First the good news: Improving U.S. economic data. Surprising strength in consumer spending. Solid earnings.
Then the bad: Irish banking problems. Korean military exercises. Disappointing employment figures.
As the year winds down, investors confront a number of confusing trends, making it harder to figure out if it's a time to buy or sell.
One example of how bewildering it's become: The Federal Reserve has launched a historic program to buy bonds, a step termed "quantitative easing," aimed at pushing down bond yields and mortgage rates and other consumer interest rates. But long-term bond yields and mortgage rates have climbed, not fallen, since the program was unveiled just over a month ago, underscoring how mystifying the current investment environment is.
Indeed, on Thursday, stocks capped their best two-day performance since July, only days after dealing with marked weakness. Then on Friday data showed a much-weaker-than-expected job market in November.
To try to make sense of it all, we examined key sectors in the investment world and asked top analysts whether investors should be bullish or bearish in the near and longer terms.
Small-Cap Stocks: BUY
The year has been good for stocks, but it's been great for smaller companies. The Standard & Poor's 100 index, which represents the 100 biggest stocks, rose 6.5%, through Thursday, while the Standard & Poor's 500-stock index was up 9.5%. By contrast, the MidCap 400 and SmallCap 600, which track smaller companies, rose 21% and nearly 20%, respectively.
Jack Ablin, chief investment officer of Harris Private Bank in Chicago, advises investors to stick with smaller stocks, especially those in international markets. That's because these companies have seen bigger earnings improvements, so they still trade at attractive levels. Small-cap shares trade at a price-to-sales ratio of about 0.4, compared with a more expensive ratio of 1.2 for stocks in the S&P 500.
Tobias Levkovich, Citigroup's (NYSE: C - News) chief U.S. equity strategist, argues that during periods of profit-margin improvement — which has been happening lately — small-cap stocks best their bigger brethren. That trend should continue for the next six months or so, Mr. Levkovich predicts, making small- and mid-cap shares the place to be.
A big risk for stocks: China. With annual inflation running at 4.4%, Chinese leaders are working hard to slow their economy and keep a lid on price increases. If the economy slows too much, it will affect global growth and U.S. shares.
So far this year, betting on consumer spending has worked out, even as most consumers work to cut debt. Consumer discretionary shares, or those of companies that sell items like clothing and music, are up 24%, while utility and health-care shares are down about 1%.
Some say that technology shares, up nearly 7%, now are the place to be. Alan Zafran, co-founder of Luminous Capital, a Los Angeles-based investment adviser, adds that investors should focus on so-called cyclical stocks that tend to do well as economic growth rebounds. He likes both energy and information-technology shares, which have strong balance sheets and impressive growth.
Microsoft (NYSE: MSFT - News), for example, trades at less than 10 times its earnings, excluding its huge cash position, and pays a 2.5% dividend yield. Mr. Zafran argues that Congress might reach a compromise to allow companies like Microsoft to repatriate cash held overseas, giving the company even more resources to boost its dividend or take other steps.
Utility shares could continue to underperform if long-term interest rates keep edging higher, making the dividends of utilities less valuable.
Prices of precious metals like gold have been on a tear for much of the year, with the price of the yellow metal up 28% this year.
Some of the strength has come from concern that the Fed's moves will push the value of the dollar lower, paving the way for future inflation. Gold, and to a lesser extent silver, tend to serve as an alternative to paper currencies. So some investors have rushed into these precious metals to protect against weakness in the dollar, as well as the euro, which is dealing with the recent bailout of Ireland.
But some analysts say it's time for gold and silver bugs to take some profits off the table. Gold will do well if the consumer-price index rises at least 3% over the next three years, argues Mr. Ablin. But with inflation currently running at under 2% and showing few signs of a surge, gold prices may not be able to advance in the near term, some argue.
At the same time, Mr. Levkovich notes that gold doesn't provide diversification for an investment portfolio like it once did, because it rises and falls with other riskier investments.
"I am a believer in global growth, so I believe the long-term uptrend in commodities will be intact," says Mike O'Rourke, BTIG LLC's chief market strategist.
But he argues that anticipation of the Fed's buying of bonds already has sparked heavy buying of gold and other commodities, and that now investors should prepare for a "pullback" in these prices.
Emerging Markets: SELL
It's become conventional wisdom that emerging-markets economies will show huge growth over the next few years, and that the U.S. economy will struggle. That consensus already is priced into stock prices, suggesting that it could be too late to jump on the emerging-markets bandwagon, some argue.
"Emerging-markets equities are expensive relative to the U.S.," says Mr. Ablin, who cites data that emerging-markets shares trade at 1.3 times their sales, compared with 1.2 for S&P 500 stocks; emerging-markets shares trade at nearly 18 times their earnings, well above the nearly 15 P/E of S&P 500 shares.
The S&P 100 trades at an attractive 13 times next year's estimated earnings and has a respectable 2.1% dividend yield. At the same time, U.S. companies are flush with cash and profit margins are wide, partly because companies have been reluctant to hire new workers.
"In each of the three times over the last 20 years that emerging markets were priced at a valuation premium, they underperformed the U.S. in the subsequent 12 months," says Mr. Ablin.