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NEW YORK Some money managers can't leave 2012 behind - even if they want to.
That's because President Barack Obama and Congressional Republicans remain locked in negotiations over avoiding the "fiscal cliff" - a package of nearly $600 billion in tax increases and spending cuts that, should they take effect as scheduled in 2013, could send the U.S. economy into a recession.
While they remain optimistic for a resolution that would prevent an economic slowdown, some investors say the fiscal cliff is complicating their investing strategies for the next year. Depending on what happens in Washington in the next few weeks, the 2013 outlook for sectors ranging from the housing market to fixed income could swing widely.
"It's a hard environment to invest in," said T. Doug Dale, chief investment officer at Security Ballew, a wealth management firm in Jackson, Mississippi, with $500 million in assets under management. "If you are riding a bike that's going only two miles per hour it doesn't take much of a slowdown to tip over."
For now, the stock market seems to expect some type of deal will be reached to avert an economic slowdown. The Standard & Poor's 500 stands at nearly the same level it did on November 6, the day of the U.S. elections, and is just 3.3 percent below its September 14 high for the year of 1,465.77.
But Dale and other money managers say they are following a two-pronged approach: focusing on fixed income and other safe assets while they wait out the delay in Washington, and positioning for the new year once a deal is reached - even if it's a retroactive fix in early 2013.
SAFE NOW, BULLISH LATER
Ted Wright, director of portfolio management at Genworth Financial, said safe assets should benefit as the negotiations in Washington get closer to the year-end deadline that will trigger the tax hikes and spending cuts. He's focusing for now on longer-duration Treasuries, which can be easily held through a fund like the $3.8 billion Vanguard Long-Term Treasury fund.
If a compromise is reached, Wright will concentrate on the improving U.S. housing sector - assuming, of course, that any fiscal cliff resolution doesn't affect the tax deduction for mortgage interest, which benefits millions of homeowners and is widely seen as a support for the housing market.
He plans to increase his holdings in exchange-traded funds like the iShares Dow Jones US Home Construction index, a $1.6 billion fund whose top holdings are Lennar Corp, PulteGroup Inc, and D.R. Horton Inc.
"The rising tide will lift a lot of boats if the housing market continues to improve, which I think is likely" as long as the mortgage interest deduction isn't changed, he said.
Other bullish investors are preparing similar short-term safety plays, such as moving more assets into cash to avoid losses should the fiscal cliff talks sour.
"Because of the fluid nature of the negotiations we are prepared to move quickly" over the next few weeks, said Dan Veru, chief investment officer of Palisade Capital, a fund manager in Fort Lee, New Jersey, with $3.5 billion in assets.
But in the new year, he plans to increase his positions in small-cap healthcare service and technology companies because he expects more of them to be acquired by large cap firms looking for ways to grow, he said. Approximately 30 companies held in his funds were acquired in 2012, for an average premium of 40 percent, and he expects that number to continue to increase over the next couple of years, he said.
There could be roadblocks, of course. Mergers and acquisitions stalled in the first nine months of 2012, with worldwide deal values down 16 percent from the year before, according to Thomson Reuters data. The resolution of the fiscal cliff, along with the full implementation of the health care reform in the United States, should give corporations more certainty to close deals in the new year, Veru said.
Investors who want to piggyback on this strategy could opt for the $4.5 billion Merger fund, a specialized fund that focuses on merger arbitrage by buying shares of takeover targets. The fund, which costs $1.33 per $100 invested, has returned just 2.2 percent in 2012, compared with a nearly 12 percent jump in the S&P 500. Over the last five years, however, the fund has bested the S&P index by an annualized 1.4 percent.
A CAUTIOUS APPROACH TO 2013
Dale, the Mississippi money manager, is pessimistic that the stock market will remain calm about the fiscal cliff. "We could easily see the market on a short-term basis fall to 1,340," he said, which would be a decline of 5.5 percent from the S&P 500's current level of about 1,418.
As a result, he's increasing his position in gold and is reducing his position in equities to 25 percent of assets from about 30 percent at the beginning of 2012. The stock market may have a short-term rally after a deal, he said, but he doesn't expect the S&P 500 to gain meaningfully in the first half of 2013.
Instead, he's increasing his position in emerging market debt, buying the iShares JPMorgan Emerging Market Bond fund, an ETF that holds U.S.-denominated debt issued by countries such as Mexico, Brazil and Turkey. These countries tend to have less debt and younger populations than the group of major industrialized nations, he said.
(Reporting By David Randall; Editing by Jennifer Merritt and Leslie Adler)