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Try to Relax, Enjoy the Ride

Which of these dueling stories will prevail, a good economy or a bad one? I'm voting for the better half. By Jane Bryant Quinn

Omigosh, what does it mean? are we in for it? A recession? Just when investments finally looked good again? How can anyone trust the market? "Frank, I told you to sell those stocks!"

Cool it, friends. I don't know whether prices will be up or down by the time you read this, but the long-term case for holding well-diversified stocks is always good. True, stocks have gone nowhere for seven long years, measured from the bubble peak. But even counting the bust, Standard & Poor's 500-stock index has averaged 7.5 percent a year over the past 10 years, with dividends reinvested. That's less than its long-term average of 11.5 percent but better than bonds, Morningstar reports, and better by far than bank accounts.

A slide like the one last week,down 3.5 percent in a single day, draws the doomsters out of their caves. I agree that there's plenty to growl about. Construction and manufacturing are in recession. Orders for durable goods, cars, furniture, machinery, laptops, household appliances' plunged almost 8 percent last month. Defaults are soaring on "subprime" and "alternative" mortgages made to higher-risk borrowers. Profit growth is slowing down. In the most recent quarter, home prices dropped at the fastest rate on record.

But that's only half the story. When you turn your eyes, you'll see strength in the service sector, entertainment, information technology, business and financial services, education, consulting, retail. Consumers have money to spend, thanks to low unemployment and a rise in real wages. Inflation is well in hand, for now. The Conference Board's Consumer Confidence Index stands at its highest level in five and a half years. In short, it's a bipolar moment. Which of these dueling stories will prevail?

I'm voting for the better half. "There are no signs of a recession on the horizon," says Lakshman Achuthan, managing director of the Economic Cycle Research Institute, which correctly predicted the past three recessions and recoveries. We face a few soft months, he says, followed by a nice recovery. Manufacturing picked up a little last month. He even sees an upturn in the construction sector later this year.

In fact, if you want a house, start looking now, he says.
Sales of newly built homes plunged last month, but sales of existing homes rose by the largest amount in the past two years. Prices may fall further. Still, they're well down from their peak, and that doesn't include special deals that sellers may offer, such as new rugs or making repairs. Mortgage rates are still low, so you've got an attractive package.

Stock analyst Steve Leuthold of the Leuthold Group thinks that last week's shock will be a short one, followed by a return to new highs. But it will slam some of the hedge funds that were out on a limb.

What should you and I take from this?

1. Investment diversification works. Bonds gained last week while stocks declined. All the world's equity markets did indeed drop together, but some held up better than others and are recovering faster. People with long holding periods' say, for a distant retirement, should stay substantially in U.S. and international stocks. People nearing retirement should devote more of their money to bonds, to help preserve their capital when equities decline.

2. You have to stay diversified. That means "rebalancing" your investments from time to time. Say, for example, that you choose to be 70 percent in stocks and 30 percent in bonds. After the market's four-year run-up, the value of your stocks might have risen to 80 percent of your portfolio. To rebalance, you'd shift some of your stock money into bonds, to get back to a 70/30 allocation. Had you done so, you'd have kept more of your profits when the market plunged last week. As a practical matter, few of us bother to rebalance or have the stomach for it (why sell stocks when they're going up?). That's why I like "life-cycle" mutual funds. They invest in a mix of stocks and bonds that are appropriate for your age and rebalance for you.

3. Chasing performance is a loser's game. The previous market correction occurred last May and June, when the S&P slid 7.7 percent. Sure enough, 401(k) money fled out of U.S. stocks and into bonds and didn't return until later in the year, after the market was many points up. The money fled into soaring international stocks. But rising interest rates in Europe could slow down its markets this year, Achuthan says.

4. You can't guess when market sentiment will suddenly change. One of the triggers this time was a skid on the Chinese stock exchanges, which toppled fast-money players (and markets) around the world. You can't compete with these global professionals, either in stock-picking or in attempts at market timing. As a practical matter, there's really no strategy but to allocate assets among U.S. and international mutual funds, rebalance regularly (or choose a fund or adviser to rebalance for you) and get on with the rest of your life.

The cyclical bull market should last as long as inflation stays within bounds and the Federal Reserve holds interest rates down, says the Bank Credit Analyst, a research firm based in Montreal. It could be wrong, of course. There are no guarantees. But I'm comfortable with the optimists' case.