Where to put your money now (p.2)

With the markets giving off so many mixed signals, it's more important than ever to stick to sound investing principles. Diversify. Use dollar-cost averaging - move money into new investments gradually rather than in one lump sum. Seek out mutual funds with low expenses. And pay extra-close attention to valuations and balance sheets when picking stocks. Being wrong about a company with little debt and a low price/earnings ratio will usually be less harmful to your portfolio than being wrong about one with a 40 P/E and a 50% debt-to-equity ratio.

Also, don't follow the crowd. For instance, do you want to bet on corn prices doubling or tripling again? Or would it be smarter to invest in agricultural commodities that often track corn but that so far have been shut out of the agricultural boom?

Finally, listen to investors who have demonstrated a consistent knack for putting up good returns in almost any market environment. Soros is obviously one. Warren Buffett is another.

A less appreciated luminary is CGM Funds' Ken Heebner. Heebner's exploits since 2000 have been well chronicled in these pages. His CGM Focus (CGMFX) returned 80% last year and boasts the best one-, three-, and five-year annualized returns (58%, 33%, and 38%) of any diversified U.S. stock fund. His CGM Realty (CGMRX) fund hits the same trifecta for the real estate fund category, boasting one-, three-, and five-year annualized returns of 27%, 30%, and 39%.

How does Heebner do it? By pairing a contrarian streak- one grounded in deep research - with a willingness to go all in (or all out) when he feels most confident about his ideas. Heebner made a bundle short-selling tech and telecom stocks in 2000. In 2001 he built a huge position in homebuilders, only to unload every single share just before real estate cooled. In 2005 and 2006, Heebner plowed his homebuilder profits into oil and copper stocks, and last year he juiced his returns with well-timed short sales of bond insurer Ambac and mortgage lenders Countrywide and Indymac.

Following the principles outlined above led us to three disparate areas. The first is Heebner's latest big bet: steel. Three steelmakers- Arcelormittal (MT), Nucor (NUE, Fortune 500) and United States Steel (X, Fortune 500) - accounted for 16% of CGM Focus's assets as of Jan 1.

For Heebner, steel is essentially a proxy for infrastructure - a bet that developing nations like China, India, Brazil, and Saudi Arabia will continue to build new hospitals, roads, bridges, and power plants. "We've never had a global steel shortage before, but all the ingredients for one are present today," he says. Heebner thinks heightened demand could eventually push steel prices up to $2,000 a ton from $800 today.

One of the enduring traits of bear markets is that good stocks inevitably get thrown out with the bad. Two such stocks are Annaly (NLY) and Microsoft (MSFT, Fortune 500).

Annaly was a pick in our 2008 Investors Guide. A real estate investment trust that pays out the bulk of its earnings in dividends, Annaly has a business model that sounds terrifying, which is probably why its stock remains unloved. Annaly is essentially a hedge fund that buys mortgage-backed securities with borrowed money.

Yet Annaly is no Bear Stearns. It doesn't take any credit risk - it buys only mortgages guaranteed by Fannie Mae or Freddie Mac - and the steepening of the yield curve (short-term rates have fallen while long-term mortgage rates have climbed) has been fantastic for Annaly's bottom line. The company just announced a 40% dividend increase - the current yield is 12% - and analysts expect Annaly's earnings to climb 95% this year. Still, the stock trades at a mere 13 times the past 12 months' earnings.

The case for Microsoft is equally straightforward- regardless of whether its unsolicited bid to acquire Yahoo proves successful. Microsoft's 16 P/E is at a near-record low. Earnings rose 92% last quarte r- helped along by strong demand for the Windows Vista operating system and the Xbox game player - and are expected to be up 25% for the fiscal year ending in June. On top of that, Microsoft has a sterling balance sheet, with no debt and $23 billion in cash to fund acquisitions, share buybacks, or dividend increases. "For years software companies were derided for having such conservative balance sheets," says Microsoft fan Manny Weintraub, a former Neuberger Berman managing director who runs his own firm, Integre Advisors. "Now they look pretty smart."

Turning to a different kind of stock, an offbeat play to consider is cattle futures. Despite rising global food demand, the price of cattle has actually fallen this year thanks to turmoil in the livestock business. "There comes a point where corn prices are so high that you can't afford to keep feeding your animals," explains Judith Ganes Chase, a consultant and agricultural commodities analyst.

Walloped by rising feed costs - corn has soared from $2 to $6 a bushel in two years- ranchers and cattle feeders have essentially flooded the market with beef. Just to stay afloat, they've been forced to sell younger and younger animals to slaughterhouses. Geoff Blanning, head of commodities investing at London-based money management firm Schroders, thinks this is about to change. "Meat prices will be the next to rise," he says. According to the latest USDA cattle report, the 2007 calf crop of 37.4 million head was the smallest since 1951. Couple that shrinking supply with rising beef exports - projected to be up 20% in 2008 - and you've got all the makings for a big rally. The easiest way to invest in cattle futures is via an exchange-traded fund available on the London Stock Exchange: ETFS Live Cattle, which tracks the Dow Jones-AIG Live Cattle Sub Index.  

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