Successfully investing in the recovery means more than just being in the market at the right time. It means being in the right places, too.
As investors get more confident that the economy is on the mend, a key to success will be which industries are best positioned to cash in on the recovery.
Some investors are already planning ahead, handicapping which sectors will stand to be the future winners in this fledgling economic healing process.
"The worst thing to do is shoot where the rabbit was," says Sam Stovall, chief investment strategist at Standard & Poor's.
So far, stocks are following an almost textbook pattern of recovery. The ones that are most exposed to the economy's ups and downs, especially financial services and technology companies, were the first stocks to perk up as investors anticipated the recession would end.
Now that investors are wagering on actual economic growth in the second half of the year, they're also making big bets on so-called consumer discretionary companies that make large-ticket items such as cars and appliances.
To figure out which sectors will be the future winners, though, investors are applying several techniques including:
•Studying the past. Since 1945, certain sectors have enjoyed their best times during particular points in an economic recovery, Stovall says. Individual businesses tend to do better at certain points of an economic cycle and investors anticipate these changes in business, he says.
If the past is to be trusted again, that means investors should expect solid performance this year not only from consumer discretionary stocks, but also from makers of materials and industrial companies. These sectors are known as cyclicals, because they are closely tied to the fortunes of the economy.
The reason is simple: Companies that manufacture products will start using up their inventories as demand picks up. When that happens, they need to order metal, chemicals and other materials to create more goods to sell.
Later in the economic cycle, energy stocks may pick up as companies expand capacity and require more fuel to keep the lights on.
History takes investors only so far, though, according to research from Jim Paulsen of Wells Capital Management. For instance, cyclical stocks ended up petering out shortly after the 1982 and 1990 recoveries began, he says. But cyclicals were the place to be for many years after the recoveries in 1970 and from 2002 through 2007. The key, he says, is, "Which will it be this time?"
•Understanding the cycle. One of the biggest things missing so far from the recovery has been growth in revenue. While companies have successfully cut costs to preserve profit, they need more demand and sales to realize a full recovery.
During the second quarter, companies in the S&P 500 reported 20.4% lower revenue than they did during the same quarter in 2008, S&P says. That was the third-consecutive quarter of lower revenue.
Analysts expect revenue to fall by less than 10% in the third quarter, S&P says. But some companies will see growth sooner than others.
The trick is figuring out which industries will stop cutting costs and start expanding, says Jack Ablin of Harris Private Bank.