A double-dip downturn? Wait and see

And that could have a significant effect on the stock market as money sloshes into retailing and out of sectors such as energy, materials and commodities. To some extent, the stock market has already started to anticipate that stimulus effect. The Select Sector SPDR-Consumer Discretionary (XLY, news, msgs) exchange-traded fund, which tracks consumer stocks in the S&P 500, was up 9.9% from its March 17 low, as of the close April 29.

Now what?

Following my one-stage-at-a-time approach, adding retail and consumer nondurable stocks to your portfolio would make sense -- after the stock market has made a decision to rally.

Some stocks that have been strong in the recent rally and that I'd expect to outperform during any retail sector advance are Coach (COH, news, msgs), Hanesbrands (HBI, news, msgs) and Warnaco Group (WRNC, news, msgs). If you'd like less momentum and more value, take a look at turnaround story RadioShack (RSH, news, msgs).

RadioShack is cheap enough right now -- especially after the company announced a 9% drop in first-quarter earnings April 28 -- that it would be a decent long-term hold even if the economy didn't recover in the second half as strongly the most optimistic economists hope. The other retail and consumer stocks I mention, however, are more short-term momentum plays. You could get a nice profit from them in a retail sector rally, but I wouldn't want to hold them if the economy disappointed.

And that's exactly what is likely to happen once those stimulus checks are spent on gasoline, food and clothing in the six months after they arrive.

My question for the economy in 2009: "Now what?" The checks are spent, and the economy is sailing against some pretty stiff headwinds.

• Home prices are still falling. In February, the S&P/Case-Shiller home price index fell 12.7% year over year. The growing consensus among economists and on Wall Street is that we won't see a bottom until the index is down 20% to 25% year to year, and that's not likely before sometime in 2009. (Economists at the Federal Reserve think the less volatile Office of Federal Housing Enterprise Oversight index has an additional 6 to 8 percentage points to fall instead of the 10-point fall they're looking for from the S&P/Case-Shiller index.)

• Home building is still in decline. In March, housing starts fell to a 17-year low, plunging almost 12%. Housing starts are now down 58% from their January 2006 peak, but that hasn't reduced the inventory of houses for sale. The supply of new homes climbed to 11 months of sales, up from an already dreadful 10.2 months of sales in February.

• Foreclosures are still climbing. RealtyTrac has reported that for the first quarter of 2008,foreclosures climbed to almost 650,000, a 23% increase from the fourth quarter of 2007. That's a 112% increase from the first quarter of 2007.

• Mortgage problems are spreading beyond the residential market. The level of nonperforming commercial-real-estate loans doubled in the 12 months that ended in the third quarter of 2007.

• Consumers are falling behind on credit card debt. American Express (AXP, news, msgs), the fourth-largest credit card issuer, has set aside an additional $881 million for credit losses in the first quarter. That's up 52% from the first quarter of 2007, and it comes, worryingly, on rising spending, up 14%, on the company's cards by cardholders.

• Unemployment is slowly rising. The number of jobless workers climbed by 20,000 in April. The absolute unemployment levels remain low: The economy has lost 260,000 jobs in the past 12 months; in the 2001 slowdown, job losses came to 281,000 in April alone. But the trend is moving in the wrong direction. And I don't see stimulus checks spent on gasoline and food generating a lot of jobs.

• The financial system is far from healed. Yes, the Federal Reserve has headed off the risk that one of the big market-maker banks would fail. But the Office of the Comptroller of the Currency has warned that smaller banks, facing losses on mortgages, home-equity loans, credit cards and auto loans, need to raise capital and might not be able to do so because the capital demands of the big banks have drained the market for latecomers. Even without an outright failure, stressed banks will continue to hoard capital to build up their reserves, as regulators are urging. That will leave them with less money to lend to businesses for things like, oh, expansion, which would create more jobs.

All this could lead to a double-dip downturn in 2009. The International Monetary Fund, for one, projects the U.S. won't begin a real recovery until 2009 and that it will take until 2010 for the economy to recover to trend growth of 2.5% a year or better.

Still benefiting in a downturn

But don't let the possibility of a double-dip downturn in 2009 cause you to panic. It's a long way away. We could get a stimulus rally led by retailers in the second half of 2008, and you don't want to be so wrapped in fear that you can't profit from it if it occurs. (Of course, neither do you want to bet everything now on a strong economy in 2009.)

A slowdown in the U.S. economy isn't the end of the world for all sectors of the stock market, either. The oil service sector tracked by the Oil Service HOLDRS (OIH, news, msgs) ETF, for example, was up 11% from the beginning of 2008 to April 21, even as the market as a whole was going nowhere. Even if we head into a double-dip downturn in 2009, there's almost certain to be outperformance somewhere.

But before we can begin to figure out where that outperformance will be, we've got to get through the near-term test of this rally and answer the question of how much stimulus is in the stimulus package.

One stage at a time is good investing strategy right now.

Continued: Developments on past columns

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