A bloodthirsty bear will shred share prices for another year, maybe longer. Or perhaps the Federal Reserve's rapid interest-rate reductions will quickly calm the financial world and set the stage for the next rally. You can argue either case. But rather than trying to forecast the markets, you'll make better use of your time by focusing on how to protect your retirement funds and other savings through what is sure to be a lengthy period of fear, uncertainty and doubt.
Defensive investing is not about moving all or nearly all of your IRA and 401(k) money to cash or bonds. That may be a wise move if you're a year or two from retirement and have accumulated enough wealth to last the rest of your lifetime. But for most people, hunkering down in low-risk investments is not a particularly attractive option when bonds and money funds yield 3% or so (although, truth be told, even tiny returns are better than losses).
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Long-term investors should keep 60% to 70% of their investments in stocks and stock funds. Recalling that stocks lost nearly half of their value in the 2000-02 bear market, which coincided with a recession, you may think we're being overly aggressive or optimistic or both. But let's put these wobbly markets -- the current one and the one earlier in the decade -- in perspective. At the outset of the 2000-02 conflagration, stocks (particularly technology stocks) were in the stratosphere. But back then, you had good alternatives. Both oil and real estate, for example, were depressed. Today, by contrast, few stocks trade at absurdly high levels, and gold, energy, other commodities and even Treasury bonds look pricey.
Keep the rest of your portfolio in low-risk investments, such as a money-market account or short-term bond fund. That will provide ammunition for a bargain hunt once you get a sense that the U.S. economy is nearing a bottom, probably later this year or early in 2009. And the bargains are starting to proliferate. As of mid February, the Nasdaq Composite index was already in bear-market territory, having dropped 20% from its October high; the broader Standard & Poor's 500-stock index was off 16%.
Clearly, markets and the economy are shaky, so you should cut back on risk. Speculative stocks and junk bonds are for another time. Developing nations such as China and Brazil are still growing rapidly, but their stocks are dangerously expensive. Stay away from those kinds of markets until they correct. Cut out or cut down on stocks that depend on lavish U.S. consumer spending or a fast housing recovery.
The bear is growling most fiercely at companies that so much as hint that customers might be backing off. Case in point: In January, Apple (symbol AAPL) reported awesome Christmas sales and record profits for the October-December quarter, and the company introduced some flashy new products -- but the stock lost 19% in a couple of hours. It was down 37% year-to-date through mid February. Why? Because Apple said the rest of the year would be merely good, not spectacular.
Some pros think the mood of investors is a bigger problem than the actual economy. Outside of real estate and the financial sector, there haven't been unusually large numbers of profit warnings, dividend cuts and other signs of serious distress. "Companies are fine," says Kelli Hill, who manages growth-stock accounts for Ashfield Capital Partners, in San Francisco. "It's the market that's a little shaky."
Hill has a point. Through early February, 64% of all companies that had reported fourth-quarter results had exceeded analysts' estimates; 11% matched forecasts. Excluding financial companies, fourth-quarter profits rose an average of 18% from the year-earlier period. Companies delivering surprises on the upside were a diverse lot, including IBM (IBM), MasterCard (MA), Thermo Fisher Scientific (TMO) and Whirlpool (WHR). Each of those stocks has outpaced the S&P 500 since the market peaked last October. There's no reason to dump the shares of any company that is growing, has been making its numbers and does a lot of business overseas. And never sell in a panic, especially at the very end of the business day. Since July, the S&P 500 has lost 1% or more on 35 different days. In 71% of those cases, stocks rose the next day.