Which Sectors Will Be Hot in 2011? — Don’t Count on a Repeat of 2010

Which sector is going to be hot in 2011? If history is any clue, it won’t be what was hot in 2010. In fact, a look back through history tells us the leading groups in one year often become disappointments the next. Moreover, lagging sectors in one particular year often blaze bullish trails in the next.

Technology is one such example. Though the sector led the way in 2009 with a whopping +57% jump — and attracted a lot of buyers based on that strength — these stocks have actually scored in the bottom half of all sectors during 2010, trailing the market by more than a little.

Before identifying what’s waiting in the wings for 2011 though, let’s just walk through the industry ebb and flow for 2010 — using iShares’ major sector exchange-traded funds (ETFs) as a proxy to verify the premise.

For the year so far, while basic materials haven’t surprised anyone as a leading group, it has not actually been the hottest sector of 2010. That title belongs to consumer services, up +18% year-to-date. Basic materials stocks are up an average of +14% for the year, while the industrial names rank third with +13% average gains.

The basic materials names are actually seeing their second good year, though let’s face facts…. gold speculation has been and is doing the bulk of that heavy lifting. Moreover, we’ve never seen three straight years of strong leadership (nor laggardship, for that matter) from the sector. 

On the flipside, healthcare is this year’s biggest loser, and the only group of stocks in the red as of the latest look; they’re off by -2%. Financials are resting on the rung second from the bottom, and are looking at a break-even return so far. Utilities are third from last, with a mere +1% gain.

Implications? If you wanted to play the odds, it’s a pretty good bet that 2010’s biggest losers — healthcare and financial stocks — will at least be in the upper half of performers in the coming year.

Even if you’re not a sheer odds player though, the underlying fundamentals still point to those two groups as real opportunities. The trailing price-to-earnings (P/E) ratio for the S&P 500’s financial stocks is 15, right in line with the broader market’s valuation. Healthcare stocks in the S&P 500 are sporting an average P/E of 12.7. The projected (2011) P/E ratios for these two sectors are 11.2 and 11.1, respectively, which make them the two lowest-priced sectors on the board for the coming year. 

Even more, the financial stocks are forecasted to grow earnings by a hefty +34.4% next year — tops for the large cap market’s anticipated income growth of +15.3%. Healthcare companies are on pace to pump up their bottom lines by +14.1% in 2011.

If it were just the fact that these two sectors’ stocks posted undeserved dismal results in 2010 or just the fact that both groups are cheap — or even just the fact that each is greatly improving its bottom line — then investors could almost ignore them as key holdings for the coming year. But with all the planets aligning, though? Sometimes you just have to buy stocks even though everyone else is selling them at the time, trusting that value will shine through eventually.

Action to take –> As the old adage goes, nothing lasts forever. That’s true for stock trends as well, in good and bad ways. The biggest winners of 2010 — consumer services and basic materials — may have burned up most of the gas in their tanks and need a year or more to fully refuel.

And based on 2010’s results and the way things have been shaping up as the year comes to a close, 2011 could be a very good rebound year for healthcare and the financial sector. You can play this rebound with the iShares Healthcare ETF (NYSE: IYH) and the iShares Financial ETF (NYSE: IYF) serving as a proxies for the respective sectors. Factor in the earnings growth rates for each of those sectors, and the bullish argument is even stronger.