Improving expectations for the economy also will change investor perspectives, likely sending them to companies that do better as the outlook improves.
AP
NYSE Traders
Evidence of sector and in particular industry rotation for the new year was quickly evident Thursday, when December sales results for big-box retailers trailed expectations while high-end stores did much better and the stocks performed accordingly.
That's likely to be part of a trend if the economic gains hold.
"This new mindset will allow investors to stretch investment horizons and focus attention on the potential value of what ultimately will be 'peak recovery cycle earnings,'" James Paulsen, chief investment strategist at Wells Capital Management, wrote in an analysis for clients.
"We recommend staying overweighted in economically sensitive stocks for another year," he added. "While most cyclical stocks have done very well in the last couple years, we still think their valuations could improve this year as confidence in the economy expands."
Consumer discretionary stocks in fact have been the market's best performer for three years running. The sector has been one of only two in the Standard & Poor's 500 that has registered gains during the period since the financial crisis began, and pulled in a whopping 25.7 percent return in 2010.
Even within that sector, the companies that appeal to bargain hunters did the best. Stalwarts like Procter & Gamble , Wal-Mart and Philip Morris were among the best performers during the sector's rise.
But the retail results showed high-end retailers such as Nordstrom and Saks posted stellar holiday sales. Family Dollar , meanwhile, has seen its shares take a beating this week after a poor earnings report Wednesday.
"A rising tide lifts all ships, and if this economy grows in that 3 to 3.5 percent range, we could see a very good US equity market," said Beth Larson, principal at Evermay Wealth Management in Washington, D.C. "Industrials should continue to do well, but consumer nondurables and technology could become the best performers."
Technology and telecom seem to be the companies most often mentioned when strategists discuss sector rotations.
But the trend also could spill over into the large-cap stocks, which underperformed even during the S&P 500's 90 percent gains since the March 2009 lows.
Small caps, as measured by the Russell 2000, rose more than 25 percent in 2010 alone, but if investors continue to gain confidence in the economy large-caps could come back into favor.
"Retail investors are going to start looking again. It's human nature to go to what they know," said Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh. "What's happening is you're getting clients looking at the brick-and-mortar companies that have truly underperformed in the last 10 years. These are the kinds of stocks they want to own—what they know and what they understand."
Hospitality is one area Baum has picked to benefit from raised economic expectations—a company such as Starwood Hotels will benefit as "the whole hospitality world is starting to turn."
To be sure, the economy remains on uncertain ground despite a fairly unfettered run of positive news over the past couple of weeks.
The level of exuberance has some advisors worried and using the time to diversify portfolios should the recovery begin to disappoint.
"Shortly we're going to run into the problem where expectations are going to rise faster than results," said Michael Kresh, president of M.D. Kresh Financial Services in Islandia, N.Y. "So at this point in time I become very contrary and look at the reasons people are making so much noise about the market. We're going to end up with expectation violations, if not in the first quarter then definitely in the second quarter because everybody's getting too excited."
As such, Kresh has diversified portfolios but with an emphasis on infrastructure, both in the US and abroad.
But should the growth story continue to take hold, many investors are likely to move in tandem. Peter Miralles, president of Atlanta Wealth Consultants, expects technology and biotech to be among the beneficiaries.
"The growth companies are going to do better. They got hit worse, as they will during every recession," he said. "As long as the economy shows positive signs, we've got a lot of important things to take us in the right direction."
