SET Monthly Issue January 2010

| January 19, 2010

January 2010


As 2010 gets underway, the markets continue marching higher.  The S&P 500, Dow, and NASDAQ are all at or near 52-week highs.

It’s really mind blowing how far the markets have come without a major correction…

As the market rally progresses, two things have become clear to me.

First, the semiconductor companies have led the markets higher.  And I believe they will continue to lead the markets going forward.

The profit margins, revenue, and earnings outlook for the chip makers continues to improve.  In fact, the outlook is improving faster than investors and analysts can keep up with.

That means there’s still huge potential for gains in semiconductors.

Second, the best values are found in the health care sector.

Health care’s been the victim of uncertainty.  Investors have been hesitant to buy healthcare stocks with the cloud of government reform swirling.

Now as the clouds clear, it’s becoming apparent who the winners are.  The drug makers and biotech companies have won key victories.  These victories should boost these undervalued companies.


Technology’s been one of the strongest sectors since the market bottomed in March of 2009.  And the semiconductor industry’s leading technology stocks higher.  All signs point toward continued strength in 2010.

It was just last month we closed our position in SPDR S&P Semiconductor ETF(XSD).  We were able to grab a 55% gain over a seven month period.

I wasn’t planning on re-entering the chip makers right away but recent market action has presented us with a great buying opportunity.

You see, the entire semiconductor industry has pulled back in the wake of Intel’s (INTC) record setting quarter.  Intel’s Q4 gross margin expanded to an all-time high 64.7%.

Some investors think the chip makers are hitting a peak in margins and earnings. They’re taking the record setting numbers as their cue to lock in profits.

I think they’re missing the bigger picture.

Macro/Economic Trend:  Beginning Of A New Cycle

There’s no doubt in my mind the stage is set for the semiconductor industry to make a strong showing in 2010.  Intel’s Q4 numbers are setting the tone for what could be one of the most profitable cycles ever.

A couple of factors are combining to create a great environment for the entire industry.

First off, Microsoft’s (MSFT) latest operating system, Windows 7, is just beginning to impact the market.

Remember, this is the first new operating system expected to be widely implemented by businesses since Windows XP.  As businesses upgrade their technology, it will drive demand for the next 1 to 2 years.

So far, chip makers increased production’s being driven by consumer demand.  New laptops and gadgets are flying out the door.  Sales rates are higher than many analysts expected.  It’s a trend I expect to continue.

The one – two punch of personal and business spending will fuel strong sales of chips to the original equipment manufacturers (OEMs).  OEMs are the companies who put semiconductors to work in computers and gadgets.

The second factor is the low inventory levels at most OEMs.

Over the last two years, OEMs slashed inventories as the economy plunged into recession.  Up till now they have been slow to restock inventories, even as the economy shows signs of improvement.

When demand hits a critical pace, OEMs will need to rebuild inventory levels.  It’s the only way they can keep pace with demand for computers and other electronic devices.

The combination of strong demand and low inventory levels is a recipe for huge profits.

Fundamentals:  A closer look at XSD

XSD holds stock in 25 of the larger chip makers.

The expense ratio is 0.35%.

The top five holdings and percentage weight for XSD are –

Company Name Ticker % Weight
Atmel ATML 4.68%
Micron Technology MU 4.57%
Atheros Communications ATHR 4.38%
Skyworks Solutions SWKS 4.22%

Technicals:  The charts lead the way

XSD is in a strong uptrend.  The 20-, 50-, and 200-day moving averages are all sloping higher.

XSD has shown relative strength to the entire technology sector.  That’s to say XSD’s gains are bigger when the market advances.  And it gives back less of those gains when the market pulls back.

Back in early December, XSD consolidated between $44 and $45 for two weeks.  It broke out of the consolidation and set new highs for the rally a few weeks ago.


Now XSD has pulled back to support at the consolidation level.  This provides us with a good low risk entry point.

Trade Alert

Buy:  SPDR S&P Semiconductor ETF (XSD) up to $48.00
Recent Price:  $45.24
Price Target:  $57.00
Stop Loss:  $38.00

Remember:  We’re looking for strong consumer and business demand to fuel higher chip sales. The recent pullback looks like nothing more than profit taking in one of the strongest industries. Look for XSD to jump higher as investors jump back on the semiconductor bandwagon. This earnings season will be big…


The biotech industry enters 2010 poised for a breakout year.

Remember, biotech only came into existence in 1982.  So far in biotech’s relatively young existence, companies have brought over 250 drugs/treatments to market.  And now there are over 400 biotech drugs/treatments in testing!

I’ve read numerous reports about the astounding number of new drugs and treatments in various phases of testing and the future looks exciting.

Even if only a fraction of the treatments gain final approval, the financial implications will be staggering.

Macro/Economic Trend:  Investment Dollars Returning

The biotech industry is an interesting mix of large, medium, and small cap companies. But one thing holds true for biotech companies of all sizes… money hasn’t been flowing into the sector during the last few years.

It started in 2008 as the markets crashed in the wake of the credit crisis.  The riskier small cap companies watched new money dry up.  This was a big blow to many of the smaller firms.

These companies need piles of cash to keep operations going, at least until they get FDA approval for one of their drugs/treatments or they’re bought by one of the larger companies.

As the credit markets and investment dollars for riskier investments dried up, it depressed the valuation of the entire industry.

The industry’s prospects were looking better at the beginning of 2009.  I even went as far as recommending the industry back in March of ’09.  Unfortunately, the threat of health care reform bogged down the industry for the first part of the year.

Finally during the second half of ’09, the industry started to gain some traction.  A few new drugs/treatments gained approval and M&A activity began to pick up.

Now things are really heating up!

Biotech stocks are actually benefiting from health care reform.  New treatments/drugs will now have a longer time frame of patent protection before generics can be made.
That makes all biotech companies more valuable.

But that not all…

Remember, the large pharmaceutical companies need to rebuild their product pipelines.Big Pharma is constantly replacing existing drugs coming off patent protection. One easy way to do this is by acquiring smaller companies.  We’re already seeing this start to happen.

As more M&A deals get done, the valuation of the entire industry is bound to skyrocket.

Fundamentals:  A closer look at FBT

FBT is an equal dollar weighted index.  It puts 5% of its assets into 20 different biotech stocks.  The holdings are rebalanced on a quarterly basis.

The aspect that really drew me to this ETF is the equal dollar weighted index.

This method puts a bigger emphasis on small and medium-sized companies than a market cap weighted index does.  And the smaller companies are where you’ll see the biggest gains!

The expense ratio is 0.8%.

The top five holdings and percentage weight for FBT are –

Company Name Ticker % Weight
Affymetrix AFFX 5.15%
InterMune ITMN 5.09%
Nektar Therapeutics NKTR 5.05%
Celera CRA 5.02%
Genzyme GENZ 5.01%

Technicals:  The charts lead the way

Since the beginning of November, FBT has been in a strong uptrend.  It’s shot up almost 20% in 2 ½ months.  The 20-, 50-, and 200-day moving averages are all in a strong uptrend.

FBT really took off in December when the 20-day moving average crossed the 50-day moving average to the upside.  Since then, the 20-day moving average has been a floor of support as FBT works its way higher.


Trade Alert

Buy:  First Trust NYSE Arca Biotechnology Index Fund (FBT) up to $31.25
Recent Price:  $29.74
Price Target:  $37.25
Stop Loss:  $24.75

Remember:  The overall trend in the industry is higher.  We’ll see the biggest gains in the biotech sector made by small cap stocks.  And FBT is the best ETF at providing exposure to these explosive stocks.  Investors are beginning to buy biotech companies in anticipation of new drugs/treatments being approved and M&A deals getting done.


Consumer Discretionary (+0.7%)

We’re still coming up short of a full-fledged rebound in consumer spending.  Retail sales slipped on a month to month basis in December.  But they were good enough for a 5.4% gain from Dec ’08.

The trend of increasing consumer spending is improving but there’s still work to be done.  What we really need is the unemployment rate to start shrinking.  Consumer spending will have a hard time of improving from these levels as long as un- or under- employment stays at current levels.

Consumer Staples (-0.9%)

The consumer staples sector is being driven by the same data driving the discretionary stocks.

As the economic recovery becomes more mature, the rapid market gains we saw for much of ’09 will slow.  This should cause the staples to begin to rise at a pace closer to the overall market in 2010.

Energy (+6.7%)

Oil rallied to set a new high for the rally above $83 last week.  Now crude oil has retreated back under $80 as the US Dollar strengthens.

Remember, a stronger dollar makes commodities more expensive to foreign investors. The US Dollar and oil will continue to move in opposite directions until the supply and demand dynamic changes.

Financials (+3.8%)

A number of key earnings reports over the next few weeks will put the financials recent rally to the test.  And if JP Morgan’s results are any indicator, they could be in for a bumpy ride.  They reported Q4 revenue numbers below analysts’ estimates.

I’m expecting investors’ expectations for economic recovery and a recovery in the financial sector to diverge in 2010.  The economy will continue to recover but earnings in the financial sector will be slower to come back.  The banking industry in particular faces a number of issues that will prevent them from being a leading sector in the near future.

Healthcare (+3.0%)

The political debate is still the dominate force in the sector.  Recent developments in the Massachusetts election to replace Sen. Edward Kennedy have thrown uncertainty back into the equation.

Regardless of the outcome of healthcare reform, the biotech industry looks like it’s primed for a banner year.  We’re recommending the First Trust NYSE Arca Biotechnology Index Fund (FBT) this month… see Trade Alert 2 for more details.

Industrials (+3.2%)

As the global economic recovery picks up steam, the industrials should continue to post solid gains.  At this point, it’s all about the pace of the recovery.  Growth estimates remain relatively conservative.  If the recovery proves to be more robust than expected, industrials should outperform other sectors.

Technology (+1.9%)

According to some analysts, growth in business investment in technology is now outpacing growth in total business investment.  It’s clear that businesses are focusing on driving productivity and cutting costs through the use of new technology.

However, the amount of money businesses are spending on tech is still well below average.  As spending returns to more normal levels, the sector should continue to outperform other sectors of the market.

We’re recommending the SPDR S&P Semiconductor ETF (XSD) this month… see Trade Alert 1 for more details.

Materials (+4.2%)

Basic materials stocks are among last year’s best performers.  The sector’s recovery mirrors the higher expectations for the world economy.

Further gains in the sector hinge on China’s appetite for materials.  The fear is China’s economy is too dependent on government stimulus measures and easy credit.  Now China has begun shrinking the money supply.  So the question becomes, will the increased demand hold up as the government removes the training wheels?

Utilities (-2.9%)

Utility stocks pulled back recently after an impressive rally to end the year.  Overall, utility stocks underperformed the more cyclical sectors in ’09.

Now as the recovery becomes more mature, utility stocks’ solid dividend yield and potential for earnings growth should boost investors’ interest.

Portfolio Changes

  • This month we’re buying XSD and FBT…
  • Market Vectors Agribusiness ETF (MOO) hit our price target.  Sell for a 31% gain!


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