After the Thanksgiving turkey was eaten, and well before Christmas gifts were wrapped, strategists and portfolio managers were looking ahead to 2011. Those that On Wall Street magazine rounded up were in an unusual degree of accord: technology and industrials were what they wanted under the tree. The only disagreement was whether health care stocks constitute a nice stocking stuffer or a lump of coal.
James Swanson, chief investment strategist for MFS Investment Management, says tech is his favorite sector. For a start, it's the biggest part of the S&P 500-now 19% of the index, the heftiest weighting it has enjoyed since 2000, right before the tech wreck. But he says that things are different this time around, as the sector is much more robust than it was a decade ago. And free cash flows, as a percent of sales, are now almost triple what they were in 1999.
Other observers also find the sector a bargain. Jeff Saut, strategist for Raymond James, says the price-to-12-month forward earnings ratio is trading at a multiple of about 13, while long-term historical averages run about 16 to 17 times.
Swanson is also drawn to tech for its exposure to the emerging markets, which are growing at 4% annually, twice the U.S. growth rate. Saut adds that smart phones are being adopted five times faster than personal computers by those emerging market middle classes. "That's becoming their uplink to the Internet," he says. His picks include NII Holdings and Millicom International Cellular.
Richard England, portfolio manager of the Calvert Social Equity fund, also likes the smart phone theme. His $1.4 billion fund's biggest holding is Apple, at 4.5% of the portfolio. England, a tech fan, believes there will be a sea-change in the sector, much like in the 1990s, when the move to Windows and Cisco helped the PC displace the mainframe. His two picks are Salesforce.com and VMware.
Within the energy sector, Saut cites a recent report from the Joint Chiefs of Staff, which predicts that the world's excess supply of oil will be gone by 2012. The report further indicates that there will be a shortfall of 10 million barrels a day by 2015. Saut also alludes to changes in weather as a potential boost to energy stocks-notably the building La Nina weather pattern. It will likely mean a very harsh mid-to-late winter for the Midwest, sending energy use-and energy stocks-through the roof. Both England and Jeff Rottinghaus, manager of T. Rowe Price's U.S. Large-Cap Core Fund, favor Cooper Industries, which is actually an industrial that owns a wide variety of businesses. Both like the company's LED light business.
Another popular late-cycle sector for the group is industrials. Rottinghaus likes the industry's aerospace segment because travel is up, and airlines need to do more maintenance on their planes. The spare parts business has very high margins and profits. United Technologies and Honeywell are his choices.
Only within health care was there any real disagreement. Swanson says that the industry here in the United States trades at a discount to the S&P, which he notes is very unusual over the long term, and also presents investors with a bargain. Although historically the sector has traded at a 20% premium to the S&P, it's now at about 0.9% because of the health care reform act.
England says he is underweight the sector for first time in years because of the challenging outlook. He attributes this, in part, to health care reform, but also notes that it is a mature industry that's seen a lot of its blockbuster drugs slip out of patent in recent years. He also cites unprecedented cutbacks on doctor visits, lab use and other parts of health care spending.
England contends that this is one of the first recessions in which the economy affected consumption of health care products and services. "Maybe it's because people are paying some of that out of their own pockets," he says. "But it's harder to find solid growth in the sector and it faces diminishing growth. It's less of a growth manager's pick and more of a value manager's."
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