Wednesday, June 15, 2011

When nothing else is working, cash is king

Today's (June 15) fall of 179 points in the Dow continued a string of almost uninterrupted bad days for the equity market. The averages are approaching critical support levels and if the market drops further, there could be serious declines coming. At the risk of sounding immodest, I'd like to point out that I predicted this drop in the equity markets in an earlier post.

Before I get too cocky, I also suggested putting much of your portfolio into commodities including precious metals, and into international bond funds not pegged to the US Dollar. As it turns out, the world economic situation has changed and those are no longer good investments. The reason I'm backing off these recommendations is threefold:

(1) Economic growth is slowing more than expected so there is little upward pressure on commodities right now - that is forcing commodity stock prices down.

(2) Other economies around the world (Europe and Japan in particular) are in awful shape.Think of the US Dollar as the 110-pound weakling battling against the 98-pound (or 44.5 kilos) Euro and Yen and you get the picture. The Dollar is weak, but it's still better than other currency options.

(3) The bond market as a whole is walking on very thin ice right now. If countries start defaulting on bonds (as it looks more and more likely will happen), it will send interest rates up very fast. The interest rate on a 10-year Greek government bond is 18% today. If a few other governments start defaulting, the interest rate for government bonds around the world will skyrocket. That will make the face value of current US treasury bonds at their lowly 3% rates plummet.

To summarize, these investments are not working right now: stocks, US bonds, international bonds, emerging market stocks,gold and precious metals, commodities and currencies.

Here are the investments that are working: (insert cricket sounds here)

Nothing is working. Not only are there no investments that are rising, all investments at this point in time have the potential risk to drop by a significant amount.

That includes bonds. If you are in bonds, I would get the heck out, and soon. Don't listen to investment advisors - bonds are not the risk-free investment that they are promoted as. They may not fall as much as stocks, and yes, you will get back your principal if you hold the bond until the end of the term (as much as 30 years). But if a bond drops by 10% in face value, that means it will take you over three years at 3% interest to bet back to even.

If you must own equities, I would stick with big-name companies with lots of international exposure, very strong brand names and high dividends. Stick with names like Apple (AAPL), Nike (NKE), Johnson and Johnson (JNJ), IBM and Altria (MO). But I would look for a low entry point, and don't buy on days when the market is up. You will probably still lose a little money over the next six months with these stocks, but if I'm wrong and stocks go up you'll have some upside potential. And these stocks pay nice dividends.

Another group of equities I like right now are banks. They have been beat down tremendously. The market hates bank stocks right now - many banks are priced below tangible book value. That means if you add up all the tangible assets (good assets, not bad mortgages) the total market capitalization on the stock is less than the net value of the company. That is a real bargain. I like Wells Fargo because it is really down and is a well managed bank. WFC closed at $26.55 today - in 2008 and much of 2009, when banks all over the US were falling like dominoes, WFC was at $30 or more. Is the banking environment worse today than it was during those dark days? I don't think so. I also like Morgan Stanley (MS) that is also under book value, and Goldman Sachs (GS), which is slightly over book value.

I would steer clear of bad-news banks like Bank of America (BOA) and Citi (C) which I think may be in for a rough ride in coming months.