Be Willing To Buy — Carefully

10/31/2011


After surging from the closing lows reached Oct. 3, the averages have been choppy amid questions about corporate profits and the outlook for Europe. While we are mostly encouraged by third-quarter results — and are on the lookout for opportunities to put money to work in stocks — a return to a fully invested posture seems premature. For now, our buy lists have about 25% in Vanguard Short-Term Investment-Grade (VFSTX; $10.67).

Sour mood

For those with patience, investing in U.S. stocks when Americans are despondent has generally been a winning strategy over the past century. If history is to repeat, and the Conference Board's index of consumer sentiment for October accurately reflects the nation's mood, now seems a good time to buy.

The index fell to 39.8, down from 45.4 in September. Since the series began in 1967, consumer confidence has only been lower during the depths of the 2008-2009 recession. A recent Wall Street Journal/NBC News poll found that 74% of Americans believe the country is "off on the wrong track," only slightly below the peak of 78% reached in October 2008.

Bears argue the pessimism spells trouble for the economy and stock market, as consumer spending accounts for more than 70% of U.S. gross domestic product. But consumer spending has not slumped with consumer confidence in recent months. Employment conditions, which historically have tracked consumer confidence fairly closely, are bad but nowhere near the levels implied by today's abysmal confidence numbers.

Moreover, partly because of increased dependence on foreign markets, the prospects of the typical large, publicly traded company have diverged considerably from the prospects of the typical American. Corporate profits are near all-time highs as a percentage of the total U.S. economy, while the percentage for wages is near all-time lows.

So far, results for the third quarter suggest profits for corporate America are holding up well. Among 118 members of the S&P 500 Index that have reported September-quarter results, about 67% have exceeded consensus profit estimates — in line with recent quarters. Expected near-term growth rates have dipped slightly, but the consensus still projects profits for the S&P 500 Index will be up 13.8% for full-year 2011 and 11.9% for 2012.

Conclusion

By itself, the pessimism of U.S. consumers is not reason enough to abandon stocks. But subscribers should maintain a somewhat defensive posture, holding a bigger-than-normal cash position while emphasizing attractively valued shares of quality companies. Intel ($25; INTC) represents a top pick.


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