A Buying Guide for Day Two

 | Jun 15, 2012 | 7:49 AM EDT
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How did we get to the point where we actually care about the Greek elections? How did we get to the point where our nation became hostage to a hadful of countries that we never used to care about, Greece, Italy and Spain?

It's a pretty compelling question when you think about it and a lot of people lately are arguing that the hostage-taking is somewhat more artificial and chimerical than it might be.

But before I give you the debunked side let's talk of indisputable concepts. First, the United States itself is weak. Our budget deficit, our entitlements and our gridlock make us far more impotent than we used to be. We have a private sector that is scared to expand here or doesn't know whether it wants to expand here. We can argue about why:

  1. Government is too involved in decisions
  2. Country is too anti-business and the regulations are too difficult
  3. We are not a growth market for much because we are mature and our growth rate is slowing
  4. It is cheaper to make it elsewhere and sell it here or to import it and sell it here

Notice I am trying not to say "and it's because of the Democrats" because it isn't. You could argue that it is more because of the power of the green faction, which has bullied its way to the majority, or you could argue that it is the fault of leadership from both parties, as one party does seem to want things stalled so it has a better case to be made in November.

But the fact that we haven't been able to grow our employment makes us hostage to Europe because we have a part of our economy that is driven by world trade (more on that in a moment).

So, because we are weak we are tied in.

But far more important is that our stocks are tied in more than our companies. This is crucial. You have to understand that there were two parts, not one part, to the post-housing crisis, post-Lehman collapse of our economy. The first had to do with real business. Real business, especially the companies that need credit to sell large, expensive items, slowed to a trickle because the financial markets were "closed" when the crisis took hold. People in finance became incredibly risk averse. So financing was difficult to come by.

That led to layoffs and a spiral down.

But it's the second factor, the business of stocks, that got hit every bit as bad or worse than the actual business. I founded TheStreet.com on the notion that stocks are separate animals from the businesses themselves and often, in the day-to-day life of the markets, stocks diverge.

When we got an economic collapse, in the first stage everything collapsed. Every stock.

But in the second stage there was a rebound, the rebound that came in a reversal of the downtrend in the stocks that didn't deserve to be hit because they either self-financed or they sold products that were recession resistant, meaning you couldn't do without them, whether you had a job or not. That means they had a good business even in a layoff environment. Maybe people traded down where they bought things, hence the amazing evolution of the dollar stores to a major cohort. Maybe people didn't buy discretionary items. But they bought everything else that they always had to buy.

It is the second stage that I am more focused on right now because the second stage will soon be upon us after Europe collapses as the runs on the French banks begins.

In the second stage you have to buy the stocks that shouldn't have been hit and avoid like the plague the stocks that deserve to be hit. Which brings me back to the linkage.

In Great Recession I, we were the epicenter, with the proximate cause being the collapse in the housing market, a market that represented trillions of dollars in financial worth, not just real property worth, because of the way mortgages are kept on the books. If banks kept mortgages, then mortgages get reworked and the banks work their ways out of the hole they are in.

But the banks in our country, with few exceptions, participated in:

  1. Bad lending at the top of the market
  2. The slicing and dicing of those loans into impenetrable pieces of paper
  3. The selling of those rancid pieces of paper, which were, by and large, worth much less than they were selling for because the tables said there could never be mass defaults because there hadn't been since the Great Depression, but the tables were were wrong
  4. The robosigning of documents, ensuring that couldn't be untangled because it was in a leveraged collection of loans or it didn't lend itself to fixing because the loan didn't hold up in court

That meant our banking system became tenuous, people pulled their money out of banks and put them in Treasuryies and ultimately the federal government had to put money in all banks and raise the FDIC of all banks to keep the money in the banks so they could one day lend again.

Now, flash forward to the Great Recession II. We certainly were not part of the Irish or Spanish lending boom. We didn't pay Italy or Greece's pensioners and government employees too much money. We don't determine whether the sovereign debt of many countries can be financed.

But because our banks told us over and over again that they wanted to be international, and because they became part of the firmament, they also became integral to European finance.

It's that linkage that is plaguing us now. We are on the hooks to Europe because of the ties of finance and the need to provide liquidity to their banks. Our banks get hurt when they get hurt (JPMorgan (JPM) for example) and our banks can't handle a total flight of capital to our Treasuries or German Bunds.

Once again, clients for Boeing (BA) or Joy Global (JOYG), for example, might not get financing and the layoffs in Europe can't be reversed without government intervention to promote growth.

If our country were hiring, and if our budget deficit were under control, I would argue that even our banks would be immune to this and could be providing credit to worthy borrowers. But our economy isn't strong enough and our international banks are too intertwined and weak.

Which brings me all the way back to Day Two after the collapse of Europe. After the collapse many stocks will be taken down because they are tied together by being in the S&P and the S&P is the preferred way of the other source of integrated capital, the $4 trillion hedge funds to make bets for or against the stock market, not individual stocks that aren't fast enough or big enough.

What I am suggesting is that we all prepare for Day Two and know that the institutions that are connected because they went overboard in Europe and the institutions that need credit will go down along with many stocks that shouldn't. If you are practicing Day Two now, you will get hurt on Day One, but on Day Two you will begin to make it back and then some.

So, scrutinize your portfolio. How much Day One stuff do you own? Be prepared for the earnings of some of these stocks to be cut severely, which includes all of the businesses that need credit and do a large business in Europe or rely on buoyant commodities.

But on Day Two, those that aren't interconnected come back. As long as you recognize the stock connection may be false because the economic connection is nil, then you know what to buy ahead of the multiple calamities that are going to occur. The stocks that come back the hardest are domestic companies with good dividends, like Verizon (VZ) and Con Ed (ED) are the examples. The second hardest are stocks of companies that pay well-above-average dividends.

Otherwise, you are going to get hurt badly on Days One and Two. And that strategy, going into a world where central bankers have to be relied on to provide liquidity, is a suckers play that you must now be a part of.

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