“This is ridiculous!” Average Joe is buying stocks and pushing the Dow to all-time highs almost every day. The Nasdaq is at five-year highs. But the guys sipping the latest reds in charity dinners are saying it is ridiculous that the market is going up.

“It’s out of control,” one broker told me. “It’s like the bubble again.” There is one thing we know: when someone says “this is ridiculous”, we know there is money to be made.

Everybody is angry. They are angry at the market for going up and leaving them behind. They are angry at their fathers for scoffing at their latest money-making ideas. They are angry for the childhood where they were once excited about the prospects in front of them. Anger at the Dow has roots that can only be uncovered in a $400-an-hour therapy session, since certainly the Dow, like your parents, like your first lovers, could not care less that you think they are ridiculous.

So why is this market rally ridiculous? First off, supposedly, a recession is coming. I think this is true. Perhaps the housing market has taken its toll, or the double-digit declines in auto manufacturing for the second year running, or the consumer is strapped by all that credit card debt. Who knows? But we are due, and I am ready for it.

But what does a recession mean? We know it means this: in every recession except one since the second world war, interest rates have come down. There have been 11 recessions. In six of the 11 recessions, the market went up. In five of the recessions, the market went down. In the past two recessions when the market went down (1973 and 2001), it can be argued the market was at unsustainable price/earnings multiples. That was particularly the case in 2001 when we were coming off an enormous initial public offering bubble – something that has not occurred in this cycle.

In fact, valuations are still cheap. With rates at 5 per cent and heading lower, the market can easily justify an average p/e of 20, assuming minimal to no growth. Forward p/e estimates are at about 15 for the S&P 500. So even if analysts are 30 per cent off in the wrong direction, we are still doing fine.

Will they be wrong? I think they are wrong, but in the other direction. Take Microsoft, for instance, with a forward p/e estimate of 17 for next year. Microsoft makes almost all of its money from Windows and Office. For the first time since the beginning of the decade, it is planning a big release of these software products, and it has a history of solidly beating estimates. My guess is that right now, Microsoft is trading at 12-13 times next year’s earnings.

S&P 500 companies are sitting on more cash per share than they ever were previously and some of that is going to go towards a big computer upgrade. Expect Microsoft, Intel, AMD, Dell, Oracle and others to benefit.

But what about home building? Won’t this cause a death spiral? Let us ask Warren Buffett, who just increased his holdings in Lowe’s, the home improvement retailer, by 800 per cent from 780,000 shares to 7m shares. He also bought an additional 10m shares in USG, the building products company. And in case we were worried about whether people would have extra cash to throw around, Mr Buffett bought an additional 1.5m shares in Nike this past quarter.

If you are nervous about a recession, then I would suggest stocks from the original Dow companies. These are seven companies that have survived every recession of the past century or more and have continued to thrive.

For instance, American Tobacco became American Brands, which then became Fortune Brands, the maker of everything from Jim Beam bourbon to golf shoes. It is a key holding of The Vice Fund. The company trades at 10 times cash flows, hands out a 2 per cent dividend every year and has returned 14.4 per cent a year over the past 50 years to its shareholders.

And don’t forget about Distilling and Cattle Feeding, now part of Lyondell Chemical. Lyondell gives out a 3.5 per cent dividend and trades at a forward p/e of just 8.5.

Also worth a look is National Lead (now called NL Industries). It makes titanium dioxide, the key ingredient of sun screen (think global warming). NL gives off a 4.8 per cent yield and trades at 20 times next year’s earnings.

Peoples Energy (in 1896 it was Chicago Gas) has a 5 per cent dividend yield. Laclede Group (formerly Laclede Gas) a yield of 3.9 per cent. And Ameren (formerly Union Electric), a yield of 5.1 per cent.

Finally, our old friend General Electric, which, among other things, has just launched the best television show of the fall season, Heroes.


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