What Will Lead Stocks Higher? Here Are Four Candidates
If the adage is true that the group that led the last bull market doesn't lead the next one, that means investors will have to forget about banks and consider a new array of choices.
Some already have: While banks have led the most recent rally, few expect the sector to continue its sharp rise upward. The need to raise capital by selling shares is likely to suppress gains in financial stocks, leaving open a path of opportunity for other sectors.
While the rebound in stocks is likely to remain uneven, three sectors have begun to emerge as the new leaders. And some analysts see a fourth possiblity: picking the top-tier stocks in a variety of sectors. Here's a look at all four strategies.
Market pros most often mention basic materials as the group most likely to take the market higher.
"On a longer-term basis, commodities are still going to be the main show, and what we've seen with the financials has just been a sideshow," says Peter Miralles, president of Atlanta Wealth Consultants. "It's good that the financials are being capitalized, but long-term the commodities will continue to perform."
Commodity stocks would be likely to outperform the commodities themselves if fears about the Obama administration's position toward trading develops into a worst-case scenario where derivative trading is hampered by regulations that inhibit speculation.
Earlier this week, Treasury Secretary Timothy Geithner called for legislation that would take derivatives trading off the over-the-counter markets and its unregulated environment and onto regulated exchanges and clearinghouses. Some analysts worried that the longer-reaching implications could lead to rising costs that would constrict positions.
The changes could lead to "the end of trading life as we know it," Tim Evans, an energy analyst at Citi Futures Perspective in New York, told Reuters.
Still, portfolio managers are bullish on commodities and believe the growth will come across the board, from mining exploration companies down to ETFs like the SPDR Gold Trust, which tracks movements in the metal.
"I'm one of those guys who believe you have to look at hard assets," says Chip Hanlon, president of Delta Global Advisors in Huntington Beach, Calif. "Nothing makes more sense to me now than gold, other than perhaps silver."
Hanlon also recommends precious metal miners who have benefited from the drop in fuel costs.
A drop in energy prices over the past year is just part of the story that has some analysts high on consumer discretionary stocks. They also could benefit from the relatively positive consumer trends of late.
Even though the news generally wouldn't be much to get excited about, the pockets of progress have spurred hope that a turnaround could be at least in the early stages.
"In a 'normal' economic environment, retailers' recent release of April sales numbers would be viewed as bordering on abysmal, but this is not a normal environment," Brad Sorensen, director of sector analysis at the Schwab Center for Financial Research, wrote this week in an analysis. "Big picture, we believe much of the negative part of this story is already priced into stocks in the discretionary sector, leading us to believe that outperformance is likely in the near term."
As with commodities, the growth in discretionary is likely to reverberate across a wide swath of the sector.
For instance, Barclays Capital on Friday upgraded media stocks, believing that growth in advertising will offset other industry problems in 2010 and 2011.
"Consensus rule of thumb is that an upturn to positive advertising growth happens 2 to 3 quarters after the end of a recession. But in light of their historically depressed valuation multiples, we think media stocks will anticipate this recovery," Barclays wrote in a research note. "Media stocks are inexpensive relative to the market and other US consumer discretionary stocks, and we can no longer justify that discount."
The Nasdaq has led the market's recovery from its March lows, and the tech sector is expected to continue to be a strong performer.
Information technology stocks have soared more than 12 percent year to date, due in part to a trend making the entire group more attractive to investors: Better balance sheets because of less exposure to risk and less susceptibility to tightening credit than other sectors.
"We believe that if businesses are going to loosen their extremely tight purse strings for anything, it's likely to be technological improvements," Sorensen wrote. "These investments are typically attractive because they tend to increase companies' efficiency and productivity at all levels, allowing companies to produce more with fewer workers, which allows companies to cut back on costs and potentially expand margins."
There's also strong sentiment that consumers, even those under pressure, will continue to buy smartphones from companies like Apple and Research in Motion.
"A hundred percent, no doubt--tons of cash, and you're going to see consolidation," Dave Rovelli, managing director of US equity trading at Canaccord Adams, says of tech's potential for market leadership. "As far as everyday living, it's food, shelter, smartphones."
With Uncertainty, Look for the Best
Amid the search for leaders to take Wall Street out of its daunting bear market remains a level of uncertainty about the two-month rally that began losing steam this week.
That has spurred a school of thought that advocates not looking for particular sectors but instead focusing on the one or two top companies in each industry across the board.
"The breadth (of the rally) is a little misleading. The leadership of the rally off the lows is more the low-quality names," says Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles. "Now as we look forward we think you're looking at more modest risk-reward ratios. The leadership is going to come from quality."
In an economic environment that is likely to have to shoulder double-digit unemployment and continued pressure on both consumers and companies to cut costs, quality could be key.
"The recovery from this economic downturn and this recession will be muted. In a tough economic environment it's going to be the strong getting stronger," Flam says. "Companies that are leaders in their businesses, franchises that are self-funding with good balance sheets, that are going to invest in their businesses, that are going to acquire some of the missing pieces in their businesses to strengthen their competitive positions, those are the ones that are going to do well in the next year-plus."