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Stocks: Which Sectors Will Signal Recovery?

Watching and waiting for the first signs of economic recovery is becoming a Wall Street obsession. Investors who correctly predict a rebound could make a fortune. Those who move too late or too early could lose out.

One way to peer into the future is economic data. New reports on May 13, for example, showed a 1% drop in March business inventories and a 0.4% fall in retail sales in April. The disappointing data, which ran counter to the "green shoots" of recovery evident in other recent reports, helped send major stock indexes solidly lower on May 13.

But another way is to look at the stock market itself, watching industries and sectors that are good leading economic indicators. BusinessWeek asked investment pros which parts of the market will serve as reliable economic weather vanes. This question is complicated by worries about false starts, as well as the suspicion by many that a recession this serious will not end in the same way as previous, more typical downturns.

1. Energy and Basic Materials

"Commodity stocks should be the first ones to rally," says Bruce Bittles, chief investment strategist at R.W. Baird. A reviving economy needs more raw materials and energy.

Some of these stocks already have rallied. The Standard & Poor's energy sector as a whole is down 7% in 2009, but a recent rally has put the oil and gas drilling industry up 19% for the year. Materials stocks are up 16.5% in the past week.

But commodities markets are not infallible. Oil prices hit a record peak last year just a few months before the world economy slipped into recession. Gary Wolfer, chief economist at Univest Wealth Management (UVSP), calls the commodities and energy rebound a "false start." In areas like natural gas, for example, Wolfer attributes the bounce-back not to the economic recovery but to "production finally being brought in line with demand."

2. Transportation Stocks

Whenever the economy heats up, the nation's shippers will get busy. Shipping volumes plunged in late 2008 when the economy ground to a halt. According to Longbow Research, a survey of truckers released May 11 offered some hope. In March, 64% of truckers surveyed had a negative outlook for demand, and by April that had subsided to 39%.

But full-blown optimism might not be warranted, according to Longbow analyst Lee Klaskow. Seasonal trends or shifts in market share could account for the change along with "an uptick in the economy," he wrote, adding, "We are very doubtful of the latter."

First American Funds Chief Economist Keith Hembre warns that shipping firms might actually be a lagging indicator: The economy could pick up but shipping volumes could remain low as firms sell off their old inventory rather than ordering new supplies.

3. Technology

Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN), says he's watching export-oriented companies very closely. An important factor for the U.S. economy is the state of the global economy, and exporters could provide an early read on overseas activity, he says.

Technology firms produce "a global product," Hembre notes. For example, last quarter, 48% of software giant Oracle's (ORCL) sales came from outside the Americas.

Some tech spending, especially on personal computers, is also a good measure of the consumer's willingness to spend, says Michael Yoshikami, president of YCMNET Advisors. An Intel (INTC) executive said May 12 that chip orders this quarter have been "a little better than expected."

The S&P Technology sector index is up 20% in the past 13 weeks.

4. Retail

The U.S. consumer makes up more than two-thirds of the U.S. economy, so retail activity is an important factor. And the best measure of consumers' outlook might be their appetite for expensive purchases. "When people feel better about the economy they will start buying big items," Gambera says.

Thus, April's retail sales data were troubling. Furniture sales fell 14.2% from a year ago, while auto sales were down 20.7% and department store spending slid 6.1%.

There could be a "burst of activity on the consumer side this summer," Bittles says. However, he warns, it might be temporary, driven by lower taxes, government stimulus, and falling energy prices.

Over the long term, there is doubt that consumers can really drive a recovery. Among the many reasons economists cite: Unemployment and consumer debt levels are just too high.

"A strong bounce-back in consumer spending is an unreasonable expectation," Yoshikami says. More likely, he says, is that spending will shift between different retailers, for example, from luxury stores to discount stores.

Those looking for clear, obvious economic signals from key stock market sectors may be disappointed. Markets often raise hopes only to dash them. But companies and industries do sometimes provide valuable clues to the economy's direction, if you know how to interpret them.

Steverman is a reporter for BusinessWeek's Investing channel.

Steverman is a reporter for Bloomberg News in New York.

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