5 buys for the (eventual) recovery

By Jim Jubak

We know which stocks will soar when the financial system, the economy and the stock market recover: the best stocks in the most-battered sectors. They will eat weakened competitors for lunch and ride the meal to extraordinary returns in the short run. That's exactly what happened in the year after the last bear market bottomed on Oct. 9, 2002.

In the year after that bottom, shares of Intel (INTC, news, msgs), which came through the tech crash with enough cash to bury competitors under a mountain of newer, more-efficient chip foundries, soared 121%, even though the tech sector hasn't had a great recovery from the crash over the long term. Since that 121% gain, from Oct. 9, 2003, to Feb. 10, 2009, Intel stock was down 50%.

So when this turn comes, and for the year after, you'll want to own the best stocks in the battered home-building, financial and energy sectors.

Just two little problems stand between you and Intel-like short-term gains: picking the "when" and the "best" stocks in these battered sectors.

Fortunately, I've got a strategy for picking both the when and the best. And it will even let you earn 7% to 10% or so -- maybe more -- while you wait for the when to arrive. In this column, I'll explain my strategy and give you five names of preferred stocks and corporate bonds you can use to carry it out.

Do your homework

The strategy, stated simply: Use your skills at reading balance sheets and cash flow statements to identify the survivors in the battered sectors, then buy preferred shares and corporate bonds of those survivors, collecting their hefty yields while you wait for the day to take your gains and trade into the common shares of these companies, which you'll know inside out.

Preferred stocks and corporate bonds with high dividends are your best bets right now for riding out a tough market while you wait for a clearer answer to "When?" And you certainly need some strategy to cope with the when, because it's the biggest risk factor in the stock market today:

• When will the economy turn? Late 2009? Early 2010? Late 2010?

• When will the banking crisis be over? In six months? A year? Two years? A decade?

• When will commodity prices start to recover some of the ground they've lost since the peak in July 2008? In 2010? 2012? Later?

Getting the direction of the market right is great -- unless you get the timing so wrong that you get wiped out before your ship comes in.

Looking beyond the consensus

The current Wall Street consensus is that the economy will start to recover in the third quarter of this year or, at worst, in the fourth quarter. That's why, as of Feb. 2, Wall Street analysts were expecting operating earnings of the companies in the Standard & Poor's 500 Index ($INX) to climb 11% in the third quarter.

The consensus could well be right. But trends are running against the consensus now, and the odds of a recovery in that period are decreasing:

• The U.S. economy shrank 3.8% in the fourth quarter of 2008. That number would have been even worse, but companies were still ordering more stuff from factories and suppliers than they could sell. In November, for example, the inventory-to-sales ratio climbed to 1.41 from 1.34 in October, a clear sign that sales were falling faster than inventories. Inventories in December were at their highest levels on record.

• It'll take the stimulus package six months to start stimulating the U.S. economy.

• As bad as things are in the United States, they're getting worse faster in Europe and Asia. The European Commission, which in late 2008 was forecasting a meager 0.1% economic growth for the countries in the euro zone in 2009, finally joined the recession camp in January. The commission projected that gross domestic product would fall 1.9% in 2009 before struggling to 0.5% growth in 2010, and that unemployment would hit 9.25% in 2009 and keep climbing in 2010.

• The export-based economies of Asia haven't so much slowed as put on the brakes and skidded over a cliff. Forecasts of GDP growth are plunging all over the continent.

Locale	Projected 2009 GDP (July 2008 forecast)	Projected 2009 GDP (Jan. 2009 forecast)
Japan	1.3%	-1.7%
South Korea	4.7%	0.6%
Taiwan	4.7%	-1.1%
Hong Kong	4.9%	-1.3%
China	9.3%	7.4%

And how far through the financial crisis are we exactly? Optimists say banks and other financial institutions have to work their way through about $2 trillion in global losses and that they've recognized about half that amount. Pessimists say global losses are more like $3 trillion and that therefore we're only a third of the way through the crisis.

Which is it? Who's correct makes a bit of a difference. If the optimists are right, the tide of defaults and the credit crunch will be over sometime in 2010. If the pessimists are right, the timetable is more like 2011 or 2012. A company that bets on 2010 could wind up running out of cash if the financial recovery is delayed until 2011 or later.

Continued: A quick comparison in commodities

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