Investment Strategies for a Broke America

Conflicts over taxes, spending and entitlements will very likely continue for decades – and transform the outlook for investing.

  • Share
  • Read Later
Paul Thomas / Getty Images

Assuming the deal to raise the debt ceiling works out as expected, the world will breathe a sigh of relief. But it would be naïve to think that U.S. financial problems have really been resolved. Not only will there be more fraught negotiations later this year. But conflicts over taxes, spending and entitlements are also likely to continue for decades – and transform the outlook for investing.

Rather than focusing on the debt ceiling, smart investing needs to be based on the long-term economic fundamentals that can be known with some degree of confidence. What will matter most in the long run is the combination of ever-more-expensive healthcare technology and the aging of the Baby Boomers. Controlling the cost pressures that result will be a constant struggle into the 2030s, according to the Social Security Administration.

(MORE: Debt Deal Winners and Losers on Wall Street)

Moreover, spending that can’t easily be restrained often leads to serious inflation. If the government allows debt to pile up, rather than paying for it with taxes, there is a strong political temptation to reduce the real value of that debt through inflation. And higher inflation also typically brings higher interest rates.

Without trying to predict exactly how these trends will play out or how serious they will be, investors can draw a few reasonable inferences. We will face a difficult financial environment for the next 20 years or more. The possibility of deteriorating credit ratings and higher interest rates makes all government bonds – federal, state and municipal – riskier than they have been since the inflation of the late 1970s. And insofar as similar problems are taking place in Europe, possible defaults on Eurozone bonds could adversely affect bank stocks all around the world.

(MORE: The Folly of Trying to Time the Market)

As safe havens become harder to find, investors are likely to pay a premium for financially strong stocks, as well as for companies with especially secure businesses. Shares that pay high, reliable yields should also become more attractive if investors have less confidence in government bonds. With those things in mind, here are six investment categories – some of which overlap – that seem especially timely.

  1. Companies with more cash than debt. Apple now has more ready money than the U.S. government does. And Apple isn’t alone. Other cash-rich companies range from tech stocks like Intel (yielding 3.8%) and Microsoft (2.3%) to brokerages and fund companies like Charles Schwab (1.6%) and T. Rowe Price (2.2%).
  2. Companies with AAA credit ratings. Thirty years ago, dozens of companies qualified for top credit ratings. Today only four still receive top marks from Standard & Poor’s: Automatic Data Processing, currently yielding 2.8%; Exxon Mobil, paying 2.4%; Johnson & Johnson, 3.5%; and Microsoft, 2.3%.
  3. Top consumer brands. Companies that sell consumer staples tend to hold up well in a troubled economy – especially if they have well-known brands. These four stocks receive top ratings for quality and have paid dividends for at least 25 years in a row: Coca Cola, yielding 2.8%; Colgate-Palmolive, 2.7%; Johnson & Johnson, 3.5%; and Procter & Gamble, 3.4%.
  4. Oil stocks. Over the long term, oil stocks ought to profit from rising demand for energy. They also provide some protection in the event of serious inflation. Three U.S. oil companies stand out for their commanding positions in the industry and their solid dividend yields: Chevron, paying 3%; Exxon Mobil, 2.4%; and ConocoPhillips, 3.7%, which is in the process of splitting off its refining business.
  5. Stocks with above-average yields. Several solid stocks offer yields higher than the 3.8% available on 20-year Treasury bonds. Among them are depressed drugmakers Merck (4.5%) and Pfizer (4.2%) and phone companies AT&T (5.9%) and Verizon (5.5%), both of which are benefiting because they provide wireless service for Apple’s best-selling iPhone.
  6. Foreign funds. While both the U.S. and most of Europe face serious financial problems, there are a few countries that are in good shape, and you might want to diversify your investment portfolio by including a couple of foreign funds. The iShares MSCI Germany Index fund (EWG) focuses on the largest German companies. And the closed-end Swiss Helvetia fund (SWZ) has the merit of owning stocks denominated in Swiss francs, one of the few major currencies nowadays that isn’t in some kind of trouble.