How rough was this summer for investors? The answer isn’t nearly as bad as the market mood, at least not for those who focus on quality companies that continue to post strong earnings.

Scanning the Utility Forecaster Portfolio, the only picks to suffer significant setbacks since the end of May were energy producers, which have sold off in the wake of sliding oil and natural gas prices. Importantly, these are still well up for the year, particularly Canadian trust ARC Energy Trust (TSX: AET-U, OTC: AETUF), which is up more than 50 percent.

To be sure, there were some major ups and downs. Unfounded rumors, for example, pounded shares of Atlantic Power Income Fund (TSX: ATP-U, OTC: ATPWF) until the company’s strong second quarter earnings numbers and share buyback sharply reversed the losses last month.

FairPoint Communications (NYSE: FRP) was another stock that did several flips and twists this summer. The shares actually fell briefly under $6 a share in early August prior to announcing second quarter earnings, as rumors of an impending disaster surfaced. As was the case with Atlantic, good numbers answered enough questions, and FairPoint shares are now actually trading above where they started June.

Like my other energy infrastructure limited partnerships, NuStar Energy LP (NYSE: NS) has been beaten up this year. Investors have taken a handful of well-publicized LP disasters as “evidence” that the whole concept is rotten and have dumped the good LPs along with the bad. NuStar units fell into the low 40s, before strong second quarter cash flows revealed a very solid business. They’ve also rebounded to pre-summer levels.

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To be sure, action in the major market averages and the economy has been disconcerting. The benchmark S&P 500 began June pushing 1400. That’s roughly 100 points above current levels, for a loss of around 7 percent. The Nasdaq 100—the best average of the largest technology stocks—fell from an early June high of around 2050 to a mid-July nadir of around 1800, before moving back to around 1900.

Most disturbing to many was the fact that even traditional safe havens didn’t seem to hold up well when the mercury rose. Big utility stock averages, for example, are down 7 to 8 percent since early June. So is the broad-based S&P Toronto Stock Exchange Income Trust composite.

The benchmark 10-year Treasury note did finish the summer in positive territory. But even this traditionally stable play has seen its share of volatility, with the yield rising as high as 4.3 percent earlier in the summer and fluctuating in a range of nearly 60 basis points. Bonds of less creditworthy entities were an even dicier proposition, as a weak US economy began to bite a growing number of companies.

The action in the commodity markets was even rockier. Raw materials and other vital resources largely went their own way (higher) from the market in the first half of 2008. Crude oil surged over $145 per barrel for the first time in history, despite growing evidence that the US economy was slowing. By early summer, natural gas had hit the low teens per million British thermal units (Btu), more than twice where it began 2008. Gold, meanwhile, cracked the previously unbroken $1,000-per-ounce ceiling earlier this year, as the US dollar continued to take a pounding against other currencies.

By July, however, intensified worries about the US financial system and economy finally caught up to even these markets. Oil is now back in the low $110s and natural gas is back to around $8 per million Btu, as even the ravages of Hurricane Gustav and other storms to come have been unable to ignite buying interest. Gold, meanwhile, is back to around $800 and could well be headed for $700 as the US dollar rallies.

The clear upshot is there have been no absolute safe havens this summer. Rather, as has been the case for every bear market in history, each sector in turn has been subject to selling. What’s done well for a period of a few months has typically performed poorly over the next several months.

Clearly, some sectors remain more vulnerable than others. The US financial system is still under threat, with mortgage giants Fannie Mae and Freddie Mac likely headed for a government bailout. That may also be the fate in store for several large industrial companies—such as auto giants Ford and General Motors—that have been battered by the slowing US economy, rising raw material costs and now the recent surge in the US dollar, which has made their exports less competitive.

But even companies that have been weathering these economic stress tests as businesses weren’t immune from selling this summer. And despite some positive market action in late August, they almost surely won’t be on bad days this fall, either.

What to Do

The bottom line is there are no places to put money now where you’ll have absolute assurance there will never be selling or that your position may be at a loss in the near term. The volatility in the 10-year Treasury note yield this summer shows even bonds are vulnerable to ups and downs. And the downside could get a lot more radical should the market start to become more concerned about inflation.

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The figures for July inflation announced last month were the highest in many years. The monthly gain of 1.2 percent in the overall Producer Price Index (PPI) was obviously skewed by surging food and energy prices, which did back off further in August. But the 0.7 percent gain in the “core” PPI—which excludes food and energy—can’t be explained away so easily.

The jump, which equates to an annual inflation rate of 8.4 percent, indicates that higher prices are starting to permeate the economy for the first time in decades. The fact that the number was more than three times what Wall Street economists expected is particularly disturbing.

The US T-bond market remains strong, largely because of concern that the contagion of a weak US economy and financial system is spreading to fast-growing Asia. In fact, there’s some evidence of this, notably India’s lower-than-expected growth rate announced last week. The US Federal Reserve has used this theory--or hope--to justify not tightening credit now to restrict inflation, a move that would likely be disastrous for the weakened US financial system.

But any evidence that the US economy (or global economy) is rebounding is certain to revive worries about inflation, pushing T-bond yields higher and prices lower. Continued evidence that inflation is still rising despite growing global economic weakness could yield even worse consequences, indicating the onslaught of dreaded “stagflation.” That would be the worst possible environment for bonds, as we saw during the 1970s.

My point, however, isn’t that we should sell all bonds now any more than it is that we should sell all stocks now. Rather, it’s that there are no absolutes.

Simply, the safest portfolio isn’t one that’s constantly seeking to concentrate on the safest individual investments. And it’s not one that’s hyper-focused on avoiding all downside. In fact, that’s more often than not a formula for disaster.

Rather, it’s one that’s focused on owning stocks, preferred shares and bonds backed by solid businesses from a wide range of sectors. Strong businesses are the best possible assurance dividends will be paid or increased and that stocks will ultimately regain a higher market valuation—i.e., a higher price. Meanwhile, diversification leavens out the ups and downs along the way for the overall portfolio, as today’s underperforming and outperforming sectors switch roles during the bear market.

Over and over again during the past year, I’ve seen skittish investors sell a group of stocks that’s come under selling pressure, taking huge and unnecessary losses. They’ve then put their funds into something perceived “safe,” largely because it’s been outperforming (or at least not going down). The new investment has sometimes risen for a while, largely due to the buying pressure created by their purchases. But then profit taking sets in and the group comes under selling pressure. The skittish then bail out again, suffering further and again unnecessary losses.

The only way to avoid this kind of portfolio nightmare is to resolve to hold stocks and bonds of companies no matter how hairy things get in the market, as long as their businesses are weathering the ongoing economic stress tests. No. 1 is rising raw material costs, a growing and intractable global trend as developing Asia inexorably builds its infrastructure.

No. 2 is the weak US economy, which has hurt consumer-oriented businesses most and is now having an impact on businesses overseas in the same boat. No. 3 is tight credit conditions, which remain a heavy burden particularly for the less creditworthy involved in consumer-oriented businesses.

We’ve just come through our fourth season of earnings reports since this bear market/economic slowdown began in mid-2007. Many companies have shown immense wear and tear. Others, however, are still going very strong, showing very little impact from any of the stress tests.

As I pointed out above, the aftermath of strong second earnings reports has given some lift to a handful of worthy companies. For the most part, however, we’ve yet to see companies that are weathering the stress tests well really get the credit they deserve in their share prices.

That’s understandably frustrated many investors, who wonder if their stocks will ever recover ground lost over the past year. Unfortunately, that’s the way of bear markets. Simply, with very rare exceptions, stock prices aren’t going to recover fully until this thing is over.

That may not be for some months. Certainly, the US economy isn’t out of the woods yet and, in fact, there’s some data that continue to worsen. We still haven’t seen one quarter of negative economic growth, let alone the official recession definition of two. But the government’s Index of Leading Indicators worsened to -0.7 percent for July, down from 0 percent in June and a prior forecast of -0.3 percent. Personal Income for July also fell 0.7 percent, versus a small gain in June and Personal Spending rose only 0.2 percent, a third the rate of last month.

History also shows that recoveries typically happen a lot faster than anyone expects and take shape long before the media publicizes them. After all, bad news sells a lot more effectively than good news. And with America about to elect a new president, fighting two wars, running up unprecedented federal budget deficits and slumping economically, there’s plenty to sell now.

The key for investors, however, is simply this: As long as a company’s business is posting healthy numbers, it’s going to weather this bear market. That’s true no matter how bad the headline economic numbers get, who winds up being elected president or how deeply our armed forces are mired in hostile Middle Eastern nations.  

When you’re talking about dividend-paying companies, the key is sustainability of the payout, which in turn also boils down to healthy earnings. As long as the numbers are solid, the dividend will be maintained or increased, and the stock will weather this bear market.

I certainly can’t rule out more intense selling on Wall Street. Again, there’s enough uncertainty out there for some really nasty action. But as long as underlying companies are healthy, they’ll only bend and never break. And they’ll recover with a vengeance when buyers do return to the market, as they always do.

The only way to realize that recovery and the dividends along the way is to absorb the gut check. If a company is blowing up, by all means sell. But if the business is healthy, hang in there. Better times are coming, and no matter how scary the action may get on any given day or even week, it will pass.

The only reliable way to keep your portfolio relatively stable in tough times is to own securities from a wide range of sectors, including those that have taken hits this summer. Many investors forget that it’s the entire portfolio that counts. Some of your holdings may take a bath at times. But if their underlying businesses are still solid, a rebound is certain.

In fact, they could well be your best performers going forward. You won’t realize that benefit if you reflexively sell just because their prices have fallen. And you’ll miss the income they provide as well.

No one likes to see their holdings in the red. But you’re likely to be surprised by how little actual damage is done to your overall portfolio by sticking with a balanced portfolio of high-quality stocks, even when they come under temporary selling pressure. The Utility Forecaster Income and Growth portfolios, for example, were roughly breakeven for the first 14 months of this bear market. And with 40-plus holdings, that includes a lot of ups and downs.

Again, the key to weathering this bear market is the same as it’s been the past 14 months. That’s to own stocks from a wide range of sectors with strong underlying businesses. As long as the numbers are healthy, you can patiently collect dividends and wait for an inevitable upside explosion.

That’s the lesson from this very tough summer in the investment markets. And it’s one that will serve us all well to follow in the coming autumn months and beyond.

Speaking Engagements

Fall is the perfect time to enjoy Washington, DC’s outdoor treasures and catch a glimpse of nature’s splendor. And this year you can enjoy the immediate aftermath of the Presidential election in the seat if the federal government.

Join me and my colleagues Neil George and Elliott Gue for the DC Money Show, Nov. 6-8, 2008, at The Wardman Park Marriott.

Go to http://www.moneyshow.com/ or call 800-970-4355 and refer to priority code 011362 to register as our guest.

We also have a special invitation for our readers. KCI Communications, Inc., is organizing an exciting 11-day investment cruise Dec. 1-12 through the Caribbean and Panama Canal. Participants will have the opportunity to meet and chat with my colleagues Gregg Early, Neil George and Elliott Gue.

This will be a unique opportunity to step away from your daily routines, relax in one of the most beautiful parts of the world and share analysts’ knowledge and passion for the markets. During the sail, you’ll not only explore the cerulean splendor of the Caribbean, but you’ll also delve deep into current markets in search of the most profitable opportunities for your portfolios. You’ll also have the rare chance to sail through one of the world’s engineering marvels, the Panama Canal.

It’s always a special treat to meet and talk with subscribers in person, and we couldn’t have picked a better setting than aboard the six-star Crystal Serenity. This is sure to be an especially memorable experience. We hope you’ll join us.

For more information, please click here or call 877-238-1270.