Sense and Spunk Are Key in ’93

Happy New Year. Did your investments provide you with many joyous returns last year--or just a lot of grief?

For the majority of investors, the results were probably somewhere in between. So let’s resolve to heed what President-elect Bill Clinton said often during his campaign: “We can do better.”

Investing wisely and profitably over the last three years meant betting on lower interest rates. But that game is most likely over--courtesy of an improving economy, a President committed to keeping it that way and the simple fact that all cycles must eventually end.

Without lower rates to bail out your mistakes, you’ll have to rely more on common sense and strong nerves to make decent money in 1993. But if you keep in mind some central themes when creating or fine-tuning your portfolio, you can dramatically improve your chances of success.

Four investing themes for ‘93:

1. Cash won’t be as trashy. Savers last year suffered through the lowest short-term interest rates in 30 years. Even now, the average yield on money market mutual funds is a mere 2.9%.

But look what’s been happening since early October: The discount rate on three-month Treasury bills has risen from 2.76% to 3.08% now. Other short-term rates have also reversed their long declines. The average yield on one-year bank certificates of deposit is 3.35% today, up from 3.23% in late October.

That isn’t much of an increase, of course. But it’s the trend that’s important. The economy is climbing back, and that means greater demand for money--which means the price of money is inching up.

The upshot is that people who like to keep much of their savings in short-term “cash” vehicles such as money funds and CDs will earn more in 1993. Many Wall Street pros figure that short-term rates could rise a full percentage point over the course of the year, which could push one-year CD yields back above 4% by December.

This is not an argument for keeping all of your money in cash. But the promise of higher short-term rates should keep conservative savers from making the mistake that others made last year: moving far too much of your nest egg into riskier stocks and bonds in a desperate search for better returns.

“It’s just when cash looks like the worst possible holding that it often turns out to be the best holding,” notes Arnold Kaufman, editor of Standard & Poor’s Outlook investment newsletter.

2. The Great Bond Rally is probably over. Believe it or not, long-term interest rates have been working their way lower for the last 11 years--since 1981. So the 1980s were a great time to own bonds: It was safe to lock in a long-term yield, because this year’s yields rarely looked as good as last year’s.

There’s still a chance that long-term yields could drop further from their current 6% to 9% range (depending on the type of bond), if Clinton can find a way to contain the monstrous federal budget deficit. And they might drop even if short-term rates rise.

But with the economy strengthening, the odds are stacking against another big decline in long-term rates, many experts say. So here are two logical ways to approach bonds in 1993:

* At best, expect only to earn the interest that bonds pay, not the price appreciation that produced double-digit total returns in recent years.

* If you’ve owned bonds for many years, it may be time to take some money off the table.

And buy what instead? Stocks, perhaps--in a growing economy, they have historically performed better than bonds.

If your goal is current income, and you have always been heavily invested in Treasury bonds, shifting to corporate bonds may make sense: They pay more and can appreciate as the finances of the firms that issued them improve.

Utility stocks also make good replacements. They yield 6% to 7%, and their dividends increase, unlike bond interest payments.

The point is, bonds could do OK this year, but you’ve got to begin preparing for the next cycle of faster economic growth and higher interest rates.

As Jack Reynoldson, manager of the American Capital Government Securities fund in Houston, puts it, “It’s going to get more and more difficult to be a buy-and-hold type investor in bonds.”

3. Stay with stocks--but make sure the trend is your friend. The stock market should have a decent year in 1993 for one major reason: The economy is getting better. That should mean better corporate profits and dividends, which ultimately underpin stock prices.

But, as in 1992, the economy’s path is likely to be lined with potholes. Growth will probably lurch, then slow, repeatedly.

Nonetheless, keep your eye on the ball: In an improving economy, the companies you want to own are those that have the most to gain as consumers and businesses gradually resume purchases that have been delayed--such as autos, computers, machinery and other big-ticket items.

And on the flip side, the stocks falling out of favor are the classic stable-growth issues whose profit prospects appear less exciting compared to their industrial rivals.

A few numbers tell the story: In 1992, shares of industrial giant General Electric advanced 12% to close at $85.50. Meanwhile, shares of Coca-Cola--one of the greatest stocks of the 1980s--gained just 4% on the year to $41.875. And Merck & Co., a drug stock that the market has long adored, tumbled 22% to $43.375.

The stable-growth companies such as Coke and Merck enjoyed windfall profit returns in the 1980s because they were able to raise prices with abandon. Those days are over, as inflation remains low and global competition for consumers’ dollars (or yen or marks) toughens.

“With these stocks people think, ‘If the price is down it must be cheap,’ ” says Marshall Acuff, investment strategist with Smith Barney, Harris Upham & Co. in New York. “But that kind of reasoning can be fatal,” he warns, because where profit growth is decelerating, stocks often continue to slide.

That isn’t to say that Coke is going out of business. It’s just that the market cycle that favored such stocks is giving way to a new cycle that favors industrial, technology, telecommunications and transportation issues, among other economy-sensitive areas, many pros believe.

That’s where the trend is your friend. And in a year in which overall stock market returns may not be much greater than the 8% total return of blue chip stocks last year, you definitely want to be on the side of the trend.

Likewise, the odds of continued above-average profit growth by smaller companies suggest that the small-stock surge of the last two years has further to run. That trend is your friend.

4. Be prepared for a wild ride--and make volatility work for you. Every time Clinton opens his mouth after Inauguration Day, stock and bond markets could react violently. America wants change, but how much and who pays are the unanswered questions. Wall Street may not like much of what it hears at first.

Meanwhile, international crises loom: Iran is rearming; Japan’s banking system remains fragile; Russia could yet erupt in civil war.

All of this suggests that 1993 will be a very volatile year for stocks and bonds, probably much more so than 1992, which mostly was a year investors spent waiting on the election.

And volatility these days feeds on itself: So many people are trying to time short-term moves in the markets that every swing runs the risk of being grossly exaggerated.

Rather than fear this volatility, however, you should tap into it. If you want to own a particular industrial or technology stock, but believe that it’s overpriced right now, decide what is a fair price to pay--and if the stock sinks to that level, be ready to buy aggressively. (The same goes for mutual funds you like.)

This sounds elementary, of course. But the biggest problem for many investors is that they shy away from buying just when a stock is most attractive--when the price is temporarily down.

Last spring, slot machine maker International Game Technology was a hot stock, riding booming sales as gambling expanded nationwide. But for no apparent reason, the shares began to sell off in May--promptly dropping from $35 to $25. The company’s outlook hadn’t changed, but the stock suddenly became very cheap.

By year’s end, IGT was at $50.875. As usual, investors who did their homework--and went against the crowd at a difficult moment--were well rewarded.

Interest Rates: The Slide is Over After declining for most of the last two years, interest rates have inched up since October. As the economy strengthens, most analysts believe that short-term rates in particular will continue to edge higher in 1993--which could slow the outflow of money from bank CDs to stocks and bonds. (Latest 1992 figures) 3-month T-bill: 3.07% 1-year CD avg.: 3.35% 5-year T-note: 6.04% T-bill rates on a discount basis. Source: Bank Rate Monitor; Federal Reserve Bank of St. Louis