The Word for 2010: Be Prepared

The markets have been moving lower, with the S&P 500 down 3.5% in the past six trading days with the tech oriented NASDAQ down nearly 4%, giving up gains made during the first weeks of 2010.

The move shouldn’t come as a shock to attendees of the 2010 May-Investment Economic Update, which warned of an overvalued stock market which seems to be discounting in a pretty robust economic recovery, while the new May-Investments Leading Economic Index merely shows an economy which has stabilized, but is still essentially in recession. Republicans may be blaming Obama’s proposed new banking restrictions for the sell-off, but that doesn’t explain the big declines that we’ve seen in the gold and commodities sectors. Continued weakness in the job market and a disappointing start to the earnings season are probably the main culprits.

In our forecast, we called for investors to “be prepared.” Be prepared for the economy to roll over and head back down into recession. Be prepared for the markets sink as it goes from “overbought” back down to undervalued. This doesn’t mean that I think we’ll go back to last March lows, but markets are volatile. Markets swing. Investors should be prepared to capitalize on the swings, because it is impossible to escape them. Finally, investors should be prepared to watch interest rates go up, even in the face of renewed talk of recession. Eventually, as the economy works its way through the recent imbalances, there will likely be a great buying opportunity on the other side. For now, though, my belief is that markets are still dangerous, and risk averse money needs to stay on the sidelines.

We continue to have some money on the sidelines, as we are concerned about the sustainability of the market rebound which began last March. We have one of our ten investment buckets invested in money market funds, so that if the market turns over, we’ll have money available to buy assets at lower prices. We also have the inverse Treasury fund, which hasn’t displayed as much volatility as stocks and would also be a source of funds if the stock market turned markedly lower.

We continue to hold two positions in junk bonds, which pay high dividends while we wait for the resumption of economic growth. If growth resumes, we would not hesitate to become much more aggressive in our positioning. On the other hand, if our gauge of economic activity rolls over, and the market is in fact turning down, we could become a little more defensive, still. I’d like to say we’re “cautiously optimistic,” but in reality I’m a bit more cautiously pessimistic – but would gladly be proven wrong.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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