The stock market looks shaky. Buy these stocks now.

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Positive factors for stocks, such as rising corporate profits, offset concerns about inflation.

Lorenzo Pegoraro / Dreamstime.com

An unusual pattern emerges in

actions,

and that is not encouraging. While

the market

rose, growth stocks fell or did not follow.

This doesn’t happen in the early stages of a bull market, when high growth stocks lead the way. This is more characteristic of the fading phase as leadership shifts from speculative growth to value stocks and safer blue chips. Indeed, the spinning out of growth in recent times has uncomfortable parallels to market peaks in 1929, 1972 and 2000, all of which preceded brutal bear markets.

“This could be a sign that the market is going to generally go down,” said Ben Inker, head of asset allocation at GMO, a value manager with more than $ 60 billion under management.

Certainly, for all the negatives that plague stocks, including fear of inflation and tightening monetary policy, there are positives. Corporate profits are beating Wall Street forecasts as the economy grows, growing at its fastest pace in decades. As the pandemic ends and hiring picks up, earnings estimates could even rise.

But many market signals are flashing red. Cryptocurrencies, specialist acquisition companies and tech stocks are struggling. Share issues hit their highest levels since the dot-com bubble. Investors have flocked to option bets on individual stocks. And the meme stock frenzy earlier this spring was a warning that excess liquidity was spilling out. This money may be starting to flow faster than it rushed.

With valuations looking high, investors may need to moderate their expectations for stock returns. Inker, for his part, expects returns of 3%, adjusted for inflation, in blue chips like

Microsoft

(symbol: MSFT),

Johnson & johnson

(JNJ), and

Apple

(AAPL). This would be lower than the historic 6% real return on stocks. But it beats the yields of higher quality bonds, and that may be all investors can reasonably expect at this point.

Another place to look is the universe of value. While nothing is cheap in absolute terms, Inker says value always looks more compelling than growth. The value normally trades at 50% of the growth estimate, but it now sits at 33%, down from 28% last fall. To return from the current valuation to normal, according to Inker, this would involve “gaining” the value of 64% over growth.

“We think value stocks have a lot of wiggle room over the market,” he says.

Within the value universe, he recommends better quality stocks, while avoiding the most indebted and lower quality companies. The mid-cap small-cap stock now has debt that’s six times its earnings before interest, taxes, depreciation, and amortization. “It’s a little scary,” he says. “Some of these companies have a lot of debt. It’s cheap now, but it doesn’t give them much leeway if the economy doesn’t turn out to be strong.

Investors can gain exposure to these themes with exchange traded funds. Names to consider include the

IShares Russell 1000 Value ETF

(IWD),

Vanguard Small Cap Value

(VBR), and

iShares S&P Small-Cap 600 Value

(IJS).

These ETFs won’t provide shelter in a torrential downpour, but they could leave investors dry powder for another day.

Write to Daren Fonda at [email protected]


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