The majority of analysts are proclaiming that all is well in the financial markets, and that investors should expect outstanding returns in 2011. All I would say is be careful. Not that I am a pessimist, but more of a realist. Serious questions remain about both the existence and depth of the economic recovery. I am also concerned about the extent to which the economy and the markets have been propped up via government action, inaction and intervention.
With the overwhelming supply in residential and commercial real estate, private equity deals still on investment banks balance sheets and money market funds yielding essentially nothing, we have to be careful of a “double-dip”. However, the U.S. looks relatively good compared to the rest of the world. Europe struggles with sovereign debt issues which have resulted in major refinancing in Greece and Ireland and debt downgrades in Portugal, with others on the way. We are also entering the third year of President Obama’s term, a year in which markets generally outperform. To stay in power, the president typically uses policies designed to stimulate the economy before voters go back to the polls in November of the next year. If the trend holds, the stock market will be entering the third year of a bull market in March.
When the markets rise to all-time highs, we tend to want to buy and we rush to sell when markets hit a new low. History suggests that the public tends to be the last in to a hot market. We have seen a very nice two-year run in stocks and a decade-long rally in bonds; I look for a reversion to the mean and perhaps much worse. Remember, slow and steady wins the race.
We need changed behavior at the governmental level and we can use it at the individual level too. We are not saving enough. We are not planning enough. We are not careful enough. Without serious and significant change, something has got to give. But that doesn’t mean we have to run and hide from the markets. Opportunities exist even in bad times. Sometimes, the best opportunities come up during the worst times.
Here are my top investment ideas for 2011.
1. Diversify. In the past it might have been possible to rely upon only one or two investment ideas to achieve success. But investors must cast their nets wider today.
2. Use alternative investments to obtain wider diversification. An investment that is not one of the three traditional asset types (stocks, bonds and cash). Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts.
3. Explore managed futures. Investments involve going long or short in futures contracts in areas such as metals, grains, equity indexes, soft commodities as well as foreign currency and U.S government bond futures.
4. Focus on dividend producing stocks. Dividend yield can mitigate the impact of a less- than-great stock market. Moreover, increasing exposure to high-dividend securities can provide a valuable diversification benefit.
5. Consider multi-strategy absolute return funds. An absolute return fund seeks to make positive returns every year, irrespective of market performance, by employing different investment management techniques.
6. Beware of bonds generally. Is a bond bubble on the horizon? No one can say for sure, but I can say with certainty that the recent high bond market returns are over. If rates go up quickly, the decline in value will be even sharper. I am very leery of bonds generally.
7. Use TIPS for additional inflation protection. TIPS – Treasury Inflation-Protected Securities – offer investors the closest thing to a sure bet today. These bonds have the full backing of the U.S. government and provide investors with returns that are guaranteed to keep pace with future rates of inflation, as measured by the Consumer Price Index.
8. Consider municipal bonds. But be careful. Buy revenue bonds backed by reliable income streams, which can hold their value even if there is a budget scare; sewer and water bonds that support needed services in well-established communities. Go for quality. Tax-free bonds issued by counties, cities, and towns can all go bankrupt. That’s where most defaults in this market will likely arise.
9. Focus on Guaranty Products. Income guarantees can be accomplished via an income annuity through the use of a SPIA. Principal-protection options include traditional and indexed annuities, indexed CDs, and permanent life insurance.
10. Rebalance Portfolios Systematically. The Wall Street Journal called it, “The Lost Decade”. Business Week called it, “A Decade of Decay”. But investors who diversified, kept costs low, rebalanced their portfolios and avoided the worst of the carnage.
The issue of whether the past decade represented a paradigm shift to this new investment world is a major concern for those considering how to investment going forward. The U.S. faces huge challenges. I therefore encourage investors to remain skeptical, cautious, defensive and opportunistic. In 2011, investors should look to take advantage of the opportunities that present themselves while carefully managing and mitigating risk.
The opinions expressed are those of Eric J. Viavattene and Eric James Financial Advisory, PLLC. Securities and advisory services offered through Madison Avenue Securities, Inc. Member FINRA/SIPC and a Registered Investment Advisor. For further information please contact Eric at (602) 279-9679 or email at [email protected]