Economic Growth Is Increasing but Don't Expect Stocks to Ride With It

NEW YORK (TheStreet) -- The economy is now really, seriously beginning to move --but it may mean less for the stock market than you think.

At least, in the short term, Wednesday's report the economy grew at a 4% annual pace in the second quarter backed up all manner of bullish predictions -- that growth this year could still get close to 3%, that this year's pace of 230,000 new jobs a month should push the unemployment rate near 5.5% by year's end, even that the economy could grow at close to 4% next year. Friday's jobs report will tell us more about how realistic all of that is.

But even if all that happened, this would still not be an especially strong recovery by historical standards. Since the Standard & Poor's 500 has jumped 38% since the beginning of 2013, a lot of the good news is already in stock prices.

The first problem for the market is that stocks are relatively expensive. At 19 times trailing earnings, the S&P 500 is near its 1980s peak and around the last sane levels of the 1990s, before the bubble mania of 1999 and early 2000 set in.

Neither do bonds look like any refuge. While there's no consensus on how rapidly Janet Yellen and the Federal Reserve may raise interest rates, they won't be going lower. Ten-year Treasurys are yielding 2.59% a year -- a third lower than they were five years ago when the economy was still in collapse. A serious foreign shock is about the only thing that would make growth slow enough for bonds to rise, as rates sag, again. Even another epic winter wouldn't do much for bonds -- by fall, the upward trend in growth, and interest rates, will be clear in a way it wasn't when the weather sucked the economy into its vortex last December.

Rates are likely to rise, a little sooner than many expected, but they won't rise much. If Yellen & Co. have made one thing clear, it's that they are willing to absorb inflation that flirts with the central bank's 2% annual target rate, or even exceeds it slightly, in order to absorb the three million workers who are working part-time because they can't find full-time work. (Actually, there are 7.5 million, but there were 4.4 million near the peak of the last cycle).

So while rates may rise as soon as March, as economist Joel Naroff predicts, they won't rise rapidly unless inflation cranks up. That protects stocks' recent gains to a degree, but it warns retirees that they shouldn't count on fatter interest payments on bonds just yet. Yields on 30-year bonds are actually 0.32 percentage points lower than a year ago, reflecting how calm the markets are about inflation risk.

That means the way to make money is to be selective, mostly in equities.

Look for secular growth in technology, including social media, cloud computing, clean energy and health-care IT, all of which are well-known themes but still have room for stocks like (FB),Facebook  Twitter (TWTR), Athenhealth  (ATHN) and Tesla Motors (TSLA)  to run. Fidelity Investments makes the argument that this is a good time to buy tech in general, since the middle of the cycle is when enterprise spending picks up -- which the second-quarter GDP report supports.

The cyclical play is trickier, since that's where some companies have already seen shares rise more than they deserve. That said, with consumers still holding on to the oldest stock of durable goods they have owned since World War II, there's a big replacement cycle waiting to happen. That will benefit makers of consumer durables.

If there is one sector that's cheap because it's unloved right now it might be home builders like NVR (NVR), D.R. Horton (DHI) and Pulte Group (PHM). Builders are down 10% since July 1 as weak sales and permits macro data has come in. But the data look off, MKM Partners analyst Megan McGrath says -- they are dominated by a reported collapse of activity in the southern U.S. that is far worse than what publicly traded builders have reported, she said.

The combination to watch in building could be a revision of some of the macro data in coming months, coupled with the ongoing impact of an improving job market and rising consumer confidence.

A better economy doesn't automatically mean a better market, because the market's job is to anticipate and lock in the fruits of that move as it's happening, or even before. But with attention to the economy's details, a savvy investor can make solid predictions about which parts of the move are likely to last long enough to let latecomers cash in.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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