Markets & Finance

Shedding Light on the Second Half


We're halfway through 2006, and the year still seems as opaque and unpredictable as it did last New Year's Eve. Investors are puzzled: Will the economy march forward, with business investment picking up the slack from a retrenching consumer? Or is the Federal Reserve on the verge of overtightening monetary policy, undermining the housing market and sending the U.S. into its second recession of the new millennium? Was the stock market's big gain on June 29 a harbinger of a second-half bull market, or just a feint?

In this package, BusinessWeek.com examines the outlook for six key sectors: finance, real estate, retail, autos, energy, and tech. We share with you the thinking of some of the smartest Wall Street analysts—which stocks they like, and in some cases which ones they hate. Consider it a manual for the second half of 2006.

Ethanol, steel, and oil dominated the market in the first six months of the year. Of the 147 industry groups that make up the Standard & Poor's 500-stock index, the group that consists solely of ethanol producer Archer Daniels Midland (ADM) was first overall, with a 68% gain; the steel group was second, at 62%; and oil and gas equipment companies were third at 26%.

The losers? Homebuilders, darlings of the market as recently as last summer, were the second-worst performer, down 30%. Only the tire and rubber group—dragged down by Goodyear (GT)—finished worse, with a 34% tumble.

For the rest of the year, it probably makes sense to go light on growth stocks and stick to more defensive plays, because the Federal Reserve is determined to put the chill on inflation by slowing the economy down. The Fed raised the key overnight lending rate to 5.25% on June 29 and may well go higher still in August if there are signs of accelerating inflation or too-vigorous growth. The stringent monetary policy is already having the desired effect. After growing at a 5.6% annual rate in the first quarter, the U.S. economy probably slowed to a bit over 3% annually in the second quarter and will most likely dip below 3% in the second half.

Investors will be challenged with treacherous terrain for the second half of the year. As Bernanke hikes interest rates to keep inflation in check, the economy overall will cool, presenting challenges for key sectors of the economy.

Homebuilders, auto makers, and retailers will face particular pressure. Energy and financial players look to have the most promising outlook. Still, the easy money is gone. It's no time for brazen risk taking.

Here's a sector-by-sector outlook:

Housing

Finance

Retail

Autos

Energy

Technology


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