Although the U.S. economy has been battered by the recession and the stock market plunge of 2008-09, your clients should be able to breathe a little easier in 2010, which should be a relatively calm year for U.S. stocks.

Corporate profits have recovered some lost ground. In 2006, U.S. pre-tax corporate profits equalled 12% of gross domestic product. This dropped to 8% last year, but has since rallied to about 9.5%.

Furthermore, New York-based Standard & Poor’s Corp. estimates that earnings on the bellwether S&P 500 composite index will rise by 35% over estimated final earnings of 2009. Better still, the US$75.5 estimate of earnings on the index this year is 7.2% above average earnings in the “good years” of 2003-06.

S&P 500 earnings in 2010 for the consumer staples, consumer discretionary, information technology, health-care and utilities sectors are expected to be between 14% and 83% higher than the 2003-06 averages.

Although S&P is recommending market weight for most of these sectors and underweighting for utilities, the consensus of analysts is to overweight them. Because all except utilities are industries in which the Canadian market is underrepresented, this provides your clients with an opportunity for greater sector diversification.

Last year, investors in U.S. mutual funds cut their equities holdings and queued up to buy secure income from bond funds. The equities they did buy were dividend-paying stocks, especially those with above-average yields, which pushed those stocks to levels at which many appeared fully priced.

Investment advisors are now recommending that clients seeking assured income switch their focus to preferred shares from bonds, as many fear bond prices will tumble if inflation pressure builds. That is not an immediate concern, however, in light of dropping consumer and producer prices.

Another consideration is currency risk. Most economists think the Canadian dollar will remain at around parity with the U.S. dollar. (See page B4.) But investors who are nervous about the possibility of a higher C$, which would reduce returns on U.S. investments when translated into C$, should consider currency-hedged U.S. investments.

Here is a summary of analysts’ views on the 10 sectors of the S&P 500, in descending order of size, with S&P’s recommended strategic weighting:

> Information Technology. The IT sector led the way in the 2009 rally and continues to outperform the market. IT is the current era’s growth engine, so clients should be invested in it.

Computer hardware and systems software are the two largest industries in the IT sector, and both continue to rise by more than the broad market. Microsoft Corp. is a top-rated firm because of the recent launch of its Windows 7 operating system. Microsoft’s success often results in a boost for computer makers, mainly Dell Inc. and Hewlett-Packard Co.

Meanwhile, computer applications provide solutions for businesses, as they continue to look for ways to cut costs to deal with the impact of the recession. Companies benefiting from this trend include Intuit Inc. and Fiserv Inc.

Another industry in the IT sector that is worth a look is the semiconductor business, which “serves as a driver, enabler and indicator of technological progress,” says a research report from Chicago-based Zacks Investment Research Inc.

Manufacturers of cellphones and smartphones, for example, have become major consumers of semiconductors. Although semiconductor sales may have dropped by 12% in 2009, gains of 8%-10% are expected in 2010 and 2011. Intel Corp., the industry’s largest player, remains a prime investment selection — and its dividend yield is around 3%.

Google Inc., with its dominating Internet search system, is extending its array of services.

IT represents 19% of the S&P 500, which is the same strategic weighting S&P recommends for the sector.

> Financials. Underperforming the market since early 2007, this sector suffered the hardest wallop in the 2008 market crash — an 80% drop. In the inevitable “dead cat bounce,” financial stocks rebounded, doubling in seven months; but they were still 61% lower than in the 2003-06 period.

Toxic loans, as well as still unknown values and risks of suspect derivative contracts, continue to contaminate this sector. In addition, more losses are expected in commercial real estate; bank failures persist; and banks are cutting their lending, making profits by borrowing cheap (Treasury bills at near-zero yields) and lending long (buying U.S. Treasury bonds).

As a result, life insurance companies are better positioned in this environment, with MetLife Inc. and Prudential Financial Inc. being the most favoured.

@page_break@Financials represent 14.2% of the S&P 500, which is the same strategic weighting that S&P recommends for this sector.

> Health Care. Despite the political turmoil over legislating a government health insurance system, earnings in this sector are rising.

Still, some portions of this broad sector are risky in the new environment. Big pharmaceutical manufacturers have become tax targets. And with few outstanding new drugs being developed, these companies are looking to acquisitions and licensing deals to provide growth. Biotechnology companies are the favoured partners. This puts such stocks as Gilead Sciences Inc. and Biogen Idec Inc. in positive investment positions.

Hospital care companies will have a difficult time when the new health-care system is in place, but S&P suggests that Kindred Healthcare Inc. and Sun Healthcare Group Inc. will “prosper in the new environment.”

Health care represents 12.9% of the S&P 500, which is the same strategic weighting that S&P recommends for the sector.

> Energy. This sector contains the largest single industry in the U.S.: integrated oil and gas companies. They are lagging the market and, consequently, the energy subin-dex has been dropping in relative strength since January 2009. With energy so important and diverse in the Canadian market, this sector lacks appeal for diversification.

However, S&P recommends overweighting the sector, which represents 11.6% of the S&P 500.

> Consumer Staples. As a refuge in times of market stress, this sector has been outperforming the market since the autumn of 2008. The outlook is for more of the same, but with a change of emphasis.

Tobacco stocks have been downgraded by analysts, removing a consistently strong group of dividend payers from consideration. Soft drinks, one of the dozen largest industries in the S&P 500, are also receiving less emphasis from analysts’ recommendations.

High on analysts’ recommended lists are Wal-Mart Stores Inc., Target Corp. and CVS Caremark Corp. among the retailers; and General Mills Inc. among food products. A smaller food distributor, Andersons Inc., has been recommended by S&P, in part because of its strong cash-flow generation.

Consumer staples represent 11.1% of the S&P 500, which is the same strategic weighting S&P recommends for the sector.

> Industrials. This multi-industry sector’s relative strength has just reversed upward, and technical indicators have turned positive. A bullish industry is transportation. Airlines are cutting fares to bargain levels; railways have strong volumes to haul; and even truckers are feeling less pain from fuel costs than they did two years ago.

Two industries that have become stronger in the past couple of months are aerospace/defence, and industrial conglomerates; this is expected to continue. Individual stocks favoured by analysts include General Dynamics Corp., Shaw Group Inc., 3M Co., Precision Castparts Corp. and Republic Services Inc.

Industrials represent 10.9% of the S&P 500, and S&P recommends overweighting the sector.

> Consumer Discretionary. When the recession was approaching, it appeared logical that consumer discretionary stocks would drop. Instead, they outperformed the market through 2009 — and continue on that trend.

In this most diversified of sectors, movies and entertainment, cable and satellite services, and restaurants are the largest industries.

The strongest current industries, however, are Internet retailing, consumer electronics and automakers, the last of which are bouncing from their bottom. None of these industries are significantly represented in the Canadian market.

Consumer discretionary stocks represent 9.6% of the S&P 500, which is the same strategic weighting S&P recommends for the sector.

> Utilities. This sector appears to be bottoming after underperforming the market for most of 2009. The prospect of dividend growth is enhanced by the forecasted gain in earnings, which would put the sector’s earnings well above their 2003-06 average. Overlooked diversified utilities such as UGI Corp., which has favourable cash flow, have appeal.

Utilities represent 3.8% of the S&P 500, and S&P recommends underweighting the sector.

> Materials. Chemicals, fertilizers and industrial gases are the largest components in this sector. The fertilizer group is, of course, dominated by Canadian firms Potash Corp. and Agrium Inc. Favoured stocks in other industries include International Paper Co., packaging specialist Pactiv Corp., agricultural chemical and seed producer Monsanto Co. and Dow Chemical Co.

Materials represent 3.5% of the S&P 500, and S&P recommends overweighting the sector.

> Telecommunications Services. The smallest sector by market cap continues to trail the market, with modest forecasts of earnings growth. Large debt positions hamper most major companies, making them vulnerable to any retrenchment in consumer spending. As well, competition is getting tougher.

Telecom stocks represent only 3.2% of the S&P 500, and S&P recommends underweighting this sector.

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