Shaping a portfolio for 2012 (VI): putting the pieces together

my equity strategy for 2012

two caveats:  

–I’m looking at equities as a US-oriented individual investor with a global outlook.  My portfolio will be keyed off the S&P 500.

–I think there’s a chance that the EU is the new Japan.

Two decades ago, faced with a choice of preserving a traditional way of life or beginning a painful reorienting of priorities that would stimulate economic growth, the forces of the status quo in Japan overwhelmed those of progress.  Japan’s economy has since stagnated.  Its stock market, once the largest in the world, is now a backwater.  Its leading companies, other than auto firms, have been surpassed by foreign rivals.  Global investors don’t bother with Tokyo stocks.

Something similar could easily happen with the EU.  Bad for people who live there; not such a big deal for everyone else.  For investors, the EU would become a special situations market.  Portfolio managers would be on the lookout for unique, counter-culture firms, or for international giants who would be European only by accident of listing.   There’d still be the possibility, however, that such stocks would be held back by the general economic malaise andnot perform as well as they would if listed elsewhere.

That’s a worry for the future. My main concern for the present is the transition from superstar securities market to irrelevance.

That process didn’t go smoothly inside Japan, but it had relatively few negative effects on the rest of the world.  Japan was a single country, relatively isolated, and whose banks and government were funded by Japanese citizens.

In contrast, there’s some possibility that if the EU–a bunch of different countries, all dependent on outsiders to keep their financial systems afloat– chooses the Japanese route, the bumps in the road will have considerable negative effects for the rest of us.

How to protect yourself against these possible bumps?

I think this is an asset allocation issue–you protect yourself by having a smaller allocation to equities and a larger one to other asset classes, especially cash.

My equity strategy doesn’t consider that European financial woes might send temporary shockwaves across the rest of the globe.

(Two other points on Europe:  although investors outside the US seem to me to continue to be especially fearful, securities markets have been discounting Eurozone problems for over a year, and increasingly so over the past six months.  Also, I think the worst nightmare of the markets–another “Lehman moment”–is an unlikely outcome.  Even if the failure of a key financial player in Europe were to happen, the world already has a blueprint for action to prevent global trade from grinding to a halt.)

up 10%?

I’d characterize good performance for 2012 as being up 10%.  In looking at an individual stock, my first question is how it will deliver at least that return.  For what it’s worth, I expect stock markets will be volatile throughout the year and that the bulk of the year’s return will come in the second half.

what I’m doing

1.  Three years ago, with the US as ground zero of the financial crisis, it was clear that the US would be growing more slowly than the rest of the world.  So the right thing to do was to avoid stocks that were focus on the domestic economy and heavily overweight those that, while US-based, have the bulk of their profits elsewhere.

That worked exceptionally well until several months ago.   But it’s no longer the right thing to do, in my opinion.  Why not?

–Nothing works forever.  Stocks get expensive, and relative growth rates in the world change.

–Today, economic recovery in the US is broadening and many Americans have gotten excessive debt under control.  The housing market appears to be bottoming after almost five years.  Yes, recovery is slow and unemployment is high.  But changes on the margin are positive and that’s what counts.

–In contrast, Europe is in the midst of a crisis where the outcome is certain only to be one of various shades of ugly.  Emerging markets, while still generally growing more quickly than the developed world, are struggling with overheating.

It seems to me that consumer businesses that address a broad base of American customers and industrial makers of durables and of manufacturing equipment are the place to be.

2.  Market attention is also shifting again–correctly, I think–to larger, more mature companies.

Part of this is that American income-oriented investors are continuing to buy dividend-paying stocks.  Yes, this process isn’t new.  It’s been going on for two years.   And, yes, it’s scary that the trend has hit the newspapers.  But these slow growers are also reasonable ways to play the gradual bounceback of the fortunes of the average American.  And the Fed is likely to keep interest rates artificially low on fixed income for at least the next year.

Not exciting stuff, but investing is about making money–not about glitz.

3.  Not every consumer stock will be a winner.  Over the past couple of years, the clear winners were the luxury retailers and the dollar stores–the consumer bookends of the very affluent and the very not-affluent.  We’re now in a period, I think, of average Americans beginning to spend more freely. So the bookends are not the place to be.  I find it hard to figure out the net result of trading up and having too much bricks-and-mortar retail capacity, however.

4.  I still find IT attractive–e-commerce, social networking, cloud computing, mobile…are all important growth areas in all economies.  A big issue with the sector has been that the index is heavily tilted toward very mature companies.  In the current environment that may be a good thing.  I own a bunch of smaller companies.  INTC is my largest position.

5.  Europe is a place to avoid for now.  Yes, you can pick and choose among European-listed companies that have large exposure to the US or to emerging markets (I’ll confess to owning IHG).  But risks of a particularly unattractive outcome to the Greece-Italy situation are still higher than zero.  So why expose yourself to that possible downside if you can find comparable stocks at reasonable prices in the US?  If you’re going to buy Europe anyway, find something listed in the UK, Sweden or Switzerland rather than in the Eurozone.

6.  I think direct emerging market exposure of some type should be a continuing part of any equity portfolio.  Nevertheless, actively buying individual stocks in any of these countries (with the possible exception of Hong Kong) is financial suicide for just about everyone.  You might just as well burn the money in the street–at least you might get some entertainment value while your money goes up in smoke.

For what it’s worth, I own the Vanguard emerging markets index fund and a couple of the Matthews China-related mutual funds.

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