Finding the Market's Sweet Spot

08/06/2009 1:00 pm EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

Richard E. Band, editor of Profitable Investing, says mid-cap stocks are a good place to profit from an incipient economic recovery, and he recommends one fund and one ETF.

Even after a 40% stock market rally, the mood of the nation remains sour. On balance, though, it seems to me that the evidence points to a happier outcome. We aren’t in for a dramatic V-shaped business recovery this year, but a broad saucer bottom appears to be forming.

Among the signs:

1. First-time claims for unemployment insurance have dropped sharply. Unlike the unemployment rate, the number of folks filing their first claim for jobless insurance is a forward-looking indicator. Since late March, the weekly total of first-time filers has plunged by more than 150,000 (about 22%). The job market is beginning to stabilize.

2. Inventories are shrinking. On July 9th, the Commerce Department reported that inventories in the hands of US wholesalers fell in May for the ninth month in a row. At the current sales pace, it would take 1.29 months for distributors to unload the entire stock of goods on hand—the smallest overhang since November.

Next stage: Factories ramp up production.

3. Exports are creeping up. While imports have plummeted for ten months in a row, exports rose by $1.9 billion in May, the first up tick since July 2008. Foreign countries, especially the fast-growing emerging markets of Asia and Latin America, are buying more of our goods and services.

[One] area where I advise you to concentrate your buying now [is] mid caps. Mid-sized companies (those with a market value of roughly $1 billion to $4 billion) have made a splash this year. Through June 30th, the Standard & Poor’s Mid-cap 400 index chalked up a total return, including reinvested dividends, of 8.5%—more than double the gain on the large-cap S&P 500 index.

As the market recovery proceeds and investors get more comfortable with smaller, faster-growing companies, I look for the mid-caps to extend their lead. They’re certainly cheap enough, trading (as a group) at only five times cash flow, less than half what they fetched five years ago.

I could single out individual mid-caps, but why not own all 400 companies in the index via an exchange traded fund, the Midcap SPDRs (NYSE: MDY). MDY carries an annualized expense ratio of only 25 cents per $100 invested, making it an extremely efficient vehicle. Pay up to $110 for MDY. (It closed above $116 Wednesday—Editor.)

Perkins Midcap Value (JMCVX) is up 7.9% [this year]. Why an actively managed fund rather than an exchange traded index fund like MDY? Only this: Tom Perkins is a brilliant skipper who has beaten the S&P mid-cap index by 2.8% a year, net of fees, over the past five years. Go with MDY if you prize the freedom to trade any time during the business day; go with JMCVX if you plan to let a great manager make money for you over many months or years.

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