Summer Shifts

Although summer tends to be a slower time for the market, we believe it can also be a time to make some tactical shifts to your sector allocations in order to attempt to take advantage of the changing economic environment. As we've been noting in various Schwab publications, we believe the downbeat economic data seen over the past couple of months is largely due to temporary factors, and that the second half of the year was setting up for a potential market rally. We've seen some glimmers of that recently as the market rallied roughly 6-7 per cent off of the recent lows we saw in June, before pulling back on renewed debt and economic skittishness. Despite this volatility, we believe it’s time to start to shift to a more aggressive sector stance to attempt to take advantage of a decrease in risk aversion.

While we may continue to see some sideways trading and some brief pullbacks, we think the slightly defensive stance we took in May has served its purpose but is now time to be changes. As we've explained, sectors tend to move due to both 'bottom up' factors—specific issues influencing specific areas of the economy, they also are heavily influenced by "top down" factors. As business cycles develop and economic conditions change, investors tend to move toward sectors that typically benefit from the overall environment. For example, during times of economic slowing, defensive sectors such as health care and utilities tend to do better as people need electricity and medical care no matter what the economy is doing. Conversely, more economically sensitive sectors, such as consumer discretionary and materials, tend to do better during times of economic expansion as businesses look to invest and grow and consumers look to spend as they feel more confident in their prospects.

It is that latter point that we think we are about to embark on and our changes reflect that. In order to take the first steps toward a more cyclical view, we are upgrading our views on consumer discretionary and materials back to marketperform, while also boosting our rating of the industrials sector to outperform. We have moved consumer discretionary sector to market perform from underperform as part of our overall sector shift to a more aggressive strategy. The materials group has rebounded to marketperform as signs are beginning to emerge that the recent moderation in economic growth was only temporary, and that we could see an acceleration of activity in the second half of the year. Finally, the industrials sector has been moved to outperform after a period of economic moderation. We believe we'll start to see a renewed acceleration in economic activity in the second half of the year, which should benefit the sector as businesses look to invest in their equipment and put large cash balances to work.

At the same time, we are downgrading our view of the health care sector to marketperform, and moving consumer staples and utilities to underperform. The health care sector seems to be among the groups that have recently traded most closely with the shifting view of the overall economy. With our belief that we’re in store for a better second half performance, we believe it's appropriate to move our rating on the sector back to marketperform from outperform for the time being. Consumer staples have been moved from marketperform to underperform.  While this is a positive sector during tough economic times, it can also be a negative during times of improving economic conditions as consumers don't typically expand their spending on such items as the economy improves—demand stays relatively constant. In connection with our belief that we are starting to emerge from the economic soft patch and are about to see brighter days ahead, we have moved this rating down.

Finally, we believe the utilities group will underperform over the next several months. Investors typically flock to the group when economic uncertainty increases and away when growth expectations improve. We believe we're in the process of investors upgrading their economic assessments. This leaves us with technology and industrials at outperform, while utilities and consumer staples will be our underperform groups. As mentioned, making these moves would result in a portfolio that is modestly more aggressive, with a bit more potential risk but also the potential for a bit more return.

We also continue to hold a marketperform rating for energy, financials, materials and telecom. Industrials and information technology remain at outperform. Our recommendations can and do change quickly at times as we continually monitor economic progress and specific factors influencing individual sectors.

Kully Samra is UK branch director at Charles Schwab.

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