The Wall Street Journal-20080123-What-s a Small Investor to Do-- Market Drop- Fed Cut Create Opportunities For Cherry Pickers

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What's a Small Investor to Do?; Market Drop, Fed Cut Create Opportunities For Cherry Pickers

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If fears of recession, slumping stock markets around the world and an emergency rate cut by the Federal Reserve have left you scratching your head over what to do with your money, you have plenty of company.

Many advisers, however, say that for investors with a long-term view, the stock-market's decline creates some alluring value. At least one financial firm, Bank of America Corp.'s Banc of America Securities LLC, is recommending that investors slightly increase their exposure to equities in the wake of the market selloff.

Investor anxiety following the Asian markets' plunge this week depressed the Dow Jones Industrial Average more than 460 points at the opening of trading yesterday. But the Fed's emergency 0.75-point rate cut helped the Dow industrials recover much of their losses, to end the day down 128.11 points, or 1.1%, at 11971.19. That leaves the blue-chip index 15% below its peak, hit last fall. Meanwhile, the bond market rallied strongly, with yields on 10-year Treasurys sinking below 3.5%, its lowest yield since mid-2003.

Some stock investors are cherry picking among the carnage overseas, in markets ranging from South Korea to Eastern Europe. Others are focusing on recession-resistant stocks in the U.S., including health- care and consumer-staple issues. And while Treasury yields are pathetically low, some advisers are recommending preferred shares, or even some short-term junk bonds, for higher yields. Meanwhile, lower interest rates could be welcome news for many borrowers -- from consumers who carry a credit-card balance to homeowners seeking a home-equity line of credit.

Here then are market strategists' recommendations about how to maneuver amid sinking stocks, soaring bond prices and lower interest rates.

Stocks

Compared with Treasurys, stocks are as cheap as they've been since the late 1970s, based on their earnings yields, says David Kelly, chief market strategist at J.P. Morgan Chase & Co.'s JPMorgan Funds. Lower interest rates will benefit financial stocks as these companies regain the ability to borrow more cheaply at the short end of the yield curve and lend at higher rates at the long end, he says. Indeed, financial stocks benefited from yesterday's Fed rate cut, with J.P. Morgan Chase, for instance, rising more than 3%.

"I see it as a buying opportunity for people who are long-term investors," says Thomas Griebe, a retired mechanical engineer in Northville, Mich. Mr. Griebe, 55 years old, says he is fully invested already, but this week emailed his nephew to encourage him to buy an index fund of the total stock market.

Still, investment advisers are recommending that investors move to large-company stocks that are better able to weather economic slowdowns. Many strategists are recommending defensive havens like health care and consumer staples, which make the stuff people need even in bad times.

Ernie Ankrim, chief investment strategist at Russell Investments, says the firm's fund managers are buying more of the stocks they've been recommending, such as Coca-Cola Co., McDonald's Corp., Gilead Sciences Inc. and Google Inc., in sectors such as health care, technology and consumer staples. Yesterday, Mr. Ankrim also slightly boosted his recommended allocation to non-U.S. stocks, primarily on the basis that the Fed's rate cuts could further weaken the U.S. dollar, which will help boost returns for U.S. investors from foreign stocks.

But fears of a U.S.-led recession are sparking a selloff across a multitude of countries big and small. Some of those declines almost seem overdue, as stock valuations, especially in developing countries, soared in recent years. But amid the widespread rout, stock prices are falling even for companies that have few, if any, ties to the U.S. or global economy. Indeed, fund managers around the world are using the declines to essentially cherry pick through local companies and industries that are suddenly inexpensive.

Thomas Neuhold, portfolio manager in Vienna for Vontobel Asset Management, says his fund had "a very big cash position in the fourth quarter," because so many of the Eastern European markets he invests in had escalated dramatically in recent years and he was leery of putting that money to work. But "many companies have dropped 30% and 40% in the last couple of weeks and are very attractive at the moment," he says.

Mr. Neuhold says he is selectively buying in sectors with strong ties to their domestic economies, especially stocks in real estate, telecom and banking. Among his targets: Immoeast AG, a leading Austrian real-estate firm focused on Central Europe; Magyar Telekom, the Hungarian phone company; and Austria's Erste Bank, with tentacles across Central Europe.

Andrew Foster, acting chief-investment officer at Matthews International Capital Management, the San Francisco firm that runs the Matthews Asian funds, says he's cherry picking in Japan and markets like South Korea, Thailand and Malaysia that have been generally outside the limelight. The firm favors businesses that are critical to Asia's domestic build-out, such as consumer durables and consumer- oriented financial services. "These declines are exaggerated. The Asia economies are still chugging along and there are now values to be found," he says.

Bonds

For the most part, the bond market isn't the place to be looking these days. Two-year Treasurys yield just over 2%, while the 10-year is about 3.5%. As such, Marilyn Cohen, president of Envision Capital Management, a Los Angeles bond-investment firm, says "there are no opportunities in Treasurys, and don't let anyone tell you there are."

Instead, Ms. Cohen yesterday said she put client money to work in a new batch of Citigroup Inc. preferred stock that began trading this week. Those shares yield 8.125%. "There are some really sumptuous yields available in preferreds these days," she says.

She also says that individual investors should look selectively at junk bonds, despite the growing risk aversion in the markets overall. She points to the 6.85% General Motors Corp. bonds that mature Oct. 15 of this year. Though there's always risk of default when you buy junk bonds, Ms. Cohen says the timeframe is so short that "I think individual investors are absolutely fine with this kind of paper." The current yield is about 7.9%.

Borrowers

The biggest beneficiaries of the Fed's surprise rate cut will likely be homeowners who have adjustable-rate mortgages that are about to reset. The one-year Treasury -- a common benchmark for ARMs -- has fallen to about 2.3% from 5% in July. As a result, borrowers with an ARM that's about to reset could see their interest rate increase to about 5% instead of what would have been 7.5% if that reset had taken place last summer, says Greg McBride, a senior financial analyst at Bankrate.com.

Borrowers who are planning to take out a new fixed-rate mortgage may want to hold off, since more rate cuts are expected, which could push mortgage rates even lower. But that could be risky. "The future is very uncertain. Mortgage rates rise more quickly than they fall, and trying to time the bottom is a very bad idea," says Keith Gumbinger, vice president at HSH Associates. "If today's rates make your deal work, then don't delay."

Indeed, Victor Steiner, vice president at ISB Mortgage, a subsidiary of Investors Savings Bank of New Jersey, says call volume among consumers surged yesterday after the Fed cut interest rates.

To be sure, while borrowers may be able to lock in a lower rate, they may also have a tougher time qualifying for a mortgage. "What borrowers really have to worry about is if lending guidelines tighten or if the value of their home declines and they no longer qualify," says Mr. McBride. Average rates on 30-year conforming fixed rate mortgages are 5.6%, which are their lowest levels since July 2005.

However, rates on jumbo mortgages -- those above $417,000 -- are nearly a full percentage point above a conforming mortgage, because of continued disarray in the mortgage-securitization markets. With some shopping, though, more credit-worthy borrowers can find jumbo rates as low as 6% or so.

The Fed rate cut will also translate into lower rates on home-equity lines of credit and credit cards, which are typically linked to U.S. banks' prime rate. Borrowers with home-equity lines of credit could see the lower rates reflected as soon as their February account statement, although credit-card issuers can take as long as 90 days to pass along an interest rate cut, says Mr. McBride. Average rates on HELOCs and variable-rate credit cards are currently 7.44% and 13.14%, respectively, according to Bankrate.com.

Borrowers with loans tied to the London interbank offered rate, or Libor, which is an interest rate charged by banks for short-term loans to each other, may not see as much relief as borrowers with loans indexed to Treasurys or the prime rate. Libor is frequently used to set rates for subprime adjustables and is also used as a benchmark for about half of private, variable-rate student loans.

Savers

Savers are likely to see stingier rates on their savings accounts and other cash investments within weeks. As a result, investors considering a certificate of deposit should lock in yields as soon as they can, suggests Bankrate.com's Mr. McBride. Amid strong demand for deposits, banks have continued to offer attractive rates on deposit accounts even though the Fed has been cutting interest rates. Average yields on one- and five-year CDs are 3.32% and 3.56%.

Money-market mutual funds, whose yields are currently averaging 4.32% for the 100 largest funds, are likely to fall to about 3.5% in about a month, says Peter Crane of Crane Data LLC. "If we get another cut, we may be on our way to 3%," he says.

(See related article: "Getting Going: Five Good Reasons Stocks Are Attractive Despite Downdraft" -- WSJ Jan. 23, 2008)

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