Five Ways Investors Can Play Defense

Anthony Mirhaydari MSN Money February 23, 2012

2/22/2012 6:37 PM ET

By Anthony Mirhaydari, MSN Money

ETFs and even some market sectors can offer safety in the gathering market storm. The goal is to find stability that pays dividends.

Yes, the Dow is flirting with 13,000 again. But these are still crazy days for the economy and the stock market.

Big structural problems are in play -- from the world's $8 trillion debt hole to the specter of 1970s-style inflation, issues we've explored in my recent columns. We've dug a deep hole.

The takeaway: 2012 is shaping up to be a tough year, filled with market volatility, social unrest, political dynamism, a slowdown in corporate profits and a stalling of economic growth.

Efforts to fix the problem have focused mainly on central bank intervention. But with inflationary pressures building, the stage is set for a repeat of the mid-2011 slowdown, which was caused by rising energy prices.

So, what are investors to do?

Simply put, it's time to play defense by moving into large, stable dividend stocks.

Total returns in the stock market

In any case, bondholders get lower prices and an interest rate that won't compensate for lost purchasing power or rising default and credit risks.

Anthony Mirhaydari

Right now, 10-year Treasury bonds are offering a 2% yield. After accounting for inflation, that's actually a negative 1% yield. And this assumes that the U.S. government will pay its debt in full despite last summer's downgrade of our AAA credit rating and politicians' lack of meaningful progress in addressing the structural deficit.

Inflation risk worries me most. A negative interest rate is dangerous: It disrupts the natural order of the money markets, twists incentives around and sows the seeds for big-time inflation.

And it also fits with the "financial repression" idea that has the government essentially stealing wealth from cautious bond investors by engineering negative real interest rates to pay down its debt, as it did in the aftermath of World War II -- a subject I explored in July.

Moreover, given the hopeful rebound in some of the economic data and stocks, interest rates should be higher, according to Credit Suisse analysts. The difference between manufacturing orders -- as measured by the ISM new orders index -- and Treasury yields has swelled to the highest level since 2003. (An increase in new orders suggests economic growth is improving, which should push up real interest rates. The fact it's not suggests the bond market is not buying the improvement for some reason. Either it's right and growth will slow again, or it's wrong and bond prices will fall to compensate.)

If my dour outlook is wrong and the economy rebounds, bond prices will fall to push yields back up to close this disconnect. That'll hand even deeper losses to bond investors.

If I'm right, then bonds are now priced to perfection, and the outlook is cautious relative to the outlook for stocks. Given that the market for U.S. Treasury bonds is the largest in the world, one must assume investors have the most accurate information. In other words, they're probably right.

Why dividend stocks?

Clearly, there are big, strategic reasons to avoid fixed-income assets. But there are also a number of reasons to consider dividends as a critical piece of your overall long-term investment strategy.

Historically, 70% of the total return from stocks has come from dividends. This has been even more pronounced over the past 12 years or so, with the Standard & Poor's 500 Index ($INX) now trading near levels first reached in 1999.

Backing up even more, over the past 112 years, U.S. stocks have returned an inflation-adjusted capital gain of just 1.9% a year versus a total return (including dividends) of 6.3% a year. Compare that with the 2% inflation-adjusted return to holders of long-term bonds over the period -- or the 0.9% return on short-term bills.

It's also worth noting that the last time the economy was in shambles and burdened with excess debt, as it is now, was in the late 1940s and early 1950s. The scars from the Great Depression were still fresh. And people were largely ignoring stocks and flocking to bonds.

But all that started to change in 1951. People were pushed out of bonds and back into stocks as the average dividend yield pushed well above what was offered on Treasury bonds.

I think we could see a repeat in the months and years to come. There is certainly the capacity for higher dividends: According to Wells Fargo, dividends equal just 27% of S&P 500 earnings, the lowest in 100 years.

In the postwar years, it was the increased attractiveness and "safety" of dividends that changed the tenor of the investing environment and unleashed the massive 20-year bull market that took the Dow Jones Industrial Average ($INDU) from a low of 161.6 in 1949 to a high of 1,051.7 in 1973, a gain of 551%.

If the past 30 years of the market was all about hot growth stocks, the next era of investing will be all about dividends and income -- making this a long-term thesis.

Continued on the next page. Stocks and funds mentioned include: Southern (SO, news), FirstEnergy (FE, news) and Utilities Select Sector SPDR (XLU)

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3CommentsNewestOldestBestWorstControversial clownfeet46 minutes ago

No one says they know where the market is going but yet the advice is to buy dividend stocks Warren buffet says when people are selling He is buying, and when they are buying he is selling! or something to that effect!

The best thing that could happen is to declare an emergency in the country and force all big companies worth over ten billion to pay one billion dollars in cash on the debt ones like apple should pay ten billion in cash on the debt, MCdonalds, wall-Mart, ko pep and all the other really big companies ones like Buffet Microsoft etc. should pay ten billion in cash on the deficit, every millionaire should be forced to pay fifty thousand in cash ones lower twenty five thousand, fifteen thousand, ten thousand etc. to bring the debt down by 6 or 7 trillion dollars, If this made the stock market go down it would be a good thing its over valued !

almost everyone will disagree with this but it happened to middle class America, they lost eleven trillion dollars overnight, when the debt comes down by seven trillion the economy would start to recover well and they should pass a trillion dollar stimulus as they are doing this! it would seem hard at the beginning but it would put the country back on track, and everyone would make more money in a short time after this! the debt problem would be solved the country would have recovered what the middle class lost, and the ones that caused this recession would learn to not go there again!!!

1 0ReportSpamclownfeet1 hour agoInvestors took profits out this week to me that is a buying opportunity, Warren Buffet is buying! 1 0ReportSpamAG-991 hour agoA 5% dividend isn't going to give you much love if your stock falls 10%. 2 0ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment?/**/ DATA PROVIDERS

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