Even with all the money pouring into stock mutual funds, Americans still have almost $1 trillion in money-market funds.
If you hold some of that cash, you may be wishing you had put it into stocks two years ago. But now, market indexes are pushing toward record highs. If you think the next big move could be down, what should you do?
Here are questions and answers that may help you decide:
Millions of dollars continue to pour into stock funds. Isn't a major "correction" unlikely?
Most analysts at major investment houses argue that stocks will keep climbing. But others are sending up warning signals. Sheldon Jacobs, who edits the No-Load Fund Investor, is urging clients to be cautious. He believes a modest correction of 10 percent or less could occur "at any time." A bear market - with declines of 10 to 25 percent - "is not imminent, but could occur later this year or early in 1998."
If stocks drop 10 percent, isn't that a buy opportunity?
Could be. But that kind of minor correction might turn into something worse, as happened in 1929 and 1972, notes Tim Opler, a finance professor at Ohio State University, Columbus. He foresees corporate profits falling in the months ahead. If the market drops in response, baby boomers might stampede out of equity funds, causing further drops. His advice on stocks: "Head for the door now."
Others aren't so pessimistic. Peggy Farley, chief executive officer of AMAS Securities Inc. in New York, predicts the Dow Jones industrial average will climb to 7000 this year, from about 6800 now. But easing corporate profits may cause a modest correction, Ms. Farley says.
After a dip, you should still think a little defensively, she says. The high US dollar will make US exports more expensive abroad, so investors should be wary of export and technology stocks.
Are foreign stocks a good buy today?
Yes, say many analysts. As discussed in this column Jan. 28, buying into a foreign-stock fund can be a good way to hedge against a US downturn; some observers say global markets have become increasingly disconnected from each other. In the individual years between 1986 and 1995, the US never once had the best-performing stock market, according to Pioneer Funds Group in Boston.
Any other good defenses?
Farley recommends consumer-oriented companies that offer some defense in a correction.
To prepare for a bear market, Mr. Jacobs recommends several types of funds: real estate funds, short-term bond funds (with maturities of two to five years), long-term bonds and bond funds, international bond funds, high-yield "junk" bond funds, utility funds, and safe money-market funds. One thing all these have in common: Solid income payouts compared with most stock funds.
He also recommends some "contrarian" funds, which aim to offset or minimize the damage of a down market. These include the Rydex Ursa Fund, Robertson Stephen Contrarian Fund, and Lindner Bulwark Fund.
Funds to avoid, he says, include convertible-bond funds, gold funds, market-timing funds, small-company funds, and, perhaps surprisingly, international funds. (He says the latter may do poorly in a short bear market.) Jacobs offers a brief but useful pamphlet, "How to Protect Your Mutual Fund Profits in Any Market" ($19.95; call 800-252-2042).
Do contrarian funds live up to their name?
No one knows. Most have only been around a few years. In last year's midsummer correction, Jacobs notes, Rydex Ursa rose 4.7 percent, Lindner Bulwark fell 6.6 percent, and Robertson Stephens fell 1.1 percent. The average diversified fund, by contrast, was down 5.5 percent. Note: Rydex Ursa will likely lose money in an up market; it is designed for downturns.
Will junk bonds really perform well in a market slump?
That depends. High-yield bonds, called junk because of their greater-than-average risk of default, have been hot in recent years (see chart). They can provide high total return during a relatively short correction, experts say. But investor demand has narrowed their yield advantage over standard bonds. And they can be risky in a severe downturn. In 1990, when the Standard & Poor's 500 index fell 3.12 percent, high-yield bond funds tracked by Morningstar fell 9.17 percent. One fund, the Dean Witter High Yield Securities Fund, lost 40 percent in 1990, but gained 67 percent in 1991.
If I want to invest some cash, how should I do it?
"Dollar-cost averaging" makes sense. That means spreading out your investment, such as buying a bit every month. That way, you don't invest it all at a peak price.
And remember, cash isn't trash. If nothing else looks like a good buy, hang onto that money-market mutual fund. It should yield nearly 5 percent and be safe from losing face value.
Jacobs notes that no bear market since 1982 has lasted more than eight months. But in the last major bear market, in 1973-74, the Dow dropped 45 percent.