Your Magic Formula for Success In 2012

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We’re living in frightening — but also exciting — times. Signs of impending disaster abound, together with portents of great hopefulness. Small wonder so many financial gurus have been tossing off extreme forecasts, cheery or gloomy.

So who’s right? Nobody has 20/20 vision into the future, and pundits who shout louder than their peers don’t necessarily see the horizon any more clearly.

However, we can learn from both the doomers and the boomers. Chances are, at least some of the issues each side is highlighting will, in fact, move the markets significantly in the months and years ahead. The key is to figure out which issues, when and to what degree.

Persuasive Pessimists

Let’s take the doom case first. Here, in my judgment, are the most persuasive concerns the pessimists are voicing:

  • Europe isn’t dealing effectively with its problems.

Despite at least 15 summits over the past two years, European leaders still haven’t found a lasting solution to the continent’s sovereign-debt woes. Greece will almost certainly default within the next few months. Hungary and Portugal will probably follow soon after. While the latest European Central Bank liquidity injections have bought time for Italy, Rome still must raise about 90 billion euros between February and April alone to refinance its debt.

In today’s interconnected world, it’s a stretch to imagine that the U.S. won’t feel any impact from Europe’s oncoming recession. (America’s technology companies net 25% of their sales from Europe.) Greece by itself may not have been such a big deal, but Europe is.

  • The current economic expansion is uncommonly weak.

Whether you trace the cause to the housing bust, China’s predatory trade policies, bailout fatigue or something else, two facts stand out: Abnormally high unemployment rates and abnormally low interest rates.

Never since the Great Depression has unemployment remained stuck at 8.5% more than two years after a recession ended. A healthy economy would have created far more jobs by now. Furthermore, near-zero rates on short-term debt tell us that business chiefs continue to see a lot of risk out there and a lack of high-payoff investment opportunities — hardly a mantra for robust growth.

  • The U.S. government is frantically running up debt, while an entitlements crisis looms.

Total federal debt recently crossed $15 trillion, up 64% in just four years. But the monster’s appetite is just warming up. Already,  Medicare is paying out more than it collects in taxes, interest and other income (by $37 billion in 2010), and this deficit will explode in the years ahead as baby boomers crowd into the system. Social Security is in somewhat better shape, but here, too, benefits exceed current tax receipts. Yet the president and Congress keep putting off any meaningful reform.

Points of Light

I could lengthen the list of negatives to fill the Encyclopedia Britannica, but we need to let the other side have its say. Amid the disheartening news, a careful observer can spot occasional pinpricks of light glimmering through, particularly on the domestic front:

  • Households and businesses have chopped their debt burdens.

You’ve probably heard about the cash buildup on corporate balance sheets. But did you know that household debt-service payments (principal and interest), as a percentage of take-home income, have fallen to a 17-year low? Once job creation picks up in earnest, consumers will be in good shape to spend again.

  • Prodigious supplies of low-cost domestic energy are being discovered within our own borders.

New techniques such as horizontal drilling and hydraulic fracturing are unlocking huge reserves of natural gas deep within underground shale formations. In fact, it’s now estimated that the U.S. is sitting on 2,543 trillion cubic feet of gas, enough to power the nation’s needs (at the current rate of consumption) for more than a century. Low-cost gas is already stimulating our domestic steel and petrochemical industries, and others will follow.

  • The persistent drain of U.S. manufacturing jobs overseas may soon begin to reverse.

Leave it to the free market to cure a problem that baffles politicians. Surging costs for labor, transportation and real estate in China — together with issues related to inventory management and quality control — are tipping companies’ hands. According to a recent Accenture survey, 61% of North American manufacturers with overseas operations are considering bringing at least some of them back here.

Dealing With the Facts

With the evidence so mixed and contradictory, what’s an investor to do? First, recognize that it will take time — several years, most likely — before the positive factors I’ve listed begin to make themselves strongly felt. By the same token, we probably won’t see much progress toward resolving the one big long-term negative on my list (the government debt/entitlements crisis) until at least the 2012 election cycle has run its course.

In other words, the risks are mostly front-loaded into 2012, while the potential “blue sky” largely depends on events that will occur in later years. For the time being, therefore, it makes sense to adopt a more conservative investment posture than usual, with the intent of becoming more aggressive (buying more stocks) as the fundamental underpinnings of both the economy and the equity market improve.

Here, specifically, is what I advise:

  • Limit your stock exposure to about half your portfolio.

If share prices drop, the news background brightens or both, return to a safer allocation of about 60%, or a little higher, in stocks.

  • Focus any new stock purchases on companies with recession-resistant franchises and generous dividends.

At the moment, I’m keen on water utilities, which the crowd has left behind in the speculative fling of the past few weeks. Water utilities offer an excellent combination of safety and yield. Two in particular, American States Water (NYSE:AWR) and California Water Service (NYSE:CWT), have raised their dividends, year after year, for decades. What’s more, both of these pint-size outfits carry a significantly lower price tag, in terms of estimated 2012 earnings, than some of the industry’s larger players. That’s an invitation for a takeover bid, at perhaps a 15% to 25% premium over today’s share price.

The health care industry is also another recession-resistant stalwart. Among purveyors of medical devices and supplies, Baxter International (NYSE:BAX) has doubled its profits in the past five years and will likely notch a second consecutive year of record earnings in 2012. You might also pick up a few shares of Unilever (NYSE:UL), the Anglo-Dutch maker of foods (Hellmann’s, Lipton and Wish-Bone) and soaps (Dove and Lux).

  • Build a well-rounded stable of bonds.

Bonds can keep your money growing when the stock market is stuck in a rut. Last year, the Barclays Aggregate Bond Index, a broad measure of the U.S. bond market, gained 7.8%, including reinvested interest. The S&P returned only 2.1% (with dividends).

  • Hedge yourself with precious metals, managed commodity funds, short sales, options or other assets that don’t need a rising stock market to prosper.

Generally, I suggest limiting these “different drummer” investments to 10% of your portfolio — 15% if you’re exceptionally knowledgeable about alternative assets.

With these four steps, you can make money and avoid losing it — your magic formula for success in 2012.


Article printed from InvestorPlace Media, https://investorplace.com/2012/02/your-magic-formula-for-success-in-2012-awr-cwt-bax-ul/.

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