When the overall stock market was in the throes of global recession, almost every asset class saw its share price fall. Then came 2010's economic recovery and subsequent impressive equity performance. A rising tide lifts all boats and now investors must once again focus on fundamentals. Certain sectors and individual stocks offer better values than others. By focusing on these beaten down sectors rather than just buying the iShares S&P 500 Index ETF (NYSE:IVV), investors can profit from those values.
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It's All About Rotation
At its core, sector rotation is an investment strategy that involves moving of money out of one industry or sector to another in an attempt to beat the market. Investors hold an overweight position in strong sectors and underweight positions in weaker sectors. It first started as a theory as economists and analysts data-mined National Bureau of Economic Research (NBER) statistics on economic cycles, dating back to 1854. From this data, we can predict the start and finish of various business cycles and what sectors perform well during those times. Since then, sector rotation theory has been expanded to include various calendar, geographic, and fundamental factors.
Given the severity of the recession, it can be difficult to judge where we are in the normal business cycle. However, if we look at fundamentals, the financial, health care and utilities sectors are currently the cheapest sectors on a price/fair value basis. Investors may want to shift some of their capital to these sectors and take advantage of their value.
As one of the few sectors of the U.S. economy that has seen constant growth, the sector may be one of the better choices for 2011. The new elected Republican house is a positive for the sector and compromise and amendments to the landmark Obamacare legislation seems likely. In addition, the sector has seen jobs growth over the last 10 years in the neighborhood of 30%. Patient admission rates are starting to rise as individuals are no longer delaying expensive, non-necessary surgeries or treatments. Trading a P/E of just 16, the broad-based Health Care Select Sector SPDR (NYSE:XLV) follows such firms as insurer UnitedHealth Group (NYSE:UNH) and drug producer Eli Lilly (NYSE:LLY). Additionally, the pharmaceutical subsector is also quite cheap and can be played via iShares Dow Jones U.S. Pharmaceuticals (NYSE:IHE).
While the financial sector was hurt during the recession and subprime mortgage crisis, it has rallied back. Many of the large money-center banks have repaid their loaned TARP funds and are now better capitalized. Loan growth is returning as well as dividends for investors. With uncertainty still plaguing the sector, investors wanting to add financials should stick to the biggest banks. The SPDR KBW Bank (NYSE:KBE) follows the biggest of the big and both the price/cash flow and price/book value multiples of many of the stocks the ETF holds are well below the S&P's average. For those who want even more security, the PowerShares Financial Preferred (NYSE:PGF) moves investors further up the bankruptcy ladder and pays a 7.32% dividend.
Moving past their traditional "widow and orphan" legacy, many analysts see the utilities sector as a new growth engine. The smart grid build-out has spurred new transmission lines and technologies which has upgraded utilities' stodgy image. However, the sector still trades at a price/book ratio of about 1.5, or the cheapest that the sector has been at since 2002. The Vanguard Utilities ETF (NYSE:VPU) offers investors a way to tap into the sector's future growth.
As the United State's economy has recovered, so have the equity markets. Almost all of the markets various segments are off of their recession lows. Investors looking for value among the various sectors should focus their attention towards the health care, financial and utility sectors. The previous exchange traded funds make adding increased exposure to those sectors easy. (Many would-be, first-time investors don't believe the stock market is a fair playing field. See Is The Stock Market Rigged?)
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