Lessons learned

After a tough year that saw a lot of volatility but little substantial movement in the overall indices, it's sometimes easy to look back and lament missed opportunities. The danger with this is that it can have the effect of impacting future decisions and while we should learn from history, it's important to look ahead when making investment decisions. As most investors will know, the stock market is considered the ultimate forward-looking indicator as prices tend to reflect market expectations for what will happen, not what has already occurred.

As we glance in the rearview mirror of 2011, we are pleased with some of the decisions we made but certainly focus on the disappointments. The biggest stain on our record from last year was underestimating the staying power of the more defensive sectors through the second half of the year. While the US economy continued to expand at a greater rate than many pundits expected, which was in line with our forecast and moved us toward a more aggressive stance, investors seemed to remain hamstrung by the ongoing crisis in Europe, while also taking a hit from the debt ceiling debacle in the US. This resulted in our calls slightly underperforming the broad index in the second half of the year.

While disappointing, we believe we should learn from the events of the last 12 months, but not base our future decisions on the past. When looking at the coming months, we see indications of continued growth in the US, while the European economy may not be in as bad a shape as some feared, and central banks around the world are now largely moving toward an easing bias, away from the tightening that occurred through much of last year. As such, we continue to believe that a bent toward more cyclical sectors is the way to go in the first part of 2012.

Sector decisions

We are holding our outperform ratings on information technology and industrials, and our underperform ratings on utilities and consumer staples in the belief that investor money will start to rotate away from these groups. With information technology, we continue to like this sector despite some occasional blips due to growth scares, management shake-ups, inventory concerns, and supply chain issues, as we believe these are largely temporary issues that provide potential buying opportunities. We are slightly concerned that flooding in Thailand will impact some of the supply lines, however, but don’t believe at this point that it warrants a change to our rating. We continue to keep industrials at outperform as we believe we're seeing a modest acceleration in US economic activity that will continue and hopefully benefit the industrials sector as businesses look to invest in new equipment and put large cash balances to work.

We hold utilities at underperform as we have some concerns within the sector. With housing still struggling, the demand for utilities continues to be relatively weak, which would seem to limit growth. However, a glimmer of hope is emerging with electricity production starting to grow again. Although there could be some investor interest due to the relatively high yield offered by much of the utilities space, we don't believe it will be enough to overcome the desire of equity investors for capital appreciation potential. As such, we believe the group will underperform over the next several months.  

With consumer staples, the sector has performed relatively better than most others during the periods of decline in the market through the course of 2011. Its traditionally defensive characteristics are attractive to investors during heightened times of uncertainty. However, for now, we don't believe this performance will continue in the new year, as we believe the economy has perked up in recent months and recession fears will continue to fade.
Additionally, we are moving closer to upgrading the energy sector as global events seem to be moving in the direction of supporting that group, but we’re holding off to let developments in the Middle East and China play out a little further.

As well as the above ratings, we also continue to hold a marketperform rating on consumer discretionary, energy, financials, healthcare, materials, and telecoms.

Our recommendations can and do change quickly at times as we continually monitor economic progress and specific factors influencing individual sectors, so check back often.

Kully Samra is UK branch director of Charles Schwab