The Sectors That Will Lead the Real Recovery

When will the recovery come? Has it already begun?

These are questions experts can answer only in hindsight. But just because no one knows exactly when the recovery will arrive doesn't mean it's not coming. It always has, so one can say with a fair degree of certainty that it will again -- at some point.

Since 1945, the country has been through a dozen recessions and 11 expansions, one after the other, with varying durations. And the pattern of recovery is also clear. It goes something like this:

 

In the early stages of a bull market, high-tech and industrial shares tend to outperform. As the bull market begins to mature, basic-industry stocks enter the picture. As the bull peaks, energy and metal companies outperform.

As the country enters the early parts of a bearish period, consumer staples and service stocks outperform. On the way down, utilities do best. Near the bottom, financial and consumer cyclical stocks lead the pack..

To determine where to allocate capital, one must first ascertain where we are in this cycle. Keep in mind that the average bear market since 1945 has lasted 10 months, with the longest (1973-1975) stretching on for 16 months. This means that if we're still in a bear market, we're in an unusually long one. If history means anything, the end is near. Of the downturn, I mean.

Financials have performed best during the past three months. Since the beginning of April, financials have gained +15%, compared with an overall -5% for the S&P 500. This suggests the economy is near the bottom of the cycle. If that's true, then the best place to invest is in consumer cyclical and technology companies.

There are excellent plays in either category.

Consumer cyclicals include giants like Toyota (NYSE: TM), Nike (NYSE: NKE), and Polo Ralph Lauren (NYSE: RL). The sector can be easily captured with a sector ETF like the Consumer Discretionary SPDR (NYSE: XLY).