Sunday, August 28, 2011

Those Safe Havens You've Been Flocking to Aren't So Safe

It's time for a flight from safety.
The recent market maelstrom has sent investors fleeing to traditional safe havens such as Treasury bonds, recession-resistant stocks, Swiss francs and gold.
But that has only made these assets riskier, exposing investors to the possibility of a tumble. Gold, for example, shed a quick $200 an ounce this past week before rebounding.
For investors whose "safety" now poses danger, here are some unloved assets to consider instead.
In the fixed-income world, corporate bonds look better than Treasurys. Five-year Treasurys yield less than 1%. With inflation running at 3.6%, yields aren't keeping up with consumer prices. By contrast, the Barclays Capital U.S. Aggregate Bond Index, a benchmark for investment-grade bonds, yields about 3.7%—enough to keep up with inflation and a much better deal than Treasurys.
Switzerland, where the economy depends heavily on exports, has a big problem: The rising franc is making it more difficult for Swiss firms to compete abroad, which could weaken its economy over time.
Even "junk" bonds, which have been pounded lately, could be attractive. The Merrill Lynch High Yield Index has a yield of 8.6%, which suggests investors anticipate a 7% default rate, says James Swanson, chief investment strategist for MFS Investment Management.
That isn't unthinkable. Defaults topped 9% in 2009. But the rate was barely 2% in June. And publicly traded nonfinancial companies have 12% of their assets in cash, the most since 1954, says Mr. Swanson.
Investors who wish to add corporate bond exposure can use exchange-traded funds like the iShares Barclays Aggregate Bond Fund. For experienced bond buyers who don't mind risk, the sweet spot of the market might be debt rated double-B. Spreads between double-B bonds and high-grade corporates are 2.5 times normal levels, Mr. Swanson says.
In stocks, consumer staples seem expensive. The Standard & Poor's 500 Food Products Index is up 3% this year, while the broader S&P 500-stock index is down 7%. Kraft and General Mills sell for 15 and 14 times forecast earnings, respectively, at a time when more than 100 of the 500 companies in the index have price/earnings ratios in the single digits.
Military stocks, in particular, have suffered. Raytheon, General Dynamics and Northrop Grumman trade at eight times earnings with an average dividend yield of 3.8%, better than the S&P 500 yield of 2.3%.
Such stocks are cheap largely because investors fear defense cuts. But cuts are unlikely to be sudden, says Jefferies & Co. analyst Howard Rubel, and share prices reflect a worst-case outcome. All three companies are expected to boost earnings in coming quarters and keep making their dividend payments.
The Swiss franc is another potential trouble spot. It has gained around 20% against the dollar this year, thanks to Switzerland's budget surplus and lack of membership in the troubled European Union.
But Switzerland, where the economy depends heavily on exports, has a big problem: The rising franc is making it more difficult for Swiss firms to compete abroad, which could weaken its economy over time.
"Purchasing power parity" is a measure that uses local costs for a set basket of goods to show which currencies are expensive or cheap relative to others. It suggests the Swiss franc is among the world's priciest currencies. The Swiss government is worried enough that it has tried to weaken the currency in international markets. It has had little success so far, but that could change.
Expensive assets like the Swiss franc might not be as safe as investors hope. Instead of pulling money out of U.S. dollar savings to buy francs, they might be better off sticking with dollars. Not only is the dollar cheaper than the Swiss franc on a PPP basis—it is also cheaper than the euro, yen, British pound and Australian and Canadian dollars.
What about gold? It is up more than sevenfold in a decade. But while many investors believe gold is a classic inflation hedge, its track record suggests otherwise. Gold's three-decade correlation with the U.S. inflation rate is just 0.08, according to a 2010 study by researcher Ibbotson Associates. (A correlation of 1.0 means two assets move in lockstep.)
Some investors buy gold to own a tangible asset. Another route: rental properties, which can pull in yearly income that rivals junk bonds. Mortgage lending is tight, but interest rates are at historic lows. Another potential boost: the White House is considering a program to bundle distressed properties and sell them to income investors.
Many investors are buying gold simply because it seems safe in a crazy world. But when America last snapped out of a long, frightening economic funk three decades ago, the metal lost half its value in two years.
—Jack Hough is a columnist at Email:

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