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Jeff Saut: 'Tis the Season for Superior Market Performance


Mix some holiday cheer with sectors like energy, consumer non-cyclicals, basic materials, and REITs.


According to ISI, "profits have increased sequentially for the past three quarters at an estimated +34.8% annual rate -- a record for a recessionary environment." As of yet, however, the inventory rebuild has been muted. But with inventories plumbing record lows, we think the inventory cycle is about to begin.

If correct, the aforementioned sequence should play. Importantly, consumption comes at the back-end of the cycle, not the front-end. Consequently, those arguing we can't have a normal recovery until unemployment declines are like skiers skiing downhill looking at the tails of their skis.

We think the normal economic cycle will play once again. If so, economic reports, fundamentals, and earnings should continue to improve, putting even more pressure on underinvested participants (according to the latest surveys, hedge funds are only about 52% net long). And, that pressure should buoy stocks into the first part of 2010.

It's the back half of 2010 that begins to worry us due to harder earnings comparisons, loss of the "sugar high" stimulus funds, higher taxes, an election year, increased government regulation, etc. In fact, it's the probability of further government regulation of corporate America that worries us the most, and we are not alone. As our energy analysts wrote last week:

ENSCO International (ESV) to pick up shop and head to UK after watching rivals Transocean (RIG) and Noble Corp (NE) move to Switzerland, ENSCO has announced its intentions to re-domesticate from Delaware to the UK.

ENSCO joins a growing list of companies, like Tyco (TYC), that are moving offshore driven by worries of increased regulation and taxes. I'm old enough to remember the exodus of UK companies, and talented people, to America in the 1960s to 1970s for similar reasons.

Another example of governmental incursion came full circle last week when Pfizer (PFE) announced the closing of six Research and Development facilities. One such site is located in New London, Connecticut.

It was four years ago when the government used eminent domain to seize homeowners' homes. The government (state/local) then spent $78 million to bulldoze those properties to build condos, and offices, to enhance Pfizer's nearby research facility. The "spin" was that the project would create jobs and bring in more taxes. Now that land stands vacant, without any of those promised benefits. With Pfizer's closing of its New London facility, that land will likely remain fallow.

As the Wall Street Journal writes, "Economic development that relies on the strong arm of government will never be the kind to create sustainable growth."

The call for this week: In bull markets, be they secular or not, it's rare to get anything more than a 7% to 10% correction; while we have been looking for such a correction for more than a month, time is running out.

The trick then becomes to commit some capital to areas that have good risk/reward metrics. By our pencil, the sectors displaying the best relative strength are energy, consumer non-cyclicals, basic materials, and real-estate investment trusts (REITs).

Our REIT analysts just returned from the NAREIT national conference and reiterated their Outperform rating on 3.5%-yielding Apartment Investment and Management Company (AIV). Another way to get at the REIT theme would be via the ETF iShares REIT (IYR).

On the energy theme, our analyst upgraded American Superconductor (AMSC) this morning. As for consumer non-cyclicals, the ETF that makes sense to us is the Consumer Staples SPDR (XLP), as does Walmart (WMT). And, we still like our previous recommendations of Pfizer and Altria (MO), which are both followed by our research correspondents.

Read what Ron Coby & Denny Lamson have to say about REITs & IYR with a FREE trial to the Grail ETF Investor newsletter

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