Financial Fitness & Life Planning

 
The stock market was propelled higher in July by consistently strong second quarter earnings reports. Early in the month, investors remained skeptical. The market was looking through the reports to the future, which is growing cloudier as economic indicators continue to weaken. Investors were also justifiably concerned that sales were weak, therefore signaling that the strong growth in profits is not sustainable. As the month went along and the robust corporate profit reports continued to roll in, however, the market finally capitulated and jumped higher in response.
 
Just because the market changes its behavior, however, does not mean that you should alter your outlook. In fact, one should perhaps grow more cautious and conservative, reducing overall exposure even further while also concentrating holdings in only the very largest and highest quality stocks. I doubt that second quarter earnings foreshadow a robust environment going forward. Investors seem to be ignoring the fact that comparisons were remarkably easy, as the second quarter of 2009 was a period when the economy was on the brink. Future comparisons will become more difficult. Also, as the economic recovery is now clearly slowing, I believe that more of the second quarter strength was pulled from the early part of the quarter, which of course would not be a good sign for what lies ahead. The housing market, which drives the US economy, is reeling again while sovereign debt risk in Europe remains high. We are mired in the aftermath of a giant credit bubble. It is going to take years to get through it, and that will not occur until there is true growth in the private sector. 
 
Against such an unpleasant backdrop, one must play the hand that he or she is dealt. Quality stocks remain priced moderately, pay dividends and have extremely strong balance sheets. Earnings are stable and should continue to grow even in a chronically stalled economy. As long as those earnings grow, the stock prices will be higher in the years ahead. The overall market, however, is not necessarily attractive and so investors might consider balancing quality holdings with a large cash position. Cash protects against deflation and also provides the liquidity to take advantage of perhaps more attractive future stock prices and market levels. Finally, investors should also consider building a position in gold. While deflation is a more pressing concern right now, our policy makers will fight deflation with every tool at their disposal. This will inevitably lead to inflation and currency debasement. Gold production peaked a decade ago, but the supply of paper money is limitless.
 
Because of the environment that we are in, a defensive mindset might be warranted. If the market continues to climb for a while, investors with such a posture will lag behind. That is a risk that one must be willing to take, however, in order to protect his or her capital.  
 
The information included in this article is not intended to be used as a basis for making investment decisions nor should it be constructed as a recommendation to buy or sell any specific security. Consult your investment professional for additional information and guidance.
 
Michael H. Berlin, CFA, CPA, is the founder and portfolio manager of MHB Equity Partners, a value-oriented private investment partnership. He previously worked at Lehman Brothers, and before that at Ernst & Young. Mr. Berlin holds an MBA from Columbia and a BBA from Michigan.
 
Michael can be contacted at mberlin@mhbpartners.com and at (631) 629-4928.