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Defense Wins Championships

Prepare for the worst with a stout portfolio


We’ll get through this tough period for the markets — don’t you worry! And we’ll do it with our wits (and our wallets) largely intact.

What makes me so sure?

I know because I’ve built a strong defense, which I continue to bolster month by month. I’ve beefed up my holdings of short-term bonds and other fixed-income instruments. In the stock segment of my portfolio, I’ve gradually weeded out my higher-risk names, replacing them with lower-volatility issues that pay generous dividends.

In other words, I’m ready. My preparations aren’t finished, of course — that’s an ongoing project. But I’m ready for any trouble that a reasonable person could foresee in the near term.

If the world’s policymakers pull a bunny out of the hat and conditions improve, we’ll rejoice. Meanwhile, I’ll rest easy with a stout defense.

Outlook and Strategy

Here, in a nutshell, is my outlook and strategy for my portfolio:

Stocks (56% of the total) have mustered an erratic, incomplete recovery from their summer swoon. While this lackluster showing doesn’t guarantee further weakness in the new year, it tips the scales in favor of caution. The S&P would need to drop to 1,000 or slightly below for stocks to generate an historically normal 10% yearly return over the long pull.

Strategy: As part of my plan to buy defensive stocks and peel off more vulnerable holdings, I’m looking for a good spot to exit my 5% stake in the SPDR S&P Midcap 400 ETF (NYSE:MDY). I penciled in a target of $173 in November, but that level was never reached. I’ll lower my sell target to $165. If necessary, I may take a somewhat lower price, but I want to be careful not to let my shares go too cheaply — below $155, the decline is likely more than halfway over (in percentage terms).

In November, for speculators, I recommended nine potential short sales. Three reached my sell prices: Clear Channel Outdoor (NYSE:CCO), Lennar (NYSE:LEN) and Pulte Group (NYSE:PHM). I’m going to hold these shorts with a stop-loss 15% above my entry point, taking profits at $8.50 for CCO, $14 for LEN and $4 for PHM.

I’ve raised my sights on LEN and PHM because it appears that the long bear market for home prices may finally reach its nadir around mid-year 2012. If so, homebuilder share prices will probably bottom sometime between February and May.

On the buy side, Waste Management (NYSE:WM), announced a 4% increase in its quarterly payout, effective with the March installment. While the boost won’t knock your socks off, it does keep your income stream rising faster than the cost of living — and it extends WM’s string of annual dividend hikes to eight.

At a plump 4.2%, WM yields more than about 9 out of 10 stocks in the S&P. What’s more, the new rate appears sustainable, since WM will be dishing out, as dividends, only about 60% of estimated 2012 profit.

Fixed income. Fear still dominates the bond market, driving investors into Treasuries despite ultra-low yields. (The government’s Dec. 14 auction of 30-year bonds drew the lowest yield ever for that maturity, 2.92%). This pattern can continue a while longer, until traders fully discern the scope of the global economic slowdown now under way. But the swing in the other direction, when it comes, will catch numerous investors painfully off guard.

Strategy: Avoid Treasuries. For new money, I recommend that you closely follow a mix of bonds and FDIC-insured CDs. You’ll net a yield of about 3.8%, with very modest fluctuations in your total principal. If you’ve got spare cash for just one purchase, make it Vanguard Intermediate-Term Investment Grade Fund (MUTF:VFICX). Yield spreads on medium-quality corporate bonds — the extra yield you earn from these bonds over Treasuries — have remained stuck near their highs for the past year, making this sector of the bond market particularly attractive on a risk/reward basis. Current yield: 4.2%. There’s no sales charge or redemption fee if you buy directly from Vanguard.

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