Last week I began a discussion about how the nearly $2 trillion that the government is injecting into our financial system and economy will produce a short-term recovery in the stock market and our economy as well as reduce unemployment but will also create longer-term challenges. Here’s the rest of the story along with a few self-defense strategies you can use:
Falling US Dollar. Currently, the U.S. dollar is strengthening against most foreign currencies. The primary reason is that all foreign countries are experiencing a similar economic downturn and globally, investors still believe the U.S. Dollar is the safest currency in the world. Once the world economies begin to recover, expect foreign investors to abandon the U.S. dollar on a wide scale. As a result, the dollar will plummet.
- Strategy: Own foreign currencies. Consider holding deposits in foreign money market accounts. This can easily be done through Exchange Traded Funds (ETFs). For more information, go to www.CurrencyShares.com.
- Strategy: Own international mutual funds (Vanguard Total International Stock Index- VGTSX) or ETFs such as EFA that do not ‘hedge’ against the U.S. dollar.
High interest rates. The Fed has purposefully driven interest rates down in an effort to add liquidity to our financial system and stimulate borrowing, so far with modest results. Currently the Fed Funds Rate stands at between zero and 0.25%. Knowing that it can’t go below zero, interest rates only have two possibilities, stay in a sideways pattern or go up. Best bet…up.
- Strategy: Avoid long-term bonds. Your best defense is to stay relatively short (less than 5 years) with bond maturities unless you are specifically using a bond ladder to cover future cash flow requirements.
Rising energy costs. We all remember the anxiety of $4 per gallon gasoline. A barrel of oil has ranged from a high of $147 last year to about $40 a barrel range today. What’s in our future? Expect to see $60 to $80 per barrel in the next 2-3 years and likely $100-plus per barrel within 5 years. The driver will be a recovering world economy including China, India and the United States.
- Strategy: Buy energy related securities such as energy stocks (Exxon); ETFs (IYE) or mutual funds (Vanguard Energy- VGENX).
Rising income taxes. If Obama fulfills his campaign pledge, taxpayers making over approximately $200,000 will face higher tax rates.
- Strategy: For high tax payers, consider tax-free municipal bonds. The value of existing tax-free bonds will increase when tax rates go up. Also, tax-free bonds currently offer attractive yields on a relative basis.
- Strategy: Max out contributions to tax-deductible, tax-deferred retirement plans such as 401k, Roth IRA and Traditional IRAs.
Gold as a hedge. No discussion about building a defensive portfolio would be complete without considering gold. Historically, gold has proven to be an imperfect choice as a hedge against inflation or a faltering economy. In fact, it only works as one would expect it might about 60% of the time. However, if the current recession were to topple over into a depression, gold prices would likely soar.
- Strategy: To hedge against a potential economic catastrophe, consider gold stocks, gold ETFs (GLD) or gold coins or bullion.