MONEY The Economy

Puerto Rico’s Debt Is Worse Than Detroit’s Debt Was

Puerto Rico's governor said the island cannot pay its $72 billion debt. Add high unemployment to the equation, and that's a bleak economic picture

Things aren’t looking good for the Isle of Enchantment. Puerto Rico is in 3½ times as much debt as Detroit was in when it filed Chapter 9 bankruptcy in 2013. The island’s $72 billion debt is larger per capita than any state, but the island’s government can’t file bankruptcy like Detroit did because only cities are allowed to file Chapter 9. Puerto Rico’s governor, Alejandro Garcia Padilla, said the island’s debts are not payable, and that he needs to pull it out of a “death spiral.” This is bad news for mainland consumers as 70% of American mutual funds have Puerto Rico bonds.

MONEY mutual funds

A New Take on the Indexing Versus Actively Managed Funds Debate

And the winner is...

It’s another win for index funds.

If you’re a regular MONEY reader you’ll know the mutual fund world has been split by a long-running debate between two fundamentally different investment strategies: Active investing, where funds employ portfolio managers to attempt to select stocks that beat the market benchmarks like the Standard & Poor’s 500, and indexing, where funds aim merely to match the performance of the benchmarks.

While it may be counter-intuitive, academic research has shown that because of a) the inherent difficulty of consistently picking stocks that outperform the market averages and b) the extra costs incurred by these funds for things like research, brokerage fees, and manager salaries, only the most skillful stock pickers actually end up beating the benchmarks over long periods of time. Plus, determining who those managers are in advance is a fool’s game.

Not surprisingly, given the livelihoods at stake, this is a controversial conclusion. Now fund researcher Morningstar has offered up a new approach to the debate. While index funds are known for keeping investment fees as low as possible, costs can put a drag on their returns, too. So Morningstar set out to compare active funds not just to the returns of market indexes, but to the actual index funds that attempt to track them. The method could arguably yield a fairer comparison, more in line with what investors actually experience.

Unfortunately for the partisans of active management, the results were as clear-cut as those of any previous study, if not more so. Among the twelve types of funds Morningstar examined—from large blend stock funds to intermediate bond funds—the majority of active funds beat their passive counterparts in just one category over the past decade: U.S. mid-cap value.

Morningstar did find that investors could improve their odds by focusing on active funds that had lower costs. The majority of low-cost active funds, those in the least expensive quartile of their peers, beat low cost index funds in five of twelve categories, including U.S. large and mid-cap value funds.

Of course, since cost is still the key factor, that’s likely to be cold comfort to many active investors.

 

MONEY leadership

The Stunningly Low Number of Women Running Mutual Funds

Sallie Krawcheck Of BOA Merrill Lynch
Bloomberg via Getty Images Sallie Krawcheck, former head of Merrill Lynch's global wealth management unit, recently launched Pax Ellevate Global Women's Index Fund, which invests in companies with a high percentage of women in leadership roles.

Women exclusively manage just 2% of the $12.6 trillion held in US mutual funds.

Women are under-represented among mutual fund managers, a new study found, in a gender imbalance that poses challenges for an industry looking to run more money from female clients.

Among 7,410 portfolio managers of U.S. open-end mutual funds, only 9 percent were women, the study released this month by researchers from Morningstar Inc of Chicago, and widely discussed at the research firm’s investor conference this week, found. It also found that women exclusively managed only about 2 percent of the $12.6 trillion held in those funds.

That’s a lower level of representation compared to other professional fields, the study’s authors found, even as the women held their own in terms of fund performance. Twenty percent of law firm partners are women, for instance, and 19 percent of partners in U.S. accounting firms are women.

The figures are in sync in with other studies showing women holding relatively few positions of power in finance.

Attendees at this year’s Morningstar Investment Conference said the findings were noteworthy because clients now expect to have more women overseeing their money.

“As a portfolio manager, I get a very good reception from people out there,” said Dawn Mangerson, co-manager of the McDonnell Intermediate Municipal Bond fund. It is co-managed with Jim Grabovac, a lineup Mangerson said goes over well. “If there are both men and women (involved) it’s looked at favorably.”

Clients also have more fund managers to choose from in general, and so can be more discerning about qualities they like in a manager, said Mary Jane McQuillen, a portfolio manager for Legg Mason Inc’s ClearBridge Investments unit.

The Morningstar study found firms with the highest percentage of women fund managers included Dodge & Cox, where 6 of 24 fund managers were women, and Franklin Templeton Investments, where 19 of 129 fund managers were women.

In a keynote speech at the conference, Sallie Krawcheck, a former wealth-management executive, said that while women control $11 trillion in wealth, many are unhappy with their financial adviser.

Firms could do more to include women among their leadership, Krawcheck said, and she questioned an idea outlined in the bestselling book by Facebook executive Sheryl Sandberg, “Lean In,” which suggested women push harder to get ahead.

That’s an easy message for companies to adopt rather than changing their own cultures, Krawcheck said.

Taken to an extreme, Krawcheck said, “Lean In is shorthand for: ‘you women should really do something about this’.”

MONEY mutual funds

Everything You Need to Know About The Fidelity Contrafund Mutual Fund

William Danoff, vice president of Fidelity Management & Research
Scott Eells—Bloomberg via Getty Images William Danoff has been managing Fidelity's Contrafund for nearly a quarter century.

How this gigantic fund has consistently beaten its peers over the last 5 years.

Fidelity Contrafund isn’t contrarian in the way that you might think. Contrarians are fearless and independent, buying stocks the herd hates. But who on Wall Street dislikes Berkshire Hathaway, Contrafund’s largest holding? Or Apple, its second-largest position?

Yet there’s one counterintuitive thing Will Danoff, the fund’s skipper for 24 years, has accomplished. While big funds often lag, this $110.7 billion portfolio—now larger than Fidelity Magellan was at its peak—has still beaten two-thirds of its peers over the past five years. How much longer can Danoff keep it up?

Money

How It’s Different

Morningstar classifies this portfolio as a large growth stock fund. But Contrafund has some latitude, as exemplified by its big stake (4.7% of assets) in Berkshire Hathaway. The insurance-heavy conglomerate run by Warren Buffett isn’t exactly a high-flying growth stock. Neither is another holding, Wells Fargo, the conservatively run megabank.

Fear not. While Contrafund has an outsize stake in value-oriented financials, it doesn’t stray too far afield. Among its other top holdings are growth stalwarts Facebook and Biogen, and the fund bought Alibaba on its initial public offering. Tech, which is the biggest sector for growth portfolios, represents about 24% of the fund, just a tad below the 25% average for large growth funds.

 

Money

Danoff’s Defensive Moves

What distinguishes Danoff as a manager? He does well when the market doesn’t, and that’s helped the fund over time. Contrafund outperformed large growth funds in the two major bear markets of this century, which has allowed the fund to clobber its peers by 1.6 percentage points a year over the past decade.

Still, “for a contrarian, the most difficult moment is investing in a market that has gone well,” says Jim Lowell, editor of Fidelity Investor. Sure enough, Contrafund has been about average over the past three years. The fund has made some good defensive moves, downshifting from an 8.6% stake in energy in 2011 to 2% now. But don’t expect to see Contrafund among the top gainers when the market soars, Lowell says.

Money

A Question of Size

One big elephant in the room is Contrafund’s elephantine size: It is the second-largest actively managed stock portfolio, behind only American Funds Growth Fund of America. Plus, Danoff has led this fund for nearly a quarter-century, when the average manager tenure is 5½ years.

Fidelity does have a massive staff of analysts. And Danoff “doesn’t exhibit any signs of weariness or burnout,” says Lowell. But there’s no denying this fund is enormous, which means buying small, fast-growing companies won’t do it much good. If you’re okay with just blue-chip names, this is “a fund with a well-proven manager, strong risk-adjusted returns, and low expenses,” says Todd Rosenbluth, director of mutual fund research at S&P Capital IQ.

(Note: Losses are from March 24, 2000, to Oct. 9, 2002, and Oct. 9, 2007, to March 9, 2009. Source: Morningstar)

MONEY mutual funds

Why the Simplest Investing Option Is Still the Best

illustration of house of $100 bill cards
Taylor Callery

Stock-picking fund managers have started the year strong. But indexing still has the edge.

On Wall Street, the knives are out for index funds. In the past few months this low-cost strategy—in which funds buy and hold all stocks in an index like the S&P 500 instead of picking and choosing—has been called a fad, a mania, and mindless. It has been blamed for market volatility. One recent anti-index broadside, a report by Wintergreen Advisers, even pins runaway CEO pay on the funds.

Why are proponents of “active” management so riled up? Maybe it’s because of this: Since 2009 investors have yanked $257 billion out of actively managed stock portfolios while pouring $1.1 trillion into stock index funds.

Sour grapes? Or should you worry that index funds’ popularity is a bubble ready to deflate? Let’s take a look at three popular arguments against indexing.

Argument #1: It’s a Stock Picker’s Market Again!

Diversified stock funds gained 2.6% in the first quarter of 2015, vs. 0.95% for the S&P 500 index. Yet over the past one, three, five, and—keep counting—10 years, less than 25% of blue-chip stock funds beat their index.

Argument #2: Okay, But Wait Until a Bear Market Strikes…

It seems like common sense that active managers should do better in a down market, since index funds must hold all the stocks in a market—in good times and bad. In the 2008 bear, however, most active managers fell at least as much as their bogey, says John Rekenthaler, vice president of research at Morningstar.

Active funds looked stronger during the dotcom crash in 2000. A bubble in one part of the market meant some managers could hide in cheaper small-cap and value-oriented stocks. These days, though, even traditional value stocks look pricey. “Where is the refuge for active managers in this market?” asks Rekenthaler. “I don’t see one.”

Argument #3: If Indexing Gets Too Popular, Active Funds Will Win.

One reason it’s hard to beat the market is that whenever you bet on a stock, there’s another clever trader taking the other side. If everyone indexes, though, maybe there’s less “smart money” in the market to match wits against, making it easier to find opportunities in mispriced stocks. We’re a long way from that day, though. Indexing still accounts for just 15% of the money in various kinds of U.S. funds. Besides, if active funds did start beating the market consistently, you can count on money, both smart and dumb, pouring into those strategies. At that point watch the odds shift back to indexers.

MONEY mutual funds

This Is The Absolute Easiest Way to Invest for Retirement

559136159
Andy Brandl—Getty Images/Moment RM

Stay on track by keeping things simple.

Most people know they need to save for retirement, but many are intimidated by the complexity of the investing world. To make investing for retirement simpler, many financial companies have created target date mutual funds that combine a number of different investments into a single package. The Vanguard Target Retirement Fund series is one such fund, created by the Vanguard Group as a way for people to get everything they need to save for retirement in a single investment. Let’s look at the Vanguard Target Retirement Fund and why it could be the simplest way to long-term riches for you.

The basics of Vanguard’s Target Retirement Fund
The first thing to know about the Vanguard Target Retirement Fund is that you actually have 12 different mutual funds from which to choose. Funds corresponding to target dates every five years ranging from 2010 to 2060 make up the bulk of the offerings, and a single fund aimed at providing income for those already in retirement closes out the list.

The idea behind the Vanguard Target Retirement Fund is that investors should pick the fund that corresponds to the year they expect to retire. Over time, the fund goes from a more aggressive mix of assets when you’re young and still have a long time before retirement to a more conservative asset allocation as you grow older and approach the end of your working life. For instance, the 2060 fund is composed of 90% stocks and 10% bonds, while the 2020 fund has a much larger 40% bond allocation and just 60% in stocks.

Vanguard isn’t the only company offering target date funds, but the advantage of using Vanguard is that you gain access to the low-cost funds the index fund pioneer is famous for promoting — with index funds connected to the stock and bond markets both within the U.S. and internationally. The funds tend to favor domestic investments but still have significant foreign exposure, giving investors diversification. Another benefit of using Vanguard’s index funds as underlying investments is that the expense ratios on the Vanguard Target Retirement Fund are very low, ranging from $16 to $18 per year for every $10,000 you have invested.

The downsides of the Vanguard Target Retirement Fund
All that said, Vanguard’s target date funds are far from perfect. One criticism is that you can duplicate the funds’ portfolios yourself by buying the underlying index funds directly and save some expenses. With those component funds charging between $5 and $19 annually per $10,000 investment — and most of the allocated money going to the cheaper part of that range — wealthy investors can save hundreds or even thousands of dollars each year just by monitoring their balance on their own.

Also, not all investors agree that index funds are the best strategy for long-term investing. Some competing target date funds offer actively managed mutual funds rather than index funds; while they’re more expensive, top funds can sometimes earn a sufficient extra return to offset higher costs.

Finally, like any other target date fund, the Vanguard Target Retirement Fund takes the decision about asset allocation out of your hands and puts it squarely on Vanguard’s shoulders. That’s fine when things work out, but during the financial crisis many target date funds took heat for being too heavily invested in stocks. If you’re not comfortable with the level of risk that Vanguard’s target date funds take, then you’ll probably prefer to create a do-it-yourself mix of funds on your own.

The Vanguard Target Retirement Fund series isn’t the only way to invest for retirement, but it is one of the simplest. With basic exposure to the most important investments you’ll need and extremely low costs, a Vanguard Target Retirement Fund can be a great way to build up your retirement savings over time.

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MONEY Opinion

How History Can Mess With Your Investing Strategy

Traders work on the floor of the New York Stock Exchange March 2, 2009.
Shannon Stapleton—Reuters Traders work on the floor of the New York Stock Exchange March 2, 2009.

People get history wrong when they look back at specific events and expect them to repeat in the future.

Do you read history? Believe almost all of it? Use it as a guide to the future?

Me too. But let’s consider something. Take these two statements:

“11 million jobs have been created since 2009. The stock market has tripled. The unemployment rate nearly cut in half. The U.S. economy has enjoyed a strong recovery under President Obama.”

“The recovery since 2009 has been one of the weakest on record. The national debt has ballooned. Wages are stagnant. Millions of Americans have given up looking for work. The economy has been a disappointment under President Obama.

Both of these statements are true. They are both history. Which one is right?

It’s a weird question, because history is supposed to be objective. There’s only supposed to be one “right.”

But that’s almost never the case, especially when an emotional topic like your opinion of the president is included. Everyone chooses the version of history that fits what they want to believe, which tends to be a reflection of how they were raised, which is different for everybody. We do this with the economy, the stock market, politics — everything.

It can make history dangerous. What starts as an honest attempt to objectively study the past quickly becomes a field day of confirming your existing beliefs. This is like steroids for inflating your confidence and puts you on a path to misguided, regrettable decisions. (Misguided and regrettable decisions being the one thing everyone agrees history is filled with).

In his book Why Don’t We Learn From History?, B.H. Liddell Hart wrote:

[History] cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art.

Those who read history tend to look for what proves them right and confirms their personal opinions. They defend loyalties. They read with a purpose to affirm or to attack. They resist inconvenient truth since everyone wants to be on the side of the angels. Just as we start wars to end all wars.

I see this all the time in investing. The amount of investing data is incomprehensible and growing by the day. Anyone can think up a narrative, then sift through mountains of historical data to find examples backing it up.

Think stocks are expensive? History agrees. Think stocks are cheap? History agrees. Think tax cuts spur economic growth? History agrees. Think tax cuts don’t spur economic growth? History agrees. History shows that raising interest rates is both good and bad for stocks. It proves that buy-and-hold investing is the best and the worst strategy. In the age of big data, no idea is so absurd that a good spreadsheet can’t make it look right.

And a lot of the historical events investors try to study — recessions, bear markets, bouts of hyperinflation — are rare enough that we don’t have many episodes to draw conclusions from.

To know a lot about recessions, for example, you’d ideally want hundreds of examples to study. But there have only been 33 recessions in the last 150 years. And the data we have on most of them is dubious. Estimates on how much the economy contracted during the 1920 recession range from 2.4% to 6.9%, which is the difference between a moderate recession and a near-depression. In the last 50 years, when data is more reliable, there have been just seven U.S. recessions. So how are we supposed to take seriously any historical statistic about the average recession? How long the average recession lasts? How frequently they occur? How high unemployment goes? We’re talking about something that has occurred just seven times in the last half-century.

So, what good does looking at history do us?

A lot, in fact. You just can’t take it too far.

People get history wrong when they look back at specific events and expect them to repeat in the future. It’s so easy to underestimate how much past events were caused by trivia and accident rather than trends that should repeat in some clean way. Investors who have unshakable faith in markets reverting back to specific historical averages have some of the worst track records you can imagine. This goes into overdrive when you acknowledge the subjectiveness of historical recordkeeping. “I have written too much history to believe in it,” historian Henry Adams once said.

But history can be great at teaching broad, unspecific lessons. Here are five.

Something usually occurs to keep good news and bad news from going on forever.Recessions end because excess gets washed away; booms end because everything gets priced in. Most people wake up every morning wanting to make the world a better place, but psychopaths, idiots, charlatans, and quacks are persuasive enough to occasionally shake things up.

Unsustainable things last longer than you think. Every war was supposed to be over in a month, every boom was surely going to pop any day, and every round of Federal Reserve money printing meant high inflation right around the corner. In reality, things that look unsustainable can last for years or decades longer than seems reasonable. “I was right, just early,” are famous last words, and indistinguishable from “wrong”.

Normal things change faster than you expect. “History doesn’t crawl,” Nassim Taleb writes, “it leaps.” Things “go from fracture to fracture, with a few vibrations in between. Yet we like to believe in the predictable, small incremental progression.”

Irrationality spreads at the worst possible times. Most people can keep their heads straight when things are calm. It’s when things get exciting — bull markets, bear markets, wars, recessions, panics — that emotions take over. Importantly, decisions during made during those crazy moments are the most important decisions you make over the long run.

Nothing is stronger than self-interest. When someone in charge of lots of people gains the most by promoting their own interests, you get inefficiencies at best, disaster more often. What everyone knows is the truth or the right thing to do is ignored because a few people can get ahead doing something else. This describes most organizations.

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MONEY stocks

Give Your Investments a Midyear Checkup

Kagan McLeod

How to ensure your wealth is still in good health.

Halfway into the year, and 2015 may have already thrown you and your financial plans for a loop.

Stocks, which were supposed to slow as the bull market entered its seventh year, are back to setting all-time highs—and have gotten frothy as a result. Gas prices, which were on the verge of plunging below $2 a gallon, have reversed course and are now headed toward $3. And the job market, once on a roll, looks to have hit another speed bump.

Okay, the changes aren’t of the magnitude of what you saw in the financial crisis. But they don’t have to be to throw your financial plans off-kilter. As with your annual physical exam, the midway point of the year is a smart time to take some vitals, run some tests, and reassess your own situation. Over the coming weeks, we’ll provide you with a wealth-care checklist. First up: a review of your investments.

STRESS-TEST YOUR PORTFOLIO

Ailment: Rising rates. The Federal Reserve says it could raise interest rates at any one of its upcoming meetings now—which would mark the first rate increase in nearly nine years.

Hiking rates is like stepping on the economy’s brakes. Historically, there’s an 80% chance stocks will fall by 5% or more once investors see Fed “tightening” as imminent. Moreover, bond prices move in the opposite direction of market rates, so fixed-income funds could take a hit too. When the Fed lifted rates in 1994, for instance, intermediate-term bond prices sank 11.1%.

Treatment: Don’t overreact. The natural inclination is to be überconservative. But market watchers from Warren Buffett to bond guru Bill Gross think global growth is slow enough for the Fed to be patient. And even if the central bank acts in the coming months, short-term rates are still expected to rise only about half a percentage point by year-end, according to a survey of economists by Blue Chip Economic Indicators.

Move to the middle on bonds. The traditional advice for fixed income is to “shorten up.” That is, sell funds holding long-maturity bonds and hide out in short-term debt that’s less vulnerable to price declines. But with short rates still near zero, you could be leaving a lot of money on the table, warns BlackRock portfolio manager Rick Rieder. Plus there’s no guarantee bonds will lose money. When rates rose in 2005, bond prices fell but investors earned 1% on a total return basis when factoring in yields. So instead of going all short, stick with intermediate funds like Dodge & Cox Income DODGE & COX INCOME FUND DODIX 0.37% , whose nearly 3% yield can soften the blow from price declines.

Stay (mostly) the course with stocks. Not all pullbacks turn into bear markets. In fact, history shows most sectors keep rising six months after the Fed starts raising rates, including economically sensitive ones like technology and consumer discretionary, notes S&P Capital IQ’s Sam Stovall. That’s why Stovall says you’re better off holding on and selling equities only if you need to rebalance. In which case…

REBALANCE YOUR INVESTMENT DIET

Ailment: A frothy market. Stocks are still on a roll, with blue-chip equity funds having posted 15% annual gains over the past three years, vs. 3% for intermediate bonds. What’s wrong with that? Based on 10 years of average profits, the price/earnings ratio for stocks is now above 27, where it was leading up to the Great Depression, the 2000 tech wreck, and the 2007 financial crisis. Even if there is selloff here, history says to expect meager returns over the next 10 years.

Treatment: Get back to your target weight. If you started with 60% stocks/40% bonds three years ago, you’re closer to 70% stocks now. Shift your allocation back before the market does it for you, says planner Eric Roberge.

Use the 5% rule: Don’t overmedicate, as rebalancing can trigger trading costs and taxes. So rebalance only if your mix shifted by five percentage points or more, says Francis Kinniry with Vanguard’s investment strategy group.

Think small: Since rebalancing is about selling high, unload your frothiest equities first. Over the past 15 years, small stocks have trounced the S&P 500 by four percentage points annually, and now trade above their historical 3% P/E premium to bluechip shares.

Sell American: In the past decade, U.S. stocks have outpaced foreign equities by 3.5 points a year. American shares now trade at a 15% higher P/E ratio than global stocks, even though they have historically traded at similar valuations.

MONEY college savings

The Earnings on Your 529 College Savings Account Stink. Here’s Why That’s OK

dollar bill shoved in pile of books
Mudretsov Oleksandr—iStock

It's not all bad news.

The average investor in a college savings plan made just about 4% last year, even though the total U.S. stock market rose by almost 14%, a new study from Morningstar found.

But the lead author of the report, Leo Acheson, says that performance may not be quite as depressing as it sounds, for these six reasons:

  • It still beats tuition: Although 4% severely lags the Standard & Poor’s 500, it beat tuition inflation, which rose by 3.7% in 2014, according to the College Board.
  • Older students should earn less: A disproportionately large percentage of all 529 assets are funds that have been saved over time for students who are now at or nearing college age. Funds for those students should be—and typically are—invested very conservatively. Savings plans designed for current college students, for example, are typically almost entirely in safe bonds, which means they are earning less than 2% a year right now, Acheson notes.
  • Diversification setbacks should be short-term: Younger and more aggressive investors whose portfolios were globally diversified also earned less than the Standard & Poor’s 500 in 2014 because of trouble in international markets. Overall, emerging markets funds lost about 5% in 2014, for example. But, in theory, at least, globally diversified portfolios should do better over the long run.
  • Savers get federal tax benefits: When parents take the money out of 529 accounts to pay college bills, they don’t have to pay taxes on the gains, which boosts their effective return. Morningstar estimated that a family in the 25% to 35% tax bracket that saved $2,400 annually over the last five years would have netted $15,275 after taxes in a typical mutual fund, but $15,628 after taxes from the same investment in a sheltered 529 account.
  • Some also get state tax benefits: About half of Americans live in one of the 34 states that give deductions or credits on state tax returns for contributions to 529 plans. Those initial tax breaks reduce families’ state tax bills by an average of 8.7% of the contribution, according to Morningstar. (See if you live in a state with a 529 tax break.)
  • Fees are shrinking: One of the biggest criticisms of 529 plans has been the high fees that eat away at parents’ investment returns. Morningstar found that, for example, large value index funds offered in 529 plans charge expense ratios of .78% of assets, while the equivalent mutual fund outside of 529 plans charges just .56%. But 40 plans cut their fees in 2014, bringing the average gap between mutual funds and similar 529 plans down by more than half, Acheson found. In addition, the best plans, recommended by MONEY and by Morningstar, have fees as low as .08%.

The bottom line of all of these developments, Acheson says, is that for families in moderate to high tax brackets, and those who live in a state with a 529 tax break, “it makes sense to save for college in a 529 plan…especially one with low fees.”

MONEY stocks

As Earnings Shrink, Here’s Where to Hunt for Profits

Zachary Zavislak

Finding pockets of growth is the key to higher returns.

Though the economy is growing and the stock market remains near record highs, one key fundamental indicator has taken a sharp turn for the worse. Corporate earnings, which helped propel this six-year-old bull market, actually shrank in the first quarter. And if profits sink again this spring, as is widely expected, it would “qualify as an earnings recession”—the first since the global financial crisis, says Burt White, chief investment officer for LPL Financial.

With the S&P 500 trading at a price/earnings ratio of 18, which is about 20% above the historical average, diminishing profits are a reason to worry, but not to panic.

For starters, there have been three years since 1974 in which earnings failed to grow without the onset of an economic recession: 1986, 1998, and 2012, when equities posted double-digit gains. What’s more, the biggest drag on overall profits has been energy, where analysts forecast a 58% decline in earnings per share through 2015. Strip out that sector and analysts predict a modest earnings increase in the second quarter.

You just have to know where to look for that continued growth.

See who wins cheap oil

While the oil market collapse has crushed energy companies, the decline in crude prices boosts other parts of the economy. With less money going into filling up their gas tanks, consumers can open their wallets a bit more. No wonder retail sales in March posted their biggest monthly gain in a year.

One industry that benefits from higher consumer spending and lower fuel prices is transportation. A smart way in: SPDR S&P Transportation ETF SPDR SERIES TRUST SPDR S TR/S&P TRANSN ETF XTN 0.78% , which emphasizes cheaper airline stocks over frothier railroad shares. The portfolio’s average P/E is just 14.9, vs. 19.4 for consumer stocks.

Focus on Revenue Growers

The profit boom in the years following the financial crisis had more to do with cost cutting than expanding sales. Eventually, though, “earnings grow because sales grow,” says Pat Dorsey of Dorsey Asset Management.

S&P Capital IQ says the sector with the biggest revenue growth in the second quarter will be health care. The sector is “relatively immune to changes in the economy,” notes Morningstar analyst Karen Andersen.

Still, health care stocks have doubled in the past three years, so you have to tread carefully. Andersen notes that biotechnology stocks look particularly pricey.

One exception is Gilead Sciences GILEAD SCIENCES INC. GILD 1.41% . With a P/E ratio of just 14—thanks to rapidly growing earnings—this biotech giant is priced 30% below its five-year average. This is despite an expected jump in hepatitis C drug sales that alone could add $14.4 billion to Gilead’s revenues this year. Andersen sees earnings growing 11% in 2015.

Ride the Currency Waves

With the U.S. dollar up 22% in nine months, American firms selling to Europe and Asia are at a disadvantage. Not only are their goods more costly to foreign buyers, but they have to convert those sales back into dollars, deflating their results.

One way to avoid the fallout is to stick with truly domestic stocks. Firms (excluding energy) with most of their sales in the U.S. are expected to see 11% profit growth in 2015. Comcast COMCAST CORP. CMCSA 0.27% makes only about 5% of its money abroad, vs. 46% for the S&P 500. Despite the nixed deal for Time Warner Cable, its earnings are expected to grow more than 11% annually for the next five years.

On the flip side, analysts expect European earnings to beat S&P 500 results in 2015, as the weaker euro cuts prices for the Continent’s goods sold abroad. A cheap option is Vanguard European Stock Index VANGUARD EUROPEAN STOCK INDEX INV VEURX -3.02% , which charges just 0.26%.

Look for Growing Dividends

At a time of uncertainty over profits, a good sign companies are confident “in their future prospects” is if they boost dividends, says Haverford Trust chief investment officer Hank Smith.

A bonus: Rising dividends beat the market. Since March 2006, $100 invested in the S&P 500 has grown to $414. The same amount invested in the S&P 500 Dividend Aristocrats index, which tracks stocks that have raised dividends every year for at least 25 years, has become $526. For a solid dividend growth fund, go with SPDR S&P Dividend ETF SPDR SERIES TRUST DIVIDEND ETF SDY -0.18% , which is in our MONEY 50 list of recommended funds and ETFs.

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