Investors will be taking advantage next week of the some of the last remaining trading days of the year to place their bets on what will be the winners of 2011.
One of the defining characteristics of 2010 has been the strong correlation across asset classes. Movements in the dollar or in bonds had just as much impact on equities as more fundamental factors, such as corporate outlooks.
The tight relationships came as investors focused on the same factors -- further stimulus from the Federal Reserve, sovereign debt worries in the euro zone and the strength of the economic recovery.
The macro focus has meant investors made the same trades rather than differentiating individual sectors and industries.
No matter how much work you put in trying to pick winners and losers, the profit available from doing so was way below normal, said Charlie Blood, director of financial markets strategy at Brown Brothers Harriman in New York.
Analysts expect that correlation to ease in the coming year, allowing sectors to see more divergence and affording investors more chances to outperform the market.
It's structurally just unsustainable to have that kind of (correlation) because it doesn't allow for diversification, said Nicholas Colas, chief market strategist at the ConvergEx Group in New York.
I do think it has to reverse -- it's just not a healthy part of the capital market, he said.
Even as investors reposition themselves, the broad market is likely to drift until year-end with next week shortened by the Christmas holiday.
Indeed, Wall Street's fear gauge, the CBOE Volatility index, or VIX <.VIX>, on Friday fell to its lowest level since April.
Investors will also take in a round of economic data next week, including the final reading of gross domestic product for the third quarter, new and existing home sales for November and December consumer sentiment.
TOO HOT TO HANDLE
Stocks that have been the best performers for the year are already seeing a pullback, suggesting investors are happy to lock in profits as they search for fresh opportunities.
Similarly, small- and mid-cap indexes have outpaced blue chips with the S&P MidCap 400 index <.MID> and S&P SmallCap 600 index <.SML> both up more than 24 percent in the year to date compared to the S&P 500's <.SPX> 11.6 percent gain.
But with valuations on smaller companies becoming stretched, investors are likely to shift into blue-chip names next year, said Bob Gorman, chief portfolio strategist at TD Wealth Management in Toronto.
The extent of the valuation gap would suggest to us you probably start to see that rotation into bigger companies with more consistent sales, earnings and dividend growth and that are selling at lower multiples, said Gorman.
Investors will also continue to put their faith in technology shares next year on the expectation they will benefit from corporate and consumer spending as well as strong balance sheets.
The sector's sensitivity to the economy made for a lackluster performance for the sector overall this year with the S&P tech sector <.GSPT> gaining 8.7 percent, though some of the year's best gainers were in the tech space.
Financials are starting to look favorable to some, particularly with the possibility the large banks could resume paying dividends next year, but others view the uncertainties of financial reform as too much of a headwind.
Colas said he likes financials as a contrarian play, noting: They don't seem to go down very much when the bad news strikes and that's usually a sign that it's an OK contrarian investment.
Others are betting the less flashy industrials sector will hold onto its leadership position next year after gaining 22.8 percent so far in 2010.
They haven't attracted the hot money like emerging markets have or like the trendy consumer stocks or cloud computing have, said Derek Hernquist, chief investment officer of Integrative Capital in Charlotte, North Carolina.
When I see those major broad groups are attracting the smooth, steady money flows that they are, it seems like it would point to a healthier economy, which is not fully priced in yet, said Hernquist.