Recovery? Not for These Stocks

Not all stocks in battered sectors will bounce back in a second-half economic upturn. Here are some that could be left behind

by David Bogoslaw

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Most market players expect that the Federal Reserve, after lowering rates one more time on Apr. 30, will pause to assess the impact of its monetary easing policy and assorted other moves on the economy. The prospect of a hiatus in the Fed's rate-cut cycle, along with a notable decline in market volatility and a smaller-than-expected number of lowered profit forecasts from U.S. companies—not to mention eager anticipation of the first tax-rebate checks—have a lot of people convinced that any U.S. recession will be short and shallow and that a recovery may begin as early as late summer.

Some investors believe certain industries and stocks would automatically profit from an economic rebound, based on the notion that the rising tide will lift all boats in the group. But not all companies in recovery-ready industries will benefit. There are some that are likely to disappoint investors, due either to sector- and company-specific problems or to a weakening in key markets outside the U.S. that have been a major source of revenue growth.

Uncertainty Reigns

Stocks in the financial and consumer discretionary sectors immediately come to mind as recovery candidates when investors think the economy may be on the mend, and technology names may also seem to be good bets.

How you invest "comes down to your core beliefs. If you believe growth is going to gradually get better in the second half [of 2008] and that we've seen the worst of negative [earnings] revisions, then you want to own classic cyclicals," says Alec Young, equity strategist at Standard & Poor's Equity Research. "Right now there's a lot of uncertainty about that, and that's why the market keeps churning around."

That uncertainty is reflected in the Standard & Poor's 500-stock index, which has repeatedly failed to break above the 1400 level in recent weeks, notes Young. He points to another challenge for the market: "There's still a lot of bad news on the economic front." Indeed, on Apr. 29, the Conference Board said its Consumer Confidence Index fell to a five-year low in April, and the S&P/Case-Shiller index, which measures the average price of homes in the 20 largest U.S. metropolitan areas, fell 12.7% in February from a year ago, the biggest drop since its inception in 2001.

Still, investors may have itchy trigger fingers while waiting for a potential recovery. There is an enormous amount of cash currently parked in money-market funds and CDs earning very low interest rates. Those low-yield instruments make investors hungry for higher returns, says Chris Sunderland, a senior portfolio manager in the global fundamental strategies group at State Street Global Advisors (STT) in Boston.

Beware Retail Stocks

Sunderland worries that investors have been too quick to start discounting an economic rebound and recommends they wait four to six months to play what he and others predict will be a temporary recovery, which may last for only a few quarters before the economy slips into a deeper recession in 2009.

"The most likely to disappoint could in fact be retail stocks. We're going to have $4 [per gallon] gasoline at the pump this summer," he says. "That, coupled with home prices continuing to deteriorate and declining consumer sentiment, all weigh on the consumer."

Men's clothing retailers such as Jos. A. Bank Clothiers (JOSB) and Men's Wearhouse (MW) will continue to have difficulty, predicts Bill Rutherford, president of Rutherford Investment Management in Portland, Ore. "Men's clothing is the first to turn down and the last to recover" from a slowdown, he says. "Jos. A Bank was already doing badly and will continue to do badly."

David Joy, chief investment strategist at RiverSource Investments in Boston, says he expects some luxury retailers to disappoint since "there's very little pent-up demand." If an unwinding of the extraordinary amount of debt that has been created occurs, that will affect even those in upper-income brackets, he adds.

Split Decision: Automakers

Although they usually count as industrials, automotive manufacturers are an example of the consumer discretionary stocks that Stuart Schweitzer, global markets strategist at JPMorgan Private Bank (JPM) cites as likely to benefit as people gain spending power from their tax rebates. He expects automakers to offer special incentives to coincide with the rebates, which would essentially double the value of the rebates.

While Joy at RiverSource says he likes Ford Motor (F) "because of specific things being done there," he thinks automakers are not going to do very well in a recovery.