The beginning of the month is usually positive for stocks, as pension and other automatic savings plans pour into the market. However, that wasn’t the case for September, as Friday’s employment report makes very likely that the U.S. economy-- and perhaps the world economy -- is heading for a double-dip recession.
Last time the U.S. experienced a double-dip recession was back in 1981-82, and it was ugly both for Wall Street and Main Street. Unfortunately, this time around things may be worse for the U.S. as economic policy, especially monetary policy, is maxed-out. For instance, in 1982 short-term interest rates were around 16 percent, while this time around they are near zero. This means the economy cannot count on lower rates to recover, as was the case in 1983-84.
Compounding the problem, economic policy is maxed-out in Europe and Japan, that are facing their own prospect for sliding into a recession— actually half of Europe is already in a recession, ravaged by sovereign debt woes.
Simply put, investors face two trends that will dominate September trading: The prospect of a worldwide recession, and the prospect of continuing, even worsening European sovereign debt issues. However, the problem is that the two trends create crosscurrents that make investing in certain classes of assets tricky. The prospect of a recession, for instance, is bearish for precious metals, while the prospect of worsening sovereign debt woes is bullish. This means that investors should pursue a subtle trading strategy.
Here are several trading ideas they may want to consider:
1. Sell high-flying cyclical stocks. A double-dip recession is certainly not good news for cyclical stocks like Ford (F), General Motors (GM), Toyota Motor Company(TM), and Honda Motor Company (HMC); and it is certainly bad news for high-fliers in the materials and energy space like Walter Energy (WLT) that missed on second quarter revenues by a great margin, and is up 400 percent since 2009. Cliffs Natural Resources (CLF) is up 300 percent; and energy companies included in Oil Service Holders (OIH).
2. Avoid Precious Metals. Precious metals are caught at the crosscurrents of a bearish trend (the recession), and a bullish trend (the sovereign debt crisis), that’s why it is best to avoid them, especially after their big run up. Ishares silver trust (SLV) is up 350 percent since early 2009; SPDR Gold Shares (GLD) is up 100 percent; and Freeport-McMoRan Copper and Gold (FCX) soared 400 percent. But the commodity rally may be over. Monetary policy is no longer ultra-accommodating, and some have raised rates (China, Brazil, and India). The dollar is stabilizing, the world economy is slowing, and inflationary expectations are tapering off. In addition, changes in margin requirements may limit the flow of funds into commodities.
3. Avoid Chinese stocks. A global recession will slow-down for Chinese products, and may even intensify trade tensions between the two countries. As we discussed in a previous article, buying Chinese companies traded in U.S. exchanges is a high-risk strategy, as these companies are subject to frequent changes in rules and regulations that undermine their ability to stay in business and maintain profitability. Smaller Chinese companies, especially those listed through ”reverse mergers,” are conducive to accounting fraud and manipulation. This realization prompted some discount brokers to take certain Chinese stocks off the margin list last Wednesday — resulting in hefty losses for popular Chinese companies, like Youku.com, Inc. (YOKU), Sina Corporation (SINA), Baidu, Inc. (BIDU), and Sohu.com Inc. (SOHU).
4. Avoid momentum stocks. Momentum investing is a strategy based on hype about an investment theme, a new product or a new industry that captures and captivates the investor mind-- at times when money is cheap. In the late 1990s, the theme was telecommunications and networking, with momentum funds flowing into companies like Cisco Systems (CSCO), Ciena Corp (CIEN), JDS Uniphase Corp (JDSU), Corning, Inc. and Ariba Inc. (ARBA). Now the theme is social media and web-based companies, like Netflix, Inc. (NFLX), Open Table Inc. (OPEN), and LinkedIn Corp (LNKD). Momentum investing can be very rewarding as long as it lasts. But it can result in hefty losses once it fades away, especially for investors who got in at the top.
5. Buy non-cyclical stocks. These stocks fare better during a recession like big pharma stocks - Pfizer (PFE), Bristol Mayer’s Squibb (BMY), Abbott Laboratories (ABT), Eli Lilly (LLY) and Merck (MRK) – that enjoy hefty profit margins, ranging from 19% to 32%; and pay hefty dividends, ranging from 3.80% to 5.5%, compared to 1.88% for S&P 500 stocks (SPY).
7. Stay away from U.S. Treasuries--and Treasury ETFs like AGG, BND, LAG, and TLT. Though U.S. Treasuries are the first investment to come to mind when the economy heads into recession, this time yields are already near record low levels, notwithstanding the impending downgrades. So any gains from these levels will be limited.
8. Buy protection. Short or buy puts on SPDR S&P 500 (SPY). The problem, however, is that S&P500 had a big correction already. So investors may want to average into this trade rather than going outright into a major position; and they may want to do the same with iPath S&P 500 VIX Short-Term Futures ETN (VXX).