"Don't fight the Fed" is more than an old Wall Street saw. The Federal Reserve is a powerful force in the economy and in the markets. Sooner or later, the economy will turn around. When that happens, you'll want to be in small-company stocks, junk bonds and consumer discretionary stocks.

As the nation's central bank, it's the Fed's job to make sure that the economy grows steadily, without inflation. In a recession, the Fed pushes short-term interest rates down to get the economy going. In the process, the Fed also makes more money available to lend.

By lowering interest rates and making more credit available, the Fed makes it easier (and cheaper) for businesses to borrow and expand. Companies can also refinance existing debt at a lower rate, which boosts profits. As business improves, companies start hiring people again, consumers start spending, and the economy recovers.

Naturally, stocks benefit from the Fed's actions, because stocks do well in a growing economy. And when rates fall, stocks look more attractive compared with returns from money market funds or bonds.

The problem, of course, is that the wheels of monetary policy grind slowly. It takes about 18 months for a Fed rate cut to take full effect. In the meantime, all kinds of things can happen. For example, had you invested in the Standard & Poor's 500-stock index on Sept. 18, 2007, when the Fed started lowering interest rates, you'd still be kicking yourself today: The blue-chip index has fallen 12.8% since then.

And so far, many of the consequences of the Fed's rate cut have been negative for investors. For example, the value of the dollar has fallen 12.9% against the euro since Sept. 18. As the dollar has fallen, gold his soared 33% since the first rate cut.

And interest rates on short-term savings vehicles, such as bank CDs and Treasury bills, have fallen from "low" to "ridiculous." A three-month Treasury bill yields just 1.28%. (At that rate, it would take about 55 years to double your money.)

But sooner or later, lower rates and more plentiful credit will help revive the economy. When that does, what will fare best?

•Small-company stocks. A big, successful company has many ways to get a loan, even in a credit crunch. But in a recession, banks treat small companies like crack-addled cobras. As a result, small companies get hit the hardest when loans are hard to get. The average fund that invests in small, undervalued companies has fallen 12.4% since the Fed started cutting rates, according to Lipper, which tracks the funds.

As banks begin to lend and the recession ends, however, small-company stocks begin to soar, says Hugh Johnson of Johnson Illington Advisors. "It's one of the signs you look for at the bottom" of an economic cycle, Johnson says.

•Junk bonds. Junk bonds are long-term IOUs issued by companies with credit ratings slightly better than North Korea's. The rationale for junk bonds in the early recovery is the same as for small-company stocks. Sometimes, you can make more money in a company that's moving from terrible to mediocre than in a good company that's becoming great. Junk bond funds have fallen 3.8% since the Fed began cutting, and that's including reinvested yields of 6% or more. But when the economy recovers, these companies will generate more income and have an easier time repaying their debts, making their bonds more valuable.

•Consumer discretionary stocks. If you invest in sector funds, consider those that invest in companies that sell clothes, shoes, consumer electronics and other items that people buy when times are flush. These stocks typically lag in the six months after the Fed starts cutting rates, says Sam Stovall, chief strategist for Standard & Poor's. But the stocks are up an average 31% in the 12 months following a Fed rate cut. Tech stocks are typically up 33% the same period.

How do you know when the stock market is sensing a turnaround? Look for smaller gains in defensive stocks, such as utilities and health care stocks, and bigger gains in more volatile, riskier stocks, such as technology. A big part of the Fed's job, after all, is restoring confidence in the financial system — and one sign of confidence is a willingness to take greater risks.

No doubt about it: The economy is still in trouble, and the worst may not be over yet. But when the worst is past, you'll regret trying to fight the Fed.

John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com.

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