Investing for the Long Uncertainty Ahead

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Staying in Fixed Income

In one strategy, advisers choose between fixed income and any or all of the 10 sectors represented in the S&P 500 index, while the second strategy lets them select between fixed income and the stocks in any or all of 20 countries outside the U.S., using exchange-traded funds. "Today, these equity portfolios are 100% in fixed income, because all the signals point to the risk/reward trade-off being more favorable right now in fixed income than in equities," says Hughes. Comprising intermediate bonds, Treasury Inflation-Protected Securities (TIPS), high-yield corporate bonds, and 7-10 year Treasury bonds. the fixed-income portfolio offers a yield of roughly 7.5%. As fundamental and risk-based factors change, he says he expects the portfolios to inch more into stocks.

Hughes views the four-day rally of the week ending Mar. 13 as a technical rebound based on hope rather than changed economic prospects. "It's clearly welcome, but to get overly excited by it is not warranted," he says. "It's going to be a sideways market for the foreseeable future."

But with stocks down by nearly 60% from their October 2007 peak, how can you go wrong buying at such cheap valuations? Even as the major stock indexes were able to log four consecutive days of gains last week, some wary pros warn that this may turn out to be a "suckers rally," when none of the economic fundamentals has changed.

Impervious to Fiscal Stimulus

Of course, there are still some high-quality individual stocks to be had for reasonable prices without putting your portfolio at much risk, says Walter McCormick, a managing director and senior portfolio manager at Evergreen Investments in Boston. Among his favorites are Automatic Data Processing (ADP), since the payroll business will always be needed, McCormick says. In addition, Automatic Data Processing has kept on raising its dividend. Another favorite is Visa (V), which benefits from the expanding use of credit and debit cards worldwide without taking on any of the nonpayment risk borne by retailers and companies such as American Express (AXP).

The real danger, one that most people would prefer not to confront, is that this recession turns out to be one of those rare times in history—such as the early 1930s in the U.S. and Japan in the 1990s—when no amount of fiscal stimulus will work, says Waddell & Reed's Avery.

He cites the analysis by Richard C. Koo, Chief Economist of Nomura Research Institute, the research arm of Nomura Securities, who said that with the asset side of their balance sheets so depleted and little prospect of anything to sufficiently re-inflate it on the horizon, consumers will focus on what they can do: Reduce their liabilities side by paying down debt and cutting back on their purchases.

If Koo is correct, it's going to take a long time for the U.S. economy to recover, says Avery. Investors then will have to navigate the doldrums with some smart defensive strategies.

Bogoslaw is a reporter for BusinessWeek's Investing channel.