"Valuation in the marketplace tends to cause our portfolios to migrate from one sector to another. Right now we find that there is reasonable value in some of the energy and the material stocks. We?re also finding some value in the technology and the industrial areas. What?s becoming a little less interesting to us are some of the defensive sectors such as the food and beverage stocks and some of the healthcare stocks."

Deleveraging is likely to be the dominant economic force affecting the stock market for the next year or two. The period ahead will be a journey in which both businesses and consumers reduce debt and rebuild their balance sheets. This process is akin to rebuilding one’s savings account – it will ultimately restore our financial health, but delayed gratification won’t be as much fun as the lifestyle to which we have been accustomed.

For at least a generation, and arguably two, the U.S. economy has been based on the expanding use of credit. In recent years, the expanded use of credit has been predicated on rising home and stock prices. We believe the door to that era slammed shut with the bankruptcy of Lehman Brothers.

In economic terms the process of reducing debt is the same as increasing savings. This process will ultimately restore our economy to health, but the transition will be disruptive. In recent years consumer spending has accounted for nearly 70% of economic growth. If consumers save more, economic growth will be less robust. The economy and stock market will adapt to a higher savings rate but the transition from a low to a higher savings rate will create some economic turbulence.

This period of deleveraging is likely to lead investors to have below-average exposure to equities and should lead them toward high-quality bonds. Signs to watch for an improving climate for the stock market include lower corporate bond yields and rising rates on short-term U.S. Treasury bills. Both would be signs that the credit crunch is thawing.

Foothills Asset Management, Ltd.
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