2014 Equity Sector Investment Opportunities and Risks

Even though no one can know how equities will perform next year, it won’t stop investment professionals from speculating.

While the majority of predictions are overwhelmingly positive for next year’s market, there are naysayers who see the potential bumps in the road. Fidelity Investments highlighted its perspective on investment opportunities and risks in 2014.

Some trends Fidelity noted are the U.S. housing recovery, the growing middle-class and rising wealth in emerging markets, and isolated but improved economic indicators in Europe.

“The positive performance of the U.S. equity market in 2013 has been underpinned by compelling returns in all 10 sectors with nine out of 10 generating positive earnings growth,” said Chris Bartel, senior vice president, Global Equity Research at Fidelity Investments.

Here are the five investment sectors and the opportunities and risks that Fidelity’s team of investment professionals noted for each.

Consumer discretionary

The U.S. housing market recovery, which has been ongoing for more than a year now, is the obvious investment opportunity. While housing starts are up from 2008, they still remain well below the historical average.

While exposure to Europe was a big risk for consumer discretionary stocks a year ago, that’s not the case now. With a more favorable outlook

Today, the outlook for Europe is more favorable; the European economy may be in the early stages of a cyclical recovery based on improving economic data,” sector portfolio manager Gordon Scott wrote.

Meanwhile, the United States is a risk for the sector with the partial government shutdown eroding economic output and lowering the confidence of business and consumers. Plus, it’s unknown how the Fed’s unwinding of assets will play out in 2014.

Consumer staples

Penetration in emerging markets that have growing middle-class populations and rising wealth is promising for these stocks as consumption of products increases.

However, the emerging markets aren’t a cash cow for consumer staples as there was a cyclical economic slowdown in these countries in 2013, according to Robert Lee, portfolio manager at Fidelity.

“Going forward, investors should be mindful of the potential greater sensitivity of consumer spending in emerging markets, as further economic weakness could hinder sales and profit growth, as well as stock price appreciation for some multinational companies.” Lee wrote.

Energy

America is about to experience a crude oil boom. Many energy companies have been producing more crude oil because it’s more economical to do so with natural gas prices at historically low levels, according to John Dowd, portfolio manager at Fidelity.

Investors should look at oil producers with operations in strategic drilling locations, like those in the shale oil and natural gas field regions of Eagle Ford and Permian in Texas, Bakken in North Dakota and the Marcellus in the Appalachians.

However, faster-than-expected production of crude oil can be a risk that would put pressure on oil prices and the profits of those companies engaged in oil production.

Financial services

Electronic payments have been growing slowly for years now, but Fidelity seems to think the growth will be enough in 2014 to be a positive for financial services stocks. Not only is the younger generation supporting this, but, like with consumer staples stocks, the growing middle class in emerging markets will drive this growth.

Chris Lee, portfolio manager at Fidelity, also views regulations in this industry as an opportunity for investment.

“… new banking regulations have placed curbs on certain profitable activities previously conducted by investment banks, such as proprietary trading,” Lee wrote. “This has created opportunities for alternative asset management companies to absorb this activity. Not only have these alternatives been able to grow assets quickly, but they have also benefited from talent migration, given more attractive compensation opportunities and fewer regulatory constraints.”

Again, the Federal Reserve unwinding of its asset purchases will be a risk in 2014, as no one quite knows just yet how it will play out. Plus, while the emerging markets are playing into many investment opportunities, they are a risk since the economic growth in several of them has slowed.

Health care

Unsurprisingly, health care has many investment opportunities thanks to a large number of changes, and one very large risk because of those changes.

Some of the opportunities that remain from previous years are the full innovation pipeline, the fact that the industry is recession proof, the evolution of consumers as primary purchasers, consolidation of providers and aging populations.

“A major benefit when constructing a health care portfolio is the diversity of the industries in the health care sector,” wrote Eddie Yoon, sector portfolio manager at Fidelity. “Health care spans a wide range of industries globally, each with a unique set of opportunities.”

And yet the uncertainty about the Affordable Care Act remains a looming concern and large risk.

“In the near term there are many unknowns and challenges, not the least of which is investor uncertainty about cuts in government spending on health care,” Yoon wrote. “For the most part I am staying away from investments in managed care organizations, hospitals, and providers, and from policy-centric investments in general.”

See the remaining five sectors here.