Stock market strategists appear to be sticking to the classic cyclical playbook. With expectations of a market recovery, they are leaning toward sectors like technology and industrials, which outperform in an up business cycle.
Sam Stovall, chief investment strategist at Standard & Poor's, analyzed the companies in the S&P 500 and sorted them by debt-to-equity ratios within sectors. He notes that the low-debt crowd also happens to be the sectors that tend to perform best in a recovery: technology, health care, energy and industrials. "It's like the Casablanca captain saying, 'Round up the usual suspects,'" he says.
Out of the low-debt group, he focused on the sectors that S&P analysts like. The winners had to have five stars from S&P analysts, as well as a ranking of four or five on S&P's Fair Value model. Stovall's final picks include ExxonMobil, Chevron, Family Dollar Stores (which received a buyout offer after he published a report on the subject Feb. 14), Apple, Celgene, EMC Corp., Coach, Jacobs Engineering, Federal Express and Thermo Fisher Scientific.
Brian Gendreau, market strategist for El Segundo, Calif.-based advisory firm Financial Network, cites a 2009 MSCI Barra study, which notes that sectors that do the best in a recovery are those most closely correlated to leading economic indicators. "Unless history is providing us with a bad guide, materials, industrials and technology is a good place to be," Gendreau says.
Another top pick for Gendreau is consumer discretionary, which was one of the best performing sectors in 2010, as shoppers, more sanguine about the economy, bought luxury goods.
Gendreau also notes that the most globalized sectors stand to benefit from a low dollar. Coincidentally, that includes the low-debt-to-equity group, which is also the recovery group: materials, technology and energy. "Before the last recession — December 2007 to June 2009 — these three sectors did the best." He says that energy is currently thriving because of high gas prices and a low dollar, but the sector is generally negatively correlated with the business cycle.
Richard England, portfolio manager of the $1.6 billion Calvert Equity Portfolio, mixes the favored and the out-of-fashion worlds with his favorite sectors: technology and financials.
England is not as focused on the timing of the business cycle as he is with the timing of the technology wave. "We think we're in the second inning of the third big technology wave. The last one we had was driven by the movement from a mainframe computing environment to a distributed computing environment," he says, citing the 1990s revolution led by Microsoft and Intel. He believes the second wave has changed to where users of technology store their data. It has moved from centrally — on their desktop — to outside their organization, in either a public or private "cloud." In the new crop he likes salesforce.com, which has created something like an operating system for the cloud. VMware, a play on server virtualization, is another favorite.
England goes against the cyclical play with his fondness for financials. He thinks the troubled sector is finally on its way out of the woods, noting that bad loans peaked in late 2009. Delinquencies have moved steadily lower for at least a year, and earnings have improved over the last year, thanks to the decline in charge-offs.
England believes 2011 will see the industry out-earn the rest of the S&P for the first time in several years. "Earnings have been mostly driven to this point by reducing bad loans, but new loans are starting to happen," he says. However, he adds, the financial arena is still "an unloved sector."
England expects dividends and share repurchases to return in the next three months, especially among the largest and well-capitalized banks, like JPMorgan Chase and Wells Fargo, both of which he owns. He also likes regional banks like Suntrust and Zions; and asset managers like T. Rowe Price and Franklin Resources. His last financial pick, Lazard, shows his faith in the cyclical story, since he owns it for the firm's M&A business. "We think there will be a lot more M&A in the next few years, as the economy improves," he says.
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