Stay Off the Mechanical Bull

By Bryan Perry

I'm the kind of investor who likes to buy the healthy businesses on bad days, and not chase the bad businesses on good days.

Watching investors climb into stocks like Merrill Lynch (MER) and American International Group (AIG) right now is like seeing a guy who just put away a case of beer stagger across the barroom toward the mechanical bull, boasting, "I can ride that!"

There are some things you just can't do in a market like this.

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Seeing the market rally just because shares of Merrill Lynch didn't crater when it announced it would dilute its shareholders by 38% was a real eye-opener.
Investors want any excuse to buy the financials, since it's the most blown-out sector and the government is doing all it can to buttress the still-fragile credit market.

There is definitely evidence of a more bullish tone when you see the market shake off such negative news and then trade higher. But, to tell you the truth, I've had a hard time buying into the validity of the rebound -- although I'm not about to fight the tape.

I just don't see the logic at this point in time and, more importantly, the easy money was made in the past two weeks thanks to massive short covering. Now these stocks mostly have to earn their way higher -- and that could take years.

Friends, I'm not that patient and neither is the market.

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Everything in the financial sector popped and now the separation process has begun. The cream of the financial sector crop will come under strong accumulation in the weeks and months ahead, but at the expense of the banks, brokers and insurance companies still hiding massive losses on their balance sheets.

I'm skeptical about this shot-across-the-bow move in financials, but I'm willing to change my stripes if we get a few more upside surprises, like Wells Fargo (WFC), in the third quarter. The market won't stand for a one-off, that's for sure.

I'm also sure WFC didn't raise its dividend by 10% without checking in with its largest shareholder, Warren Buffett, first. That might be the most insightful market tell of the past month.

There's no way the Oracle of Omaha would approve a dividend hike in a financial holding if that dividend couldn't be maintained. When a company the size of Wells Fargo or IBM (IBM) raises its quarterly dividend, it's a clear message that there is good visibility for the business in the future.

Seeing a bank headquartered in California -- one of the hardest hit real estate markets -- beat estimates, raise guidance and raise its dividend is like seeing the Marines plant the American flag on Iwo Jima -- it's the signal that a beachhead has been established.

If you're thinking about dipping your toes in the financials, be a very cautious investor.

Bryan Perry is Editor of The 25% Cash Machine.