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Keeping Your Balance in a Scary Market

The summer of '02, déjà vu? I hope not, but here are five ways to protect your portfolio.

Bearish financial news dogged managers, advisers and others who were in Chicago for Morningstar's annual mutual fund convention, which ended June 27. Shares had crumbled 3% the day before, putting the major stock indexes on the cusp of bear-market territory and confirming that the down trend that began last October is no run-of-the-mill correction.

It was all a bit scary because I heard echoes of the 2002 Morningstar conference, which I also attended. During that year's confab, WorldCom confessed it had falsified its cash flow and earnings by billions and would probably go bankrupt. Stocks plunged nearly 2% on the second day of the conference, followed by a terrifying dive that slashed the Dow Jones industrial average from 9286 on June 24 to 7702 on July 23 -- a 17% plunge in one month.

I'm not going to forecast that the Dow will now repeat that terrifying 2002 fall, which would send the average below 10,000 by baseball's All-Star break. But the vibes I carried away from three days among Morningstar's guest list of esteemed mutual fund managers and financial advisers wasn't encouraging.

The money managers are optimistic, all right, with some even venturing that a year or two from now, you and I will remember the summer of '08 as a splendid time to be an investor-if somehow you still have money to invest.


It was the financial advisers I chatted up who gave me pause. They are recommending to maintain a defensive posture until the market's wildness settles down (and they don't see that happening anytime soon). Charles Tarara, an independent adviser from Minneapolis-St. Paul, related how he had intervened when he saw a client essentially betting his retirement on comnpany stock that had done well but was overrepresented in his portfolio. "I saved his [posterior]," he said. His was a lesson in prudence and diversification.

Tarara's approach makes sense in this environment. Again, consider the parallels between 2002 and 2008. In 2002, the summer of losses owed most of its severity to accounting fraud. Wall Street traders made everyone pay that year for executive-suite misconduct.

The trouble in 2008 is out-of-control oil prices, sweeping nervousness about the condition of banks, and the realization that inflation and interest rates are as low as they'll be for some time to come. That is a worse threat to the well-being of investors' nest eggs than the death of such corporate sinners as WorldCom and Enron.

Also, in 2002 you could dodge the stock market's worst problems by buying real estate investment trusts and energy investments. Today, real estate looks risky (with some niche exceptions) and energy shares may be too high to buy.


You can go to Morningstar's Web site and read what stocks some of the speakers recommended from the dais. But a lot of the real insights took form away from the main stage. Here are some of my takeaways.

1. Buy municipal bonds. Trust me. I'll say it again: Buy muni bonds. The reason is that the tax-exempt bond market is not only abolishing bond insurance but also the very ratings system that dragooned cities, counties and states into paying for insurance to get a triple-A rating for an issue instead of, say, an A-. Soon 48 states, many cities and counties, and almost every essential-service agency (water and sewer, public hospitals, toll highways) will be regarded as AAA, says Tim McGregor, a municipal-fund manager for Northern Trust.

Essentially, there will be two muni-bond ratings: triple-A and non-investment-grade. Today, a ten-year AAA tax-free bond yields you 3.79%, while a ten-year Treasury note pays 3.97%. A ten-year single-A-rated municipal offers 3.81%, so close to a triple-A yield that, in effect, the bond market has abolished the distinction. Yet, looking ahead, with taxes likely to rise, that tax-free 3.79% could be the equivalent of more than 6% this time next year. This is my safest investment idea.

2. Be wary of buying opportunities touted by some longtime fund managers. Bill Nygren was manager or co-manager of the Oakmark fund during its salad days but has tossed four lemon years out of the past five. He told a standing roundtable of advisers and journalists that he sees "great value in everything except commodities and weak dollar plays." He also said he expects a big drop in oil prices and with it a recovery in the dollar. That might bail out Oakmark's big holdings of bank stocks and consumer-spending names, such as Best Buy, but it didn't sound convincing to me.


Brian Rogers, the chairman of T. Rowe Price and manager of its T. Rowe Price Equity-Income fund, has also been struggling (relative to the fund's category), though not as long or as badly as Nygren's Oakmark. Rogers also says that oil prices are crazy -- he figures they're $40 a barrel into bubble territory -- which is why there is so much negativity in the stock market. "Buying into stress is generally a good thing to do," he says, and cites the downtrodden and increasingly unwanted shares of General Electric (symbol GE), now at $27, as an example of a great buy. That's because GE has a strong balance sheet and, says Rogers, "I don't have any concern for its viability."

GE yields 4% and sells for 12 times its per-share earnings -- but it's been sitting there for the entire decade, so far. Why should its shares perform any better if this near-recession turns into the real thing with rising interest rates, inflation and maybe taxes?

3. Look for shelter in emerging-market bonds. Many speakers at the conference extolled the stock markets of China, India, Brazil, Hong Kong and all the other nations with oil or commodities. But are they really the answer to every investor's frustration?

The Shanghai stock exchange index is down nearly 50% since its peak earlier this year. Investors, take heed: There's a big difference between a country's economic profile and the volatility of its stock market.


Emerging-markets bonds, which you can buy through funds, are a better deal because oil- and commodity-exporting countries have loads of cash to pay interest. Unfortunately, bonds get short shrift at a conference built around words from mainly bullish stock-fund managers to whom bonds are an afterthought. (There was one bond session on the panel in three days and none devoted to high-dividend payers.)

4. There are too many ETFs under construction. I saw new ETFs promoted everywhere. Hundreds of them. I see some sense to PowerShares Global Wind Energy ETF (PWND). It may not do well because most alternative-energy stocks are very expensive given two years of hype. But there are now close to 1,000 ETFs, up from a few hundred two years ago, and more than 25 ETF originators.

The problem? ETFs by nature enable rapid-fire sector investing and quick trading, which isn't a good thing. Some of these newbies are eager to claim they'll do better than the established ETFs because of "proprietary" or "secret" systems for stock-picking or portfolio composition.

I sat down with Jim Porter, an earnest and friendly gentleman from New Century Capital Management. He explained that his new Aston/New Century Absolute Return ETF fund (a fund of ETFs) will excel because of a quantitative process full of derivatives he and only he developed and knows. But how could it be worth 1.50% in expenses to have Porter build you a portfolio of iShares and other ETFs that charge you a tenth of that?

5. Yes, there are a few good investment ideas (although you probably can't use them). It would be unfair if I stopped and left you certain that everyone who manages money and who attended the conference was either in a time warp or there to defend what's not working.

Robert Hagstrom, who manages Legg Mason Growth Trust, has studied up on energy and makes a convincing case that natural gas, both as a commodity and a class of stocks, has been left behind in the oil rush. He also suggests that the electrical grid needs repairs and improvements. Hagstrom is right on, but it will be a challenge to profit from that fact because the utilities own the grid and the work will be paid for out of the earnings they would otherwise have paid out as dividends.

An ETF devoted to the power grid would be a big winner -- if only there were stocks you could pick to populate the ETF. So there's the final frustration from the mean carpets of Morningstar. Here's a field of business widely known to be starved for capital and yet nobody can find a way to invest in it directly. Ah, well, there's always oil futures and China.