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Tipping Away From Recession

Decisive action to lower interest rates appears to have stemmed a financial panic and helped steady the economy.

Hollywood crews were in downtown Washington, D.C., recently to film a spy thriller starring Russell Crowe and Leonardo DiCaprio. That same day, a real-life drama unfolded down the street at the Federal Reserve building, where central bankers -- marquee players on the world's financial stage -- met to chart the course of interest rates. The Fed's script led to a half-point cut, to 4.75%, in a key short-term rate that affects, among other things, what home buyers pay for mortgages. That should be enough to stem a panic among lenders, reassure consumers and stave off a recession.

Months may pass before we know for sure whether the Fed's heroics save the day. "The housing market will remain in a severe downturn through this time next year," says Mark Zandi, chief economist at Moody's And falling home prices will weigh on consumer spending this holiday season, he predicts. On the plus side, global growth is fueling demand for U.S. exports, inventories are lean, and corporate balance sheets are strong. Look for economic growth of 1% to 2% in the U.S. over the next couple of quarters. And expect the Fed to cut its federal funds rate another quarter-point by early next year. "This has not been a fundamental crisis but a confidence crisis," says Wells Capital Management strategist Jim Paulsen.

You can thank Wall Street wizards for allowing defaults on a subset of admittedly risky loans to balloon into a global credit crunch. It used to be that investors who bought bonds backed by mortgages knew the risks involved. But the recombination of little pieces of all sorts of debt securities has made the end products inscrutable. Worried about traces of subprime defaults in their portfolios, investors washed their hands of any debt not issued by Uncle Sam himself or by a blue-chip corporate equivalent, including short-term IOUs funding the daily operations of a huge swath of U.S. business. Little wonder that worries of economic fallout linger.

In your own investments, stay away from homebuilders, real estate investment trusts and companies that make big-ticket consumer items, such as cars or appliances -- purchases that people will likely put off buying for now. Instead, focus on stocks of big, blue-chip multinational companies -- especially tech companies, which as a group get more than half of their revenues overseas. These market leaders will muscle through any lingering credit crunch, prosper as overseas sales climb, and even benefit from a falling dollar, as foreign revenues translate into more greenbacks here.