My Strategy for Strategy Lab

07/31/2008 12:00 am EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

What a great time to be joining MSN Money's Strategy Lab!

We're in the middle of a financial crisis, a bear market, and a near-recession; we've had record oil prices and inflation appears to be heating up. An ideal environment for investing!  Just kidding.

MSN's Strategy Lab brings together professional and amateur investors who each invest $100,000 in play money. The winners-those who post the best performance over a six-month period-go on to the next round.

In this piece I'll lay out what I expect to see over the next six months and give you a few picks. You can follow my trading diary and that of all the other participants here.

But first, let me recap my "passive/aggressive" approach to investing. The vast majority of your assets (80% to 90% of your investment portfolio) should be spread widely among broad index funds. That way you can generate returns that beat inflation over time while lowering your risk as much as possible.

That's especially difficult in a market like this one, as I spelled out in a column early this year.

The other 10%, the "aggressive" part of my approach, is what I'm investing in Strategy Lab (assuming a $1-million investment portfolio, just to make things easy).  The goal of that part of your holdings is to take some risk and try to boost your return, whether it be in stocks or ETFs. I prefer ETFs to individual stocks, but will recommend some stocks, too, based on simple criteria: strong franchise, solid balance sheet, relatively low price-to-earnings-growth (PEG) and price-to-sales ratios, and strong price momentum. The latter is particularly important given Strategy Lab's six-month time period. "Hot hands" tend to stay hot in the short run, all other things being equal.

Most of my recommendations, however, will be based on my Big Picture view of the next six months. I'll then choose ETFs that I hope will profit from the trends I expect to develop. When it looks as if I'm right, I'll buy more. When I'm wrong, I'll sell. My goal is to have fun and to help you make money.

So, what are the major trends?

First of all, it's clear to me we're now in a bear market, which is unfolding along textbook patterns. (My previous hope that we would avoid one has unfortunately been proven wrong.) Sam Stovall of Standard & Poor's points out that the average bear market lasts about 14 months and reaches official bear market territory (20% off its peak) nine months after the high.

We hit that nine-month target right on the nose this time, and I expect the S&P 500 to lose up to ten more percentage points in a bear market that goes on for four to six more months. Unless the financial crisis gets a lot worse-which no one can predict-this six-month Strategy Lab could mark the bear market low and the beginning of a turnaround. Keep your fingers crossed.

The six months ahead will also be marked by two major global events-the Beijing Olympics and the US presidential elections. Each of those could have major impacts on investors, and they give rise to some of my Strategy Lab picks.

The 2008 Summer Olympics, whose opening ceremonies begin next week, have spurred a massive building boom as part of what may be the greatest economic transformation in history. They will showcase the new China to the world.

But once the Olympics and Paralympics end in mid-September, China will face a tougher reality. Inflation is high, heavily subsidized fuel costs are taking a bite out of the country's budget, and demand for Chinese-made products is slipping amid economic slowdowns in the US and Europe, causing excess capacity to grow in Shenzhen and other manufacturing centers.

The Chinese government, which has avoided taking strong measures to control these problems in the months leading up to the Games, may begin to move once the television cameras are gone and the klieg lights are off. If it doesn't, China may face a bigger threat-runaway inflation. Either way, the Shanghai market, which experienced what may have been the biggest bubble of modern times and is already off more than 50% from its peak, should move even lower in the months ahead. 

That's why I'm recommending the ProShares Ultrashort FTSE Xinhua 25 Index (Amex: FXP)-a two-for-one play on Shanghai's decline. This is not for the faint of heart-if you want to bet against Shanghai, you can also buy put options on the iShares FTSE Xinhua 25 index (NYSEArca: FXI). Either one would get crushed in a bear-market rally, so I'll be keeping one eye on the exits.

Here in the USA we have a momentous event of our own coming up-the first up-for-grabs presidential election (in which neither candidate was a part of the previous administration) since Dwight Eisenhower defeated Adlai Stevenson in 1952. To make things much more interesting, first-term Senator Barack Obama has become the first black candidate to head a major party's ticket.

Right now the race is pretty tight, according to the polls, even though Senator John McCain is running the worst campaign since-well, Hillary Clinton in this year's Democratic primaries. But ultimately, as I wrote here in March, I think this is the Democrats' year. Odds are they will widen their majorities in the US Senate and House of Representatives, giving them enormous power to shape events even if Senator McCain wins the White House.

And a "simple electoral barometer" combining the incumbent president's approval rating, the GDP growth rate, and whether the governing party has controlled the White House for two terms has correctly predicted 14 of the last 15 presidential elections. "The barometer," writes Clive Crook in the Financial Times, "says Mr. Obama is going to waltz to victory."

Such a Democratic sweep may well precipitate the market capitulation everyone is looking for as investors despair about the higher taxes and greater regulation associated with Democratic administrations. At that point, more financial blow-ups notwithstanding, the Federal Reserve may begin to raise short-term interest rates again, too. So, my best guess is we'll see a bear-market bottom in November.

Overall I see the US dollar strengthening, at least for the short run, as the economic slowdown bites deeper in the UK and the Euro zone. That's why I'm recommending ProShares DB US Dollar Index Bullish (Amex: UUP). The dollar may weaken again later, but I think it's going to have a respite now as the rest of the world catches our bug.

In the rest of my Strategy Lab portfolio, I'll invest for the bear and prepare for the new bull. That means sticking with some strong stocks and sector ETFs and buying other things that could pop if the market turns around for real. Two ETFs I like now are the SPDR S&P Biotech ETF (Amex: XBI) and the iShares S&P MidCap 400 Growth Index (NYSEArca: IJK). Both areas have held up well, and midcap growth would be an early beneficiary of a market recovery.

That's it for now. I'll be coming up with more picks in the days ahead, so please keep watching Strategy Lab and reading this column!

Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his own and do not necessarily reflect the views of InterShow or MoneyShow.com. At this date, he does not own any of the securities mentioned in this commentary.

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