When markets get carried away and "overshoot" as they invariably do, there is, sooner or later, a consequence that affects us all.
In 2007, after four years of relentlessly rising markets, cracks started to appear. And in 2008 the bubble burst in spectacular fashion following the Lehman Brothers collapse.
Going forward, inflation, value and 'bubble-blowing' government policy all worry The Fleet Street Letter team.
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It's not impossible that markets could mimic their 2008 capitulation. A V-shaped recovery is "priced into the markets" according to one banker at Morgan Stanley. That means that if the economy doesn't jump straight back into growth, stocks will fall. The next three months will tell us whether the bulls or bears have it right.
The question is: What is the best way to play it? Stocks? Bonds? Funds?
Our answer, what is ironically the most contrarian advice, is to diversify.
How to manage your risk
You see, one major shortcoming in so many investors is small-mindedness. By blindly investing in the same old fare, time after time, investors are failing to manage risk. It's dangerous the way investors gang around one single approach to investing. No doubt you've seen it yourself:
Small cap investors loathe blue chip investors;
Fundamental analysts pour scorn on chart followers;
Stock pickers hate fund managers;
Traditional fund managers despise hedge fund managers
And so on, ad nauseam
These turf wars are frivolous and (something many investors don't seem to have realised) you don't have to pick sides! Ignore the stock market fascism and be more open-minded as there's nothing stopping you investing any way you see fit. After all, it's your money!
Consider the world's most consistent and wealthiest investors Warren Buffett, John Paulson, George Soros, Paul Tudor Jones, etc. What all these investors have in common is that they do not discriminate. They see the big picture and invest in the best idea at the best time in the best way to make the most money.
- Why UK property prices are going to fall 50%
- When it will be time to get back in and buy up half price property
How we pick stocks
Right now, we like defensive shares
We like companies that offer high yields, stable earnings and strong balance sheets. And when you're talking about defensive, you have to mention British American Tobacco (LSE: BATS). Tobacco has been the FTSE's most defensive sector and BAT its most defensive position.
BAT makes more than half its profit from emerging markets, ensuring diversification. Plus, in some developed markets it dominates think Canada, South Africa and Australia. To cut costs, it is "centralising" management, marketing and production. It has a strong balance sheet and pays high, growing dividends. The weak pound is currently a benefit but could soon become a threat should sterling recover.
Tesco (LSE: TSCO) is another defensive we like. As if you didn't know, it's the UK's leading food retailer. It towers over the industry with over 20% market share, growth is driven by non-food and e-commerce business. Abroad, Tesco is growing too. It has a strong brand in Ireland, Central Europe and Asia.
We also embrace the best growth stocks
Inmarsat (LSE: ISAT), the satellite business providing communications services, is not only growing earnings in high double figures. It's also at the end of its research and development cycle. You see, Inmarsat completed a seven-year capital spending programme in 2007. Now the group is entering a spell that the directors are describing as a cash flow harvesting period. It's not cheap, but nor is any growth stock in this climate and these types of positions are essential for maintaining the right dynamic for the portfolio.
And now for something slightly different
In the current climate, investing in stocks alone is a bad policy.
This is a lesson of the credit crunch that many investors, and indeed many brokers and fund managers, have failed to learn. As such, they are likely to repeat history's mistakes.
Gold is a fine hedge to hold in your portfolios, as we have repeatedly said here in The Right Side. We're long gold in The Fleet Street Letter.
Another asset that all investors should consider is corporate bonds. Safer than stocks and paying a higher yield too. The common criticism is that bonds have less potential to rally. But try telling that to our readers who have so far secured a 25% rise since our corporate bond recommendation some months ago. And that's before considering the 7% dividend.
It's this diverse approach that helped us to record gains in 2008. While all stocks were falling, we were invested in European bonds and non-stock funds that were gaining. We play the stories and sometimes the stories are not limited to the stock market.
This article was written by Theo Casey, investment director of The Fleet Street Letter, and was first published in the free investment newsletter The Right Side .
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