The S&P 500 is sitting in nearly the same place it was one year ago but much has changed. S&P 500 earnings for 2011 are likely to be 15% higher than for 2010 once the final numbers are tallied, hence valuations are significantly better than they were at this time one year ago. A year ago sentiment was giddy on "The David Tepper Win-Win Rally" and investors were aggressively positioned. Today, investors are scared and positioned conservatively.
One year ago investors were heavily overweight cyclical sectors while shunning utilities, healthcare and consumer staples. Cyclicals are showing large losses for 2011 while defensive groups are showing large gains. I don't believe sector positioning is as lopsided as it was a year ago but it seems investors are slightly tilted towards defensive sectors now.
Valuations are attractive and investors are positioned conservatively, which is generally a good combination for a higher market. However, there are huge imbalances in the global economy that cannot be ignored. Valuations are pricing in some turmoil as earnings would be able to miss expectations by 10% and the S&P 500 would still be reasonably priced. However, a large scale disaster is not priced in and the potential for one exists.
Heading into 2011, I was not very optimistic about the market or the economy. The giddy sentiment and global imbalances worried me. I believed the economy would slow. The economy performed as I expected but corporate profits performed much better than I could ever have imagined given a slowing economy. A combination of my bearish outlook and excellent valuations had me positioned in defensive sectors, with my largest holdings being in healthcare. Being positioned in defensive sectors made my year.
Heading into 2012, I am not very optimistic about the economy but valuations make me somewhat constructive on the market. In the early part of the year I am planning to maintain a medium sized net long posture (short term trades not included). I will be reluctant to get aggressive other than for short term trades given all the imbalances in the world economy. I still like select defensive stocks like Vodafone, given the still good valuations and slow economy. I also like certain cyclical stocks such as in software, where valuations are already pricing in a lot of pain (ORCL, CA, BMC).