Are you in the right sectors of the stock market for this point in the economic recovery?
Solid data stretching back to 1945 show that certain industries and sectors outperform during specific stages of any economic recovery. (The best work on this subject comes from Sam Stovall, the chief investment strategist for Standard & Poor's Equity Research. His 1996 book, "Sector Investing," is still the best resource on the subject.)
My first rule of investing is "Put every trend you can on your side." Neglecting what we know about which sectors thrive when is, in my opinion, wasting an asset that could help you make bigger profits.
Stovall divides the economic cycle into four stages:
- Early recession. You should remember this stage vividly. Consumer sentiment ranges from fear to terror, industrial production plunges, interest rates peak and then start to fall, and unemployment begins to rise rapidly. Sectors that have done well -- relatively, at least -- during this stage include services, near the beginning; utilities; and, near the end of the stage, cyclicals and transports.
- Full recession. Gross domestic product tumbles, interest rates keep falling, and unemployment rises. Sectors that do best during this stage, historically, have been cyclicals and transports, at the beginning of the stage; technology; and, near the end, industrials.
- Early recovery. Consumer sentiment improves, industrial production turns up, interest rates hit bottom, and unemployment peaks and starts to move lower. Sectors that do best are usually industrials, near the beginning of the stage; basic materials; and, near the end, energy.
- Late recovery. Interest rates rise as the central bank tries to control inflation, consumer sentiment heads down, and industrial production is flat. Sectors that have done well in this stage include energy and, near the end of the stage, consumer staples and services.
I think it's pretty clear that we're in the early-recovery stage. (And I hope that we stay there. No backsliding, Mr. Economy.)
One company's recovery
To confirm that opinion, I took a look at the performance of the sectors in the Standard & Poor's 500 Index ($INX) this year, through Jan. 20.Health care led the bunch with a 5.03% gain since the beginning of the year. Much of that wasn't related to the economic cycle at all but was a result of a rally in the sector based on the declining prospects for the Obama administration's health care plan. The financial sector was in second place at 4.95%. That, I think, was a result of the origins of this recession in the near collapse of the financial system. I wouldn't discount this when planning portfolio allocations right now, but that's a topic for another column.
Trailing sectors included consumer staples (0.75%), consumer discretionary (0.6%), information technology (-0.11%), utilities (-0.35%) and telecommunications services (-6.42%).
To see why industrial stocks historically do so well during the early stages of a recovery, take a look at Precision Castparts (PCP, news, msgs), a company that makes components for jet engines and industrial gas turbines.
After Precision held its revenue almost constant in its fiscal 2008, its prospects turned increasingly grim during the latter half of fiscal 2009 and the first two quarters of fiscal 2010 (the company's fiscal year ends March 31). Revenue fell to $1.62 billion in the third quarter of fiscal 2009, then to $1.60 billion in the fourth quarter, $1.38 billion in the first quarter of fiscal 2010 and $1.30 billion in the second quarter.
Not unexpected when Boeing (BA, news, msgs) and General Electric (GE, news, msgs), both hit hard by the recession, are two of your biggest customers.
The company announced third-quarter results for fiscal 2010 on Thursday. Revenue hit $1.37 billion. That's not a huge increase from the second quarter's $1.30 billion, but it's a move in the right direction.
Finally.
Earnings per share showed a similar rebound -- to $1.61 a share, up from $1.54 in the previous quarter -- as the company cut costs and saw margins increase to 25.8% from 23.3% in fiscal 2009.(For more on why companies see rising profit margins in the early stages of a recovery even as unemployment stays high, see my previous column on MSN Money.)
In its earnings conference call last week, Precision's management said that in the quarters ahead it expects unit sales to pick up as the airline and utility industries speed up capital spending. Sales of replacement parts should also rise as airlines fly more miles and need to do more maintenance. And finally, Boeing's troubled 787 Dreamliner made its first test flight Dec. 15. At that point, Boeing had 840 orders for the planes.
All of this leads Standard & Poor's to project 11% sales growth for Precision in fiscal 2011. Operating margin is expected to climb to 26.4% for fiscal 2010 as a whole and then to 27% in fiscal 2011. Projected earnings of $7.75 a share in fiscal 2011 would be 12.5% higher than they were in fiscal 2008, before the bottom fell out of the economy.
My only hesitation with Precision Castparts right now is that the stock has roughly doubled from its March 2009 bottom. Maybe it will pull back enough in what is shaping up as a decent correction for me to find a buy compelling.
Continued: 3 stocks to buy now
