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Jubak's Journal
Recent articles:
• 5 big trends investors must watch, 8/5/2003
• Our first 'Clean Stocks:' Apache and Paychex, 8/1/2003
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| | Jubak's Journal
5 ways to make the big trends work for you
The portfolio for the next decade needs to be more hedged, more outward-looking and more flexible. Here are the companies and strategies to do it.
By Jim Jubak
In the decade of the 1980s, an investor wanted to be in retail. It was the great era of consumer stocks. During the decade, Wal-Mart Stores (WMT, news, msgs) shares gained 4,341%. Home Depot (HD, news, msgs), a latecomer that didnt go public until 1984, still managed to gain 452% by 1989.
In the 10 years from Jan. 1, 1987, through Dec. 31, 1996, the place to make money was in computer stocks, as long as they were the shares of companies making hardware and software for personal computers and not for mainframes or minis. In that period, Microsoft (MSFT, news, msgs) shares climbed 6,252% and Dell Computer (DELL, news, msgs) shares 3,849%. IBM (IBM, news, msgs), in contrast, gained a comparatively paltry 82% over the same period.
Looking back, could an investor have predicted the trends that drove those stocks and sectors higher? Id argue that the rise of the PC and of Microsoft and Dell was foreseeable, as was the decline of IBM once it served notice that it would only dabble in the PC technology. Predicting Wal-Mart and Home Depot would have been tougher, although anyone focused on the continued suburban migration and the explosion of new forms of consumer credit would probably have decided to overweight a portfolio toward the sector.
The possibility of nailing long-term trends correctly is so tantalizingly juicy that I believe it constitutes portfolio abuse not to at least try to link the construction of your portfolio to macro trends.
In my last column, "5 big trends investors must watch," I laid out five macro trends that I think will shape the next 10 years.
In this column, Im going to suggest five ways to profit from those trends -- or to limit the damage that these trends might inflict on your portfolio.
Plan for volatility from debt
As I pointed out last week, were living in a very leveraged world -- especially in the United States, where personal, corporate and government debt have all grown dramatically in the past few years. Why does this matter? Because leveraged assets tend to be more volatile. For most investors, the major goal should be to limit the damage inflicted by this volatility. One way to do that is to have enough cash on hand (enough to cover six to 18 months of expenses) to avoid selling long-term investments at panic prices.
It also means analyzing individual investments for their own use of leverage. In 2004-05, large amounts of debt will come due at companies that have weak cash flows and anemic credit ratings. This will restrict their ability to find new debt financing. For example, investors can ask for cash and stock in exchange for their Lucent Technologies (LU, news, msgs) 8% redeemable convertible preferred as early as Aug. 2, 2004. The liquidation value of that preferred was about $1 billion recently. If the economy doesnt recover as strongly as is now hoped or stalls, then these leveraged companies could again see their stock prices plunge.
Invest in aging and beyond the developed world
This volatility is going to be mixed, conversely, with an aging, slow-growth industrialized world. The developed countries of the world arent getting any younger, and their output is projected to constrict. Here are two ways to attack that problem: - Add positions in big drug companies that invest in products for the aging. Consider Pfizer (PFE, news, msgs), Merck (MRK, news, msgs) and Genentech (DNA, news, msgs), big-cap medical-device companies such as orthopedic-device leader Stryker (SYK, news, msgs) and Johnson & Johnson (JNJ, news, msgs), and big-cap testing and health-care companies such as Quest Diagnostics (DGX, news, msgs) and HCA (HCA, news, msgs). Investors could also create an anti-aging core by buying shares in mutual fund Vanguard Health Care (VGHCX). (The fund currently carries a $25,000 minimum initial investment. Funds with almost equal performance, such as Fidelity Select Healthcare (FSPHX), come with smaller initial investments, but watch for the front-end sales charge.) To this core, an investor could add more aggressive demographic plays such as NPS Pharmaceuticals (NPSP, news, msgs), which is developing drugs to treat osteoporosis.
- Look at China and Asia, but with care. China, with a projected annual growth rate above 7%, is certainly intriguing, but its also dicey because the country doesnt have the built-in safeguards most U.S. investors take for granted. One company worth considering, however, is electrical component maker Jinpan International (JST, news, msgs). The company is well-positioned as China builds out its electrical power system. Plus, because the company is listed on the American Stock Exchange and has to meet Amex's financial reporting standards, the stock carries less risk than most Chinese stocks. But still the company is 92% controlled by just five Chinese investors and is structured as a complicated combination of joint ventures and subsidiaries.
A good alternative for most investors might be an Asia-except-Japan mutual fund. Matthews Asia Growth and Income (MACSX) is one good choice. Another possibility is to find a U.S. company positioned to attack successfully the Chinese or Indian market. An example is Alameda, Calif.-based UTStarcom (UTSI, news, msgs), which specializes in a mobile phone technology called PAS (for personal access system). PAS is about 80% cheaper to build out than conventional cellular technologies. That seems to be enough of a price differential to make up for the limitations of PAS technology: Callers can make and receive calls in only a limited area, and theres no roaming. The company is expanding from China into India and Vietnam.
Build inflation protection into your investments
Inflation-indexed bonds and hard-asset stocks belong in portfolios. For U.S. investors, inflation-indexed stocks come in two varieties, TIPS and I Bonds.
TIPS, or Treasury Inflation-Protected Securities, are probably the more familiar of the two. These 10-year notes carry an interest rate that adjusts with the Consumer Price Index measure of inflation. The principal value of the bond also increases with inflation. The guarantee is that youll receive a real rate of return on the bond equal to the coupon when you bought the bond, no matter what inflation does. The value of your principal is similarly guaranteed. TIPS are good bets whenever the coupon on the new offering is near 3%. Thats the historical real rate (above inflation) of return on Treasurys. (Watch out for phantom taxes on TIPS. You have to pay tax on any upward adjustment in the value of the bond at the time of the adjustment, even though you dont receive that adjustment in cash until you sell the bond.)
I Bonds are technically Series I savings bonds, the inflation-protected version of good old U.S. savings bonds. They dont get as much play in the financial press as TIPS do for a couple of reasons. One, theyre sold directly by the Treasury, so nobody makes a commission, and two, theyre designed for small investors, with annual purchases limited to $30,000 or less. Like TIPS, the interest rate and principal are adjusted upward for inflation, so an investor is guaranteed a real rate of return equal to the initial coupon. Like all savings bonds, these are accrual bonds: Investors dont get any interest or principal payments until the bonds are redeemed. That accrual feature also enables an investor to defer taxes on interest until the bond is redeemed or matures.
And if inflation kicks up more strongly than 3%, then stocks of hard-asset companies are likely to do even better than TIPS and I Bonds. The price of these stocks is linked to increases in the prices of the real commodities they produce, plus some premium thats based on the fear among investors that inflation will spike higher. Big-cap metals producers to consider for inflation-hedging include Rio Tinto (RTP, news, msgs), Freeport-McMoRan Copper and Gold (FCX, news, msgs) and Newmont Mining (NEM, news, msgs).
Look for companies that profit from a falling dollar
A modest fall in the price of the dollar would be a boon to U.S. companies that sell overseas and would see the price of their products fall in local currencies (and see those currencies translate into higher revenue in dollars on their books back home.) So one way to profit from a moderate decline in the dollar is to own shares of companies such as Caterpillar (CAT, news, msgs), Procter & Gamble (PG, news, msgs), IBM and Intel (INTC, news, msgs) that generate a lot of their sales overseas. But if the modest decline in the dollar (especially against the euro) should turn into a rout, then investors need to make sure that theyve contained their exposure to the rising interest rates that are likely to result. That means:- Watching out for leverage (see item one)
- Building bond portfolios around ladders of graduated maturities and holding bonds to maturity
- Making sure that you avoid interest-rate-sensitive sectors in the stock market such as home builders.
Dont lock your retirement funds in company stock
Lastly, governments and companies, both here at home and abroad, will have a difficult time keeping pledges to provide health care and pensions to retirees. I have called this a world of broken promises. To avoid being whipsawed by both government and company cutbacks, make sure you dont have the bulk of your retirement funds locked up in the stock of your employer. Start exploring -- now -- the options open to you if your ex-employer suddenly decides it wont pay retiree health-care benefits anymore or if the federal government decides that everybody should pay $2,000 a year for government health insurance. Theres no way to take the pain out of broken promises like these. Thinking about them in advance, however, is likely to give you a better shot at seeing them as challenges that can be met.
The portfolio for the next decade needs to be more buffered from volatility, more insured against inflation, more outward-looking from the United States to the developing industrial economies, more carefully constructed to contain the risks of rising interest rates and more flexible in its planning to take account of the likelihood of broken promises.
Stock selection, if you follow that logic, is likely to put more emphasis on inflation-hedging assets such as inflation-adjusted bonds and hard-asset stocks. It will also include more international stocks, not as part of reducing risk by further diversifying a portfolio but as essential to finding growth in a slow-growth world economy.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Microsoft and Pfizer. He does not own short positions in any stock mentioned in this column.
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