Here's your 7-point guide for the next phase of the stock market

Some ideas: Own value stocks and regional bank stocks, and hold cash.

  • By Michael Brush,
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Shaken by the recent stock market volatility? Relax, this isn’t The Big One. A recession is still far enough away that we aren’t entering a sustained bear market.

But the tone of the market will undoubtedly be a lot different once the correction is over and we move into this bull’s senior years. Survival and success will depend on new tactics. Here’s your seven-point guide to late-cycle investing.

1. Stay in the market (depending on your age)

If you are a millenial, ignore the market volatility. “Don’t pay any attention whatsoever,” says Mark Zandi, chief economist of Moody’s Analytics. “It’s too hard to time getting back in.”

Besides, owning stocks in a broad S&P 500 Index (.SPX) exchange traded fund like the SPDR S&P 500 (SPY), or the iShares Russell 2000 (IWM) is a bet on America’s future. And as Warren Buffett likes to point out, that’s a good bet. The best thing to do is continue dollar-cost-averaging in, and don’t stop when the going gets rough — like now.

Also, while this sounds like heresy, consider active fund managers. Most have lagged the markets for years. But the late stage of an economic cycle is more about stock picking if only because overall market returns may be more modest. “Active management may offer opportunities for better returns,” says Saira Malik, the head of equity strategy at Nuveen.

If you are a boomer, it’s another story. You’ve got less time to recover from any sustained down market that may play out after this bull market ends. It’s too late to sell, in this pullback. But the next two years are a time to sell into strength.

Consider using the cash to “ladder” into staggered positions in short-term bonds that you continually roll over, depending on cash needs. Also consider Treasury Inflation-Protected Securities (TIPS). “The end of the market cycle is often characterized by the economy overheating, causing unexpected inflation,” says Frank Van Etten, another Nuveen strategist. TIPS help protect against inflation.

2. Own “quality”

The late stages of a bull cycle are a time to de-risk your holdings, says Frank Holmes, the CEO and chief investment officer at U.S. Global Investors. “Stocks that have not shown dividend or cash growth in the last year, they are gone,” he says. Companies with rising dividends and cash flow do better late in a cycle. Here, he likes NetApp (NTAP), Visa (V), Best Buy (BBY), Ross Stores (ROST), and Zoetis (ZTS), as examples.

“Now we are getting to the point where things are starting to look cheap again,” says Lamar Villere, portfolio manager of the Villere Balanced Fund (VILLX), “There are opportunities to buy very good companies that have gotten cheaper.” He cites the auto insurer Progressive (PGR), which contains costs by selling directly to consumers. Interest-rate increases will help because the company invests its float in bonds. Another example is Steris (STE), which should see steady demand because it sells supplies to hospitals.

Robert Bacarella, who helps manage the Monetta Fund (MONTX), and the Monetta Core Growth Fund (MYIFX), favors high-beta, “quality” growth names like Costco Wholesale (COST), Starbucks (SBUX), Amazon.com (AMZN), Alphabet (GOOGL), and Adobe (ADBE), “Stay with the growth companies. Stay with the winners,” he says. “They go down twice as much as the market and they will come back more than the market.”

3. Focus on companies that enhance productivity

Companies that enhance productivity typically do better in the late stages of the economic cycle, says Eric Marshall, a portfolio manager and head of research at Hodges Capital Management. That’s because labor costs are rising, so companies are looking harder for ways to contain costs. One way is to spend money on technology and equipment to increase labor productivity. Marshall cites Brooks Automation (BRKS), FARO Technologies (FARO), and Rockwell Automation (ROK).

4. Buy value stocks

Investors move into defensive names that pay dividends for late stages of a bull market. But this isn’t a good time for that. They were already expensive heading into this correction because of the demand for yield. Now as fears mount, they’re even more in demand.

Instead, it makes sense to buy value names like cyclical stocks which are pricing in a major recession that is not going to occur, says Sam Stewart of Seven Canyons Advisors. “Cyclicals are very cheap,” he says. Investors are pricing in an “earnings collapse.” But Stewart thinks the next recession will be fairly mild, so this is overkill. The next downturn will be mild because it doesn’t look like it will be a reaction to wild excesses in the economy like 10 years ago. Plus, technology is helping companies better manage inventories.

“The earnings in cyclicals are not going to get crushed, and right now you have a lot of damage priced in,” says Stewart. Cheap cyclical names he likes include global bank J.P. Morgan Chase (JPM); package deliverer FedEx (FDX); Triton International (TRTN), which leases shipping containers; MSC Industrial Direct (MSM), an industrial-parts distributor; and Masco (MAS), a building-parts supplier.

5. Own regional banks

Long-term interest rates often rise late in the cycle as investors price in inflation. An upward sloping yield curve helps regional banks. They borrow at the short end and lend at the long end. And they get more income from loans relative to larger banks, which have more fee income in the mix.

Plus, banks have been conservative. So they are well-capitalized, points out Marshall, at Hodges. “It won’t be the regional banks that have a lot of bad loans,” he says. One he likes is Dallas-based Triumph Bancorp (TBK). It has purchased a lot of deposit-rich rural banks, and it’s deploying those deposits into its factoring business, or loans against business receivables.

Lamar, at Villere Balanced Fund, agrees that rising interest rates on the long end of the yield curve will help regional banks. Two he favors are Kearny Financial (KRNY) and First Hawaiian (FHB).

6. Own emerging markets

They’re even more beaten up than U.S. stocks, but the growth potential is there. “If you are simply being clinical and not emotional, then you have to ask what opportunities are the markets giving you, and that is emerging markets. They have sold off tremendously,” says Darrell Riley, a strategist at T. Rowe Price. This includes emerging market stocks and emerging market bonds denominated in dollars.

Nuveen’s Malik agrees. “We also continue to find value in non-U.S. markets, particularly in emerging markets, which are trading at a deep discount to the U.S. and hold greater potential for accelerating earnings growth over the next few years,” she says.

7. Be in cash

Cash has gotten overlooked during the bull market because interest rates were so low. “Now that interest rates have perked up, you can get 2%-3% on cash,” says Stewart at Seven Canyons Advisors. Cash may not be king, because we are not going into a bear market. But it is moving up the ranks.

At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested JPM, AMZN, GOOGL, SBUX and BRKS 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 in the Knight-Bagehot program.

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