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Sector Analysis - December 23, 2011
Investors who want to look at the “big picture” often start by examining the state of economy and the stock market in general, and then look, in order, at market sectors, at industries within a sector, and then at companies within a given industry.
This week, Value Line provides its quarterly update on the 10 stock sectors we follow, which include nearly 100 industries, highlighting the notable changes that have occurred in the past few months. The sector ranks are based on the Timeliness ranks of the individual stocks within the sectors, and are positioned from 1 (Highest) to 10 (Lowest) in order of attractiveness.
The Basic Materials retains its highest ranking for Timeliness since our September report, largely on the earnings momentum of the Chemical (Basic) and Chemical (Diversified) Industries. Precious Metals is also one of the more timely industries, even though gold prices have endured a correction in the past few months, as the U.S. dollar has strengthened. The sector could get a lift as central banks more aggressively pursue a growth agenda in the coming months. In particular, another round of quantitative easing in the United States would very likely be a plus for gold prices, since such a move would likely be seen as fueling inflation.
The Utilities sector is this year’s star. Long perceived as stodgy and boring, investors looking for a safe haven found a home in this sector. The group’s performance handily beat that of the Dow Jones Industrial Average through the first 11 months of 2011, even before dividends. We acknowledge that investor preferences could easily switch to favor shares with greater capital gains potential, as circumstances warrant. But utilities stocks should continue to fit the needs of income investors, as long as yields on Treasuries, money markets, and bank accounts offer minuscule returns.
High oil prices remain a key underpinning of the Energy sector. Crude oil in the $100-a-barrel range is a clear positive for drillers, and quotations have held up reasonably well despite slowing business conditions. That is partly on account of ongoing instability in the Middle East. The tremendous quantities of oil consumed every year support prices, too, since no cost-effective substitute for petroleum has been developed, despite decades of trying. Shares of natural gas producers seem like more of a long-term proposition, though, given persistently low prices for that fuel. But natural gas prices probably won’t remain low forever, due to electric utilities’ preference for natural gas over coal and nuclear energy.
The Industrial sector is tied to the economy more than most other sectors, and it has the fourth highest sector Beta (a measure of correlation with the overall market), behind Basic Materials, Consumer Cyclical, and Energy. Thus, Industrials have benefited to an extent from the somewhat better-than-expected economic data emanating from the United States of late. Another positive is that the group will still enjoy the benefits of the government stimulus package that allows for bonus depreciation and tax incentives for equipment purchased through 2012. The Industrial sector is the only sector to move up in Timeliness this week.
Indications are that consumers are drawing on savings to boost purchases, rather than benefiting from wage gains. Job growth has also been unexciting, and lower home prices detract from spending. Even so, there are some notable bright spots, such as consumers replacing vehicles they purchased prior to the recession. On the other hand, a number of retailers have indicated that a portion of their customer base continues to be under pressure, and that the selling environment is fiercely competitive and highly promotional. This mixed picture leaves the Consumer Cyclical sector in the middle of the pack for Timeliness.
The Consumer Staples sector’s defensive characteristics allowed the group to shine in 2011. As the stock market gyrated on fears of recession and the implications of Europe’s malaise possibly spreading, investors found comfort in owning shares of companies that produce everyday essentials. Nevertheless, increased competition from China and a downshift from premium consumer goods to less expensive brands are pressuring margins. On the plus side, many of the large companies in this space have ample room to increase efficiency through cost-reduction programs.
Telecom is a sector in transition as consumers move toward wireless devices and as companies look to break ground in non-traditional areas, including cable TV. Consolidation has been an important trend within the sector, although one which the Justice Department has dampened through its challenge of AT&T’s (T - Free AT&T Stock Report) proposed buyout of T-Mobile from Deutsche Telekom (DTEGY). The Telecom sector is one of the smaller in terms of market capitalization (with only 67 companies of the 1,700 Value Line covers overall). A handful of Telecom stocks offer hefty dividend yields, while many others offer sizable capital gains potential. The sector as a whole offers greater appreciation potential than any other, except for Technology.
In a market that saw an unusual amount of volatility, the Healthcare sector benefited from the greater stability it provides in the past year. The group is one of only three sectors (Utilities and Consumer Staples are the other two) with a Beta of less than 1.00. It has also helped that some high-yielding stocks (Merck (MRK - Free Merck Stock Report), Pfizer (PFE - Free Pfizer Stock Report), and Bristol-Myers Sqibb (BMY)) have recently boosted their dividends. There is still uncertainty regarding changes in healthcare laws, of course. The U.S. Supreme Court is due to hear the case against the Congressional legislation passed in 2010 in the upcoming months. But most companies appear to be adapting to the need for change.
The Technology sector lagged in 2011, as indicated by the tech-heavy NASDAQ’s underperformance relative to the Dow Jones Industrial Average. Strangely enough, part of the problem was weather-related. (That explanation is usually reserved for retailers.) In a year that saw an unusual amount of violent storms and natural disasters worldwide, electronic parts shortages, first from Japan following an earthquake and tsunami, then as a result of floods in Thailand, wreaked havoc on a number of high-profile tech companies’ supply chains. Sector appreciation potential is above average, however.
The long-suffering Financial sector continues to bring up the rear among the various sectors. Financial companies must bear the burden of increased regulation and restrictions, falling asset yields, a weak lending environment, fears of contagion from Europe, and fallout from the bursting of the nation’s mid-2000s real estate bubble. On the bright side, the sector has taken steps on the road to recovery. Most TARP recipients have paid back the government funds they received, for instance. But financial stocks still have a way to go to regain investor confidence.
At the time of this report's issuance the author did not hold positions in any of the companies mentioned.