Confidence in short supply


Stocks face renewed selling pressure, with pessimism regarding the economy and corporate earnings bringing the Oct. 27 lows within striking distance. The Dow Industrials are roughly 1.3% away from 8,175.77, while the Dow Transports are about 3.1% away from 3,364.98. A move below those points would be discouraging, though it would not impact the bearish status of the Dow Theory.

For now, subscribers should maintain a defensive posture. As a partial hedge, subscribers should hold 25% to 35% of equity portfolios in a money-market or short-term bond fund. Our Buy List and Focus List have 29.8% in Vanguard Short-Term Investment-Grade ($9.72; VFSTX), while our Long-Term Buy List has 34% in this low-risk bond fund.

Consumer slump
While the panic on Wall Street has eased somewhat, and banks have become a little more willing to lend, U.S. consumers are now facing their own crisis of confidence. Reflecting sharp job losses in recent months and lower home prices, consumer-confidence indexes have dropped to record lows.

Sales of new vehicles dropped 32% in the September quarter, and automakers are bracing for further declines. Retail sales have slumped, with Circuit City seeking bankruptcy protection and Best Buy ($22; NYSE: BBY) issuing a downbeat profit forecast. Even some health-care companies are feeling the pinch as consumers cut back on discretionary tests and treatments.

The U.S. economy has lost about 1.2 million jobs so far this year. With job losses expected to continue, many economists fear a negative feedback loop in which spending cuts and layoffs reinforce each other. Economists at Goldman Sachs now expect the unemployment rate to reach 8.5% by the end of 2009, up from 6.5% last month. In the 1981-82 recession, the worst since World War II, unemployment peaked at 10.8%.

With consumer spending, business investment, and foreign demand all slumping, many investors appear to have concluded that the situation is hopeless. But such sentiment is always present at market bottoms, and history suggests the time to be optimistic is at the point of maximum pessimism.

In general, we prefer to let the market’s action signal that the point of maximum pessimism has passed before deploying our cash reserves. But we intend to remain engaged, looking for stocks capable of bucking the bearish trend. Two defensive names with attractive year-ahead potential, Biogen Idec ($47; NASDAQ: BIIB) and AstraZeneca ($42; NYSE: AZN), are being added to the Buy List this week.

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