COLUMN-Sure things in the age of uncertainty

Mon Jun 25, 2012 2:47pm EDT

By John Wasik

CHICAGO, June 25 (Reuters) - If there was such a thing as a global financial uncertainty index, it would be soaring to a stratospheric level.

The euro zone crisis still festers, 15 major banks were recently downgraded by Moody's and the U.S. faces a boatload of political risk through its year-end of fiscal cliff tax increases.

Markets are being roiled by volatility, and so bonds have become like caves - refuges from widespread fear.

Welcome to the golden - or rather leaden - age of uncertainty.

"It's a groundhog day effect - it's as if the news is replaying and the European Union goes around in a tortuous circle," says Jeremy Grantham, chairman of GMO LLC, speaking at the Morningstar Investment Conference in Chicago on June 22.

The positive news that's often being obscured by darker headlines is that earnings for large U.S. companies are fairly robust, although Grantham, whose firm manages more than $105 billion and is known for being a top value investor, sees them as "abnormally high" and U.S. stock valuations as "not cheap".

While Grantham may not be optimistic about short-term market conditions, he's long advocated high-quality stocks and a focus on long-term resource shortage issues. Even in a skittish time, for the largest corporations, profits usually translate into steady dividend payments. His firm's GMO Quality III fund , for example, invests in mostly giant companies like Microsoft Corp, Johnson & Johnson and Apple Inc . The fund's dividend yield is 2.7 percent.

Like many market observers, Grantham sees slow-to-moderate economic growth over the next seven years. He forecasts that U.S. "high-quality" stocks will grow about 5 percent over the next years, overshadowed by emerging markets at nearly 7 percent and international large companies at 6 percent.

Running a parallel path with his outlook for stocks is a growing reality that natural resources aren't keeping pace with the population growth of the 7 billion souls already on the planet. That forces a long-term focus on resource allocation and commodities. To feed everyone, more land, fertilizer and agricultural productivity is needed.

Grantham has created a chart of a commodity index that starts in 1900 and shows that there have been "rolling crises of availability" only broken by a "great paradigm shift" in recent years in which demand has soared.

"Never has there been such a crushing of an asset class (commodities) and a rebound to an all-time high," he added at the conference.

How will the world produce more natural fertilizers and arable land when the supply is finite and food production may be hitting an "agricultural glass ceiling?" That answer isn't known, but in the interim, Grantham suggested "thinking favorably about farms, resources, fertilizer and timber."

OPPORTUNITIES

In this bleak scenario, what should a long-term investor keep in mind? That the euro crisis and U.S. political logjams will eventually pass, although not without a heavy dose of sturm und drang or "storm and stress".

There will be opportunities to buy stocks that have what analysts call wide "moats," that is, they can generate cash and dividends in even the most trying global situations. Grantham's Quality fund, for example, is heavily weighted in consumer defensive and healthcare stocks.

A more long-term approach is to buy funds that track an index of commodities such as the PowerShares DB Agriculture exchange-traded fund that holds futures contracts in everything from coffee to wheat.

If you want even more specialization in this sector, consider the Global X Fertilizers/Potash ETF, which concentrates on fertilizer companies; or the Market Vectors Agribusiness ETF, which has a broader mix of companies in this sector.

Other considerations include ETFs like the Consumer Staples Select SPDR fund, Vanguard Consumer Staples ETF or the iShares Consumer Staples Index fund.

Aside from tweaking your holdings, there's always an opportunity in the age of uncertainty to lower portfolio risk. Make sure you adjust your allocations to the human capital opportunity you have. Are you nearing retirement and heading into a fixed-income lifestyle? Then your main concern should be cash flow, limiting your expenses and hedging against inflation with inflation-protected securities and annuities.

If you're younger, evaluating your human capital risk also involves an honest view of how your income will be impacted in coming years. Are you in an industry or profession that's prone to downsizing or outsourcing? In recent years, even once-secure government jobs have been disappearing.

Ultimately, it's your ability to generate a sustainable income and save it that will be the most demanding test in these anxious times. Remember the best forecast has nothing to do with stocks or bonds; it's the one that most accurately predicts your ability to weather the many storms ahead.

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