Conflicting forces

We look for returns on the lower end of that range. The main reason: The improved mood of investors because of the Fed's anticipated change of course will collide with slowing profit growth. Some companies are already trimming their profit projections for this winter and spring, mainly because of higher costs for energy and raw materials.

You may be able to earn double-digit gains in the coming year, but it will take superior stock-picking skills. As an example, look at how a few savvy decisions could have improved your returns in the past year's mostly directionless market. If you had invested equal amounts of money at the beginning of the year in, say, six key stocks in the Dow Jones industrial average -- AIG, Coca-Cola, Intel, IBM, Merck and Pfizer -- you'd have lost 23% over the ensuing ten and a half months. But if you had substituted MetLife for AIG, Pepsi for Coke, Motorola for Intel, Apple for IBM, and Genentech and Amgen for Merck and Pfizer, you might have thought you were in the middle of a bull market. Shares of the six substitutes, all large companies in their own right, gained 44%, on average, into November.

Another way to improve returns is to tilt your portfolio toward foreign stocks, which are cheaper than U.S. stocks and stand a good chance of outpacing our market for a fifth straight year. After years of lackluster performance, Japanese stocks in particular appear poised to excel (see the box above).

One of the best reasons to lean toward stocks in '06 is that there are no compelling alternatives. Don't expect much from bonds. Still-low long-term interest rates could rise with every hiccup in energy prices, which will put pressure on bond prices (bonds lose value when rates rise and vice versa). At best, high-quality bonds will generate low-single-digit total returns over the next 12 months. Real estate investment trusts aren't attractive either because they're expensive relative to earnings and dividends. If you don't want to take much risk, your best bet is a six-month certificate of deposit yielding 4.4% (that's what you get from the highest-paying CD; the average yield for six-month CDs was recently 2.7%).

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