The new year is upon us, and it's time to think about investing in 2005. Making serious money will require playing through a complex series of interest-rate, currency, and electoral cycles. Knowing how to arbitrage cost imbalances in the global economy will help as well. Investors will have to distinguish between near-certainties (the dollar will fall; interest rates will rise) and worrisome uncertainties (the shape of Social Security reform and events in the Middle East). Surprises abounded in 2004. We can expect no less in the new year.
Here is what to look for in 2005:
CASH. With interest rates probably entering a rising cycle, companies with strong balance sheets, low debt, consistent earnings, and plenty of cash on hand are bound to outperform. Look for companies repatriating big earnings from abroad as well. They will pay only 5.25% in taxes on billions of dollars in profits. Look, too, for companies paying dividends. They did better than nondividend-paying companies in 2004 and will probably do so again next year. With earnings growth expected to be in the single digits in 2005, dividends will offer an added kick to overall returns. And the reelection of George W. Bush almost guarantees that the capital-gains and dividend tax cuts passed in his first term will be made permanent in his second. When people face paying an income tax rate of up to 35% on savings or 15% on dividends, they'll choose dividends. General Electric Co. (GE) and Boeing Co. (BA) just raised their dividends. Follow the money.
THE DOLLAR. If history is any guide, the dollar has at least another year to go in its descent. One look at the yawning current account deficit should tell you that there could be an additional 10% to 15% decline before the trade gap begins to close substantially. That means U.S. multinationals that generate 30% or more of their earnings abroad should do well in 2005. Look especially for companies with large operations in Europe and Japan. The dollar is falling most sharply against the euro and the yen. Shifting asset allocation to invest more in German, French, and Japanese companies also makes sense. And if Beijing decides to revalue the yuan, investors in highly profitable Chinese companies could get a windfall.
POLITICS. Wall Street is pumping out stories on how to play the Bush reelection, but investors should be cautious. Even if Congress passes a bill partially privatizing Social Security in 2005, it will probably take two or three years to set up 100 million private accounts and several additional years for them to amount to much. Investment options will initially be limited to a half-dozen low-fee index funds. So low-cost financial-service firms are more likely to get the Social Security private account business. Wall Street's prominent brokerage firms, however, should profit much sooner from health savings accounts that are already spreading throughout Corporate America. Bush made them legal in his first term and promises to sweeten them with more tax breaks in his second. HSAs are likely to be modeled after 401(k)s, with many investment options and more business for Wall Street.
MARKETS. Investors will need to be nimble in 2005, moving into segmented markets. The Hispanic market is booming, and companies successfully selling into it are profiting. Media, financial, and health-care companies that target Hispanic consumers should do well. Tax breaks, energy worries, and global warming are making nuclear, wind, and solar energy increasingly important markets. The so-called BRICs -- Brazil, Russia, India, and China -- are growing much faster than Europe, Japan, and the U.S. Investing in them means playing the outsourcing and offshoring game, arbitraging the cost differences within the global economy. Russia, of course, is almost a pure energy play, so caution is warranted.
The mergers-and-acquisitions market could take off in 2005 as companies deploy their billions in cash holdings. The yearend burst of M&A activity may be a harbinger of lots more action to come, providing expanding opportunities for investors. Look for consolidation in software, telecom, textiles, retail, and high tech.
No one, of course, can predict what next year's surprises will be, only that there will be some. A bloody election in Iraq could send oil prices skyrocketing again. The dollar could crash, but it might also bounce back by yearend. And bonds remain a mystery. Long-term rates continue to be surprisingly low even as the Federal Reserve is on the march to raise short-term rates and soak up liquidity. At some point, long rates could lurch upward. Or not. Happy New Year.