Investing for the recovery: What are the best picks?

ByABC News
September 17, 2009, 12:15 AM

— -- The investment climate in the next 12 months will be better than it has been since the start of the credit crisis last year. Of course, that's a bit like saying the dishes won't rattle as much now that the earthquake is over.

One year ago, the credit markets were nearly collapsing, the stock market was plunging and government officials fretted about the next Great Depression.

Fortunately, the banking system didn't collapse, and we don't live in a world of bread lines. The Standard & Poor's 500-stock index has soared 54% from its March 9 low ; interest rates have fallen; and the money markets have thawed. "All the predictions were too dire," says Robert Doll, chief investment officer at BlackRock. "The world wasn't going to end as we know it."

But few observers are jumping up and down about the prospects for the next 12 months. Even though inflation will remain low, interest rates are likely to rise, and so are taxes. The value of the U.S. dollar will probably fall on the international currency exchanges. And commercial real estate could crumble.

In short: A bull market that brings us to all-time highs seems as improbable as, well, the next Great Depression. The odds seem stacked for a middling stock market and bond market. But don't rule anything out: "The spread of possible outcomes is wider than normal," Doll says. For investors, that means it's a good time to diversify broadly not just in stocks and bonds, but in money funds, real estate and possibly even commodities.

Because the bond market is the most sensitive to the economy, we'll start there. After all, it was the bond market that sent stocks and the rest of the financial markets reeling last year.

The next 12 months should be good for bonds, because the bond market is happiest when the economic outlook is tepid-to-grim.

To most observers, the economic outlook is tepid. Bill Gross, chief investment officer at bond powerhouse Pimco, thinks that economic growth should flatten in 2010 as the effects of the government stimulus fade. "We sense a move back to zero growth unless the employment situation gets better," Gross says.

And the employment situation isn't very good. The unemployment rate, now 9.5%, should peak at 10.3% by March, says John Lonski, chief economics for Moody's Investors Services. Unemployment is a lagging indicator companies don't start hiring again until the recovery is well underway but he doesn't see the jobless rate falling quickly. "It won't be a V-shaped recovery," Lonski says.

Moody's says that the default rate among companies that issue high-yield, high-risk bonds will peak in November at a postwar high of 12.7%. The all-time high, set in the Depression, was 15.4%, Lonski says.