5 Bottoming Stock Sectors Primed for a 2012 Bounce

NEW YORK ( TheStreet) - The best January for the Standard & Poor's 500 Index in 25 years has helped investors forget a depressing 2011, where a second half slowdown left the market flat for the year. Now, there is something more important to focus on.

The new year looks like a bottom for some of the troubled sectors in 2011, with last year's laggards turning into leaders and netting greater than 20% stock gains. Off big stock losses, it's easy to view a 2012 rally as a simple bounce from low valuations. That would miss the point.

A Friday jobs report that showed the U.S. economy added 243,000 jobs, pushing the unemployment rate to 8.3%, the lowest level since Feb. 2009 gave investors cause for cheer, but don't wait for a full economic rebound to start searching for recovery investments. Sector returns from the U.S. Large Cap Russell 1000 Index and the U.S. Small Cap Russell 2000 Index show that investors are eying some 2011 underperformers as 2012 winners.

In some bruised and battered sectors that are showing a 2012 shine recent quarterly earnings and analyst expectations of a bottoming bode well for investors, even after a January pop.

In February, the Dow Jones Industrial Average traded at its highest level since May of 2008 and the technology sector seems to breach new highs on a daily basis. Meanwhile, as of early February, U.S. companies were beating quarterly earnings estimated 60.7% of the time, with that trend improving through earnings season, according to Bespoke Investment Group data.

In Europe, a looming resolution or default by Greece hasn't been a damper on markets. Government bond yields in core countries like Italy and Spain have fallen in 2012 on stronger than expected bond auctions and the European Central Bank's long-term repurchase operation. Banks facing a capital crunch like Unicredit have been able to tap investors for much needed cash.

While the potential for a Eurozone recession, a Chinese slowdown and a bitter partisan divide in 2012 Presidential elections give investors plenty to fear, savvy traders may also want be a little bit greedy, targeting pockets of recovery.

Here's a look at some of the sectors that may be finding a bottom, along with stock picks to watch for.

For more on 2012 asset allocation themes, see Barrington Research's best stock picks for 2012 and industries to avoid.

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5. Large Cap U.S. Banks

After a mixed set of earnings results, with some like Wells Fargo ( WFC) reporting blowout earnings and others like Citigroup ( C) and Goldman Sachs ( GS) still struggling to grow sales and profit, the large-cap bank sector is filled with both landmines and undervalued stocks.

"We believe the Large Cap Banks can sustain their current price rebound due to their earnings recovery power going forward. We also estimate that our Large Cap Bank dividend yield should exceed the S&P 500 yield for the first time since the beginning of this recession and financial crisis," writes Marty Mosby of Guggenheim Securities in a February note that details an 18% price target increase for the sector. It's a signal that January stock gains aside, expectations are still high for 2012 investment gains.

As of Feb 6., the Russell 1000 Financial Services sector is up nearly 12% after posting a near 13% drop in 2011. Within the investment banking and brokerages subgroup, those gains are nearly 18% after an even sharper 8% 2011 slide.

Mosby highlights U.S. Bank ( USB), Bank of New York Mellon ( BK) and Wells Fargo ( WFC) as the banks with the largest upside to Guggenheim's price estimates, each with a potential 20%-plus gain. The banks also may be best equipped to handle twists and turns in the European debt crisis and the still fragile U.S. recovery. "We believe that even if the operating environment turns unfavorable again and investors' aversion to risk regains strength these stocks have enough momentum to still sustain a positive return to risk outlook," writes Mosby.

If macroeconomic risks to the banking sector were to stabilize, Mosby targets Bank of America ( BAC), Regions Financial ( RF), SunTrust Bank ( STI) and Zions Bancorporation ( ZION) as stocks that could double in price.

Even with a slow 2012 deals and trading start, investment banks may also be primed for a continued share price recovery after some shares were nearly halved. Prior to Tuesday's mega commodities merger with Glencore buying Xstrata for $41 billion in a deal that may net investment banks roughly $150 million in fees, advisory fees and trading volumes off by nearly 50%. But a current lull may be outdone by recovering asset prices.

"The most positive sign in the early stages of 2012, however, is improvement in asset prices," writes Goldman Sachs analyst Daniel Harris in a February note. Tighter credit spreads, investment banking backlogs and a European credit recovery may all be tailwinds. Harris favors fee earning investment banks like Morgan Stanley ( MS) over trading revenue based firms like Charles Schwab ( SCHW) and Stifel Financial ( SF).

"We note that the second half of 2011 was abysmal, so the first quarter year-over-year comparison does not need to be favorable in order for 2012 to end up materially better than 2011," writes JMP Securities analyst David Trone of investment banks in a February note.

Rising markets may not lift all banks stocks, however. Community banks may suffer from a low interest rate environment that will cut at the net interest margin they earn on deposits. In February, the Federal Reserve indicated that it will continue to keep short term interest rates through 2014, keeping the yield curve flat and cutting at a key profit center for smaller lenders.

"With a high probability of a sustained low-rate environment, which will lead to profitability erosion, upside from current valuations is limited while downside is meaningful should the economic recovery falter," writes R.W. Baird analyst Bryce Rowe in a February note. Rowe recommends a short of Bank of Hawaii ( BOH) and a long position in First PacTrust ( BANC) and The Bank of Kentucky ( BKYF).

For bank investors, Deutsche Bank analyst Matt O'Conner highlights the Federal Reserve stress test results due in mid-March, the implementation of the Volcker Rule and credit card interchange fee litigation due to go to court in September as industry catalysts.

Bank of America investors should watch for a settlement of private label mortgage securities and a resolution of similar suits with MBIA and the New York State Attorney General, while Citigroup investors should watch for an upcoming option to sell a piece of its Morgan Stanley Smith Barney stake in May, according to O'Connor. Finally, PNC Bank ( PNC) investors should watch its closing of a bank branch purchase from RBS ( RBS) and the Fed stress tests will reveal whether Regions Financial has made progress in repaying TARP funds received during the crisis.

For more on bank stocks, see 5 overbought bank stocks and why Bank of America may hit $30 .

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4. Industrial and Mining Players

With Glencore's merger with Xstrata now in the history books as the largest ever mining merger -- and by far the largest deal of the year at a $62 billion valuation -- it's certainly time for investors to re-examine whether the industrial machinery and mining sectors are still set for a upturn.

Some in the mining and machinery sectors like Martin Marietta ( MLM), Glencore and United Rentals ( URI) are moving aggressively to cut mergers that will time a continued upcycle for both industries. After an over 17% drop in the metals and minerals subsector of the Russell 1000, the industry has turned positive, posting a near 14% gain year-to-date. Meanwhile industrial machinery makers have seen a near 24% 2012 lift after a 7.5% drop last year.

Within machinery, Credit Suisse analyst Peter Chang highlights United Rentals as his sector pick because of its lack of competition in the rental of industrial equipment space after acquiring its closest competitor RSC Holdings ( RRR) in January.

"As the largest rental company in the space (poised to get larger once the RSC Holdings deal is completed), we remain bullish on URI. If we are on the cusp of an upcycle, then multiples for the rental space should begin to expand," writes Chang in a February note. With a sustained recovery, United Rentals valuation could rise to historic multiples above 5 times earnings before interest, taxes, depreciation and amortization from present 4.6 times EBITDA levels.

For those looking to own machinery sales instead of profiting from a recovery in the rental market, Goldman Sachs recommends like blue-chip players like Caterpillar ( CAT), Joy Global ( JOY) and Cummins ( CMI), citing exposure to markets that are in the early phases of a recovery, which could lead to a boost of 11.5 times 2012 earnings valuations and overall dividends.

The firm also recommends selling Oshkosh ( OSK) on slowing government orders. "US Machinery demand is accelerating ahead of expectations, particularly for construction equipment, trucks, and power generation," writes Goldman Sachs analyst Jerry Revich in a February note.

Separately, Goldman Sachs also highlights better than expected U.S. economic data like ISM readings, payrolls reports and auto sales as pointing to stronger industrial machinery demand. "Despite year-to-date outperformance for cyclicals, we continue to see compelling risk-reward in large cap Machinery," adds Revich.

Bullishness in industrial machinery carries over to a key mining end market, which may continue to be bolstered by rising commodity prices such as copper. "While a bullish thesis on copper has become more consensus than it was several years ago, we believe plenty of skepticism still exists," writes Peter Ward of Jefferies in a February note. "Presuming consensus GDP forecasts are correct, with an inelastic demand curve, we expect high copper prices to be sustained for the next several years," adds Ward.

Jefferies anoints Freeport-McMoRan ( FCX) as its top mining pick on greenfield mining projects that will require less capital expenditure and generate more free cash flow than its peers. That industry leading cash generation ability will likely flow back to shareholders through regular and special dividends, according to Ward. For other metals and mining stocks, Ward points to a cyclical recovery in construction and steel demand as a boost to commodity producers, even if scrap prices underperform.

For more on United Rentals, see 6 small cap stocks that may rise of to 82%. For more on Freeport-McMoRan, see 10 stocks JPMorgan says may rise up to 58% .

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3. Media

With plunging newspaper stock prices and the biggest decline in box office receipts in a generation in 2011, traditional media has been a hard sector to invest in, just as social media companies like Facebook and LinkedIn ( LNKD) dominate the headlines.

However, a surge in 2012 movie viewing and strong network T.V. results coupled with expectations of pay wall-based revenue gains from news media firms augurs well for the media and entertainment industry.

Overall, the Russell 2000 Small Cap media subsector has gained over 13% in 2012 after shedding nearly 20% last year. While the Russell 1000 Large Cap media subsector posted an impressive 8%-plus stock gain in 2011, the group is off to a faster 2012 start.

Box office receipts are up 13.5% year-to-date according to calculations compiled by BMO Capital Markets analysts, boosted by strong opening weekends for movies like The Grey, Chronicle and The Woman in Black. Overall, the firm rates large cap players like Disney ( DIS) and Time Warner ( TWX) as an "outperform," based in part on an expectation that box office receipts will grow up to 5% after a drop in 2011 movie attendance and DVD sales.

While Evercore Partners analyst Alan Gould cut Time Warner's earnings-per-share expectations by 7 cents in February ahead of the company's Wednesday earnings, he expects that management will be talking about sales growth nearing 10% for coming quarters. Meanwhile, the company's 2.5% dividend yield steadily climbed in 2011, with expectations that momentum won't slow. "We would not be surprised with a similar raise this year bringing the dividend to $1.04 per share, or a 2.8% yield," writes Gould.

Time Warner shares have gained over 5% in 2011, adding to an over 20% recovery from August lows.

At the New York Times ( NYT), falling fourth quarter profits overshadowed improvement in the newspapers' key businesses; its print subscriptions and online revenue. In 2011, the company ended its long-standing policy of giving away content online by putting up a pay wall, and revenue benefits are starting to show.

While overall revenue and profits fell, Web ad revenue grew and the company added 66,000 digital subscribers. That progress was dimmed by an over 25% drop in the company's revenue from About.com and a large decline at The Globe newspapers. Nevertheless, analysts are optimistic that the business model is stabilizing.

"We expect the NYT.com paywall to add $85 mm in revenue in 2012. This, coupled with recent print price increases (home delivery/newsstand) should benefit NYT Media circulation revenues," writes Evercore Partners analyst Douglas Arthur in a February note. While the Times enters year two of its pay wall strategy, risks like rising costs and the ever-competitive media arena persist.

In addition, the recent retirement of former Chief Executive Janet Robinson gives the company uncertain management in the interim. Company Chairman Arthur Sulzberger Jr. will step in as CEO until the company finishes an external search for a replacement.

For more on media stocks see, 10 risky media stocks and the highest yielding media stocks .

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2. Alternative Energy

The sun didn't shine on the solar industry in 2011, with many stocks falling by more than 50% and other large industry players falling into bankruptcy, with dim prospects of ever reemerging. However, even sector bears have changed their tune in 2012, as short-term pricing pressures wane - leading many industry titans like First Solar ( FSLR), SunPower ( SPWRA) and Suntech ( STP) sharply higher.

The moves followed December investments by Berkshire Hathaway ( BRK.A) -owned MidAmerican Energy in large-scale solar plants being constructed by First Solar. Investment in the developments, called the Agua Caliente and Topaz solar projects, signaled that there was a buyer for plants that broke ground in the fall of 2011.

In January, Deutsche Bank analyst Vishal Shah said that solar stocks may have fallen too low given a reasonable demand forecast and a lessening inventory overhang.

"Although we expect solar companies to report losses during the upcoming Q4 earnings reports, we note that street estimates are already low and confirmation of the above trends could likely drive upside sentiment surprise," wrote Shah. Trina Solar ( TSL) and Yingli Green Energy ( YGE) are the biggest beneficiaries from a better macroeconomic environment, according to Shah.

Those companies have since gained significantly, but other industry watchers say there is still plenty of value left in the sector.

Alternative energy shares in the Russell 2000 Small Cap Index fell over 58% in 2011, however they've turned a strong 8.7% gain so far this year.

"In the face of growing consensus for global solar demand to be flat-to-down Y/Y in 2012, we expect an upside surprise to 30 gigawatts ," writes Aaron Chew of the Maxim Group in a January research note.

After raising 2011 and 2012 solar demand estimates by roughly 10% in February, Credit Suisse analyst Satya Kumar recommended Trina Solar and Yingli Green Energy as benefitting from strong brands and low costs, while still attractively valued at a 0.6 times their book values.

Nevertheless, risks remain. Germany could impose a cap on solar subsidies that gave a lift to overall demand. Meanwhile a brewing trade war between the U.S. and China could lead to tariffs that would be a hit to Chinese solar producers.

With still low natural gas prices and falling subsidies in Europe and the United States, wade carefully into solar even if the sector's prospects have brightened from near record pessimism.

See the 5 stocks JPMorgan warns to absolutely avoid and Al Gore generation investment management for more on the U.S. solar industry.

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1. Auto

"It's halftime America and our second half is about to begin," said Clint Eastwood in a memorable Chrysler commercial was featured at the midpoint of Sunday's Super Bowl that was a ringing exclamation of the U.S. auto industry's recovery.

While record profits at once-bankrupt U.S. auto titans like General Motors ( GM) may boost the re-election chances of President Obama, they've not helped the world's largest automaker win votes from the investor community.

Since a blockbuster Nov. 2010 IPO, General Motor's shares are off by nearly a quarter - the company's stock lost over 40% in 2011. However, Eastwood's gritty halftime call and U.S. auto sales figures signal that 2012 may mark a full turnaround for the sector.

Overall, auto manufacturers and the industry's parts suppliers shed over 24% in the Russell 1000 Large Cap Index and over 36% in the Russell Small Cap Index in 2011. Those losses have turned to 17% and 27% gains, respectively in 2012, as investors jump into the sector as it retakes the global sales lead.

In January, U.S. auto sales of 14.1 million at a seasonally adjusted rate was the highest post-crisis recording, with the continued strengthening of GM and Ford ( F), supplemented by the return of Japanese automakers like Toyota Motors ( TM) and Honda Motors ( HMC) after a post-tsunami production slowdown. While both U.S. titans lost share in the month to Fiat-owned Chrysler, Mazda and Volkswagen, Sterne Agee analyst Michael P. Ward rates both companies a "buy" in a February research note.

With first quarter U.S. auto production set to rise 12% year-over, R.W. Baird analyst David Leiker writes in a February research note that the Chevrolet Cruze, the Chrysler-owned Jeep Grand Cherokee and the Ford Escape will be three-month winners. Models losing ground will be the Honda Accord, the Toyota Rav4 and the Chevy Impala, according to Ward.

Demand for new auto's is set to push GM and Ford to record sales and profit in 2012 according to consensus Wall Street estimates, signaling a further recovery from the financial crisis and a pullback in large consumer purchases. Already, historically low inventories point for strong demand in the face of production increases. Inventories at Ford and GM were 13 and 9 days below their decade averages, according to UBS analyst Denny Galindo. He reiterated his "buy" rating for both automakers citing "attractive valuations."

Meanwhile, the average age of the US vehicle fleet at the end of 2011 reached a record 10.8 years. For cars the average age in service increased to 11.1 years. Industry analysts are now expecting a combined 13.9 million new vehicles (automobiles plus trucks) to be sold in 2012, a 10% year-over-year increase.

In the auto parts space, Morgan Stanley analyst David Gober recommends O'Reilly Automotive ( ORLY), while Citigroup analyst Itay Michaeli recommends American Axle ( AXL), citing double digit sales growth and limited European exposure.

In January, private equity firm The Gores Group bought Pep Boys ( PBY) for $1 billion of $15 a share, signaling that some savvy investors are interested in getting into the auto's sector ahead of a continued recovery. Also in January, Robert Bosch bought the automotive aftermarket diagnostics division of SPW Corp ( SPX) for $1.15 billion.

For more on autos, see 2012 Super Bowl stocks and stocks for the coming replacement cycle .

>>To see these stocks in action, visit the Stocks in Bottoming Sectors Primed for a 2012 Bounce portfolio on Stockpickr.

-- Written by Antoine Gara in New York

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