I’m off with the family for a few days. So I asked Don Lucek to fill in for me and reveal how he plans to play the market “aggressively defensive.” — Bryan |
There’s no denying that some recent negative economic reports are giving the market trouble.
For instance …
* The industrial economy staggered under temporary supply chain disruptions, with the Chicago Purchasing Managers Index (PMI) and the Institute for Supply Managers (ISM) releases missing expectations by a country mile.
* Housing continued to slide, with the release of a worse than expected decline in prevailing home prices from S&P Case-Shiller.
* And the releases of several jobs reports — culminating on Friday with the all-important non-farm payrolls survey — gave the market nothing to be hopeful about for the near term.
In short, these reports are telling us that:
* The U.S. industrial economy is not yet back in fighting shape, but more distressing, that we don’t know when it will reveal stronger recovery.
* The risk of weakness showing up in 2nd quarter company earnings or company guidance has increased.
* Consumers are still a wild card in helping confirm any improvement in the economic outlook.
I’ve been following the volume patterns associated with moves in stocks of different market sectors, and have found that this most recent move down did not seem to be a normal sector rotation into defensive stocks.
Voices of reason will rightly tell you that a smart near-term strategy against this backdrop is to exercise extreme caution — do not fight the tape; take money off the table. But what do you do if you’re already defensive, and want to actually profit during periods of market turmoil?
My suggestion …
Play the downside, and look for even better entry prices for stocks you want to buy — after the storm is over.
Everything I’ve monitored lately tells me that negative sentiment is still gathering steam. But I think the rough patch we’re experiencing right now is transitory, and that after the dust settles we’ll be back to a more bullish tilt. However, I don’t know when that will happen.
So this could be the time to become aggressively defensive. I’ll be hedging some of my long positions, but looking for spots to purchase great stocks at a discount over the next couple of months.
The worst numbers seem to be coming from the global industrial sphere, so I plan to pay special attention to international issues for proper analysis. I’ve been able to get a good read on situations on the ground, in business, and in finance in Europe, which give me additional confidence in the medium-term prospects for a global economic recovery.
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| It’s going to take consumers to get the economy rolling. |
Before that can happen, though, we need a rejuvenated consumer to help support economic growth. But while we’ve seen some glimmers of strength at the high-end, it’s not yet present at large, which will continue to provide a drag on growth. Amid slumping housing prices, weak job growth, and high gas prices, a great resurgence seems unlikely for now.
Not all of this is bad news, if you have the right hedges in place, and dry powder — in the form of a good-sized cash position — at your disposal. Also you should keep in mind that the non-stop flow of data from around the world can mislead the market, especially given the extraordinary issues affecting it right now — such as natural disasters and big picture issues like a potential financial crisis in a huge economic bloc.
Back in April, I acknowledged that the market could be in for a rough patch as we contended with Wall of Worry issues like jobs, the industrial economy, and potential financial system stress should we have deeper trouble in Europe.
That’s why I suggested keeping a large cash position, picking only high-quality stocks — ones that could weather near-term economic potholes, provide dividend income while we waited for real recovery, or to take advantage of other factors not yet present in financial reports.
But at the same time, I cannot deny that …
The Domestic and Global
Economies Are Growing!
Not at the pace we’d like to see, but growing nonetheless. With the way our domestic economy is evolving, we need to take a more global view in our analysis of profit expectations.
We’ve seen global effects like the job outsourcing trend, and increased international trade, which affect firms in ways that do not fit the old models. Jobless recoveries have been a more-common sight over the last few recoveries, and probably need to be factored into this one too.
We also have an important disconnect in the way that publicly-traded firms’ earnings beat estimates so soundly while smaller business saw a drop in profits and fewer opportunities to expand their operations or workforces. My read on this: We are going into an election cycle, bank credit is still tight, and small business will feel the pressure from macro concerns.
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| Many small businesses are holding back until politicians settle their differences. |
Once politicians’ positions on issues like health care reform and taxation become clearer, I think small business owners will be able to forecast their needs more accurately, which could unleash a positive trend from this main engine of job growth. That same political debate will help accentuate the choppy market in the near term, though.
The type of market we’re seeing right now is frequently referred to as a stock-picker’s market, but also seems to be developing a negative bias. I think it will remain so for at least the next 6-12 months. The only exception I could see would be some of the more classic defensive moves into particular sectors by institutional investors. And that will only occur if we get a downturn that lasts well into the summer or beyond.
That’s because many of these investors — who have been contributing far more than their share of the market’s volume during the entire run-up since March 2010 — must stay invested, so support for some stocks will be there.
My Game Plan — Deploy the Hedges,
Search for Values
I remain a bull on the markets and on the economy, but realize the headwinds are too strong to ignore. The S&P 500 has closed below an important support level. And I think we’ll see some violent rallies over the very near term, as the market fights to the upside and to the downside. So I don’t want to have too much inverse exposure while we watch for a trend to either develop, or not.
Best wishes,
Don
