Fed Rate Cut Gives Investors A Psychic Boost

The Federal Reserve’s unexpected quarter-point cut in interest rates last week gave investors a psychic boost and reason to hope the good times for the stock market aren’t over.

Too bad. The good times can’t go on forever, and a dose of investor caution is called for, experts say.

The biggest worry: the federal budget battle between President Clinton and Republicans in Congress could continue into the New Year like a bad hangover.

The stock and bond markets are flying high, partly because investors expect the two sides to come up with a credible deal to reduce government spending and balance the federal budget by 2002. The hope is that would lead to lower interest rates and greater economic growth.

Even if a deal is done by Christmas, investors have other reasons to be wary. “We’ve reached silly season on Wall Street,” says Norman Fosback, publisher of the Mutual Fund Forecaster and Market Logic newsletters.

“This market has gone to places it has never been before - without a correction of more than 10 percent in five years,” he says.

For a time Monday, it appeared the five-year bull market for stocks might be ending as the Dow Jones Industrial Average took a 100-point plunge, its biggest in four years. But the Fed’s rate cut sparked a 34-point rebound Tuesday.

But Monday’s drop should also remind investors that markets are fickle and can fall for far less consequential reasons than battles over federal budget deficits.

They should also remember that the Fed’s rate cut is a sign that all is not well with the economy. Economists expect far slower economic growth in 1996, lower corporate earnings and less consumer spending.

What should investors do? Face reality and prepare for even more market ups and downs. Experts offer these tips for worried investors:

Re-evaluate your portfolio and your asset allocation. Stocks are at all-time highs. You’re likely to have more money in stocks than you realize, thanks to this year’s runup in stock prices. Rejigger your portfolio so the balance between stocks, bonds and cash is one that you are most comfortable with.

Go to cash. Can’t afford even a small decline in stock prices? Consider moving money into bonds or money-market accounts.

Go conservative. Growth stocks have lead the market this year, but that doesn’t mean they will next year. Another possibility: Go with growth-and-income funds or balanced funds that mix stock and bonds. These funds typically fall less in bear markets.

Lighten up on tech stocks. Technology stocks have been this year’s star performers. But nothing goes up forever, so don’t be greedy. Much of what happened in Monday’s market decline was because smart investors, portfolio managers, were selling stocks to try and lock in the huge gains they’ve made this year.

Be prepared to make money on the rebound from a market sell-off. Sock away some cash. And look for stocks that have been beaten down recently and are likely to bounce back.

Don’t bail out completely. The stock market is still a very good place to be. Even if stocks post single-digit instead of double-digit returns in 1996, they’ll still outperform bonds and money markets, experts say.