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Trim Domestic Stock Exposure

By Joseph Lisanti In the face of rising interest rates, persistently high energy prices that could restrain consumer spending, and several downbeat corporate revenue forecasts, Standard & Poor's Investment Policy Committee has lowered its stock market expectations for this year and next. We now see the S&P 500 ending 2005 at 1220 (previously we had predicted 1270) and 2006 at 1290 (formerly 1335).

Because of the lower targets, we have reduced our recommended domestic equities exposure to 45% from 50% and increased our foreign stock allocation to 20% from 15%. To effect these changes in our model exchange-traded fund portfolio, we suggest that you reduce your holdings in the S&P 500 to 35% (from 38%), the S&P MidCap 400 to 6% (from 7%), and the SmallCap 600 to 4% (from 5%). We advise increasing exposure to emerging markets to 3% (from 2%) and adding a 4% position in Japan (via the iShares MSCI Japan ETF; ticker EWJ).

This year has been a disappointment for investors, with the S&P 500 now below where it started 2005. We still expect a rally in the traditionally strong fourth quarter, and do not suggest that you abandon equities.

The advance we anticipate should cause the market to end the year with a gain of less than 1%. If that expectation and our projection of a 5.7% advance in 2006 prove true, few investors will be delirious with excitement over the next 14 months.

That's why we suggest that investors now tilt their portfolios to overweight stocks in the consumer staples and health care sectors. Demand for the goods and services provided by companies in these sectors tends to be relatively stable, no matter the economic conditions. In other words, if the cost of heating their homes and driving to work leaves people with fewer dollars to spend, necessities like food and medicine probably will take precedence over the purchase of new gadgets. Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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