How Stock Market Prices Affect Us?

Don't expect fireworks in your investment portfolio between now and the end of the year. Slower growth in the economy and profits, plus the move higher in interest rates, leaves limited scope for eye-popping returns. Stocks are still the best bet over the long term, but their upside potential in the near term is fading after a gain of about 5% so far this year and a robust rally over the past 12 months. Look for the increase in Standard & Poor's 500 stocks to average 2%-3% by year end, with the average return to shareholders working out to 9% or 10%, including a 2% dividend yield, for the entire year.

Eroding confidence will soon guide investors toward a more cautious approach. The list of jitters-inducing issues includes rising gasoline prices, the cooler housing market, growing tensions between the U.S. and Iran and uncertainties about this fall's midterm congressional elections. On a more fundamental level, growth in corporate profits is poised to decelerate after double-digit gains in the first quarter. S&P companies will average 8% better profits this year, compared with 13% last year. Blame higher tabs for energy, skilled labor and other expenses, which will trim firms' profit margins as slower economic growth leaves little room for passing along cost hikes to consumers.

Large-company growth stocks are the best bet in these uncertain times. Healthy earnings at General Electric, 3M and similar firms still haven't shown up in their relatively cheap stock prices. To capture the sector's gains in a mutual fund, check out T. Rowe Price Growth Stock and Marsico Growth. And there are opportunities abroad, with the economies of Japan and Europe revving up. Dodge & Cox International fund offers broad global stock coverage. We advise earmarking about a quarter of your stock profile for non-U.S. equities.

Bond prices will fall as long-term interest rates head higher. The benchmark 10-year Treasury bond will yield 5.25% at year end, up from 5% now. On the corporate bond side, investors need to be alert for downgrades by credit-rating agencies as slower economic growth reduces some firms' creditworthiness. The risks of downgrades are highest in the telecom, automotive and consumer products sectors.