If your first instinct is to run for the hills, don't do it, investment pros say. Those looming defaults by European governments – and perhaps other nations – may have a silver lining. That's because the same dynamics that have imperiled sovereign debt obligations might also be creating new opportunities.
What investors have to do is find those areas of investment that will outperform in an era of slow growth and possible government defaults. The debt crises point the way.
"What the sovereign debt issues highlight is not just a particular country's ability to pay or make good on its obligations, but rather the rate and pace of global growth," says Lincoln Ellis, chief investment officer for Strategic Financial Group, a Chicago-based money management firm. "Those kinds of structural dislocations do in fact create opportunities for investors."
So where should you look? Bill Morse, senior vice president of Chicago-based Ziegler Wealth Management, likes the high-end retail sector, because the wealthy have shown an enduring appetite for luxury items, such as jewelry from Tiffany & Co. Mr. Ellis favors so-called defensive stocks, such as makers of consumer staples, along with broad market indexes that he says have been "oversold" recently. Jim Kee, president of South Texas Money Management in San Antonio, sees value in handpicking individual stocks that enjoy a competitive advantage in critical industries, such as computer security.
But what about the recent plunges in stocks? That's actually a positive sign, investment pros say: Stocks are now cheaper.
"We've been waiting for a sell-off. That sell-off has come," says Nicholas Sargen, chief investment officer for Fort Washington Investment Advisors, a Cincinnati-based money management firm. "We think this is a good opportunity."
To be sure, today's markets include wild cards that just might pop – or fizzle. Financial stocks, especially those of major banks, have taken a beating of late. Example: Bank of America stock lost 20 percent of its value over a few hours of trading on Aug. 8. Multiple factors have been at work, including worries about big banks' exposure to shaky European debt.
"There's huge opportunity and huge risk if you're talking about large, money center banks," Mr. Morse says. Best prospects, in his view, include firms such as JPMorgan Chase & Co., which aren't overly concentrated in one industry (e.g., housing) and have relatively clean balance sheets with few remaining bad loans or write-offs.
Some investors aren't ready to dive into the banking sector. South Texas Money Management is leery of financial stocks, Mr. Kee says, especially those with significant exposure to European sovereign debt or US mortgages. Other investors, however, think markets have been too hard on banks, including those that aren't on the hook for risky European debt.
"These stocks have been battered, and the market is pricing in too much negativity, long term, for their prospects," Mr. Sargen says.
Anxiety about sovereign debt has helped intensify risks in certain areas that promise strong returns. Kee includes in this category dividend-paying stocks with notably high yields.
"A stock can have a high dividend yield either because it pays out a lot, or because its price is cheap," Kee says. "If its price is cheap, there's usually a pretty good reason why: It's riskier. So going headlong into high-dividend-yield stocks is not the way to earn the kind of long-term returns that a lot of clients are looking for."
Silver also poses significant risks that some investors might not recognize, Morse says. Its price has soared in recent months, yet demand for the metal tends to be low in contrast with demand for gold, stocks, or bonds. Unloading silver at high prices can be difficult if the relatively small pool of silver investors turns fickle.
Bonds continue to offer opportunity, observers note, for investors seeking decent yields from solid issuers. US Treasury bills and notes are offering low yields because the "price of safety" is now paid in the currency of meager returns, according to Kee. Ultralow rates present their own risks in terms of inflation and foregone opportunities.
To gain a consistent 2.5 percent to 3 percent return, Sargen has been investing in bond funds with a time horizon of weeks or months. These tend to track indexes consisting of US government-backed debt or high-grade corporate paper. Morse also likes highly rated corporate bonds (BBB rating or higher), which can pay as much as 4 percent to 6 percent.
"It's not the same opportunity in high-yield corporate bonds, or junk bonds, that there was back [in 2008]," Morse says. "But high-grade corporate bonds is still a nice place to be."