Prices are a powerful indicator. If a stock is actively trading, the price is the point where buyer and seller demand is at equilibrium. Both buyers and sellers are willing to trade at that price at that point in time given all available information. Price is one of the most complete and objective sources of information about the condition of a stock and the market overall.
From the March 2009 lows, the major indices rallied about 40%, before pulling back last week. Still, the price of the market is clearly saying that the economic prospects of the United States appear much brighter today than they did three months ago.
Assuming the bounce was not driven entirely by short-covering and irrational exuberance, it appears our economy is in the process of returning to positive growth.
So we’re going to give you a list of the sectors that will likely benefit most from an economic recovery and the stocks that stood out as most attractive right now.
Our Method for Picking Winners
In an effort to objectively identify the best-of-the-best economic recovery beneficiaries, we decided to use price as our indicator. Strong stock price performance is the quantification of the optimism market participants have for the future performance of the underlying company.
We ranked almost all stocks in the market by relative strength. The relative strength we used was a comparative look at the price of each stock relative to all of the other stocks in the market. In layman’s terms, we wanted to find stocks that market participants believe have the brightest prospects as measured by their price.
Well, before the market started to bounce in March, several groups of stocks started to advance. Overall, the Russell 2000 (RUT), which is comprised of smaller cap stocks, led the pack.
Smaller capitalization stocks leading during a recovery is typical, as smaller companies have the most leverage to small changes in business fundamentals, and are nimble and able to quickly position themselves to be in the path of the recovery.
3 Sectors Set to Benefit Most From an Economic Recovery
In determining which sectors will benefit most from an economic recovery, our bet is it will be the sectors that started to recover the soonest and are continuing to show leadership today.
On the group level, the three stock groups with the best overall relative strength dating back to the first week in February 2009, are consumer discretionary, consumer staples and energy.
And within these groups, the smaller capitalization companies are having the strongest runs.
Recovery Beneficiary #1: Consumer Discretionary
Consumer discretionary stocks are by far the strongest measured by relative strength.
All of the top five strongest sectors in the S&P 500 (SPX) are consumer discretionary sub-industry groups.
In order, they are:
1. Tires and Rubber
2. Auto Dealers
4. Casual Dining — micro cap
5. Men’s Apparel Retailers
6. Book Stores — this does not include Amazon.com (AMZN)
What the price of stocks rolled up into industry groups is saying is that the hardest hit consumer areas will be some of the first areas to recover, and have the potential to rebound with higher absolute and percentage gains than other sectors.
Automobiles (dealers and parts) may show a tremendous bounce as the existing dealer base is reduced, GM, Chrysler and Ford (F) focus on selling fewer but better cars, and Congress potentially enacts short-term stimulus legislation directed specifically at the car industry (e.g., a cash-for-clunkers law much like what has already been enacted in many European countries).
After running these strong consumer discretionary groups through both technical and fundamental screens, the stocks that stood out as most attractive now are:
- Group 1 Automotive Inc. (GPI)
- Asbury Automotive Group (ABG)
- Carrols Restaurant Group (TAST)
- Books-A-Million Inc. (BAMM)
Recovery Beneficiary #2: Consumer Staples
The second strongest group as measured by relative strength is consumer staples.
Within this group, small-cap soft drink bottlers and agriculture additives were the two standouts.
The three strongest stocks in these groups are:
Another stock that stands out as a winner from an economic recovery whereby by the resumption in consumption is muted is Perrigo Company (PRGO).
Perrigo is the nation’s largest manufacturer of store-brand, over-the-counter, non-prescription pharmaceutical products, and it also manufactures store-brand nutritional products.
The company has 70% market share and gaining. Its products sell for 30% less than brand-name products.
Earnings are growing at a 15% rate, and the stock is trading for 13 time 2010 earnings. There are no financing concerns, and the company could easily become an acquisition target.
Recovery Beneficiary #3: Energy
On the basis of relative strength, energy is strong.
Intuitively, this does not come as a surprise, as oil has just bounced from $30 per barrel to north of $70. What is a surprise is that the strength is concentrated in the geophysical and ethanol subsectors.
The three strongest stocks in the energy group from a relative price perspective are:
Of this group, OMNI looks the most interesting from a technical standpoint.
Hedging Your Bets
Every recession is different, and the timing and power of economic recovery is difficult to predict, so we want to offer you a hedge.When the market has pulled back recently, healthcare stocks have outperformed.
The relative strength of the small-cap biotech stocks has been the fifth strongest group in the market since February. The pace of earnings growth in this group is somewhat detached from the broader economy, as it is based on drug discovery more than consumer demand. Additionally, many of these companies are acquisition targets by large pharmaceutical in both good times and bad.
In the event the economic recovery is less than expected, owning a group of small-cap biotech stocks could provide an important source of portfolio diversification.
Exchange-traded funds (ETFs) you may want to consider buying include:
Andrew Houghton and Nick Atkeson are the editors of Big Money Options. To learn more about them, read their bios here.