I believe that we're in the early inning of a prolonged economic depression. Stagnant economic growth for years will cause a secular shift in American behaviors that will result in a turning away from debt-financed consumption and more towards responsible savings. If these were the only factors that we needed to worry about to determine our investing strategy, it would be easy. We'd likely just focus on consumer staple stocks and bonds with decent yields. Unfortunately, perhaps the biggest factor moving forward is the government & Fed. With zero interest rate policy (ZIRP) for the foreseeable future and more quantitative easing down the road, it's tough to determine where to find return.
While I do believe in the principle of protecting capital first and finding return second, protecting your capital in an inflationary environment is still a losing proposition. Since the Fed is determined to absolutely punish savers, you have to have some element of risk in your portfolio just to break even. Yes, you can thank our leaders for this policy that they have deemed is in the name of the greater good.
Stocks are a decent hedge against inflation. To an extent, companies can pass on costs to their consumers. Now, in a severe-inflationary environment or hyperinflationary environment, this will probably not hold up and equities will still suffer. Therefore, we can perhaps hedge against inflation which seems very possible with some sound dividend stocks and the less probably severe/hyper-inflationary situations with some small positions in gold and other instruments that are seriously leveraged to a jump in commodities. For this, you might consider SPDR Gold Shares (NYSEARCA:GLD) or PowerShares DB Oil (NYSEARCA:DBO) which have shown to have a decent correlation to the underlying commodity; gold and oil respectively. If you're bullish on gold, there is no replacement, however, for physical gold in your possession. If you wish to speculate further, consider the Market Vector Gold Miners ETF (NYSEARCA:GDX) which should really outperform in an environment where gold is going higher. With that said, gold mining companies will likely collapse in a hyperinflationary environment as costs for everything including labor and equipment spiral out of control so there is still risk with GDX even with higher gold prices.
Dividend yielding stocks that will perform in a slow economy should make up the bulk of your portfolio. For this, I really like Wal-Mart Stores, Inc. (NYSE:WMT), McDonald's Corporation (NYSE:MCD) and Philip Morris Int'l (NYSE:PM). You might also consider a stock like Healthcare Services Group Inc (NASDAQ:HCSG) which has a track record of dividend growth, is positioned to thrive in the demographic shifts that are happening and is still a relatively small company with lots of growth potential ahead.
While I'd love to say that you should just bail on the stock market and stick to cash, with the Fed policies both now and what I anticipate in the future, I just can't see that as the best strategy. You could consider a portfolio of just cash and gold but I like the combination of cash, dividend stocks and a small chunk of gold or commodity positions that will jump in an inflationary situation.
To hedge against volatility, consider adding short positions to your portfolios in the extreme areas of consumer discretionary spending. The number one area here in my opinion is boating. Adding a short to companies like Brunswick Corp (NYSE:BC) or Marinemax, Inc (NYSE:HZO) can help hedge against losses in your long positions during a time when there will undoubtedly be volatility in the markets.
Any real return in the next decade is going to be a positive, so don't think you need to hit it out the park. For young investors, the compounding ability of dividend paying stocks can make you very wealthy - something I address in more detail in How to get where you want to be in 10 years.
Disclosure: Long PM, WMT, MCD, HCSG, GDX; Short BC