Bailout Lifts Stocks, Gold

5/17/2010


After slumping to two-month lows on fears of debt contagion in Europe and jitters after an apparent breakdown in U.S. stock-trading systems, the Dow Industrials and Dow Transports have rebounded on news of a massive European bailout plan.

The Industrials are about 2.7% below their April 26 closing high of 11,205.03, while the Transports are 3.1% below their May 3 closing high of 4,806.01. A rally that lifts both averages above those levels would be encouraging, while a failure to reach new highs in both averages would be cause for concern.

For now, our plan is to look for buying and selling opportunities one stock at a time while watching the averages and holding 5% to 15% of our buy lists in Vanguard Short-Term Investment-Grade ($10.73; VFSTX), a relatively low-risk bond fund.

Bailout boost

Stocks surged around the globe after the European Union unveiled a nearly $1 trillion plan to avert a government-debt crisis. While skeptics note that the bailout does not address Europe’s underlying structural and economic weaknesses, the size of the plan was enough to calm panicked markets.

Barring a worst-case scenario, analysts now think a debt default by a European Union country other than Greece is unlikely in the near term. European debt markets rebounded, with traders moving back into the riskier assets seen as most vulnerable to a credit crunch.

The European Central Bank began buying debt of weaker Euro-zone countries, a controversial role and a surprising about-face just days after the ECB had said such bond purchases were not under consideration. Many fear the ECB’s decision will erode its independence and lead to inflation, and gold prices surged as European investors sought an alternative to paper money.

European taxpayers have reason to be concerned about who will ultimately pay for the bailout, and European investors have reason to be worried about debasement of the euro. But the bailout plan is good news for U.S. companies, as it forestalls one of the major near-term threats to the global economic recovery.

Conclusion

With recent U.S. economic reports showing continued vigor, U.S. inflation under control, and U.S. interest rates back in the middle of a yearlong trading range, profits for American companies are likely to remain on an uptrend.

The median U.S. stock is reasonably valued relative to expected profit growth, and shares of large and high-quality companies appear cheap. For new buying, IBM ($127; IBM), Intel ($22; INTC), Newmont Mining ($58; NEM), and Varian Medical Systems ($54; VAR) represent especially promising picks.


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