GREG HOFFMAN
April 16, 2010 - 9:42AMEven dyed-in-the-wool, bottom-up stockpickers like me have to accept one inalienable fact; economies and markets are now so interconnected as to be systemically linked; a problem in one area of the system rapidly moves to another.
That fact does not demand predictions as to what will go wrong, when or where. But it does imply preparation for scenarios that would impact your investments. Don't predict, prepare.
For Australian investors, leveraged as we are to the China growth story, that preparation should include an assessment of how your portfolio would stand up were China's growth to slump, if only temporarily.
''Up ahead they's a thousand' lives we might live,'' counselled Ma in John Steinbeck's The Grapes of Wrath, ''but when it comes, it'll only be one.'' And so it is with our portfolios.
It's prudent not to weight your portfolio wholly towards any single possible ''life''. And, several factors are leading The Intelligent Investor's analysts to recommend investors consider building some protection into their portfolios.
These factors include the fact that many previously unloved stocks are now back in vogue, the possibilities of China's growth slowing, inflation and the substitution of private for public debt by governments around the world.
I'd encourage you to consider your own exposure to currently fashionable cyclical stocks like One.Steel, Seek and Amcor. If you find you're a bit heavy, then it might be a reasonable time to think about re-weighting your portfolio.
Bolstering your cash balance is a great way to build capital stability and also maximise your flexibility for any future dip or downturn in the market; the proverbial financial ''dry powder''.
We're also looking to build in another layer of protection through careful re-investment. A number of top-class blue chip stocks have been left behind by those rushing back into cyclicals and some of these might make great additions to a long-term portfolio.
Current stock recommendations
Stocks such as Foster's Group, Santos and Insurance Australia Group are on our current shopping list, as are several quality stocks with significant offshore income (such as QBE Insurance and Sonic Healthcare).
These stocks offer the potential for significant gains if the Aussie dollar were to take a tumble for any reason (bear in mind that a little over a year ago, our dollar was fetching less than 70 US cents).
We also have a few carefully-selected infrastructure stocks on our buy list as well as a property developer or two. We expect the latter to provide more cyclical oomph if Australia manages to skirt any major economic setbacks from here.
By combining a higher cash balance with a re-weighting towards less cyclical stocks, we hope to maintain a sensible equilibrium between offence (should markets continue higher) and defence. But how you react from here will be crucial.
We're now recommending investors begin changing their stance in the expectation that further gains will be much harder fought. A number of commentators seem confident that the Australian business sky is blue as far as the eye can see.
It's an increasingly fashionable idea and we've been around long enough to know that in financial markets, danger can lurk in such trendy consensus views.
Our preference is to begin buttressing our portfolios for any potential bumps in the road. Our weapons of choice are increased cash holdings and a higher weighting to more stable, defensive businesses, which currently strike us as offering better value than the more expensive and volatile cyclicals.
This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investor
Greg Hoffman is research director of The Intelligent Investor
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