What to Do Now

• ByTim Melvin, RealMoney.com Contributor
• On 10:00 am EDT, Friday October 2, 2009

We are heading into what the weather forecast predicts to be a near-perfect weekend here in the mid-Atlantic region. While I am looking forward to a couple of tight pennant and wild-card races as well as the always-critical Navy Air Force football game, I will also be digging into the stocks of company reports accumulating on the desk. A good friend stopped by last night, saw the stack and asked an interesting question. Although he knew what I wanted to buy when prices collapsed, he wondered why I have not said much about what he and other investors should be doing now.

So here is my view of what investors should be doing now. Keep in mind that this applies to investors with a long-term time frame. I am not a short-term trader and would not even think of giving advice in that particular art. I will leave that to the very capable RealMoney contributors who specialize in it. I know that in the short and intermediate term, I have been wrong on market direction. I do not think I will be wrong over the longer time frame, and it is still a time to be cautious.

First, if you have been fortunate enough to speculate in financial stocks, I think it is time to sell them. There is no good news coming for the banks in the short run. Declining asset values, renewed regulatory pressure and a weak economy just do not bode well for the group. It is my belief that the regulatory bodies are going to be pressuring banks to clear out other real estate owned in the months ahead, and that is going to hurt balance sheets further. Many of these stocks have jumped nicely off the lows, but the risk of owning them right now is just off the charts, in my opinion.

I also would be trimming my holdings in any stock with exposure to the consumer. It is going to be a terrible holiday season. I know we saw an uptick in spending in August, but a lot of that came from Cash for Clunkers and other government stimulus programs. Unemployment continues to rise, and that is going to cap consumer spending for several quarters. I see no sign of job creation in the horizon either. In this country, 80% of the employment comes from small to medium-size businesses, and those folks are not expanding. The ones I talk to are worried about increased taxation, health care and energy costs in the future to aggressively expand. Larger public companies have been shedding jobs to prop up the bottom line, and I think this will continue. High-multiple stocks such as J.Crew and Urban Outfitters would be out of my portfolio right now.

This spills over to my favorite group to hate. I just see no valid reason to own casual dining stocks. I love when people tell me they were in this or that place last weekend and it looked full. Go back on Monday or Tuesday and see what you find. The bills are paid in the weekends in the restaurant business, and profits are made during the week. People are staying home more, and again, I expect this to continue. I am looking to re-establish shorts in companies such as Cracker Barrel, Darden and Brinker rally at all.

If I owned any of the market darlings, I would head for the doors as well. When the market turns, the high-multiple darlings of the Street are going to collapse much faster than the overall market. Companies such as Google and Intuitive Surgical may be great companies, but the multiples of sales and earnings are just too high to justify owning them for a long-term investor. They are great trading stocks here but not so great for owners. At a minimum, I would be hedging these types of stocks. This is especially true of those with huge consumer exposure, such as Amazon.

I would hold my too-cheap-not-to-owns. I addressed those in an article last week, and I have no intention if selling those stocks, with the possible exception only of Adaptec (ADPT). I am watching the proxy fight very closely, and if Steel Partners fails to prevail, I will re-evaluate my position. In general, 95% of what I own right now sells for less than net current asset value. If they fall in market decline, I will simply buy more.

I also suggested looking into the new Third Avenue credit fund, Third Avenue Focused Credit. The fund will be buying stressed corporate securities, and this is going to be a tremendous opportunity for at least the next five years. The high-yield and distressed markets have bounced this year, but this is a new fund that is basically all cash right now. The firm has been in the distressed market for almost 25 years, with great results. It buys still-performing loans that it thinks will be paid even if the credit defaults. I stole that philosophy form Mr. Whitman years ago, and it has worked very well.

It is a time to be rational. Business conditions are not pretty, and earnings are suspect, in my opinion. You cannot cut your way to prosperity. Credit is tight, and jobs are scarce. Even if I am wrong, I am not taking a lot of risk in my opinion. The last time we had a recession this deep, the market started rallying in 1982. I could have waited for two years and still enjoyed most of the bull market. I prefer to miss a little as opposed to losing a lot.

Enjoy the weekend.

Buzz up!