3 Winning Investment Themes for 2011

If you're interested in asset allocation, the start of the year is an opportunity to think about the best way to position your portfolio for success around a small number of investing ideas. Here are three of my favorite themes for 2011:

Theme 1: Overweight technology and financials
Strictly on the basis of price-to-earnings multiples (on 2011 earnings estimates), the two cheapest sectors in the S&P 500 are Health Care (11.2) and Financials (12.1). While the P/E multiple has its limitations, research firm Morningstar has confirmed that these are indeed the two most undervalued sectors, by rolling up their analysts' valuations of individual stocks across each sector. At the end of last year, they pegged the percentage discount to fair value for both sectors in the high teens.

Motley Fool Pro's $1.4 million portfolio has a clear tilt toward the technology sector. Hardware and software stocks represent nearly a fifth of stock holdings -- roughly 10 percentage points over the corresponding figure for the S&P 500 index.

Chip heavyweight Intel (NYSE: INTC  ) is the portfolio's second largest position, and the Pro team currently rates the stock a "Buy First"; advisor Jeff Fischer believes Wall Street doesn't appreciate the diminishing cyclicality of the firm's business. Intel also happens to be representative of my second theme for 2011:

Theme 2: Overweight large- and mega-cap, underweight small-cap
Small-cap stocks smashed large-cap stocks in 2010, with 26.9% for the Russell 2000 against 16.1% for the Russell 1000 indexes. The gap with mega-cap stocks is even wider, with the Russell Top 50 recording only a 9.5% return (all figures include dividends). Small caps' outperformance stretches far back, with the Russell 2000 ahead of its large- and mega-cap counterparts over the prior three-, five-, seven- and 10-year periods.

That phenomenon will reverse. Although no-one can be certain when that will occur, I'd rather bet on a reversal that has to happen, rather than on a status quo that can't continue indefinitely. At an estimated price-to-earnings multiple of 15.2, I much prefer the Russell Top 50 today (estimated P/E of the Russell 2000: 20.1).

Indeed, high-quality large-cap stocks remain the most attractive segment of the market (although they are less attractive in absolute terms after the recent run-up in stock prices). Buying franchises like Wal-Mart (NYSE: WMT  ) at an 8% earnings yield, JPMorgan Chase (Nasdaq: JPM  ) at 10% and Hewlett-Packard (NYSE: HPQ  ) at better than 12% -- now that's a strategy that offers significant protection against a permanent loss of capital.

Theme 3: Long timber
Timber is an interesting asset in that it has a predictable growth characteristics, and it offers substantial diversification with regard to stocks or bonds. Fund manager GMO -- one of the best asset allocators out there -- estimates that timber will produce an annualized inflation-adjusted return of 6% over the next seven years, the highest of any of the 12 major asset classes it tracks.

There are a small number of timber REITs (real estate investment trusts) in the U.S., the most prominent of which are Weyerhaeuser (NYSE: WY  ) , Plum Creek Timber (NYSE: PCL  ) and Rayonier (NYSE: RYN  ) . However, as GMO's head of asset allocation, Ben Inker, told Barron's recently, if you want exposure, "you have got to own the trees directly ... unfortunately, it doesn't do you a lot of good to even own a timber real estate investment trust ".

Indeed, these REITs display a very high degree of correlation with the S&P 500 and Plum Creek shares -- arguably the REIT that is the best proxy for timber -- and have surprisingly low correlation with the NCREIF Timberland Index. That doesn't mean it's not worth owning: It has certainly provided historical investors with rich returns, but if it's pure timber exposure you're after, you could be barking up the wrong tree, so to speak. Unfortunately, I see no easy way for individual investors who don't have access to specialized vehicles to properly gain this exposure.

Stock picking plus
Motley Fool Pro advisor Jeff Fischer is a highly successful stock picker who also pays attention to broader market trends. With a 70% target allocation, individual stocks are the keystone of Pro's real-money portfolio, but Jeff also uses ETFs and options to take advantage of and hedge against opportunities and risks at the sector or asset class level. Stock picking while being mindful of asset allocation is a very powerful strategy, particularly in an environment where macroeconomic trends remain at the forefront of investors' concerns.

Your next step
If you'd like to learn more about Pro's approach to investing, simply enter your email address in the box below. In return, Jeff will send you his free report, 5 Pro Strategies for 2011, along with a private invitation to join Motley Fool Pro when it reopens this month. Take this simple step toward mastering the market in 2011!

Fool contributor Alex Dumortier, CFA has no beneficial interest in any of the stocks mentioned in this article. Intel and Wal-Mart Stores are Motley Fool Inside Value recommendations. Wal-Mart Stores is a Motley Fool Global Gains selection. The Fool owns shares of and has bought calls on Intel. The Fool has written covered calls on Plum Creek Timber. Motley Fool Options has recommended buying calls on Intel. The Fool owns shares of JPMorgan Chase and Wal-Mart Stores.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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