Diversification, Perma-Bulls And Bears, And Market Reality

Includes: AWP, HZNP, MS, MT, PBI
by: Adam Aloisi

While I've always thought it was good investment sense, I'm becoming a bigger proponent of diversification. Despite the fact we are developing a global, intertwined economy where asset classes tend to move more in synch than ever, both here and abroad, the complexity of our markets has led to severe lack of predictability in broad asset behavior. While sound, fundamental financial analysis can seemingly spot value and opportunity on a micro level, trying to predict broad asset class or sector movement has become a much more difficult endeavor, in my view. In the absence of a crystal ball, spreading risk thoughtfully through multiple channels would seem a prudent choice in an increasingly unstable, global asset market.

Further, we have entered uncharted economic waters both domestically and internationally. Forced Fed stimulative policy, continued wind-down of a nearly catastrophic domestic mortgage/banking episode, and most recently, instability in Europe, all are contributing to an even more volatile stage for retail investors' monies.

Yet through all this complexity and uncertainty we face, voices of conviction echo in the distance. Optimistic calls for an impending economic Renaissance that lifts most boats conflict with doomsayer cries for a near-term massive depression. While diversity of opinion is a given in all markets with permabulls and permabears always promoting their opinions and predictive wares, the backdrop to our future seems much cloudier than I've seen in my nearly twenty years of market experience. Be trusting of either camp at your own risk.

This combination of financial market complexity and the cloudy economic times we face calls for a cautious approach to the market. While I don't consider myself a doomsayer, I'm equally not inclined to coddle you with unfounded, optimistic thoughts. To me, reality is somewhere between the far-flung camps, and unfortunately, that points to a repeat of the past ten years, another lost decade, if you will. In a recent article, I argued that the last decade would become the next decade. Investors will continue to be exposed to a multitude of conflicting economic data, deceptive corporate earnings, but will continue to be able to mine gems from the mud.

Investment Strategy

While I agree that diversification for diversification's sake is a bad philosophy, I'm of the thought that investors can find value in just about any asset class if they dig deep enough. Take bonds, for example. Bonds are an out-of-favor asset, yet with the assumption of 1% risk free return, investors can garner four times that amount on BBB rated paper going out 5 years. This morning, I saw paper from names like Arcelor-Mittal (NYSE:MT), Pitney Bowes (NYSE:PBI) and Morgan Stanley (NYSE:MS) yielding in that range. For risk-tolerant investors, taking looks at names like these that are not firing on all cylinders, but are unlikely to go out of business in five years, is a value proposition compared to sitting on cash, in my view.

Also, consider the REIT sector. Domestically, the sector seems fully valued, with stocks having appreciated smartly the past several years and yields slumping to historically low levels. I chose to take a position in a globally positioned REIT, the Alpine Global Premier Properties Fund (NYSE:AWP), which yields better than 9% with minimal leverage and trades at a 10% discount to net asset value. It has a liberal charter, investing in emerging market property, domestic mREITs, as well as some of the familiar stand-bys. Again, not a low-risk choice, but I feel a value add for my portfolio, and perhaps yours as well.

For aggressive capital investors, the winners and momentum plays will always be out there. I won't pretend to be able to find you the next Apple (NASDAQ:AAPL) or Facebook (NASDAQ:FB), but speculative investors are still able to find emerging stories with accelerating stock prices. One such stock I had success with recently is Horizon Pharma (NASDAQ:HZNP), which is developing novel pain therapies for arthritis patients. The stories are out there, but you need to dig deep, have vision and patience to find and profit from them.

More conservative equity investors should stick to what they know, but should not fall asleep at the wheel either. The days of buy and hold may not be dead, but they have been seriously compromised. There has been wide disparity in price performance from companies with similar product offerings. Coke (NYSE:KO), not Pepsi (NYSE:PEP), was the stock to own the past three years, while Colgate (NYSE:CL) and not Procter and Gamble (NYSE:PG) was the portfolio standout. Stock pickers have been rewarded, whereas indexers have been by-and-large disappointed.

A Rocky, Yet Flat Road Ahead

No one has a crystal ball, but my conviction is that the market is headed nowhere quickly. While I'd love to cheerlead an economic recovery and encourage everyone to invest in equities wholesale, my reality is that for every positive I see in the broader economy, there's a headwind negating it. Still, I don't think we're headed for Armageddon, and though financial markets may be bumpy for the foreseeable future, the landscape on the horizon appears mostly flat. Diversification, thoughtful allocation, and a keen eye for value should help most investors through the uncertain times we face.

Disclosure: I am long (AWP), (HZNP), (CL). I also own (MT), (PBI), and (MS) fixed income positions.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.