(MONEY Magazine) – In the wake of the United States' swift military victory in Iraq, the geopolitical picture has finally begun to clear. Can we say the same of the economic outlook? We've certainly seen encouraging signs in recent weeks. Retail sales hit a 17-month high in March. Oil prices have fallen from their prewar levels. Inflation remains in check. And consumer confidence surged in early April. Wall Street has responded with guarded optimism: The Nasdaq composite, as of this writing, has climbed more than 7% since the start of 2003, and the S&P 500 is also up.

To me, this all signals a solid recovery for both the economy and the stock market. But obstacles remain. This month, I asked two of the most insightful and engaging Wall Street watchers for their take on what's coming next. These pros were divided over the economy's short-term prospects, but both pointed to stocks or sectors worth investing in now.

THE CASE FOR RECOVERY

"We think that the economy will be putting in a better than expected performance over the next several months," says relative optimist Tom McManus, chief investment strategist at Banc of America Securities. "We need to remember that the economy always slows down in the winter and always bounces back in the spring." And since this winter has been worse than most, economically speaking, McManus reasons that the bounce should be that much stronger. He believes that once many of the President's proposed tax cuts are passed, the economy will likely accelerate as we move into 2004.

That should be a plus for the stock market. "Right now, expectations for economic growth are very low, in sharp contrast with a year ago," explains McManus. "Investors are still betting that the economy is slowing and that the Federal Reserve might actually be required to ease [interest rates] again."

Donald Straszheim, president of Straszheim Global Advisers, is more cautious: "The economy is going to grow very slowly--well below our long-run potential. I think for the rest of this year, growth isn't likely to be any higher than 2%. The problem is really centered on the lack of job growth."

VOLATILITY AHEAD?

Straszheim argues that we are going to see continued volatility in stock prices, with perhaps a modest--but only modest--trend toward higher prices. "There is not going to be vigorous economic growth and, accordingly, there is unlikely to be very strong earnings growth either," he says.

But at least we aren't going backward anymore. Corporate earnings are showing signs of improvement since last year. In fact, McManus believes, "the earnings cycle has bottomed." Straszheim agrees that we're seeing progress: "There's been an enormous amount of cost cutting that has occurred in recent years...and that will pay benefits." However, he warns that without very rapid economic growth, earnings gains are going to be frustratingly slow compared with the recoveries in previous post-recession expansions.

And what about the consumer? The reports of a consumer pullback have been greatly exaggerated, to steal a line from Mark Twain. McManus says there's no doubt that some consumers are spending less. However, he believes there's still plenty of "upside leverage" in consumer spending. "For every consumer who is already leveraged to the hilt," he says, "there are many more who have reduced their outlays substantially with the idea that those outlays might resume once the job outlook improves." So a decent uptick in employment figures could make these consumers feel secure enough to spend again, and they'd still have a way to go before they maxed out their credit cards.

And McManus says that "as consumer confidence improves, corporate confidence in the economy will be improving," which will lead businesses to plan ahead and invest. However, McManus adds that companies need some additional stimulus to spend right now. He'd like to see President Bush's growth package allow corporations to depreciate the value of their capital equipment faster--in effect, sweetening the tax break for companies who frequently replace the tools they use to do business. That would be terrific news for the numerous companies, from Cisco to General Electric, that make and sell such equipment.

Straszheim is doubtful about the near-term impact of the President's plan. "The tax package will be a minor factor and not a major factor in the economy's performance in the next two years," he says. He concurs that the tax-cut package will be a plus in the long run but adds that what's most important is "just a healthier broad economic environment." How to get there? "It's time. It's cost cutting. It's repair of balance sheets, and it's vigorous management [working toward] the company's objectives." And the biggest risk? Poor job growth. "I think it's going to be a problem for all of 2003 and probably well into 2004," says Straszheim.

McManus, meanwhile, thinks the real danger is that recent weakness in the economy "could become a self-fulfilling prophecy," whereby the economy is caught in a vicious cycle. "Consumer demand would remain sluggish, and corporations would be so focused on protecting their respective bottom lines that hiring would remain sluggish." He also worries that "we're not past the era of companies cooking the books." The revelations about HealthSouth have caused McManus to become concerned again. The market and, crucially, CEOs need to see some evidence that the Sarbanes-Oxley corporate reform legislation has teeth.

"The simple fact," says McManus, "is if investors require an 8% to 10% annual return to compensate them for the risks of owning stocks, then they would require a significantly higher return if one out of 10 or one out of 20 or one out of 50 companies weren't really what they were cracked up to be. That's because investors would need to have their other investments compensate them for the risk that a given company out there might be smoke and mirrors." So how do investors show that they "require" higher future returns from stocks? They push share prices lower, of course.

But at the moment, Straszheim says, stocks overall are "really quite richly valued." He says it will be a stock picker's market in the next few years, as opposed to an indexer's market. "There are always companies at any time that do well. But with slow [economic] growth, earnings growth is going to be relatively weak, and that's going to put a lid on the pace of equity advance."

WHERE THE BUYS ARE

Straszheim thinks that technology is going to do well for the next couple of years. "In the long run," he says, "technology is how companies leapfrog other companies and countries leapfrog other countries, and that hasn't changed." He says that although there was a painful collapse in technology, the process is finally beginning to turn itself around, and he predicts that tech will probably be the strongest sector in the economy, and probably in equities, in 2003 and 2004.

McManus likes firms that will benefit from the fall in oil prices and a recovery in demand for leisure and travel. He also likes oil drilling and service stocks. His top picks include Avon Products, Carnival, Disney and Patterson-UTI Energy.

Straszheim advises investors to look for quality companies with managements that have a proven track record. He thinks this is also going to be a market in which dividends are going to be more important than they have been in the past. He adds that investors need to keep a close eye on price/earnings ratios. "The problem is that it's going to be very easy for some of these stocks to get bid up to excessive P/Es in a hurry because earnings growth is still pretty slow," he says. Finally, Straszheim stresses an important message for these fast-changing times: Investors "most of all" need to pay attention and should be willing to actively manage their portfolios.

And I'd say it looks like a good time to start adding to those portfolios as well. Yes, there are challenges to an economic recovery--both McManus and Straszheim make that clear. But the worst is probably behind us, and the Coalition's fast and decisive win against Saddam Hussein has now opened up the way ahead.

Lou Dobbs is the anchor and managing editor of CNN's Lou Dobbs Moneyline.