3 Conservative Plays for Income Bulls

The stock market�s powerful and persistent rebound since October is nothing to scoff at. Around the globe, the rally has reinvigorated investors� taste for risk.

Once awakened, �animal spirits� can drive prices higher for some time. So it�s prudent, at this point, for us to assume that the bull has won a life extension of at least several months or perhaps until late April or (less likely) mid-July — two well-worn seasonal stopping points in past market uptrends.

The main question for us, as long-term investors, is whether stocks can continue to climb through the rest of the year and end on a bright note. Or will the early energy dissipate, as it did in 2011, leading to a sharp setback and, at best, a ragged recovery?

We can�t know yet, of course. But the next five to seven weeks may give us a clue.

If some of the fundamental issues I�ve discussed earlier (European debt and higher taxes) start moving toward a favorable resolution while market values improve and speculative fervor cools, I�m prepared to add to my equity exposure.

For now, though, I�m sticking with a conservative allocation of just over half of my portfolio to stocks. A three-year-old bull can live on, but he�s due for a couple of important health checks soon. Watch and listen to the vital signs:

Stocks

Stocks (51% of my portfolio) have repeatedly defied calls for a pullback in January and February. However, investor sentiment is now so lopsidedly optimistic that a brief �tummy tester� seems almost inevitable. Watch for the S&P 500 index to backtrack 5% to 8% from its recent highs before driving ahead to a new post-2008 peak — by a small margin — in late April or early May.

Strategy: With the market�s longer-term trend still unclear, it�s crucial to make sure your stocks pack maximum value. Earlier in the month, I sold defense contractor Raytheon (NYSE:RTN) to buy health insurer Wellpoint (NYSE:WLP). Government-spending patterns will no doubt affect both companies in the years ahead, but it will be easier for Washington to cut defense than health care. At today�s share price for RTN, I estimate less than 3% appreciation potential for the shares in the next 12 months — too low for my portfolio.

For income investors, Royal Dutch Shell (NYSE:RDS.B) is looking attractive again. Back in 2004, the Anglo-Dutch oil titan sullied its once-pristine reputation by overstating its hydrocarbon reserves. Seven years later, after extensive management changes, RDS has opened a new chapter. CEO Peter Voser is targeting a 25% increase in oil-and-gas production, to 4 million barrels a day by 2018.

In early February, the company also announced its first dividend hike in three years, to 86 cents quarterly. At a current 4.5%, the shares yield more than the longest-dated U.S. Treasury bond, with a built-in hedge against inflation. The London-based Class B shares are attractive, carrying no withholding tax on dividends.

Fixed income

Fixed income is 49% or my portfolio. I guess you’d have to say Ben Bernanke�s zero-rate policy is �succeeding.� Treasury yields across the maturity spectrum remain extremely low, and yields on most other kinds of IOUs (public and private) continue to shrink. Absent an unexpected economic boom, I doubt the benchmark 10-year T-note yield will budge above 2.4% for very long during the rest of this year.

Strategy: With the Federal Reserve pledging to hold money market rates down through 2014, there�s little need for you to keep buying Ally Bank�s Raise Your Rate CDs. Accordingly, for my portfolio, I�m eliminating my position in these CDs, distributing 4% to Intermediate Credit Bonds and 2% to Short-Term Bonds. If you own the Ally CDs, you may find (depending on your remaining term to maturity and the early-withdrawal penalty) that it makes more sense to let the CDs mature before swapping to my recommended bond funds.

Note that I weight my two intermediate bond funds differently. Only a quarter of my intermediate stake (5% of my portfolio) resides in DoubleLine Total Return Bond Fund (MUTF:DLTNX). DoubleLine is a mortgage fund with an aggressive strategy.

For every $1 you put into DLTNX, you should devote about $3 to Vanguard Intermediate-Term Investment Grade Fund (MUTF:VFICX). The Vanguard fund yields less (4.1%) but also focuses exclusively on better-quality paper. Proper diversification between these two funds will let you eat well and sleep well, too.