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How to Thrive as Market Cycles Return

We’re heading back to the old normal. The Fed is raising interest rates as the economy approaches full employment and inflation picks up.

Come June, it will be eight years since the end of the longest and deepest economic downturn since the Great Depression. Yet we are still feeling its effects. There remains, for example, a shortage of what John Maynard Keynes called animal spirits—the risk-taking that greases an economy’s gears. Business start-ups are still down by one-fourth from their 2006 peak. Growth has not recovered to anything close to traditional levels. In the seven full years since the recession ended, gross domestic product has increased by an average of just 2.1% annually, about one-third less than the post–World War II norm.

Also, in a time of rising rates, be sure to ladder your bonds so that they mature in sequence, year after year. That way, if rates rise, you can invest the proceeds from lower-yielding bonds as they mature into new, higher-yielding bonds. Or, for better diversification, you can purchase a series of funds whose portfolios are composed of bonds that mature in a single year, such as Guggenheim BulletShares 2022 Corporate Bond ETF (BSCM, $21). The exchange-traded fund yields 2.9% and charges annual fees of 0.24%. Versions that mature in 2023, 2024 and so on are available.

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Assume also that the old rules apply for stock investing: Diversify and hold for the long haul. I have a penchant for shares that have lagged the market. A good example is the Dow itself, which over the past five years has trailed the S&P by an average of one percentage point per year. You can buy the 30-stock Dow portfolio through SPDR Dow Jones Industrial Average ETF (DIA, $206), which charges just 0.17% per year.

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I expect that as real recovery finally comes to the U.S., it will come as well to Europe, which has also lagged. Consider France. It is home to some excellent companies, including drugmaker Sanofi (SNY, $45); LVMH MoËt Hennessy–Louis Vuitton (LVMUY, $44), the world’s premier luxury-goods firm; and energy giant Total (TOT, $50). You’ll find all of these stocks in iShares MSCI France (EWQ, $27), which has returned an anemic 6.7% annualized over the past five years.

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Speaking of energy, I expect that sector to come back. A barrel of oil at $50 is just not normal. A good way to buy oil and gas is through Vanguard Energy (VGENX), a mutual fund managed by real people (not algorithms) that has outpaced the average fund in its category in six of the past seven calendar years (including so far in 2017). Among its top holdings are Schlumberger (SLB, $78), the services company, whose shares are down by one-third from their five-year high, and such integrated energy companies as Chevron (CVX, $107), which sports an attractive dividend yield of 4.0%.

Finally, we have financial-services companies. Banks benefit from rising rates because, typically, the spreads widen between the short-term rates at which banks borrow and the long-term rates at which they lend. Insurance companies win, too, because they can invest the premiums they collect in bonds with higher yields. Some financials have performed well lately, notably the large banks, such as JPMorgan Chase (JPM, $88), that I recommended in my October 2016 column.

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The best strategy is to own a broad portfolio such as Fidelity Select Financial Services (FIDSX), a mutual fund that owns regional banks such as Huntington Bancshares (HBAN, $13), based in Columbus, Ohio; insurers such as Travelers (TRV, $121); and big banks such as Bank of America (BAC, $24). (For an ETF that taps into this sector, see This Financial Fund Is Heating Up.

I’ll end with a key lesson from old-normal history: Unlike what occurred during the new normal, stocks will eventually fall. That’s when you’ll face your toughest task. You will have to stick with your stocks until the cycle starts moving up again. It always does.

James K. Glassman, a visiting fellow at the American Enterprise Institute, is the author, most recently, of Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. He owns none of the stocks mentioned.

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