The Chinese panicked, stock markets around the world choked and the Fed blinked. What a quarter it was, replete with swings only a die-hard baseball fan could enjoy.
After a 6% drop in broad US market indexes, is this just the beginning of a deeper decline or only a long-awaited, run-of-the-mill correction with continued gains ahead?
It’s true, some headline data describes an economy that is still growing. Following a weak first quarter affected by the cold, the government’s official guess for the second quarter showed nearly 4% growth. The unemployment rate is down to almost 5%. Inflation, excluding energy prices, is still well below the Fed’s arbitrary 2% target. And, with rates low, auto and home sales are doing just fine. All in all, the view from 30,000 feet looks fine enough.
Now, to the on-the-ground view. We all know financial markets don’t operate on how things appear today. Instead, they focus on that never-to-arrive and always-uncertain, tomorrow. Given this, I think markets are flashing yellow warning signs.
First, risks are rising in lower-rated corporate bonds. Lower-quality bonds have declined about 5% in short order. This is raising concern among investors as weakness in junk bonds has traditionally been a leading indicator for periods of weak stock markets.
Next, stock prices are way down for companies most sensitive to cyclical economic shifts, such as industrial companies, big-ticket equipment manufacturers, commodity- and basic material companies as well as transportation companies. Compared to the market as a whole, these sectors have felt a much bigger brunt of the recent market downdraft.
In the midst of this under-the-surface activity, what’s catching my eye?
To begin, despite the uncertainty in the oil and gas market, I feel strongly there is value to be found in the massive carnage. Choosing even among the blue chip companies, such as Exxon Mobil, investors can benefit from large dividends at today’s low prices.
Next, there are a number of financially-strong industrial companies, such as Dow Chemical, that actually benefit from low energy prices. At a 4% dividend yield today, Dow provides the type of income that helps to battle this inhospitable rate environment. In addition, companies in the midst of corporate transformations, like Alcoa, offer good prospects. I also see tremendous value in a much-improved General Motors that currently pays a dividend of almost 5%.
Lastly, many blue-chip tech companies are just flat-out bargains today, in my view. With huge cash piles and serious earnings power, I think companies like Apple, Cisco and Microsoft are too hard to ignore for long-term investors.
Now, if the current yellow warning signs turn into bright red stop signs, you should also fully expect to see bargains go lower still. That’s the way markets work, of course, so please be sure to diversify and use common sense.
I do believe a change is afoot in markets today. Navigating it is going to require skill and investors might just want to get re-acquainted with seeing some red figures in their quarterly statements. If managed properly, for the prepared investor, yellow and red are not colors to be ignored or to be feared.
