What to invest in for 2012

Global stock markets got 2012 off to a good start.

The FTSE 100 jumped by more than 2%. The S&P 500 gained around 1.6%. And gold jumped back above $1,600 an ounce.

Why the good cheer? Manufacturing data from China and the US was better than hoped. But it was also probably time for the dollar to give back some of its recent gains, which in turn suggests most other assets will rise.

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Is 2012 a turning point? Probably not. We're in a long period of paying down debt rather than building it up. That didn't change when the calendar moved from 31 December to 1 January the other night.

But that doesn't mean there's nothing worth buying out there

Hedge funds had a duff 2011 but some are worth watching

Many newspapers took great glee in pointing out that last year was a pretty duff one for the average hedge fund. 'These guys are supposed to be able to make money in any environment,' is the general take. 'They can't.'

There's nothing wrong with the criticism. An average decline of 4%-odd (depending on the research firm you ask) is pretty poor compared to the flat performance from the S&P 500. After all, hedge funds charge a lot of money for the promise that they'll deliver market-beating returns.

But so do normal funds. Nobody invests in any sort of actively-managed fund in the expectation that it will fail to beat the market. Yet over the long run, a majority do.

That's one reason why we often favour 'passive', or market-tracking investments. If you can't be confident of beating the market, then why pay extra for active management?

However, not all active fund managers are a waste of space. Within the general funds sphere, there are consistent outperformers like Neil Woodford, whose Edinburgh Investment Trust we regularly tip.

And as for the hedgies, even if you don't want to shell out the fees to invest with them, it's often worth listening to their views. Because they aren't restricted to one investment style or sector, and can also profit from selling stocks short, you won't just get the generic 'it's never a bad time to buy stocks' view that you often get from standard fund managers.

This period of deleveraging could last for 20 years

One group worth paying attention to is Bridgewater Associates, the world's biggest hedge fund firm. By the end of November last year, the company's flagship Pure Alpha Strategy fund which has made a profit every year since 2000 had returned 25% for 2011, according to Tom Lauricella in the Wall Street Journal.

How did it make its money? The fund was invested in gold, but cut back in the third quarter (which is roughly when gold peaked last year). It bought into the rally in US government debt (Treasuries), just as the likes of bond fund giant Bill Gross were selling out. And rather than shorting the euro against the dollar, it shorted it against the yen, a far more successful bet.

Those are all impressive calls. So what does the group expect for the year ahead? More of the same. Robert Prince, Bridgewater's co-chief investment officer, isn't turning bullish for 2012, he tells the Wall Street Journal. "We're in a secular deleveraging that will probably take 15 to 20 years to work through and we're just four years in."

In the US, consumers are still more indebted comparing their household income to their net worth than they were in 2008. In Europe, "you've got insolvent banks supporting insolvent sovereigns and insolvent sovereigns supporting insolvent banks".

So any bursts of growth will inevitably be undermined by the weak underlying position of the economy. Indeed, we can expect slow growth, high unemployment, and low interest rates for a long time to come. The years of credit growth are over. We're now in a long process whereby instead of increasing our debts, we pay them off.

It was always wishful thinking to hope that this could be dealt with overnight particularly as our governments and central banks desperately want to prevent asset prices from falling, or any significant players from losing any money.

Investing in a low-growth world

So how do you invest in a world like this? Prince expects to see more bursts of quantitative easing from the Federal Reserve as it tries to prop up the US economy whenever growth threatens to falter. As a result, he remains keen on both gold and US government debt.

But what about stocks? While a weak economy is bad news for stocks in general, Prince seems to believe that much of this is priced in, at least for a long-term investor. The catch is, this assumes that there are no big shocks along the way.

So what's our take on this? I'm with him on gold, of course. On government debt excluding the eurozone, developed world debt was a great performer last year. But with the notable exception of James Ferguson, who regularly tipped gilts along with other defensive plays throughout last year, we're not keen on government bonds at MoneyWeek.

There's no denying that they've done well, and the evidence of Japan suggests they could continue to do so. But by any historical measure they are expensive, and more to the point, they are too vulnerable to nasty surprises from governments, or mood swings from investors.

As for stocks: again, it makes sense to us to stick with high quality defensive plays. The FTSE 100 has plenty of globally-exposed blue chips, but it's worth looking further afield to the US as well. If we get a stonking economic recovery, multinationals will still do well. And if we don't, they'll hold up better than other companies.

Another very promising-looking area and one of the sectors that could potentially provide a very pleasant surprise for us all in the coming years is in the field of natural gas and alternative sources of fossil fuels, such as shale oil. Cutting energy costs, and our dependence on the Middle East, is one of the West's best hopes for getting through this slump more quickly.

This is a theme we've been looking at regularly over the past couple of years (you can read my colleague James McKeigue's most recent MoneyWeek magazine cover story on the topic), and we'll be returning to it very shortly in Money Morning. Meanwhile, you can find out more on what our experts think you should buy in 2012 in the next issue of MoneyWeek magazine, out on Friday. If you're not already a subscriber, subscribe to MoneyWeek magazine.

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