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A Jump in the Hedges in the Market

The market swoon is no reason to panic about a crash


Clunk!  Looks as if our instinct to do a little hedging was right on the money. Stocks plunged on Thursday with the Dow industrials clocking their second-worst decline of the year (251 points). Gold fell $50.30 an ounce, basis the active August futures contract, to $1565.50 an ounce. Oil for August delivery sank to $78.20 a barrel, the lowest settlement for the nearby contract since last October.

As usual, the commentators are citing myriad reasons for today’s big drop in stocks and other so-called risk assets.  Some gurus are pointing to the sharp drop in the Philadelphia Fed’s index of manufacturing activity in the Middle Atlantic region. For June, the Philly Fed barometer skidded to -16.6, down from -5.8 in May and worse than economists were expecting. (Zero is neutral.)

Other pundits, less plausibly, are blaming a bearish research note from Goldman Sachs (NYSE:GS). Goldie reportedly is calling for the S&P 500 index to pull back to 1285 — hardly an earthshaking collapse. That traders would hang so much weight on a single brokerage firm’s short-term market opinion only reaffirms what I’ve been saying for weeks: A lot of investors are confused and afraid, and don’t know what (whom) to believe.

At such times, I retreat to my chart room and study my technical gauges more intently than ever. Numbers have no emotions!  Here’s what I’m seeing.

The stock market’s behavior since the May 18 momentum low closely resembles the pattern off the May 2010 momentum bottom. (The momentum low is the point at which the headline indexes achieved their greatest negative rate of change.)

Two years ago, the market rallied 20 days into a June top, then slid back to a new marginal low — about 4.6% beneath the initial May low, as measured by the S&P 500 — on July 2.

This time around, the rally off the May momentum low again lasted 20 days, to the June 19 peak on the S&P. If the market’s rhythm continues to match the 2010 precedent, we can expect a final low around July 3. Since daily volatility is running about 30% less today than in 2010, I project a gentler decline than two years ago, to an ultimate bottom of about 1254 for the S&P.

Then the market will be ready for the second-half climb I talk about in July. So, while I’m cautious for the next few weeks, I expect to accelerate my buying as prices step down toward my target.

Anything worth buying right here? All four of the blue chips I spotlighted in July look attractive. If you’re particularly nervous about the economic outlook, go with Baxter (NYSE:BAX), Emerson Electric (NYSE:EMR) or McDonald’s (NYSE:MCD), all of which are likely to post solid earnings growth through year-end 2012.

On the other hand, I’m intrigued with Procter & Gamble (NYSE:PG) precisely because this great enterprise, with its long growth record, has stumbled a bit in the past couple of quarters. After Wednesday’s downbeat profit forecast, CEO Bob McDonald is under excruciating pressure to turn the ship around.

I’m betting he’ll succeed. Why? Unlike so many organizations — even Apple (NASDAQ:AAPL)! — which rely on a handful of products to bring home the bacon, PG boasts 26 brands with sales of more than $1 billion a year.

That’s spectacular diversification, and it buys PG the most precious commodity of all — time. Time to fix problems that arise, inevitably, in the life of this (or any) business. If only Eastman Kodak (PINK:EKDKQ) or Nokia (NYSE:NOK) had the same luxury!

Buy PG. Counting both dividends and capital appreciation, I think you’ll double your money over the next five or six years.

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