Stocks: The Next Hot Sectors

Amid the volatility, Gene Marcial talks with stockpicking pros about the market sectors they see leading the next major advance

by Gene Marcial

I always say try not to pick the market's bottoms or peaks. Leave that to the pros. Such guessing will only sabotage your sober perspective. That is not to say that you shouldn't prepare for the market's next move, whatever it may be. More than a few market prognosticators are already quite sure the stock market's next big move will be up. Could they be right? Most investors aren't betting on it. But that may be one of the reasons a bull-market rally could be just around the corner. Of course, no one rings a bell to alert investors the bull is stampeding back.

"All signs are out there now for the market to move to the next cycle, which is best described as the next 'greed wave' that will propel the next advance," says Steven Charest, chief market strategist at Divine Capital Markets in New York. The "fear factor" wave is just about over, he says. Sure, there will be bouts of profit-taking as rallies occur. After all, there is a lot of uncertainty surrounding the economy and the liquidity and financial crises.

The stock market continues to be volatile. On Mar. 18, the Dow Jones industrial average exploded and soared 420.41 points, a 3.15% gain, to 12,392.66, spurred by the Fed's move to increase liquidity for financial institutions and the Fed-engineered bailout of Bear Stearns (BSC) by JPMorgan Chase (JPM). And on Mar. 24, the Dow again blitzed higher, shooting up 187.32 points, or 1.5%, to 12,548.64. Predictably, the market surrendered some of its gains. The Dow on Mar. 27 fell 120 points, or 1%, to close at 12,302.46—a drop of 229 points in two days. The Nasdaq tumbled nearly 2% the same session, spooked by slower sales at Oracle (ORCL).

Not So Fast, Say the Bears

What to do at this juncture of the fickle market? Prepare to snap up shares in groups that promise to be big players in the market's next major move. It is important to determine which stocks will sparkle and to identify the sectors likely to lead the next parade. Some savvy pros have assembled some names in those sectors.

Technology, industrials, and infrastructure/construction—and yes, some energy and financials as well—stand out as the batch of potential big winners the next time around. Here are some stocks that some smart-money pros picked: in technology, Corning and Diodes; in industrials, Itron, Joy Global, and Fuel Tech; in infrastructure/construction, Chicago Bridge & Iron; in energy, Schlumberger, Transocean, and Weatherford International; and in financials, Wells Fargo and U.S. Bancorp.

This is not to say the bears have thrown in the towel. They continue to growl loudly and to predict that investors will suffer more pain. "The market is in imminent trouble. Expect the worst," warns Bert Dohmen, editor of Bert Dohmen's Wellington Letter in Los Angeles, a newsletter that focuses on the Fed, economic issues, and the stock and bond markets. If the worst doesn't happen, "it will be a pleasant surprise," but don't go down the slippery "slope of hope," which so many analysts use today, Dohmen says. He notes that financial stocks continue to be pummeled. "No stock market rally can go far without the banking stocks," he argues.

Steve Rogé, an investment manager at R.W. Rogé, is also not sanguine about the outlook. There are "pockets of opportunity" for value investors, he says, but he expects any market bounce would last for just a month or so. "The recession may have been already priced into the market, but not the credit bubble," warns Rogé. He expects the Standard & Poor's 500-stock index to fall to 1,200 before any meaningful advance takes place. The S&P 500 finished at 1,325 on Mar. 27, down nearly 10% for the year.

Eye Out for the Early Cycle

Nonetheless, some equally intransigent market observers believe otherwise.

Jeffrey Kleintop, chief market strategist at investment firm LPL Financial in Boston, says we may have already witnessed the "definitive action we have been looking for" to prompt the stock market to swing from late-cycle behavior—where price-earnings ratios are falling and energy and basic materials are the best-performing sectors—to early-cycle behavior, with p-e ratios rising and the market leadership shifting to sectors such as consumer discretionary.

He notes that in recent weeks, the dollar rose in combination with the sharpest decline of commodity prices in more than 50 years. That combination, he explains, shifted the sentiment on inflation, which boosted the stock market and switched stock leadership away from the energy and materials sectors, as the price of oil fell by about $10 a barrel and gold dropped by $100 an ounce. Kleintop points out that this reversal in the direction of the dollar and commodity prices—two important factors that affect inflation—may have marked a shift to the early-cycle positive environment that, in the past, delivered powerful returns to investors.