At the moment, Wall Street is paying little attention to the fiscal cliff. However, that will change, I suspect, as investors start poring over anemic Q3 earnings and looking ahead to Q4. Panic could grip the financial markets if policymakers are unable to reach agreement and the government actually sends us over the cliff.
While it’s impossible to assign precise odds to the worst-case scenario, I suggest shading your investment strategy to the conservative side until the danger has passed.
Specifically, here’s what I recommend:
#1: Maintain an adequate weighting in bonds and cash to offset volatility in your stocks. Currently, 49% of our Profitable Investing model portfolio is earmarked for fixed income. If you’re particularly worried about the economic outlook, you could take the percentage even higher. You can earn a decent yield and avoid major risks to your principal if you mix up your own custom blend of bonds — different maturities and different sectors. The key is to do it gradually, accelerating your purchases on meaningful price pullbacks.
In the September issue of Profitable Investing, I advised readers to buy a slug of long-dated Treasuries if the price of the exchange-traded iShares Barclays 20+ Years Treasury Bond Fund (NYSE:TLT) dipped to its 200-day moving average. On September 13, the fund reached our target.
My rationale for buying Treasuries isn’t that they carry such a liberal interest coupon. TLT yields only 2.8% right now. However, a position in T-bonds could generate big capital gains if the economy and stock market run into rougher sailing in 2013. Think of TLT as a hedge both for your stocks and for any lower-credit-quality bonds you may be holding.
What to Do Now: At last glance, TLT’s 200-day average price stood right around $121. Accordingly, I’ll make that our official buy limit for now.
Another higher-quality bond fund to accumulate, particularly on a dip, would be Vanguard Intermediate-Term Investment Grade Fund (MUTF:VFICX). The minimum to invest is $3,000. VFICX, which emphasizes corporate bonds, yields a good deal more than TLT at 3.7%. Because of its shorter average maturity (6.4 years), though, VFICX won’t show as great a price gain if bond yields fall again in 2013. At the same time, the shorter maturity structure will insulate the Vanguard fund to some extent should rates unexpectedly bolt higher.
What to Do Now: Buy VFICX at $10.35 or less. Most discount brokers charge a transaction fee to handle Vanguard funds. If this expense irks you, deal directly with Vanguard by calling them toll-free at 800-662-2739 or by visiting their website.
Meanwhile, if your portfolio is too heavily freighted with zero-yielding cash, do yourself a favor by switching to a FDIC-insured money market account at CIT Bank. CIT is paying a league-leading 1.05% on deposits of $25,000 or more (0.9% for $100 to $24,999).
#2: Focus your new stock purchases on generous dividend payers. This advice may at first seem paradoxical, given the threat of higher dividend taxes. In a market squall, though, stocks with an above-average dividend yield nearly always hold their value better than low-dividend or no-dividend names. Jittery investors crave the security of immediate income. It was true 50 years ago — when the top income tax rate was much higher than even President Obama is proposing — and it’s still true today.
Among my top picks, utility PG&E Corp. (NYSE:PCG) looks appealing at a yield of 4.2% — more than double a 10-year T-note. PCG has settled most of the lawsuits arising from the 2010 San Bruno pipeline explosion. The company has also patched up ties with customers, regulators and the media. As a result, the dividend now appears safe — no increase likely this year or next.
What to Do Now: Buy PCG up to $44 for a projected total return of at least 12% in the year ahead.
Another longtime dividend favorite of mine is McDonald’s (NYSE:MCD). In recent months, the world’s largest hamburger chain has reported an abrupt slowdown in sales growth, leading some commentators to fear that Mickey D’s has lost its competitive edge. I understand the concern, but expect it to be short-lived. Repeatedly over the past decade, Mickey D’s has re-energized itself with new menu offerings and clever marketing — and it will happen again.
Don Thompson, Mickey D’s youngish (49) new CEO, was the mastermind behind the company’s smashingly successful line of McCafé drinks. You can be sure he’ll launch a raft of surprising innovations in the years ahead. MCD already plans, for example, to open its first vegetarian fast-food restaurants in India next year.
Meanwhile, you’re pulling down a generous 3.3% yield. What’s more, Ronald McDonald has sweetened his payout 35 years in a row — no clown act there!
What to Do Now: Buy MCD at $91 or less for an estimated total return of 15% or more in the next 12 months.
#3: Upgrade your holdings. The stock market is far from “efficient.” From time to time, the pricing of individual stocks, and even the whole market (remember the Internet bubble in 2000), can get thrown out of whack. Whenever Mr. Market gives you the chance, you should upgrade from lower-quality stocks to higher-quality names that offer the same — or greater — appreciation potential.
In early September, I alerted Profitable Investing subscribers to one such opportunity. We sold Pepsico (NYSE: PEP), a Growth & Income Play in our model portfolio, and replaced it with Coca-Cola (NYSE: KO).
Pepsi is a fine organization, but Coke enjoys even stronger brand recognition worldwide. Yet PEP shares have outperformed KO by a wide margin since mid-May, when activist investor Ralph Whitworth disclosed a $600 million stake in PEP. That doesn’t compute. Whitworth can nudge, but he lacks the voting power to elect even a single Pepsico director. At today’s levels, KO clearly offers the better value.
What to Do Now: Buy KO at $38 or less. Current yield: 2.7%. Coca-Cola has boosted its dividend every year since 1963, with the latest hike, announced in February, amounting to a hefty 8.5%. Stick with this outfit in retirement, and your income will almost certainly outpace inflation over the long run.