Watch CBSN Live

James Paulsen: Keep Buying Stocks

James Paulsen

A few wise href="">market commentators, including our own href="">Allan Roth and
de Aenlle, think a stock market pullback is possible after the recent big run-up. But Wells Capital
Management's chief investment strategist, James Paulsen, says now is
actually the time to keep buying. Strong corporate earnings, the stimulus from
Washington, and improved investment sentiment are all going to pull in large amounts
of cash from the sidelines and keep this rally going, according to Paulsen. "When
everyone believes risk is high, the reality is that risk is actually low;
investors should take advantage of that," he says.

Paulsen, who’s written a popular monthly newsletter
on the market for the past 25 years, underestimated how badly the credit crisis
would hurt the U.S. economy and stock market. He’s been conspicuously
bullish since the start of this run, however, and he has a good track record
for spotting bullish turns, having predicted the market rally following 9/11
and the bursting of the tech bubble.

Paulsen spoke to contributor
Jeff Nash last week about what’s driving the rise in stock prices,
what investors should be doing with their portfolios, and what sectors of the
market he particularly likes.

What do you make of this rally?

Our leadership in this country basically created a run on
bank stocks when they entertained a public discussion about nationalizing the
banks. As soon as public officials came out and said they weren’t
going to go through with that plan, we bounced back out of it. So did we really
have a 50 percent rally, or did we just have a dipsy doodle created by
Washington? The other thing that’s happened is the market has taken
the fear of the “second coming of the Depression” out of
the equation. So we’re up 50 percent from March, but are still
essentially flat for the past 10 months. We’re very early in turning
this corner.

Considering all the bad news still out there, how can you be so bullish?

At the end of a recession, the numbers are always
terrible. They have to be terrible, almost by definition, or else you’re
not really at the bottom. That said, the recent earnings season was
phenomenally better than expected. We’ve had a tremendous
100,000-plus drop in initial weekly unemployment claims, layoff announcements
are down to levels seen before the crisis, and housing activity has even
started to come back to life a bit after free-falling. Not to mention the Wall
Street signals: Bond spreads have narrowed, stocks are up, and cyclical stocks
are leading. There just seems to me to be an overwhelming amount of evidence
from Wall Street and Main Street that the recession has ended. But there’s
always a lot of doubt at the end of a recession.

So how should investors position their portfolios?

I would try to focus on the next two to three years. The
key is to tilt your asset allocation a little, not to make sweeping changes.
Investors shouldn’t have gone outside their risk parameters during
the bear market, either. That said, you should be overweight risky assets,
including equities. In the near term, I also like small-cap stocks. The biggest
beneficiary of U.S. trade improving is a small, domestically domiciled company,
because trade improvement means the domestic marketplace expands. And if there
is any inflationary fallout from the stimulus plan, small caps typically do
better than large caps as inflationary pressures build.

How much of this recovery do you think has been fueled by the stimulus

I would argue that so far it has nothing to do with the
policy stimulus. Most of the stimulus we dumped into the economy didn’t
occur until the collapse of Lehman Brothers in September, and it takes, on
average, at least a year for these policies to have an impact. So we’re
not even at the point where most of it would start to show up, and I’m
not even talking about Obama’s $787 billion plan, which won’t
show up until 2010. All that juice is still coming. The recovery so far has more
to do with healthy players calming down. People who have jobs and are
financially in good shape are spending again. And well-capitalized companies
are less concerned now with cutting jobs and scaling back operations.

So it’s not too late to buy stocks?

Yes, but you need a long-term view. There will be some
consolidation and scary sell-offs. Any stable recovery gives you gut checks
along the way. But the fundamentals — the policy push from
Washington, the improving investor sentiment, the better-than-expected
corporate earnings — all suggest to me there’s more room on
the upside over time. On top of that, the great bulk of investors are
underinvested in stocks right now. At some point, maybe when the S&P
500 hits 1,050 or 1,100, there will be a conversion of bears to bulls. Right
now, we have investors who are underexposed to risky assets, so there’s
a lot of excess dry powder that could come in and push the market higher.

You’ve compared this market to the 1982 recovery, which initiated
a 20-year bull market. Do you see something similar happening now?

I hope so, but I can’t predict that. All I was
saying is that the character of sentiment that existed then is similar to
today. It, too, was tagged as the worst recession since the Great Depression.
Banks were riddled with problems from farming, oil, and Third World debt, and
confidence collapsed. The stock market went up about 75 percent by the summer
of 1983 before a majority of investors agreed the recession was over. They got
in the market just in time for the pullback. We caution investors today not to
wait too long to re-enter the stock market for the same reason. There’s
lots of evidence of recovery right now, but nobody’s buying into it.

What segments of the stock market do you like in the near term?

I like stocks in more economically sensitive areas that
will benefit from earnings leverage from overcutting during the recession. My
favorites are industrials, basic materials, consumer discretionary, and
financials. I still like technology too, although many stocks are now extended.

This recovery cycle will not be valuation-driven, but
earnings-driven. And companies in these sectors I mentioned have great earnings
leverage from slashing inventories, workforces, and capital spending. They’ve
become more mean and lean.

You’ve been bullish on emerging markets. Do you still see value
there, despite the huge rallies in many markets this year?

Emerging markets are extended. They could suffer a bigger
pullback, but longer term they were the leader as this decade began and they
will remain the leader. They’re operating with young demographics
that have high savings, low debt, and high aspirations. They are the epicenter
of world growth, and they’ll continue to be that. I also think
commodity markets are likely to receive another boost, and these markets will

More on MoneyWatch:

View CBS News In
CBS News App Open
Chrome Safari Continue