Bruised sectors may draw buyers

Investors placing their bets for 2012 are faced with the classic dilemma: Stick with market sectors that performed best last year or search for value in beaten-down names?

The question is especially tricky considering that 2011 was a turbulent ride of mixed economic news at home, worse news abroad and painful sell-offs that tested even seasoned traders. Investors’ reaction was textbook -- dive into stock mutual funds stuffed with big, dividend-paying companies known for relative stability in good times and bad.

That meant top-performing funds focused on utilities, consumer staples and healthcare companies. Meanwhile, mutual funds heavy on financial stocks were among the worst, sideswiped by Standard & Poor’s downgrade of the U.S. credit rating and continued financial turmoil in Europe.

With the U.S. economy showing more signs of strength, now might be a good time to move some money into depressed sectors.

“The classic strategy is to reduce holdings in areas that have done well and have become very crowded, and to rotate to areas that have few friends now,” said David Dietze, chief investment strategist at Point View Financial Services in New Jersey. “It’s smart to rebalance a little bit in those directions.”

But is that strategy a good policy for personal investing in 2012? Here’s a look at the sectors that analysts are watching:

Financials flop

Mutual funds that focus on banks and brokerages are certainly trading at prices well below a year ago, but many analysts are not yet ready to jump in.

The S&P; 500 financials were crushed in 2011, falling 18% amid Europe’s tumult and lingering trouble in the battered real estate industry. In fact, Bank of America Corp. fell 58% to earn the distinction as the single worst performing stock in the entire index.

Not surprisingly, mutual funds that are heavy in financials got battered last year. ProFunds’ Financials UltraSector fell 24%, State Street Global Advisors’ financial sector ETF was down 18% and Schwab’s Financial Services Fund dropped 14%.

Analysts say the banking industry remains under pressure, especially with no sign that the European debt crisis is ready to let up. There are a number of reasons to be concerned about the sector.

“You’ve got other factors, like regulation, Dodd-Frank, that are crimping the way large banks do business,” said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. He also pointed out that low interest rates hamper the sector. “Banks can’t make money from the deposits they’ve been accumulating.”

Defensive moves

With the state of the global economy in doubt, as it was for much of the year, investors flocked to defensive stocks: companies that produce things people buy whether or not the economy is thriving -- food, beverages, cigarettes, energy and healthcare. Utilities were the top-performing sector in the S&P; 500, gaining nearly 15%. Consumer staples jumped 10.5%.

Many of the year’s top-performing funds focused on the utilities sector, including top-ranked ProFunds Utilities UltraSector that returned nearly 26%.

Some experts say defensive sectors such as utilities and consumer staples now are a little too expensive.

“We think people are going to rotate out of some of those defensive names because the economy is starting to do better,” said Brad Sorensen, director of market and sector analysis for Charles Schwab. “Investors will be looking for a little more growth as the economy seems to be stabilizing and the employment rate improves.”

Healthcare stocks remain promising despite last year’s run-up, several analysts said.

“We generally like two ingredients, sectors that are relatively cheap and have some momentum,” Ablin said. “The No. 1 sector in that space right now is healthcare.”

That’s because even after a 10% gain for the S&P; healthcare stocks in 2011, the sector is still far below historic highs, he said. And even with uncertainty in Washington about the future of healthcare, an aging population will increasingly need medical care.

“It is cheap and it’s starting to gain some strength,” Ablin said.

Technology boost

An anticipated jump in business spending may make technology -- a flat sector last year -- a good bet in 2012.

Since the financial crisis in 2008, corporations across the globe dialed back spending and instead sat on their cash. This might be exactly the time where companies begin to replace aging computers and other technology, especially with the U.S. economy looking a bit more bright.

“We think the technology spending cycle is going to be relatively robust, in part because technology spending was so restrained in the 2000s,” said Barry Knapp, market strategist at Barclays Capital in New York.

Tech stocks in the S&P; 500 inched up just 1.3% overall in 2011, leaving the sector a “fair value,” Ablin said. Zacks Investment Research rates MFS Technology Fund a strong buy. The fund, heavily weighted in tech giants Apple, Google, Oracle and EMC Corp., gained 1.2% last year.

Small-caps slide

Small-company stocks performed poorly in part because they started the year at near-record highs. Investors tend to sell off small-cap stocks during turbulent times, ducking volatility for the safety of larger companies. That pushed the Russell 2,000 index of smaller companies down 5.5% last year.

“In a year when people were really reining in their risk-taking, small caps are going to end up getting the short end of that stick,” Ablin said.

“The only area where small-caps outperformed large was in the financial sectors. The bigger you were in the financials, the worst things got.”

Meanwhile, anyone who had significant exposure to emerging markets or Europe felt some pain. The popular iShares MSCI Emerging Markets exchange-traded index fund fell 20% last year.

The downturn was largely related to China, where stocks were hammered on concerns about inflation and Beijing’s monetary policies. T. Rowe Price’s European Stock Fund was down 12%.

Last year’s losses make emerging markets appealing again, Ablin said.

“For the first time in two, three years emerging markets are actually trading at discounts to the U.S.,” he said. “They got hammered last year and they’re starting to look relatively cheap.”

Schwab’s Sorensen said he is also high on emerging markets, in part because inflation -- especially the cost of food -- is starting to stabilize. That gives consumers around the world “a little more spending power,” he said.

“We think the environment is improving for emerging markets and investors who got out due to the underperformance may want to start adding positions there if they’re looking to the longer term,” Sorensen said.

Hold the gold

Investors looking to balance their stock investments made big profits last year in precious metals. GLD, the popular ETF that tracks the price of gold, gained 10% on the year.

Jacob Gold, a financial planner in Scottsdale, Ariz., said he discourages investors from chasing gold.

“I always tell people when you start to see infomercials about anything the ship maybe has already sailed,” said Gold, who runs boutique firm Gold & Associates.

“For the most part, our clients still have faith in the [stock] market long-term. They just want enough hedging in their portfolios that they don’t open the door to another great setback like they saw in 2008,” he said.

“The best way to give them that is a portfolio that includes corporate bonds, government bonds, municipal bonds, TIPs [Treasury Inflation-Protected Securities] and having more in cash than we normally would.”

[email protected]