Taking a Breath

After a month full of sector changes, it's time to take a step back and review where we are and how we got there. There is no doubt that the vast majority of economic data as of late has been at least somewhat disappointing. Talk of a possible renewed recession has started to percolate again, while some investors are again looking to the Federal Reserve to extend their current quantitative easing program, scheduled to be completed at the end of the month.

First, we want to reiterate that we do not believe we are headed for another recession in the near term and believe this downshifting of economic growth is temporary in nature and influenced heavily by one-off factors such as flooding in the US Midwest, the Japanese earthquake, and perhaps an overreaction to rising oil prices. However, we do believe uncertainty and sluggishness will continue for at least a couple of months and believe that a slightly more defensive tactical tilt to portfolios may be appropriate.

In order to achieve that goal, in the last month we have moved health care up to outperform and consumer staples up from underperform to marketperform. The health care sector has performed well lately, as the defensive, seemingly stable group appears increasingly attractive to investors concerned about the economic environment going forward. To regular readers of our views, you know that we have liked the health care sector for some time but were waiting for investor interest to return to the beaten down group to upgrade. As for the consumer staples group, with disappointing economic data dotting the landscape as of late, the traditionally defensive staples sector's performance has perked up and we recently upgraded the group to marketperform from underperform.

In contrast, we moved the more economically sensitive energy group from outperform to marketperform and materials to underperform from marketperform. With global economic growth moderating, at least temporarily, and central banks around the globe (except in the US) tightening monetary policy, these sectors may see some moderation in demand for their products. Additionally, we have seen a bit of US dollar strength as some flight-to-quality buying has occurred, which could remove the tailwind of a weaker dollar that has helped fuel some of the gains in those two sectors.

On the other hand, while the consumer has been relatively resilient in the face of increasing headwinds, we continue to believe the discretionary sector will underperform in the coming months relative to the overall market. We want to note that this does not mean we think that consumer spending is going to fall off a cliff, but that there are challenges that we believe will weigh on the sector in the near term.

These changes, combined with our continued outperform rating on the technology sector and underperform rating on the consumer discretionary sector, leave us with an overall portfolio construction that is tilted a bit toward the defensive side. At this point, we don’t believe there’s a reason to overreact and move to an even more defensive stance, and would guess that our next move may be to a more aggressive stance. However, only time will tell.

We also continue to hold a marketperform rating for financials, industrials and telecoms. Info technology remains at outperform and utilities remains at marketperform. Our recommendations can and do change quickly at times as we continually monitor economic progress and specific factors influencing individual sectors.

Kully Samra, UK branch director at Charles Schwab, gives his views on the US market.

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