The economic tea leaves for 2007 reveal nothing if not mixed investment portents. Profits appear healthy, hence the Dow’s upward trajectory in the third and fourth quarters of 2006. Gross domestic product forecasts from many of the economists we interviewed, however, project growth of less than 3 percent, the result of the Federal Reserve’s rate increases. Liz Ann Sonders, chief investment strategist at Charles Schwab in New York, estimates the risk of recession in 2007 is now 50 percent, based on the slowing housing market, oil prices and the inverted yield curve.

Many economists see real estate as the strongest portent of a recession (although others believe it is simply an inevitable correction). In 2007, Zandi expects property values to continue to fall, hitting bottom this coming summer.

The Hedge
Some sectors will run counter to the slow-growth norm. Investment advisors such as Sonders suggest looking to defensive positions in publicly traded health care companies; this market benefits from an otherwise flat economy because demand is nondiscretionary. In technology, some large-cap public companies may remain attractively valued, and could benefit when corporations unleash pent-up demand even as the economy slows, according to Mike Williams, global strategist at Tocqueville Asset Management in New York. In real estate, investors might consider growth markets overseas, such as India, China, the UK and Germany. Advisors are recommending REITs that provide exposure to international real estate markets (see "Building Your Global Real Estate Portfolio"). Investors can now find REIT-like structures in Japan, Hong Kong, Singapore and France. Investors should be able to tap British and German markets this year as well.

When GDP growth reverts to the mean, hybrid strategies may work well for many investors. Kathleen Gaffney, co-manager of the $7 billion Loomis Sayles bond fund in Boston, believes a great deal of credit for her fund’s 13 percent average annualized return over the past five years (through October 2006) goes to her use of fixed-income instruments. Gaffney sees opportunity ahead in BBB corporate debt purchased along with its company stock. To maximize this play, "look for industries that have suffered from bad news, but where there’s no disaster coming," she says. The homebuilding market represents one conspicuous example. The idea is that you boost income while adding a greater potential for capital gains, assuming the company will improve its credit rating and, in tandem, its share price.

Photo Illustrations by C. J. Burton.

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