Scorched-Earth Policy Could Fry Portfolios

The market has reacted to the imminent sequestration deadline with a lackadaisical shrug. Although indexes have been hovering around five-year highs, you have to wonder why so few investors seem concerned that terrible gusts of economic headwinds could wipe out many companies' profitability.

The market is indeed bipolar, but the supposedly smartest professionals are reluctant to make the diagnosis and get clinical about the reality.

Investors shouldn't panic and ditch stocks, but it's time to do some portfolio housecleaning and aim to focus on the best, most well-positioned companies. Read on for why investors should worry, and how to change your investment strategy so you can sleep at night.

Scorched earth and shrinking prospects
Along with still-high levels of unemployment, continued mass layoffs, rising gas prices, payroll tax hikes, and other negative factors, sequestration could send serious ripple effects throughout the public and private sectors. This isn't simply limited to government agencies and services. Take defense contractors, many of which are publicly traded. The federal government pays out $500 billion every year to such firms, and contractors represent 7.5 million workers.

Regardless of where the money comes from, fewer jobs and slashed consumer incomes can devastate economies. When individuals stop spending, it hurts everyone else's income and spending power, affecting businesses from mom-and-pop restaurants to maid brigades to gardeners to giant corporations like Wal-Mart.

Although paring U.S. debt, reducing government spending, and getting America's fiscal house in order are all rational goals, a scorched-earth policy is hardly a reasonable path to get there. As far as investors go, it's time to look beyond today, this month, or next quarter and realize that these tactics threaten many companies' sales and profits at a time when the economy is still very fragile.

La-la-la, we're not listening
Traders don't seem too troubled today; the rest of us should wonder what they've been smoking.

Earlier this week, Federal Reserve Chairman Ben Bernanke defended the Fed's continued unprecedented levels of stimulus given economic negatives like still-high unemployment. In addition, he admonished Congress for its poor handling of the sequestration mess and its potential to hurt GDP.

Interestingly, though, Bernanke also said, "I see no evidence of a stock bubble" despite the fact that the market's hovering near five-year highs. And this rally has come way before much meaningful recovery as well as during continued economic drags.

Hit rewind, and recall that Fed Chairman Alan Greenspan failed to detect another big bubble: housing. Bernanke didn't believe there was one, either, right before he was nominated as the next chairman. We're still digging out of that debacle. His failure to detect came at a time when almost everyone was convinced the artificially pumped-up economy was actually healthy, too.

Bernanke indicated that strong corporate earnings explain the rally mode. That's not exactly correct. Many of us know that profits are being juiced by many companies through cost-cutting, not actual sales growth.

The strong survive
The overall picture isn't pretty, particularly when you throw sequestration into the already nasty mix. We shouldn't give up on stocks, but we should admit that some are heading for a fall and focus our portfolios on the strongest companies with the brightest futures, strong balance sheets, and great leadership.

That also means avoiding value traps at all costs. For example, tidings from J.C. Penney (NYSE: JCP  ) and Sears Holdings (NASDAQ: SHLD  ) show these two companies are like two drunks tethered together jumping out of a plane. This pair is unlikely to navigate a far more challenging macro climate.

J.C. Penney's quarterly results were horrific, with a mind-boggling 32% decline in same-store sales in the holiday quarter. Yesterday, Standard & Poor's cut its debt rating on top of the obviously ugly news in its financial release.

Sears may have reported a "less bad" quarter this week than in the past, narrowing its quarterly loss, but sales still dropped by 2% and same-store sales fell 1.6%. It's also topped a list that's no reason to celebrate: It's become the most shorted company on the Nasdaq.

Best Buy (NYSE: BBY  ) bucked the trend by reporting a better-than-expected quarter, but don't be fooled. Revenue and same-store sales were still weak, rising anemically by 0.2% and 0.9%, respectively.

Rather than falling for value traps, investors should hold gold-standard companies throughout today's uncertain times. The Motley Fool's list of The 25 Best Companies in America gives investors great ideas for protecting their portfolios from dangerous, weak stock holdings. The Fool's list points to companies that are built to survive and thrive because their focus is not solely shareholder value but also the value they create for customers, employees, and the world.

There are some surprise stock ideas to consider here, too. The company that came in at No. 1 is one many of us may not have even heard of: Cummins (NYSE: CMI  ) . It manufactures engines, but part of its magic is its emphasis on cutting greenhouse gas emissions and launching world-friendly initiatives like the Technical Education for Communities Program, which trains young people in economically challenged communities the skills they need to work at companies like Cummins.

What really powers prosperity
Focusing on great companies is a great investment policy during times of economic hardship and prosperity alike. The companies that take more into account than simply shareholder value boost our economy instead of detracting from it. So let's hunker down and protect our portfolios.

If you're looking for more stock ideas, The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

Check back at Fool.com for more of Alyce Lomax's columns on environmental, social, and governance issues.


Read/Post Comments (20) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 01, 2013, at 7:08 PM, neelvk wrote:

    How can we talk about a stock bubble when companies are hoarding record amounts of cash and dividend yield is in nosebleed range?

  • Report this Comment On March 01, 2013, at 7:30 PM, JadedFoolalex wrote:

    Now imagine what will happen when all that Hoarded cash comes back into the markets!!!

  • Report this Comment On March 01, 2013, at 7:35 PM, ryanalexanderson wrote:

    Dividend yield in nosebleed range? On what planet? It's 2%, and the long term average is 4%!

  • Report this Comment On March 01, 2013, at 9:18 PM, ynotc wrote:

    When government spends money it gets that money from the people.

    If they spend money they don't have they borrow that money on the faith and credit of the tax payer. In other words we the people are the guarantors of 536 people taking out a loan.

    Taxes now remove money from our pockets and reduce jobs because those who have to pay that tax can no longer spend it.

    Deficits spend future money again reducing the amount that we can spend in the future which also wrecks the economy later.

    Your thesis that if government does not spend it then our economy will suffer while technically correct is flawed in that it enriches some at the expense of others

  • Report this Comment On March 02, 2013, at 7:34 AM, skypilot2005 wrote:

    I like "Hard Assets" here. Re.:

    Profitable precious metals miners.

    On March 01, 2013, at 9:18 PM, ynotc wrote:

    "Your thesis that if government does not spend it then our economy will suffer while technically correct is flawed in that it enriches some at the expense of others."

    Yup. Those "Others" feel they can better spend our money than we can.

    I call it "The Big Lie".

    Sky

  • Report this Comment On March 02, 2013, at 9:47 AM, Darwood11 wrote:

    I do own individual stocks in a number of companies that made the Motley Fool Best 25 list. I didn't simply purchase for high yield. If that were true, I supposed I'd own a few MLPs, etc. but I do not.

    The dividend yield of my portfolio of dividend paying stocks is 3.24%. Not stellar, but as I do reinvest all dividends I'm investing in my future by doing so.

    I think there are "win-win" scenarios.

  • Report this Comment On March 02, 2013, at 8:36 PM, HanSoLow wrote:

    I would love to see some research on the amount of cash held on companies' balance sheets as compared to their short term funding needs. As an individual running a household, I keep 6 months worth of expenses in cash in a savings account earning 0.9% interest. While this is not even beating inflation, it sure allows me to be prepared for some sort of catastrophic occurance. I wonder if the cash held on companies' balance sheets is a prudent way to prepare for the next credit freeze.

  • Report this Comment On March 02, 2013, at 11:13 PM, neamakri wrote:

    Democrats have created a spending monster. Not one democrat is willing to spend one penny less. This monster is alreading causing inflation via QE's.

    It just makes me sick to see government taking money from me ("with a badge and a gun") and spending it on programs like "pre-school". I consider kindergarten to be pre-school. Anything before that is babysitting. I as a taxpayer do not support free babysitting. Babysitting is a parent's responsibility.

    You know, there are euro countries that are facing severe austerity budgets because they overspent. Are we headed that way? Or will Ben Bernanke just keep printing inflated money?

  • Report this Comment On March 03, 2013, at 8:33 PM, jovahu2 wrote:

    Why do I get the sensation that The Motley Fool has just morphed into Fox News?

  • Report this Comment On March 03, 2013, at 10:54 PM, Shawnerz wrote:

    "these two...are like two drunks tethered together jumping out of a plane"

    Classic! I love it! I may have to borrow that line at my next cocktail party.

  • Report this Comment On March 04, 2013, at 9:48 AM, mdk0611 wrote:

    Why do I get the sensation that Alyce morphed into MSNBC a long time ago?

  • Report this Comment On March 05, 2013, at 10:30 PM, NOTvuffett wrote:

    lol, mdko611, Aylce is just to the right of Pol Pot.

    I think I had a weird sex dream with 2 women tethered together but that is another story for another day, lol.

    Even though I usually disagree with Alyce. She is always even tempered. Few men can do that.

  • Report this Comment On March 05, 2013, at 11:16 PM, smartmuffin wrote:

    " Take defense contractors, many of which are publicly traded. The federal government pays out $500 billion every year to such firms, and contractors represent 7.5 million workers."

    Let me get this straight. You're saying that the government could offset the ENTIRE amount of the sequestration by simply cutting defense contractors by 16%?

    And we're supposed to freak out at this? They're still going to cut teachers and police and firemen and close the national parks and not pay out social security?

    What a joke. This is absolutely why the "scorched earth" policy is necessary. The idiots in both parties have had millions of chances to cut waste. They refuse to do so. They think we don't have any waste.

  • Report this Comment On March 06, 2013, at 10:33 AM, mdk0611 wrote:

    Not pay out social security?????

  • Report this Comment On March 06, 2013, at 10:36 AM, mdk0611 wrote:

    Addendum

    Boone: "Germans?"

    Otter: "Relax, he's on a roll."

  • Report this Comment On March 08, 2013, at 1:56 PM, moneytrail wrote:

    Alyce –

    perhaps you should have been running around the country with Bozo the Pres when he was ranting about the demise of the US economy because he can't manage a miniscule 1.2% reduction ($44 bil this year) from a $3.7 TRILLION dollar spend fest, which is an INCREASE to last year’s spending.

    (The $44 bil represents about 10 days of the $4 bil+ per day, we are borrowing from our children who will have to pay it back, along with the $17 TRILLION, and growing, that is already mortgaging their future.)

    If, as according to the Obama Administration’s and many economists the economy is gaining momentum while government spending is dropping, as a percentage of GDP, aren’t they making the case that decreased government spending BOOSTS the economy rather than depressing it?

    In fact, the case for economic growth arising from decreasing the government waste of private sector created wealth has been made by every socialist country that has adopted free market reforms.

    Why?

    Because the private sector creates wealth, the government destroys it.

    Perhaps MF will grant you a sabbatical so you can brush up on Eco 101. PLEASE, stop spewing Krugman economic confusion upon the less astute MF readers.

    Thank you.

  • Report this Comment On March 08, 2013, at 10:01 PM, awitner wrote:

    Ironically, Alyce Lomax answers her own question as to why America is ignoring Washington politicians. It is the constant scare tactics from the left that are making people not only not worried about the sequester, but laughing at these idiots. Alyce dives head first into this scam with the use of "Scorched Earth" in her title. Think about this...we will still spend more money in 2013, than in 2012. There are no cuts! Yet this reduction in growth is characterized by Lomax as scorched earth! Gee, I wonder why people aren't listening. Please continue crying wolf and watch your written words become completely worthless.

  • Report this Comment On March 08, 2013, at 11:52 PM, ChrisBern wrote:

    @smartmuffin-- exactly.

  • Report this Comment On March 09, 2013, at 10:19 PM, NOTvuffett wrote:

    This is comedy gold- Maxine Waters explains how sequestration will cost the USA 170 million jobs: W6rlv9v90hwyc42m

    Of course, on the face of it the numbers are stupid. Why do I get the sensation that many of our leaders couldn't even balance their own checkbook? lol.

  • Report this Comment On April 04, 2013, at 5:55 AM, thidmark wrote:

    The sequestration cuts amount to a rounding error in the budget. Of course the market dismissed it.

    Where does TMF find these doofuses?

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