(01/02/12) 4 Funds to Ride Rising Sentiment

This year may be ending with more of a whimper than a bang, but investors like where we're headed, it seems, writes Benjamin Shepherd of Personal Finance.

Investor sentiment seems to be shifting for the better as we reach the end of the year.

In mid-December, small-cap stocks—as measured by the S&P Small-Cap 600 Index—had outperformed large-cap and mid-cap stocks. The index remains in the red, booking a 3.5% loss at the time of writing. But this relative outperformance by small-cap stocks is a strong indication that equities as a whole are poised to perform strongly in 2012.

Corroborating evidence of this equity revival can be found in the American Association of Individual Investors’ Sentiment Survey, which recently broke into bullish territory, albeit by a slim margin. In the most recent survey, about 40% of respondents identified themselves as bullish, 33.6% of respondents were bearish, and 26% of participants had a neutral outlook.

These data points—combined with the recent decline in gold prices—suggest that investors have begun to respond to improving US economic data and the EU’s tentative moves toward resolving the Continent’s sovereign-debt crisis. We don’t claim that it will be smooth sailing for the markets or global economy next year, but these augur a favorable 2012 for investors.

T. Rowe Price Small-Cap Value (PRSVX) and Wasatch Small Cap Growth (WAAEX) have both performed well in recent weeks, and small-cap stocks should continue to outperform in 2012. Continue buying both T. Rowe Price Small-Cap Value and Wasatch Small Cap Growth.

Additionally, the negative sentiment toward Asia—particularly China— seems overdone. Analysts continue to debate the sustainability of China’s economic growth. One side predicts a sharp decline in growth, sparked by a wave of nonperforming loans in the country’s banking system. China bulls believe the government will engineer a soft landing for the economy, successfully slowing economic growth to sustainable levels without stifling growth altogether.

Runaway lending in China is a cause for concern—commercial bank credit expanded by about $4 trillion between August 2008 and July 2011, and there are bound to be some bad apples in the bunch. However, the country’s fiscal authorities have the policy tools to respond to a spike in nonperforming loans and a slowdown in economic growth.

The nation also holds more than $3 trillion in foreign currency reserves that it can deploy as needed. The recent decline in inflation, which is currently forecast at about 4% for 2012, gives the central bank more flexibility to implement pro-growth policies next year.

That’s good news for Matthews Asia Dividend (MAPIX) and iShares MSCI All Country Asia ex Japan (AAXJ), both of which allocate about 25% of their investable assets toward China. Matthews Asia Dividend will also benefit from its focus on Chinese blue chips such as Growth Portfolio holding China Mobile (CHL).

Matthews Asia Dividend and iShares MSCI All Country Asia ex Japan will benefit from a healthy Chinese economy and remain buys.

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