By David Sterman
Every few months, hedge-fund managers take a fresh look at the economy, trying to figure out key trends that will yield the best returns in the months ahead. Once they complete their analyses, they rotate some money out of sectors that no longer appeal into sectors that provide the freshest upside.
With 2011 winding down, this is a good time for individuals to anticipate where the action will be later this winter, and on into the spring and summer.
To be sure, as I've recently noted, the economic outlook for 2012 doesn't look all that different than 2011. The economy should grow at a modest pace, inflation should remain benign, and the U.S. consumer will likely get a little healthier. But you can sense a slight shift in sentiment as recession fears start to diminish and hopes that we may start to see more solid growth start to build -- at least in 2013 and beyond. This means what worked in 2011 won't necessarily work in 2012.
For example, utility stocks posted solid results this year, rising roughly 15% on average, as they represented safety in a storm. Consumer staples and health care stocks rose about 10%, according to Goldman Sachs. There's no reason to sell these kinds of stocks in 2012, but there's also little reason to expect them to lead the market once again. Instead, here's my sector-focused game plan for 2012.
The crisis in Europe has been especially hard on banking stocks as fears of a Lehman Bros.-like contagion began to build. A typical financial services stock fell roughly 10% this year, but many within the group fell far more sharply. We've discussed the merits of Warren Buffett's favorite bank stock, Wells Fargo (NYSE: WFC), but I remain convinced Citigroup (NYSE: C) represents the best upside in a group that is likely to rotate back into favor in 2012.
Many bank stocks -- including Citigroup, now trade well below tangible book value -- which is reason enough to expect a sector rally when the European crisis recedes. Yet Citigroup's fast-increasing exposure to Latin America and Asia still fails to get much respect on Wall Street. This is bound to change as these foreign operations generate superior returns to those seen in Europe and the United States. By 2013, Citigroup could also be talking about improving operations domestically, as the housing market gets back on its feet.
This group rebounded nicely from the March 2009 levels, but many key stocks have slipped considerably after peaking this past spring. Stocks such as Deere (NYSE: DE) and Schlumberger (NYSE: SLB) have slid 25% from their peaks, even with their long-term outlooks remaining quite bright. Yet for my money, the biggest gap between investor perception and reality can be found among automakers and auto-parts suppliers. These companies emerged from the 2008/2009 economic downturn in far stronger shape, and even though they're well up off the lows seen back then, they're also well below their recent highs.
Auto-parts suppliers such as Lear (NYSE: LEA) and Magna International (NYSE: MGA) are 30% to 40% off of their 52-week highs and look awfully tempting trading at seven or eight times projected 2012 profits. Yet two publicly-traded auto stocks may be the biggest bargains of all, trading at even lower multiples. GM (NYSE: GM) represents the biggest value in the group, as its entire operations are assigned zero value after its net cash is excluded from the market capitalization. Ford (NYSE: F) represents the better operator of the two. Which one appeals the most depends on your investing preference.
3. Consumer discretionary
For the past three years, we've been hearing tales of consumer deleveraging. Millions of Americans have sought to repair their personal balance sheets by paying off credit card loans, shortening vacations and getting a little more use out of old clothes and appliances.
The retrenchment in spending has been partially fueled by fears that the U.S. economy may fall off a cliff. But it's becoming apparent that the worst-case scenarios for the U.S. economy simply won't come to pass. This should, with each passing month, make consumers a little less cautious. Few expect a spending boom in consumer discretionary spending, but even a modest upturn would have an outsized effect for any businesses that operate with high-fixed costs and low-variable costs.
Does this mean consumers will replace aging washing machines and dishwashers? If so, then Whirlpool (NYSE: WHR), trading at around six times projected 2011 profits, looks like quite the bargain. Will Mom and Dad treat the kids to a vacation instead of a "stay-cation?" If so, then Disney (NYSE: DIS), trading at levels seen back in 1998, may get a solid lift.
For my money, the major airline and hotel stocks stand out as consumer discretionary subsectors with the strongest upside potential. Both of these industries may sell more plane seats and hotel rooms, respectively, so they may be able to boost prices for each seat and room as well -- a double-barreled gain that could greatly enhance profit margins. Delta Airlines (NYSE: DAL) should fare very well in a slowly-improving economy -- if oil prices don't shoot through the roof. In the lodging space, keep an eye on Starwood Hotels (NYSE: HOT), Marriott International (NYSE: MAR) and lodging REIT Host Hotels (Nasdaq: HST), all of which are well off of their 52-week highs.
Risks to Consider: Right now, the risks start and end with Europe. The U.S. economy appears to be on the mend, but a deep slump in Europe would blunt any momentum we may be seeing here at home.
Keep your expectations in check. Few of these stocks (outside of Ford, GM and Delta) appear capable of really big stock price gains in 2012. But all appear poised to deliver respectable 20% or even 30% returns in the coming year if the U.S. economy keeps showing signs of improvement.
Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.