I think it's only sound financial strategy to prepare for the consequences of the mountain of bad debt that has built up in China, of the really troubling conjunction of huge government debt and a rapidly aging population in Japan, and of the utter dependence of the U.S. on the kindness of strangers to fund its dual government and trade deficits.
Investors who pay attention to fundamentals know that in the long run, such things as mountains of bad debt and undisciplined borrowing do count. The Piper always gets paid -- eventually.
But experienced investors also know that it can take quite a while for "eventually" to arrive. They also know that projected dangers can materialize in unexpected forms. The debt bomb, for example, could fail to blow up but instead just usher in a long, long period of a gradually weakening dollar and slowly increasing inflation.
So, while I don't think a smart investor will ignore the problem posed by these mountains of debt, running immediately to turn stocks and bonds into a stash of gold and soybeans isn't a particularly good solution.
So what do you do? Three steps make sense to me:
Get your own debt under control.
Make sure that you won't get trapped at the long end of the debt market.
Gradually build a hell-in-a-handbasket portfolio as part of your larger equity portfolio.
Let me quickly explain points one and two, then spend more time on the hell-in-a handbasket portfolio. (Jubak's Journal is, after all, a column about stocks.)
Global debt is out of control. So what kind of shape is your household debt in?
Move From Adjustable to Fixed
It's tough to reduce debt overnight, but here's how you can ensure that the debt bomb won't blow up your personal balance sheet if it goes off. Make sure that all your debt (or as much as you can) carries a fixed rate of interest. I expect a hike in interest rates from the
in the last quarter of 2004 or the first quarter of 2005. (Call me a cynic, but there is an election in November, remember?) So you've got some time to shift from adjustable to fixed debt.
Next, familiarize yourself with the fine print on your loans, especially on your mortgage. If interest rates and delinquencies begin to rise, you can expect that banks and other lenders will move quickly to invoke penalty clauses that allow them to boost interest rates for even a single late payment.
Shorten That Maturity
Many fixed-income investors have been forced out to the long end of the bond market in an effort to find a yield above 2%. That move made sense, especially while interest rates were falling. And it didn't cause too much portfolio damage in 2003 as interest rates rose very slightly and bond prices fell.
But that won't be the case if interest rates start to climb in advance of a Fed move or in response to continued dollar weakness. Investors in long-term bonds, whether corporate or government, will see the market value of their bonds drop with every upward hitch in rates.
So while you have time, rearrange your fixed-income portfolio. At the most conservative end of a range of possible moves, you could use bond ladders of gradually lengthening maturities to reduce the average maturity of a portfolio. That would give you a chance to reinvest at least some of your fixed-income assets at higher rates.
More aggressively, sell your long maturities now and move the money into dividend-paying stocks of companies with histories of raising dividends over time.
all yield more than 3% and have a history of raising dividends.
Let's be honest, if a debt bomb or two blows up in the wrong way and takes down a major hunk of the global financial system, which stocks you own won't be especially important. In a worst-case scenario, every financial asset will fall hard. And it won't matter if a company's earnings are priced in U.S. dollars or Thailand's baht.
But let's say the consequences from this debt are limited to a weaker dollar, interest rates that climb at a relatively modest rate, global inflation, climbing uncertainty and the like. Then, picking the right stocks can spell the difference between major losses and modest profits.
I don't think any investor needs to implement this entire portfolio right now. This is the time, however, to start moving in this direction. Some sectors that make the most sense in the high-debt world that I've sketched out have already started to move up in price.
I could be wrong, however, if somehow the global economy and financial markets muddle through. Just in case, I've kept an eye out for solid defensive stocks that have a good chance to appreciate in price if the global economy continues, without explosion, to ride current trends. Here is a look at some stocks I think are worth considering, broken up by themes.
Protection From a Falling Dollar
Oil is priced in dollars, so you might expect a falling dollar to hurt oil stocks. But the oil producers have a mechanism called OPEC (the Organization of Petroleum Exporting Countries) that allows them to take the purchasing power of the dollar into account when they set global oil prices. When the dollar falls in value, OPEC can make up the difference by raising the price of oil.
And the non-OPEC oil producing giants such as
Shell Transportation & Trading
, one of the holding companies for the Royal Dutch/Shell Group, are only too happy to go along. The result is an earnings report like the one ExxonMobil released on Jan. 29: Earnings per share were up 21% for the quarter and 10 cents a share better than Wall Street had projected.
U.S.-based multinationals with big nondollar sales.
In the most recent quarter,
foreign earnings accounted for 83% of the company's total earnings. At
, the figure is 65%. At
, 41%. At Citigroup, 41%. As the dollar falls against local currencies and foreign earnings are translated into U.S. dollars for a U.S.-based company's earnings statement, those foreign earnings represent more U.S. dollars.
Other big foreign currency earners include
American International Group
and big drugmakers such as
. This foreign exchange exposure is one reason that many Wall Street analysts expect big-cap stocks to outperform this year.
Gold is the emotional haven of first and last resort whenever the future starts to look uncertain. If you're new to gold, start small and start at the conservative end of the gold company spectrum. Don't plump immediately for the riskiest small-cap you can find on the often exceedingly speculative Vancouver Exchange.
is a good place for the newcomer to start, especially since the stock has pulled back in recent weeks (13.5% in January) along with the general retreat in gold prices.
Protection Against Inflation
Global demand for things such as nickel, iron ore, aluminum, coal, oil, copper and soybeans is rising along with the economies of China and India, so even if inflation doesn't pick up, commodities stocks should do well. But if inflation does surge, prices of commodities will at least keep pace. I would underweight commodity producers whose prices are based on strong currency countries -- Australia at the moment, for example. These will give up part of their earnings edge as the dollar weakens.
In the meantime, consider
Southern Peru Copper
Freeport-McMoRan Copper & Gold
Companhia Vale Do Rio Doce
, a Jubak's Picks stock, has dropped back to an attractive price for building or adding to positions.
Protection Against Single-Country Risk
Don't put all your eggs in one basket is an adage that fewer and fewer U.S.-based investors have bothered to follow in the last decade. But I think it's time to put it to use again as a way to defend against the possibility that a debt bomb could strike hard at an individual financial market.
Or at a combination of markets. Now that China is the hot international market, many U.S. investors have built portfolios in which China represents the only overseas exposure. That's a problem because China is one of the two countries that I think is most likely to go through a debt-induced shakeout. The U.S. is the other.
Still want exposure to a fast-growing giant? Add India to your portfolio mix. Two banks,
, are ways to profit from the rise of the Indian middle class. Brazil looks cheap to me right now. Investigate
Unibanco-Uniao de Banco
Companhia Brasileira de Distribuicao
Protection Against Rising Interest Rates
It's hard to find companies that should actually benefit from rising interest rates, but they do exist.
makes money from the very short-term float it gets on payroll and other client monies. Higher rates add to that profit.
And don't forget companies with huge short-term portfolios that will generate massive cash flows that can be invested at higher rates as interest rates rise. Warren Buffett has positioned
in just this way.
One final word: If interest rates rise, the high price-to-earnings (or no-earnings in many cases) stocks that led the market rally in 2003 will, history suggests, suffer more than their share of any damage.
Whatever else you may do, this isn't the time to be adding risk to a portfolio.
I'm sure these suggestions haven't exhausted the universe of ideas for defending against the debt bombs now out there. As usual, I'll be happy to share reader ideas for other solutions in a follow-up column. Just email me.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: American International Group, Berkshire Hathaway, Freeport McMoran Copper and Gold, Merck, Newmont Mining, Noranda, Paychex, Pepisco, and Pfizer. He does not own short positions in any stock mentioned in this column.