Three reasons to LOVE the slowdown

@Money September 28, 2011: 5:36 AM ET
There are plenty of opportunities during an economic recession, if you know where to look.

There are plenty of opportunities during an economic recession, if you know where to look.

(MONEY Magazine) -- There's no denying that these are scary times for you and your money. The economy is teetering on the edge of another recession.

Housing prices remain stuck in the basement. Newly downgraded U.S. Treasury bonds are paying so little in interest that you're likely to lose ground against inflation. And stocks have been sinking for months. So what's to love, you ask?

Fear and loathing usually create opportunities for bargain hunters with enough cash, credit, and Pepto-Bismol to ride out short-term queasiness.

It's not just with stocks. You can take advantage of historically low mortgage rates and rising rents to make headway in this real estate market, or you can simply borrow money more effectively than in years past.

Remember that managing your money is all about risk and return, says William Bernstein, author of "The Investor's Manifesto." "When the risks rise," he says, "the potential for future return rises too."

1. STOCKS ARE ATTRACTIVELY PRICED

When Warren Buffett was picking up shares of Bank of America (BAC, Fortune 500) on the cheap in August, after the company lost half its value, bargain hunters may have wondered if the Oracle of Omaha was trying to tell them something. Well, yes and no.

Yes, Buffett's move underscores that stocks look like a better deal. Based on projected profits, the market's price/earnings ratio has slid recently. Even using 10 years of average profits, a conservative gauge popularized by Yale economist Robert Shiller, the P/E ratio has fallen from its lofty levels earlier in the year.

Yet it remains higher than the historical average. And if Buffett thought stocks were a screaming buy, he wouldn't have sought a preferential deal with Bank of America. He could have simply bought shares on the open market.

Still, equities in general have fallen to the point where even skeptical pros think there's a good chance of seeing decent, though unspectacular, long-term returns. At the very least, stocks are really cheap compared with U.S. Treasury bonds.

One way to tell is a gauge called the earnings yield. Derived by inverting the P/E ratio, this figure looks at whether a dollar invested in a company through its stock would generate more in earnings than a similar bet on bonds would produce in yield. Right now, stocks are on top.

What to do

Rebalance your portfolio by taking profits in Treasuries, which are up more than 7% this year, and use them to buy equities that throw off dividends.

For just the second time since the 1950s, the S&P 500's dividend yield is greater than what U.S. Treasuries are paying out. Tom Rosenbluth, a fund analyst for Standard & Poor's, recommends low-cost options such as Vanguard High Dividend Yield Index (VHDYX).

What to watch out for

University of Pennsylvania finance professor Jeremy Siegel says "people who are gutsy like Buffett" can take a flier on a risky sector such as financials.

Alas, you can't get the sweetheart deals Warren can. So if you want to bottom-fish in these waters, stick with stronger players that are less exposed to mortgages than Bank of America. S&P equity analyst Erik Oja likes Wells Fargo (WFC, Fortune 500), a stock Buffett has been buying on the open market.

For those seeking a Buffett-like financial sector fund, Morningstar's Harry Milling favors Davis Financial (RPFGX).

2. INTEREST RATES WILL REMAIN LOW FOR A WHILE

With the economy drifting close to another recession -- and with debt-laden governments helpless to do much about it -- Federal Reserve board chairman Ben Bernanke has pledged to be the economy's backstop-in-chief.

Bernanke has said short-term rates will remain low for at least two years. And he hasn't ruled out the option of the Fed ramping up its purchases of Treasury bonds if the economy really tanks. The combination of those actions means those with good credit will be able to borrow cheaply for years.

What to do

Rates on 30-year fixed mortgages dipped to 4.15% in mid-August, the lowest they've been in 40 years, so this is yet another opportunity to refinance. With 15-year mortgages also at historic lows, though, the better play is to shorten the life of your loan.

It's not just mortgages that look attractive. Auto loans are also cheaper than they have been in at least a decade.

And the timing is good: Japanese automakers, slowed by the March tsunami, have been discounting prices and pushing incentives to hang on to their market share. Once they regain traction, expect U.S. and Korean car companies to react with their own incentive drive in the fall.

What to watch out for

The reason the Fed is open to another round of bond buying is to prevent the economy from slipping into Japan-style deflation. But an unintended consequence of Bernanke's aggressive stance on rates may be similar to that of deflation.

When prices fall precipitously, consumers postpone purchases because they know prices will drop even more if they wait a few months. Well, since Bernanke is committed to keeping a lid on rates, you can play the same waiting game. There's no rush to borrow to buy something now; you can wait for sellers to ply you with deals.

3. INVESTMENT PROPERTIES ARE A DEAL

Not only are mortgages cheap, home prices nationally are back to summer 2003 levels, and foreclosure filings have sunk to their lowest levels since November 2007.

The result: The monthly cost of owning a home is now less than average rents in most cities. This is "the opportunity of a generation," says CB Richard Ellis (CBG, Fortune 500) economist Gleb Nechayev.

Yet concerns about jobs and credit problems are keeping buyers on the sidelines while demand for rentals keeps rising.

For anyone who needs to sell a home to buy a new one, the market still is "terrible," says Rick Sharga of RealtyTrac. For people who don't need to sell -- like those in the market for an investment property -- this is a buying opportunity.

What to do

Interested in being a landlord? Target properties in stable neighborhoods that have good schools and are located near an employment center, like a university or hospital.

It makes sense to stay close to home, since you know your neighborhood. At the very least, work with an agent who knows the market you're interested in.

Then, make sure your estimated rental income will cover loan payments, insurance, and taxes -- and then some. Leave a minimum 20% cushion to cover the costs of maintenance and periodic vacancies.

What to watch out for

Be prepared to pay a higher mortgage rate -- by around half a percentage point -- for a rental property than for an owner-occupied home, and to put 20% down.

And unless you have a two-year track record as an investor, lenders may not count future rental income toward qualifying for the loan, says Mike D'Alonzo, president of the National Association of Mortgage Brokers.

Finally, understand that this is a long-term commitment. "Investors aren't able to flip properties as they did even a year ago," says Thomas Popik, research director of Campbell Surveys, which collects sales data from 3,000 agents. Most analysts say it will take at least five years, probably 10 in some depressed markets, for prices to recover enough to give you solid gains. This isn't a get-rich-quick market for real estate -- or stocks for that matter.

Still, those with the patience to seek out the opportunities being created by this new low-rate, slow-growth reality should do fine. Case in point: Shares of Procter & Gamble (PG, Fortune 500), the maker of Pepto-Bismol, have returned 1% in a year when the rest of the market has generated losses.  To top of page

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