The "Fiscal Cliff Ahead" warning sign was first flashed nearly 10 months ago and not much has changed since. Fund managers are preparing for the worst, but anticipating something not so horrible.
Already some say they have shifted assets to prepare for a prolonged period of stunted growth, large budget deficits, and potential inflation in anticipation of what comes after a Washington cliffhanger that has been previewed for so long there is not much drama left.
The market remains almost exactly where was at on February 17 when Federal Reserve Chairman Ben Bernanke popularized the term, saying the U.S. economy was headed for "a massive fiscal cliff of large spending cuts and tax increases."
Washington may indeed "kick the can" with moderate tax hikes and spending cuts, and it's not likely to impose Tea Party-proportioned government curtailments. Instead, slow growth and low interest rates are what many fund managers expect. And for stocks, that is not a bad scenario.
How are fund managers planning year-end moves with the cliffhanger approaching? Here are views of three of them:
Rob Lutts, president and chief investment officer of Cabot Money Management, says any solution to the fiscal dilemma would likely weaken the dollar and lead to inflation at some point soon. The big winner would be gold, he says, which tends to rise if the dollar falls. Cabot is heavily invested in the pure play of bullion as opposed to mining stocks. His top investment is SPDR Gold Shares Trust (symbol: GLD), an exchange-traded fund (ETF) that tracks the price of physical gold.
But he sees a bigger problem looming in a government bond market pumped up by Fed policy in recent years by ultra-low rates. Lutts is preparing for an end to the "bubble phase" for U.S. bonds, which could collapse at the smallest whiff of inflation or sign that the Fed is moving to tighter credit.
"The assets we normally think of as having the lowest risk—high-quality U.S. bonds—have the highest risk right now," Lutts says.
He prefers financial assets in other currencies, among them two Wisdom Tree ETFs: Emerging Market Local Debt (ELD) and Asia Local Debt (ALD). He expects both funds, with a yield now between 4 percent and 5 percent, to rise to the 6 percent to 7 percent range for total returns in the year ahead.
He also likes Pimco's Income D (PONDX), a fund that can perform strongly even if the bond market falls because it is managed to adjust when the interest rate environment changes. Its yield is now just over 6 percent.
"We feel potentially good upside in equities when we get past this nervous period of concern," Lutts says. He prefers stocks of companies best positioned to maintain pricing power during times of inflation. His tech favorites are Qualcomm (QCOM), Sourcefire (FIRE), and electric car maker Tesla (TSLA). TJX Cos (TJX) is a retail stock he says could do well managing profit margins in a consumer rebound.
David Cassese, an associate fund manager at BlackRock who concentrates on consumer, healthcare, and technology sector funds, says that the market could get back to a fundamental earnings focus after two years of worry over fiscal brinkmanship in the United States and Europe. He says he will be "modestly optimistic" once there is a solution to the fiscal dilemma, which has "created a lot of noise" in markets.
"A slow-growth environment is not the worst thing in the world," he says. "Equities as a class are under-owned and valuations are attractive."
[Slideshow: Are Second Terms Good for Stocks?]
Microsoft (MSFT) and Intel (INTC) are stocks his funds own. The launch of Windows 8, which promises "not fast growth but a long upward slope," he says, could lift earnings for the "Wintel" allies. In the mining sector, BHP (BHP) and Rio Tinto (RIO) are companies that can manage costs as demand grows for materials, he says. The retail sector also could hold up relatively well. His fund owns retailer VF Corp (VFC), a leisure apparel company.