Equities Investors Need To Stay On The Defensive In 2012

Janet Whitman, |Special to CNBC.com
Wednesday, 18 Jan 2012 | 9:53 AM ET

Stocks are probably in for another bumpy ride this year, but that doesn’t mean investors should steer clear.

By making selective and defensive picks investors still should be able to eke out some decent returns — at least better than the paltry payouts offered by money-market funds these days, market strategists and portfolio managers say.

Rose | Mueller | Stock4B | Getty Images

“A lot of headwinds, including political paralysis in the United States and Europe, have been weighing on the market and that’s going to continue in 2012,” says Brian Gendreau, market strategist with Cetera Financial Group. “But we still recommend a substantial allocation to equities.”

Gendreau likes defensive plays such as high dividend-paying stocks and defensive sectors including healthcare, consumer staples and utilities.

He advises investors to be cautious when it comes to the energyand technologysectors, which tend to have a lot of global exposure, and also to be wary of the downtrodden financial sector.

“Financials are beaten down,” says Gendreau. “Someday they’re going to be a great bargain, but we are not brave enough to recommend them to our clients yet.”

The major US indices are off to a positive start in 2012, after a mixed 2011: The closely-watched Dow Jones Industrial Average ended 5.5 percent higher; Standard & Poor’s 500 Stock Index flat; the Nasdaqdown 3.2 percent.

Hugh Johnson, chairman of Johnson Illington Advisors, expects the stock market to stay “trendless and volatile with a slight upward tilt” in 2012.

“If we do go up, it’s probably not going to be by much,” he says.

With the European Union’s sovereign debt woes and geopolitical risk in the Middle East and Asia, stocks might manage a gain of 5 percent for the year plus an additional 2 percent in dividends for a total return of 7 percent, he says. “I give that estimate with my fingers crossed.”

For that kind of market, investors should choose “a somewhat boring portfolio,” he adds. “You need to own things that work well in a bull market and things that work well in a bear market – or at least go down less.”

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He advises overweighting in bull-market sectors such as consumer cyclical and industrial stocks as well as bear-market sectors such as consumer staples and healthcare.

He also recommends picking companies that have low exposure to Europe. “One way to do that is to go with small caps, which have mostly domestic exposure. Or if you want to go large cap, try U.S.-focused companies such as Coach and Disney . They have some European exposure, but it’s not overwhelming.”

One problem for investors this year is that money poured into dividend-paying stocks and other defensive plays last year as the stock market sputtered.

Scott Richter, a portfolio manager with Fifth Third Asset Management, sees some upside if investors are selective.

“There’s still some value in healthcare,” he says. “The energy sector is still cheap.”

In particular he likes California biotech company Amgen , oil field services company Baker Hughesand oil giant Royal Dutch Shell .

While utility stocks have had a big run up, Richter says electricity company Exelon is an exception, making it a good bet.

James Swanson, chief market strategist with Boston-based mutual fund MFS, says investing in dividend-paying stocks is a no-brainer.

He notes that dividends represent 40 percent of investor returns in the long run and are much less volatile than corporate earnings.

Contrary to some other market strategists, he also likes big technology companies, such as Intel.

He expects a surge in demand for the products Intel and other tech giants produce because companies in the United States have been putting off such purchases.

Jim Paulsen, a market strategist with Wells Capital Management, thinks investors should start putting their money where others aren’t.

He’s optimistic that concerns about Europe will fade to “chronic problem” status and the economy and stocks will perform better than expected.

With that in mind, Paulsen says he would be wary of what he calls “steady-Eddie consumer staples, risk-averse utilities and dividend-paying large caps.

“Not that they’re going to get killed, but everyone ran there [last year] and bid up their values,” he says. “I’d be underweight there and take stuff people have been throwing out the window in the summer.”

On that list would be cyclicals and emerging market stocks, “which everyone left for dead,” he says.

For cyclical sectors, Paulsen likes U.S. industrials and materials best.

He notes that industrial companies were downtrodden because they were among those hardest hit by supply-chain problems coming out of the post-tsunami environment in Japan.

Manufacturers should gain an improved competitive position, meanwhile, from what he expects to be a weaker US dollar, as the currency loses some of its “safe-haven” premium.

For emerging markets, he recommends being diversified across the developing world, not just in China and India.

“Given how much of the emerging market was left for dead, it’s a great time to look at some of the frontier market as well,” says Paulsen.

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