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Five hot sectors for 2016

So with only days to go until we ring the final bell on 2015 – it is time once again to look ahead. What will 2016 bring for equity prices and interest rates? It is time to reconsider the impact of possible multiple Federal Reserve moves in interest rates and what that means for investors. Will the Fed move at all or will they move faster than expected?

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Recent commentary from Fed Chair Janet Yellen has suggested that we could see four more incremental rate rises of a quarter percentage point each in 2016 as she tries to convince us that rising interest rates are a sure sign of an improving economy. That would bode well for corporate profits, which, in turn, should support higher equity prices and if that is true then I have a bridge I would like to sell to you. I would like to know what country the members of the Fed are living in.

Our economy remains a bit weak and rising interest rates in a weak economy are potentially a big problem for the markets. Higher rates would increase the cost to borrow money, (raising monthly carrying charges), which would make revolving credit even more expensive for consumers — never mind what it would do to a struggling housing market. If rates rise at all in 2016, it will only happen because the Fed will try to somewhat normalize rates after seven years of near zero rates — it will not happen because of a strongly improving economy. So, any talk of multiple rate rises has the ability to cause another year of increased volatility, apprehension and a re-pricing of equities.


Now, to be clear — I think we will see at most two hikes in 2016, but more likely just one. I do not think the U.S. economy is strong enough just yet, never mind what the international economies are doing as all seem to be in recession mode. I do not think the job environment is what they say it is and I do not think that, in a presidential election year, the Fed will move on rates after June — that way, they're not accused of supporting one party over another. That means we have six months to move — do you really think we are getting four increases in six months? Doubtful.

So what's ahead for 2016? First, expectations from the Fed and Street economists are for the U.S. economy to grow at about a 2-percent rate thru 2017 … and, as long as energy and other commodity prices are under pressure, they don't expect inflation to rear her ugly head. That would keep rates low, which should keep a floor under equity prices. Now, at some point that will all change — energy and commodities will find a bottom and then return to higher price levels. That would cause the conversation to return to worries about inflation but I don't expect that until sometime in late 2017/ early 2018. And even that is a bit optimistic, as the market doesn't believe that inflation will return to the 2-percent range until closer to 2020!

So what does it mean for stocks? Well if you listen to Jeremy Grantham of GMO, a Boston-based asset manager, or Mark Hulbert, of Marketwatch .com, or Ken Moraif of Dallas-based "Money Matters" – then prepare yourself for Armageddon. They are all suggesting that we could see a 50-percent retracement in the Dow and S&P, which means the Dow could trade back at 9000, while the S&P would revisit 1030. Reasons for concern? Seven years of ultra-cheap money accompanied by massive stimulus programs enacted by every major global central bank as well as the delay in U.S. rate normalization by the Fed. All of these actions have allowed the bubble to grow, making the coming burst that much more powerful. Now, while I agree that that is a potential problem — I do not think the Fed will be irresponsible at all.

On the other side of the fence, we have predictions of a return to normal, which would dictate about a 7-percent return on stocks — add in dividends and we should return about 10 percent — that does seem reasonable to me, since I do believe that the global economy will improve — albeit slowly. I am not in the disaster camp at all. I don't expect the Fed to move swiftly. Erring on the side of caution is the roadmap.

The sectors I like include financials, tech, industrials, solar and energy. Energy is clearly the hot button, as many consider money in energy to be dead for another year or so, but change in psychology could happen quickly — so it's about making that bet. Some of these names have gotten absolutely slaughtered yet their businesses remain intact and, at some point, the market will recognize this and reward those investors.

On the international front, I would stay away from China — it is a developing market not a developed market and so therefore there is added unnecessary risk. Remember: You will get exposure to China via investments in global U.S. and European blue chips, so you won't be missing the boat at all. I also think continental Europe is setting up to be a big beneficiary of the improving global outlook and would look to those same industries as potential opportunities.

Remember though, projections are hard to make — especially when there is so much uncertainty at home and abroad. So, any projections that you do make need to have plenty of escape clauses that allow for dynamic investment decisions.


Commentary by Kenny Polcari, director of NYSE floor operations at O'Neil Securities. He is also a CNBC contributor, often appearing on "Power Lunch." Follow Kenny on Twitter @kennypolcari and visit him at kennypolcari.com.

Disclosure: The market commentary is the opinion of the author and is based on decades of industry and market experience; however no guarantee is made or implied with respect to these opinions. This commentary is not nor is it intended to be relied upon as authoritative or taken in substitution for the exercise of judgment. The comments noted herein should not be construed as an offer to sell or the solicitation of an offer to buy or sell any financial product, or an official statement or endorsement of O'Neil Securities or its affiliates.