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David G. Dietze, JD, CFA, CFP
David G. Dietze, JD, CFA, CFP
Articles (55)  | Author's Website |

Investing Strategies as Economic Momentum Wanes: LNKD, JPG, WFC, BAC, BTO

The economic recovery is screeching to a halt! Just look at the sobering data served up on Friday; only 54,000 jobs were created in May, the least since September, while the national jobless rate unexpectedly ticked up to 9.1%.

True, jobs are not the entire economy, and the report covered one month. Unfortunately, other economic metrics confirm the economy has hit the skids.

A key measure of manufacturing strength retreated sharply in May, surprising economists with the biggest monthly drop since 1984. A weaker dollar and robust exports had helped prop up manufacturing activity, so this news was particularly disappointing.

Housing, the epicenter of the financial crisis, shows no signs of bottoming, much less rebounding. Existing home prices slid another 5.1% in the first quarter, leaving values at new lows in a much feared double dip situation. Home prices nationwide are down to where they were in 2002, and even lower in regions like Atlanta. With consumers constituting nearly 70% of all spending, and housing typically their biggest asset, the dismal state of residential real estate has to give pause even to the staunchest bull.

Investors are running for the exits in the face of this dismal news; equity mutual funds saw heavy outflows in the month of May, averaging $3.5 billion weekly. That's coming at an awkward time for their managers, as the percentage of cash of equity funds' assets is at record lows.

Of course, investors aren't the only ones worried. No president since FDR has been reelected with the unemployment rate exceeding 7.2%! Below are strategies to cope with the outlook.

Maintain a Balance Between "Risk On" and "Risk Off" Assets

The mantra in January was that a better economy and inflation were at our door step. Overweighting commodities, industrials, cyclicals and emerging markets were the ways to play the bullish outlook; dumping bonds, particularly longer dated Treasuries, would allow an investor to sidestep the inevitable interest rate rise.

Things haven't worked out that way. On the commodities front, silver has lost a third of its value since its April peak. Copper has dropped nearly 10% this year. Similarly, gold mining stocks are down nearly 6% year to date.

Meanwhile, the longer dated Treasury bonds have come on strong. The ten year's yield peaked at 3.72% in February but has since plummeted to less than 3% in early June; over the last three months the long dated Treasury ETF (iShares Barclays 20+ Year Treas Bond (TLT)) has returned nearly 8%, confounding the naysayers.

Given the deterioration in economic conditions, we believe it is far too risky to abandon defensive holdings like fixed income, and far too risky to overweight "risk on" assets like commodities.

Although silver has retreated by a third, it is still double its price a year ago. As commodities retreat demand for inflation protection subsides, while softer economic conditions reduce industrial demand. In short, we would continue to urge caution on commodities, particularly silver.

Fixed income will be the ticket if this soft patch gets worse. Before protesting that current interest rates are too low, remember that the Japanese 10 year sovereign bond's yield is a just a shade over 1%, and that the 10 year US Treasury got as low as 2.1% in late 2008.

Our preferred fixed income focus is US Treasuries, municipal bonds, and government agency debt, with a maturity of 6 years or less. The shorter maturities will be less impacted if interest rates rise. The non-corporate debt helps to hedge the risk that the private sector flounders in an increasing weak economic environment.

Avoid Exuberance

The entire world has been transfixed by the performance of the recent LinkedIn (NYSE:LNKD) IPO. Its sales and earning cannot justify its current stock price.

As other entrepreneurs eye the riches, expect plenty of competition. Why would you post your profile on LinkedIn if a competitor offered you cash/airline miles/coupons for doing so on its website?

History has not been kind to investors who chased fads and hot sectors. Indeed, virtually no investor who's bought LinkedIn after the stock came public has profited because the stock dropped below initial trading price.

Current economic weakness makes it all the more important for investors to be cautious about what they are paying for stocks. Avoid the over loved sectors. That would seem to include just about all internet and social media outfits.

Play Offense

Despite the questionable outlook, many sectors appear to have already discounted economic Armageddon - the downside should the bad news bears be spot on could well be much less than the upside if the pessimists are, well, too pessimistic.

Exhibit A is the financials. These companies have performed poorly this year as investors fret about increased regulation, stiffer capital requirements, weak loan demand, an abominable real estate market, and the fallout from potential European sovereign credit defaults.

However, the valuations are as attractive as they've been in generations, with blue chip names trading below book value. While you can always find fault with a particular company, the business of depositing, lending, and managing money is not going away. Brand name institutions like JP Morgan (JPM), Wells Fargo (NYSE:WFC), and Bank of America (NYSE:BAC) look attractive. Or consider the closed end John Hancock Bank and Thrift Opportunity Fund (NYSE:BTO), offering broad exposure to the industry at a discount to net asset value.

Next to consider might be the Japanese stock market. Down 80% in the last 20 years, valuations are much cheaper, particularly on a price to book value, than the rest of the world. Although the earthquake/tsunami/nuclear disaster is a human and economic tragedy, the fact is that the country has recovered from worse. Further, it will be a catalyst for increased fiscal and monetary stimulus at a time when nearly all other countries are reining in government spending and tightening monetary conditions. Diversified investment vehicles to play this market include the exchange traded iShares MSCI Japan Index Fund (EWJ), the closed end Japan Equity Fund (NYSE:JEQ) and the open end no load Fidelity Japan Fund (FJPNX).

Stick With the Cash Cows

Amid increasingly uncertain economic times, stick with companies that are generating large cash flows and have either low debt or large amounts of cash on their balance sheets. This financial strength offers protection when times get tough; it also permits them to pursue aggressively any opportunities the weak conditions create. Cash can also fund dividend hikes and stock buybacks, both shareholder friendly actions.

Large cap tech offers several possibilities. Consider Microsoft (NASDAQ:MSFT). It's got $41 billion in cash, just $12 billion in debt, and $20 billion in free cash flow annually. Enjoy the above average near 3% dividend while waiting for CEO Balmer to step down, which could boost the stock price 10%.

Intel (NASDAQ:INTC), the world's largest chip maker, with 80% of the microprocessor market, boasts nearly $8 billion in cash versus $2 billion in debt. These resources, coupled with $40 billion in annual sales, give it the financial strength to fare better than the competition in any slowdown. It also permits future increases to its already generous 3.9% dividend yield. That yield has grown over the last five years at an average annual rate of 14.5%, before its most recent 16% hike.

Finally, Hewlett Packard (NYSE:HPQ) may be the cheapest stock in the Dow, trading at just 6.6 times projected earnings, despite being the largest tech outfit on the globe. At $127 billion annually, it's got more sales than IBM, but HP's $20 billion debt is just two thirds IBM's. HP's global reach helps insulate it from weakness in the domestic economy.

In Sum

Divining the future is always difficult, particularly our economic future. Few saw the last financial crisis; few will be right going forward. Friday's jobs report was a shocker, made all the more so because the best and the brightest economists were so abysmally off the mark; the average prediction of the economic soothsayers was for nearly three times as many jobs to be created.

Stress test your own portfolio under various economic assumptions to see how it might hold up. Don't assume that the present economic worries will materialize. Hold both risk on assets, meaning securities that should thrive in a recovering economy with strong demand and even inflation, and risk off assets, meaning those that would hold up in the opposite conditions.

From Pointview Financial Services

About the author:

David G. Dietze, JD, CFA, CFP
David G. Dietze is president and chief investment strategist of Point View Wealth Management Inc., an SEC registered investment advisor, which he founded in 1993.

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