(MONEY Magazine) – There's a whiff of recession in the air. Those with a pessimistic outlook, such as Irwin Kellner, chief economist at Manufacturers Hanover, believe it may be here already. Less dour seers, such as Donald Straszheim, chief economist at Merrill Lynch, expect only a modest slowdown in 1988. Either way, you should be shifting your portfolio now to include investments that can prosper if business conditions take a turn for the worse. Such investments generally fall into three broad categories: fixed-income securities such as Treasury bonds, high-yield stocks and the shares of manufacturers of products or services for which demand remains strong in a business downturn. During a recession, interest rates typically fall and both fixed-income securities and high-dividend stocks rise in price because their payouts are more attractive to investors. And even if the stock market declines overall, the shares of companies that report steady earnings growth can often buck the trend. Usually, the stocks whose profits hold up best are the shares of companies that make basic necessities, such as food, beverages and tobacco products. Even in a recession, consumers like to eat cake, and smokers retain their yen for cigarettes. But over the next few years, analysts expect a surprising stock group to prosper. As long as there is not a deep recession, says Merrill's Straszheim, there could well be a boom for U.S. producers of capital goods -- equipment such as machine tools that are used by companies to manufacture other products. Below, Money highlights 10 investment categories that could thrive if the economy weakens and inflation remains subdued in 1988 and 1989. For the stocks mentioned, price/earnings ratios are based on analysts' estimates of 1988 earnings, and yields reflect projections of dividends for 1988.

CASH EQUIVALENTS High-quality short-term debt issues and funds are so liquid and safe that they are virtually as good as cash. But cash equivalents have an obvious advantage over stashing your savings in a sock -- they pay interest of 5% to 7% currently. Such investments include Treasury bills, money-market funds and money-market deposit accounts (MMDAs) -- bank accounts that are roughly comparable to money-market funds. But while money funds pay interest at prevailing market rates, MMDA yields are set at the whim of the bank and can be as much as a percentage point lower. Treasury bills are backed by the full taxing authority of the U.S. government and are virtually free from the risk of default. The safest money funds are those that invest exclusively in Treasury securities. You pay for this safety. According to Donoghue's Money Fund Report, government money funds were yielding 6.2% on average in early December, compared with 6.6% for funds that take greater risks by dealing in more exotic short-term investments, such as Eurodollar CDs, banker's acceptances and repurchase agreements. Such general money-market funds also surpassed MMDAs, which were yielding 5.8%. Money funds are more convenient as well, since they allow unlimited checkwriting, compared with only three checks a month for MMDAs.

LONG-TERM BONDS In a recession with declining interest rates, ''the longer the bond the better,'' says Dennis Hesse, managing director of First Chicago Investment Advisors. That's because when interest rates fall, bond prices rise, and long- ^ term bonds (those with maturities ranging from 10 to 30 years) enjoy the greatest price increases. You should make sure, however, that your bond can't be called, or redeemed, in less than 10 years. If interest rates turn up, though, long bonds would lose the most, which makes them riskier than short- term issues. If a recession is severe, Treasuries are a better choice than corporate bonds, because a poor business climate could cause the credit rating on corporates to deteriorate, limiting their price gains. Most investors should avoid mortgage-backed securities issued by government agencies, such as Government National Mortgage Association certificates (GNMAs) and mutual funds that invest principally in such issues. These securities can be paid off ahead of schedule if interest rates fall and homeowners refinance their mortgages, thereby depriving GNMA holders of the lofty yields that they thought they had locked in. The bonds most likely to default by missing a payment of interest or principal in any economic downturn are those with the lowest ratings -- namely junk bonds. Avoid them. Better bets are high-quality bonds in industries that tend to do well regardless of economic downturns, like medical supply companies, food and liquor producers, and major integrated oil companies.

SHORT-TERM BONDS Issues with maturities between one and 10 years are the best compromise for most fixed-income investors. Since yields are usually higher the longer the maturity of an issue, short-term bonds offer a bigger return than money funds (8% for a three-year bond vs. 6% for a government money fund). And because of their shorter maturities, such bonds are less volatile than long-term securities, a crucial consideration if interest rates are rising. For example, a one-percentage-point rise in interest rates would cause a 3% drop in price for a typical three-year bond vs. 9% for a 30-year issue, says Joe Taylor, a corporate bond analyst at Smith Barney. Short-term corporate bonds typically offer yields as much as a percentage point higher than those of Treasuries. Taylor advises investors to stick to investment-grade issues -- those rated AA or AAA by agencies such as Standard & Poor's and Moody's. He recommends three bonds listed on the New York Stock Exchange that were recently issued and therefore trade actively: American General 9 1/2s maturing in 1994 (trading at $990 per bond and yielding 9.5%), General Motors Acceptance Corp. 9 3/8s of 1992 ($1,000, 9.4%) and Sara Lee 9.10s of 1992 ($1,000, 9.1%).

MUNICIPAL BONDS Like Treasuries and corporates, long-term municipal bonds can be solid investments in an economic downturn, because their prices will appreciate if interest rates fall. Moreover, these bonds are one of the few tax-advantaged investments left after the 1986 tax reform law. Because interest on munis is exempt from federal income tax, a muni yielding 8.2%, say, provides just as high a yield after taxes for someone in the 33% bracket as a Treasury yielding 12.2%. Munis come in two flavors: general-obligation bonds (GOs), which are backed by the taxing power of a state or local government, and revenue bonds, which pay their interest out of revenues from a specific project, such as a toll road, hospital or power plant. Because revenue bonds depend on the project's success, they can be a little dicier than GOs and therefore pay a slightly higher yield to compensate -- 8.4% recently vs. 7.9% for top-quality 20-year GOs. Most investors tend to buy long-term munis, which currently yield 7% to 8.5%, 90% of the yield of long-term Treasuries. But some shorter-term issues are extremely attractive as well. For example, so-called pre-refunded munis can be excellent buys, says Steve Hueglin, executive vice president at Gabriele Hueglin & Cashman. The New York Metropolitan Transit Authority 9 7/8% maturing in 2017 (trading at $1,180 per bond) is such an issue and yields 6.8%. It is backed by a pool of Treasury securities and will be paid off early in 1994, giving it an effective maturity of six years, Hueglin says.

FOREIGN BONDS American investors in foreign issues are benefiting handsomely from the decline of the dollar. When it falls, securities priced in foreign currencies are automatically worth more in dollar terms. (For more on this, see the story on page 161.) Foreign bonds would get a further boost if a recession spread to foreign countries, causing their interest rates to drop and bonds in those countries to rise in price. Investors with less than $100,000 to commit to foreign bonds are better off buying one of the 17 existing foreign-bond mutual funds. On average, these funds returned 15% for the past 12 months. There are also three closed-end funds -- investment companies that operate like mutual funds but have a fixed number of shares outstanding that trade on stock exchanges: the First Australia Prime Income Fund (American Stock Exchange, $8), up 3.5% for the past 12 months; the Kleinwort Benson Australia Fund (NYSE, $8.75), down 2.7%; and the Global Yield Fund (NYSE, $10), up 24.3%.

UTILITIES Electric companies' stocks do well in a recession for two reasons: First, the demand for electricity is fairly steady. Second, utility shares sport high yields and therefore behave much like long-term bonds, rising when interest rates fall. Moreover, utility yields are generally secure. Managements know that investors buy utilities for income, so they try to maintain dividends at almost any cost. In the 1981-1982 recession, for example, ''not one electric company cut a dividend,'' says Barry Abramson, an analyst at Prudential-Bache Securities. The best electric companies to buy are those that have mostly residential customers. Utilities in the Southeast, in particular, have such customer bases, says Smith Barney analyst Daniele Seitz, who likes FPL Group (NYSE, $28.50, yielding 7.7%), with revenues of $4.3 billion, which serves Florida, and $6.8 billion Southern Co. (NYSE, $21, 10.1%), which provides power in Georgia and Alabama.

REAL ESTATE INVESTMENT TRUSTS Most real estate investment trusts (REITs) own a diverse assortment of commercial property. They earn income from leases to tenants who occupy these properties and pay 95% of their earnings to shareholders in the form of regular quarterly income distributions. As properties are sold, the trusts may pay out capital gains as well. As long as their buildings are occupied, REITs are not affected greatly by economic fluctuations. A related type of company -- known as a mortgage REIT -- makes loans to builders and commercial property owners. Such REITs may make fewer new mortgage loans when the economy is depressed, but they continue to earn income on existing mortgages, assuming the owners don't default. Since both kinds of REITs generally offer high yields -- 10% for regular REITs, 14% for mortgage REITs -- they behave much like bonds, and their prices are buoyed by their lofty payouts. This was reflected in the tumultuous period of Oct. 16 to Oct. 27, 1987, when the Alex. Brown equity REIT index dropped only about 9.5%, compared with a decline of 28% for the S&P 500. In addition to Washington REIT with properties worth $193 million, Alex. Brown analyst Burland East recommends that investors concentrate on conservative REITs operating in healthy economies. His top picks: $25 million ^ Burnham Pacific Properties (ASE, $15.75, yielding 7.6%), which owns commercial property in San Diego, and $92 million United Dominion Realty Trust (recently traded over the counter at $16.25, yielding 6.4%), which owns apartments in the Carolinas and Virginia.

MAKERS OF GOT-TO-BUY GOODS Some industries do well even in a recession because consumers continue to buy their products. ''The idea is to focus on companies that make products we consume every day and that are not discretionary,'' says Dick Strong, president of the Strong Group of mutual funds. Historically this has been true of food, beverage and tobacco companies, so-called defensive industries. This time around, food and beverage producers are not likely to fare as well, however, because a recovery in farming is driving up their raw material costs at a time when it is difficult for them to pass the increases on to consumers in the form of higher prices. ''These companies have had their day in the sun,'' says Charles Clough, portfolio strategist at Merrill Lynch. He favors tobacco stocks, particularly Philip Morris (NYSE, $50). A large portion of that company's $29 billion sales are overseas, which makes it less vulnerable than other domestic producers to anti-smoking legislation in the U.S. Demand could also be strong for the services of child-care companies. Since they primarily serve middle-class workers, such businesses would be among the last to be hurt in a downturn, says Merrill Lynch analyst Jerry Levine, who singles out $231 million Kinder-Care (OTC, $7.50). Other companies that could remain relatively unaffected by a downturn, analysts say, are $5 billion American Home Products (NYSE, $70), a maker of over-the-counter medicines such as Advil, and $146 million King World (NYSE, $16.25), an entertainment company that produces popular TV shows like Wheel of Fortune.

WORSE-IS-BETTER STOCKS Some companies benefit when the economy falters and unemployment rises, because demand grows for their products and services. For example, vocational schools stand to do well even if unemployment increases only modestly. These schools attract low-income people, who are often the first to lose jobs. Government loans -- arranged by the schools -- are readily available to cover tuition, which can run $3,000 or more per student. ''Unless the economy goes totally to hell and there are no jobs to be found, investors ought to own these companies,'' says Michael Adkins, an analyst at the brokerage Fechtor Detwiler in Boston. In addition to United Education & Software, with revenues of $80 million, he likes $247 million National Education (NYSE, $16.75) and $42 million CareerCom (OTC, $8). Temporary-help agencies also fare better during uncertain times because managements -- cautious about increasing costs by hiring additional full-time employees -- make greater use of these services. Jack Sullivan, a principal at the San Francisco brokerage Van Kasper & Co., recommends $145 million Robert Half International (OTC, $14.50), a provider of temporary personnel for accounting and financial services, and $32 million Diversco (OTC, $4.75), a South Carolina company that specializes in the blue-collar jobs prevalent in the region's industrial and textile plants. Similarly, companies that lease equipment to businesses fare well during downturns because companies will refrain from purchasing equipment that they can rent instead. Here Sullivan likes $47 million Amplicon (OTC, $6.75), a leaser of mid-range business computers and software.

RUST-BELT REBOUNDERS Capital-goods companies usually suffer in an economic downturn, because most companies are hesitant to invest in additional production facilities. But as a result of a severe depression in the manufacturing and capital-goods sectors the past several years, these companies underwent extensive restructuring that greatly increased their ability to compete against foreign producers. Now, because of the declining dollar, which benefits U.S. companies by forcing their foreign competitors to raise prices in dollar terms, some analysts predict that the U.S. industrial sector will experience strong growth in 1988, even if business slows for consumer products companies. Merrill's Clough, for example, expects the lower dollar to help companies such as Caterpillar (NYSE, $57.25), a maker of earth-moving equipment, with revenues of $7.9 billion, $1 billion Clark Equipment (NYSE, $25.25), a forklift producer, $1.8 billion Parker-Hannifin (NYSE, $25.50), a manufacturer of industrial components, and $491 million Trinity Industries (NYSE, $23.75), a maker of assorted metal products. A full-blown recession would hurt capital-goods manufacturers as well as consumer-goods producers, says Merrill's Straszheim. But he anticipates a further dollar devaluation of 7% in 1988, which would be sufficient to offset the impact of what he predicts will be nothing more than an economic slowdown.

BOX: Benham Capital Preservation Fund , This money fund invests only in Treasury bills. As a result, Benham Capital (800-472-3389, 800-982-6150 in California) pays a yield below that of some other money funds but offers a very high degree of safety. Minimum initial investment: $1,000 Yield: 5.6%

U.S. Treasury bond (due in 1998) Bonds with maturities of 10 years or more offer the highest yields. But long- term issues can fluctuate sharply in price. Analysts currently think that 10- year issues provide the best trade-off between high yield and low risk. Maturity: 10 years Yield: 9%

Twentieth Century U.S. Govts. Returns for this short-term bond fund have been consistently higher than money fund yields. Twentieth Century (800-345-2021) buys only government issues. Minimum initial investment: None Portfolio maturity: 2.4 years Yield: 8.5%

Nuveen National Insured Trust Nuveen (800-221-4276) is one of the largest packagers of municipal bonds, and its trusts are among the highest yielding. Rated AAA, the trusts yield the equivalent of 11.5% to investors in the 33% bracket.

Maturity: 27 years Yield: 7.7%

Mass. Fin'l Internat'l Trust: Bond Port. The first foreign bond fund, started in 1981, Massachusetts Financial favors government and top corporate bonds of strong-currency countries such as Germany and Great Britain. The fund charges a 7.25% load. Price: $13.19 Yield: 5.5%

Potomac Electric Power (NYSE) This utility's dividend has doubled over the past 10 years, says Barry Abramson, an analyst at Prudential-Bache Securities. With revenues of $1.3 billion, Potomac serves the prosperous Washington, D.C. area. Price: $21.75 52-week range: $27.25 to $18 Yield: 6.3%

Washington REIT (ASE) With assets worth $193 million, this REIT owns offices, apartments and shopping centers. Its properties are in and around Washington, D.C., a region marked by little overbuilding, says Alex. Brown analyst Burland East. Price: $21.50 52-week range: $27.25 to $17.50 Yield: 6.5%

Tambrands (NYSE) With revenues of $600 million, Tambrands commands 60% of the U.S. tampon market and has only one major competitor overseas. ''Its Tampax products are exceptionally profitable,'' says Shearson Lehman analyst Andrew Shore. Price: $49 52-week range: $71 to $45 P/E: 12.4 Yield: 3.9%

United Education & Software (OTC) This trade-school firm, with revenues of $80 million, will do well if unemployment increases, because laid-off workers will seek retraining, says Michael Adkins, an analyst at Fechtor Detwiler in Boston. Price: $12 52-week range: $17 to $10 P/E: 11.4

Norton (NYSE) Norton, a producer of abrasives, is a beneficiary of a lower dollar, which makes U.S. goods cheaper for foreigners. Paine-Webber analyst Eli Lustgarten notes that 10% of Norton's $1.3 billion sales are exports and 50% are foreign- based. Price: $38.75 52-week range: $60 to $31 P/E: 10.9 Yield: 5.2%