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Are you in the right sectors of the stock market for this point in the economic recovery?

Solid data stretching back to 1945 show that certain industries and sectors outperform during specific stages of any economic recovery.

No argument from me on that. I think investors should do everything they can to put the economic cycle behind their portfolios.

Just one little question: Where exactly are we in the economic cycle? And in the new global economy does it any longer make sense to think about over or underweighting sectors just on the basis of where the U.S. stands in the economic cycle?

My best estimate is that the U.S. economy is now, again, in the early recovery part of the economic cycle. Which means you should be over-weighting those sectors that do best in that stage: industrials, near the beginning of the stage; basic materials; and, near the end, energy.

But my best estimate is also that the global economy—especially the emerging economies of the world—is further along in the recovery cycle and has made the transition from early late recovery. Which means you should be overweighting those sectors that do best in that stage: energy and near the end of the stage consumer staples and services.

Let me explain and lay out a way to position your portfolio for this stage of the global economic cycle. I’ll end by suggesting a few stocks that I think fit this rather complicated picture.

The best work on this subject comes from Sam Stovall, the chief investment strategist for Standard & Poor’s Equity Research. His 1996 book, “Sector Investing,” is still the best resource on the subject.

Stovall divides the economic cycle into four stages:

  • Early recession. You should remember this stage vividly. Consumer sentiment ranges from fear to terror, industrial production plunges, interest rates peak and then start to fall, and unemployment begins to rise rapidly. Sectors that have done well — relatively, at least — during this stage include services, near the beginning; utilities; and, near the end of the stage, cyclicals and transports.
  • Full recession. Gross domestic product tumbles, interest rates keep falling, and unemployment rises. Sectors that do best during this stage, historically, have been cyclicals and transports, at the beginning of the stage; technology; and, near the end, industrials.
  • Early recovery. Consumer sentiment improves, industrial production turns up, interest rates hit bottom, and unemployment peaks and starts to move lower. Sectors that do best are usually industrials, near the beginning of the stage; basic materials; and, near the end, energy.
  • Late recovery. Interest rates rise as the central bank tries to control inflation, consumer sentiment heads down, and industrial production is flat. Sectors that have done well in this stage include energy and, near the end of the stage, consumer staples and services.

In 2009 it sure looked like we knew where we were. The economy had bottomed in the second quarter with U.S. GDP contracting by 0.7%. The economy then grew by 1.6% in the third quarter and by a huge 5% in the fourth quarter.

The recovery was off and running.

And then the economy double-crossed us.

In 2010 GDP growth dropped to 3.7% in the first quarter and to 1.7% in the second quarter.

1.7%? Wasn’t that just about the 1.6% growth investors had seen in the third quarter of 2009?

No wonder that lots of economists and investors started to worry that we were headed to a double-dip recession—and that the next quarter would show a drop back to something like the negative 0.7% growth of the second quarter of 2009.

And then the economy decided that it had at least one more zigzag up its sleeve. Economic growth accelerated again to 2.6% in the third quarter of 2010 and now economists are expecting 3.5% growth for the fourth quarter of 2010.

In January 2010 I wrote ( ) that we were in the early recovery stage of the economic cycle.

This January, in my opinion, in the United States we’re back or still (take your pick) in the early recovery stage. We are a little bit further along on the way from early recovery to late recovery: in the last calendar year I think we’ve traveled maybe three to four months in the economic cycle. But we’re not looking at the beginning of the late recovery stage until the end of 2011 or so.

Emerging economies are further along. Since they rebounded more quickly from the global economic crisis, they’ve moved more quickly through early toward late recovery. Although I don’t see any signs yet that industrial production is flattening—we’re talking about China, India, and Brazil here—we are seeing interest rate increases designed to slow what I think is already runaway inflation in all of these countries. (For more on the emerging economy inflation problem see my post )And we are seeing some signs that consumer sentiment is weakening. Recent surveys have indicated that rising food prices are leading consumers in emerging markets to think about cutting back on discretionary purchases. Just a few signs yet, mind you, but certainly a trend that needs watching and that fits into the traditional pattern of the economic cycle.

Okay, so how do we as investors come up with a strategy that fits hose complexities?

I think it boils down to developing a two track investing approach for the United States and for emerging economies. But you shouldn’t keep those two tracks completely separate. When investing in the United States, you need to keep in mind the effects of the “late recovery” emerging economies on those U.S. companies.

How do you do that? I gave you a good example of the methodology in my recent update on Johnson Controls (JCI) In that post I went through the sources and geographical distribution of the company’s business to see the balance between slowing and accelerating economies, sectors, and industries.

I’d stress that you need to include the timing of growth and slowdown in the United States and the emerging economies into this analysis. Right now, for example, makers of production equipment for everything from LEDs to automobiles are showing gangbuster growth as producers in both the United States and in emerging economies order equipment to increase capacity and improve efficiency. This has meant boom times for a list of companies that includes, among companies that I’ve either mentioned recently or own in Jubak’s Picks Siemens (SI), Aixtron (AIXG), ASML Holding, and among less familiar companies Germany’s industrial robotics maker Kuka and Switzerland’s Schindler, the world’s biggest maker of escalators.

But any eventual slowdown in the emerging economies will take some of that boom out of these stocks. And you, as an investor, need to watch for the timing of that slowdown. Since emerging economies are further along in the economic cycle than the economies of the United States or Germany, any slowdown for these companies could come earlier than you’d expect if you paid attention just to the economic cycle in the United States of Germany.

One sector that I’ve been watching recently that looks well positioned to benefit from the relative economic cycles of both the United States and of the emerging economies is drilling equipment and services. I’ve seen new orders reported by companies that make drilling platforms such as Singapore’s Keppel (KPELY) and very solid quarterly financial reports from service companies such as Schlumberger (SLB).

This sector would seem to be a good one for bridging the early/late recovery cycle distance between the United States and the emerging economies. Look for a pick or two later this week.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Aixtron, Asmel Holding, Keppel, and Schlumberger as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at