It’s Smart To Invest In Five Categories These Days

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BERLIN – The best minds on Wall Street generally agree: Global markets will continue to be unsettled throughout 2008. The ongoing uncertainty has naturally made some investors skittish.  But there’s a flip side to market volatility: Just as many of the market leaders of the past several years have slipped, a new group is emerging.

“Leaders going into a period of increased financial market volatility simply have not been the leaders coming out,” said Richard Bernstein, Chief Investment Strategist at Merrill Lynch.

So what’s behind the market upheaval? In part, it’s the tectonic shifts in worldwide economic conditions.

“Volatility is predominantly a symptom of change in the underlying global economies,” said Bernstein. “And the biggest change is the tightening of credit markets around the globe.”

While the credit crunch is likely to continue, Bernstein believes that “market leaders tied to the credit bubble will likely change.” Sectors such as U.S. small caps, emerging markets, commodities, energy and low-quality bonds all tend to flourish in times of easier credit. But they’re more vulnerable when banks are less willing to lend.

Several other underlying factors are expected to contribute to ongoing volatility in 2008, and these factors will also help to create a different set of market leaders. Take, for instance, the market’s disappointment in global economic growth.

“Back in 2006, 68% of countries experienced accelerating growth,” said Bernstein. “That dipped to 42% in 2007, and we think it will slow to 19% in 2008 — with many markets not priced for a slowdown, particularly emerging markets.”

So, while emerging markets stand to grow over the next 12 months, they probably won’t expand at the pace they have in the past few years.

What will best serve investors in a volatile, tight-credit climate? Bernstein’s focus is on higher-quality assets. Specifically, he cites those that are self-financing and not dependent on outside capital, as well as those whose improving fundamentals have been largely ignored. He points to five investment categories:

(BULLET)High-quality bonds. Top-shelf corporate and municipal bonds appear more attractive than their riskier counterparts. The spread between more speculative bonds and the 10-Year Treasury has narrowed sharply, and high-quality corporate and municipal bonds look likely to offer a better return than the 10-Year Treasury.

(BULLET)Large-capitalization stocks in the U.S. and small-capitalization stocks outside the U.S. Domestic large caps tend to outperform because in times of rising volatility investors are more likely to turn to big companies with strong balance sheets, predictable profits and multinational exposure.

(BULLET)Defensive sectors in the U.S. Consumer staples and health care — particularly pharmaceuticals — are safe havens when growth is scarce because their products are necessary whether consumer demand is high or low.

(BULLET)A more conservative mix of developed and emerging markets. Much of the value in the global equity markets is in developed markets, and relative GDP forecasts start to favor developed markets in 2009. Among these markets, China and India have been popular, but Bernstein prefers South Korea and Taiwan.

(BULLET)High-quality dividend stocks and cash. Dividends offer a buffer against volatility, and stocks from large, well-established companies that have raised their dividends consistently for years can offer growth in addition to portfolio-steadying income.

Bear these five strategies in mind as you discuss portfolio rebalancing with your financial advisor, who can help you take advantage of emerging opportunities.

(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)

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