Tuesday, September 21, 2010

Why Stocks Make Sense Now

Investing in the under-the-radar recovery

By John F. Wasik (Reuters)

Two main theories about the global economy dominate these days: 1) We’re headed for a double-dip recession, and 2) things are getting better at a thick, syrupy pace.

I subscribe to the slow-as-molasses rebound view. While I don’t rule out another European debt crisis, the worsening of the U.S. home market and unemployment or any other calamity, things are slowly getting better. It’s time to start investing in stocks again.

When there’s so much conflicting news in the business headlines, I tend to listen to influential institutional investors like Dan Farley, who manages more than $190 billion for Boston-based State Street Global Investors.

I heard Farley run through some relatively optimistic numbers last week at the Morningstar ETF conference in Chicago. Although Farley admits there are still a bunch of wild cards in the economy, he’s somewhat upbeat.

“Right now, we’re in a stable but shallow recovery mode,” Farley said. “Corporate cash is at a record high of 50 years, and equities have room to grow.”

“Banks are no longer tightening loan requirements and starting to lend; companies are starting to borrow. Hiring plans, inflation and durable goods orders are likely to pick up until (factory) capacity utilization picks up.”

Why look for a silver lining when the U.S. is staring at a $13 trillion national debt, some European countries are still in trouble and the jobs picture remains dark? Farley uses words like “anemic” to describe the nascent recovery and he’s certainly not sanguine about employment, which he doesn’t think will fully rebound until 2015.

Corporations now have a “cash horde” that they can spend on hiring, dividends, stock buybacks or acquisitions, Farley notes.

Naturally, with billions flowing into bonds and gold, this hardly seems like the time to be talking about investing in stocks. For millions, the market psychology is still a “blood in the streets” mentality. But if Farley is right, it’s a good time to position your portfolio for future gains.

Patience is critical now. We’ll eventually exit this trough of the business cycle; companies will have the money to rebuild.

All of this prognostication is for naught if you take a narrow-minded approach to recovery investing. The U.S. may take a long time to fully bounce back, but that shouldn’t stop you from looking at a number of sectors, countries and opportunities. Here are some mistakes to avoid:

Don’t Make Concentrated Bets: That means avoiding trying to pick winners in individual stocks. Your risk is much higher that way. It’s better to pick a basket of stocks like an index fund.

Only focusing on the U.S: Most of the valuation of the world’s stocks is outside America. A better approach is a broadly-diversified world stock fund like the Vanguard Total World Stock Index exchange-traded fund (VT). You get 2,900 holdings in 47 countries in this index fund for a management fee of 0.30% per year (compared to about 1.4% for the average global fund).

Ignoring Dividends: As noted above, big, established corporations have lots of cash for dividends. The SPDR Dividend ETF (SDY) is a good vehicle for capturing these payments.

Ignoring the Little Guys: Not all of the growth will come from the blue chips. The little guys — small and medium-sized companies — tend to bounce back faster during a recovery. The iShares Russell 2000 Index ETF (IWM) owns a broad basket of these stocks.

Ignoring the Developing Countries: You never know where the more robust growth will occur. Will it be China, Indonesia, Brazil, Chile or India? Why even make a bet on a single country? The iShares MSCI Emerging Markets ETF (EEM) does the picking for you.

Another temptation that overly confident investors try to make is to guess exactly when the market is going to turn around. Nobody knows that date and few bet correctly.

You can ease back into the market gradually. If your investment reflexes are like molasses (mine sure are), this is a low-risk approach of getting a piece of the recovery.

John F. Wasik is the author of The Audacity of Help: Obama's Economic Plan and the Remaking of America (www.audacityofhelp.net)

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