Some investors are learning it for the first time, while others are painfully reacquainting themselves with the most basic rule of the financial markets: Wall Street is two-way.
Sure, in theory, everyone knows that. But it has been a long time since investors lived through a gut-wrenching market decline. U.S. stocks climbed steadily into record territory from October, 1992, until February of this year without missing a step. Then they stumbled, dropping 10% in eight weeks. The bond market's surge ended in late 1993, but it wasn't until February that bond prices started melting like an iceberg in the tropics.
Sure, it has been scary. But the markets and most investors--save a few ultraleveraged hedge funds that made bad bets--have survived very well. Stocks have come back to the levels at which they started the year. Not so bonds. But bonds have rallied back from their lows. Yes, it's safe to go back in the water again. That's the theme of BUSINESS WEEK's Midyear 1994 Where to Invest--a guide to investment survival and success in the second half.
The Federal Reserve's actions have set the tone for this year's markets. The central bank hiked short-term interest rates four times in as many months to cool the economic expansion lest it turn inflationary. The markets' decline was a reaction to those rate increases.
What has many investors nervous is that the Fed's track record on raising rates to lower the pace of the economy has been mixed. William E. Dodge, portfolio strategist for Dean Witter Reynolds Inc., remembers when it worked. He sees the current tightening and market reaction as similar to what happened from mid-1983 to mid-1984. "The economy was expanding very rapidly, long-term interest rates shot up, and the Fed tightened," recalls Dodge. The stock market declined 13%, but the pullback cleared the way for a 124% move over the next three years. The Fed attempted another economic "soft landing" in 1989--and, notes Richard S. Huson of Crabbe Huson Group, a pension and mutual fund manager, "the landing gear smashed right through the wings."
As for the Fed's moves this time, so far so good. The BUSINESS WEEK survey of economists in the accompanying Economic Outlook shows a belief that higher interest rates will do the job of slowing growth without sending the economy into the tank. If they're right, that's a big plus for the markets.
Of course, a slower-growing economy will force investors to fine-tune their portfolios, dropping some of the cyclical companies for the growth stocks that don't need a hard-charging economy to thrive. Investors may also take a look at some of the small-capitalization stocks, a market where a good product or service can make big bucks for companies and their shareholders no matter what the economy is doing. For other insightful investment ideas, turn to Inside Wall Street.
Equity investors should look abroad for opportunities, as well. The European economies are finally coming out of the doldrums, and even Japan, with the industrial world's strongest market in the first half, is picking up. And the emerging markets, which are in a slump so far this year, still offer attractive opportunities. It's not surprising that of the four professional investors whose stock picks we've tracked since December, the pro with the global portfolio is the winner thus far.
It's also time for buyers of bonds--both taxable and tax-exempt--to step up to the plate. There are bargains in today's nervous market. Want to bet on lower interest rates--or higher rates, if that's your conviction? Turn to page 154 for the lowdown on how to play the fast-moving bond market through options.
Of course, you may not want to bother with the trouble of selecting individual stocks and bonds. That's where mutual funds help. Turn to page 148 for an up-to-date look at which funds lead the pack. Precious-metals funds, last year's sizzlers, are in the red so far this year. Gold bullion isn't attracting much interest, either. If you want to know what's hot, check out page 158.
Sure, for a while, the financial markets looked like a one-way road heading south. But the traffic is starting to move in the other direction. It's time to head north and hit the gas.