I believe we are in another lost decade for stocks, i.e. that 10 yrs from now the S&P 500 would be at the same level it is today. This investment outlook is based on my thoughts for overall economic growth, which drives profit growth and thus stock returns, over the long run, combined with a secular bear market that drives valuation compression even in the face of moderate economic growth.
Where does this view come from? My favorite source for economic analysis is Dave Rosenberg, Chief Economist at Gluskin-Sheff. Rosenberg is probably everyone’s favorite bear. He has been more right than wrong over the last decade and he backs up his views with great analysis. As a counterpoint, I read Brian Wesbury, Chief Economist at First Trust. Brian is definitely a glass half-full kind of guy and is much more bullish than Rosenberg. In my opinion his analysis is not as good as Rosenberg’s and neither is his track record. Yet he makes many good points about the positive points in the economy of which there always are many.
But probably the main reason I side with Rosenberg is that in managing a retirement portfolio in retirement where you are withdrawing money every year it pays to lean to safety. As Warren Buffet says, the first rule of investment is don’t lose money – the second rule is to remember the first rule. Wealth protection is job #1. Negative returns are anathema to a retiree, in particular an early retiree (with a 40+ year retirement period) and early in your retirement years. A $1M retirement portfolio that takes a 20% hit in the first year is a lot worse than a portfolio that takes a 20% hit in year 20!
Thus, I lean towards a pessimistic outlook and focus on doing well in such an environment. If I’m wrong and there is more upside great. What I need to minimize is the chance of being wrong to the downside. In this light where does one look for solid investments with chances for upside. I think Rosenberg has it right with his SIRP (Safe Income at Reasonable Price) strategy. In his latest update he lays it out pretty clearly:
INVESTMENT STRATEGY IN A DEFLATIONARY ENVIRONMENT
1. Focus on safe yield: High-quality corporates (non-cyclical, high cash reserves, minimal refinancing needs). Corporate balance sheets are in very good shape.
2. Equities: focus on reliable dividend growth/yield; preferred shares (“income” orientation). Starbucks just caught on to the importance of paying out a dividend.
3. Whether it be credit or equities, focus on companies with low debt/equity ratios and high liquid asset ratios – balance sheet quality is even more important than usual. Avoid highly leveraged companies.
4. Even hard assets that provide an income stream work well in a deflationary environment (ie, oil and gas royalties, REITs, etc…).
5. Focus on sectors or companies with these micro characteristics: low fixed costs, high variable cost, high barriers to entry/some sort of oligopolistic features, a relatively high level of demand inelasticity (utilities, staples, health care — these sectors are also unloved and under owned by institutional portfolio managers).
6. Alternative assets: allocate significant portion of asset mix to strategies that are not reliant on rising equity markets and where volatility can be used to advantage.
7. Precious metals: A hedge against the reflationary policies aimed at defusing deflationary risks — money printing, rolling currency depreciations, heightened trade frictions, and government procurement policies.
With that in mind I plan my portfolio allocation and choose my investments. Right now a lot of attention and money has gone into income oriented investments so many are fairly to slightly over-valued based on history. But in relation to a sub 3% 10yr, maybe not. A few of my favorite investments right now that I consider undervalued are:
RDS.B - big oil in turnaround mode with a great approx 6% yield.
NGG - UK based utility, also with US assets, recently beaten down, offering a 6%ish yield
AT - Atlantic Power, merchant provider of electricity. Approx 8% div with consistent outlook to 2015.
Disclosure: Long NGG
Disclosure: Long NGG