So far, 2011 has had plenty of excitement, with big ups and even bigger downs in some markets. But when you look closely at exactly which stocks are moving in which direction, the moves make a lot more sense. More importantly, they should start giving way to more fundamental considerations in the days and weeks to come.
A tale of two markets
Whether 2011 is going well depends on your focus. If you own a broad-based swath of U.S. stocks, then you should generally be pretty happy. The S&P 500 hit another two-year high yesterday, recovering from an early sell-off to post decent gains.
But other investors haven't been so fortunate. Both emerging markets and developed international stocks haven't kept up with gains on domestic stocks, with the Vanguard European ETF (NYSE: VGK) down for the year. Even previously hot areas have cooled off in a hurry; India Fund (NYSE: IFN) has already dropped from its 2010 close. And precious metals investors have been especially hard hit, with big drops in the prices of all of the metals, particularly silver.
Some commentators have suggested that this spells the imminent end of some major market trends, such as the commodities boom. Yet while I've argued that underperformance in U.S. stocks relative to international equities has been long overdue to change, this week's moves look more like investors making some prudent risk-management decisions about their portfolios. Moreover, some of the moves will end up being short-lived, as the underlying premises behind those long-term trends reassert themselves.
Rebalancing: the smart move
The beginning of the year is a great time for investors to consider rebalancing their portfolios. And looking at some of the hardest-hit stocks this week, many investors have clearly made rebalancing part of their annual rituals.
For instance, among commodity-related stocks, Silver Wheaton (NYSE: SLW) and Freeport-McMoRan Copper & Gold (NYSE: FCX) enjoyed very strong returns in 2010. Each has given back a small portion of those gains over the past three days on above-average volume, with Silver Wheaton's 2011 loss exceeding 10% for a few hours during Wednesday's trading session. That's definitely consistent with the idea that investors were waiting for a new year to begin to take profits, deferring the resulting tax liability until April 2012 while locking in strong gains.
Meanwhile, the stocks that have benefited from the rebalancing trade include some weaker performers from 2010. Health-care stocks have seen some nice gains, with Intuitive Surgical (Nasdaq: ISRG) bouncing back from a losing 2010 to rise more than $11 per share. Health insurer UnitedHealth Group (NYSE: UNH) and drugmaker Elan (NYSE: ELN) have also seen their shares rise in the past week, as investors apparently see attractive valuations overcoming any uncertainties about the future of health-care reform.
What's next?
These rebalancing moves are likely to continue for at least the next few days, as investors continue to maneuver their positions around. But after these short-term moves are done, you can expect to see pressure for long-run trends to regain momentum. It's hard to argue that anything has fundamentally changed just because you have a new calendar on the wall, especially with major policy moves like the extension of tax cuts through 2012.
So if you want to position your portfolio to anticipate the continuation of the trends that have supported commodities and international markets, then this week's weakness in those areas is a great opportunity to do so. But if you discover that your exposure to risk and volatility among your investments has risen because the past year's winners and losers changed your overall asset allocation, then making some rebalancing trades is still the prudent thing to do -- even if prices may have moved against you.
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