On Monday, we warned that the latest excitement over the strong market rally is reason to be cautious, a time to favor fear over greed.

Bloomberg reports that master trader, Paul Tudor Jones is in the same camp. Jones, who runs a $10 billion hedge fund, calls this a “bear market rally” and believes the equity markets are setting up for a decline. Jones says:

“Impressive counter-trend rallies are a feature, not an oddity, of secular bear markets. We are not inclined to aggressively chase the market here. Many doubts remain about the sustainability of this recovery, most prominently the weakness of household income growth.”

If you are sitting on big gains, you might want to take some money to safety. But a super-strong rally is not reason enough to sell everything and get out.

Even the world’s greatest investors can’t time the market to perfection. A better idea is to run trailing stops on your positions and move those stops closer as the exuberance increases. That way you make the most of the rally, by letting your winners run. And rather than trying to predict the top, you let the market tell you when it’s time to sell.

Another sign that this rally is a house of cards is that it has been led by the weakest names.

In The Growth Stock Wire yesterday, Jeff Clark pointed out that high-quality companies like Exxon, Intel, Apple and Wal-Mart have underperformed the market recently.

At the same time, American International Group (AIG), Freddie Mac and Fannie Mae have rocketed higher, along with hundreds of other stocks fueled by short squeezes and bottom feeders looking for quick profits.

A market led by the laggards is not the basis for a sustainable rally. Take a look at your portfolio. If you have made great profits on weak stocks over the past few months, it’s time to upgrade your portfolio.

Jeff Clark is not the only expert to notice the garbage rising to the top…

Our own value analyst and dividend-investing expert, Andrew Gordon issued similar comments to subscribers of his research service, INCOME, this week.

He notes that Coke (KO) has risen 18% in the last three months – slightly better than the S&P 500. Coke is up 9.3% on the year. On the other hand, “healthy” beverage company, Leading Brands, is up 40% in three months and 150% on the year – despite the fact that the company’s revenues declined almost 40% in the first quarter.

Andy writes:

“This rally has been very kind to companies which don’t have much going for them except low prices when the rally began. And now they don’t even have that. I predict that two years from now you’ll make at least twice as much from Coke than from Leading Brands. You won’t have the enormous ups and downs of the stock price to worry about. And you’ll be getting cash in the mail just for investing in a global industry leader.”

The story of Coke and Leading Brands is the story of this rally we’re in. If you let it, it will teach you all the wrong lessons. Weak companies are the last place you should invest when the economy is on its knees.

So, where should you invest? As always, the first place to look is toward companies that have raised their dividends consistently for many years.

Despite the weak economy and a plethora of cuts and cancellations, dozens of companies still have an unbroken streak of raising their dividends for many years.

Jeremy Siegel of the Wharton School of Business studied market data from 1871 to 2003. He found that reinvested dividends account for 97% of the real return of stocks. Think about that.

Short-termers are controlling the market right now. And that’s great news for long-term investors.

The most promising companies for the long term are being relatively ignored. But Andrew Gordon and his subscribers aren’t ignoring the best of the best.

He is adding one dividend-raising company after another to the INCOME portfolio. The most recent addition is a global company that continues to increase revenues, with no government help. Not only did the company beat the Street when it reported earnings last week, they raised their dividend by 9% — marking the 32nd year in a row this company has increased its cash payments to shareholders.

To learn more about INCOME, click here.

Yesterday, the Non-Farm Productivity Rate came in for the second quarter at 6.4% versus an estimate of 5.5%. This number would usually be seen as a positive for the economy, but not this year.

The increase is not the result of increasing production. It is the result of merciless cost-cutting through employment reductions. 72% of companies that have reported earnings in the recent earnings season beat their estimates. However, 52% of those reported lower revenues. And during the same period, the U.S. Gross Domestic Product shrank.

Steve McDonald, editor of The Bond Trader makes the point that this is not a formula for long-term success:

“The real significance of this report will be more evident when the retail numbers and consumer confidence numbers come out Friday. If the trend of increasing unemployment, decreasing consumer confidence and stagnant wages continues, we have a problem. If the buyers don’t have jobs there won’t be any revenue growth and there are only so many employees that companies can let go.”

Currently, investors are rewarding companies for cutting costs. But that’s like betting on a football team because of its great defense, while ignoring its non-existent offense.

Costs are half of the equation. But companies have to play offense at some point. They have to find a way to jack up revenues. You can only cut costs so much. And the bulk of corporate cost-cutting is probably over.

Good Investing,

Bob Irish
Investment Director
Investor’s Daily Edge