The stock market was on fire in 2013 across the board, but the very best stocks to buy this year came from decidedly “risk on” sectors.
Consumer discretionary stocks, for instance, are up about 36% vs. a 25% gain for the S&P 500 this year — led by roughly 55% gains in e-commerce giant Amazon (AMZN) and 50% gains in coffee king Starbucks (SBUX). Investors thought these plays were the best stocks to buy earlier this year on hopes of a recovery in consumer spending and lower unemployment — and they have been right.
On the other hand, sleepy sectors like utilities and telecoms have lagged. The Utilities SPDR (XLU), for instance, is up only 9% on the year. That’s partly because these low-risk sectors were bid up during more rocky periods for the market in the past few years, so valuations are stretched right now. But it’s also because investors were on the offensive instead of on the defensive in 2013.
So where can investors find the best stocks to buy in 2014? Typically the sectors that lead one year do not lead the next … so where is the money going to go?
Here are three sectors to watch in the new year that may attract the most cash and boast the best stocks to buy in 2014.
Best Sector #1: Energy Stocks
The energy sector hasn’t performed all that great since the financial crisis, thanks to soft prices for commodities like oil and natural gas, as well as weak demand.
But upbeat economic indicators could change the demand picture big-time in 2014, so energy plays could be the best stocks to buy in the new year.
Upbeat job news continues in the U.S., with a sharp dip in unemployment to 7% in November on better-than-expected job creation. Not only is this news great on its face, but the details show even more momentum considering it illustrates strength for the labor market even across the disruptions of a government shutdown.
Furthermore, we just learned U.S. GDP grew at a 3.6% rate in Q3. While some of this was indeed due to inventory growth, the better-than-expected pace here is also encouraging.
Energy is a very cyclical sector, and stocks in this area of the market have largely sat out the rally. Take oil major Exxon Mobil (XOM), which is up just around 10% year-to-date in 2013, as one example.
However, improving demand could boost both total consumption as well as prices in 2014.
If you believe in a cyclical recovery taking shape in 2014 and into 2015, now is the time to get into energy — particularly if you like the dividend potential of stocks like XOM, which pays a 2.7% yield and has increased its payouts for 31 consecutive years.
Best Sector #2: Materials Stocks
Beyond energy, materials might also offer potential in 2014 as a cyclical play.
Some claim that we at the mercy of a commodities “super cycle” that will mean nothing but pain for metals, energy and agricultural commodities. But after materials stocks have taken a pounding in the last few years, it’s hard to argue there’s much more room for declines.
According to financial data provider FinViz, as a group, basic materials stocks are the only core sector of the S&P 500 that currently trades for a price-to-sales ratio of less than 1. Also, forward earnings estimates show materials stocks trading on average for a current P/E of about 14.7 — the second-lowest sector in the S&P — and a forward P/E of 13.1. That’s much less than the broader market’s average, and if you’re concerned about overstretched valuations in a sector like tech than it’s worth looking at how “cheap” materials stocks are.
Some I’m watching include base metals stocks like Alcoa (AA) and Southern Copper (SCCO), but also chemicals companies like Huntsman (HUN) and DuPont (DD).
One big risk, of course, is that the dollar will remain strong and keep commodity prices soft. And the idea of “tapering” at the Fed surely will keep a floor under the greenback in 2014.
But given how long the sector has sat out and the recent strength in materials, there’s momentum as we enter 2014. Just look at the 14% gains for the Materials SPDR (XLB) since July vs. 11% gains for the S&P 500 as proof that this late-blooming sector is looking good right now.
Best Sector #3: Healthcare Stocks
Healthcare stocks took off in 2013, in large part due to anticipation of the Affordable Care Act (aka Obamacare) opening up new “customers” to many healthcare providers. As a result, the Health Care SPDR (XLV) exploded by about 37% — dramatically outpacing even the impressive 25% gains for the S&P 500.
But don’t think healthcare will be cooling off in 2014. The fact is that Obamacare hasn’t rolled out in full force and has experienced some delays in implementation. Furthermore, the demographic pressures from the baby boomer population will continue to create more demand for prescription drugs, medical devices and other treatments as the American population ages.
Two of my favorite plays in healthcare for 2014 include senior housing REITs, which pay big dividends, and funds that play smaller biotech stocks that could pop big on a buyout or the creation of a blockbuster medication.
The lower-risk value play is senior housing REITs. If you like this route, take a look at Senior Housing Properties Trust (SNH), Ventas (VTR) or Health Care REIT (HCN). All have posted losses in 2013, but their day might come in 2014 — and all pay dividends between 4.7% and of 6.9%.
The growth play is biotech. It’s risky, since stocks that fail to get FDA approval for their treatments could crash and burn, but you can mitigate your risk with broad funds like the iShares NASDAQ Biotechnology ETF (IBB) or the SPDR S&P Biotech ETF (XBI) that cast a wide net. Those funds are up 61% and 46%, respectively, in 2013, so they are a bit frothy, but the potential is still big, and every year you can count on a couple biotechs earning their place as the best stocks to buy.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not own a position in any of the stocks named here. Write him at email@example.com or follow him on Twitter via @JeffReevesIP.