Stepping Back for few Minutes

Over the last several weeks we’ve been focused on the day to day, and week to week, movement in the financial markets. As investors, our first duty is to pay attention to what’s happening where we have our assets invested. The stock market correction is clearly discounting something. For today, let’s return to a wider view of the economic landscape.

We can find any number of reasons for concern about risk assets: there is enough current data, from the likes of ECRI, ISM, MBA, and the government to paint a picture of a recovery that is losing momentum. Whether you think we are in for a return to recession, or simply below trend growth, doesn’t make a great deal of difference for the markets (unless, of course, you are in the deflationary collapse camp). In spite of their disagreements about the “double dip”, most analysts agree we aren’t looking at robust growth. Employment recovery? Forget about it.

Looking abroad, there isn’t much good data, in the case of the very sick European banking system, or data you can trust, in the case of the Chinese economy. So you have to assume, and the markets clearly do, that there are more snakes in those woodpiles – especially in Europe.

Peeking under the US stock market’s hood, let’s have a look at what’s going on with the 30 Dow stocks. The industrial, financial, energy, and tech stocks – the cyclical companies who are more levered to economic conditions – have underperformed recently. Health care (well, except for the pathetic Pfizer) and telecoms (utilities) have held up better.

Taking the broader view of the S&P 500 sectors, the utilities, which lagged behind the rally off the March 2009 bottom, have been the strongest sector since the May “flash crash.” Going broader still, growth stocks are lagging value stocks and small caps are lagging large caps. That, my friends, is a picture of a stock market playing defense.

This is the economic tone going into the second half of 2010: growth is anemic, risk is out, safety is in. Stock shares and bonds of blue chip companies with good dividend paying histories and solid cash generating business models look to be the best performers. See Verizon (ticker: VZ) as an example:  it was a laggard during the run up, but recently has seen lower volatility than the market indexes. With a current dividend yield above 7% – compare this with 30 year Treasuries paying less than 4% – the shares are becoming attractive to investors who now appear to be focused on total return rather than share price appreciation.

Soon we’ll be getting the Q2 earnings reports. Who knows what what that will bring; certainly the optimists are predicting good earnings and even a resumption of the stock market rally. Seems to me the market has already discounted a disappointment. We’ll see soon enough. For my part, I’m still very overweight cash and long a few defensive stocks and ETFs, with some Asia and TIPs for good measure. If the earnings turn out to be a positive surprise, and the market reacts well, some of that cash can get back to work.


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