Second Half Is Looking Up for Stocks

But today, a real second-half comeback isn't such a sure thing thanks to creeping inflation and the depth of the housing bust. Both are hurting consumers. Instead, a short-lived rally is just as likely, if not more so, than a bull-market rebound. So what's the best place to put money in such a skittish recovery?

Between the Fed's rate cuts and the $117 billion in tax rebates landing in bank accounts, stocks could get at least a moderate boost in the coming quarters, according to Street economists and strategists. The market has already fallen about 20% from peak to recent trough, which is close to past median declines during economic slowdowns. And things have looked better in recent weeks. The S&P 500 is up 11% since hitting a 52-week low in March and the Dow Jones Industrial Average has gained 12% since its low in January.

"It makes some sense to assume a healthy bounce in the third quarter that overflows into the fourth quarter," says Fritz Meyer, senior market strategist for money manager Invesco Aim Management Group.

Tobias Levkovich, Citigroup's chief U.S. stock strategist, is predicting a "W-shaped market pattern" for this year, as he believes earnings expectations are still too high and will have to come down, disappointing investors and putting pressure on stocks.

But in the near term, Citigroup analysts Deborah Weinswig and Charmaine Tang say broadline retailers could outperform over the next two quarters, in part because of the tax-rebate checks. When the last round of rebate checks came out in 2001, about 40% was spent on clothes and accessories, they say. J.C. Penney (JCP) and Kohl's (KSS) are among their picks, since those companies' lower retail prices fit with a muted recovery. In addition, the retailers have already cut their first-quarter earnings estimates so that "the bad news is priced in." They expect J.C. Penney alone to get an added $150 million in sales over the second and third quarters from the tax-rebate checks.

The last time Washington handed out "free" money, consumer spending jumped almost 5% in July and August 2001, according to Merrill Lynch economist David Rosenberg, who expects the rebates to result in a modest boost to economic growth. But Rosenberg, like many economists, also says it's "far too premature to be predicting a sustained recovery."

To be sure, while stocks are looking better, the economic picture isn't. The Federal Reserve's Beige Book report in April showed that the economy had weakened since data were collected earlier in the year, with consumer spending and employment soft, and prices rising for food, energy and raw materials. There were also signs of upward pressure on wages.

"It's a titanic battle between a weak economy and cheaper stocks," says Aaron Gurwitz, managing director and co-head of the portfolio advisory group at Lehman Brothers. "The [Fed's] rate cuts are helping keep the economy from contracting into a very severe recession, and likewise we see some boost from the fiscal stimulus showing up in people's mailboxes. The question is what happens afterward — if the fiscal and monetary stimulus are enough for momentum, or if we slip back into a period of slow growth. Our worry is it's the latter."

The good news is few on the Street seem to think we're headed for much, much worse times. More likely, it'll be a longer-than-hoped-for slog. "There's going to be a second-half recovery, but it'll be somewhat muted," says Tom McDowell, chief executive of asset manager Rice Hall James. McDowell says bank stocks are one area looking more interesting, since many have already been hit hard. Retail is also intriguing although "it's hard to find a real reason to invest in any particular consumer discretionary stock." He's also shying away from energy and homebuilders.

"If I had to guess whether there will be a sudden move up or down, I'm more on the bearish side," he says.

Also See: