A lot of bad news is converging on the stock market — here’s how to deal with it – MarketWatch

Heads up, investors: Wednesday’s selloff in the stock market may be the start of something bigger, for the five key reasons I cite below.

The good news is we’re not going to see a full retest of the March lows or anywhere near that kind of decline, thanks to several positive factors in the mix (also below).

The upshot: It’ll make sense to buy stocks after potential 5%-10% declines in the S&P 500
Dow Jones Industrial Average

and Nasdaq

Here are some tactical suggestions.

• Focus on buying a group that I call “public space” stocks. The eight stocks I put in my public-gathering-place portfolio in my stock newsletter, Brush Up on Stocks, on March 17 were up 70.7% by the close June 15, compared with 26.3% gains for the SPDR S&P 500 ETF Trust
As the big gainers (and the ones most vulnerable to Covid-19 resurgence fears), they will likely decline a lot, offering the best opportunity for a rebound when Covid-19 fears recede again.

If you missed this play the first time around, you will get another shot on a smaller scale. The eight stocks are: Churchill Downs
Royal Caribbean Cruises
Planet Fitness
Home Depot
Howard Hughes

and Cedar Fair
These all have solid brands, good business prospects and decent insider buying levels.

• Buy the most cyclical areas, which will also get hit the hardest. This means energy, industrials and basic materials. Consider solid names in energy like Exxon Mobil

and Royal Dutch Shell
which get Morningstar’s highest (five star) stock rating, or one I like and own among mid-caps, Continental Resources
In industrials and chemicals, there’s been compelling insider buying in TransDigm Group

and LyondellBasell Industries

over the past several weeks.

For exchange traded funds (ETFs), consider Energy Select Sector SPDR
SPDR S&P Oil & Gas Explore & Production

and Vanguard Energy

in energy; Industrial Select Sector SPDR Fund

and Vanguard Industrials

in industrials; and Materials Select Sector SPDR
Vanguard Materials

and iShares Dow Jones US Basic Materials

in basic materials.

• Own gold or gold-mining stocks. They are a hedge against potential weakness. Consider SPDR Gold Trust
iShares Gold Trust
VanEck Vectors Gold

and VanEck Vectors/Jr Gold Miners

­• Don’t get too aggressive in selling biotech stocks or the iShares NASDAQ Biotechnology Index

or SPDR S&P Biotech
Biotech is less likely to sell off sharply, and it may even go up since it’s now considered a “defensive” group that rises on increasing fears about Covid-19 spread. Politicians need breakthroughs on vaccines and therapies, so they are in love with the sector. No more talk about drug price regulation, at least not for now. Biotech stock valuations are largely based on the discounted net present value of earnings many years out, when therapies get approved. What happens over the next 12 months is less important to valuations.

The bottom line: This is not a time when you need to rush into the markets for fear of missing out. Wait for price. Get out of trades and positions you are not certain about. But don’t touch core long-term positions. A disastrous long-term recession does not appear to be in the cards. Be wary of using margin. Slowly raise some cash or keep some on hand.

Then as market weakness develops, scale into stocks getting hit the most, such as the public-space stocks and companies in cyclical areas like energy, industrials and chemicals. There are plenty of things that could crop up to create volatility and better prices, near term. Here are five reasons why.

The stock market is more vulnerable now

1. Sentiment is turning bullish. Not feverishly so, but enough to make this a less compelling time to buy stocks in the contrarian sense, meaning you should get less bullish as the crowd gets more bullish. The dozen sentiment indicators I track are all now either neutral or bearish (showing too much bullishness). Excessive optimism is seen in the high levels of call buying at the Chicago Board Options Exchange, for example, and the record number of new accounts at discount brokerage firms and Robinhood.

2. Insiders have shifted to neutral. Insider buyers have left the building. On Tuesday there were only 12 companies whose own executives bought more than $100,000 worth of stock, which is low. Part of the decline is because we are moving into earnings reporting season. So insiders are getting locked down. But this doesn’t explain all of it.

3. Covid-19 risks are rising. In the early days of the coronavirus resurgence, you could argue case counts were rising because of more testing. No longer. The infection rate per number of tests is going up because the coronavirus case count is rising as people circulate again. Epidemiologists I talk with, including Dr. Michael Mina at Harvard, caution that the chances are very high that we will see even more serious outbreaks in early October when flu season returns.

4. Political risk is rising. Polls show Joe Biden is now the favorite to win the White House. Betting odds at gaming sites suggest there is a good chance the Senate will go Democratic. Both events would be perceived as negatives for stocks since tax and regulation policies of Democrats can be viewed as bad for stocks. Democratic presidential candidate Joe Biden’s policies would impose $3.5 trillion in costs on businesses and investors by increasing the corporate tax rate, and capital gains and dividend tax rates, according to Cornerstone Macro.

5. The seasonally weak time of year lies just ahead. That means July through the end of October.

Not all bad news

Offsetting those negatives are six factors that suggest any selloff won’t be too dramatic and that the current Covid-19 resurgence won’t be as bad as the initial phase.

1. Cash levels are really high. Money market funds now hold $4.8 trillion, says the Investment Company Institute, above the prior high of $3.8 trillion in January 2009. Deposits in commercial banks increased sharply in March-May (by $2 trillion), moving those levels up to a record $15.4 trillion, or around twice as much as 2009 levels, according to the Federal Reserve. Those numbers suggest a lot of investors who sold the March selloff never got back in. They are itching to do so, which means they will support the market in any significant decline.

2. The personal savings rate has increased dramatically. This boosts consumer-spending power. Defined as the percentage of income left after people spend money and pay taxes, this rose to a record high of 33% during April from 8.2% in February.

3. The Fed and the federal government have injected massive amounts of stimulus in the economy. They are not even done yet. Phase 4 with an infrastructure-spending component awaits. To consider infrastructure stocks, here is a recent column I wrote on this theme.

4. We probably aren’t going back into full lockdown mode. That’s because the trillions of dollars in costs seem too high, in economic damage and government stimulus funding to offset it.

5. Covid-19 immunity for people who get it seems to be real. Mina, at Harvard, notes we see very few cases of people getting infected twice, and when it happens it’s because of severe immune-system problems. Meanwhile, we have learned a lot about how to track and contain virus spread, even if adequate testing and surveillance infrastructure is not in place, according to Mina.

6. The Covid-19 resurgence may be limited geographically. The biggest spreads so far are happening in the Sunbelt. This suggests it may be linked to staying indoors because of the heat, with air conditioning recirculating viruses. People stay out of the heat and use air conditioning in the North, too, but less so. Many relatively cooler states currently do not show as much of a resurgence.

For example, recent testing in New York City showed a steady 1% infection hit rate, despite the fact that there were mass protests and riots long enough ago for Covid-related infections to show up.

At the time of publication, Michael Brush owned FUN, HHC, CCL, CHDN, CLR and XOP. Brush has suggested FUN, LOW, HD, HHC, RCL, CCL, PLNT, CHDN, TDG LYB, XLE, XOP, GLD, GDX, IBB and XBI in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School. Follow Brush on Twitter @mbrushstocks.

Read More: A lot of bad news is converging on the stock market — here’s how to deal with it – MarketWatch

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