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Strategists advise caution on streak of bleak stock returns

The recent bleak returns on Wall Street have ushered in a period of accord among investment advisers. Many are prescribing the same bromide to their clients: Switch to defensive stocks and cut back on bonds.

While the strategists may differ somewhat on how weak the economy will become -- or indeed, whether it is already in a recession -- they generally expect the Federal Reserve to cut interest rates substantially this year. Lower interest rates tend to produce better returns, but this time around, many analysts say, rate-cutting might not have an immediate salutary effect.

Aggressive rate cuts have been a boon for investors most of the time. For example, the Standard & Poor's 500-stock index has gained 12 percent, on average, in the first six months of the past 11 Fed rate-cutting cycles. Those cycles, of course, don't necessarily mesh neatly with recessions and rate-cutting doesn't always set off a market rally.

Sam Stovall, the chief investment strategist at S&P, pointed out that the index actually lost ground during the first six months in four of those 11 periods.

"History is a great guide, but it is never gospel," Stovall said.

S&P recently raised the odds of a recession this year to 50 percent. It predicted that the Fed would cut the federal funds rate, the key interest rate under its control, to 3.5 percent by this summer, from 4.25 percent now.

Like many strategists, Stovall says this means investors should emphasize defensive sectors like health care, utilities and consumer staples.

Michael Metz, the chief investment strategist at Oppenheimer & Co, is one of the more bearish strategists on Wall Street and says the US economy is already in a recession.

"The consensus is that we will be in a recovery mode by the second half of this year," Metz said, but he added that in his view a recession could last into early next year.

"Normally when the Fed cuts rates, it stimulates demand for credit and housing," Metz said.

Bond prices have risen sharply in recent months, Metz said, so many fixed-income investors would be better off holding cash than bonds now.

David Darst, chief investment strategist of the global wealth management group at Morgan Stanley, also said investors who didn't need current income should hold cash rather than bonds.

Investors who wanted a fixed-income portfolio -- like retirees who need income -- should stick with investment-grade bonds, he said.

Morgan Stanley is recommending that an investor with a moderate appetite for risk allocate 16 percent of a total portfolio to cash, up from a recommendation of 5 percent cash in more certain times.

Richard Bernstein, the chief domestic strategist at Merrill Lynch, also recommended defensive stocks, in particular emphasizing health care, utilities, telecommunications and consumer staples.

"If the US economy slows because of a consumer-led recession, it is hard to see how emerging markets are immune," he said.

He pointed out that US consumer spending was four times the size of the entire Chinese economy.

"Yes, domestic demand is picking up" in China, he said. "But that's a 10-year story, not a 10-month story."
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