3 Down-and-Out Sectors Primed for a Big Rebound in 2014


Time certainly flies when you're having fun -- and much fun was to be had this year, with all three major market indexes returning more than 20% year to date and the S&P 500 soaring to a fresh all-time closing high yesterday following the Federal Open Market Committee's QE3 taper announcement.

To keep this joyous spirit going throughout the next couple of day leading up to Christmas, I've decided to once again count down this holiday season with my own Foolish rendition of the "12 Foolish Days of Christmas." Instead of turtle doves, French hens, and partridges invading pear trees, you'll be privy to high-growth stock ideas, game-changing innovations from a wealth of industries, unique ways to fuel your retirement account, and so on.

Over the previous nine days of our Foolish holiday kickoff, we've counted down the:

Now it's time to move the countdown lower by a notch!

"On the third day of [Foolish] Christmas, my true love gave to me..."

Three depressed sectors primed for a big rebound in 2014!
Even in the market's best years there will always be laggards, and 2013 was no exception. According to data found on Morningstar, 14 industries are underwater year to date, and dozens of others are up by less than 10%, even as each major U.S. market index has gained more than 20%. Occasionally, though, the best gains can be found by mining through the previous year's losers. Here are my three picks for sectors primed to rebound in a big way in the upcoming year.

Electric utilities
One thing you'll notice about broad-market rallies is that investors tend to be willing to take on more risk than they do in flat or downtrending markets. To that end, investors spent much of 2013 chasing riskier but faster-growing biotech and technology stocks higher while leaving traditionally defensive plays like electric utilities wallowing on the sidelines. I suspect 2014 could bring the winds of change (and optimism) back to the electric utility sector.

One of the primary draws of the utility sector is that nearly every company delivers relatively consistent cash flow because the product they produce, electricity, is considered a basic necessity. Basic necessities have inelastic demand and tend to be purchased or used in similar quantities regardless of the current economic conditions, meaning utilities always possess moderate to good pricing power.

Why I feel electric utilities could be particularly intriguing in 2014 has to do with the FOMC's announcement that it plans to begin winding down its monetary-easing stimulus program by $10 billion per month. It's widely expected that the tapering of this stimulus could cause long-term U.S. lending rates to rise, which has the effect of reducing borrowing and slowing business expansion. This slowdown could be enough to stop the near-vertical upward march in the market and get on-the-edge investors back into safe/hedge investments like electric utilities.

Two names I'd consider watching here are Entergy and Duke Energy .

Entergy certainly ranks up there as one of the cheapest electric utilities within the sector, trading at just 17% above book value and yielding an impressive 5.4% with a forward P/E of just 12. Entergy has also been a model of operating efficiency, with its human capital management overhaul expected to save the company up to $250 million annually and add around $1 in EPS by 2016.

Duke Energy is equally inexpensive at just 20% over book value, and it has made $2.5 billion worth of investments in both wind and solar energy over the past six years, which should begin paying dividends by lowering its long-term energy-generation costs. According to Duke's website, the company currently has more than 1,000 MW of generating capacity, and this figure is growing annually.

Residential REITs
You'll find that an expected rise in interest rates and a subtle slowdown in U.S. economic growth are a driving factor for all three sectors here, and residential REITs are no different.

Source: AvalonBay Communities.

Some of you are probably doing the head-scratch thing and wondering, "What's a residential REIT?" A residential REIT is simply a company that owns apartment-community properties and leases out those individual apartments. The "fancy part" -- and what makes them a REIT (real-estate investment trust) -- is that in exchange for a favorably low tax rate, these companies must return at least 90% of their profits to shareholders in the form of a dividend.

Residential REITs were left in the dust this year for many of the same reasons as electric utilities: Investors were seeking high-growth, which is something you aren't going to find with apartment communities.

The reason this sector looks so appealing in 2014 is that the expectation of higher interest rates would drive on-the-fence homeowners back into renting and raise already impressive occupancy rates. Higher interest rates also have the effect of boosting apartment communities' pricing power. We've already witnessed a 60% drop-off in mortgage loan originations because of a 100-basis-point jump in the 30-year mortgage rate earlier this year, so unless interest rates move very close to a new historic low, I doubt the spoiled U.S. consumer will fuel the homebuilding sector for much longer.

The one name I'd suggest keeping an eye on here is AvalonBay Communities , a residential REIT focused on the middle-to-upper income clientele. Through the first three quarters of the year, AvalonBay has delivered a 0.2% increase in economic occupancy rates, while rental rates have moved higher by 4.5%. Since higher rental rates lead to heftier funds from operation, Avalon has been able boost its dividend by an average of 5% over the past 13 years.

Gold and silver miners
The final grouping would normally be a sector that you'd expect to be hit when interest rates rise: gold and silver miners. The unraveling of QE3 will mean less money being pumped into the economy and a presumably smaller chance for inflation, which is what gold, and to a much smaller extent silver, feed off of. By that account alone most analysts have taken a negative view on the metals market and miners moving forward. But I feel this overlooks a few key market drivers for this sector.

Source: Mark Herpel, Flickr.

First, metals are still a tried-and-true market hedge in cases of market weakness. Although the U.S. economy has delivered considerably stronger-than-expected GDP growth in the third-quarter, only a hair over half of all S&P 500 companies managed to top Wall Street's sales expectations. In other words, even though profits are topping estimates, share buybacks and cost-cutting are doing the hard labor rather than organic sales growth. That could be a recipe for disaster for the markets and the perfect moment for metals and mining stocks to shine.

Another aspect I don't quite understand is why the market gives most sectors credit for their cost-cutting efforts, it remains oblivious to the fact that gold and silver miners are doing a phenomenal job of cutting back capital expenditures and lowering their operating expenses. Even with gold well off its highs, some miners are still chugging along well above their all-in sustaining costs.

The two names that I find most intriguing here are Yamana Gold and, once again, Silver Wheaton .

Yamana finds itself at the top of the heap in practically every gold mining comparison because of its inherently low cost-structure, aided by the sale of by-product metals. In the third-quarter, Yamana reported all-in sustaining of $730 per gold-equivalent ounce, which was a 20% reduction from just the sequential quarter! Yamana is masterful when it comes to controlling costs, and it'd take another 30% to 40% tumble in gold before I'd even worry about its mining viability.

Silver Wheaton, on the other hand, isn't a miner at all so much as a royalty interest negotiator extraordinaire. Silver Wheaton offers up cash to mining companies looking to build-out or expand a mine in exchange for the rights to purchase part, or all, of the production for a fraction of the current spot price. With all of Silver Wheaton's contracts structured over the long term, and both gold and silver needing to fall 60% or more to really put Silver Wheaton's business model in jeopardy, I'd call it a good bet to rebound in 2014.

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The article 3 Down-and-Out Sectors Primed for a Big Rebound in 2014 originally appeared on Fool.com.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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