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Investing in 2010: Stocks, Bonds and Commodities

This is part of a three-part series on what to do with your money in 2010. For what to do with your banking and credit cards, click here; and for new tax strategies, click here.

After a furious rally from the March low, the stock market is up more than 60 percent, which leaves investors with a quandary: What are the best investments for 2010? Should you buy the stocks and mutual funds that did the best in 2009, in the hope that they will keep on climbing? Or should you sell in preparation for the inevitable correction? The answer to both questions is no. Many financial experts do expect a stock market slowdown or correction in 2010, but it’s unlikely that you will be able to time your selling and buying to take advantage of the market moves. Instead, build a balanced portfolio, and make sure you have exposure to high-quality growth stocks that have stable earnings, high dividends and low debt. Whatever you do, beware the temptation to look to 2009’s winners —low-quality stocks and bonds — as the best investments for 2010.

The market outlook with perhaps the most currency right now is the “new normal,” a term coined by Bill Gross and Mohamed El-Erian of Pacific Investment Management Co. (Pimco). It calls for weak global economic growth as the world deleverages and governments re-regulate. If the model since the great bull market began in 1982 assumed falling interest rates, rising asset prices, and nominal GDP growth of nearly 6 percent, Gross’s “new normal” anticipates U.S. GDP mired in the 1 to 2 percent range and a sluggish stock market that reflects that slow growth. As a result, El-Erian is recommending investors cut their stock exposure from the typical 60 percent to between 30 and 54 percent; half of that, he believes, should come from outside the U.S. Mauro Guillen, a professor of international management at The Wharton School at the University of Pennsylvania concurs. “If you believe the stock market tends to grow as much as GDP, right now the U.S. market doesn’t look too good for the next five to 10 years,” he says.

To be sure, there’s always another side to the trade. “Some of what I hear about the ‘new normal’ seems like utter nonsense,” says James Swanson, chief investment strategist of MFS Investment Management, a mutual fund firm. He believes companies are in a “Never-Never Land sweet spot” with rising profits and low inflation, and that pent-up consumer demand will boost revenues. “The average age of cars on the road is 9 years. Pretty soon those cars will need to be replaced,” he says.

Stocks

Whether you’re a full-fledged “new normal” believer or not, U.S. blue chips are likely to offer exceptional opportunities in 2010. As MoneyWatch editor-in-chief Eric Schurenberg recently pointed out, GMO chairman Jeremy Grantham calls high-quality stocks with stable cash flows and low debt levels the “only free lunch” in the market now. You can buy a mutual fund that specializes in such companies, such as the Jensen Portfolio (JENSX), or you can hedge your bet by owning a low-cost index fund such as The Vanguard Total Stock Market Index Fund (VTSMX). As the name implies, you capture the returns of the total market, but since it’s top-heavy with the largest, most-stable companies, you’ll still benefit if they do indeed outperform.

One thing most observers agree on for 2010: Foreign securities will likely do better than domestics. Guillen recommends keeping at least a third of your money “in foreign stocks and bonds of countries that will be liable to grow quickly over the next five to 10 years.” International stock funds with excellent track records and below-average expenses include Oakmark International (OAKIX), Janus Overseas (JAOSX), and Vanguard International Growth (VWIGX). They’ve all beaten more than 80 percent of their peers over the past 10 years.

You can combine high-quality U.S. stocks and foreign exposure by owning U.S.-based multinationals that generate much of their profits overseas. To do this, you can take the index route, owning an ETF such as the iShares S&P 100 Index (OEF). The Jensen Portfolio offers similar exposure. Jensen co-manager Robert McIver has noticed a migration towards such stocks in his fund, due to a weaker dollar and changing corporate strategies. “The percentage of our companies’ foreign revenues has grown from 33 percent two years ago to 50 percent today,” says McIver.

If the slow-growth thesis proves accurate, high-quality dividend-paying stocks should do well in 2010, after lagging in 2009. “One of the underappreciated lessons of equity investing is the value of compounded income from dividends,” says Swanson. “In the stock market, 50 percent of investors’ returns have come from [compounded] dividends historically.” Two ways to buy a basket of dividend-paying stocks: Vanguard Equity Income Fund (VEIPX), with a 2.52 percent yield, and SPDR S&P Dividend ETF (SDY), with a 4.02 percent dividend yield.

Bonds

Interest rates on U.S. government bonds are at historic lows, which suggests they have nowhere to go but up. As a result, bond investors should stick with high-quality, short maturity bonds or funds that hold them. They won’t gain as much as long-term bonds if rates fall even farther, but they’ll lose a lot less if rates climb. Consider Vanguard Short Term Bond Index (VBISX), which owns a mix of government and corporate bonds and has beaten 90 percent of its peers over the past 15 years.

If you prefer to own nothing but U.S. government bonds, buy an ETF that holds Treasury Inflation-Protected bonds, such as iShares Barclays TIPS Bond ETF (TIP). To help your portfolio benefit from a falling dollar, consider a foreign-bond ETF such as iShares S&P/Citi 1-3 Years International Treasury Bond ETF (ISHG), which purchases foreign government bonds exclusively.

Commodities

Inflation may be low now, but if the global economy continues to strengthen in 2010, it’s likely to start heading up. Since commodities tend to rise as the value of a buck falls, you may want to keep 5 to 10 percent of your portfolio in commodities. MoneyWatch’s primer on commodity investing can help you do this wisely. Two ideas: the PowerShares DB Commodity Index ETF (DBC) and the Credit Suisse Commodity Return Strategy Fund (CRSOX). Both track commodity futures indexes that reflect actual commodity prices, rather than investing in stocks of commodity producers or distributors. Historically, commodity futures have been a better way to diversify, since movements in commodity stocks tend to be more correlated with the broad stock market.

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