StreetAuthority Market Advisor for February 10th, 2003
Volume 2, Issue #6

Published weekly on Sunday evening, the StreetAuthority Market Advisor is an invaluable resource for self-directed investors looking to earn above-average profits in the equity markets. 

1.  WEEKLY MARKET RECAP

CLOSING INDICES FOR THE WEEK OF FRIDAY, FEBRUARY 7TH

INDEX           CLOSE    CHANGE    WEEK%    YTD% 
Dow Jones       7,864     -190     -2.4%   -5.7%
S&P 500           830      -26     -3.0%   -5.7% 
S&P MidCap        403      -13     -3.2%   -6.1%
S&P SmallCap      183       -7     -3.7%   -7.0% 
Nasdaq          1,282      -38     -2.9%   -4.0%


TOP FIVE WINNING SECTORS OVER THE PAST MONTH

SECTOR                  %CHANGE 
Toys                      2.8%
Pipelines                 2.1%  
Precious Metals           0.8%
Nonferrous Metal          0.2%  
Secondary Oil             0.2%


TOP FIVE WINNING SECTORS FOR THE CALENDAR YEAR

SECTOR                  %CHANGE 
Pipelines                 5.7%
Nonferrous Metal          3.7%  
Toys                      2.9%
Home Construction         1.9%  
Office Equipment          1.7%

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TOP FIVE LOSING SECTORS OVER THE PAST MONTH

SECTOR                  %CHANGE 
Tires                    -26.0%
Insurance                -22.2% 
Aluminum                 -19.6%
Airlines                 -18.5% 
Fixed-Line Comm.         -18.1%


TOP FIVE LOSING SECTORS FOR THE CALENDAR YEAR

SECTOR                  %CHANGE 
Tires                    -24.2%
Coal                     -19.1% 
Insurance                -18.0%
Aluminum                 -14.1% 
Airlines                 -13.8%

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2.  MARKET COMMENTARY

The major indices trended lower yet again this week as investors continued to fret over rising geopolitical tensions, sluggish economic data and cautious corporate outlooks for 2003. The Dow, S&P 500 and Nasdaq Composite all tumbled roughly -3% on the week. And as we've seen all too often in the new millennium, all three indices are now firmly entrenched in the red for the year, having already given back -5.7%, -5.7% and -4.0% since January 1st, respectively.

MY THOUGHTS ON GEOPOLITICAL TENSIONS
It seems as though the Cartoon Network is just about the only channel on TV today that isn't running round-the-clock coverage of escalating tensions between the U.S. and Iraq. And rightfully so. After all, the manner in which the situation in that country ultimately plays out will have dramatic implications not only for the U.S. and for President Bush, but also for the U.N. and its member countries, for nations in the Middle East, and really the rest of the world for that matter.

Market participants appear to be more focused on Iraq than on domestic issues at the moment, and everyone seems to have a different opinion with respect to what the markets might do in the event of war. On one hand, bullish pundits are now predicting that the markets will mount a sustainable comeback once war breaks out. They believe that's when the uncertainty will end.

I disagree.

Although I hate to be bearish on the market's prospects (after all, as a long-term investor I'm still bullish on the markets when looked at from that perspective, and I still believe the markets will mount a comeback later in the year), I don't think a few dropped bombs will mark the end of geopolitical uncertainty. (I'm more concerned about this than I was even a few weeks ago.) We may see a sharp rally at the outset of any war, and the markets could soar if the U.S. wins a swift and decisive victory, but ultimately, uncertainty will probably continue to hang over the market in the coming months.

Why?

Well, should it eventually take place, this war with Iraq could end up being far different than the previous Gulf War. For starters, the U.S. won a fairly swift victory in the early 1990s, but that does not necessarily mean it will be quite as easy this time around. America's superior military force will ultimately win out, but U.S. casualties could be much higher than in the previous Gulf War. In particular, I'm concerned about apparent U.S. plans to occupy Iraq at the end of the conflict. Since organized, concentrated military confrontations can be controlled and managed much more effectively than widespread "police-like" forces, such an occupation could potentially put U.S. soldiers at even greater risk than they'll be in during the actual war itself. In addition, I don't even want to think about what might happen if Saddam decides to use weapons of mass destruction against U.S. troops or allied nations. And if the U.S. does occupy Iraq, when will that occupation end? Will the country of Iraq -- or the entire region for that matter -- ever enter into a prolonged period of peace and stability? In my mind, all of these factors will combine to create a level of uncertainty in the months ahead that few investors have factored in yet.

Next up on the uncertainty list, we have the potential for terrorist attacks and reprisals against the U.S. Don't get me wrong -- in the post-September 11th environment we're all keenly aware that this threat is ever-present. However, few would disagree that the chances of an imminent attack on U.S. citizens will INCREASE if America does indeed go to war in the Middle East. The government's decision last week to raise its national terror alert to "orange" from "yellow" could serve as a disturbing premonition of things to come on this front.

And as if all of this weren't enough, keep in mind that I haven't talked about the escalating situation with North Korea yet. (I'll tackle that topic in future issues as it relates to the market.)

Of course, we can throw all of the above analysis out the window if Saddam goes into exile and diplomatic efforts between the U.S. and North Korea start to bear fruit. But from where I sit, the chance of either of those events happening in the near term looks to be pretty slim.

AS INVESTORS, WHY SHOULD WE BE SO CONCERNED WITH THE GEOPOLITICAL LANDSCAPE?
If you're a long-term investor, then you shouldn't be (unless of course the war with Iraq marks the start of a broader, prolonged conflict). But if you have a shorter-term time horizon, or if you have some cash on the sidelines and you're wondering when to jump back into the markets, then the above analysis is important to consider. After all, the rising likelihood of war with Iraq is largely responsible for the declining market we've seen in recent weeks. Moreover, if any of the above risk factors (terrorist attacks, heavy war casualties, etc...) come to pass in the coming months, then these are bound to have a huge impact on investor sentiment, consumer sentiment, government budget deficits, consumer/corporate spending and a host of other related variables. These, in turn, will put even more strain on the U.S. economy, corporate earnings and equity prices. We're already starting to see some of this, as several big-name companies, including Dell Computer (DELL, $23), have recently warned that corporate technology spending will remain soft this year thanks to a weak economy and war jitters. Any further uncertainty on those fronts could have a devastating impact on hundreds of other firms in the months ahead.

WHERE DO WE GO FROM HERE?
We may see a sizable rally at the outset of war (should it take place) in the coming weeks, but contrary to what other analysts are saying right now, I think there's a good chance that this rally will be short-lived. Barring any unforeseen positive events (like Saddam's exile or a very quick victory), geopolitical uncertainty will still be present, the economy will remain sluggish, and the broader markets will probably retest (and possibly fall below) their October lows in the weeks or months ahead.

This is not a pretty picture, and it isn't pleasant to think about. On the positive side though, the good news is that this declining market WILL present us with some incredible buying opportunities fairly soon. Over the past few months we've profiled dozens and dozens of stocks on our "Watch Lists" for possible inclusion in one of our recommended portfolios. Should equity prices continue to tumble, many of these picks are bound to reach levels low enough to give us a sufficient "margin of safety" to invest for the long haul.

In the short term, it's important to remember that there are very few bargains in a plummeting market. So in cases like what we're seeing now, if you have a shorter-term time horizon, then you might want to turn to alternative investment ideas. Even though I would not advise them as long-term investments, short sales (see section #5 below) and counter-cyclicals (see section #7 below) usually do well in this type of uncertain environment, so that's what my staff and I have chosen to focus on in this week's issue. In addition, I've also brought you an analysis of four safe-haven plays that could hold up well amidst difficult market conditions.

Good investing in the week ahead.

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3.  FOUR SAFE-HAVEN STOCKS FOR A DIFFICULT MARKET

Several weeks ago I brought you a closer look at the defense industry and gave you my thoughts on those stocks that should perform well in the months ahead if the U.S. goes to war with Iraq. As part of that article, I briefly mentioned several safe-haven stocks in other industries that have proven to be steady performers during previous military conflicts. Due to popular demand, I've decided to devote this week's feature article to a more in-depth analysis of four of those companies.

Thanks to their enormous size, geographic diversity and broad product lineups, the following safe-haven firms should hold up well regardless of whether or not the U.S. goes to war...

GENERAL ELECTRIC (GE, $23) -- With over $125 billion in annual sales and literally hundreds of different business lines -- including broadcasting, medical systems, financing, power generation, industrial products, aerospace systems and home appliances, among other things -- General Electric is the world's largest diversified conglomerate. In the 1990s the company and its superior management team were the envy of just about every other corporation around the world, and GE boasted one of the most successful, consistent track records on Wall Street. But due to the economic slowdown, company revenue growth has stalled over the past few years and the firm's seemingly invincible shares have taken a huge hit, falling from a high of around $60 down to recent multi-year lows around $20. Although its growth has slowed and investors have expressed some legitimate concerns about the company as of late (GE is too large to post stellar growth, too difficult to analyze, etc...), the firm still has a number of things going for it:

-- Superior management team.
-- Solid balance sheet and a rare AAA credit rating.
-- Cost-cutting efforts fuel bottom-line growth.
-- GE maintains a leadership position in most of its markets.
-- The firm's diversity has helped it weather the economic storm, and GE generates over a third of its profits from overseas.

This stock is no longer the Wall Street darling that investors used to know and love, but given its recent pullback and projected earnings of $1.76 next year, it could make for a solid, defensive-minded value play at current levels.

JOHNSON & JOHNSON (JNJ, $52) -- J&J is the world's #1 health care company. The firm has managed to post decades upon decades of consistent double-digit growth thanks to booming sales of pharmaceuticals and medical supplies, as well as its diverse lineup of stable consumer products (including such well-known brands as Tylenol and Band-Aids). Here's what I like about the firm:

-- Diverse product lineup and geographical presence gives the J&J stability. 40% of sales come from overseas.
-- 82-cent annual dividend payment.
-- Average compound annual cash flow per share growth of 23% over the last five years.
-- J&J holds $7.3 billion in cash and also boasts a rare AAA credit rating.
-- Operating profit margins are healthy at nearly 25%.
-- The firm's drug portfolio has tremendous potential. In particular, J&J's drug-coated coronary stent should receive FDA approval in early 2003, paving the way for a ramp-up in sales.
-- J&J is now reportedly in talks to purchase red-hot biotech company Scios (SCIO, $42) in a deal that would give the firm an impressive pipeline of new potential drug candidates.

On the downside, Johnson & Johnson's consumer products segment, which accounts for about 20% of the firm's revenue base, has seen its growth grind to a virtual halt in recent years (this segment still provides stability though). In addition, the firm faces substantial product-specific risks in its pharmaceutical division. For example, the stock tanked sharply last July due to concerns that its anemia drug, Eprex, is causing a deadly disease in a small number of patients. The good news for investors, however, is that J&J always seems to handle these situations well. The stock has rebounded strongly since then, and management has been able to restore investor confidence. Because the firm boasts such a diverse revenue stream, any further product-specific events like this one are unlikely to have a meaningful long-term impact on J&J's results.

The company should continue to grow at a steady 10-15% clip in the years ahead, and given their recent pullback, the shares are now approaching a level at which I might consider adding them to one of our portfolios. Stay tuned for a possible News Flash in the coming days/weeks, as I may decide to add J&J to either our Value or Bellwether Portfolio.

PFIZER (PFE, $29) -- Thanks in large part to quality research and a series of strategic acquisitions (including a blockbuster deal with Warner-Lambert in 2000), this pharmaceutical giant has managed to post 24% average annual earnings growth since 1992. Pfizer should have no trouble posting double-digit growth well into the future due to the firm's stable of blockbuster drugs, promising new drug candidates, and cost savings related to its pending $50 billion mega-merger with rival Pharmacia (PHA, $40). Pharmaceutical stocks took a beating last year due to weak investor sentiment and a raft of patent expirations. Yet with stocks like industry leader Pfizer now trading at roughly 15X this year's EPS estimates, the sector looks poised to rebound in 2003. Also, it's worth noting that pharmaceutical firms tend to move independently of the overall markets. So even if equities continue south, I still expect Pfizer to post solid gains this year. The stock remains on our Top Ten List.

PROCTER & GAMBLE (PG, $84) -- Marketing over 300 brands to 5 billion consumers in 140 countries, Procter & Gamble is the world's largest and most successful consumer products company. P&G is a rock-solid firm that should continue to do well no matter where the economy or geopolitical situation goes from here, so I'd view it as a stable value play for long-term-oriented, defensive-minded investors. In late January the company posted fiscal second-quarter earnings of $1.49 billion, or $1.06 a share, representing a 14% increase over the year-earlier period. In addition, P&G raised its third-quarter guidance to high-single-digit growth. For shareholders, this type of stellar performance has been par for the course in recent years, as P&G has managed to simultaneously boost sales (thanks to strong volume growth) and lower costs (thanks to an aggressive restructuring campaign). Although the shares could take a near-term hit if the highly acquisitive P&G announces another big acquisition, the stock looks attractive at current levels, especially in light of the current geopolitical turmoil.

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4.  THE PORTFOLIO TRACK -- AGGRESSIVE GROWTH "WATCH LIST"

Below you'll find a table of companies that I'm now considering as possible new additions to our Aggressive Growth Portfolio. My staff and I here at StreetAuthority are constantly researching and following all of these picks, and we may add a few of them to this portfolio if and when their risk/reward profiles meet our stringent investment criteria. Also, since there are very few true bargains in a down market (especially when it comes to aggressive growth stocks), we'll likely hold off on adding many of these picks until the broader indices begin to show signs of stabilization and strength.

Company                   Price
InVision Tech (INVN)       $25
NetScreen Tech (NSCN)       19 
PEC Solutions (PECS)        29
SRA Intl (SRX)              27 
Starbucks (SBUX)            22
USA Interactive (USAI)      23 

ACTION TO TAKE:

INVISION TECHNOLOGIES (INVN) -- From a portfolio standpoint, I think one of the best ways to take advantage of a war with Iraq might be to take a look at the less obvious -- and perhaps less immediate -- consequences that such a war could have. What I'm talking about here is the potential for a counterattack against the U.S. Although it's terrible to think about, Iraq -- or any major militant group sympathetic to that nation -- could try to mount a strike against the U.S. This would most likely come in the form of further terrorist attacks on U.S. soil, which would put a premium on those firms that produce security detection equipment. In fact, even if another attack does not take place in America, the mere threat and/or increased probability of such an attack should be enough to push shares of detection equipment firms higher.

InVision has already proven to be one of the biggest beneficiaries of the war on terrorism. The stock has soared in the post-September 11th environment thanks to booming sales of its FAA-certified explosive-detection systems, which are now being used throughout the nation's commercial airports. Although the firm will likely face stiffer competition from the likes of L-3 Communications and others in the future, the shares still look attractive at today's levels. Projected earnings of about $3.50 per share this year and solid long-term prospects make this a stock to watch. However, U.S. airports can only purchase a finite number of detection systems, so that market is likely to slow down in the future as capacity is filled. As such, I'm going to want to see InVision diversify its product lineup and expand its sales to foreign airports and other key markets before I'll consider adding the firm to our Aggressive Growth Portfolio.

NETSCREEN TECHNOLOGIES (NSCN) -- NetScreen is an emerging network security firm that provides a broad range of network firewall, virtual private network (VPN) and traffic management systems to major enterprises and service providers. If you've been reading this newsletter over the past few months, then you already know that the computer security industry is one of my favorites, as it is expected to grow at a double-digit clip for at least the next five years -- to $15 billion in annual sales by 2006. Despite the fact that most domestic firms are still slashing their IT (information technology) budgets, spending on critical network security remains strong. And as corporate networks grow in both scale and importance in the years ahead, this spending spree will no doubt continue.

Understanding that the computer security industry will remain one of the fastest-growing tech sectors in the years ahead is the easy part. The hard part is knowing exactly where to invest. Most security stocks are extremely volatile, and the industry appears to be poised for some major changes in the years ahead. I expect to see a swift round of consolidation here in the coming years, as the industry will ultimately come to be dominated by just a handful of giant firms that can offer comprehensive solutions in one integrated package. Symantec (SYMC, $46) should be one of these key survivors, which is why I've held it in my Aggressive Growth Portfolio for the past year. NetScreen, on the other hand, might have to either expand aggressively into new markets or look to partner up with a larger player. The firm's revenues and earnings are soaring at the moment thanks to strong demand for its VPN and firewall software, and this growth is likely to continue in the years ahead. But even though it could probably perform well as a standalone entity for at least the next few years, I think NetScreen might get snatched up by a larger rival before then. So the question then becomes, what would the company fetch on the auction block? My best estimate at the moment is at least $20 per share, but that value could change dramatically based on how the firm performs in the months and years ahead. In an effort to give us a greater margin of safety on this stock, I'm going to wait for another pullback into the low-teens before adding the shares to our Aggressive Growth Portfolio.

Side Note: Another firm in this industry that you might want to keep an eye on is Internet Security Systems (ISSX, $14), which recently partnered with major player Network Associates (NET, $15) to provide intrusion detection software to major customers. Analysts are now speculating that NET could make a buyout offer for ISSX sometime within the next year or so.

PEC SOLUTIONS (PECS) -- PEC Solutions is a professional technology outsourcing firm that develops web-based and other high-tech applications primarily for federal and state government entities. For example, the firm builds information systems for criminal justice departments, delivers technology solutions to defense and intelligence agencies, and provides management consulting services to the INS (Immigration & Naturalization Service), among other things. PEC has staked a strong foothold in the booming eGovernment solutions market in recent years, allowing the firm to post tremendous revenue and earnings growth (in the neighborhood of 70% for full-year 2002, although we'll find out more when the firm reports its 4Q results tomorrow) in an otherwise rough domestic IT market. I like the relative earnings stability PEC enjoys thanks to the fact that its main customer -- the U.S. government -- has the deepest pockets on the planet. In addition, PEC should benefit nicely from the government's new homeland security push. However, with the stock now trading at over 30X this year's projected EPS of 90 cents, the shares are far too richly priced for my taste. I'd wait for the stock to drop back to the low-$20s before considering this one.

SRA INTERNATIONAL (SRX) -- The story is much the same for this firm, which is also a provider of information technology services to the federal government. The shares trade at a comparable valuation to those of PECS, so until I see that multiple drop into at least the high-teens, I'm going to remain on the sidelines here.

STARBUCKS (SBUX) -- If you take a look around, it seems as though this specialty coffee retailer already has a store on nearly every street corner in America. Yet by expanding into new U.S. locations as well as hundreds of international markets, Starbucks aims to grow its store count from 6,000 now to roughly 25,000 by the time all is said and done. In fact, the firm plans to open a minimum of 1,200 units each year for the foreseeable future (that would equate to 20% growth this year alone). Yet this isn't the only source of growth for Starbucks. With recent same-store sales increases of 9% (in January), improving profit margins and other growth opportunities (bottled coffee drinks, etc...) in mind, Starbucks should have no trouble continuing its double-digit earnings growth streak well into the future. Analysts are calling for Starbucks' earnings to grow at a 23% clip each year over the next five years.

The company is still in great shape on the earnings and growth front, but trading at over 25X next year's EPS estimates of 80 cents, the shares don't come cheap. I might add the stock to my Aggressive Growth Portfolio on a dip back into the high-teens, but for now I'm content to watch this one from the sidelines.

USA INTERACTIVE (USAI) -- This firm operates a diverse lineup of electronic commerce and media outlets, including Expedia.com (EXPE, $63), Ticketmaster (TMCS, $21), Match.com, Home Shopping Network and Hotels.com (ROOM, $43). Despite the economic slowdown, each and every one of these business units has posted strong growth in recent quarters. In particular, the firm's Expedia.com and Match.com subsidiaries have been on an absolute tear, boasting year-over-year sales growth of 100% and 111% in the fourth quarter of 2002, respectively. With continued expansion of its existing business lines, strong free cash flow due to its new transaction-based focus, $2.9 billion of cash and marketable securities in the bank, and a number of potentially lucrative new acquisition candidates on the horizon, USA Interactive appears to be in excellent shape at the moment.

However, its stock is an entirely different story right now. USAI tends to be extremely volatile and is currently trading at a multiple that is far too rich for my blood. For those with a longer-term time horizon, the shares could perform well in the coming years. Buyer beware though: You should only consider USAI if you're willing to sit back and wait at least five years for CEO Barry Diller's e-commerce vision to become a reality. But given how quickly this business moves and how frequently the deal-making Mr. Diller has been known to change his business mix and strategy, USA Interactive could be an entirely different firm by then. That makes it extremely hard to predict the company's future revenue and earnings stream, so one really needs to have a great deal of confidence in the firm's management. In addition, it's worth noting that even though it is currently an industry leader in many categories, the barriers to entry in some of the firm's existing business lines (like travel and online dating) are fairly low, so USA's continued leadership in these markets is anything but certain.

Given all of the aforementioned risk factors, I would need a substantial margin of safety before I'd invest in the firm. Until the shares drop back to at least the mid-teens, I'm going to stay on the sidelines here.

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5.  NEAR-TERM SPOTLIGHT -- SHORT-TERM SWING TRADING IDEAS FROM DR. MELVIN PASTERNAK

In today's issue I'm pleased to bring you several more short-term trading recommendations from the newest member of our staff -- technical trading expert Dr. Melvin Pasternak. Melvin comes to us with more than 40 years of investing experience, having made his first trade in 1961. Along the way, he has spent more than a decade teaching classes in technical analysis for TD Waterhouse and has designed and taught stock market classes at the college level. On the educational and journalistic front, Melvin holds both Ph D. and MBA degrees and has previously written regular financial columns for a leading international website.

DR. PASTERNAK'S INVESTING PHILOSOPHY
An expert technical analyst, Melvin strongly believes in combining multiple indicators to enhance his probability of making profitable trading decisions. Through synthesizing candlesticks, trendlines, short-term four-stage analysis, moving averages, support and resistance, bollinger bands and indicators such as MACD and stochastics, he has built a solid track record of winning trades over the last several decades.

This week Melvin has been kind enough to provide STREETAUTHORITY MARKET ADVISOR readers with another batch of potentially profitable short-term trading recommendations, as well as continued guidance on his picks from last week. However, due to his extensive use of charts and other visual aids, you'll need to visit the special link below in order to view this week's recommendations. You can jump directly to Melvin's picks by clicking on the following link:
http://www.StreetAuthority.com/st/archives/02-10-03.htm#4

PLEASE SEND US YOUR FEEDBACK!
Would you be interested in receiving further short-term trading ideas from Dr. Pasternak each week? We're planning to launch a new newsletter -- the STREETAUTHORITY SWING TRADER -- with Melvin on March 1st, so we'd love to hear your thoughts! Any and all feedback you can give us would be much appreciated, so if you have any comments or suggestions (regardless of whether they are positive or negative), please do not hesitate to contact us at the following email address:

Feedback@StreetAuthority.com

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6.  STREETAUTHORITY'S TOP TEN LIST

(NOTE: We understand that you're looking for guidance not only on the stocks and funds that you already own, but that you also want to know which particular securities to buy NOW. In this section of the newsletter we present a list of the top ten stocks that we would buy TODAY if we didn't already own each of them. We have chosen these top ten from among our various portfolios and specialty lists.)

Company               Add     Add     Current Total  
                      Date    Price   Price   Return 
Capital Auto. (CARS)  10/01  $17.98   24.25    35%
Chelsea Prop (CPG)    10/02   31.99   34.05     6%   
Dow Jones REI (IYR)   10/01   77.32   74.10    -4%    
First Data (FDC)      10/01   28.75   33.84    18%   
Goldman Sachs (GS)    07/02   67.73   65.70    -3%  
Harley Davidson (HDI) 09/02   46.01   40.77   -11%   
Panera (PNRA)         10/01   16.40   27.46    67%  
Pfizer (PFE)          10/02   31.82   29.30    -8%   
Symantec (SYMC)       10/01   17.39   46.09   165%   
Target (TGT)          10/01   31.07   26.80   -14%   

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For an in-depth analysis of exactly why we like each of the above stocks and funds, please read the company descriptions posted on our web site for all of our holdings (on our Portfolio pages). 

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7.  INSIDE THE NUMBERS -- THE SEARCH FOR COUNTER-CYCLICAL STOCKS

(NOTE: In this section we use our proprietary software and screening methods to develop a list of investment opportunities that might be worth examining further.)

A few months ago I dedicated this "Inside The Numbers" section to the search for counter-cyclical stocks that I thought would hold up well during a continued market downturn. Since most of those picks have indeed held up well since then (some have even moved sharply higher!), and since many market analysts are now calling for the major indices to slump to new multi-year lows in the coming weeks/months, I thought that now would be an appropriate time to run a similar -- yet more robust -- screen in search of several new counter-cyclical investment opportunities. Enjoy!

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In an effort to diversify their portfolios, most investors spread their money around by purchasing a variety of mutual funds and common stocks. Many of the more thoughtful folks also take great care to ensure that their stocks and funds aren't heavily weighted in one particular industry group. They buy a few technology stocks, a few industrial conglomerates, a handful of REITS, a few financial plays, etc...

After carefully crafting this "diversified" portfolio, they then kick back and wait for the profits to roll in. The problem, however, is that many investors then expect their portfolios to outperform the S&P 500 in both good and bad markets. However, most don't even come close.

Why not?

For starters, it's critical to understand that diversification isn't exclusively dependent on the NUMBER of companies you hold in your portfolio. Sure, it's important to purchase companies that operate in a wide variety of different industries. However, doing so will NOT necessarily leave you with a well-diversified portfolio that will hold strong while the broader markets plummet.

Why?

Well, no matter how many holdings you have or how many industries you invest in, if most of your stocks and funds generally follow the performance of the overall market, then your individual portfolio will also closely track the broader market.

Millions of investors were perfectly okay with this when the S&P 500 (one of the best benchmarks for overall market performance) was booming in the late 1990s. But with the S&P now down nearly -50% from its all-time highs, I can't think of anyone who has been satisfied with the returns they've seen from the S&P over the past three years.

With this in mind, how can you ensure that your portfolio won't tank if the overall markets head lower from here? Well, nothing in life is guaranteed, but you can improve your odds of surviving a continued market crash by purchasing stocks that vary inversely with the S&P. (In other words, stocks that generally head higher when the overall market tumbles, but go down when the market rises.) But in order to do so, you'll first need a basic understanding of betas. (If you're already familiar with this financial concept, then please skip the next two paragraphs.)

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"Beta" is a basic measure of the systematic risk of a particular security. It is calculated by measuring the volatility of that security relative to a major market index -- usually the S&P 500. Although the specific equation and analysis used to calculate this variable is beyond the scope of this article, the good news is that you don't need to calculate it yourself. Since most major financial sites list beta values for all securities that they cover, you can usually just look this variable up.

When it comes to understanding betas, the important thing to realize is that betas indicate how a security has moved relative to the S&P on a historical basis. It's also important to know that they generally fall somewhere in the neighborhood of 1. A beta of exactly 1 indicates that in the past, the security has usually moved in tandem with the S&P. So if the S&P were to gain 20% next year, then all things being equal (and assuming that the stock behaves similar to how it has in the past), chances are fairly good that a stock with a beta of 1 would also gain about 20%. Meanwhile, a beta of greater than 1 indicates that the security is usually more volatile than the S&P. If the S&P were to gain 20% next year, then a stock with a high beta would probably gain even more. (It would also probably lose more in a down market.) A beta between 0 and 1 indicates a security that is less volatile than the overall market. Meanwhile, securities with betas of 0 generally don't move in tandem with the market at all. And last but not least, securities with negative betas generally move in the OPPOSITE direction relative to the overall market. These are the type of stocks we're going to focus on today.
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WHY FOCUS ON COUNTER-CYCLICAL STOCKS?
A number of prominent market analysts, including several bearish observers on our StreetAuthority.com staff, are now of the opinion that the S&P 500 is likely to hit fresh multi-year lows sometime in the coming weeks/months. Given that the downtrend that began in early 2000 is still intact, I also think there is a good chance that we'll see new lows sometime relatively soon. Since the S&P 500 is still around 10% off its October nadir (as of this writing on Thursday afternoon), and since that widely-followed index could head even lower from there in the months ahead, now might be a prudent time for you to diversify your portfolio by adding a few stocks that generally move in the OPPOSITE direction relative to the S&P.

With the above analysis as a backdrop, I searched through our universe of 10,000 stocks to find companies that met the following criteria:

1. Share price of above $2.00
2. Market capitalization of greater than $100 million
3. Average daily volume of greater than 100,000 shares
4. Beta of less than or equal to -0.20 (calculated based on the past five years of market data)

My goal was to come up with a list of firms that are fairly large and heavily traded, but whose shares generally move in the opposite direction relative to the S&P 500. After running this data through StreetAuthority's advanced scanning software, I came up with the following list of companies:

Company                         Price    Beta  
Alliance Gaming (AGI)            $14    -0.28
Blockbuster (BBI)                 13    -0.30  
Community Health (CYH)            18    -0.55
Endo Pharmaceuticals (ENDP)        9    -0.42  
Glamis Gold (GLG)                 12    -0.39
Hershey Foods (HSY)               64    -0.35  
Kinross Gold (KGC)                 7    -0.32
Philadelphia Suburban (PSC)       20    -0.29  
RenaissanceRe Hldgs (RNR)         39    -0.24 
Right Management (RHT)            14    -0.56  
Royal Gold (RGLD)                 26    -0.24 
Sierra Health Services (SIE)      13    -0.21  
Southern Company (SO)             28    -0.44 
TXU Corp (TXU)                    17    -0.44  
United Therapeutics (UTHR)        15    -0.29  

Before we go any further, it's worth noting that past performance is not necessarily indicative of future results. Although all of these firms have negative betas based on data from the past five years, this doesn't necessarily mean their betas will stay negative in the coming years. Also, I'm viewing this as a short-term move. As soon as the markets turn around, I'm going to present you with a list of high-beta stocks (above 1) that you might want to add to your portfolio in an effort to outperform the S&P on the upside.

At any rate, after having my research staff take a closer fundamental look at each of the above firms, we came to the conclusion that Endo Pharmaceuticals (ENDP), Glamis Gold (GLG), Kinross Gold (KGC), RenaissanceRe Holdings (RNR), Royal Gold (RGLD), Sierra Health Services (SIE) and Southern Company (SO) are all worth a closer look. (I would not hold the gold stocks for the long haul, but they could continue to outperform the S&P over the near term.)

As always, please make sure to do your own due diligence on each of these firms to decide if they are right for your portfolio.

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8.  COMING IN OUR NEXT ISSUE

I sincerely hope that you've enjoyed reading this edition of the StreetAuthority Market Advisor. We will publish our next full issue on Monday, February 17th. In it, I will take a closer look at the real estate sector and will examine a few of today's most attractive dividend-paying REITs (Real Estate Investment Trusts). In addition, I'll present you with a full sample issue of our newest short-term trading newsletter -- the STREETAUTHORITY SWING TRADER. In it, technical analysis expert Dr. Melvin Pasternak will not only bring you several additional short-term trading ideas, but he'll also provide you with continued guidance on today's picks (see section #5 above). And finally, I'll also feature our Value Portfolio in our PORTFOLIO TRACK section.

To view our publishing schedule for the remainder of the year, please click here:
http://www.StreetAuthority.com/ma/schedule.htm

Good investing in the week ahead!


Paul Tracy
Editor
The StreetAuthority Market Advisor
Washington, D.C.

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