Do This Before the Green-Shoot Bubble Pops

I know nobody wants to think about it, but I believe the market (and the economy) are still a long way from being out of the woods.

It seems like plenty of people don't want to see them, but I'm seeing storm clouds gathering on the market's horizon. I just spent a few minutes scanning headlines and this is what I saw:

• On U.S. railroads, carload traffic, an excellent measure of the health of U.S. manufacturing, is down almost 19%.
• New jobless claims -- a measure of the number of people claiming unemployment insurance for the first time -- rose unexpectedly last week.
• A new survey found that one in eight U.S. households with mortgages was in foreclosure or behind on payments in the second quarter, The Wall Street Journal reported. That's not "one in eight subprime mortgages" -- we're talking about one-eighth of all residential mortgages.

I could go on -- there's plenty of significant not-so-good economic news out there to choose from. But why does that translate to storm clouds on the market's horizon?

Here's why: Because we've had this big rally, which -- to the extent it was driven by anything at all other than stimulus and bailout cash being shoved into the markets -- was driven by the idea that a recovery would be underway by the end of the year.

Y'know, those "green shoots." I'm tempted to call this rally a "green-shoot bubble." And bubbles, of course, pop.

I'm thinking that this one could pop soon.

OK, why now?
Think about it. What if we get into September, maybe October, which tend to be tough months for the stock market even in good times, and the economic news continues to be grim? What if it starts to become clear that the "recovery" isn't going to be here anytime soon? What if companies continue to cut back, a few more big names end up in bankruptcy court, energy prices start to rise, and the dollar falls? What if reality sets in?

I think the odds of some or all of that happening are pretty good, and I think we could see a sizeable drop in stocks when it does.

On the other hand ...
I might be completely wrong. Not wrong in the I-expected-a-20%-drop-and-it-went-down-30% sense, but wrong-wrong. Maybe this is the start of an economic recovery. Or maybe it's not, but the markets end up not caring. Markets can stay irrational longer than you and I can stay solvent, as the old saying goes, and a continued more-or-less-upward trend wouldn't really surprise me.

Long story short, I'm not sufficiently convinced of the impending-drop thesis to sell everything and take a big position in one of those double-short index ETFs. But I do think it makes sense to be more defensive right now, while staying invested in stocks.

If you're thinking what I'm thinking, and you've been taking profits on stocks that have had big gains in the last few months, here's an idea for what to do next.

Buy dividends
Dividend stocks tend to be boring, right? Although there are plenty of exceptions, it's probably fair to say that dividend-paying stocks as a group are less volatile than many of the other stocks that investors find attractive.

The beauty of a sustainable dividend is obvious: You get paid to hold the stock! And if you reinvest that dividend, and plan to hold for the long term, a dip in the stock's price doesn't bother you -- it just means your dividend will be buying more shares.

Even better ...
Look for companies that have raised their dividends since the economic unpleasantness really set in last fall. That's often -- not always, but often -- an excellent sign. There are quite a few companies that have been able to raise their dividends prudently despite the economic conditions. Here are a few I've been looking at:

Source: Motley Fool CAPS, Yahoo! Finance.
*Year-over-year change following multiple increases.

Sure, none of these big names are likely to shoot the lights out from a growth perspective. But that's not what we want right now. What we get with stocks like these are some stability to the downside, some ability to keep pace if the market keeps going up, and a dividend that is likely to keep coming even if the economy stinks for a while longer.

I think that adds up to a reasonably balanced defensive-ish posture that's appropriate for right now, and I plan on increasing my exposure to stocks like these in the coming weeks. What do you think? Am I on the right track? Scroll down and leave a comment to let me know.