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A Stock-Pickers' Market for 2016? Learn to Hone Your Selection Skill

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December 29, 2015
Hand-picking stocks and sectors for 2016

As the S&P 500 (SPX) looks ready to close 2015 barely changed from where it started the year, it begs the question: Could 2016 be a year for stock pickers? A cloudy macroeconomic picture and the age of the stock market’s current run could push investors into a careful, sector-by-sector—even name-by-name—approach.

The overall economic environment remains generally positive, with moderate U.S. GDP and historically low levels of inflation, but some analysts warn that the aging bull market in equities (eyeing its seventh birthday in March 2016) could be showing some wrinkles.

"This is not the best backdrop as we move into the New Year,” warns Patrick O'Hare, chief market analyst at Briefing.com. “We are seeing narrow market leadership, increased geopolitical stress, and valuations that are stretched. I'm not looking for much potential return in the market in 2016. I think it could be a sloppy year that will lend itself to being a stock-pickers’ market. People won't be as willing to pay up at any price” as they were when many wanted to ride the bull market no matter what the cost of entry.

Top-Down Approach

This time of year tends to lead many investors to review their portfolios, and one approach that some investors consider is sector selection starting with "top-down" stock analysis.

How’s it work? "Assess your overall opinion on the market, then pick your sectors. Next, identify stocks within those sectors under the theory that a rising tide tends to lift all boats," says JJ Kinahan, chief market strategist at TD Ameritrade. "It's time to get ready for 2016. You should be doing this exercise regularly—at least quarterly, if not monthly.”

TD Ameritrade clients can use the Trade Architect® Heat Map function to view a picture of S&P 500 sector activity (figure 1). 

Heat Map from Trade Architect

FIGURE 1: CHECK THE TEMPERATURE.

Log in to www.tdameritrade.com > Trade > Trading Platforms > Trade Architect. On the right-hand side of the screen, click “Trade Architect” under “Platform Launcher.” Once Trade Architect has opened, go to Idea > Heat Map. Double-click on any of the listed indices to view its respective heat map and select the time frame you’d like to see. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

Here are three sectors that Briefing.com's O'Hare suggests could draw increased scrutiny in 2016 thanks to shifting fundamentals.

Financials

The financial sector includes major money center banks as well as smaller regional banks. The sector also includes consumer finance companies, investment banking, brokerages, and real estate services firms. Within the financial sector, banks could see some tailwind in a rising interest rate environment courtesy of the Fed in 2016.  

"In a stronger economy, banks typically lend more. Also, banks will be quicker to raise their loan rates than deposit rates, so their profits markets should increase," O'Hare says.

Information Technology

IT includes industries from application software to communications equipment to semiconductors and even social media. 

Expected stronger earnings growth could be a boon to information technology in 2016, and the cash-flush sector isn't burdened by high debt levels relative to other sectors, notes O'Hare.

Consumer Discretionary

If the U.S. economy continues to gain momentum, with stronger levels of employment, rising wages, and still-low energy prices, it could help drive higher levels of consumer spending in discretionary areas, O'Hare says. "Government economic data shows that consumers have spent the last seven years paying down debt,” he says. “There could be pent-up spending potential." 

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