Surviving The New New Economy

By Daniel Kadlec

Cash is king on Wall Street again--made clear last week in the flight from both stocks and bonds. Sopping up investment dollars were ultrasafe short-term Treasury notes and money-market funds and--get this--gold-mining stocks. Gold hasn't been a great investment in decades, and probably won't be anytime soon. So take the asset shuffle for what it is: a knee-jerk response by money managers who must show their hand to clients each quarter.

Does that mean you should ignore the financial fallout of what CNN is calling America's New War? Not at all. A recession is all but certain. Yet economically speaking, things haven't changed that much. We were in a severe slowdown and heading for recession before the attacks. Events will unfold faster now, deepening the impact. That should be your main concern. But don't fret about the economy's ability to rebound; it will, possibly even sooner and with more force than would have otherwise been the case. While waiting out the slump, here's how to survive it:

GRAB A MORTGAGE NOW. If the recession proves to be a tough one, mortgage rates could keep falling. But any further decline would be tortured and not amount to much. Why? The average 30-year fixed rate stands at about 6.89%, vs. a low of 6.68% in 1998--a level that didn't last long and was the lowest average mortgage rate since the 1960s. If rates sink much lower, virtually everyone with a mortgage will be an instant candidate for refinancing. The volume of new business would overwhelm bankers, who'd no longer have a reason to drop rates aggressively. Already there's evidence that bankers are getting their fill. Since June, the decline in mortgage rates has not kept pace with the decline in the 10-year Treasury-bond yield, their benchmark.

Meanwhile, mortgage rates could push higher. We just got a tax cut. Congress is leaning toward deficit spending. And Alan Greenspan is shearing short-term rates as if he were Edward Scissorhands at the botanical gardens. All this stimulus is spooking bond traders, who are shoving up long rates, speculating that a vibrant recovery may be just around the bend.

INVEST FOR THE LONG HAUL. At times like these it makes sense to reassess your portfolio. Owning a wide range of stocks, not just tech or some other sector, is critical, as is dividing your portfolio among stocks, bonds and cash. The more you have of the latter two, the less risk you're taking. Continue to contribute to your 401(k) plan. Indeed, kick up contributions if you can. Consider rebalancing too, because with the long slide in stocks you may find that bonds make up a larger part of your asset mix than you like. If so, sell some bonds and buy stocks. Feeling sheepish? Stock index funds that track the S&P 500 or Wilshire 5000 almost always do well over 10-year periods.

Don't be too eager. Let the market stabilize, even if it means missing the early stage of a rally. In the short run, stay away from most airline, insurance, travel, leisure and high-end retailer stocks. Utilities, discount retailers, food and drug companies, defense contractors and select tech firms including wireless and surveillance should hold up. Above all, don't sell just to sell. "You want to buy into panics, not sell into them," says Peter Canelo, U.S. investment strategist at Morgan Stanley.

PAY ATTENTION TO TAXES. If you've been out of work, your income may have fallen low enough (below $43,850 for couples last year) to qualify this year for a 10% capital gains rate, rather than the usual 20%. You should also look to sell stock funds where you've lost money, using the loss to offset any gains. Then buy a similar fund so as not to risk missing a rally. Be wary of stocks that have fallen a great deal. Preparing to close their books for the year, mutual funds dump losers in October for tax reasons. That can further punish already depressed shares.

SHOP WISELY. As the economy slumps, you should be able to get deals on anything travel related, from airline tickets to hotels, resorts and theme parks. President Bush is after Detroit to lower vehicle prices rather than slash production. You'll soon be able to find more designer brands at discount chains such as Target and T.J. Maxx. TV and computer prices were already tumbling, and should go lower.

And while reassessing your finances don't forget that it always makes sense to keep your will updated, leave a clear record of family assets where it can be found and make sure your life-insurance policy will pay off all your household debt and replace at least 80% of your income. Peace of mind requires a little work.