TODAY'S SIX BEST INVESTMENTS ALAN GREENSPAN'S INTEREST-RATE HIKE MEANS FURTHER TOUGH TIMES AHEAD FOR U.S. STOCKS. BUT THESE TOP-QUALITY INVESTMENTS CAN CUT YOUR RISK AND KEEP YOU ON TRACK FOR DOUBLE-DIGIT RETURNS.
(MONEY Magazine) – William McChesney Martin, Federal Reserve Board chairman from 1951 to 1970, aptly described his job as being "the chaperone who takes away the punch bowl when the party gets going good." In other words, whenever the economy threatens to turn overexuberant and stock investors begin dancing with abandon, the Fed is supposed to take away the happy juice. That is, the central bank raises short-term interest rates to dry up the flow of money, which sobers up the economy--and ultimately the stock market.
Given the gala stock gains of the past two years, investors would have to acknowledge that today's Fed chairman, Alan Greenspan, has been a generous host. In 1995 and '96, he reduced short-term rates three times--a total of three-quarters of a percentage point. As a result, with corporate profits growing more than 10% a year, lower interest rates spurred the Dow Jones industrial average to gains of more than 80%.
In late March, however, Greenspan decided that the economy's continued strength might lead to higher inflation and hiked interest rates by a quarter of a point. Odds are he will boost them again: On 11 of the 13 occasions that the Fed has increased rates since 1936, it has raised them again a median of 3.6 months later. "Greenspan's move signals the end of easy profits in the stock market," says Rao Chalasani, chief investment strategist at Everen Securities in Chicago. Share prices don't always dive the first time the Fed raises rates after a period of easy money.
In March, however, while Standard & Poor's 500-stock index dropped a mere fifth of a percentage point the day the hike was announced, it then declined 4% over the next four trading days. Based on historical patterns, here's what to expect.
--Stocks will provide below-average annual returns for three to five years. Whether share prices fall at least 15% before rebounding--as we think likely--or simply drift choppily sideways, blue-chip stocks are likely to post subpar returns for at least three years. In fact, when stocks are trading at price/earnings ratios above 17, as they are today, during the next five years they typically return less than 7% annually--four percentage points below their average since 1926.