If the hoped-for business recovery starts this year, your clients will probably require a different investment focus: one that emphasizes cyclical industries, such as materials, rather than defensive industries, such as consumer staples, health care, telecommunications and utilities.
When stock trading quiets down, bad corporate news reports become infrequent and some cycli-cal stock groups start to rise, as has recently happened; this could be the early warning of a coming business revival and could mark the time to change investment strategy.
However, you also must be sure that your clients know this could be an atypical recession without the same quick bounce-back in stocks. For investors with a long-term time horizon, this isn\u2019t necessarily a problem. They could start buying some cyclicals now at bargain prices and \u2014 even if it takes time before the stocks move up \u2014 these investors will eventually be rewarded.
For clients with a shorter-term horizon, it\u2019s probably better to be very cautious and wait until there are more signs that the recovery is imminent before taking the plunge into cyclicals.
A stock market revival usually starts about six months before the business recovery becomes evident. Whether that timeline will hold true this time around in the badly shaken world economy is a major unknown.
The difficulty, as most economists point out, is that no one knows when the recession will end.
Efforts by the U.S. government and the Federal Reserve Board to provide capital to banks and prevent the automobile industry from going bankrupt have no guarantee of quick success.
Also, the Fed\u2019s steep cuts in short-term interest rates do not assure a quick boost to corporate borrowing and investment.
And the Obama administration\u2019s plans for huge deficit spending may not succeed as quickly as it hopes. The world business slowdown has been so sudden and so deep that such desperate measures may be ineffective \u2014 at least, in the short run.
As a result, there are huge differences of opinion about the value of stocks. For example, Morningstar Inc. <\/b>figures the fair value of the Dow Jones industrial average at about 12,500 (compared with its 2008 yearend level of 8,776). But economist and investment strategist Gary Shilling says the S&P 500 composite index could drop as low as 600 this year (vs a yearend close of 903), given his estimate of only $40 in earnings for the index in 2009.
The least risky strategy entering 2009 is defensive, but be alert for the appearance of early signs of a business recovery to prompt your switch to cyclical stocks.
Cyclical industries normally lead in the beginning of new bull markets. Industries such as steel, lumber, paper and industrial metals are among the first to respond to the first stirrings of increased business activity.
Other industries that stir early in a revival include trucking, railways, airlines and \u201clogistics\u201d companies, advertising firms and communications businesses.
A typical early sign of a coming economic recovery is a pickup in the container and packaging industry. Manufacturers and distributors order more containers and boxes as they recognize improvement in their own prospects.
With Wall Street trying to gain a firm foothold as 2009 begins, it is possible that the market is signalling a business recovery to start around mid-year. But note that only a few stocks in the usual collection of turnaround leaders are bullish; others remain resolutely bearish.
A good indication that conditions are not getting worse will be a lessening in the number of companies reporting layoffs, plant closures and lower sales and earnings forecasts.
Another indication will be markedly lower stock market volatility.
But even when this happens, Canadian investors also have to consider the exchange rate when contemplating investing in the U.S. market. The crash of the loonie this past fall means that U.S. dividends now buy more Canadian dollars. A big rally in the loonie will cut dividend income and would also reduce the value in C$ of U.S. stocks bought at a lower exchange rate. So, if you are factoring in a significant rise in the loonie, you should expect at least a balancing gain in the price of any U.S. investments.
Given all these provisos, this is what analysts expect for the 10 sectors of the U.S. market \u2014 starting with the largest and ending with the smallest, in terms of market capitalization:
@page_break@> Information Technology<\/b> has become the most heavily weighted of the 10 sectors in the U.S. stock market. This is not because it has grown in importance but because other sectors have shrunk. For the past half-dozen years, this sector has accounted for about 16%-18% of market capitalization.
IT has reached a dull spot in both software and hardware product innovation. In addition, spent-out consumers and squeezed businesses are cutting back on purchases.
Analysts expect earnings will drop heavily for IT this year, but investors can find a few growth prospects in this area.
San Diego-based Qualcomm Inc., the leading wireless chip provider, has broken the downtrend from its 2008 high. Analysts expect higher earnings from both Qualcomm and Irvine, Calif.-based Broadcom Corp.
> Energy<\/b> is tied (with health care) as the U.S.\u2019s second-largest industry sector, despite this past autumn\u2019s collapse of oil prices. Earnings are dropping, of course. Still, overweighting this sector is recommended. Stock prices have dropped more than warranted, analysts say, so there is stock price appreciation potential from any rally.
One reason for overweighting this sector is the steady, long-term performance of the integrated oil companies. They form almost 70% of the energy sector weighting. Although oil prices are volatile, shares of integrated companies are not. Their dividend payments make for smoother sailing than commodities prices suggest.
Hence, Irving, Tex.-based Exxon-Mobil Corp. continues to be a large-cap stock with appeal, despite an expected slide in earnings. It has paid dividends annually since 1882, and increased the payment again last year. San Ramon, Calif.-based Chevron Corp. ranks second in appeal.
> Health-Care<\/b> sales may be curbed by consumers\u2019 need to reduce their spending, even on prescription drugs. In life sciences, more takeovers of small biotechnology\/genetics companies are likely. Contract research companies are likely to gain business as drug companies try to cut costs. Princeton, N.J.-based Covance Inc. is highly rated in this industry.
Medical equipment companies \u2014 such as Franklin Lakes, N.J.-based Becton Dickenson & Co.; Kalamazoo, Mich.-based Stryker Corp.; Covidien Ltd., which is based in Hamilton, Bermuda, but most of whose corporate functions are located in Mansfield, Mass.; and C.R. Bard Inc. of Murray Hill, N.J. \u2014 appear best placed for gains in 2009.
Among pharmaceutical and health-care supplies manufacturers, Amgen Inc. of Thousand Oaks, Calif., and Johnson & Johnson of New Brunswick, N.J., are highly rated by analysts. MedcoHealth Solutions Inc. of Franklin Lakes, N.J., is similarly placed in health-care services.
> Financials<\/b> used to be the largest industry sector on Wall Street, with 21% of total market cap. That proportion has shrunk by more than one-third as a result of the sector\u2019s 58% drop in share prices in 2008. Financials had a loss overall for the year. Although there are risks of unexploded disasters, earnings recovery by financials is a big reason for the expected gain in total earnings on the S&P 500.
There seems to be little reason for Canadian investors to venture into this minefield, given the favourable condition of Canadian banks and insurance companies. Still, if your clients must, U.S. insurance companies have the least risky prospects in this sector in 2009.
> Consumer Staples<\/b> have gained in importance relative to other sectors as clients bought them as a hedge against a business slowdown. This didn\u2019t work totally, as the sector index lost 29% from March 1 to its Nov. 30 low while the broad market lost 32%.
That said, sector earnings are growing at a steady rate, which is expected to persist through 2009. Two trends will help: lower commodities prices and higher marketing spending by brand-name companies.
Minneapolis-based General Mills Inc. and Northfield, Ill.-based Kraft Foods Inc. earn recommendations in the sector, as well as Coca-Cola Co. of Atlanta, Procter & Gamble Co. of Cincinnati and Avon Products Inc. of New York.
> Industrials<\/b> will continue to have poor results, with a few exceptions. If political promises about rebuilding U.S. infrastructure materialize, construction equipment and machinery manufacturers will benefit. And if an economic recovery comes soon, industries such as air freight and trucking will be leaders on the upside.
> Consumer Discretionary<\/b> stocks have steadily lost relative importance in the S&P 500 index over the past few years. Given the jump in unemployment and a higher household savings rate, this sector will continue to be hurt by consumers\u2019 reined-in spending.
Most major areas are suffering, including retailing, advertising and publishing, movies and entertainment, broadcasting, hotels, resorts and cruise lines, and, of course, autos.
Education services are the big exception in this sector, as the share prices of these companies are rising. Apollo Group Inc. of Phoenix is a leader in this industry. Restaurants such as Oak Brook, Ill.-based McDonald\u2019s Corp. also have positive prospects.
> Telecom Services<\/b> are still in a downtrend, but they have strong appeal thanks to growing cash flow. Demand for smartphones and new services, continued growth in volume of traffic and growth of broadband services contribute to this.
A current leader in this sector is Boston-based American Tower Corp. The company operates 19,500 communications (cellphone, broadcast) towers in the U.S. Some analysts expect the firm\u2019s stock will regain its 2008 high, which was about US$46 a share, and earnings estimates range from a rise of 25% to 100% in 2009.
Dallas-based AT&T Inc. is favoured among service providers, with SBA Communications Corp. of Boca Raton, Fla., a more speculative favourite among wireless service companies.
> Utilities<\/b> shares have been unable to gain traction recently. This probably reflects lack of current potential. The recession will limit growth, while the credit crisis restrains utilities companies\u2019 ability to borrow for building new plants and purchasing equipment.
Still, the sector has some appeal because there are so few major utilities companies trading in Canada. However, the risk in buying U.S. gas and electric utilities for income is the exchange rate.
> Materials<\/b> companies shares have been rallying from their deep drop. Whether this is an early sign of a business recovery is questionable. The business slowdown cuts demand for just about every product in this sector, from copper and steel to lumber and containers.
In contrast to Canada, this is the smallest sector of the U.S. investment market. Because of this, the sector will have minimal appeal for Canadians, except for the existence of large and generally successful U.S. companies.
The intriguing event in this sector is the rise of the stocks of two packaging companies \u2014 Neenah, Wis.-based Bemis Co. Inc. and Broomfield, Colo.-based Ball Corp. \u2014 as 2009 began. This may not be a true early-warning sign of business revival, but it is a situation to be watched.\tIE<\/b>
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