Be heartened by the resilience of the market

There is a glaring gap between investor expectations and the actual stock market price trend. Investors worry that the US and UK economies will slip back into recession. Double-dip fears escalated in August on the back of a slew of weak economic reports.

But the UK stock market hardly reacted. After rising 7 per cent in July – the fifth-best July gain in the last 100 years – shares gave back just 0.6 per cent in August. Given the flow of weak economic news throughout the month, the market’s resilience is worth thinking about.

Also recall that oil giant BP remains a heavily weighted member of the FTSE 100 in spite of a steep price decline since April’s oil leak. BP shares fell 6 per cent last month and accounted for one-quarter of the FTSE 100’s decline.

However, the stock market appears to be giving low odds to the double-dip recession story. Federal Reserve chairman Ben Bernanke supports this optimistic view, saying the Fed will strive to prevent a double-dip slowdown.

Unfortunately, though, there are no free lunches in the world of investing. Serious economic implications could be associated with additional Fed stimulation. For example, the odds of an inflation spurt in the future will increase. There is also a good chance that the economy will plod along for several years, if not a decade, before it finally returns to good health.

There are two important investment implications, as well. In the short run, the absence of another recession increases the odds that current stock market lethargy is temporary and a fresh bull market up-wave will soon kick in.

Looking further ahead, huge annual stock market gains of the kind we saw in the 1980s and 1990s are unlikely in the decade that lies ahead. A more realistic roadmap is a re-run of the 1960s when UK shares drifted sideways for most of the decade. Money was made in some years and lost in others. The only way to profit in the 1960s was by skilful stock-picking. Holding a balanced and diversified portfolio proved to be disappointing.

As for my own stock-picking, I have been active in recent days. I have just purchased shares in Avon Rubber, a member of the FTSE Fledgling index. Avon disappointed the City in the past and now appears to be deleted from many institutional “watch lists”. But I suspect this will change because the company has turned the corner. Double-digit profit increases are expected in each of the next few years.

Its largest division makes respirators, or gas masks, for the military. It has a major multi-year contract with the US military, with fine prospects for additional sales to other military organisations throughout the world. The division suffered some painful teething problems as it ramped up production to satisfy Defence Department needs. Now, those problems have been resolved and profits are starting to roll in.

Another US division manufactures breathing apparatus for fire-fighting services. It had been losing money but has just moved into the profit column.

The company also produces milk liners for the world’s dairy farmers. These are small rubber interfaces placed between a cow’s teat and a milking machine. Avon is the category leader with a world-wide market share in excess of 50 per cent.

As our graph shows, Avon’s shares have been steadily rising and I expect further gains to follow in the months ahead.

In addition to my Avon purchase, I have just closed two positions. One was in Brammer (BRAM), a long-time trading favourite. It distributes parts and repairs production machinery for commercial customers throughout Europe.

Brammer is a fine company with excellent prospects. Its shares enjoyed a healthy bounce after recent upbeat news. But they are trapped in a gently rising trading range. Prices recently reached the top of the range and ran out of steam. I fear there is further risk to the downside in the next few weeks and elected to bank my profits.

My other sell was in Vislink (VLK), a provider of secure communications in areas such as broadcasting and law enforcement. I hoped the company was on the verge of a turnaround when I purchased its shares a few months ago. But my investment turned into a disaster and I sold at a painful loss.

I was on holiday in July when the company released a depressing trading statement. Shares quickly dropped nearly 20 per cent. Upon returning to my desk, I elected to hold my position, hoping that all the bad news was now in the price. Sadly, I was wrong. Vislink’s recent first-half earnings report contained more bad news. Current losses did not worry me because I assumed they were already reflected in the price. My concern was the company’s admission that it hoped for (not expected) a gradual improvement in revenues. It went on to explain that even this modest goal was in doubt because of potential delays in public procurement processes.

Another worry is that Vislink is firmly entrenched in a lengthy cost-cutting and reorganisation programme. These are good steps to ensure long-term profitability but can be potentially poisonous for short-term stock market gains. I fear that Vislink shares have little up-side potential in the immediate future and have elected, belatedly, to cut my losses.

Stock market historian David Schwartz is an active short-term trader, writing about his own trades and strategies. Send any comments or suggestions to tradersdiary@ft.com