In This Issue:

Reasons For Cautious Optimism Continue To Appear
Many Promising Stocks Attract Long-Term Investors
The Bottom Line This Week

The stock market continued to lose ground last week as the Dow and the Nasdaq declined an additional 2.5% and 3.4% respectively.

A growing number of analysts believe the stock slide will continue until the market tests (reaches) the low point it made on November 20. If so, it will be a classic correction to a bear market rally.

A much bigger issue is what will come next if the November lows are reached. Pessimists believe the market will continue to decline until blue chip P/E ratios get closer to 10. If so, the S&P 500 would drop from today's 832 to 750, or so. Super bears think the index might fall another hundred points.

On the other hand, optimists believe the market will bounce back in a classic stage two bear market rebound. If history repeats, the second time should be the charm as a new rally would typically test its former highs – and then continue up. The 298 point jump the market took during the first three days of this week suggests that the optimists may be right.

Reasons For Cautious Optimism Continue To Appear

We are of the opinion that if another big economic shock doesn't occur, the market will follow the second scenario and begin to move up again.

Our more optimistic outlook isn't based upon wishful thinking. Instead, we see additional indications that the economy may begin to claw its way out of the hole starting late this year. Here are some of the most important changes that suggest this tough recession may not last as long as most people expect:

First, as we reported last week house sales are continuing to pick up as buyers decide to make use of the lower prices that are now available in many markets. Since home prices are continuing to weaken throughout America, we think sales will increase further in the coming months.

Second, cash levels are now at record levels. At the same time, interest rates are at near-record lows. Not surprisingly, cash levels dropped last week and, for the first time since August 2007, volume picked up on Wall Street. We think the numbers indicate that investors are moving some of their cash from fixed income accounts into better-paying stocks.

In our opinion, dividend yields are more important to investors now than P/E ratios. Solid companies with payouts above 3.25% seem unlikely to decline much further even if their multiples are still a bit high for a severe bear market.

Third, oil prices are beginning to tick up again. Part of the rise is due to a reduction in supply by oil producers. But analysts also think higher prices reflect small increases in global economic activity. In the past, oil has been a good barometer of early changes in growth that didn't show up on economists' radar screens for several months.

A similar case can be made for the recent uptick in gold prices. Critics may say the change only indicates that investors are expecting inflation to come back. However, the only way inflation can return is if deflation is on the way out. We can think of few changes that would be more bullish for the economy than a slowdown in the destruction of assets.

Fourth, there are old adages on Wall Street that say, "don't fight the Treasury" and "don't fight the Fed." That means don't bet against the Treasury's ability to rejuvenate the economy by pumping money into it, or the Fed's ability to boost growth by lowering interest rates.

For all the problems that the bailout programs will create, they should also have a positive impact on the economy. However, it will probably take from six to nine months before the beneficial effects begin to show up.

Fifth, consumer confidence is at record lows. As Dr. Steve Sjuggerud at Daily Wealth (www.dailywealth.com) pointed out recently, the lows typically occur just before a recession runs out of steam and growth starts to inch back up. The tougher the recession --as in 1973-74 and 1981-82-- the more reliable the indicator becomes.

Sixth, the more we look at what's happening in America the more it looks like the financial crisis is much worse than the economic crisis. In other words, most of the red ink is pouring out of banks. Nearly all blue chip industries are seeing their profits slashed, but most of them are still in the black. Some companies such as Apple, IBM, Heinz and Google are doing very well – to name only a few.

Any company that is weathering today's storm is a lot stronger than its stock price would suggest. In addition, most companies are rapidly adjusting to the tougher conditions.

Seven, as we discussed last week, credit is continuing to come back. To the great surprise of many investors, the pharmaceutical giant Pfizer was able to raise $22.5 billion to buy Wyeth. To be sure, the lenders took precautions against a default, but that should always be the case. If lenders had been running their businesses responsibly in recent years, there would be no credit crisis.

Although the Pfizer/Wyeth case is attracting a great deal of publicity, thousands of much smaller deals financed by regional banks are doing the most to help turn the economy around.

Eight, people in every walk of life are absolutely certain that the economy is circling the drain. However, what everybody "knows" is often wrong. In this case, the expectations of more pain may be accurate near term, but they are almost certainly off the mark for the longer-term.

Lastly, the Conference Board just announced that the Leading Economic Index rose 0.3% in December. That wasn't a very big increase. However, almost all analysts were expecting another decline. The news didn't attract much attention because one month does not make a trend. But if the index moves up again in January, we think Wall Street will take notice.

Many Promising Stocks Attract Long-Term Investors

Since we are long-term investors, we continue to urge our readers to use the bear market to pick up high quality stocks at bargain prices. Many of the world's finest multinational blue chips are affordable for the first time in over a decade. If you don't buy them now, you may not get another chance to do so for another ten years or so.

Readers who have been with us awhile undoubtedly remember the names of the blue chip value stocks that we have been recommending. We keep waving their flags because we think they are the stocks that most investors should buy.

This week we will discuss two recommendations that we have not featured recently, plus one new one for your consideration.

H.J. Heinz (HNZ) is back in the news, and for good reason. http://finance.yahoo.com/q/bc?s=HNZ Heinz is one of the many companies that managed to increase its earnings in fiscal 2008. Nevertheless, the stock price is still very low, and the dividend yield is a very attractive 4.6%. In addition, this solid blue chip raised its dividends in 40 of the past 41 years.

Heinz is also very unlikely to lose its leadership standing in its industry anytime soon. Nearly all of its products are rated either first or second in their markets. And since most of the company's products (such as ketchup, mayo, pickles, etc.) are inexpensive, shoppers are not under any great pressure to switch to cheaper brands.

IBM (IBM) is at the other end of the technology spectrum from Heinz, but it is doing no less well. http://finance.yahoo.com/q/bc?s=IBM The company just released its fourth-quarter numbers, and they are impressive. Profits rose 12% during a time when most banks were having staggering losses. Moreover, IBM issued a rosy outlook for 2009. The company is expecting to earn from $10 to $11 a share vs $8.75 predicted by analysts.

IBM is a good example of a giant company that is nevertheless able to think and act quickly as business conditions change. A year ago management noticed that the hardware side of its business was losing ground to an explosion of rivals that were finding it easier to enter the server market. As a result, IBM started to place more emphasis on software and services that are harder for competitors to match.

Home Depot (HD) is a new recommendation that popped up on our value screens this month. http://finance.yahoo.com/q/bc?s=HD The company needs little introduction since its home improvement stores can be found in nearly every city.

After soaring in price during the real estate mania, the stock dropped sharply when the bubble ended. However, Home Depot is still profitable. That's not surprising since many people who hoped to purchase new homes have decided to fix up their old places instead. Home Depot has expansion debts, but it has the income to cover them. Meanwhile, the dividend is an attractive 4.1%.

The Bottom Line This Week

The economy is not out of the woods. Far from it. Growth should continue to sink for another few months. However, there are some early signs that the situation will change for the better late this year. Since prices for many blue chip companies are currently very low, and most yields are high, we think investors should take positions for what should be better days ahead. Among the companies that look especially good are Heinz, IBM, and Home Depot.