If Stocks Tank, Don’t Worry

This is the case for embracing stocks – and ignoring fears about dips and bubbles.

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An electronic monitor displays the Dow Jones Industrial Average on the floor of the New York Stock Exchange near the close on Monday, Aug. 8, 2011, in New York. The Dow Jones industrials fell 634.76 points that day.
An electronic monitor displays the Dow Jones Industrial Average on the floor of the New York Stock Exchange near the close on Monday, Aug. 8, 2011, in New York. The Dow Jones industrials fell 634.76 points that day.

BEVERLY HILLS, CALIF. – Wall Street is waiting for a stock-market correction, which could shave 5 percent or even 10 percent off stock indexes such as the Dow Jones Industrial Average. With stocks up a frothy 11 percent so far this year – and some bad economic news brewing – many top investors feel a pullback would be natural, even healthy.

As ordinary investors gain confidence in the economy and wade back into stocks, many are waiting for a drop in prices as an opportunity to "buy the dip." Others still feel stocks are too unstable and lack the stomach to ride out even a short correction.

The best approach, however, may be to stop worrying about dips or bubbles. "I can't time when the correction is going to come," said Art Steinmetz, chief investment officer for Oppenheimer Funds, in an interview at the annual Milken Institute Global Conference here.

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"I'd rather be in the market and not have to worry about picking the bottom. Corrections will happen. The world is fraught with risk."

Many of the financial gurus gathered here also think it's filled with opportunity, as the U.S. economy heals, Japan embarks on a bold new effort to stimulate growth and many big companies prepare for a robust recovery.

"I'm quite optimistic we'll get back to low unemployment and high growth," said John Rogers, CEO of Ariel Investments. "Stock prices are cheap in today's environment. There's been extraordinary risk avoidance. We're now seeing people get more comfortable with riskier assets. I think we'll get back to the old normal."

Under the old normal, which might seem hard to recall, ordinary investors were relatively optimistic about their personal prospects and the future of the economy. They were willing to take risks by buying stocks, with no guaranteed rate of return, and by committing to big purchases, such as a house, with as much debt as banks would give them. The twin housing and stock market busts in 2008 and 2009 obviously shocked many people into more conservative behavior.

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Many financial advisers are now trying to talk their clients into taking the kinds of risks that might have caused little concern eight or 10 years ago. But that requires convincing them that the economy can stand on its own without unprecedented government support, and that stocks won't tank once the Fed pulls back on the "quantitative easing" that has inflated asset prices.

Like many other financial advisers, Steinmetz believes that Fed action has pushed up stock prices – but only by accelerating gains that would have happened anyway. "Stocks have recovered sooner than they would have otherwise," he says.

"But when you look at earlier episodes of Fed tightening, what you find is stocks do rather well when monetary policy is being snugged up, because by then the economy is growing. What might be different this time is we may have found we front-loaded the rally."

Oppenheimer advises clients to abide by a "new 60-40 rule," with the 60 percent of their portfolio invested in stocks including global equities from every region, and the 40 percent in bonds including only a small portion in supersafe assets like Treasurys, with the rest in higher-yielding bonds.

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High-quality (and low-yielding) bonds have performed well during the last four years, but they could lose value if interest rates rise, which is what would happen as the Fed tightens its policy. That alone may boost demand for stocks, helping raise prices.

There are still a lot of risks, including profound problems in Europe and legislation out of Congress that seems to be harming the economy more than helping it. Some prominent investors think the stock market is heading for trouble.

Todd Morley, CEO of the G2 Investment Group, said at the Milken conference that Fed intervention has created "zombie markets pumped up on steroids," which he prefers to stay away from.

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Yet the most conservative investing strategies are risky, too. "You can't have all your money in high-quality bonds earning less than inflation," Steinmetz says. "Some people are comfortable knowing they're going to lose money, as long as they lose money slowly."

If that's the new normal, it makes the old normal look awfully good.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.