U.S. ECONOMY

A "Bottom-Line" Outlook for the U.S. Economy

Clearly, if Congress cuts back on government spending in the New Year, we can expect to see some acceleration in growth. However, that acceleration will be brought to an end - probably in 2012 - by the surge in inflation from the U.S. central bank's amazingly accommodative monetary policy, which will cause a rise in interest rates and a crash in commodity and U.S. Treasury bond prices.

This development - combined with the still-troubled U.S. housing market - will spawn a new (actually, a renewed) banking crisis. And that will make the next recession an exceptionally nasty one, with a market "bottom" and spike in unemployment that's deeper and more damaging than the predecessor that ended in 2009.

There could be a good-news outcome to this gloom, however - provided that the second "dip" is followed by restrained public spending, that bank bailouts are avoided and that interest rates are boosted to a level that's at least 2% to 3% above the inflation rate. If those conditions are met, U.S. growth will resume at the traditional brisk U.S. rate, probably with a post-recessionary catch-up to absorb the high level of unemployed people and other resources that have stood idle.

That brings us to the bottom line for this New Year U.S. economy outlook: If, as I expect, Congress cuts public spending substantially, while the Fed pursues easy money as long as it can, my prognostication is for rather faster growth in 2011, followed by a nasty financial crisis and second "dip" in 2012-13. After that, if fiscal and monetary policies have been restored to a more normal track, the U.S. economic recovery that follows that nasty spell should be brisk as what we experienced in the very strong stretch that took place from 1983-85.

Actions to Take: With uncertainty serving as the watchword in the New Year, investors will want to position themselves to profit should the U.S. stock market run up - while at the same time protecting themselves against possible downturns.

Impossible, you say?

Not if you adopt this "protective portfolio" to your own needs.

Here are the five steps that you can take. This strategy will allow you to add to your existing holdings in such a way that you will benefit should the economy (and U.S. stock market) continue to advance. But should the U.S. economy stumble, causing U.S. stocks to do the same, these moves should cushion - or even offset - some of your losses.

Investors looking to adopt such a stance should:

1. Buy gold: At some point, the U.S. Federal Reserve will be forced to abandon what is clearly the most accommodative monetary policy in modern U.S. history. But until that happens, inflation remains a real threat. And that means you need to hold gold. There are many ways to invest in gold. Physical gold is always an option. Exchange-traded funds such as the SPDR Gold Trust (NYSE: GLD) is also worth considering.
2. Buy dividend-yielding U.S. stocks: Income rules, especially during periods of uncertainty. Most investors fail to realize that dividends account for a major piece of the historic returns that stocks have offered over the long haul. Dividends provide a cushion during the tough times, when stocks are stuck in a trading range, and can help prop up a company's share prices when the broader market is in decline. One good example right now is B&G Foods Inc. (NYSE: BGS), the Parsippany, N.J.-based maker of such consumer products as Cream of Wheat oatmeal, Maple Grove syrups and pancake mixes, Ortega taco mixes and sauces - as well as many other products that grace American cupboards. The stock currently yields 5.3%.
3. Reap the best of both worlds: As part of the portion of your portfolio dedicated to U.S. stocks includes several American companies that have some muscle in overseas markets. This is a great way to hedge your bets - you get the disclosure and accounting-rule benefits of U.S.-listed companies, and the growth offered by such fast-evolving overseas markets as China, India, parts of Latin America and other parts of Asia. Companies in this category would include such U.S. stalwarts as Caterpillar Inc. (NYSE: CAT), McDonald's Corp. (NYSE: MCD), soda-and-snack-maker PepsiCo Inc. (NYSE: PEP), soft-drink giant Coca-Cola Inc. (NYSE: KO), jet-airliner leader The Boeing Co. (NYSE: BA), and fast-food magnate Yum! Brands Inc. (NYSE: YUM).
4. Look abroad: It's a U.S.-centric world no longer. That means that markets such as China, India - and others - can no longer be viewed as portfolio afterthoughts. They must be given serious consideration at the start of the construction of any investment portfolio. In the New Year, one such market that can't be ignored is Chile, which is positioned to be a top performer in 2011. The most-straightforward way to travel is the exchange-traded fund route, via the iShares MSCI Chile Investable Market Index Fund (NYSE: ECH). In terms of individual stocks, check out Vina Concha y Toro SA (NYSE ADR: VCO), a producer of very-high-quality wine. It's currently trading at about 21 times earnings, with a dividend of nearly 4.0%. That's a somewhat premium valuation, but I like the dividend and Vina Concha is unquestionably a premium company.
5. Don't ignore the possibility of an economic downturn: If the U.S. economy were to experience a "double-dip" recession, the U.S. stock market will suffer in kind. We recommend buying out-of-the money "put" options on the U.S. Standard & Poor's 500 Index. Look at options that are well out of the money. That will allow you to purchase this "insurance" at a reasonable price, and will put you in a position to offset some of your losses with gains on these securities - should U.S. stocks nose-dive. You can purchase these on the Chicago Board Options Exchange (CBOE). Right now, I'm looking at the December 2012 puts with an S&P 500 strike price of 700 (meaning the S&P would have to fall from its current level at 1,186 all the way down to 700 - a 40% decline). This option right now trades at approximately $37. You'll only make money if the market really crashes - as it did in 2008. But if that happens, you'll reap a real bonanza.

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