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What's Not to Love about Stocks?: Searching for Alpha for September 2010

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As new home sales decline to the lowest levels since the government began tracking them in 1963, unemployment stays stubbornly high, and durable goods orders stagnate, the public's perception of the equity markets continues to drop. U.S. individual investors pulled $33.1 billion from stock funds in the first seven months of 2010, according to the Investment Company Institute. Indeed, some believe that the era of risk-taking among the investing public is coming to an end.

In other words, it's time to buy stocks.

Valuation is certainly one driver. There are a plethora of stocks with strong earnings, good balance sheets, and an enviable record of dividend growth that are trading at very reasonable levels. According to Bloomberg data, large-cap tech companies are trading at around 15 times earnings, a level not seen since at least 1992. Consumer stocks such as Johnson and Johnson (JNJ) are trading near all-time low P/E multiples. Considering their upside potential, tech and consumer names offer compelling value for long-term oriented investors.

Investor sentiment has clearly shifted in favor of the bears, and is another reason market participants should get prepared to buy more equities. Indeed, most firms that measure investor's attraction to stocks–including the Investors Intelligence advisor sentiment survey, the American Association of Individual Investors, and Yardeni Research–have all noted that the predilection to sell is as dramatic since March 2009.

Research has shown, however, that declining sentiment is usually associated with rising stocks prices. My guess is that hedge funds desperate to make back the money they lost in 2008 (and only partially recovered last year) will help create an upswing sometime in the fourth quarter. A sentiment shift in favor of the bulls would add fuel to the fire.