Investing in a Recovery

A lot of people believe stocks are anything but a slam dunk, even though prices fell over the past three years and we appear to be in the early stages of a recovery. Bond prices are sliding, and higher interest rates are signaling a slowdown in real estate. So where can investors expect the best returns over the next 12 months and beyond? TIME brought together a diverse group of investment experts to probe the question, and their answers may surprise you. Bonds have fallen enough to be a bargain at least until the recovery really takes off. But beach houses to rent for income are so five years ago. For more, you'll have to read on. Our panel met in early August and was moderated by TIME senior writer DANIEL KADLEC. The experts: Seymour Lotsoff, senior managing director at hedge-fund firm Lotsoff Capital Management; Dagny Maidman, managing director of private client services at Bank of America Securities; Robert Smith, manager of the T. Rowe Price Growth Stock Fund; and Tobias Levkovich, U.S. equity strategist for Smith Barney. Their thoughts:

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TIME: With all assets seemingly expensive, are we doomed to low returns?

TOBIAS LEVKOVICH: Most people are colored by the high returns in the latter part of the '90s. Annual appreciation compounded for the past 50 years, counting dividends, is about 10%. Going forward, we would argue that you're looking at something like 7% from stocks. That could move higher if companies start paying more in dividends, which is beginning.

DAGNY MAIDMAN: But that's just talking about stocks. If a client is truly diversified, I don't think we're going to have significantly lower returns than usual. A whole portfolio moves in the best of years up 10% to 15% and in the worst of years down maybe 3%. You need fixed income, equity and some alternative assets like a hedge fund. You might include some emerging-market debt. These things together, I think you can get 7% to 8%.

TIME: Not so bad, if you're right. Tobias, you're the closest thing we have here today to an economist.

LEVKOVICH: Oh, God.

TIME: Nevertheless, we're happy to have you. What's your view of this recovery? Bond yields are rising, suggesting we're firmly on the mend.

LEVKOVICH: Let's understand what's happening. In May, [Alan] Greenspan got up in front of Congress and said he will use nonconventional tools to fight deflation. Bond prices soared, and yields plunged, because that meant if worse came to worst, the Treasury would buy long-term bonds. Then in testimony in July he basically took that promise off the table, and everyone sold Treasuries.

MAIDMAN: He was even talking about the economy showing signs of recovery by then. So the low 3.11% yield of June was the anomaly, not where we are today, about 4.5%. Everybody is studying a move that's just nonsense.

TIME: So you don't think we're getting a strong signal from the bond market that the recovery is here?

LEVKOVICH: We're getting a signal that things are improving, but we're not about to see a torrent of growth.

SEYMOUR LOTSOFF: In fact, bonds are probably not a bad investment here because of this correction, which has been overdone. Low-grade corporate bonds should do well. As the economy kicks in, you'll have a problem, but you can address it at that point. If the economy doesn't take off, you can stay in these bonds longer. I'd play it through junk-bond mutual funds.

TIME: Junk bonds have been hot this year. Isn't that play about over?

LOTSOFF: No. You have another year.

MAIDMAN: Even though they've already had a pretty solid run, if nothing else you'll capture nice yields, maybe 7% to 10%. In addition, there will be more capital appreciation. As the economy recovers, balance sheets and credit ratings improve, and junk bonds rise. Now you have a price gain of maybe 10% plus your 7% yield.

TIME: We all seem to agree, though, that things are getting better.

ROBERT SMITH: Absolutely. The economy will be better in the second half and will flow overseas. Europe will be difficult initially, but that should pick up toward the back end in the fourth quarter. It's encouraging that the government has basically said it's going to do anything it can to get the economy moving and, once it begins to move, will let it run for a while. I don't think you can ask for more than that.

TIME: Yet this recovery is atypical. Stocks never came down as far as one would have expected Tobias is shaking his head and real estate never cracked.

LEVKOVICH: Stocks dropped more than $7.5 trillion of value.

TIME: But they shouldn't have had that value to begin with, right?

LEVKOVICH: I don't debate that. But they have come down a great deal and aren't necessarily expensive, especially if earnings continue to improve and companies keep raising dividends.

MAIDMAN: What was different is how we went into the recession, which is that usually house prices would decline going into it because usually interest rates were going up. So, of course, it's going to be sort of different in a recovery. It doesn't always work the same way. A lot of my clients have definite feelings like, Well, the economy is going to recover, so I want to put 90% of my money in stocks. I like to talk to them about, What if they're wrong?