Investor Alert

Dec. 1, 2011, 12:02 a.m. EST

Hope and fear head fakes

Commentary: Dividends and gold can offset headline risks

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By David Kudla

GRAND BLANC, Mich. (MarketWatch) — As the euro-zone teeters back and forth between hope and fear, headline news risk impacting the markets has dealt investors a series of head fakes over the past several months.


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After the downturn for stocks in September, stocks rallied in October on the hope for the “Merkozy Plan” – a deal to be struck between Merkel and Sarkozy that was to solve Greece’s problems, recapitalize European banks, and address the overall sovereign debt problems of European countries. By late November, however, hope had again turned to fear as bond yields in Italy, Spain, and even France continued to climb when these governments found it increasingly difficult to find buyers for their debt.

Europe’s problems are solvable with their resources alone if that continent’s leaders can demonstrate the political will to do so. At this point, the solution for the euro-zone largely hinges on Germany’s willingness to bail out the rest of the region. The challenge is that Germany’s leaders want to wait until they have wrung out all of the concessions they desire from the countries they must backstop, risking that they may wait too long.

On this side of the pond, confidence in our political leaders to solve our country’s structural debt problems is not any better. The “Super Committee” in Congress recently adjourned, unable to accomplish anything at all in terms of deficit reduction.

So, as with last summer, many had “hoped” for the political will in Europe and the political will in the U.S. to find real solutions to sovereign debt issues only to be let down again. The markets teetered back to “fear”, setting up investors for yet another head fake.

On the bright side, the third quarter earnings season is going well, with 83% of S&P 500 companies (that have reported) beating expectations. The current estimate for GDP growth in the third quarter stands at 2.0%. While not as strong a growth rate as we would like to see, it is certainly not recessionary either.

As tactical asset allocators we must recognize the ongoing concerns for the economy and markets, weigh them against good company fundamentals, and invest accordingly. Doing so can be especially frustrating given head fake after head fake that headline news has dealt investors.

In this environment, a stock’s dividend yield may prove to be an important cushion against market volatility. Plenty of companies are performing well this year and are seeing their share prices hold up and even advance, with the added bonus of rewarding shareholders by paying dividends. With U.S. government bonds yielding next to nothing, an income stream from a dividend paying stock is even more attractive.

For a lower risk, diversified play in high dividend paying stocks, we recommend Federated Strategic Value Dividend /zigman2/quotes/209602288/realtime SVAAX -0.21%  . This fund is far outperforming the S&P 500 in 2011, and has longer-term volatility at about three-quarters of that benchmark index.

ETF investors can consider iShares Dow Jones Select Dividend Index /zigman2/quotes/204321812/composite DVY +0.37%   for a diversified play in this space. While more aggressive than SVAAX and a bit more volatile than the S&P 500, it is holding up well through the head fake environment of 2011 with a positive return so far this year.

Additionally, we still like gold as an appreciating asset that also provides a hedge for our portfolios. With the sovereign debt issues of developed nations and the inflationary money printing that is an inevitable solution, gold continues to shine. In the third quarter, central banks around the world bought a record 148 million metric tons of gold bullion as they stepped up their diversification away from fiat currencies, according to the World Gold Council.

What other growth asset class has had a positive return in each of the past eleven calendar quarters?

SPDR Gold Shares /zigman2/quotes/200593176/composite GLD -0.43%   is an ETF that reflects the price performance of the shiny metal itself. More conservative investors can consider Permanent Portfolio /zigman2/quotes/205061618/realtime PRPFX -0.64%  . This fund is broadly diversified across several asset classes, including a 20% stake in gold, and can provide refuge in an uncertain market environment.

David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only, independent, Registered Investment Advisor. More information about his firm can be found at www.mainstaycapital.com .

Disclosure: Clients and employees of Mainstay Capital Management may hold the securities mentioned in this article in their investment portfolios. The securities mentioned may not be suitable for some investors, based on their tolerance for risk or their investment time horizon.

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