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Sunday, April 08, 2007

Alpha and the Week Ahead

The holiday shortened week saw stocks rally across the board. Short term factors seem to explain this week's gains with oil prices falling on the easing of middle-east tensions, good geopolitical news from Iran coupled with some favorable U.S. economic reports.

Although daily volumes are still subdued, confidence that the current rally can be sustained is growing. This is evident in all three indexes showing consecutive days of gains. For the week the Dow Jones Industrial Average closed 1.67% higher, the NASDAQ Composite gained 2.05% and the S&P 500 rose 1.61%.

However we continue to advise our readers to move cautiously as the underlying macro-economic picture is weak; the Institute for Supply Management Service index grew at the slowest pace in almost four years in March, inflation has not yet abated and the housing market remains suspect with credit becoming tighter.

This week’s true bright spot was that jobless rate continues to fall and wages are rising. However, the full impact of the consumer’s reluctance or inability to continue to fuel economic growth with capital, which they have historically extracted by refinancing their homes, remains to be seen.

Most of the week’s action took place on Tuesday as falling oil prices and signs of an improving housing market sent the DJIA up 128 points to close above 12500 for the first time since 02/26/07. The remainder of the week saw minor gains as the DJIA ended the period with a string of six straight daily advances. Year-to-date, the Dow is up 0.8% while the NASDAQ has gained 2.3% and the S & P 500 Index up 1.80%.

Weak economic news triggered a fall in bond prices on Friday’s abbreviated trading day with the price of the 2-year note dropping 7/32 with a yield of 4.74%. The 5-year note dropped by 14/32, raising the yield to 4.66%, the 10-year bond dropped 18/32 with a yield of 4.75% and the 30 year bond dropped 25/32 to yield 4.92%.

We remain modestly Bearish, in line with the posture of our long-term market model it adopted on December 8, 2006. The total universe of stocks, ETF’s and mutual funds which we review on a daily basis is 1847. Of those reviewed, 389 are rated "Buy," 367 are rated "Sell" and 1091 "Neutral.” We have adjusted our recommendations accordingly and are currently recommending an allocation in the range of 50% in cash or money market investments and 50% Long Funds or ETF’s. The Model Stock portfolio was increased to 64% equities and 36% cash this past week.

Recently our friends at Standard & Poor's Equity Research published a report on current market conditions and we have taken the liberty to extract the following:

“A major blow off took place in 1987. This time period, as well as the chart pattern from back then, matches up well with recent market activity. In 1986, there was a four-year cycle low in which we did not have a bear market, just like 2006. The bull market was in its fifth year, after the August 1982 bear market low. We are currently in the fifth year of a bull market. In early 1987, the S&P 500 rallied 24.5% in less than three months. This is certainly a larger gain than the present advance we've had from the summer 2006 lows, and much faster. The index then went through a fairly quick shakeout, falling 7.5% in six trading days. This is somewhat similar to what we just went through. The market then put in a double bottom, broke out, and then retested the lows. Sound at least a little familiar?

The "500" then had an upside explosion, running 21% in 67 days right into the 1987 top.
Again, we note the scenario sketched out above is just that - a possible scenario based on technical observations in the past. But it's one that bears watching.”

As such we will adherer to our discipline which has proven to be very accurate over the past 19 years and wait until our market model turns Bullish before recommending that you commit more capital.

At this time we do not see any AAS Buy Rated Broad Market Indices as attractive alternatives for seeking alpha. Of the Style choices, Mid Cap Growth (JKH), Value (JKI) and Core (JKG) come up as high Neutral-rated styles with Small Cap Growth (JKK) and Core (JKJ) similarly rated. If you are inclined to venture into the market in the coming week we suggest focusing in the Mid Cap area. Experience teaches that Small Caps are much more volatile in times such as these which are charged with economic uncertainty.

Energy, Utilities, Basic Materials, Global Energy and Natural Resource are the leading AAS Buy rated Sectors at the time. ETF’s which work into this strategy are the iShares DJ U.S. Utilities (IDU), iShares DJ U.S. Energy (IYE), iShares GS Natural Resource (IGE), iShares S&P Global Energy (IXC) and iShares DJ U.S. Basic Materials (IYM).

There are many individual equities that are currently rated an AAS Buy, fall into the Mid Cap Style groups, and come from within these sectors. For those interested take a further look at Grant Prideco Inc (GRP), Albemarle Corp (ALB), Cooper Cameron Corp (CAM), Tidewater Inc (TDW), Northeast Utilities (NU), Equitable Resources Inc (EQT), Helmerich & Payne Inc. (HP) Noble Affiliates Inc (NBL), FMC Technologies Inc. (FTI) or Southwestern Energy Co (SWN).

Mutual Fund investors seeking to use Fidelity Funds might look at Fidelity Select Utilities Growth (FSUTX), Fidelity Select Energy Service (FSESX), Fidelity Select Materials (FSDPX), Fidelity Select Natural Gas (FSNGX) or Fidelity Select Energy (FSENX).

ProFunds offers a more aggressive alternative for those with their Ultra Sector Funds. These fund alternatives seek to match approximately 150% of their underlying benchmark. For those so inclined look into the ProFund Ultra Sector Basic Materials (BMPIX), ProFund Ultra Sector Oil & Gas (ENPIX), and ProFund Ultra Sector Utilities (UTPIX). The ProFund Ultra Mid Cap (UMPIX) fund differs slightly as it seeks to return 200% of its underlying benchmark. Lastly the ProFund Small Cap Growth (SGPIX) aims at simply matching its benchmark.

Those of you who prefer the trading feature of the Rydex Family of Funds should look at Rydex Energy Services (RYVIX), Rydex Basic Materials (RYBIX), Rydex Utilities (RYUIX), Rydex Commodities (RYMBX) or Rydex Energy (RYEIX).

Short-Term Technical Indicators

Investor Sentiment

Long-Term Market Model – Bearish since December 8th.

Asset Allocation – AAS Model Portfolios are allocated at 50% cash and 50% long.

Top Alpha Generating Securities
Date = Date of AAS “Buy” or “Short/Sell” Recommendation

Top Major Market ETF – iShares S&P Mid Cap 400 (IJH 3/20/07)

Top Style-Box ETF for Alpha – iShares Morningstar Mid Cap Growth (JKH 3/20/07)

Top Sector ETF for Alpha – iShares Dow Jones U.S. Utilities (IDU 3/12/07)

Top Long Stocks for Alpha

RTI International Metals (RTI 10/11/06)

Brush Engineered Material (BW 3/6/07)

Precision Castparts Corp. (PCP 9/20/06)

U.S. Steel Co. (X 2/28/07)

Cleveland-Cliffs Inc. (CLF 11/17/06)

Chaparral Steel Co. (CHAP 11/1/06)

Varian Semiconductor (VSEA 3/27/07)

Belden CDT Inc. (BDC 1/19/07)

Universal Corp. (UVV 11/29/06)

Vulcan Materials Co. (VMC 10/31/06)

Top Short Stocks for Alpha

Beazer Homes USA Inc. (BZH 1/25/07)

Fremont General Corp. (FMT 12/29/06)

Meritage Homes Corp. (MTH 12/18/06)

The Ryland Group, Inc. (RYL 2/20/07)

Advanced Micro Devices Inc. (AMD 9/27/06)

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