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Global Boiling Point, What's Next?

It wasn’t long ago that nations like Spain and Italy were thought of more for their great beaches and fine wines than for their impact on the global economy. But times have certainly changed, and these days, Spain can be considered as a sort of world barometer: The higher the Spanish 10-year bond goes, the hotter tensions become and begin to boil around the globe.

This story played out yesterday, when the yield on the Spanish 10-year bond rocketed to 7.5%. The surge came after two municipalities requested aid from Spain’s already cash-strapped federal government. There are even rumors that Germany could resign from the euro all together, which I don’t think is likely, and speculation is increasing over whether the International Monetary Fund (IMF) will give additional aid to troubled Eurozone nations. So this request for aid from Spain’s local economies only underscored its monetary “point-of-no-return” status, spooking the markets.

Suffice to say that the brief period of calm that Europe enjoyed after it agreed to bailout measures in June is over, at least for the moment. Rattled investors sent stocks on a downward spiral yesterday and the same pessimism persists today, with the Dow and S&P 500 both down around 1% in afternoon trading.  

But before you start stuffing your money under a mattress, let’s look at what in the U.S. will be impacted the most by a slowdown in Europe, and what strengths we can capitalize on as the macroeconomic picture changes.

Flight to Safety

Believe it or not, I’m bullish on stocks right now. The global economic concerns are very real, but in periods where the market is trying to find a direction, it’s crucial that we determine where the real weaknesses and strengths lie to tell an accurate story. 

Let’s start with financials. Unlike what many analysts are forecasting, financial companies won’t be that hard hit if things get worse in Europe. That’s because big banks like JPMorgan Chase (JPM) and Goldman Sachs (GS) have already priced in their losses should Greece default, and they’ve hedged against further downside risk by reducing their exposure to Europe’s debt. The bottom line is that the U.S. banks are pretty well prepared.

Where I do expect some possible short-term trouble is with big corporations that have lots of global exposure, particularly in healthcare, energy and auto companies. Take McDonald’s (MCD), which has huge exposure to Europe and China. This is making it difficult for the company’s shares to break out of the $90 range. There may be further weakness a head for the global fast food giant, but it remains a well-run company that should do well over the long-term - and pays a decent dividend to boot.

Similarly, automotive company AutoNation (AN) reported stellar second-quarter earnings, but its sales were primarily in the U.S. That’s due to American cars hitting an all-time high in terms of age, with the average car around 11 years and two months old. With people needing to replace their cars, AN found an equilibrium, but the story isn’t the same in Europe. The takeaway here is that multinational stocks could face headwinds as uncertainty escalates in Europe and we see which direction China’s economy goes. As we head into the second half of the year, we can look to quarterly earnings reports do the talking. For example, industry bellwethers like Caterpillar (CAT) and DR Horton (DHI) will be telling of the real economic picture in China (and whether growth is slowing or starting to pick up there) and in U.S. homebuilding, which is showing signs of life.

In the meantime, stocks on a relative basis are very cheap right now. Selling in the first half of the year brought a lot of stocks down under $5 and $10, positioning the second half of the year to end on a high note. This, along with the possibility of more easing from the U.S. Federal Reserve, is keeping investors in the market and creating an environment that is very advantageous. And, with the history of strong election years on our side, now is a great time to take advantage of low-priced stocks.

Great Opportunities with Small Caps

This advice may surprise you, as smaller-cap names often have a reputation of being riskier. A $0.50 drop in a $30 stock is only a 1.6% decline, but that same drop in a $5 stock is 11%. The upside, however, is that it works both ways: When the market bounces, low-priced stocks are often heartily rewarded. And since institutions would rather be out touting bigger companies, low-priced stocks are a great way for us individual investors to get a leg up. Finally, M&A activity is heating up in the second half of the year. This means that corporations sitting on record levels of cash will use it to scoop up smaller companies. When they do, we profit.

All of these factors add up to an exciting time for some lucrative opportunities! So how can you take advantage? By investing in low-priced stocks of solid companies that have strong catalysts to move them forward, even in a slow environment.

One name that I like is Casual Male Retail Group (CMRG). This men’s retailer had a solid second quarter that was boosted by better-than-expected earnings and a strong performance from its primary catalyst: The Destination XL larger-format stores, which combines the company’s three different price points and is still in its infancy, so the potential here is very exciting. With easy sales comparisons in place for the rest of the year, I believe estimates of $0.025 for the current year are realistic, and that number should grow as DXL continues to be rolled out. The company’s debt-free balance sheet also adds to the attraction of the stock, which is trading at bargain prices.

Another attractive stock right now is air pollution control services provider CECO Environmental (CECE), which recently announced it is seeing increased demand from both new and existing customers, and that global demand is improving. I found this news very encouraging since it should help the company continue to report strong results even if the economic environment remains volatile. The company also has a strong balance sheet, with a net cash position of $0.71 a share. Along with the earnings visibility, CECE is a solid pick for the quarter.

The bottom line is that while the market is in a period of uncertainty, we don’t have to be. Small cap stocks are a great opportunity to invest in names that are well positioned to pop as we close out the year.

Signed- Hilary Kramer

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