How Many More Bloody Noses?

07/03/2010 05:12 am ET | Updated May 25, 2011

If someone repeatedly punches you in the face, bloodies your nose, and knocks you to the ground, you've got a problem.

Any investor who plays the stock market on the long side knows the feeling as the Dow also wound up with a bloody nose on Friday as it got whacked for a loss of nearly 159 points.

The chief reasons, well documented in many press reports: The criminal investigation of Goldman Sachs, weaker than expected first first-quarter GDP growth of 3.2%, following a 5.6% rise in the fourth quarter, the oil spill in the Gulf of Mexico, which could push oil prices even higher, and fears of a spreading sovereign debt crisis amid increasing rating downgrades.

The size of that drop, coupled with the culprits that caused it, raises an obvious question: How many more bloody noses are we in for?

Even some bulls expressed concern about that decline, which, in turn, raises doubt about the continuing headlong rush into stocks in the face of about a 75% surge in equity prices since early March of 2009.

There's still a lot to worry about, says 84-year-old bull Robert Stovall, a fixture on the investment scene for 55 years and currently a strategist at Wood Asset Management, a Sarasota, Fla. investment firm which runs about $800 million of assets. Among Stovall's chief worries:

--The Goldman criminal investigation could expand to the point where it might affect other banking companies.

--The sovereign debt crisis, which could impact the stability of the European markets, may well embrace the U.K. and Italy.

--There are too many bulls (usually a good contrary indicator) and the heavy flow of public money into bond mutual funds indicates disbelief in the legitimacy of the current market rally.

--Because of a surprise shrinkage in future crude supply, we could see oil top $100 a barrel, which would negatively in the world impact business and the consumer.

--Financial accidents could become more painful because of too much debt at all levels (national, international and household).

Pointing to swelling debt problems at the state level, Stovall says he would shun municipal bonds, especially in states that have overextended themselves, such as Nevada, Florida, California and Michigan.

Given his concerns and the seriousness of them, why in the world is he a bull? Because, Stovall explains, the positives outweigh the negatives.

In particular, he notes, earnings will continue to strengthen in the face of a pickup in demand and heavy cost-cutting, leading to many positive earnings surprises. Further, he says, interest rates will stay low because the Fed will not boost them with nearly 10% unemployment. In addition, he expects inflation to remain puny because we have so much unused capacity.

Stovall, whose son, Sam, is the chief investment strategist of Standard & Poor's, figures stock prices, given the plusses, should rise another 8% by year end.

His favorites sectors at this point are energy (notably ConocoPhillips, ExxonMobil, Suncor Energy and Noble Energy) and diversified financials with strong finances (especially IBM, United Technologies and Weyerhaueser). He also likes Chubb, Walt Disney and Johnson & Johnson.

By the same token, he would avoid what he views as problem stocks, namely Goldman Sachs, British Petroleum and airlines, which, he notes, are trying to merge away from the brink.

Hong Kong trader Selwyn Ortz, who focuses on global equities, takes sharp issue with Stovall's bullish posture. His view: "The smartest U.S. investors are the ones who take money off the table now." Why so? Because he thinks the U.S. market is vulnerable to a 5% to 10% correction, maybe more, starting at any time.

Aside from some of the worries cited by Stovall, Ortz sees additional risks from such threats as
a failed Treasury auction, higher taxes, a potential slowdown in China, rising interest rates, growing U.S. friction with Iran that could lead to a military confrontation and any repeat of the effort in New York City's Times Square to set off bombs in the U.S.

In other words, Ortz sees the potential for more bloody noses.

It's also worth noting that May is the 10th worst month of the year, averaging, as measured by the S&P 500, an annual decline of 0.4% since 1928

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