'Fall Cleaning': Adjust Portfolios for Safety?

Caution lights - if not stop signs - are flashing at many investment houses and financial planning firms throughout the United States.

Their message is threefold:

1. While investors may not want to pull out of the rambunctious US stock market, they should remain on alert, weeding out particularly overvalued or risky holdings.

2. When buying stocks or mutual funds, be selective. Make sure the products have growth potential even if the overall direction of market indexes turns negative in the months ahead.

3. Stick with a mix of alternative investments, including bonds and cash products, such as high-yielding bank certificates of deposit.

The stock market has been on a rampage this summer, up one day, cascading downward the next. The current trend is upward, but with valuation levels on many blue-chip stocks high and the economy growing faster than had been anticipated earlier this year, additional interest-rate hikes by Federal Reserve policymakers cannot be ruled out. That raises concerns about a steep market correction later this year or early in 1998.

"Cash is a great place to be right now," says Michael Metz, chief investment strategist at Oppenheimer & Co. in New York. "It is also time to get out of anything indexed," such as mutual funds linked to the Standard & Poor's 500 stock index. "If a person does decide to put new money into the market, they might want to be a 'sector selector,' " says Mr. Metz.

That could mean putting some of your money into single-industry mutual funds. Right now Metz favors the energy sector. And he likes stocks of small and mid-size companies more than large ones. His model portfolio: 40 percent bonds, 30 percent stocks, 30 percent cash.

Metz is not alone in stressing bonds and cash over equities. Charles Clough at Merrill Lynch recommends 55 percent bonds, 40 percent stocks, and 5 percent cash.

"We're saying that bonds are a relatively better buy right now. We also have questions about the sustainability of future earnings gains," says Lisa Cullen, a Merrill Lynch spokeswoman. Case in point: The 30-year Treasury bond has been running in the 6.5 percent range, she says. With inflation coming in at around 2.5 percent, that represents a real return of 4 percent, which may end up beating returns on stocks, she says.

In stocks, Merrill Lynch likes financials, gas and oil equipment and services in the energy area, software and computer services in technology, and some infrastructure issues, such as cement. But anything that depends on rising consumer spending is considered risky, given a possible recession, Ms. Cullen says.

Bank certificates of deposit also look attractive to some observers now.

"If you are betting that there could be additional rate hikes by the Fed this year, then I'd go short," for short-term CDs, says Robert Heady, publisher of the Bank Rate Monitor in North Palm Beach, Florida. Then you'll be ready to roll the money over into higher-paying CDs if rates rise.

But Mr. Heady says interest rates on CDs may now be starting to fall slightly. Thus, this may be a good moment to lock into a high paying certificates (see chart).

Not all analysts would avoid putting new money into the stock market.

"If a person had stayed out of the market two years ago, as a lot of analysts were urging, they would have lost a lot of money," in terms of potential gains, says John Markese of the American Association of Individual Investors in Chicago. His advice: Don't try to time the market; remain invested in high-quality stocks.

Thomas O'Hara, who heads the National Association of Individual Investors in Madison Heights, Mich., also warns against pulling out of the market. The key, he says, is "having high-quality stocks."