Industrials hold most promise for market investors - Emirates24|7

Industrials hold most promise for market investors

Healthcare, consumer staples and select sectors of industrials hold the most promise for US stock market investors over the next nine months, Global Insight, the world's top company for economic and financial analysis and forecasting said.

The sectors with the worst investment potential are predicted to be in financials, particularly real estate and banking, along with basic materials and telecommunication services, according to Global Insight's Stock Sector Rotation Strategy Advisory.

The healthcare sector continues to be in an overweight position relative to the sector's neutral weight in the market. While the healthcare sector's stock price momentum has lagged behind that of other sectors during the past six months, healthcare still supports a reasonable dividend yield and has robust prospects for growth.

The underlying demand for the sector's products and services is less connected to swings in economic cycles and strong demand and positive pricing power for the sector help to raise the predicted growth in healthcare's free cash flow to very attractive levels. Similarly, when the "trailing" P/E ratio is adjusted by fast future profits growth the resulting "peg" ratio for healthcare is cheaper compared to historical levels and across sectors.

The consumer staples sector continues to have a sizeable overweight recommendation, partly due to its reaction in a slowing economy, where lower stock prices and earnings growth rate has less volatility than typically seen in other sectors.

This sector has performed well on a relative basis so far in 2008, as reflected by the positive readings in the momentum indicator.

While the sector P/E of 16.8 per cent for consumer staples is not much lower when compared to other sectors, it is lower than typically seen in this sector.

Furthermore, the increasing exposure to global markets for new demand should help keep the average forward growth of profits steady at 4.8 per cent, which is strong enough to lower the peg ratio to an attractive range and raise the free cash flow "turning point" indicator. Industrials' healthy forward profit growth and relatively low P/E ratio result in one of the lowest peg ratios compared to other sectors.

Within industrials, Global Insight favours sectors that benefit from the weak US dollar, such as agriculture equipment, aircraft and machinery that have good prospects for profit growth.

In addition, oil and gas field machinery and farm equipment will also benefit from high capital spending in the farm and energy sectors.

The positive fundamental view on industrials is also supported by strong readings in the sector's technical momentum indicator. At the same time, a slowing US economy will hurt some parts of industrials. Several segments within the industrials sector that will be vulnerable are the automotive industry and related supply chains, construction and construction machinery and industrial equipment.

The information technology (IT) sector has an equal-weight recommendation.

The IT sector, led by semiconductors, hardware, and networking, outperformed other sectors in 2007, but the sector has been lagging the market in early 2008. Global Insight expects good prospects for the IT complex, both hardware and software, supported in part [as with Consumer Staples and Industrials] by good exposure to faster international growth. Even in the US, where investment in information processing equipment is expected to slow to 5.8 per cent in 2008 and four per cent in 2009, the growth in demand for IT is still at historically high levels.

In addition, IT consolidation continues as large companies acquire smaller ones to broaden their product offerings. Many software companies have strong balance sheets with significant amounts of cash. On the negative side, the dividend yield and P/E ratios are relatively unattractive in IT when compared to the other sectors, due mostly to a sharp stock price rise in 2007, but they are still appealing when compared to historical levels.

Good prospects for future profits growth and free cash flow and negative readings on valuations and technical indicator provide the basis for the equal weight recommendation. The relative view of the energy sector is negative. While oil prices have been on a rally, hitting record levels, the updated forecast is for a peak, followed by a decline.

As a result, energy has one of the strongest forward profit growth expectations among all sectors for 2008, yet one of the weakest prospects for earnings growth for 2009. Also, the dividend yield for this sector is unattractive, since the pay out ratios are very low and dividends have not kept pace with growth in profits during the past few years. Due to the large capital-intensive nature of long-term expansion projects under way in the energy sector, the growth of future free cash flow will decelerate as capital spending remains strong for several years to come.

The financial sector should continue to be hurt by weakness in housing, credit markets and write-downs.


The number

5.8%: Growth in demand for IT will slow to this level in 2008, analysts predict