Where To Invest In 2010

Tea leaves, tarot cards, roots, potions, and Mattel’s Magic 8 Ball. If any of these things actually worked to predict the future, what questions might you pose–as an investor, that is? Here’s one: Can the financial markets continue their amazing–sometimes logic-defying–rebound in 2010? And another: Regardless of the broad market’s direction, which companies are in a position to grow profits and reward shareholders this year? Imagine what you could do if you had the answers. With apologies to the infamous Magic 8 Ball, black enterprise took a more scientific approach to get a read on the investment picture, surveying a handful of expert market watchers.

Certainly, no one could have foreseen the events of 2009. Markets were full of the splash, spectacle, and drama you’d expect from a Super Bowl highlight reel. There was suspense from the start as stocks fell flat and dragged through January and February. By March, when the Dow Jones began to climb again, hope reappeared as the markets launched a heart-stopping rally–one of the strongest market rebounds on record. It took investors time to trust the recovery’s reliability, but by the end of the year, nearly 43% of investors described themselves as “bullish,” up from 28% in late June. Still, the markets were volatile. “We probably saw as many 2% climbs and drops in this past year as we experienced in the entire decade before 2008,” says Ted Parrish, director of investments at Hennsler Financial Group in Atlanta.

What continues to keep investors on edge is the mountain of issues facing the U.S. economy. It’s not clear, for instance, whether corporations in a recovering economy are now reporting profits as a result of brutal cost-cutting or because “green shoots” of growth are actually sprouting. It defies basic logic that sustained economic progress can occur in the midst of double-digit unemployment. Credit and housing markets remain unstable and don’t forget the staggering debt Uncle Sam is running up for the sake of saving the world financial system.

As it stood last November, the pros interviewed by our editors are divided into two distinct camps. There are optimists and then there are pessimists. Each side believes their investment approach can prove profitable. “I think 2010 is going to be difficult in the equity markets,” says Wayne P. Weddington

III, an institutional investor with Brunswick Capital Partners L.P., a New York-based hedge fund. “We’ve obviously had a very strong run. But to continue this pace, you’d expect the Dow to hit 15,000 this coming March, which I can assure you won’t happen.” At the same time, Chief Investment Strategist Sam Stovall of Standard & Poor’s Equity Research says a gradual brightening of investor sentiment could possibly contribute to a double-digit stock market return (factoring in both share price gains and dividend yield) for the year.

One point all the experts agreed on: The year ahead could be choppy as investors attempt to gauge the true strength of the global economic recovery. There will be periods over the next several months–a promising unemployment release here, a dour housing report there–that are likely to trigger sharp advances and declines in the financial markets. All the same, whether your aim is to cash in on a recovery, leap at investment bargains, or secure a long-term position in the financial markets, there are ways to scan the terrain and make smart moves.

Stocks to Consider
You might summarize the investment community’s outlook on the stock market in two words:  cautiously cautious. Sectors of the economy have begun to stabilize. Proof of that lies in earnings growth or profits that publicly traded companies report each quarter. According to Standard & Poor’s, the S&P 500 should turn in a 9% increase in earnings for 2009. S&P analyst Stovall says indications are that profits could increase 35%.
Even so, the goal for any investor in 2010, says Eugene Profit, CEO of Silver Spring, Maryland-based Profit Capital Management (No. 15 on the BE Asset Managers list with $931 million in assets under management) is to be defensive without running from stocks in order to take advantage of any upside potential the market may have. The solution, he says, is to invest in industries that either didn’t take part in last year’s run up, or exhibited ample strength in 2009. Two sectors that fit the profile for Profit are the technology and healthcare industries. “Because of concerns over reform, a lot of good healthcare companies have been held back,” he says, “In technology, you’ve got good news coming from major players such as Microsoft and Apple.”

Medtronic (MDT), the

Minneapolis-based manufacturer of cardiac devices such as pacemakers and stents, is a healthcare company Profit has held in recent years and continues to like going forward. “The demand will continue to be there no matter what,” says Profit. One of his tech picks is Microsoft (MSFT). He believes its release of Windows 7 is likely to spur an upgrade cycle for corporations and households. Meanwhile, Apple (AAPL) continues to grow market share, thanks to the popularity of its iPhone and iPod products. “I think the company has quite a bit of room to go from here,” he says.

Hennsler’s Parrish will set his sights on companies with good prospects that were either punished or lagged in 2009. “My firm is really conservative to begin with,” he says, “and we’re sticking to what we do best–buying what we think are high-quality companies.” Along those lines, he has an unconventional take on publishing outfit McGraw-Hill (MHP). The company’s Standard & Poor’s rating agency came under fire after the meltdown in mortgage-backed securities. “The black cloud over the company is too dark,” says Parrish who believes its thriving textbook business and sale of BusinessWeek magazine to Bloomberg L.L.P. are two positives for the company. He maintains that his second selection, Wells Fargo (WLS), shunned by investors for its purchase of Wachovia, is poised to grow earnings at a healthy clip as housing sales rebound.

ETFs with Promise
One worthwhile strategy for 2010 could be to take advantage of growth in broad sectors of the economy while reducing the risk of exposure to the volatility of some individual stocks.  Exchange-traded funds (ETFs), or shares that invest in a basket of commodities or stocks, make that possible for the everyday investor. Weddington of Brunswick Capital Partners observes several macroeconomic trends to follow in the year ahead. First, there are basic materials, what he calls the “raw underpinning of economic activity,” which includes metals such as steel, iron, and aluminum, along with chemicals. “The sector should continue to perform well, especially since China has been buying up energy and materials companies,” Weddington notes. A weak U.S. dollar, he points out, will help push up the costs of basic materials commodities and, in turn, boost profits in related industries. He recommends the Basic Materials SPDR (XLB), an ETF which tracks the shares of basic materials companies in the S&P 500.

Another ETF sector play is energy, Weddington asserts, since rising oil prices have fueled a rally for companies in the industry. He suggests the Energy Select Sector SPDR (XLE). Like Profit, Weddington sees technology thriving regardless of any slowdown in retail consumption. A way to invest in that growth: Technology SPDR (XLK). Conventional wisdom suggests that REITs (real estate investment trusts) may have a tough road in the beginning of 2010 due to a weakening commercial market. However, the money manager thinks they may be positioned to rebound sharply toward the end of 2010. To take advantage of that upturn, he suggests the DJ Wilshire REIT ETF (RWR).

Standard & Poor’s Stovall says investors might also consider funds tracking consumer staples such as the Consumer Staples Select Sector ETF (XLP), traditionally made up of defensive food and clothing companies that tend to weather any economic storm. To balance your portfolio, he advises an equal weighting in a technology ETF. “Tech’s been the best performing sector for close to 20 years but it’s volatile. History has shown, but does not guarantee, that if you hedge it with a stake in consumer staples and you can get the best of both sectors with a risk-adjusted return that’s better than the market itself.”

Bonds of Affection
Bonds, of course, are another traditional way for individual investors to hedge their bets. And if you think that 2009 was an action-packed year for the stock market, consider the drama in the fixed-income arena. As investors searched for shelter in the aftermath of 2008’s market meltdown, they stampeded into U.S. Treasuries in droves. After the dust had settled, early last year, a new mass migration began–this time to riskier fixed-income investments including junk bonds.

In 2010, bond investors have two issues to keep in mind: inflation and increasing long-term rates. A steep ramp-up in either of those factors can send bonds in a tailspin. Mary Pugh, CEO of the Seattle-based fixed-income institutional investment firm Pugh Capital (No. 12 on the BE Asset Managers list list with $1.2 billion in assets under management), says inflation doesn’t look to be a major factor despite the government’s burgeoning budget deficit. “Right now, there’s more likelihood of disinflation over the next

couple of years,” she says. “One of the biggest drivers is the high unemployment rate–any time you have a significant portion of the population under- or unemployed, you’ll likely see wages dropping. We also have significant excess manufacturing capacity putting downward pressure on price levels. It looks as if we’re safe from increasing inflation for the next 24 months.”

Over the longer term, Pugh and Vanguard Group Inc. Portfolio Manager Gregory Davis agree the bond market expects interest rates to rise. Indeed, investors have begun to price higher rates into some longer-term holdings. Pugh and Davis advise investors to avoid the herd that rushed into junk and high-yielding bonds. Instead, they recommend a more measured approach. For instance, Pugh suggests that investment-grade, high-rated corporate bonds with a mid-range five-year maturity make sense right now.

Mutual Funds to Ponder
A large diversified portfolio is yet another hedging strategy that’s been readily available to individual investors. And, in keeping with the very measured outlook many pros have adopted for 2010, turning to mutual funds with solid management and good long-term track records will prove to be the favorable course for most investors.

Harry Milling, a mutual fund analyst for Chicago-based Morningstar, which tracks mutual fund performance, says Fairholme Fund (FAIRX), which scouts for undervalued companies to include in its very concentrated portfolio, makes the short list of well-run mutual funds worth considering. Another favorite: Fidelity Contrafund (FCNTX), a proven top-performer with a solid track record for spotting long-term trends. His final equity fund suggestions are Royce Special Equity (RYSEX) and Buffalo Midcap (BUFMX) both of which specialize in smaller companies that often lend a dosage of high-octane growth to a portfolio anchored in large company shares. Among his fixed-income fund picks, Millings recommends sticking with those with long-term track records such as Pimco Total Return (PTTAX) and Loomis Sayles Bond (LSBRX).
Whatever the final outcome in 2010, our experts tell investors to focus on long-term trends. “Many times individual investors get caught chasing returns and find that running after performance is a good way to get burned in the marketplace,” says Vanguard’s Davis. “The message is clear: You have to remain focused on the horizon, on a longer-term investment process.”

This article originally appeared in the January 2010 issue of Black Enterprise magazine.