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5 stock sectors to avoid in 2004
They were hot in 2003, but home builders, regional banks, Internet stocks, biotech and anything defensive appear likely to underperform this year. Here's why.
By Robert Walberg
After enjoying a nice break over the holidays, I spent the last several days trying to get caught up on the markets. What I found were the usual predictions for 2004 about the direction of interest rates, the growth rate of the economy, the percentage gain/loss for the Dow Jones Industrial Average ($INDU), where oil and gold prices are headed and the 10 stocks one must own now.
Given that this is a presidential election year, analysts also felt compelled to show off their political acumen. In case youre wondering, the Street is predicting Bush in a landslide.
However, if the last several years in the market taught us anything, it was that knowing what one shouldnt own is just as important as knowing what one should. And on this front, there wasnt much information to be had. So instead of offering up another article on where the market is headed and which stocks are best positioned for gains, Im going to focus my predictions on the groups and stocks to avoid in 2004.
Home builders will slow
Lets begin with the obvious: home construction. Interest rates have trended steadily lower over the past few years, triggering a boom in the housing sector. Home construction stocks such as Centex (CTX, news, msgs), Lennar (LEN, news, msgs), Ryland Group (RYL, news, msgs) and Toll Brothers (TOL, news, msgs) have consistently been among the markets best performers during this period. But in the last few weeks, these stocks have begun to lose ground amid growing concerns that the strengthening economy will force the Federal Reserve to begin raising interest rates in 2004.
Whether you think rates are going up by 50, 100 or 200 basis points over the next several months is largely irrelevant. What is relevant is that institutional investors are betting on higher rates and pulling out of the housing sector, as suggested by volume and price action.
So even though the group is expected to post another year of solid earnings gains, dont expect another year of strong prices. The stocks have already priced in the positive earnings outlook for the first half of this year; what we will begin to see more clearly in the weeks ahead from the sectors deteriorating price performance is that the market believes the best days are finally behind the group. Other home construction stocks to avoid include Beazer Homes USA (BZH, news, msgs), D.R. Horton (DHI, news, msgs) and Pulte Homes (PHM, news, msgs).
More on 2004s economic outlook
Small banks could get hit
Regional banks are another group likely to feel the pinch from higher interest rates and a slowdown in housing activity. Weve already seen a couple of pretty big breakdowns in this industry, the most notable being Washington Mutual (WM, news, msgs). However, other financial stocks tied to the recent surge in mortgage activity are likely to underperform this year. They include Wells Fargo (WFC, news, msgs), National City (NCC, news, msgs), Fifth Third Bancorp (FITB, news, msgs) and Countrywide Financial (CFC, news, msgs).
Furniture and home improvement stocks could also suffer from a slowdown in the housing sector. Consequently, investors want to think twice before chasing last years winners such as Home Depot (HD, news, msgs), Lowe's (LOW, news, msgs), Masco (MAS, news, msgs) and Ethan Allen Interiors (ETH, news, msgs).
Beware the Internet
Moving away from the housing sector, investors should also be leery of the Internet group.
Stocks tied to the Net have generally performed extremely well over the last 12 to 18 months. Soft earnings comparisons and increased institutional participation have been two big factors behind the groups gains.
However, as we move into 2004, the comparison periods will become more challenging. Thats potentially bad news for a group that is priced for near-perfection. Take Yahoo! (YHOO, news, msgs), for example. The stock trades at 85 times projected earnings and nearly 12 times estimated sales. Any disappointment in results and the institutional investors that helped propel the stock to such dizzying heights will waste little time heading for the exits.
Yahoo is not the only Net-related stock sporting a questionable valuation. Amazon.com (AMZN, news, msgs), CNET Networks (CNET, news, msgs), Ask Jeeves (ASKJ, news, msgs), eBay (EBAY, news, msgs) and DoubleClick (DCLK, news, msgs) are also trading at unforgiving earnings multiples.
Bugging out of biotech
Another aggressive growth industry that will have difficulty matching last years performance is biotech. As investors grew more comfortable taking on risks in the market, biotech stocks enjoyed a nice resurgence. But prices outran sales and earnings gains, leaving the sector richly priced.
With the Amex Biotechnology Index ($BTK.X) bumping up against stubborn resistance, several leadership components such as Genentech (DNA, news, msgs), Millennium Pharmaceuticals (MLNM, news, msgs), Protein Design Labs (PDLI, news, msgs) and Applera's Celera Genomics Group (CRA, news, msgs) trading at outrageous valuations, and the pace of collaborative funding from big pharma still in question, there are simply too many potential potholes for this investor.
Thats not to say there arent a few stocks here to like for the long-term. But if youre looking to position your portfolio for maximum gains in 2004, you probably want to underweight biotechnology.
Who'll bother playing defense?
In a year in which the economy is predicted to experience strong growth and earnings for the S&P 500 ($INX) are expected to jump by more than 12%, it's only natural to think investors will shy away from defensive areas such as food, beverages and tobacco.
Consequently, investors would be advised to reduce exposure in these areas -- especially early in the year. A few stocks that jump out as vulnerable to sizeable pullbacks, or at least modest underperformance, are R.J. Reynolds Tobacco Holdings (RJR, news, msgs), Altria Group (MO, news, msgs), Anheuser-Busch (BUD, news, msgs), Robert Mondavi (MOND, news, msgs) and Whole Foods Market (WFMI, news, msgs). Intense competition, relatively thin margins, rising sin taxes, legal hurdles and lofty valuations are just some of the reasons these particular stocks are apt to struggle to keep pace in 2004.
The key to successful investing is not only finding winners but also avoiding big losers. Hopefully, these ideas will help you make some wise adjustments to your portfolio and enjoy another year of double-digit gains.
Editor's Note: At the time of publication, Robert Walberg did not own or control shares in any of the stocks mentioned in this column.
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