Investors should adopt a defensive strategy in September, normally the worst-performing month for stocks, analysts say.
"I think that the thing to do is avoid industries that are significantly impacted by credit woes and stick with those companies that won't be affected," Steve Massocca, co-CEO of Pacific Growth Equities, told CNBC.com. "I think a lot of the subprime woes have been discounted into the market already, but we are not going to rally back to the record highs."
This September could be more troublesome than usual because of the uncertainty surrounding the credit markets and speculation about a Fed rate cut.
"I think the risk is high that this September or October, we could see very substantial declines that could be very unusual," said Martin Weiss, editor of Money and Markets. "Right now the markets are hanging by a thread. As soon as they get a clear answer one way or another from the Fed, I think the markets will suffer a severe decline."
On Friday, Fed Chairman Ben Bernanke said the central bank will act as needed to address problems in the credit markets, but he stopped short of committing to an interest-rate cut.
Keep Credit Impact in Mind
Massocca says investors should avoid the financials and homebuilders in favor of technology and healthcare stocks. He likes Lighting Science Group , which designs and sells energy efficient and environmentally-friendly lighting solutions. "They have a product that takes LED lights, which have intensive energy, that fit into a normal light socket," said Massocca.
He also likes ParkerVision , which he says has a unique power-saving technology for cellphones, and Adolor in the healthcare sector. Shares of Adolor are down dramatically from earlier this year after the drugmaker halted new trials of its lead drug, Entereg, on safety concerns. "The stock went from $15 to $3," said Massocca. "Recent analysis has shown that there are no problems, yet the stock hasn't moved."
Pacific Growth Equities owns Lighting Science Group, ParkerVision and Adolor in its funds.
Weiss is advising investors to sell stocks in their portfolios that are most affected by the credit crunch. "I'd start with the mortgage lenders, who are at ground zero," said Weiss. "Then the banking and financial stocks would be next on my hit list."
He says investors would also be wise to buy some hedges against the stocks that remain in their portfolios. He recommends a variety of exchange-traded funds designed to protect investors against stock market declines.
Weiss likes the UltraShort Real Estate ProShares ETF for investors with a lot of real estate-related assets. "This ETF is designed to go up 20% for every 10% decline in the Dow Jones U.S. Real Estate Index," said Weiss. "If you have investment real estate or real estate stocks in your portfolio, this will help you offset any losses that you might be suffering from that."
Weiss recommends the Short S&P 500 ProShares and the UltraShort Financials ProShares exchange-traded funds as well.
Look for Smart Bargains
Eric Thorne, portfolio manager with Bryn Mawr Trust Wealth Management, believes investors can use any September selloff to add to positions at cheaper prices.
"We like the idea of buying into markets where there is some short-term uncertainty such as this credit crunch situation," Thorne told CNBC.com. "Generally, investors who buy in these times of uncertainty are well rewarded."
Despite a slump in the housing market, Thorne likes Black & Decker , which manufactures power tools and home appliances. "Consumers may not move from one house to another because of the tough housing market, but they may make improvements to their existing home instead," he said.
Thorne also likes agricultural equipment manufacturer Deere & Company as a harvesting/ethanol play. "The need for alternative fuels and the need to harvest crops to produce this fuel is very intense," he said.
And, in the tech sector, Thorne likes Texas Instruments. "They are largely involved in manufacturing chips for cellphones which we think is still a growth market internationally," said Thorne. "We feel the electronics markets are still an area where consumers will want to go out and spend money."
Bryn Mawr Trust Wealth Management owns Black & Decker, Deere and Texas Instruments and buys these stocks for clients.
Phyllis Burke Goffney is a news editor for CNBC.com. She can be reached at firstname.lastname@example.org.