CLASSIC ROTATION UNDERWAY

During the past 28 days, the S&P energy sector is down 3%, the utilities sector is down 4%, the technology sector is dead even and the consumer staple sector is up 3%. These are numbers one should expect half way through a business cycle. Among the strong stocks during the second half of the business cyclewill be the steady earning companies that are either out of debt or steadily paying down debt.

Companies that rely on financing will be hurt when long rates start to rise (the ten year is near a multimonth high today). In recent weeks, the homebuilders and REIT's have taken it on the chin. The economy is currently slowing a little. Consumer confidence was smacked by high gas prices. Should spending continue to slow enough to bump claims for unemployment and should the fed continue to raise short rates, the word recession will be mentioned often. The word recession has a chilling effect on the actions of consumers and investors. The word reminds me of the contest between the wind and the sun to take a mans coat off; no matter how hard the wind blew, the more firm the mans hold on the coat. The sun smiled on the man and he took the coat off immediately.

The reason the FOMC always seems to over shoot is that the sun shines brightly until the FOMC finally gets on top of the curve, then suddenly the cold wind blows. Investors and consumers run for cover. The good news is that long rates drop when the FOMC makes it to the top. The decline in long rates then makes stocks compelling investments.

Based on current inflation rates, one can easily argue that ten year rates should be at least a point or even two higher. The problem is that the most recent inflation numbers have already been partly mitigated by declining energy costs. It is impossible to call if the next bump in short rates will convince the markets that inflation is not a problem. The next bump could easily send the dollar up, gold down and long rates down. Historically, the market starts to move up at the next to last bump in short rates.

If you are in the right stocks, the timing of the exact bottom is not very important. My family remains over weight in the airline stocks. We own financials, tech, internet, rail roads and more but we are loaded up on CAL, AMR and LCC. Google is perhaps our second largest holding.

In the coming weeks, we are likely to add more consumer staples and pretty soon we will be investing heavily in pharmas. The family currently owns MRK and PFE. These beat down companies will do well after the projected run in staples.

Today was an interesting market day. The drop in oil took down the energy sectors hard while the slamming of the bond market held the lid on everything else. Even the airlines struggled in the face of crude oil down $1.60.

Only 6% of US refining capacity is still shut in! Gulf production is still off 60% but crude is not the problem; supplies jumped 4 billion barrels. Heating oil and natural gas will be expensive all winter but crude oil prices and gasoline prices should continue to fall. I figure airlines will be moving well by the time crude hits $55.

Other "late cycle" stocks should be owned. It gets a bit tricky in the techology area. Traditional late cycle stocks would include mainframe computers and software such as IBM and Oracle. This cycle it is going to be interesting to see how quickly businesses adobt thin client technologies. SUNW may be sitting at the right place at the right time.

Sentiment, money, valuation are all lining up favorably for stocks. I expect a 30% year over year move but can't tell you when it will start. I know traders and investors are eager for the "BIG BULL" to run. A lot of money will climb on when the rally breaks through the trading range of about 2 years. History shows that long sideways trading is usually followed by a blow out year. It could start any day now!
RUN BULL RUN!