5 stocks for the pessimist in you

By Jim Jubak

I don't think this decline in the market is over just because of a few days of rally.

The true stock-market pessimist knows that the universe is swarming with malevolent spirits that delight in crushing investor's hopes.

A sustained rally is an invitation to the irrational exuberance that decimates a portfolio in the ensuing crash. A quick rally after a slump -- like that which took the Dow Jones Industrials ($INDU) up 300 points on June 14 and 15 -- is only a chance to load up on "bargains" before they head even further south.

But confirmed pessimists don't even trust their pessimism. Planning for any specific disaster just leaves you wide open to the unexpected disaster. Bury gold in the back yard to prepare for the worst and the world shifts to a palladium standard.

So I began building the Pessimist's Portfolio I started in my last column by outlining the different things most likely to go wrong. Although my two worst-case scenarios don't by any means exhaust all the possible worst-case outcomes, they do cover much of the pessimist's turf: Either the Federal Reserve will punt on its current campaign to fight inflation, leaving economic growth and inflation higher than expected, or it will stay the course and raise interest rates high enough to tank the economy.

Of course, I concluded, in true pessimist fashion, that the two most likely worst-case scenarios favor decidedly different kinds of stocks, and that it's almost impossible to find stocks that will do well under what I outlined as Scenario 1, which favors cyclical and commodity stocks, and Scenario 2, which favors big-cap growth stocks and financials.

Almost impossible. But not completely impossible. Both scenarios would produce a kind of "growth famine" that would leave the stock market searching for the rare, predictable growth stock that would hold up in any replay of the market tumble that began on May 10 and that could beat expectations even if the economy as a whole stalls.

There can't be many of these rarities, so they'll be hard to find. But because they're rare, they should be extra valuable if the pessimism about the 12 months ahead turns out to be justified.

In today's column, I'm naming five stocks that I think fit the bill. They're all relatively inexpensive. They're all projected to show very solid growth ahead. And in each case, that growth is relatively independent of how fast the economy as a whole grows. The growth catalyst at each of these companies is largely internal. (The list is alphabetical and not in order of my preference.)

Bet on a very predictable product cycle

There's not much more predictable than a software company's upgrade cycle. As products age, sales growth slows and that slowdown reaches its maximum just before a new version is released. That's because customers virtually stop buying the old version in anticipation of the upgrade. And almost always, growth slows more than the company had projected or Wall Street expected before it picks up again.

This is exactly where Adobe Systems (ADBE, news, msgs) finds itself now. On June 15, the company reported second-quarter revenue below expectations and then lowered its outlook for the full year to between $2.54 billion and $2.6 billion from a prior $2.7 billion estimate. The company's next version of its Acrobat document reader and manager for the Web is due in the fourth quarter of 2006, and the new version of its Creative Suite, which includes the next version of Photoshop, is scheduled for release in the spring of 2007.

This should keep pressure on the stock, pessimists know, until the market starts to anticipate the revenue and earnings growth to be produced by the new products. Wall Street projects 27% earnings growth for the fiscal year that ends in November 2007. The stock recently traded at 22 times projected fiscal 2007 earnings per share.

Bet on the hurricane forecast being wrong

Everybody now expects the 2006 hurricane season to be worse than that of 2005. That's a stance attractive to pessimists -- until they remember that whenever everyone expects bad news, they're generally wrong. So, instead of shunning property and casualty insurance stocks, it may be time to embrace them -- or at least one of them -– like Berkshire Hathaway (BRK.B, news, msgs).

Hurricanes produced record losses for the insurance industry in 2005. Insured catastrophic losses hit $62 billion last year. This year the record losses of 2005 are producing record premium increases. And a lot of those increases seem to be going to Berkshire Hathaway.

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