Don't Panic - Reallocate Instead

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Includes: AAPL, AMZN, TGT
by: Cory Cramer

Summary

If you were caught off guard by the worst opening week in history, don't go to cash now.

It would be more prudent to reallocate funds into companies that are insulated from potential headwinds.

I outline the factors I think are important over the medium term.

Introduction

If you got caught flat-footed the first week of 2016 and found yourself short of cash, you're probably not alone, and now is not the time to panic. I was expecting a drop in the 3-5% range this January, was fairly well prepared for it, and I still didn't like this week. I can only imagine how someone down over 10% in a week might feel. After starting the year off with a 40% allocation in cash in my 401(k), and after moving money into the market on Thursday and Friday, the cash is now down to 21%. On average, I had about 10% cash in my other accounts going into the week, and it is now down to essentially zero. So, I've been moving into the market while most other people were moving out of it, and that's exactly what I had planned to do.

But what if you started the year almost fully invested and are feeling the urge to get out? My simplest advice is: Don't. I wouldn't get out, but I would look to reallocate to companies that are less likely to face macro headwinds this year. Here are the types of companies I think will outperform over the medium term:

U.S.-based companies that earn their money domestically

With the dollar as strong as it is, I don't see any reason to buy stock in a company right now that earns the majority of its profits outside the U.S. if a similar company can be owned that doesn't have that headwind. The dollar may weaken this year, but I don't see it weakening very much. Most of the rest of the world is struggling, while our Federal Reserve is pretending it wants to tighten more. It just doesn't make sense to buy stock in companies that earn a substantial amount of their profits internationally right now with this headwind in place.

Companies that do not rely on high commodity prices (especially oil)

It could take oil a long time to turn around. There will be a time to get back into this sector, but 2016 is not the time. I would rather buy companies that benefit from cheap fuel, like US retailers, than dip my toes into an oil-related company.

Companies that can successfully compete with, or avoid competing with, Amazon (NASDAQ:AMZN)

Speaking of retailers, avoid the ones that are forced to, but cannot manage to, compete with Amazon. Amazon is crushing many of them, and is likely to continue to do so.

Companies that will not be materially affected by modestly higher interest rates

Companies with strong Free Cash Flow and/or little or no debt are what I'm looking for. Personally, I don't think the rates are going much higher at all, but we still might see credit tighten, and I don't want a company that is overly reliant on credit right now.

Companies that cater to the middle class

The middle class will benefit most from cheaper fuel and low interest rates. People who own homes and can refinance their mortgages for 4%; who can get similar financing on a new car; who are paying half of what they paid for gasoline last year; who are paying significantly less to heat their homes and businesses this winter; people whose wages are modestly rising - these people are going to spend money. In my opinion, they have already been spending money. And when earnings are reported soon, we will all find out where they are spending money.

Companies that pay over a 3% dividend

I'm not a dividend investor per se, but if you are fully invested and we do have a bear market, your dividends can provide you with investable cash during the down market that you otherwise wouldn't have had.

Conclusion

I have been trying to find companies that largely fit this profile for the past three months. Many of them were noted in my annual review here, and I've since added Target (NYSE:TGT) to the list. Of the guidelines I mentioned, most of the companies found in the links above meet five of the six requirements. The total return of the weighted basket is currently down -1.02% versus a -5.5% total return on the S&P 500 if the index had been purchased at the same times and quantities.

I have a fairly strong self-imposed rule of only making actionable suggestions in my articles that can be properly measured with specific investments, but this week has been so full of irrational commentary, I wanted to offer mine to make the point that you don't have to invest in troubled areas. Personally, I think Wall Street and the media went completely off the deep end this week. I expect earnings in the companies that fit the profile above to be very good, including Apple (NASDAQ:AAPL), which doesn't quite fit the profile above.

I could, of course, be absolutely wrong. But I'm moving a lot of my money into the market and placing my bets. I'll revisit this in May and we'll see how those bets play out. And if you find any promising companies that fit the profile above, I'd love to hear about them in the comment section.

Disclosure: I am/we are long AAPL, SWKS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.