Forex Investment

Updated from 11:33 a.m. EST

Stocks were having an up-and-down session Wednesday as mixed reports on the economy had traders struggling to position themselves ahead of the Federal Reserve’s upcoming musings on inflation.

The Dow Jones Industrial Average recently was gaining 25 points, or 0.2%, to 12,548. The S&P 500 was down fractionally at 1429, and the Nasdaq Composite was off 1 point at 2448.

Earlier, the Commerce Department said the U.S. economy grew at a stronger-than-expected rate during the fourth quarter. Gross domestic product rose 3.5% last quarter, up from a 2% annual pace in the third quarter, the government said. Economists had estimated the economy grew at a 3% rate.

The year-over-year change in inflation eased to 2.1% from 2.2% in the third quarter, but still remained a bit outside the Fed’s comfort zone.

The GDP report is the first of three that will ultimately be released on the fourth quarter.

Meanwhile, the Chicago purchasing managers’ index dropped to a reading of 48.8, below the consensus 52.0 and the lowest reading since April 2003. Though the Chicago PMI specifically discusses manufacturing activity in the Midwest, it’s closely watched for clues about the overall stability of the nation’s factory sector.

Another report from the Commerce Department said that construction spending fell 0.4% in December, whereas no change had been anticipated.

With all the data as a backdrop, investors were gearing up for the conclusion of a two-day Fed meeting in Washington. The central bank is expected to leave its target fed funds rate unchanged for the fifth straight time at 5.25%.

However, the Fed will also release a statement regarding its views on inflation, which traders will parse for any information about potential future moves.

“It would be tough for the Fed to consider sounding anything but extremely hawkish,” argued Marc Pado, U.S. market strategist with Cantor Fitzgerald. “With the weakness in housing potentially behind us, the Fed will have few excuses for why it isn’t raising rates at this or the next meeting.”

Treasuries were a bit higher. The 10-year note was up 3/32 in price and yielding 4.86%, and the 30-year bond was higher by 8/32 to yield 4.96%.

After a big rally on Tuesday, oil and other energy prices were having a rocky session, but were lately higher. Crude futures were at $57.47, up 50 cents.

The latest inventory report from the Energy Department showed that crude stores increased by 2.7 million barrels last week, distillate supplies rose by 2.6 barrels, and gasoline stocks climbed by 3.8 million barrels.

On the corporate side, Bristol-Myers Squibb (BMY) has hired investment bankers, a possible signal that it is exploring a merger, according to a published report. The Financial Times had the news, following its own article earlier this week that the company was mulling a deal with Sanofi-Aventis (SNY) .

Altria (MO) , the New York-based maker of Marlboro cigarettes, said it will spin off its 89% stake in Kraft (KFT) . The company will distribute 0.7 Kraft shares for every Altria share March 30.

Elsewhere, Time Warner (TWX) said its fourth-quarter earnings rose 34% to $1.75 billion, while sales climbed 8.2% year over year to $12.5 billion. Time Warner was off 15 cents, or 0.7%, to $21.89.

Fellow Dow component Boeing (BA) posted adjusted fourth-quarter earnings of $1.16 a share on revenue of $17.54 billion, exceeding Wall Street’s expectations. Shares were rallying $3.85, or 4.5%, to $89.85.

At Eli Lilly (LLY) , sales for the fourth quarter increased 9% to $4.25 billion, but earnings slumped to $132.3 million from $700.6 million a year earlier. Excluding charges, the drugmaker’s profits would have been $929.6 million, up 7%. On a per-share basis, adjusted earnings were 85 cents. Lilly was higher by 63 cents, or 1.2%, to $53.36.

Eastman Kodak (EK) swung to a fourth-quarter profit of $16 million, or 6 cents a share, from a year-earlier loss of $46 million, or 16 cents a share. Excluding items, the company earned 59 cents a share, beating the average estimate, even as revenue slipped 9% and missed targets. The stock was adding 26 cents, or 1%, to $25.78.

Equities were mostly lower overseas. London’s FTSE was losing 0.6% to 6203, and Frankfurt’s Xetra DAX was tacking on 0.1% at 6789. Tokyo’s Nikkei sank 0.6% overnight to 17,383, and Hong Kong’s Hang Seng dropped 1.7% to 20,106.

Following the closing bell, Internet search giant Google (GOOG) is expected to post fourth-quarter earnings of $2.92 a share. Homebuilder Pulte Homes (PHM) is projected to report a loss of a penny a share, according to Thomson First Call.

Meanwhile, analysts expect Starbucks (SBUX) to post fiscal first-quarter earnings of 26 cents a share after the market closes.

For more commentary from Tony Crescenzi and his instant reactions to the latest economic news, check out his blog on RealMoney.com.

According to the latest gross domestic product data, the U.S. economy expanded faster than expected in the fourth quarter, at a 3.5% pace compared to the forecasts for 3.0%. This gain followed subpar growth in the previous two quarters.

These fourth-quarter data are strong enough to keep the Federal Reserve on the sidelines. Although growth did accelerate, those who are bearish on the economy will seize upon some important factors in the GDP report:

- A decrease in business spending
- Sharp weakness in residential investment
- High government spending
- Lackluster nominal personal spending.

If the fourth-quarter GDP gain had been purer — in other words, if it had occurred in the absence of the aforementioned factors — speculation about the possibility of a renewed bout of rate hikes would surely have developed after the release of the report.

I don’t mean to discredit the fourth-quarter gain completely, and I have been upbeat about growth, but the reported gain must be watered down to some degree. Let’s take a look at each of the four factors listed above and how we can interpret the data.

Business Spending

First, business spending fell during the quarter, with spending on equipment and software falling at a 1.8% clip. That’s the second decline in three quarters and the largest since the fourth quarter of 2002.

The weakness is likely a response to the anemic GDP reports of the past two quarters, and businesses were probably concerned about growth prospects in light of the sagging housing sector and high energy costs that existed at that time. Business spending will probably pick up in the first quarter in response to the decline in energy costs and signs of bottoming in home sales.

Residential Investment

Another negative in the report is the sobering figure on residential spending, which subtracted 1.2 points from GDP and fell for a fifth consecutive quarter, by 19.2%. That follows decreases of 18.7% in the third quarter and 11.1% in the second quarter. The fourth-quarter decline was the highest since 1991, but seems likely to be the nadir for the cycle. Nevertheless, the decline is large enough to make clear that significant downside risks to the economy remain because of weakness in the housing sector.

Government Spending

The bear camp will surely note the relatively large contribution from the government sector, where spending increased 3.7%. The federal government led the way with a 4.5% gain in spending, which was boosted by an 11.9% gain in spending on national defense. State and local spending increased 3.3%. Overall, the government sector added seven-tenths of a percentage point to the fourth-quarter GDP gain.

The contribution should not be entirely dismissed, however, as it is likely to remain a feature throughout 2007 because of favorable budget situations at the federal, state and local levels. For example, the National Governors Association is forecasting nominal state spending to increase at a 7% clip in 2007, comfortably above its 30-year average of 6.4%.

Personal Spending

A negative that isn’t so readily apparent in the headlines relates to the pace of personal spending. On the surface, the figure looks solid, increasing 4.4%. The problem, however, is that it reflects a gain of just 3.6% in nominal spending because the personal consumption deflator fell 0.8%, its first decrease since 1961 and the largest decline since 1954, according to Market News.

This means that if the inflation rate for the quarter were at a normal level, say, up 2.0%, personal spending would have seen a very small gain of just 1.6% for the quarter. (I get this by subtracting 2.0% from 3.6%.)

The low level of nominal spending, which was the weakest in four years, reflects strain on the consumer. This figure represents the total amount of money that consumers spent during the quarter, a tally that looked good only because they caught a break with the decline in energy costs. Had energy costs increased, it would have produced a much different result. For context, nominal spending in the overall economy has increased at a pace of 5.6%; it increased at a pace of 5.0% in the fourth quarter.

When exchange-traded funds first hit the market, they were almost exclusively used to track indices such as the S&P 500.

With an ever-increasing demand for these baskets of securities that trade like stocks, ETFs have branched out to follow various sectors of business.

To identify the most-diversified ETFs, as measured by full exposure to all major sectors, TheStreet.com Ratings selected the funds reporting holdings in each of the following 12 sectors: basic materials, capital goods, communications services, consumer cyclicals, consumer staples, energy, finance, health care, technology, transportation, utilities and miscellaneous.

To ensure that a sufficient critical mass for influencing performance was present in each area, a minimum of 2% of assets had to be held in each sector.

The 10 ETFs passing the tests are listed in the table below. For each, the sector with the heaviest representation in the ETF’s portfolio is listed, along with the fund’s lightest sector holding.

In addition, the standard deviation of each fund’s array of sector holding percentages is displayed. This is a measure of how close together the fund’s percentage holdings of the 12 individual sectors are.

A low standard deviation means that the ETF is more evenly divided among individual sectors than a fund with a higher standard deviation is.

Thus, a low standard deviation of sector percentage holdings can be interpreted as an indication of less portfolio concentration and greater diversification.

Finally, the 12-month total-return performances and TheStreet.com Ratings grades for the ETFs are listed, in the below chart.

The Most-Diversified ETFs

Name and Ticker Symbol Heaviest Sector & Percentage Lightest Sector & Percentage Standard Deviation (%) 12-Mo. Total Return (%) TSC RATINGS GRADE
DOMESTIC SMALL-CAP FUNDS
iShares Russell 2000 (IWM) Finance: 24.42% Transportation: 2.47% 6.59 18.26 D-
iShares S&P Small Cap 600 (IJR) Finance: 18.90% Communic. Svcs.: 2.70% 5.34 15.08 D
Vanguard Small Cap ETF (VB) Finance: 25.13% Miscellaneous: 2.42% 6.53 15.78 B-
Vanguard Small Cap Value ETF (VBR) Finance: 25.13% Miscellaneous: 2.42% 6.53 19.54 B+
DOMESTIC MID-CAP FUNDS
iShares Morningstar Mid Core (JKG) Finance: 25.96% Transportation: 2.04% 7.72 14.22 B
iShares Russell Mid Cap Growth (IWP) Cons. Cyclicals: 18.75% Miscellaneous: 2.44% 5.88 10.51 C+
Vanguard Extended Market ETF (VXF) Finance: 26.15% Miscellaneous: 2.00% 6.63 14.38 C+
DOMESTIC LARGE-CAP FUND
SPDR 500 (SPY) Finance: 23.96% Transportation: 2.03% 6.18 15.81 C+
GLOBAL FUND (U.S. & INT’L STOCKS)
iShares S&P Global 100 (IOO) Finance: 16.76% Communic. Svcs.: 2.53% 4.04 19.90 C+
INTERNATIONAL FUND (NON-U.S. STOCKS)
streetTracks Dow Jones Stoxx 50 (FEU) Miscellaneous: 18.21% Energy: 2.19% 6.02 26.67 B-
Data as of 12/31/2006.
Source: TheStreet.com Ratings

This column was originally published on RealMoney on Jan. 30 at 9:09 a.m. EST. It’s being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Motorola (MOT) needs Carl Icahn.

I have never seen a company go from aggressive competitor to so-so indifferent player like this, other than what Carly Fiorina did with Hewlett-Packard (HPQ) .

On the other hand, I have seen Icahn stir things up in a positive way, and he should be welcomed, Jerry York-like, to Motorola. (York was helping General Motors (GM) to turn around until he quit in frustration because the company stopped listening to him.)

The cell-phone market, which Motorola used to dominate, hasn’t turned as horrid as the company implies. Sony Ericsson has done quite well. The climb in Nokia’s (NOK) stock is real; that’s from share-take and better phones.

As someone who believes in the Apple (AAPL) iPhone (how the heck did I get in the minority on that issue?!), I think things are only going to get worse for Motorola.

A few months ago, I had Time Warner’s (TWX) Dick Parsons on my show. I asked him what Carl Icahn brought to the party. He was enthusiastic and said that Icahn was a catalyst to bring about change, that he was constructive, had a lot of good ideas.

I bet Icahn does the same thing at Motorola if they let him.

They should welcome him aboard.

I recently wrote that plans to fire lots of workers won’t solve the underlying problem at Pfizer (PFE) and Motorola (MOT) : lousy product innovation.

If you survey the stock market landscape, you’ll find more former predictable growth stocks that now offer the same uncertainty that Pfizer and Motorola do. That, of course means that an investor shouldn’t pay the same high price-to-earnings ratio now for the less predictable growth of a Coca-Cola (KO) , a Citigroup (C) , an Intel (INTC) or a Dell (DELL) .

And it means that the relatively fewer growth companies still pumping out predictable double-digit growth, such as a Procter & Gamble (PG) or a PepsiCo (PEP) , deserve a higher multiple.

The most interesting — and potentially most profitable — cases are those once-great predictable growth companies that are now on the cusp. Will a company such as McDonald’s (MCD) return to the ranks of those companies able to produce predictable double-digit growth? Should investors think of Cisco Systems (CSCO) as belonging to this category? And is Johnson & Johnson (JNJ) going to defy skeptics and keep pumping out that growth?

Sometimes it feels like the universe of great, predictable growth stocks has become very small indeed. But, fortunately, investors are witnessing the emergence of a new generation of growth stocks in the developing economies of the world. That’s a topic for another day, however. New Developments on Past Columns “Five Buys for a Fourth-Quarter Rally”: There’s no place to hide, but a few spots in the supply chain do provide some shelter from the storm. In 2006, the average selling price for a 42-inch LCD television fell by almost 50%, according to iSuppli. That crushed profit margins at the companies that manufacture the sets.

Corning (GLW) , which supplies the glass for screens to setmakers, certainly didn’t escape the squeeze on prices as selling price for its glass tumbled in 2006. But the decline was a relatively less punishing 20%, according to Pacific Crest Securities, and that difference was enough to enable Corning to beat Wall Street estimates by 3 cents, or better than 10%, for the December 2006 quarter.

On Jan. 24, the company reported earnings of 31 cents a share, up from a 2-cents-a-share loss in the fourth quarter of 2005. Revenue climbed by 14%. Corning isn’t out of the woods yet, since the first half of 2007 is likely to be weak because of typical seasonal weakness in the first quarter — when Wall Street is looking for just 7% earnings growth — and continued pressure on glass and TV set prices.

Indeed, the company cut its guidance for the first quarter of the year by a penny and predicted a 10% to 15% drop in display volumes. As of Jan. 31, I’m extending my target price of $28 from June to December 2007. (Full disclosure: I own shares of Corning in my personal portfolio.)