Dow Jones Reprints: This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit www.djreprints.com
It's time for a flight from safety.
When economic clouds gather and markets turn choppy, investors often stampede into Treasury bonds, recession-resistant stocks, Swiss francs and gold.
But that can make these reputational safe havens less safe in practice, as their prices bloat up while those of less-hallowed assets become more attractive. Gold, for example, briefly tumbled more than $200 an ounce earlier this week as stocks rallied.
For investors whose excessive "safety" now poses a risk, here are some unloved assets to dip into.
Treasurys look preposterously crowded. Five-year notes recently hit a record-low yield of barely 1%. Consumer prices have lately risen at their typical pace of more than 3% a year, meanwhile.
In other words, the safest bet on short-term Treasurys is that they'll make investors a little poorer.
Corporate bonds, meanwhile, look abandoned. The Barclays Capital U.S. Aggregate Bond Index, a benchmark for investment-grade bonds, yields about 3.7%--double the normal spread against the 5-year Treasury.
Even "junk" bonds, which have been pounded lately, could be attractive. The Merrill Lynch High Yield Index has a yield of 8.6%, which suggests investors anticipate a 7% default rate, says James Swanson, chief investment strategist for MFS Investment Management.
That isn't unthinkable; defaults briefly hit an annualized rate of 9% during the 2008 credit freeze. But the default rate is just 1.1% now, meaning the economy would have to get much worse from here. Yet banks have built up capital cushions, while publicly traded nonfinancial companies have 12% of their assets in cash, the most since 1954, says Mr. Swanson.
Investors who wish to add corporate bond exposure can use exchange-traded funds like the iShares Barclays Aggregate Bond Fund. For experienced bond buyers who don't mind dipping into lower credit quality, the sweet spot of the market might be BB-rated debt. That's the high end of the junk world, so most defaults occur at lower credit ratings, and spreads between BB bonds and high-grade corporate are 2.5 times normal levels, says Mr. Swanson.
In stocks, the nervous herd has already grazed heavily on defensive food shares. The Standard & Poor's 500 Food Products Index is up 3% this year while the broader 500-stock index is down 7%. Kraft (KFT) and General Mills (GIS) are solid companies, but they sell for 15 and 14 times forecast earnings, respectively, at a time when more than 100 of the 500 index members have price-to-earnings ratios in the single digits.
Military stocks, meanwhile, have sunk to Dangerfieldian levels of investor respect. Raytheon (RTN), General Dynamics (GD) and Northrop Grumman (NOC) trade at eight times earnings with an average dividend yield of 3.8, and they spend only 29% of forecast earnings on dividends, meaning earnings could fall by half without forcing payment cuts.
They're cheap largely because investors fear drastic cuts to defense spending. But if spending falls gradually or if growth in spending merely slows, as seems more likely, these companies could keep delivering solid earnings.
The Swiss franc is another potential trouble spot. It has gained around 20% against the dollar this year, thanks to Switzerland's budget surplus, low inflation and strong bank regulations.
But Switzerland also has a big problem: the rising franc, which is making it difficult for Swiss manufacturers to compete globally. Purchasing power parity, a method of second-guessing exchange rates by comparing local costs for a set basket of goods, suggests the franc is now the world's priciest currency.
As an alternative for short-term deposits, consider one out-of-favor monetary union that has run large deficits of late but that has enormous capacity to right its finances, and soon will because it must. Its money is less expensive than that of most rich nations, despite an excellent record of innovation, prosperity and fairness.
At the risk of hyperbole, it could be the next United States. It's the current United States, and its dollar, whose humble state is driving record exports--anything but a prelude to collapse.
What about gold? It is perfect for the investor who wants a volatile trading instrument based on public angst.
As a safe haven, however, it has flaws. It produces no income and so offers little way of telling when it's cheap. Its image as "real money" is mostly owed to some lucky chemical traits that long ago made it ideal for shaping coins by hand. Today it has few industrial uses, which makes it a poor representative of things consumers buy, and thus, a poor hedge against inflation.
One alternative to gold is a diverse basket of commodities like the PowerShares DB Commodity Index fund. Another, for those seeking tangible assets, is to step outside capital markets and consider rental properties, which in some battered markets are now priced for 8% yields. The White House is considering a program to bundle distressed properties and sell them to income investors, which might bolster prices.
But many investors have simply bought gold because it somehow seems safe in a crazy world. For these, the best alternative might be to consider carefully what happens when the craziness passes. When America last snapped out of a long, frightening economic funk just over three decades ago, the metal lost half its value in two years.
Subscriber Tool
Track your own buys and sells
Ask the right questions before you hand over your money
A balanced portfolio can have a bigger impact on long-term performance than individual stock picking
Investing for retirement is more complicated than opening an IRA or maxing out your 401(k)
When choosing a stock mutual fund, consider performance, manager track record and cost before investing.
Even in times of interest rate uncertainty, a certificate of deposit (CD) can still be part of your cash strategy.
Find solutions to this and many other problems using
Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.
Read Full Article »