What To Do If Q3 Earnings Fail To Deliver

Frost Warnings For October: What To Do If Third-Quarter Earnings Fail To Deliver

By Jim Lowell, Marketwatch | 1 October 2009

NEWTON, Mass. (MarketWatch)— Thoughts of cycles and seasons, turnings from growth toward annual decay and perennial conservation in the real world and its mirror image found on Wall Street, are migrating in and out of my market musings. Talk of a big chill is circulating in the real world marketplace, and on Wall Street. It certainly feels as if the overall cycle on both fronts is overdue for a frost of some magnitude.

But I think the long-term bullish trend remains inexorably intact, whether you think that some one or group had a hand in the cycle or not is not as relevant as the fact that the cycle persists. We know that around this column's corner, we'll get an important earnings season but it won't be as significant as the prior one. Second-quarter earnings not only pulled the herd back from the cliff, they created a stampede of gains whose dust-up was the best since the Great Depression. But third-quarter earnings will be essential to supporting or supplanting this remarkable rebound.

We also know that even before we get to those earnings, we're going to continue to build a case for an economic floor on which we can stand. The production pace has been cut so dramatically below even the anemic pace of sales that a positive outcome is all but a foregone conclusion. Loosely conjectured, this could mean that we're on the road to something like a surprising 5% growth inside the third and fourth quarters. But, if third-quarter earnings fail to deliver broad-based evidence of top line sales growth and not just bottom line management via cost cutting or production efficiencies, then we could be in store for a growing economy and falling market.

So, this month's trading opportunities are biased toward risk management. Last month, we went further out on selective branches of the global market tree in order to grab a few more fruitful gains. Our best pick, iShares Comex Gold Trust (IAU 101.89, +2.06, +2.07%) , returned 5.8%. Our worst pick gained 1.6%, while the S&P 500 (SPX 1,052, +11.47, +1.10%) delivered 4.8%.

Against this year's backdrop, our weekly ETF Trader service here on MarketWatch continues to do what it's designed to do: capitalize on growth trends in the marketplace. Through Sept. 20— and against the solid 20.5% gain for the S&P 500— the service's ETF Aggressive Trader model portfolio is up 72.6%, ETF Total Market gained 39.8%, ETF Sector climbed 34.3% and ETF Seasonality Portfolio added 17.1%. To learn more about ETF Trader, and to sign up for a free 30-day trial, click here.

Here and now, my picks have us returning closer to the stocks/bonds/cash trunk to withstand better the likely near-term blows of a market that is ahead of the near-term fundamentals. My picks for managing the risk and return potential of October's landscape:

Stocks: Fidelity Select Health Care (FSPHX 98.65, +0.96, +0.98%) — Buy. Up 25.3% year to date. Manager Eddie Yoon invests in the gamut of healthcare options: pharmaceuticals, biotechnology, medical equipment and HMOs. The trumped up political crisis that has engendered a rush to 'cure' our healthcare system has done little to dent the fundamental reasons— earnings growth, demographics, and innovation— for keeping a core holding in healthcare now.

I also like Vanguard Healthcare (VGHCX 113.43, +0.72, +0.64%) by virtue of its stellar manager, Ed Owens, and its complementary Hartford Global Health (HGHAX 13.49, +0.05, +0.37%), run by Owens' team. There's also a stealth global market dose here: foreign stocks make up 13% of the holdings, but the companies that aren't listed as foreign stocks derive increasingly greater amounts of revenue form the burgeoning global marketplace.

Bonds: Fidelity New Markets Income (FNMIX 15.39, +0.16, +1.05%), up 41.2% year to date. Manager John Carlson, who used to run the Emerging Market stock fund, has a simple maxim— if you want to own the stocks, you should want to own the debt. Research, analysis, knowledge and judgment are Carlson's calling cards in this often-volatile trade. Carlson manages risk through all of that diversification— 128 plus holdings— but not at the expense of his best ideas. A total of 26% of the fund's $2.1 billion is in his top-10 picks. His debt securities range from Venezuela to Russia, Turkey to Brazil and the Ukraine to the U.S.— in the form of a 7% stake in the Fidelity Cash Central fund.

I view this fund in much the same way that I view our stake in high income, as a hedge against its correlated equity markets risks. Similarly, the yield offers a way to help salve any specific selloff while the holdings offer a way to stem the flood if panic selling in the equity markets ensues. That's a negative imprint of this positive snapshot: long-term, the growth of emerging markets and the debt needed to finance that growth are two rails on which our portfolio's financial engine can run.

Cash: My pick of the litter remains last month's exchange-traded fund, the PowerShares DB G10 Currency Harvest Fund. (DBV 23.18, +0.18, +0.78%) It's up 17% year to date. DBV ostensibly does all the currency trading work for you: it tracks the Deutsche Bank G10 Currency Future Harvest Index, intended to take advantage of the fact that currencies with high interest rates tend to rise in value relative to those with low interest rates. The 10 currencies that the index selects from include the U.S. dollar, the euro, the Japanese yen, Canadian dollar, Swiss franc, British pound, Australian dollar, New Zealand dollar, Norwegian krone, and Swedish krona.

When you combine all three 'alloctions', you have a reasonable offense and a reasoned defense for a month where harvesting gains might be the rule rather than the exception. If this does turn out to be the case, look to next month's column to spotlight seeds we can sow in November's greenhouse for next year's even more bountiful harvest.