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Cover Story: MIDYEAR INVESTMENT OUTLOOK

WHERE TO INVEST

Only six months ago, the pros were lowballing their forecasts for 1995. After the shellacking they took last year, most would have been happy to score single-digit gains in stocks and bonds--and they planned their strategy accordingly. But markets have a way of turning pros into pikers. Indeed, perhaps because expectations were minimal, the markets raced ahead at maximum speed. "Was anybody forecasting 4500 on the Dow, 6.8% on the long bond, 80 yen to the dollar?" asked Nicholas Knight, chief strategist at Nomura Research Institute Ltd., during a speech given to a recent gathering of investment managers in Zurich. The response: a few embarrassed giggles.

There are probably a lot of individual investors who followed the pros, played their cards too cautiously, and missed a good chunk of the markets' progress. But don't despair. It's unrealistic to think the stock market will rack up a further 16.9% increase in the second half or that long-term U.S. Treasuries will rally another 18%. Nonetheless, the gains are far from over.

BUSINESS WEEK's Midyear Investment Outlook finds that the fundamentals for investing are still compelling. True, the U.S. economy is slowing--so much so that recession talk is rampant on Wall Street and Main Street. Yet it's also true that inflation is low and interest rates are down, even after the dollar took a severe drubbing in the currency market. Our economists conclude that the slowdown will be short-lived and that growth will pick up again in the fourth quarter.

Another bullish factor, believe it or not, may be Washington. The pols are taking investor-friendly steps that could have far-reaching implications. Both houses of Congress have passed resolutions to balance the federal budget over the next seven years. Of course, resolutions are easy to make. Exactly how legislators will reach a balanced budget is not yet certain: The senators and representatives have to iron out the differences between their resolutions, a process that should be finished by the end of the month.

By that time, we'll also get a look at what the tax cuts might look like. What emerges will be much less generous than the House's $350 billion bag of goodies. Still, whatever comes up should be much to investors' liking. A reduction in capital-gains tax is considered a sure thing, and the restrictive laws regulating individual retirement accounts (IRAs) may be liberalized.

All in all, the investment backdrop is especially strong for stocks. Recession fears may precipitate a correction, but a pullback is just what many investors have been waiting for--an opportunity to get in at lower prices. Investors don't even have to wait to buy small-company stocks. Most of the market's action this year has been in the big-name issues, and many high-quality smaller companies are selling at attractive prices.

If you're a do-it-yourself stockpicker, be sure to check the latest hot-takeover bets in Inside Wall Street. If you're one of the millions who prefer to leave that to a mutual fund, find out which funds have been doing the best stockpicking of late. Funds that went heavy on high tech did well, which is not surprising. Many of the best-performing stocks of the year are tech issues.

Bond investors have a lot to cheer about this year, and the chances are good for an even further drop in long-term rates. Those who buy municipal bonds have had a tougher time. Their gains from falling rates have been tempered by talk of tax reform that could wipe out munis' tax-favored status.

In scouting for investments, be sure to cast a wide net. Most foreign stock markets have lagged behind the U.S. this year, but they're now gaining strength that should carry through the qecond half of the year. Even the beaten-up Japanese stock market offers some interesting plays.

It may be hard for some investors to buy when prices seem high already. But prices for investments are relative, and looking at the remainder of the year, they're relatively attractive.By Jeffrey M. Laderman in New York, with Howard Gleckman in Washington and Bill Javetski in Paris


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