Is the boom over?

[notiCIas]

Is the boom over?

Recent economic readings have investors fearing the worst. But don't write stocks off just yet.

June 6, 2005: 10:47 AM EDT
By Michael Sivy, CNN/Money contributing columnist


NEW YORK (CNN/Money) - Analysts were caught off guard by last Friday's employment report -- a paltry gain of 78,000 jobs in May. That's the weakest growth in 21 months and less than half what was expected.

That figure also raised fears that the economic recovery is nearly over.

The employment report wasn't the only surprise. Yields on 10-year Treasuries have fallen below 4 percent, a drop of about three-quarters of a percentage point over the past 12 months.

Such a rate decline is unusual at this stage of an economic recovery and is especially hard to explain given that the Federal Reserve has raised short-term interest rates eight times since 2004.

However you figure it, low employment growth and soft long-term yields signal some sort of slowdown. So what should you expect from the economy? And what do you need to do with your investment portfolio?
Not so slow

The first thing to realize is that the slowdown isn't necessarily serious. Gross domestic product has grown at an above-average rate in each of the past eight quarters. And current forecasts call for growth at an average rate or higher over the next two years.

In addition, despite the subpar jobs numbers in May, the unemployment rate ticked down. It now stands at 5.1 percent, a full percentage point below where it was two years ago.

The only worrisome number is inflation -- consumer prices have risen 3.5 percent over the past year. This figure is on the high side and is the reason the Federal Reserve has been raising short-term interest rates.

Forecasters generally expect that the Fed is almost done with its rate increases -- only one or two more quarter-point hikes seem likely, to 3.25 percent or at most 3.5 percent.

What we're looking at, then, is an almost perfectly neutral set of trends. That's why, in fact, the stock market has been flat for more than a year.

So what's next? Is the current sideways movement a top before a market decline, or is it a pause for the market to catch its breath before beginning the second half of the recovery?

General opinion has swung to the pessimistic side. Growth stocks are trading below their historical valuations, while value stocks are above their norms. Investors either expect a slump or feel the odds are scary enough to require defensive stockpicking.

The outlook certainly justifies some caution. But it's equally important to recognize that there have been no clear signs that the recovery is over.

Inflation is a tad high, but there is little upward pressure on wages and the high price of oil is already reflected in the numbers. As a result, interest rates should soon reach stability.

Slow, steady growth and stable inflation and interest rates are conditions that are typically good for big-cap growth-and-income stocks, many of which are currently undervalued.

So by all means stay defensive in your portfolio. Include stocks with price/earnings ratios below 17 and shares that pay yields above 2.5 percent. Keep some money in a foreign stock fund, preferably one that holds international blue chips, if you're worried about the stability of the U.S. dollar.

But the odds are still in favor of the stock market getting a second wind -- and big, moderate-growth stocks would be the prime beneficiaries. So be as cautious as you need to be, but remember that over the long term, investors make the best returns buying high-quality growth stocks when those shares are as cheap as they are today.