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Four Ways to Play If Your Assets Are in Cash

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Don't wait for lower lows; go to Plan B.

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Now that buy-the-dips has made it an investment hell for those with large sums of cash (and a very low exposure to stocks), I want to offer not words of encouragement (hang in there, bears stuff), but an investment opportunity that may ease some of the pain if you missed the rally and now don't know what to do. Before I describe this investment, let me touch on a few points that may help place the current environment in context.

There are 2 points in market cycles when investors who have a high percent of their assets in cash are most unsure how to proceed. One point is when a market has been beaten down for months (even years), the news is very bad, and investor psychology is so negative you could cut it with a knife. The other point is after stocks have climbed that wall of worry, with many investors clinging to their disbelief and waiting for the lower low that never comes.

The first such point occurred recently back in March of this year. The second is now.

To act at either point requires a level of conviction regarding the principles of contrarian investing (March 2009) and sound portfolio management (always). During such times, investors unwilling or unable to follow these principles can opt for Plan B.

Plan B is all about investment alternatives.

1. For example, one option involves -- options. Buy a stock and buy a put on that stock to protect the downside.

2. Or, buy a stock and sell a call to collect some income.

Both are designed to ease the pain of putting money to work at the "wrong" time -- i.e., at or around an internal low or a rally high.

3.
A third alternative is to buy a convertible bond on a company.

4.
There's a fourth alternative, one that existed several months ago and still has considerable investment merit even after the robust rally. That alternative is high-yield (junk) bonds.

When I wrote about the high-yield bond opportunity back on March 19 in Put Some JNK in Your Portfolio's Trunk, the ETF I referenced, JNK, was selling around $28. Today, JNK stands at $36 per share. The yield back in March was over 15%. Today, JNK yields 13.25%.



The reasons to own JNK (or the other large high-yield ETF -- HYG) are unchanged. Default rates on high-yield bonds (most of which aren't in either JNK or HYG's portfolios) are projected to peak around 15% to 20%. However, the yield spreads on high-yield to US Treasuries remains elevated.



As the accompanying chart shows, while the yield spread has declined substantially, it's come back to the level that occurred at the previous market bottoms. Therefore, as high-yield guru Marty Fridson recently pointed out in a Bloomberg interview, all that's occurred thus far is that the extreme fear factor that existed when the economy and markets were staring into the abyss has been worked off.

Moreover, to justify current spread levels, default rates would have to exceed 40%. On the assumption that the current economic recovery will extend into the end of 2010 (remember, there's still $700 billion of fiscal stimulus money to be spent next year), the likelihood that default rates will rise above 20% seems remote.

Investment Strategy Implications

Plan B alternatives enable cash-heavy investors with an option to earn a rate of return greater than their near zero-interest money-market accounts. JNK (and HYG) are still excellent options for a portion of one's capital for those (rightfully) concerned about a stock-market correction
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No positions in stocks mentioned.
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