5 money moves an ex-Treasury official is making
SAN FRANCISCO (MarketWatch) -- Stock investors used to worry about a company's exposure to the economic cycle, and acted accordingly. Today, the investing world is not so flat or predictable.
Instead we have "The New Normal," a label many investors recognize all too well. The term, coined by Pimco, the bond-investing powerhouse, refers to the current chilly investment climate marked by slower profit growth, debt deleveraging, spending restraint, higher unemployment and lower expectations for investment returns.
Neel Kashkari, Pimco's head of global equities, has the somewhat lonely position of being a stock believer in a temple of bond gurus. Just days ago, Bill Gross, Pimco's co-chief investment officer, ignited a firestorm when he said the "equity cult" that has influenced stock markets (and bond markets, for that matter) for a generation is dying.
Kashkari has some experience with the near-dead. He's the former Treasury official who oversaw the federal bailout of major banks known as TARP, or Troubled Asset Relief Program, which in 2008 and 2009 stanched the bleeding financial services sector and helped stabilize financial markets.
At Pimco, Kashkari focuses on reviving weak-willing investors with a dose of harsh medicine. His prescription for stock buyers has two phases:
Near-term, he predicted, the Federal Reserve's accommodative policies will remain through 2014 and probably longer.
That could fuel some market surges, but stocks will continue to be vulnerable to headline risk -- Europe, the "fiscal cliff" or something unforeseen. Meanwhile, wary investors will mostly ignore stocks' relatively attractive valuations and corporate fundamentals, which in fact, Kashkari added, are in fairly good shape. Here, careful stock selection and wealth-preservation strategies are paramount.
Longer-term, Kashkari ventured, the Fed and other central bankers are pursuing policies that will stoke inflation. Most likely, inflation will be moderate, he added, and this scenario, while hardly rosy, also favors stocks. Investors shouldn't get too excited, though; Kashkari said he expects mid-single-digit gains for the overall stock market and even less for bonds. Again, stock selection will separate the winners from the average.
"We have to be realistic about what returns are reasonable," Kashkari said. "We're diversified globally and across asset classes, with an active eye to managing downside risks."
Welcome to what Kashkari calls "the New Normal of equity investing." As such, Kashkari tells the Pimco clients and financial advisers he meets to consider these key strategies:
1. Return of capital trumps return on capital
A rocky, risky investment landscape demands that investors focus on the return of capital over return on capital, Kashkari said.
"For 30 years we levered up the economy. Now we're in the deleveraging cycle," Kashkari said. "The euro-zone crisis is going to take several years before we can see the endpoint."
So Kashkari is fastening portfolios with "shock absorbers" designed to cushion the blows from knee-jerk reactions to headline news and other unwelcome surprises. Shares of big, stable companies play a key role in a bid to gain equity exposure and limit the downside. Samsung Electronics (005930) is one example Kashkari noted.
"If some of those big macro risks hit, these higher-quality companies tend to be more resilient," Kashkari explained.
Their strength keeps rivals at bay and solidifies corporate alliances. "When bad things happen in the global economy," Kashkari said, "strong companies want to partner with other strong companies." Read more: Let Buffett's 'moat' protect your portfolio.
2. Hunt for bargain-priced stocks
Buying world-class companies is even more attractive if they trade at a 30% to 40% discount to fair market value. The discounted valuation provides a margin of safety that is especially important in a slowing economic environment, Kashkari said.
The pharmaceutical and health-care sectors are particularly appealing in this way, he added. Companies fitting the bill include
3. Buy high-quality dividend-growers
Dividends provide another layer of cushioning, but it's important to focus on cash-rich companies that can increase their dividend payments.
"We're not just counting on capital appreciation," Kashkari said. "We like companies that can grow their dividend over time." One example is
Kashkari also looks to dividend-payers in emerging markets, where profits growth is relatively more robust. He pointed to Brazil's SABESP (SBSP3) , a leader in water and sanitation, as an example.
4. Hedge portfolios against unexpected 'tail' risks
Unexpected market shocks typically hit all stocks, so Kashkari has bought insurance against this outcome. "We're trying to hedge against major drawdowns," he said.
Tactics include buying put options on an emerging markets index or a currency that in times of crisis will offset an emerging-markets downturn, such as the Australian dollar (AUDUSD) .
A knowledgable investor could buy S&P 500 Index (SPX) put options to hedge risk, for example, Kashkari said, "but it may not be as cost-effective or hedge as long as you'd like."
It's a sophisticated strategy even for many financial advisers, but the central idea is to have assets in a portfolio that move in opposite or unrelated ways to each other.
5. Ride in 'multi-asset' vehicles
Another way to hedge risk, and one that retail investors can easily construct, is to spread assets across the globe in a variety of areas.
Such an asset allocation gives an investor the ability to participate in market moves -- wherever and whenever they occur. The upside potential is blunted, but so is the downside; broad diversification smooths the ride over time.
Pimco Global Multi-Asset Fund (PGMAX) , for example, invests in stocks and bonds worldwide, along with global currencies and commodities. The fund is just one of many multi-asset products that fund companies offer, but their goals are similar.
"This enables clients to sleep better at night," Kashkari said. "They experience less volatility." That's a psychological benefit for some investors, he added: "They stay in the market."