Tobacco Facts.

Investors know the hot industry of one year can become the dog of the next.

The whiplash from 2008 to 2009 was especially jarring. To take one example of many: In 2008, the S&P 500 consumer electronic stocks industry index dropped 75%, but in 2009 industry shares doubled.

As investors enter a new year, they’re trying hard to predict which kind of businesses will win market favor in 2010.

Sell-side equity analysts offer their own predictions, in the form of buy, hold, and sell recommendations.

According to the most recent data from Capital IQ, the S&P 500 tobacco industry has the highest rating from analysts these days. (The rating is based on an average of all analyst recommendations on industry stocks.) Lorillard (LO), Altria Group (MO), and Phillip Morris International (PM) on average all get stellar ratings from analysts, meaning the stockpickers see the potential for price appreciation for the shares despite some substantial returns already in 2009. Lorillard and Altria outpaced the market, with 44% and 31% returns respectively, while Phillip Morris lagged the Standard & Poor’s 500-stock index’s 24% return, with an 11.5% advance.

Excluding industries consisting of only a couple of stocks, Capital IQ data show analysts also positive on: the Internet and catalog retail industry, including Amazon.com (AMZN); biotechnology, led by Gilead Sciences (GILD); electronic equipment, instruments, and components, led by Corning (GLW); and the health-care providers and services industry, which includes Express Scripts (ESRX) and McKesson (MCK).

Health-Care Hopes

Analysts’ least favorite industry is leisure equipment and products, in which a strong sell rating on Eastman Kodak (EK) brings down more mediocre ratings on Mattel (MAT) and Hasbro (HAS).

Also largely disliked by analysts are commercial banks, including M&T Bank (MTB) and Comerica (CMA); and real estate investment trusts, or REITs.

But analysts often do a better job of reflecting current thinking on Wall Street than predicting the future. For portfolio managers, the goal is to find industries that will be in favor not now, but in several months or a year.

That’s why Channing Smith, portfolio manager of the Capital Advisers Growth Fund (CIAOX) has found various health-care industries as fertile ground for investing.

The debate over health-care reform has made investors cautious. Pharmaceutical firms, for example, are worried about government efforts to cut costs, but Smith says there are positive factors, including newly insured Americans using more health care, the aging of baby boomers, and the improvement of health care in emerging markets.
“We think you’re going to have to be selective,” Smith says, but his fund owns Abbott Laboratories (ABT), which underperformed in 2009 with a return of less than 2%.

In a year full of uncertainties, several investors said they will be looking for firms and industries with steady, predictable earnings. “We think earnings visibility is going to be key,” Smith says.

Tech Trend Continues

Eric Cinnamond, portfolio manager of the Intrepid Small Cap Fund (ICMAX), thinks the stock market’s expectations for the economy in 2010 are too high. “Instead, [I'm] focused on stable companies that are not as susceptible to a letdown on the economy,” he says.

Among small-cap stocks, he likes the rent-to-own industry, where he owns both Rent-A-Center (RCII) and Aaron’s (AAN). The firms have navigated the recession well, he says, and profits should improve in 2010. The stores are some of the few places many Americans will be able to get credit, Cinnamond says.

Tech industries were stock market favorites in 2009, and many investors believe that could continue in 2010.

Roy Williams, chief executive of Prestige Wealth Management, favors information technology stocks, saying he expects firms to boost spending on IT this year. After years of cutting back on expenditures, “you’re going to have corporations spend money,” he says. “They need to.” He owns Cisco Systems (CSCO) and Oracle (ORCL), but believes smaller firms could also benefit from buyouts from larger tech firms, which have lots of cash on their balance sheets.

Another tech trend attracting attention is the increasing importance of high-speed broadband Internet. “The growth of broadband continues to be huge even during tough economic times,” says Russell Croft, manager of the Croft Value Fund (CLVFX). He owns Cisco, classified as part of the communications equipment industry, which also includes Qualcomm (QCOM) and Harris Corp. (HRS).

ETF Plays

One way for investors to play their favorite industries is by buying shares in exchange-traded funds, or ETFs. In recent years, Wall Street has created narrowly focused ETFs designed to capture particular industries, everything from aerospace and defense to the timber industry.

But there are dangers with a narrow approach, warns John Merrill, chief investment officer at Tanglewood Wealth Management. “An ETF works well if it’s [replicating] a broad-based sector or asset class,” he says. Investors should beware of ETFs with a narrow focus or consisting of less liquid investments like bonds or microcap stocks, he says.

Merrill favors tech, so he owns shares of the PowerShares QQQ (QQQQ) ETF, which replicates the performance of top large-cap tech stocks.

The market’s crazy course in 2009 amply demonstrates how difficult it is to predict what a new year holds. But, by focusing on the broad trends that will lift or sink industries, investors might find ways to make 2010 profitable.

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