COLUMN: In times of trouble, investors can build a bridge

CHICAGO, March 23 Fri Mar 23, 2012 4:55pm EDT

CHICAGO, March 23 (Reuters) - Having been a stock market investor during the worst downturns over the past quarter century, I'm naturally cautious about national economic shocks like recessions, inflation, bubbles and wars.

None of those threats have disappeared from my radar screen. But being a squeamish investor, as I'm watching the steady ascent of the U.S. stock market this year, I have one question: What should you be most afraid of?

I share the caution espoused by former Treasury Secretary Robert Rubin, whom I heard speak at the Chicago Council on Global Affairs on Thursday. "I'm an investor - a troubled investor - with a very deep concern," Rubin said. "If we (the U.S.) don't get on a sound fiscal trajectory, there will be a severe crisis in the bond and currency markets."

I also share Rubin's other concern that markets could be tripped up by a European debt default. That seems less likely with the passage of time, although it's certainly on the table. Even though I have issues with Rubin's role in overseeing disastrous financial deregulation in the 1990s, he's still a keen observer of markets.

MORE CONCERNS LOOM

Will there be another U.S. debt-ceiling brouhaha? We have about eight months before that might happen, and it could be another grotesque event for the markets. There's also the threat of trouble with Iran leading to higher oil prices, although the stock market hasn't quite reacted to that yet. What about the prospect that investors buying U.S. debt will demand higher interest rates because of the increasing perils of investing in an overleveraged country? That one is beginning to give me agita.

Maybe we got a warning shot across the bow recently when U.S. Treasury yields briefly shot up to 2.3 percent for the 10-year note last week from around 2 percent. Is this the beginning of the end for the great bond bull market that began in the 1980s as the economy heats up or foreign investors demand greater returns on Treasuries?

The sanguine view is that a slight uptick in interest rates reflects improving economic news in employment, industrial production, household income and corporate profits. "We believe the current trend of rising yields signals an acknowledgement of growing optimism around the economy and, as such, is a positive for stocks," wrote Bob Doll, chief equity strategist for BlackRock, in his weekly newsletter.

"As we have been saying for the past several weeks, it appears the U.S. economy is improving to the point that it is entering a self-sustaining cycle, helped in large part by advances in the labor market," Doll added.

A slight uptick in interest rates is not worrisome - if it's tied into the prospect of sustained economic growth. Rob Sharps, a growth-stock manager for T. Rowe Price, is even more optimistic: "Easier monetary policy outside the U.S. and improved domestic housing and labor markets should support stock market gains in 2012," Sharps says.

Should you share this optimism about economic recovery, make sure that you're not holding long-maturity bond funds, which will decline the most if interest rates rise. Buy Treasury inflation-protected bonds atThen take a look at how much you own in stocks. The percentage you hold in stocks should roughly match your age, which is a basic rule of thumb for risk reduction.

The best way of taking advantage of the growth-stock rally is through passive index funds like the Vanguard Growth Index Fund or the iShares S&P 500 Growth Index Fund.

For a more broad-based approach, don't forget that small companies are also in on the rally. The iShares S&P Small Cap 600 Growth Index Fund or the Vanguard Small-Cap Growth Index Fund are worthy considerations. If your 401(k) doesn't offer low-cost stock index funds, ask for them.

I yearn to be optimistic, yet you still have to be aggressively cautious because of the sum of all fears: the massive disruption of the 2008 meltdown won't be sorted out for years and it will lead to a lingering malaise.

There is no short-term solution for that malarial economic malady, but you can easily focus on personal capital preservation in the interim.

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