Investment Themes for Today’s Market

Dave Rosenberg has been recommending a cyclical-defensive barbell strategy focusing on US bonds, consumer staples, health care, and defensive stocks on one side, gold and energy on the other – both with an income-oriented focus (interest and dividend yield).  This is not a bad bet.  Here is my take on some of the market sectors:

Health care – be careful in this sector, because most health care revenue comes from the US and Europe, and most costs are paid for by government.  In the US, Obamacare reduces the Medicare payments for many drugs and treatments.  In Europe, there was a great article in the WSJ yesterday telling about cost cuts for prescription drugs in a number of countries, including France and Germany as well as Spain and Greece.  Some drugs will no longer be offered in Greece due to the price changes.  In many ways we must remember that the health care sector is a part of government and, while classically considered defensive, is different when government budgets are so bloated while tax revenues show no signs of picking up.  

Utilities – while these are never considered classic outperformers, I like adding them to the income theme because they are liquid, they have solid, stable dividends, and they typically incorporate low cost, low margin units they can shut off when power demands slacken.  I believe near-term tightening in bond yields can also make the dividend yields more attractive. 

US Treasuries and inflation –  US treasuries aren’t a bad idea, but I wouldn’t go beyond the 10-year note.  I’m not worried about heavy inflation in the short and perhaps medium term, but when it comes it will come fast.  Right now the money supply has been nearly doubled by the fed, but the money multiplier has contracted substantially due to the heavy recession.  When the economy picks up, this multiplier will have a bigger base to change and the CPI will increase rather rapidly.  After the great depression and WW2 we didn’t see much inflation – until the late 40’s & early 50’s.  After the Vietnam war spending we didn’t see much inflation until the 70’s – particularly the late 70’s.  Government intervention in markets such as price controls delayed this both times, but at a crippling cost to the economy and unemployment.  Regardless, we would be relatively safe holding treasuries 10-years out, but not necessarily further – and in markets like we have now its not worth trading anything that you wouldn’t feel comfortable holding for the long term. 

Defense sector – It might be worth looking into some well positioned companies in the defense industry because economic instability can often lead to political instabilities and demand for military goods. 

Energy – I have never been a fan of alt-energy companies because they are highly speculative.  They often lose money, and they are very much at the whims of government policy as well as energy prices.  Oil and Natural gas plays might be worthwhile – provided they have solid dividends – but I don’t expect much price appreciation in this sector as supply remains well ahead of demand.  However, the need for these products will not drop off, so as long as the yields are good they are a good addittion if you’re looking for some positive exposure to a market recovery. 

Real Estate – This sector was in an enormous bubble and will have many years of contraction.  Consider that those foreclosed on cannot typically purchase for another 7 years, unemployment is high for the age groups that typically purchase, shadow inventory is still incredibly high.  Despite record-low interest rates, consider that the principal cost of a home is still very high compared to the pre-bubble years before the increases in crazy loans and speculation shot the market up in 2002.  However, if you do own a home, you are in a great position to take advantage of the current interest rates.  My recommendation, would be to take advantage of the flaws in the system by maximizing your primary mortgage with a 30-year fixed (keeping rates below 5%) and investing the proceeds into 10-year US treasuries.  The interest is tax-deductable, so earning 4% on a US treasury would pay for a 5% mortgage in a tax bracket as low as 20% (5*(1-20) = 4).  This will not only allow you to take advantage of the inflationary affects when they do hit, but it is also a free type of insurance because you can always foreclose out the house and keep the amount of your built-up equity which is stored in the US treasuries.  It is a crazy market and I think fixes should, but won’t be made. 

Overall, I still see the best play as gold because it tends to do well in times of financial instability, low interest rates, and quantitative easing.  I expect the stock market 10 years out to look as flat and volatile as the market from the 1970’s, where you can’t expect to lock in long-term capital appreciation, but you can get trading profits (tough and not recommended), and you can get gains from bond and dividend yields.


About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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