(12/30/11) The Top 4 Sectors (and Stocks) for 2012

While the first half of 2012 is shaping up nicely, the second half is a bit worrisome, writes Elliott Gue of Personal Finance.

The US economy enters 2012 with significant positive momentum. Growth in the first half was hit by a spike in crude oil prices due to the civil war in Libya and manufacturing supply chain disruptions caused by a devastating earthquake and tsunami in Japan.

As these headwinds faded, growth re-accelerated, and key leading indicators of economic health are improving at the end of 2011. Initial jobless claims—the number of people filing for first time unemployment benefits—fell to the lowest level since early 2008, and measures of consumer confidence and manufacturing activity have bounced back from their summertime lulls.

The second half of 2012 worries me. The economy in 2013 will slam into a wall of new taxes if the federal government fails to pass legislation to delay or cancel planned tax hikes. A compromise extending the Bush-era tax cuts or postponing planned tax increases related to the Patient Protection and Affordable Care Act looks highly unlikely.

The future of US tax policy will be a major issue when the presidential election cycle heats up next summer. Presidential elections always introduce uncertainty, and there’s no obvious front-runner in the 2012 contest—concerns about the future of fiscal and monetary policy are likely to linger through to early November.

Normally, the stock market loosely follows the economy. But in 2011, global markets were driven primarily by politics: the high-profile US debt-ceiling debate last summer, and the EU’s ongoing struggles to address the Continent’s sovereign-debt crisis.

These uncertainties complicate our 2012 outlook. Based on corporate earnings and economic fundamentals, the S&P 500 should rally by 10% to 15% next year. So that’s what I'm looking for next year. But it’s unlikely to be a smooth ride—continued uncertainty in Europe and a contentious US election will result in significant volatility.

Europe’s economy should muddle along while the EU slowly introduces measures to reduce borrowing costs for Italy and Spain. The European Central Bank will ultimately accede to market demands and purchase European sovereign debt in larger quantities.

Asia and the emerging markets are a wild card. Although growth in these regions is likely to slow in the first part of the year, China and other countries will reinvigorate their economies with substantial fiscal and monetary stimulus measures.

Given this outlook, my favorite sectors for 2011 are:

energy
information technology (IT)
consumer staples
and health care

Energy is a cyclical sector that’s leveraged to the health of the global economy. However, I like the sector’s long-term growth story. My favorite plays on energy include several high-yielders that pay a sustainable dividend and are must-buys on any dips.

Contract driller SeaDrill (SDRL) owns a fleet of rigs used to drill deepwater oil and gas wells. Most of the company’s rigs are booked under long-term contracts that provide fixed “day rates.” In the third quarter, SeaDrill’s backlog of signed contracts jumped to a record $13.5 billion and the firm boosted its quarterly dividend to 76 cents per share.

SeaDrill rates a buy under $38. [Shares were trading around $33.25 late Thursday afternoon—Editor.]

US technology stocks have the largest net cash position of any of the S&P’s major economic sectors. In addition, the group continues to benefit from the financial strength of America’s corporate sector. Companies have continued to spend on upgrading their network infrastructure, software upgrades and enhanced security.

On the consumer front, the trend toward increased adoption of high-speed mobile data and smartphones hasn’t slowed despite weak economic growth in the US and EU.

Qualcomm (QCOM) makes chips and owns patents related to high-speed mobile telecommunications and smartphone technologies. Consumers across the globe continue to trade in their traditional mobile handsets for smartphones that offer Internet-based services, and Qualcomm receives a royalty from smartphone makers who use the company’s technology in their devices.

Qualcomm rates a buy under $65. [The stock went for under $55 just before Thursday's close—Editor.]

Consumer staples and health-care names are defensive plays that can perform well amid lackluster economic growth. These sectors are less correlated to the broader market and the economy—a drug company with a hot new treatment can perform well even if economic growth sputters. What’s more, the consumer staples and health-care sectors on average offer higher dividend yields than the broader market.

Diageo’s (DEO) impressive lineup of premium brands reads like a well-stocked liquor cabinet: Johnnie Walker scotch, Guinness stout, Captain Morgan rum, Bailey's Irish Cream liqueur, J&B scotch and Tanqueray gin. The company also distributes Jose Cuervo tequila and owns a 34% stake in LVMH Moet Hennessy Louis Vuitton (LVMUY).

With a plan in place to improve efficiency in developed markets and ramp up sales in rapidly growing economies, management forecast that the firm would grow organic sales at a 6% annualized rate over the next three years.

With a 3.2% dividend yield, Diageo rates a buy under $90. [Shares hovered around $87 yesterday—Editor.]

Biopharmaceutical outfit Celgene Corp’s (CELG) portfolio includes five commercial drugs, but the $2.5 billion in sales chalked up by cancer treatment Revlimid represented almost 70% of the firm’s revenue in 2010. Management expects sales of this blockbuster drug to account for $3.1 to $3.2 billion of the firm’s estimated $4.6 billion in 2011 revenue.

Revlimid and its predecessor Thalimid have amassed a more than 60% share of the US market for the treatment of multiple myeloma, a cancer afflicting the plasma cells that grow in bone marrow.

Celgene’s revenue could grow even more rapidly if ongoing third-phase trials demonstrate Revlimid’s efficacy treating prostate cancer, leukemia, and non-Hodgkin’s lymphoma. Recent studies have also suggested that using Revlimid over a longer period improves multiple-myeloma sufferers’ outcomes. Extended treatment periods increase Celgene’s revenue.

Celgene rates a buy under $70. [The stock traded around $67.50 on Thursday—Editor.]

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