Getting Back On The Bull - Page 2 of 5

Getting Back On The Bull

out of their rut. When rates are low, as they have been this year, there is little incentive for big institutional investors to push stocks aside and opt for Treasury or corporate bonds, which provide sure and steady interest income over time. In fact, the 10-year U.S. Treasury note, the benchmark bond experts use to chart the market, offered a mere 3.1% interest as of June 2003 — a 45-year low. Late this past summer, money market accounts, often a convenient short-term haven for cash, offered very little to arouse investors: They averaged only 1%. The S&P 500 averaged about 1.75% interest. Chances are the big money in the market probably won’t entirely abandon stocks any time soon.

The outlook for the market would be extremely bright if not for a few dark clouds. Perhaps the biggest worry is interest rates. Recently, there have been stirrings in the bond market indicating that rock-bottom rates may soon rise. Higher rates mean that the cost of borrowing money for business expansion will rise, too, which could stall a recovery. According to Isaac H. Green, president and CEO of Durham, North Carolina-based money management firm Piedmont Investment Advisors, higher rates could also make equity valuations less attractive, which could cause the stock market to correct: “I foresee a high-risk period for short-term rates until the end of 2003.”

Another concern is the market’s overall value. Morningstar showed that, if measured by the preceding 12 months worth of profits, company shares comprising the S&P 500 were priced 22 times their reported earnings this past September. Historically, the market fetches no more than an average 14 times its earnings, indicating possible overvaluations.

Green says a number of mitigating factors could well come to the market’s rescue, even if a correction does take place. He says the Fed will likely reinforce its commitment to keep inflation low, and “tradition shows that years [in which] presidential elections are held tend to be the most bullish.” Green adds, “Indications are [that] the economy is poised to help us follow that pattern.”

The truth is, as humbling as they can be for investors, bear markets are great teachers. And if there’s a lesson to be learned from the past three years, it is this: Diversifying your assets into a variety of investments can help cushion your portfolio against sudden shocks. “If you step back and look over the market, there really aren’t any slam-dunk opportunities out there right now,” says Kunal Kapoor, an associate director of fund analysis at Morningstar. “The point, though, isn’t to chase hot trends; it’s to stay diversified to minimize risk.”

One sure way to broaden your portfolio is to look overseas or to venture into small- and mid-size companies. These categories provide a good counterbalance to large company shares and mutual funds, often holding their own or posting solid gains when the S&P 500 runs into trouble.

“International stocks might be some of the best performing shares in the next few years,” says Lou