With stocks pulling back, investors seek direction

If you have been watching the economy for signs that it’s safe to invest in stocks, you might be wondering why the Dow Jones industrial average plunged 185 points Tuesday.

Although investors have been concerned recently about growth in China, the economic news in the United States on Tuesday was among the best in a long time. Manufacturing finally came in above recession levels, and housing sales picked up as first-time buyers moved fast to get the $8,000 home-buying tax credit that runs out by the end of November.

Yet, investors turned away.

They were following the advice of a favorite Wall Street slogan: “Buy the rumor and sell the news.”

In other words, since March the prospects for recovery have been uncertain, but investors bet on it anyway, driving the Wilshire 5000 stock index up 50 percent. While Tuesday’s news seemed reassuring, investors sold stocks to await confirmation they haven’t been overly enthusiastic.

“The market had priced in the economic recovery and now needs a steady stream of good news just to hold its own,” said Milton Ezrati, market strategist for Lord Abbett.

If stronger employment numbers emerge, that would be convincing, he said. The wild card remaining is who will drive corporate profits higher if U.S. consumers are struggling to get jobs and are reluctant to make purchases.

Some analysts think stocks could fall 10 percent to 20 percent after the market’s sharp climb. That leaves investors with uncomfortable questions. Those who have moved into stocks are wondering if it’s time to back away. Those on the sidelines are wondering when it’s time to move into stocks again.

“Don’t invest everything now,” said Mark Salzinger, editor of the No-Load Fund Investor newsletter. Those coming into stocks should invest a little at a time, but those already invested shouldn’t flee, Salzinger said, as long as they have diversified portfolios.

Those who have enjoyed tremendous surges in risky mutual funds that specialize in high-yield bonds, emerging markets and China could reduce exposure a bit, he said.

But despite some excessive enthusiasm over investments in China and Latin America, Salzinger is reluctant to pull away completely because investors could miss the sharp rallies that often come without warning, he said. On days when stocks are falling, he will add to holdings.

Meanwhile, for investors nervous about the stock market rally fizzling, a conservative way to manage exposure would be through a mutual fund that invests in large companies that pay dividends. Salzinger recommends the Vanguard Dividend Growth fund.

“It’s like ballast,” he said, because it invests in companies with strong cash flow, and dividends provide some insulation from falling stock prices. For retirees, he suggests 10 percent of their portfolio go there, and for 40-year-olds, about 5 percent. Overall, he suggests 40-year-olds keep 70 percent of their portfolio in a blend of stock funds.

For investors who pulled away completely from the stock market, times are too unsettled to jump in completely, he said. A sensible approach would be to invest monthly in a fund that has the discretion to hunt for deals across the stock market. By selecting respected fund managers with latitude to move into small and large companies, the investor doesn’t have to figure out where value is in the market. Salzinger suggests Artisan Opportunity Growth fund.

After the run-up in stocks, some sectors are considered pricey and, consequently, risky.

Morningstar analyst Patricia Oey is warning investors that infrastructure plays in engineering and construction could be disappointing. She thinks companies such as KBR, Fluor and Foster Wheeler could face declining revenue in an era of slow growth, lower prices and competition. Although stimulus money is going to flow into projects, she said, extra money will simply make up for shortfalls that would have existed locally without help.

Steve Leuthold of the Leuthold Group is “very optimistic” about the stock market through the first half of 2010. He’s interested in foreign financial companies, especially in emerging markets, which, he said, are better positioned than large U.S. banks. He also suggests adding Asian stocks and Brazilian bonds as a hedge against a falling dollar.

For investors nervous about speculative emerging markets, Salzinger suggests the Matthews Asia Pacific Equity. About 30 percent is focused on Japan, an area some strategists think is positioned to grow.

(c) 2009, Chicago Tribune. Source: McClatchy-Tribune Information Services.