Recession Fears Return: Three Sectors To Stick With

All it took was a couple of soft earnings reports and lackluster guidance from 3M, Caterpillar and Wachovia to reignite the fears of a looming recession. I am not surprised by the expected softness in the economy next year - I thought everyone was pretty much on the same page there. But does softness equate to recession? And what is the discount on the stock market for each of the scenarios?

In the real world there really should be no significant discount for a recession. Why should there be if an investor has at least a five year time horizon? The only rational explanation is that dividends (immediate income stream) would be cut. Now that is a possibility for a protracted recession but I don't see that happening. We have low bond yields so that is not an exciting option for investment dollars as even in a recession I don't see yields dropping much further (price appreciation).

Valuations for the domestic market remain very attractive at current levels despite an economic slowdown/recession in the next year. The Fed is on the side of equity investors by being in an easing cycle (cash becoming less attractive), bonds are not an attractive substitute, and foreign markets are not cheap. All seems to argue for stable to higher equity prices in my mind.

In fact, I can make the argument we are currently in the middle of the recession/slowdown. Remember, we don't know until it is almost over when we are in a recession/slowdown! This would explain why the current market is so cheap. Given 10 year yields the stock market should really be 10% to 20% higher right now!

The uptrend is still intact, seasonalities are in favor and for me that means to stay heavy long. I will be adding aggressively to my positions in the next week or so as I still see a return at least to the highs before the year ends. To be sure I think it is wise to underweight financial, cyclicals, and even consumer staples. Stay with strength, stay with the materials, technology, and select healthcare.