Growth stocks for pessimists

By Jim Jubak

I'm adding a growth stock to my Jubak's Picks portfolio with this column. And I expect to add as many as four more over the next four to six weeks.

Not because I'm so optimistic about the economy and the financial markets. Exactly the opposite, in fact. I'm buying growth stocks -- and adding more exposure to gold stocks -- because I'm deeply pessimistic about the economy and the financial markets over the next 12 to 18 months.

The two groups, which in normal times occupy opposite ends of the market spectrum, are to my thinking the best hedges available against the rocky times ahead over the next 12 to 18 months.

A short-term solution

I know this is a logical stretch from conventional thinking about the asset classes you should use to build a portfolio, so let me explain how I came to this conclusion.

We're still eyebrow-deep in a financial crisis set off by truly staggering wishful thinking about risk in the markets for subprime mortgages, buyout loans and other asset-backed paper.

But unlike those in the financial press and economic-analyst communities now calling for a recession, I believe we're likely to get out of this mess -- in the short run, at least -- by flooding the financial markets with hundreds of billions in new money from the world's central banks. The central banks will literally paper over the long-term problems in the debt market with billions in currency.

This flood of cash will, in the next few months, restore liquidity to those parts of the debt market, such as the market for the short-term (90-day) commercial paper that companies use to fund operations, which have threatened to seize up in recent weeks. It will restore confidence among bankers, who will stop hoarding liquidity. It will produce a rally in the stock market. And it will head off any possibility of the economic slowdown in the United States and Europe turning into a recession.

Been there, boomed that

But as I wrote in my Sept. 8 column, "How to ride the boom-panic cycle," we've been here before. At best, this massive infusion of liquidity will push inflation rates higher. At worst, this bailout will create a market boom and another market panic down the road, just as the bailout of the Long Term Capital Management hedge fund and its investors, and the bailout of the East Asian economies after a currency crisis in that region, set the stage for the boom of 1999 and the crash of 2000.

I'm adding to the existing gold and other hard-asset positions in Jubak's Picks to profit from the coming uptick in inflation that this latest bailout will produce. And I'm adding growth stocks to profit from the stock market boom that is likely to follow hard upon this most recent bailout.

Fallout postponed

Though I fully intend to profit on the short-term trends in stocks created by this bailout, I remain convinced that each bailout -- and the boom-and-panic cycle that it perpetuates -- will make the eventual day of reckoning in the financial markets more painful.

Each bailout reduces the chances of a soft landing for the financial markets and increases the odds we're headed to some kind of Volcker moment, like the kind of interest-rate shock that then-Federal Reserve Chairman Paul Volcker engineered in the early 1980s to put a stop to the runaway-inflation expectations of the 1970s.

By relentlessly driving up interest rates, Volcker broke the back of an inflationary cycle that had sent annual inflation to 13.5% in 1981. By 1983, annual inflation was down to 3.2%. The accompanying recession saw the unemployment rate rise to 10.8%, more than twice the current 4.6% rate, at the end of 1982.

As of Sept. 10, we're in Stage 2 in the current financial market crisis.

Who woulda thunk it?

I'd call Stage 1 "The Surprise." In this stage, lenders and the investors who bought financial instruments based on questionable loans reacted with surprise to rising defaults, sinking credit ratings from the three big rating agencies and tumbling prices.

"Golly, gee, whoever would have thought that when we gave mortgages to people with shaky credit histories without verifying their incomes and let them borrow even the down payments that so many borrowers would default?"

Not so long ago, lenders were pointing to still minuscule default rates on these mortgages, by historical standards, as evidence of the soundness of their lending practices. It turns out that what we were seeing was just the time lag between the day people signed a no-income-verification, zero-down, adjustable-rate mortgage and the day that payments rose enough and housing prices fell enough to make the borrowers walk away from homes in which they owed more than they borrowed.

Continued: Default rate rising

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