Chris Retzler, Portfolio Manager, Needham Small Cap Growth (NESGX)

Comments and Outlook

The stock market has recovered from their lows in June and a double-dip recession is less likely. The global economy hit a soft patch after the Japan earthquake, the European debt crisis and the ongoing debate in Washington over whether to raise the US government’s debt ceiling. The economy remains fragile. We expect markets to remain volatile throughout the summer but end the year in positive territory.

Recommended Strategies

Investors should maintain a strategic cash position during the second-quarter earnings season, with an eye toward buying names that report earnings that fall short of expectations. Investors should wait patiently for value opportunities. Growth stocks should perform well as the economy recovers and provide some protection against inflation. Companies in cyclical industries could make good investments.

What to Buy Now

Form Factor (NSDQ: FORM), which sells capital equipment to the semiconductor industry, is in recovery mode and has improved its product lines. Its second-quarter earnings call should reveal that the firm added new customers and provide clarity on its cash flow. The company already has a large cash position, which should provide a measure of downside protection.

Entropic Communications (NSDQ: ENTR) provides Multimedia over Coax Alliance (MoCA)-compliant semiconductors to cable and satellite television providers. The MoCA standard will ultimately act as the backbone for home-entertainment networking. The company’s stock suffered in the first half of 2011, as traders established short positions based on the belief that competition from Broadcom Corp (NSDQ: BRCM) would cripple Entropic’s business. But the firm’s strong position within the industry should allow it to prevail with a significant market share.

American Eagle Outfitters (NYSE: AEO) is a clothing retailer focused on the teen market. Apparel makers have struggled amid weak consumer spending and rising input costs. American Eagle has also lost market share to competitors with more attractive products. Margins will suffer in the near term, but the company has discounted its products to reduce inventory. The firm should have a stronger second half but will need a few more quarters to fully recover.

Stephen Jackson, Investment Adviser, Muilenburg & Griffin LLC

Comments & Outlook

Economic growth will slow appreciably as economies struggle with the fallout from the recent recession. EU authorities must take drastic action to right the ship in Greece and peripheral EU countries.

The US Congress is unlikely to take decisive action on the US debt burden. The Federal Reserve may resort to another round of quantitative easing, further compounding the US debt problems.

Recommended Strategies

We run a conservative investment strategy and normally recommend that our clients’ portfolios feature a heavy dose of bonds. But we’re worried that investors will soon demand higher yields in exchange for holding debt that’s far riskier than many believe. We’re also concerned that a sovereign default in Europe could spark another credit crisis. In this environment, we recommend investors focus on dividend-paying stocks that are backed by strong cash flows and clean balance sheets.

What to Buy Now

3M (NYSE: MMM) generates impressive free cash flow equal to about 15 percent of total revenue. The company usually boosts its free cash flow by about 5 percent each year.

3M carries very little debt and has an expanding international presence in rapidly growing markets. Although 3M is a mature company, there’s plenty of room for growth. The stock yields a little more than 2 percent, but with a payout ratio of only 37 percent, the dividend will almost certainly increase.

AT&T (NYSE: T) has a very stable business. Many investors have turned against AT&T now that Verizon communications (NYSE: VZ) has also released a version of the popular iPhone [Apple’s (NSDQ: AAPL) iPhone was previously exclusive to AT&T].

We believe competition will refocus AT&T’s plans to upgrade its networks for better data services. Data is now the real driver of growth and profits for wireless network operators.

Although AT&T isn’t debt-free, it generates the industry’s highest rate of free cash flow and has impressive operating margins. We believe the company’s $0.43 dividend is secure.