Markets

Stocks to Buy Before the Recovery

The market usually takes off before the economy picks up. So buy sooner rather than later.

By Amy Bickers, Associate Editor

From Kiplinger's Personal Finance magazine, August 2008

With stocks, as with so much else in life, itÕs better to be early than late. Share prices regularly anticipate economic recoveries, climbing off their lows six to nine months before the economy starts to improve.

If stocks behave as they usually do, get ready to make some money in the next few months. Based on the past ten recessions, all of which occurred after World War II, Standard & Poor's 500-stock index has gone up 32% one year after the market hits bottom during the economic downturn. (Although the U.S. is not yet officially in a recession, Kiplinger's believes we slipped into one late last year or early this year. And if the economy didn't enter into a recession then, the arrival of $4-a-gallon gasoline clinches the matter.)

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The pattern of stocks beginning a powerful rise during a recession is so strong that it would be shortsighted not to take some spare cash and put it to work in a broad index fund or exchange-traded fund that tracks the largest U.S. companies. But what if you're more adventurous? Stock-market recoveries always include groups of companies that start to rise in advance and help persuade investors that the overall market is healing. Four sectors deserving a close look today are banks, retailers, heavy industry and technology.

Banks. Banks and other financial institutions are sending mixed signals, one moment showing signs of health, the next raising questions about the value of the loans and mortgages they hold. But there's no question that the shares of good financial companies have been hammered along with those in serious trouble. Different kinds of financial companies benefit in different ways from a sounder economy, so Bill Rutherford, a wealth manager in Portland, Ore., suggests complementing a high-quality national bank with a more specialized investment-banking concern.

JPMorgan Chase (symbol JPM) is actually a little of each, but it's especially well regarded for its traditional banking business. Morningstar analyst Ryan Lentell believes that the takeover of Bear Stearns will increase Morgan's value to its shareholders and that its robust balance sheet enables it to make other acquisitions. The stock showed signs of life when it went up 36% in two months, to $49, on the news of the Bear Stearns deal. At $40 in mid June, the stock trades at 14 times estimated 2008 earnings of $2.91 a share.

Rutherford also favors Goldman Sachs (GS). For starters, Goldman missed the worst of the subprime-mortgage credit crisis. And besides investment banking, which picks up in an economic recovery, Goldman is also known for money management, a business that Wall Street values generously. Yet in the general disdain for big financial stocks, Goldman has taken its lumps. At $169, the stock has dropped by nearly one-third since last fall and trades at just 11 times estimated profits of $15.63 a share for the fiscal year that ends this November. That sounds like the price of an out-of-favor stock. But Goldman shares were also cheap throughout the economic expansion and bull market of 2003 through 2006 -- and they quadrupled.

To buy financials in one fell swoop, check out Vanguard Financials ETF (VFH). It invests in more than 500 of them. About one-fourth of the exchange-traded fund's assets are in small and midsize banks, which are still struggling, but it gives you the biggies, too, including Morgan and Goldman.

Retailers. Americans are spending less, so retailers' sales are down this year and earnings growth is rare. But better chains can benefit in hard times as weak and overextended competitors consolidate or shut down altogether. When the economy rebounds, the survivors will thrive.

Nordstrom (JWN) and J.C. Penney (JCP) are a fine double play on an eventual pickup in consumer spending. Penney has high hopes for American Living, a brand launched in February that spans clothing, accessories and housewares. Nordstrom's customers are wealthier than Penney's, although they, too, are paring back. To boost business, Nordstrom started a "click and mortar" service in May. You buy stuff online, then pick it up at any Nordstrom store.

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