4 sectors you need in your portfolio this year

These stock market sectors are likely to outperform the market in 2021.

  • By Faisal Humayun,
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In over a decade of investing in equities, a strategy of rotating stock market sectors has always worked for me. The idea is to look for specific sectors that should be able to outperform the greater market index over the course of a year.

Liquidity in the financial system tends to flow from overheated sectors to underperforming sectors. Of course, there needs to be a catalyst to justify the overweight stance in any sector.

For this exercise, I selected two stock market sectors that underperformed last year. Then I added two new sectors that have long-term tailwinds and should be good bets for 2021.

Let’s take a closer look at these four stock market sectors:

  • Financials
  • Energy
  • Technology
  • Health care

Financials

Banking stocks have already started to trend higher in the fourth quarter of 2020. I strongly believe that banking stocks will be a key investment theme for the current year. An important point to note is that the financial sector tends to outperform in the early stage of a business cycle. It therefore makes sense to go overweight on the sector.

It’s expected that return on equity for bank stocks will begin to recover in the current year. That’s a key reason for expecting banking stocks to deliver robust returns. Fitch has also revised the outlook for U.S. banks to “stable” from “negative.”

Another trigger for financial stocks is improvement in net interest income and net interest margin. In the last few quarters, the non-core banking segments have offset weakness in the core banking services. I expect core banking to deliver healthy results in the current year.

In terms of specific stocks, JPMorgan Chase (JPM) would be my top pick from financial stocks. JPM stock is attractive at a forward price-earnings ratio of 14.7x. In addition, the stock offers a healthy dividend yield of 2.6%. Bank of America (BAC) would also be interesting if interest rates trend higher. For Bank of America, a 100 basis points change in interest rates will impact pre-tax earnings by $9.6 billion.

Overall, the financial sector would be among the top stock market sectors to consider for the year as GDP growth accelerates.

Energy

The energy sector has been another underperformer last year. I expect a reversal in sentiment for 2021.

Oil is already trading above $50 per barrel and with growth revival globally, oil is likely to trend higher. The International Monetary Fund expects the global economy to expand by 5.2% for the current year after a 4.4% contraction in 2020.

With the Biden administration now in the White House, focus will remain on clean energy. However, it’s too early to believe that the conventional energy sector will underperform. OPEC believes that oil demand will plateau in late 2030s. It’s also a good strategy is to consider exposure to oil and gas companies that are increasingly investing in green energy.

As an example, BP (BP) plans to “increase its investment in low-carbon energy 10-fold to $5 billion a year by 2030.” In the last 12 months, the stock has declined by 35.4% and is attractive for exposure at current levels.

I am also bullish on Chevron (CVX). The company has a strong balance sheet, robust liquidity buffer and an attractive break-even. As oil trends higher, I expect EBITDA margin expansion and cash flow upside in the coming quarters.

Technology

Within the automobile industry, electric vehicles are pushing the technology sector higher. Tech stocks have been in limelight last year and I expect EVs to remain a key investment theme for the year.

A key reason is the push for clean energy, which is likely to translate into sustained industry tailwinds. Passenger EV sales have already jumped from 450,000 in 2015 to 1.7 million units in 2020. However, this is just the tip of the iceberg. By 2030, passenger EV sales is expected to increase to 26 million.

I would admit that Tesla (TSLA) seems expensive at current levels even with the industry tailwinds. However, TSLA stock is worth buying on dips. Further, there are other interesting names that include Nio (NIO), XPeng (XPEV) and Li Auto (LI).

Specific to the United States, it’s expected that EV sales can potentially surged by 70% on a year-on-year basis. With President Joe Biden focused on clean energy, EV sales can continue to accelerate in the coming years.

Commercial EV segment stocks are also worth keeping in the radar. CIIG Merger (CIIC) and Workhorse Group (WKHS) are likely to be solid performers.

Health care

The novel coronavirus pandemic triggered renewed interest in the health care and pharmaceutical sector. Specific investment themes within the health care sector are worth considering for the portfolio.

Virtual health care has gained traction during the pandemic. Currently, 95% of large U.S. employers are covering telehealth as compared to 56% in 2016. I remain bullish on Teladoc Health (TDOC) stock, which has already surged by 170% in the last year.

Mental health is another segment within the health care sector that will remain a key investment theme. It’s estimated that mental disorder impact more than 264 million people globally. In the U.S., an increasing number of people have reported a negative impact on mental health due to “worry and stress over the coronavirus.”

Compass Pathways (CMPS) stock is worth considering in the psychedelic stocks space. After touching a high of $59 in December, CMPS stock currently trades at $44. The company is developing a psilocybin therapy for treatment-resistant depression. Currently, Phase IIb is underway with trials to be completed late this year.

Overall, there are interesting plays within the health care sector. Importantly, the sector is worth considering in the portfolio not just for the year, but for the long term.

On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

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