It’s Time to Plan for Economic Recovery
The Fat Lady may finally have sung for this recession.
The government did, after all, report a 0.4% jump in gross national product for the April-June period, the first such rise in three quarters. It’s not too early to start mapping out your mutual fund strategy for the upcoming recovery.
Of course, your game plan will depend on how strong you believe the rebound will be. And at the moment, the consensus calls for a prolonged period of sluggishness, perhaps punctuated by occasional downdrafts.
“In a strict sense, economic activity is no longer declining,” observes Bruce Grenke, a principal at Asset Allocation Advisors in Walnut Creek, Calif. “However, we anticipate a very fragile economic recovery.” He’s concerned about weakness in the banking sector and how it might prevent the Federal Reserve from making a greater effort to stimulate growth.
Others worry about the bloated real estate market. “We have all the commercial buildings we need until the 21st Century,” says Alston (Mac) Barrow, editor of the Favorably Positioned Stocks/Funds newsletter in Tampa, Fla. He’s optimistic about equities long term but fears that the climb from the trough will be painstaking.
And even if the worst is over, there’s a chance that investors might already have discounted it in higher stock prices. “Coming out of recessions in the past, market PEs were usually pretty low,” says Jack Bowers, publisher of Fidelity Monitor, a newsletter in Rocklin, Calif. Not so this time. In the wake of the strong rally earlier this year, the Dow Jones industrial average trades at a fairly rich price-earnings ratio above 18. And that, Bowers figures, leaves stocks vulnerable to some disappointing earnings surprises.
So if the majority opinion proves correct in this case and the economic rebound is sluggish, mutual fund gains will probably be slow in coming. Here’s how a listless, sporadic recovery might affect different types of stock portfolios:
* Growth funds: Even in a weak recovery, many observers suggest that you maintain some stock market holdings. Most growth funds are well-diversified and can be expected to move in line with the broad market averages. “Growth funds may have a slow period, but I think it’s probably best to hold on and suffer through any temporary, cyclic movements,” Barrow says. Bowers recommends much the same approach, assuming that you’re willing to sit tight for at least three years. In this environment, dollar cost-averaging--investing small amounts in a growth fund each month or quarter--can make sense.
* Small-company funds: These portfolios may offer better potential, regardless of the strength of the economy, simply because they’ve lagged for so long. The funds surged earlier this year, revealing their explosive potential. “Most of the move in small stocks to date has been a recoupment of last fall’s move down,” Barrow says. He figures that these companies and the funds that hold them could outperform over a six- or seven-year stretch, as they have frequently done in the past.
* Sector funds: You might also be tempted to strive for higher returns by investing in a specific industry, particularly a cyclic one that has been hurt by the recession. Bowers, for instance, likes the long-term prospects of technology stocks, many of which have been laggards. And he notes that the health-care field has grown faster than the overall economy. You can choose from among nine health-care funds and 21 science/technology portfolios, along with nearly 100 other sector funds with a special industry focus.
Just keep in mind that with a sector fund you relinquish widespread diversification. “Sector funds are more volatile, and you can get hit pretty hard within a bull market,” says Dan Sullivan, editor of the Chartist Mutual Fund Timer, a newsletter in Seal Beach.
In addition, stocks in many cyclic industries have bounced back strongly in anticipation of an improvement in their business prospects. “If the economy recovers at a slower-than-expected rate, the cyclicals could get hammered,” Bowers warns.
That’s a short rundown on how equity funds might hold up in an anemic recovery. But then again, not everybody figures that this cycle will be all that different from those of the past--an optimistic outlook that augurs for pleasant surprises ahead.
“People always question the strength of the upcoming recovery and point to a problem we didn’t used to have,” says Jon Fossel, head of the Oppenheimer funds group in New York. In 1974, they were pessimistic about lofty oil prices and the emergence of OPEC; in 1982, they shuddered about historically high interest rates and the Fed’s seeming inability to do anything about them. “They’re saying it now about excessive debt,” Fossel notes. But the current recession-recovery transition, he figures, should be pretty close to normal.
John E. Silvia, chief economist at Kemper Financial Services in Chicago, is also betting on a steady recovery. As favorable factors, he cites lower oil prices and a generally accommodating Fed monetary policy. In addition, he believes that the dollar is still weak enough to help U.S. export sales and that corporate profits have begun to turn upward. The upshot, Silvia adds, could be a “great environment” down the road for financial assets, including stock funds.
Betting on a Stronger Region
Perhaps you’ve heard that certain parts of the country are resisting this recession better than others. If so, you might be tempted to invest in one of the domestic “regional” funds, which limit their holdings to companies in a particular state or group of states.
In theory, the funds make sense, assuming that you can identify a hot geographic area. There’s also some logic to having a portfolio manager stick with stocks based in his own back yard.
In practice, however, it’s hard to invest on a regional basis. The idea never really caught on, and only about eight such funds remain. Of those, two have achieved above-average investment results: Composite Northwest 50 (4.5% load; 800-543-8072), which concentrates on Pacific Northwest corporations, and IAI Regional (no load; 800-927-3863), which sticks with companies based in and around Minnesota. Both areas are holding up reasonably well in the current tough economic climate.
