These 5 Stocks Could Keep the Rally Going

The stock market's five-month rally has attracted plenty of attention, especially from critics who argue that it's little more than a dead-cat bounce from the nearly unprecedented drop in 2008 and early 2009. Yet as the market indexes have continued to advance, a closer look at exactly which stocks are leading the way suggests that there may be more substance to the bounce than just rampant speculation.

As an article in the New York Times observed over the weekend, dividing the rally into two pieces reveals that there are very different things going on now than were happening back in March and April. In particular, while the early stage of the rally was confined largely to the most speculative stocks, higher-quality companies have seen their shares start to catch up in the rally's latest stage.

A tale of two rallies
To illustrate this point, let's look at two groups of stocks. The stocks in the first set in the table below had some of the best returns during the first part of the rally, but subsequently stalled and have lost a substantial portion of their gains since May:

Source: Capital IQ, a division of Standard and Poor's.

A longer list of companies with similar return patterns shows numerous stocks among beaten-down sectors like casinos and financial stocks. Although their overall returns during the rally remain impressive, these shares have gone nowhere since May. And looking back further, each of them has done pretty badly over the past year, even taking into account what they've recovered recently.

Blue chips take a turn in the sun
In contrast, another group of stocks didn't do as well during the initial phase of the rally, but have taken a stronger leadership role in the most recent advance. Here's a sample:

Source: Capital IQ, a division of Standard and Poor's.

Among this group are many more familiar names: blue-chip stocks that held up better during the financial crisis than most. They made some gains during March and April but were overshadowed by the more impressive returns of their speculative counterparts. Recently, they've taken much control of the rally.

Will the rally continue?
In my view, the re-emergence of higher-quality stocks on the scene marks an important step in the recovery of the overall stock market. As long as financials and other companies that were victims of the panic of 2008 were the only ones to see their stocks making dramatic gains, it was easy to foresee that they could quickly see much of those gains taken away again -- as indeed happened to the stocks in the first table above.

The second group of companies, however, are more likely to be the ones that really pull the economy out of recession and back toward solid, stable growth. Most of these companies have never strayed from their business models, and nothing they've suffered during the financial crisis has forced them to make drastic changes in order to survive.

Whether the stock market continues to rise or starts heading downward again isn't nearly as important as what happens to the economy, on which the value of all stocks hinges. Seeing many of America's blue-chip companies recover from their losses is a necessary step toward getting the overall economy back on track.

For more on making the most of the rally, read about:

• How you can use options without getting burned.
• These stocks are worth buying again.
• Don't invest another penny before you read this.

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