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April 28th, 2011 by

A Very Uncertain Year

Another good positive day on Wall Street. We are coming close to the end of the month and it is another banner month up to now, S&P 500 is up +2.25%. It is up 7.79% for the year already, not bad for barely four months of work. At this clip we will add about 2% per month to a whopping 23% for the year. Now do you really think so?

I don’t think so at all. In fact the Wall Street is giving us good news, while the Real Estate Street that is located on the Main Street just provided us with another dismal housing sales numbers, as well as very pessimistic trend for the year. The unemployment is still high, the gas prices are rising, the Fed decided not to give up to what amounts to not quite QE3, but at least QE2+.

I am a big fan of appropriate sector selection and allocation. In my opinion it is better to invest in sectors, rather than stocks, because sectors provide a better risk return profile. Sectors are inherently diversified, very liquid and you avoid individual company risk.

So I decided to look at P/E ratios of the main S&P 500 sectors represented by XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV and XLY. Here they are sorted by highest to lowest for 2011 projected P/E.

P/E  

2006

2007

2008

2009

2010

2011E

XLI Industrials

15.7

16.1

9.7

17.0

17.2

15.8

XLY Consumer Discretionary

23.4

19.6

17.4

19.3

16.9

15.4

XLP Consumer Staples

14.3

15.1

12.6

14.5

15.2

14.5

XLE Energy

10.6

13.8

6.9

19.8

15.5

14.1

XLK Technology

20.8

21.6

11.9

19.8

15.9

14.0

XLB Materials

11.6

12.5

8.0

21.1

18.5

14.0

XLU Utilities

14.2

15.4

10.5

12.2

12.5

12.8

XLF Financials

16.1

16.1

-60.6

44.5

14.2

12.5

XLV Healthcare

16.3

15.2

10.6

12.6

11.5

11.7

Sources: AltaVista, The Rockledge Group

This chart reflects just what the Wall Street is telling, us with the ever increasing stock market. In other words according to these estimates the Industrials sector will grow (we will produce more), the Consumer Discretionary sector will grow (we will spend more), the Consumer Staples sector will grow (we will eat more), the Energy sector will grow (we will travel and build more) and so on.

Now does this really make sense? If we look at the P/E growth for each of these sectors, the perspectives changes quite drastically.

P/E  

2006

2007

2008

2009

2010

2011E

Growth
XLU Utilities

14.2

15.4

10.5

12.2

12.5

12.8

2.3%

XLV Healthcare

16.3

15.2

10.6

12.6

11.5

11.7

1.8%

XLP Consumer Staples

14.3

15.1

12.6

14.5

15.2

14.5

-4.8%

XLI Industrials

15.7

16.1

9.7

17.0

17.2

15.8

-8.3%

XLY Consumer Discretionary

23.4

19.6

17.4

19.3

16.9

15.4

-8.9%

XLE Energy

10.6

13.8

6.9

19.8

15.5

14.1

-9.1%

XLK Technology

20.8

21.6

11.9

19.8

15.9

14.0

-11.8%

XLF Financials

16.1

16.1

-60.6

44.5

14.2

12.5

-11.9%

XLB Materials

11.6

12.5

8.0

21.1

18.5

14.0

-24.3%

 

This tells a very different picture, in fact it is not as rosy as before. The two positive P/E growth sectors, Utilities and Healthcare, which are the epitome of defensive sectors. This chart tells us that we will still heat our houses and we will still take care of our health, but that’s about all that we, as consumers, might be willing to spend money on. This is not a very positive indication.

Now I don’t believe in the doom and gloom scenario for this year. There are certainly some signs of recovery. But the way I read this is that there is still too much uncertainty in the consumers’ wallets and bank accounts and this year most consumers are still very cautious about where and how much to spend.

I would stay defensive for the rest of the year and choose my investments in the well diversified sectors that are defensive in nature.

 

Position disclaimer: I and client portfolios hold positions in XLE, XLF,  XLU, XLV and XLY .

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