The summer was pretty good to us. The S&P 500 (SPY) is up 9.5 percent in the last three months in a quarter with a fairly consistent upward trend and very low volatility. The average daily fluctuation of the S&P 500 over the last three months was 0.62 percent, less than half of the 1.40 percent average daily fluctuation during the same time last year. With more quantitative easing on the way, we can hope for this upward trend to continue, but many investors, including myself, fear that a bear run could make an arrival as the United States nears a "fiscal cliff" and faces a chance at a recession.
The stock market has a high valuation on it right now. According to Yahoo Finance, he average P/E ratio of the S&P 500 is 16.49, up from 14.96 at the beginning of 2012. Earnings on the whole have met expectations this year. In addition, many S&P 500 companies are reaching record high profit margins, which is normally a mean reverting statistic. This all means that a 4 to 7 percent correction could likely happen this quarter, especially if there is sup-par market data or a widespread earnings miss. Based on this information, I have 3 recommendations.
1. Precious Metals
In my Summer Investing Strategies article, I recommended buying silver through ETFs. Since its publication, the iShares Silver Trust (SLV) is up 17.26 percent. It went up a lot faster than I thought it would go up, but there is still a little room for profit. With the potential corrections and macroeconomic issues that face us, I believe having a good chunk of your portfolio in precious metals is a good idea right now. The SPDR Gold Trust (GLD) may also be a good investment. Gold is pretty high as it hovers around $1738 per troy ounce, but any kind of panic can put it back up around the $1900 level that we saw last year. Silver outperformed gold by over 10 percent in the last quarter, which I mentioned was likely since the two are very highly correlated and gold was outperforming silver for over a year. Buying a gold or silver ETF may be a good idea if you don't already have a position in your portfolio, but don't expect to make a fortune on your investment since both metals are quickly closing in on their all time highs.
2. Low Beta Blue Chips
I've been a fan of low beta blue chips for over a year. On the whole, they have strongly outperformed the market, but were crushed by the market over the last three months. This is to be expected as the bull market that we've seen will not have as much of a pull on low beta stocks as it will on financial stocks with betas that can be as high as 3. With a potential bear market approaching, I believe low beta blue chips are good holds. I suggest that people heavily invested in technology and finance stocks allocate at least some of their portfolio with blue chips. I believe that Procter & Gamble (PG) is a good example of what to look for in a low beta stock. The stock has a beta of 0.45 and a 56 cent quarterly dividend, which is 60 percent higher than its dividend 5 years ago when shares were trading around the same price.
3. Acquisition Targets
When large cap companies have high profit margins, they tend to make more acquisitions. Surprisingly enough, large cap companies are also likely to make more acquisitions in the midst of a bull market. The strong stock market performance over the last three months will definitely spark some big mergers and acquisitions in the next few months. Some notable examples have already taken place in August. Best Buy (BBY) might get bought out by its founder, Hertz (HTZ) bought Thrifty (DTG) for $2.3 billion, Aetna (AET) bought Coventry (CVH) for $5.6 billion, and there is a potential American Airlines (AAMRQ.PK) and US Airways (LCC) merger in the works.
For individual investors, acquisition speculation is a very difficult and inexact guessing game, but it may be worth a try. As long as the companies you speculate on are fundamentally sound even if an acquisition does not take place, you will probably not get burned. A good example of a speculative buy would be the unprofitable Molina Healthcare (MOH), a Medicaid specialist. With the health care reform implementation underway, larger health care companies will look to beef up their offerings. The company is also expected to revert to profitability in 2013 and the stock will probably have nice gains if the company can stay profitable.
I expect the next three months to be worse than the previous three, but I don't believe it's time to completely abandon ship. However, I believe it is a good time to look through your portfolio and close out any positions in equities that could drop 20 to 30 percent in economically unstable conditions. Now is a time to diversify, mitigate risk, and experiment with low-risk ideas. After fees and tax implications, the bearish market that I expect is not enough to spark a selloff.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.