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Making The Best Of A Bad Time For The Economy

During the first few weeks of 2008, the stock market continued on the downward path of the previous quarter, and financial news seemed to worsen almost daily. By mid-January, most experts seemed to believe the U.S. economy was headed for either a recession or growth so weak that the gross domestic product (GDP) might as well be declining. With unemployment rising and billions more in worthless mortgage-backed investments being written off by Wall Street firms, Federal Reserve chair Ben Bernanke practically promised aggressive interest rate reductions and Washington began debating economic stimulus. Yet while portfolio pressures seemed certain to increase in 2008, this year’s troubles need not set back your long-term plans.

Keep in mind that a recession, if it happens, may not spell doom for stocks. Sometimes the fallout is severe. During the brutal recession of 1973-75, for example, the Standard & Poor’s 500 stock index dropped almost 25%—and a total of 48% in the accompanying bear market. Similarly, the S&P retreated 8.1% during the brief 2001 recession and 49% all told in a stock swoon that didn’t end until 2002. Yet the stock market is considered a leading economic indicator, and while it almost invariably drops in anticipation of an economic downturn, it may also move up before GDP rebounds. During the recession of 1990-91, the S&P gained about 3% and tacked on another 8% in the six months that followed.

Based on these divergent history lessons, anything could happen this time around. Moreover, if a recession develops, we won’t know until months after the fact, and by then stocks may or may not have begun to recover. So rather than try to time the market or forecast when it might start its next surge, consider these strategies:

Be prepared for personal setbacks. Sometimes, tough economic times come home to roost. And if, for example, yours is one of the raft of jobs cut during a recession, the performance of the stock market will be the least of your worries. So be sure to set aside a rainy day cash fund that can cover at least six months of living expenses. That may help you avoid selling investment assets when markets are down.

Keep investing, and look for bargains. If you’re investing for the long haul, buying stocks when markets are down could pay off down the road. Dollar-cost averaging, the practice of periodically investing a fixed dollar amount regardless of what’s going on in the markets, lets fund investors buy comparatively more when values are depressed. Purchasing solid companies caught in a general market downdraft also may give you more for your money. Relatively recession-proof sectors such as health care and consumer staples could hold up better than most.

Don’t ignore dividends. Historically, much of the total return of the stock market has come in the form of dividends rather than share appreciation, and steady investment income can stabilize a portfolio when markets are volatile. But companies may cut dividends when times get tough, and financial stocks, in particular, whose sunken share prices translate into high percentage yields (calculated by dividing a stock’s annual dividend by its current share price), seem likely to reduce payments to shareholders. So look for companies with solid balance sheets and a history of raising dividends.

Choose bonds carefully. On the fixed-income side, yields on Treasuries are likely to decline as the Fed continues to cut interest rates, and investors may get better returns from highly rated corporate bonds. Meanwhile, yields on many municipal bonds are nearly as high as those on Treasuries, and that’s before factoring in the municipal bonds’ federal tax-free status. But many local governments and agencies that issue municipal bonds face rising financial pressures, increasing the risk of default. High-yield (junk) corporate bonds may also suffer. Treasury inflation-protected bonds (TIPs) could help insulate your portfolio if rate cuts boost inflationary pressures.

Look overseas, but don’t overdo it. Most well diversified portfolios need an international component, and at a time when the U.S. economy and markets are under pressure, foreign stocks could provide some relief. But much of international stocks’ recent outperformance has been attributable to the declining U.S. dollar, which inflates foreign profits when they’re converted back into greenbacks. And while the dollar’s woes could well continue, that’s hardly guaranteed. Moreover, although the economic outlook for much of Europe and Asia may be brighter than for the U.S.—and while emerging markets could continue to lead developed markets—loading up on foreign stocks could add risk to your portfolio just when it makes sense to try to minimize volatility. Some of your international exposure can come via U.S. multinationals that get significant income from overseas operations. Indeed, those blue chip companies may also provide relatively high, dependable dividends.

Your response to the U.S. economic downturn could range from standing pat to making judicious adjustments. We can discuss the current economic and market environments with you, review your portfolio, and help you decide what needs to be done to keep you moving toward your long-term financial goals.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.

@2008 Advisor Products Inc. All Rights Reserved.

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