Despite Market Rally Big-picture Forces Remain Scary

April 21, 2009

Stocks may continue to rally for now, but don’t be deluded by short-term swings. Investors should pay attention to ominous big-picture forces instead.

Stocks may continue to rally for now, but don’t be deluded by short-term swings. Investors should pay attention to ominous big-picture forces instead.

This can be attributed to the end of the easy-credit era and the dampening of consumer spending, the dramatically increased role of government in private-sector activities, and the eventual—and probably dramatic— big upswing in inflation.

There is plenty of risk in stocks. The consumer is not doing better. And you can’t forecast earnings based on recent years. Profit margins reached unsustainable levels during the credit boom, and a much more competitive business environment will be our reality for years to come. More earnings disappointments in the next few months seem inevitable.

What can investors do to preserve their capital and earn a decent return today? Here are some things to keep in mind:

Corporate bonds are better. Put more of your risk capital in quality short- and medium-term corporate bonds than in equities.

But Treasury bonds are overpriced, so stick to TIPS and Ginnie Maes if you want government backing. Federally guaranteed GNMAs still have a 4%-plus yield, and the average maturities are about four years.

A few select stocks are bargains. Financial Advantage, for instance, recently added Northrop Grumman to its portfolio. “There are still some attractive stocks, but it takes more digging to find them.”

Gold still shines. Though the short-term rally has ended, gold bullion serves as a crucial hedge against all paper currencies. The US is far from being the only fan of currency devaluation. We think there is a better-than-even chance that we'll eventually see a competitive currency devaluation spiral internationally.

J. Michael Martin is the chief investment officer of Financial Advantage and can be reached at 410-715-9200 or mmartin@financialadvantageinc.com.