Stocks: Is It Time to Start Betting on a Recovery?

As some economists grow excited about prospects for recovery by yearend, here are some sectors and trends to watch. Cautions, too

By Ben Steverman

Eventually the economy will bounce back. In fact, many investors are already trying to figure out how to profit from a U.S. economic revival.

This may seem outlandish to Americans suffering from job losses in the biggest economic shock in a lifetime. However, some better-than-expected economic data in recent weeks has bolstered the case of optimistic economists. Data on housing, durable goods orders and retail sales were bad, but weren't quite as weak as expected.

"We're clearly still in decline," says Michael Englund, chief economist for Action Economics. But the decline has slowed. "At least the pace of collapse seems to have stalled." Unemployment might rise to 10% by November or December, but Englund predicts the economy could stop shrinking and start growing again by late summer or early fall.

Double-digit growth in 1934

Even the Great Depression was followed by a strong rebound, says Paul Kasriel, director of economic research at the Northern Trust Company (NTRS). After a devastating decline from 1929 to 1933, the economy found a way to stabilize in 1933, despite serious problems that were far worse than our predicaments, Kasriel said in a speech at a CFA Institute conference on Mar. 25. Given challenges that include misguided central bankers, major tax increases, and a collapse in global trade, he said, "It's amazing to me the economy recovered in 1933."

In 1934 the U.S. economy posted double-digit growth. (But there came a further economic slide a few years later.)

Investors who time the recovery correctly can do well, even in bleak times. The Dow Jones industrial average jumped 67% in 1933, more than in any single year since.

Market professionals are just beginning to sketch out what a post-recession economy and stock market might look like. Those investors who do best in a recovery will be those who can correctly predict features of the recovery: Which sectors bounce back first? Will the recovery be strong and sudden or anemic and slow?

Economists and market experts admit there is plenty of uncertainty in their economic forecasts. Here are the sectors and other trends to watch:

1. Housing

New data on Mar. 25 showed new home sales rose 4.7% in February. Existing home sales had jumped 5.1%.

Most economists and investors believe the housing market will need to stabilize before the economy can recover. But a full-scale recovery for housing could take years. Keith Hembre, chief economist at First American Funds, warns it could be "several years before it's a good environment for homebuilders."

The problem is the huge amount of inventory on the market. As for the latest figures, Englund warns that February sales were helped by warmer, drier weather.

Housing could hit bottom in 2010 but might stay there for a while, says Kasriel. Many who have delayed selling their homes might do so when they see signs of life in the market. "Once demand starts to pick up, you're going to see another wave of supply come on the market," Kasriel says.

The big homebuilders that could benefit from a true housing recovery include D.R. Horton (DHI), Toll Brothers (TOL) and Pulte Homes (PHM).

2. Financials

Recently, the financial sector has led the stock market higher. But Wayne Titche, chief investment officer at AMBS Investments, warns that the financial sector rally may not be sustainable in the long term. "They still have a lot of issues," he says. Some of the stronger financial stocks may be good bets, but they could have a wild ride. "You have to have a strong stomach," he warns.