Strategies for a slow-go market

Get ready. If history is any guide, the rally will start to downshift soon.

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By Penelope Wang, Money magazine senior writer

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(Money Magazine) -- Chances are, your 401(k) is looking a lot healthier these days, now that stocks have soared more than 40% in just the past six months. But don't get too used to investing in the fast lane.

While no one knows for certain how equities will behave going forward, the odds are good that Wall Street's torrid pace could soon start to slow. We could even see further declines. Remember that in three of the past four market rebounds since 1982, equity gains slowed to a single-digit pace in the second year of the rally, after the initial euphoria subsided.

Then there's the fact that nearly every asset class is now in the black for the year, thanks to huge gains enjoyed since early March. As a result, most assets are no longer bargains. "We've come too far too fast" in the past six months, says Rob Arnott, chairman of Research Affiliates.

Plus, "the economic problems we face are longer lasting than in previous recessions," says Jeremy DeGroot of Litman/Gregory Research. For instance, consumer spending is likely to be soft for years as Americans struggle to pay off debt. That means "the most likely scenario is low single-digit returns on stocks over the next five years," he says.

So how should you position your portfolio for a market that could slow or even possibly slip into reverse?

U.S. blue-chip stocks

The case: So far in this rally, high-quality large-cap stocks have been left behind. This means mega-cap stocks in the S&P 100 index are trading at much cheaper levels than are small stocks (see the chart).

Blue chips also generate stable revenue that provides advantages in a slow-growth economy -- like the ability to acquire competitors. "It's not just that blue-chip stocks will be the survivors in a slow economy," says Robert Zagunis, co-manager of the Jensen fund. "They will be the winners."

How to invest: You can opt for a fund like Jensen (JENSX), which focuses on big, cash-rich companies. Or if you prefer index funds, check out iShares S&P 100 Index (OEF), an ETF that invests in the 100 biggest U.S. firms.

Dividend-paying foreign stocks

The case: Granted, overseas equities have had quite a run this year, with the MSCI World Ex-U.S. index up more than 17%. But many pros think returns from abroad, particularly from the developing markets, will continue to outpace domestic stocks, as the global economy is expected to grow faster than the U.S.

You can gain exposure to this trend -- but with much less risk than through emerging-markets shares -- by owning large, dividend-paying international stocks, says Morningstar's Arijit Dutta. The payouts from big, stable companies should provide your portfolio stability, especially if the global economy hits another speed bump.

How to invest: SPDR S&P International Dividend (DWX) is a solid, low-cost exchange-traded fund that currently yields more than 5%.

High-quality corporate bonds

The case: "Investment-grade corporate bonds are a good buy," says Arnott. The yield alone on high-quality intermediate-term fixed-income investments has averaged 5.4% lately. That's close to what you might expect from stocks in the near term. And it's considerably better than the 3.8% yield on 10-year Treasuries.

How to invest: Vanguard Intermediate-Term Investment-Grade (VFICX) and iShares iBoxx $ Investment Grade Corporate Bond (LQD) are both diversified portfolios that invest in high-quality U.S. corporate debt.  To top of page

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