The best offense may be defense

Editor's note: This is the second of two stories.

The U.S. economy has come full circle over the past 30 years, said Greg Bangma, portfolio manager for Maul Capital Management.

During the late 1970s and early 1980s, the country was going through recession and rapid inflation at the same time. Observers called this stagflation, and Maul Capital thinks it looks like a possibility for 2008.

Because of market conditions, it's a good time to be defensive and conservative with investment holdings, Bangma and two other analysts agree. They are Donald Parker, president of Gryphon Valuation Consultants and president of the Chartered Financial Analysts Society of Nevada, and Randy Garcia, chief executive officer of The Investment Counsel Co. and certified investment management analyst.

Parker is less pessimistic than Bangma but still recommends cautious investment strategies.

"I really don't see this being a severe crash landing," said Parker, a former investment portfolio manager and now a business-valuation analyst. "It's time to settle for hits as opposed to swinging for the fence."

Parker said quality is paramount; that means buying blue chip stocks of the biggest and best corporations in the country.

"I would urge investors to be patient. This is not a year to make any major (investment) decisions," Parker said. "As long as you're holding good-quality companies that have the capacity to withstand an economic downturn, you should be in good hands."

He recommends several defensive sectors: drug companies, utility and energy companies, food companies, and insurers.

One strategy he likes is called the Dogs of the Dow. An investor selects the 10 Dow Jones industrial average stocks with the highest dividend yields. Then, from that list of 10, the investor buys the lowest-priced stocks if the investor doesn't have enough money to buy all 10.

Most Dogs of the Dow practitioners do the exercise once a year, replacing stocks that no longer are among the 10 highest in dividend yield.

Parker looks at his stocks weekly and makes qualitative judgments of the holdings based on fundamental financial considerations although he infrequently changes his holdings.

Parker likes Pfizer (ticker: PFE), Merck & Co. (MRK), AT&T (T) and Altria Group (MO), which are blue-chip stocks with healthy dividends. Altria Group was dropped from the Dow last week.

Among the big banks, he sees value in the depressed prices for Citigroup (C) and JP Morgan Chase & Co. (JPM).

"I wouldn't count on any of these being at rock bottom," Parker said. "The yield more than makes up for the risk. You're getting paid for that downside risk."

For mutual fund investors, Parker advises moving new money into managed funds, in which analysts actively select stocks, rather than into index funds. Index funds are passively managed and contain a whole category of investments, such as the Standard & Poor's 500 list of largest publicly held U.S. companies.

Managed mutual funds tend to do better than stock-index funds during hard times, he said.

Pick a no-load fund sold by a mutual fund company without a commission or load, Parker said. Look for funds with low fund expenses and good records of past performance.

Parker recommends investors buy Treasurys or bond funds that invest in Treasurys because of credit risk with corporate offerings that could lose value because of default or bond-rating downgrades.

But Garcia rejects the idea of buying Treasurys now, because these government bonds pay rates that are lower than inflation, particularly after taxes.

Also, Garcia said individual investors should buy stock index funds, rather than trying to beat the market by picking their own stocks or entrusting money with actively managed mutual funds. Don't even try to make investment bets on sector funds, which contain stocks only from one industry, Garcia said.

The key, he said, is determining the best asset allocation among stock and bond index funds.

•First, an individual should have adequate liquidity to meet potential cash needs without having to sell investments in a down market.

•Second, investors should consider how long they plan to hold the investments. Stocks are generally suitable for longer-term investment periods.

•Finally, investors should ask themselves, "What kind of price changes can I stomach?" If an individual isn't willing to stick with an allocation in down markets, he should get a more conservative mix of stocks and bonds, Garcia said. Otherwise, the investor may panic and sell at a low price during a bear market.

An individual may decide to put half of his money into stocks, domestic or global funds that have both domestic and foreign stocks. (Garcia warned against moving large portions into foreign funds, because they already have enjoyed a strong run in recent years and offer too little upside potential given downside risks.)

The investor should put the other half of his money in a bond fund with a diversified mix of low-, medium- and high-quality bonds, Garcia said.

Investors can simply choose a target fund, which has a mix of stocks and bonds that get more conservative as the investor ages, he said.

A good target fund "kind of is the perfect meal," Garcia said.

He advised against a lot of a la carte investments to the target fund.

Bangma, who likens the 2008 economy to the stagflation of 30 years ago, says once again gold is appreciating in value. The price of gold shattered the 1980 record high of $850 an ounce in January.

"I think it can easily go beyond $1,000 (an ounce)," Bangma said, citing demand for the yellow metal in emerging markets such as China and Brazil. "People buy gold when they are afraid. People buy gold when they see inflationary pressure."

He sees other symptoms of stagflation. Gasoline, food and health care costs are climbing. Yet, the economy is slowing.

As a result, he recommends investing in utilities, consumer staples and health care.

"You still need to eat, you still need to go to the doctor," he said. "You still need electricity in your house."

Bangma added that the local single-family housing market will "continue to be a mess."

Based on data Bangma sees, prices of existing homes could easily fall another 10 percent to 15 percent this year. Look to the prices being charged by homebuilders for new homes as a leading indication of where used home prices are going, he said.

Prices of new homes in Las Vegas are lower than those for existing houses.

Gambling also could swoon, he said.

"You can have some form of gambling in almost every state," he said. "Maybe (gamblers) just stay closer to home."

Most of the hotel rooms being built are high-priced products, which conventioneers and their employers may resist, he said.

"You could possibly see one of these major shows leaving in a couple of years."

Contact reporter John G. Edwards at jedwards@reviewjournal.com or (702) 383-0420.