HOME VALUES SINKING. OIL PRICES SCARY. DEBT MOUNTAIN-HIGH. IRAQ AFIRE. Gotta sell stocks and crawl into a hole, right? Wrong, as it turned out. I just quoted some of the headlines of 2006, which, after a bumpy start, turned into a great year for almost every investor. The only way to lose money was flipping condos in Miami. Stocks scored big.
What juiced returns? Sensational corporate profits and a global expansion that isn't over yet. Most economists expect slower growth in 2007, along with lower profit margins, but no recession. Historically, stocks have done just fine in years like that. Inflation eases, interest rates fall and stock-market valuations rise. Politics helps, too: stocks perform well in the third year of presidential-election cycles--in fact, they've never had a loss. Here's the '06 rundown, and some thoughts about '07:
U.S. stocks. Mutual-fund investors fled the market early in the year when stock prices sagged. They started returning after the giant price run-up in the second half. That's pretty typical. Stocks do best when no one is looking, which is why a buy-and-hold strategy beats attempts at market timing. For the year, Vanguard's 500 Index Fund, which mimics Standard & Poor's leading market index, jumped 15.6 percent (and beat 76 percent of similar funds run by active stock pickers). Vanguard's Total Stock Market Index Fund gained 15.5 percent. Even tech stocks perked up. The exchange-traded fund that tracks the NASDAQ 100 (ticker symbol: QQQQ) returned 7 percent.
Anyone dreaming of a new tech mania should forget about '90s-era stocks. Instead, think green. The next bubble will float on "sustainability"--technology that promotes a cleaner environment, new energy sources and conservation. Green stocks are high now, including some firms with no earnings--just what players like.
International stocks. They've led the pack for the past five years and dominated '06 returns: international funds, up 25.9 percent; emerging markets, up 31.6 percent, and Europe, up 34.7 percent, reports Lipper, a data-tracking firm. You poured a total of $146.65 billion into these funds last year, according to TrimTabs Investment Research, compared with just $38.27 billion for U.S. funds.
This year, however, the economics probably favor U.S. stocks, says Peter Perkins, editor of the International Bank Credit Analyst in Montreal. (Note that this would make the market timers wrong again.) The European Central Bank has been raising interest rates--not good for stocks--while U.S. rates are on hold and might drop later in the year. Asia is another story: Perkins thinks Asian rates might drop, too, lending their markets support. Even with slower global growth, countries that export commodities hold high cards.
U.S. bonds. High-quality bonds are boring, and that's their job. A-rated taxable funds returned 3.9 percent last year, and general municipals 4.15 percent, Morningstar reports. You don't buy them for growth. They're for security in case your life or the markets fall apart. Riskier junk-bond funds returned 10.07 percent; they tend to rise and fall with stocks, which suggests a good 2007, too.
The dollar. What will the currency traders do? Whatever they want, and all at once. Long term, our huge trade deficit will weaken the dollar against other currencies. But next month, who knows? A common scare story focuses on the Chinese: if they sold enough of their estimated $700 billion in dollar holdings, they could drive up U.S. interest rates and flatten our economy. But why would they, asks global economist Jay Bryson of Wachovia Bank. They're not going to pull the plug on their biggest customer. Of all your many worries, scratch this one off the list.
Gold. The spot gold price ran up to $730 an ounce last spring, then slid, zigzagged and closed the year at $635. Precious-metals funds, which buy mining-company stocks, finished the year up 31.7 percent. To invest in the metal itself, choose exchange-traded funds (streetTracks Gold Trust, ticker symbol GLD, or iShares Comex Gold Trust, ticker IAU. Both rose about 23 percent in 2006). Gold is a play on a weaker dollar, says Chris Laird of PrudentSquirrel.com. As a steady inflation hedge, however, the famous metal has been a bust. In real terms, its price is still two thirds under its 1980 high.
Homes. Home sellers won't be happy this year. Celia Chen of Moody's Economy.com thinks that prices will keep falling until the second half. You'll still make money if you've held your house for several years, but not if you hoped to buy, paint and flip. Buyers, on the other hand, should start looking now. Rates on 30-year loans are down nearly a point from their June 2006 peak and sellers--especially builders--are discounting heavily.
What could go wrong? Higher inflation than expected, signs of recession, oil sabotage in the Middle East or something we can't imagine now. But there are always bad headlines--look at 2006. Over 20-year spans since 1901, U.S. stocks have lost money only twice--the periods starting in 1913 and 1929. Even if '07 goes bad, it still pays to buy and hold.