How Far We’ve Come in 2011

12/06/2011 11:30 am EST

Focus: MARKETS

Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, discusses what sectors have done well so far in 2011 and which ones he favors going into the end of the year.

Paul, we’re three-quarters of the way through this year. What are the dominant themes that you saw emerge?

Well, we’ve seen a great deal of volatility emerge in the markets since late summer, and one other interesting thing that we’ve noticed at Morningstar is a reversal in the market’s appetite for risk.

Earlier in the year, we saw the continuation of what you might call the "junk rally," where small caps were outperforming large caps and the growth category was beating the value category. But ever since we had this debt-ceiling debate in the late summer, those trends have basically reversed. Now we see large is actually outperforming small, all else equal, and also value is outperforming growth by a mild degree.

Also, when you look at the sectors, you see this risk off-trade. The best performing sectors year-to-date are actually health care and utilities. Clearly two areas that are very defensive, the traditional safe harbors for investors.

On the other side of the coin, the absolute worst performing sectors are those that have the most economic sensitivity—industrials, energy, and the worst of all, financials.

How about technology? Where does it come in?

That’s been more middle of the pack. It’s toward the bottom, but in technology, you do have a handful of winners like Apple (AAPL), where you have specific factors that have lifted those stocks. But still, tech in general does have that little bit of economic sensitivity, so it’s not a top performer.

What are you thinking we should look for as we go into the end of the year and the beginning of 2012?

Well, I think we’re going to be looking at the same things that we’ve been dealing with for most of the year.

All eyes are going to continue to be on Europe until they figure out the rescue fund and what the rules are going to be there. That’s something that is constantly in flux, and has never really been resolved just yet.

And then once that is resolved, we also have our own debt and deficit issues here in the United States, and we had the so-called "supercommittee"…but one thing is for sure: the situation that we have in the federal government is not going to go on forever.

As a wise man once said, “If something can’t go on forever, it won’t,” and right now we have a situation where the government is spending about 25% of GDP and only taking in about 15% in tax revenues, so that means either tax revenues have to go up or spending has to come down.

Most likely, both are going to happen, and unfortunately, both those actions are going to be a drag on long-term GDP growth.

And we do have a really short calendar. Do you think investors can hold on that long?

Yeah, I think there’s going to be a lot of continued volatility and uncertainty in the market. That said, I wouldn’t be surprised if they kick the can that much further down the road and come up with some sort of a new plan, or even the Congress scrapping the supercommittee idea altogether and just raising the debt ceiling.

Frankly, they may even wait until after the elections, because the further we get to the presidential elections, the greater the temptation is going to be to just hold up their hands and say "OK, well. we don’t want to mess with the election."

Let the voters decide.

Yep.

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