Is the Economy Expanding or Still Recovering?

Although the last recession technically ended in June 2009, for a lot of folks it feels like we're still in the depths of a downturn. The economy has been growing and repairing itself, but unemployment and housing prices, the two measures that most closely affect Main Street Americans, remain in the doldrums. But while these two factors are still clearly in recovery mode, data for other sectors of the economy have actually been pretty solid.

Back in business
Although it may seem somewhat surprising, the U.S. economy technically moved from recovery into expansion during the last quarter of 2010. According to data from Wells Fargo, it was at this point that real gross domestic product surpassed its pre-recession peak in 2007 of $13.36 trillion. That means our economy is now producing as much value in goods and services as it did before the financial crisis and ensuing recession. Unfortunately, at the same time, unemployment has remained sky-high. The truth is our economy is producing the same amount of goods and services as it did before the recession, but it is doing so with nearly 8 million fewer workers.

While that may speak to the incredible productivity gains of corporate America, it also shows that the economy has undergone some important structural changes in the past few years. We may be producing as much in the way of GDP as we were before the recession, but the mix of those goods and services has changed. Government spending has played a larger role in the current recovery to date, as has inventory restocking, and the decades-long trend of shifting from labor-intensive industries to capital-intensive industries has accelerated in recent years . These moves will keep a lid on employment growth and keep job creation firmly in a recovery stage for years to come.

Market leaders
So for all practical purposes, our economy seems to be stuck somewhere between recovery and expansion. That likely means continued sluggish growth and a maddeningly slow recovery in the job market. And while I don't recommend that investors veer from their long-term asset allocation or investing program, you do need to give consideration to what types of companies will do well in a slow-growth recovery. While I think large-cap names are overdue for their turn on center stage, stock pickers will likely want to delve deeper and identify individual companies that are not only selling at reasonable valuations, but that have solid and stable profit margins and decent growth prospects. These are the types of companies that should thrive in a half-recovering, half-expanding economy.

Running a quick screen for large-cap stocks that are selling at P/Es of less than 20, have a profit margin in excess of 10%, and a five-year history of earnings-per-share growth above 15% yielded several interesting candidates.

Source: Yahoo! Finance.

Despite Apple's impressive performance over the past few years, the company's stock still trades at a reasonable valuation, while the company should enjoy meaningful growth prospects as its popular iPad and iPhone gadgets gain market share overseas as well as domestically. Bristol-Myers Squibb has an extremely healthy balance sheet with a credit rating of AA+, relatively low debt loads, and a history of strong dividend payments. Like Apple, China Mobile has a large and fast-growing potential market. Although the firm already has nearly 600 million subscribers, roughly 500 million people in China still don't have cell phones, which leaves a lot of room for the company to grow.

IBM's vertically integrated business structure and ability to provide IT solutions at multiple levels should ensure that the company remains competitive and a market leader well into the future. McDonald's is well-positioned to benefit from increased overseas demand and is aggressively opening new stores in Europe, Asia, and the Middle East to accommodate these fast-growing markets. And Rio Tinto, while potentially vulnerable to a potential commodity bubble, has tripled its earnings from 2009 to 2010, boasts strong cash flow, and has announced share buybacks to be completed by 2012.

Bigger is better
Of course, if you're not a stock picker, you can still get broad exposure to the large-cap segment of the market through an inexpensive exchange-traded fund like SPDR S&P 500 ETF. If you want to focus just on higher-quality large caps that have more financial stability, it might make sense to check out a fund like American Century Equity Income (TWEIX). Management here looks for firms with solid balance sheets that pay out stable dividends. The fund ranks in the top 1% of all large-value funds over the past 15 years and comes with a reasonable 0.97% price tag. Funds like these should help you capture some of the benefits that high-quality large-cap firms are likely to produce in the coming quarters.

The bottom line is that our economy is now expanding. However, various structural economic changes have contributed to a weak housing market and high unemployment, which will keep a lid on growth, causing us to feel like we're still in a recovery phase. But by choosing the right investments, you can still profit from those firms with the ability to thrive in this type of environment.

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