Mixing Stocks and Bonds Works Best

04/23/2007 12:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, publisher of the Forbes/Lehmann Income Securities Investor, says the ups and downs of the market so far this year should remind investors of the importance of a balanced portfolio.

So how did you fare in the first quarter? If you invested in the stock market, you did well if you are back where you were at year-end 2006. All in all, a blending of bonds and equities and a rebalancing of that blend as the stock market weakens [still] offers the best way to play the stock market over the long run.

Pundits tell us that the stock market will recover and finish the year higher, and maybe they will be right. However, there is plenty of reason to worry, since the premise for such an optimistic outcome is that old and dangerous saw, "this time, it's different."

The current concern about sub-prime mortgages may be overblown as to the effect on lenders, but there is another effect-that of foreclosures. Should lenders decide not to renegotiate bad loans and opt instead to foreclose and put the properties back on the market, another down leg in house prices can be expected.

Not that the first wave of the housing bubble correction has completely played itself out, although the effect does appear to be largely regional (with the word '"largely" still open to interpretation).

The lowest-quality junk bonds still don't show investor concern, with CCC yields being down for the year [and] spreads from Treasuries down to 505 basis points, which is less than the default rate for CCCs. If concern levels in junk bonds reach that of the concern about sub-prime mortgages, this spread could easily jump to 800 basis points. In any case, the low default rate for corporate debt over the last five years represents more of a postponement of a serious default wave than a reflection of better debt management. Continue to avoid CCC and B rated issues.

And since the next default wave may be a year or more off, we feel some market risk is warranted for those investors willing to accept a medium to high level of risk.

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