5 Reasons Stocks may be Undervalued

It's very unlike me to be an optimist. In fact, earlier this year, I wrote 5 reasons stocks are overvalued, which were:

Stocks have recovered but the economy hasn't.
Stock prices have increased 106 percent.
Experts were predicting a great 2011.
Money was flowing back into stock mutual funds.
Bonds scared me as rates can't fall below zero.

Obviously, four out of five of these signs are no longer the case. And though I'll offer my usual disclaimer that this is not a prediction, there are some very hopeful signs that are giving me courage to buy into this stock market now.

Here are the five reasons I'm turning into an optimist:

Turn the page for reason 1: AFTERSHOCK

1. Aftershock is the #1 business book on Amazon
At the bottom of the market in early 2009, Harry Dent's book, The Great Depression Ahead, was a best seller. Of course, the advice offered in the book turned out to be pretty awful advice since the stock market roared back in short order. Earlier this week, the book AfterShock was the number one business book on Amazon. I haven't read this book on how to protect yourself from the next global financial meltdown, but I'm very encouraged by both it's title and the fact that it's doing so well.

I frequently write about the reality that human beings are herd animals. When fear rules, we want confirmation that it's okay to be scared and that more bad things are going to happen. Oddly enough, the worse the news, the better markets usually perform.

Today, the news is again rather bleak and the recent popularity of the book Aftershock only serves as an example of how bad we believe things are. Despite our tendency to extrapolate the recent past into the future, the truth is that neither good nor bad times last forever.

There is no crystal ball, but bad news is a good sign for stocks.

Turn the page for reason 2: January has come and gone

2. How goes January, goes the stock market
USA Today thought enough of the January Barometer to write about it. The January Barometer shows a very strong pattern that the month of January predicts the stock market. I saw several giddy articles written about it in late January and early February. Those bubbling articles made me quite nervous about stocks.

I'm happy to say I've heard nary a peep on this nonsense lately. That's a really good sign. Not only is pessimism on top, optimists have turned away. This tells me that the fair weather investors have gone buh-bye, which is more good news for stocks.

Turn the page for reason 3: Dumb money

3. Fund Investors yank $40 billion out of stock funds last week
I follow mutual fund cash flows reported by the Investment Company Institute. The Associated Press reported that the $40 billion taken out of stock funds last week was the most since the 2008 collapse of the stock market.

In the video below, Jason Zweig of The Wall Street Journal, reports that investors are mad as hell. They are abandoning stocks as an asset class.

Investors will almost always do the wrong thing. They panic and sell when markets are down only to buy after stocks have recovered. Earlier this year, the funds that were flowing into stock funds were starting to make me uneasy. I can breathe a sigh of relief now that the herd has changed direction and the stampede is on. Don't be part of the dumb money in the middle of the herd.

This contrarian benchmark isn't always right, but it's the best single indicator I know of. Investors are fearful which, in the words of Warren Buffett, means you should be greedy.

Turn the page for reason 4: Where else can you earn 5.25% cash?

4. Stocks Yield 5.25% Cash
Last week I did an analysis of how much cash S&P 500 companies were giving back to shareholders. The answer shocked me in that stocks were yielding 5.26 percent. Between the dividend they were paying and the stock repurchases they were making, they are now yielding more than five times the five-year Treasury.

It's true that the yield on the Treasury is far more certain, yet the yield on stocks has the potential to grow much faster.

Some people I respect have pointed out that these same S&P 500 companies are also issuing new stock via stock options for employees and officers. I haven't been able to get much data on new issuances, but luckily the FASB accounting standard now makes each company show it as an expense. That would logically cut down on new shares being issued.

Image from Marshu.com
Turn the page for reason 5: Advisors have no where to hide

5. This time advisors can't put you in cash and bonds.
Let me put it plain and simple - advisors time the market really poorly. I've written about the TD Ameritrade advisors who put their clients' 74 percent in stocks at the height of the market only to move to cash at the bottom. I didn't write about the Schwab study earlier this year that showed advisors were optimistic about the market.

This time, however, it really is different. If advisors put clients in cash earning 0.03 percent annually, their clients may just question their 1.5 percent fee and their negative earnings. Bonds would be the next logical choice but you have to go out nearly ten years to beat that 1.5 percent fee. The five-year Treasury yields a pathetic 0.89 percent. Thus only lower quality or long-term bonds are options for advisors who want to get their clients out of stocks and still make some money off of them. One thing you can be sure of is that those in my profession will never forgo making money from their clients.

So what does all this mean? - turn the page for the "so what"

My advice
Beating the drum about buying stocks on sale in March of 2009 hurt like the dickens, just as it does to be buying stocks over the past three weeks. But I'm still going to beat that drum, even though there is the possibility that I'm writing this piece to convince myself to stay the course as much as I am writing it for my readers and clients.

The bottom line is that I have no idea what the market will do over the next day, month, or year. I have, however, been around the block a few times and think I have learned from my mistakes, which I see happening over and over again like some sort of investing version of the movie "Groundhog Day." Want to break the cycle? Try keeping the following in mind.

Don't fall for the investment book of the times, whether they are predicting Dow 50,000 or a great depression or aftershock.
The January effect, presidential election cycle, Superbowl, or any other pattern is something I once considered meaningless. Now I think it might be a good counter indicator.
Don't be part of the dumb money by following the herd. Herds get slaughtered.
Take a great yield. Corporate America seem to be finally doing the right thing and returning cash to shareholders.
Never forget that a good bit of individual money is controlled by financial advisors. They are people too and tend to do the wrong things as frequently as the non-professionals.

Being a true investor means you have to move in counter-intuitive directions, such as into pain and away from pleasure. The truth is that most people are more like moths than investors. When the moths start moving toward the light, I get optimistic I'll make some money when they get swatted. It probably won't work as well as it did in 2008 and 2009, but I'm betting it will work again over the next few years.

More from CBS News