Where are we headed?

Stock markets around the globe have experienced a pronounced sell-off in recent weeks, culminating in yesterday’s 500 point Dow Jones Industrial Average decline.

For investors that follow our blog and quarterly newsletter, these events should not come as a major surprise, as we have repeatedly expressed our skepticism with the sustainability of the stock market rally.

In our view, the combination of high unemployment, a stagnant housing market, continued consumer thriftiness and the debt crisis in Europe (not to mention here in America) has tempered our enthusiasm for higher risk investments like stocks and commodities.  Instead, we have encouraged clients to be cautious and defensive, despite the seemingly unending rally in stocks.

While many market commentators have pointed to the debt ceiling debate and subsequent compromise as a catalyst for a short term sell-off, we think the problems run much deeper and poor economic data is more likely the cause of negative market sentiment.

Our pessimistic view on the economy was confirmed last week, when the US GDP for Q1 was revised down from an initial estimate of 1.9% to .4%, a huge 1.5% move down.   Second quarter GDP came in at 1.3%, well below analyst estimates of 1.9%.  This Q2 number could stand to be revised down next quarter.

In addition to the GDP data, on Monday of this week, the Institute For Supply Management (ISM), released their July factory index number (which tracks manufacturing orders).  This number fell to 50.9, well below analyst estimates of 55, and was the lowest number on record since June 2009.

Both of these data points suggest that the economy, which had been showing some signs of life after record amounts of government stimulus had been pumped in to help stave off a depression, is still nowhere near the levels of growth we saw pre-credit crisis.

So where does this leave investors?

We believe stocks will continue to sell off in light of structural headwinds in the US economy and persistent debt problems in Europe.

As a result, we continue to recommend a defensive portfolio for clients, with high quality, short term/intermediate bonds and cash making up the bulk of client holdings.

We think there will be an opportunity to buy high quality stocks on the cheap in the coming weeks and have targeted a list of companies using the following criteria:

1. Large cap, US-based companies that have significant exposure overseas, particularly in developing markets
2. Companies that pay a dividend, with a yield preferably above 4%, and have a proven history of paying dividends to investors in virtually every market cycle
3. Preference for defensive/non-cyclical industries like consumer goods and utilities rather than banks or financials

We believe that longer term investments in these types of companies will perform well.  In the short term, they will provide cash flow through dividends, so investors will benefit by being paid to hold these stocks in the event the stock market trades in a flat or negative trajectory.

It’s important to note that this strategy may not be appropriate for every investor, particularly for those investors who may need access to their money in the short term.

We strongly recommend that investors do their own research and speak with an investment adviser before making any major portfolio changes.

If you would like to discuss our market views or investment selection process in further detail, please feel free to give us a call or send us an email.