A Value Investor's Plan for 2006

It's not too late to reflect on the past year and plan for the one ahead.

I'm going forward in 2006 overweight in consumer staples, energy and basic materials, and underweight in everything else. Consumer staples cover the bear case; energy and materials cover the bull case. Financials, which are dependent on interest rate margins, will have a hard time.

In insurance, I think that large-cap life names such as MetLife (MET - commentary - Cramer's Take) and Prudential (PRU - commentary - Cramer's Take) will pack a punch. Scale is an advantage in the life insurance business. Allstate (ALL - commentary - Cramer's Take) is undervalued, and its pricing model is more powerful than the market thinks.

Assurant (AIZ - commentary - Cramer's Take) is one of those companies that everyone will wish they bought at the IPO. It is a very good capital allocator. Beyond that, the property and casualty reinsurers in Bermuda are undervalued, but who can tell how bad the catastrophes will be this year? I am getting more hesitant about the group.

In bonds, I think the yield curve will be flat to inverted for a longer time than most anticipate. In general, short rates will rise, and long rates will stay pretty stable. The federal funds rate should top out at 5%, give or take 25 basis points. Credit spreads will remain tight for most of the year and widen a little toward the end of 2006 on fears of recession and consumer credit problems.

There won't be stagflation in 2006, but growth in real GDP will slow, and inflation should rise a little. Toward the end of the year, news stories about a likely recession will proliferate, partly due to a weakening of the residential real estate market.

My guess is that on the whole, the stock market won't perform too badly, but the indices will only see single-digit gains. It won't make either the bulls or the bears happy.

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At the time of publication, Merkel and/or his fund was long MetLife, Assurant, Prudential, Sappi, Dorel, Gold Kist, Fresh Del Monte Produce, Neenah, Cemex, Anglo-American, Apache, Japan Smaller Capitalization Fund, Toyota and Allstate, and was short Ford, though positions may change at any time.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.

Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.