INVESTING: Recipe for 2007 success: Avoid overheated sectors

In a way, 2007 is starting off right where last year ended. Large-cap Chinese stocks (up about 25 percent since I mentioned them here in October) tore it up in the first day of trading.

I don’t know how long these Chinese stocks can keep cranking, but I have a feeling that, by the end of this year, big-cap stocks in America will have outperformed most foreign markets, including China.

Keeping an eye on expectations can be a great way to keep ahead of the increasing risk with investments. When things get too popular, as they are in China right now, it pays to cut exposure and let just small amounts ride.

The consensus among major analysts and economists on Wall Street is that in 2007 the economy will slow, but earnings still will increase, though by a much smaller amount than last year.

A lot of experts are predicting that the run of double-digit-percentage earnings growth will end at some point this year. Many analysts think the S&P 500, which closed the year at 1418, will advance about 8 percent in 2007. Well, if that comes to pass, the index will be within 20 points of its all-time high set in March 2000. The very fact of getting that close should be enough to push it over.

But I am a contrarian by nature (as if that’s a shock), so I expect the S&P will do something other than advance 8 percent.

When thinking about consensus and expectations, a powerful thing to keep in mind is usually the furthest thing from the minds of most. There are plenty of bulls looking for a mild advance. There are more than an average number of bears looking for a decline. There are virtually no prognosticators looking for either a powerful rise or a large drop. The real path will most likely lie within one of those two directions.

Using the market data produced over the last six months, my crystal ball is telling me prices should generally move higher this year. OK. Now combine that with what we just talked about above and I get the idea that this could be a banner year for stocks.

Here’s the strategy I am laying out for the first part of 2007: Most foreign markets got a little too hot recently and therefore contain a little too much risk. I will be looking to buy them on a pullback of around 7 percent or 8 percent. I still like Australia, though, because it hasn’t gone straight up, and its economy offers the best balance sheet of any country in the world.

Though it is taking longer than I expected, small-cap stocks are giving up their momentum to bigger stocks. That should continue, and I am concentrating my exposure on large-cap stocks. Within that universe, I am holding health care and big growth stocks, like well-known technology companies and semiconductor firms.

Using these same investment theories will keep me out of energy stocks unless and until they suffer a sizable correction.

Energy has been the No. 1 performing sector on average the last three years, and now investors are fully on board. That means risk is high, and I don’t want any part of that. My new year’s resolution is to stay far away from risk while staying in the range of grabbing some solid gains for 2007.