Economic Slowdown: How To Navigate The Storm

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So you got a little careless. You didn't rebalance your portfolio as tech stocks soared a year ago. Maybe you hung on to that dotbomb until it exploded, and then made things worse by running up your credit cards. Or while your investments were booming, you decided you could afford to save less. With stocks cratering and the economy slowing, you don't feel so flush anymore. It's time to get real and fix those giddy-times mistakes.

In some cases, the fixes will take time. The NASDAQ just turned in the worst year of its 29-year existence, falling 39%. The Dow and the S&P 500 were also losers last year. The more than $2.5 trillion of vanished stock-market wealth since March won't be easy to get back. The NASDAQ, for example, would have to rise more than 15% a year for five years to return to its high. Meanwhile, consumer debt (excluding mortgages) has doubled over the past decade and averages nearly $15,000 per household. It will take years for borrowers to pay down those debts--and for lenders to deal with defaults.

Still, it's important at times like this to step back and count your blessings. Inflation is no longer on top of Alan Greenspan's worry list, so the Fed chief has room to cut interest rates, probably starting late this month. Corporate profits, though slowing, will still be up in the coming year. Mortgage rates have declined sharply, putting a floor under home values. That's critical because despite the explosion of stock-market wealth over the past decade, the most valuable asset most Americans own is their home. The unemployment rate remains low at 4%, and many economists believe that even in a recession it wouldn't go much higher than 4.5%, so you'll probably keep another of your major assets--your job.

Even in the stock market, if you have been investing for two years or longer, you're probably still ahead. The past year's declines have wrung many excesses out of the markets, and the shares of many solid companies are now available at bargain prices. So although there's danger dead ahead, there are also opportunities. Here are some ideas for dealing with both:

INVESTMENTS

The most important concept to grasp at this point is how the stock market interacts with the economy. Both run in cycles. But because investors focus on the future, the stock-market cycle is usually ahead of the economic cycle by six months to a year. With an unprecedented 49% of all American households owning stocks, and so much information available immediately via the Web and financial TV channels, this linkage is tightening. But there will always be a gap between the market and the real economy. That means stocks may be at their lows just as a slowdown becomes apparent. Where are we today? The slump is just now smacking us in the face, but the stock market started discounting it 10 months ago.