Two safe stocks for 2010

The next 12 months won't see markets making the gains they made in 2009, but there will always be opportunities. Theo Casey looks at what to avoid and what to buy, including two stocks from his favourite sector.

I don't usually pay any mind to what the City has to say, but I've just received a great research note on what each of the major investment banks has predicted for 2010. The views from Goldman, JP Morgan et al on the markets' next turn can be summarised like so

Stocks will rise around 9%

Oil will level at $80

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Gold will pick back up to about $1,200

And Brazil (at 11/2) will win the World Cup

Of the above, I can only agree with the Samba boys going all the way in South Africa. The rest of the forecasts look a bit too good to be true.

I think that the next 12 months will be pretty flat for financial markets. There is no easy money left to be had. Gains on the market will come from hard graft. A strict adherence to value-investing principles and a ruthless selling policy are the only way to play the game.

With that said, in a market with over 50,000 tradable investment ideas, there are always going to be opportunities. So, despite my concerns, continue to buy in this market until there is either a serious policy mistake (i.e. the Bank of England raising interest rates), or a double-dip in economic activity.

The Bank of England is expected to keep interest rates at 0.5% this week. And, as the economy has yet to pull out of recession, talk of a double-dip is moot. With both fears at bay for now, what should you be investing in?

Avoid last year's winners

Last year's roaring market rally was punctuated by the banks. There was major sector leadership from the financial firms. Indeed, some readers were critical of our reluctance to buy the banks. However, with firms like RBS and Lloyds unravelling towards the end of the year, the prudent choice was to stick on the sidelines. The outperformance of this sector will depend more on the strength of the economic recovery than government stimulus in the coming year. Given that UK plc is only just finding its feet, we can expect a few more false starts from UK banks.

If you are going to buy banks, opt for the global players HSBC (LSE: HSBA), Standard Chartered (LSE: STAN) and Barclays (LSE: BARC).

The other big movers of 2009 were the miners. The FTSE 350's resource stocks, led by the Australian contingent of Rio Tinto and BHP Billiton, gained 90.9% over the past 12 months. Unlike the banks, miners have continued to rally.

The fear is that the buyers of basic resources (i.e. China) might slow down. In particular, Chinese manufacturing has expanded so rapidly, that some are already calling for the breaks to be put on. PMI, or the Purchasing Managers Index, rose to 56.1. The measure is based on a survey of more than 400 manufacturing companies. Given that any score over 50 indicates expansion, fears are apparent that inflation pressures are building and parts of the Chinese economy could overheat this year. If China were to police its economic growth more strictly, it would be bad news for commodity markets, and, by proxy, mining stocks.

If investors are to play mining, go for the big boys BHP Billiton (LSE: BLT) and Rio Tinto (LSE: RIO).

My favourite sector for the year ahead

I really like pharmaceuticals

Large-cap pharmas such as GlaxoSmithKline (LSE: GSK) and AstraZeneca (LSE: AZN) are trading at low valuations. Particularly, in the case of AstraZeneca, at nine times next year's earnings, these stocks are cheap as chips. Markets have worried about the big players' exposure to the healthcare reform in the US. This programme is now expected to be less punishing for these large caps with US operations.

This has already begun to spur rising prices.

There's also the potential for mergers and acquisitions. It's widely expected that GSK will continue to buy in generic, rather than patent-protected global pharma companies. And Astra, with quite lacklustre stock performance in 2009, would do well to follow suit.

The sector has high yields and cheap valuations. And, crucially, drug stocks have fewer fundamental drawbacks than other defensive sectors such as oil (fluctuations in commodity prices) and tobacco (high unemployment is a particular drag in this sector).

While it's a mistake to wait on the sidelines for a correction, you should still play it safe

Double-down on defensives, and think about pharmaceuticals as your first trade of 2010.

This article was written by Theo Casey, investment director of the Fleet Street Letter , and was first published in the free daily investment email The Right Side on 4 January 2010.