows and corporate profits at record highs, now could be the perfect time to buy those blue chip companies at a price that's hard to beat. Read on, and I'll give you a chance to download a special free report that details five stocks The Motley Fool owns and that you should, too.

Three reasons you'll want to buy
Yes, it's true. Bloomberg reported that the number of shorted stocks climbed to the highest level since the Lehman blow-up of 2008. The number of borrowed shares climbed to 11.6% of stock in September, up from 9.5% in July. Some of the Dow components had notable numbers: Alcoa (NYS: AA) is the most shorted stock in the Dow, while Pfizer (NYS: PFE) and General Electric (NYS: GE) had the biggest gains in short interest last month among NYSE stocks.

Sounds scary. But should you follow short-sellers or at least dump the shares you own?

"The Lehman collapse is way too clear in people's minds," explained one strategist at Nordea Bank. "They don't want to get burned as much again."

But that attitude will ultimately burn investors in the long run, as they sell out of solid companies at depressed valuations and buy into low-return assets like bonds and CDs.

With short interest at Lehman-like levels, should short-sellers worry you? On the contrary, you know what followed the Lehman debacle -- some of the best and quickest returns on America's blue chips in a decade. Or as Bloomberg noted, "Bearish bets last increased faster in March 2009, the same month the S&P 500 began a bull market that doubled its value."

After all, those short-sellers had to get back into the market and buy, driving the price of shares back up. So the high number of short shares now also means that there's clearly a pool of investors out there who will be forced to buy later on.

And there are some signs that the short trade is getting crowded. According to the chief U.S. equity strategist at Deutsche Bank, "Valuations and short interest are approaching Lehman levels. It's not very easy to continue to take larger and larger short positions." That's good for bulls.

So short pressures could be abating, meaning that positive market news could even lead to a short squeeze, sending shares higher. And I don't want to be the one getting left behind by a bull market.

Moreover, there are two other reasons that you should be optimistic: high corporate profits and low valuations.

Following a rough couple of years and painful downsizing, corporate America has turned into a lean, mean, money-making machine. Profit growth in the S&P 500 has returned to its historical average since the 1960s.

But surprisingly, valuations aren't taking account of that profitability. The S&P is trading at just 10.4 times the forecast for 2012 earnings. That's well below the historical average of 13.7 during recessions since 1957.

So that all spells opportunity for the long-term investor.

But what do I buy?
Just because S&P stocks as a whole are profitable and cheap doesn't mean you should buy any old stock. Instead, you should focus on buying value-priced stocks with a history of solid profit growth. The low valuations help insulate you from market panic, while profit growth means you can expect future stock gains.

One good place to begin is with Berkshire Hathaway (NYS: BRK.B) , the conglomerate run by superinvestor Warren Buffett. The company comprises some 80 businesses with durable competitive advantages and is trading at an incredibly cheap valuation -- just 1.1 times book value.

Plus, Buffett has put something of a floor under shares. He's stated publicly that he would consider repurchasing Berkshire shares when they are trading for less than 1.1 times book value. Berkshire is sitting on a pile of cash, so it can back up its words, and Buffett is not one to talk idly.

Also of interest are names like Philip Morris International (NYS: PM) and Intel (NAS: INTC) . Each company trades at a reasonable valuation (15 and 10 times earnings, respectively), dominates its markets, and generates gobs of cash. Plus, each has a solid practice of rewarding shareholders with a steadily rising stream of dividends. Right now Philip Morris offers a 4.7% yield, while Intel offers a 3.7% payout. These are rock-solid blue chips companies that provide a bank-beating yield and long-term upside. It's hard to see how you can go wrong over the next five to 10 years with these stocks.

If you're more aggressive on the yield front and don't expect or require capital gains, you might opt for Annaly Capital (NYS: NLY) . This mortgage real estate investment trust trades at tangible book value and offers a 15% yield. Things look solid for this dividend giant as long as interest rates remain low. This company thrives on business conditions that sink other stocks, meaning it can make a good hedge for your portfolio.

Want more?
So, far from bailing out of the market, now may be a great time to pick and choose your winners for the next decade. If you're intrigued by the possibility of scoring good long-term returns, you should download our special free report "5 Stocks The Motley Fool Owns -- And You Should Too." The stocks (including one named above) were selected by our top analysts, and The Motley Fool has put real money behind the picks. It's complete free, so you have nothing to lose, just click here.

At the time this article was published Jim Royal, Ph.D., owns shares of Annaly, Philip Morris, and Berkshire. The Motley Fool owns shares of Philip Morris, Annaly, Berkshire Hathaway, and Intel. Motley Fool newsletter services have recommended buying shares of Intel, Philip Morris, Berkshire Hathaway, and Pfizer. Motley Fool newsletter services have recommended creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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