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NEW YORK (AP) - Treasury Secretary Henry Paulson said Friday that China was not moving quickly enough on currency reform, and said he hoped high-level talks next month would produce results. “They’re not moving in my judgment quickly enough,” Paulson said in a speech in New York. “I feel quite strongly there’s a need to move more quickly in the short term, but we need to get to a point in the intermediate term where China has a market-determined currency. “There...

Weekend Reading

Past performance is not a guarantee of future performance.

I remember a time when Fannie Mae (FNM) was a failed financial company, viewed no better than a savings and loan during the lending crises of the 1980s.

The FDIC and Congress worked through the savings and loan debacle, while a restructured Fannie Mae provided much-need capital and liquidity for the financial lending system. Those shareholders who were patient with this stock saw it move from a low of $2 in December of 1987 to a high of $89 in December of 2000.

Flash forward six years.

This week, Ben Bernanke issued a warning that all financial crises involve the failure of a large entity and originate from oversight failure. He clearly spelled out a case against two government sponsored entities: Fannie Mae and Freddie Mac (FRE) . In the process, he pointed out that their combined outstanding debt exceeds $5.2 trillion, more than the $4.9 trillion of public government debt.

So what’s Bernanke’s problem with the government sponsored entities (GSEs)?

The situation is pretty clear. These are two large entities at the heart of the financial markets where investors incorrectly continue to assume an implied government guarantee. And the misplaced incentives reward the companies for taking risks.

The effect, according to Bernanke, is a pair of undercapitalized entities that, unlike banks, will not protect investors. Shareholders must bear the burden of a restructuring when it occurs.

It seems the market agrees. Fannie Mae shares were down 3.5% to $54 during the last five days. In the same period, Freddie Mac shares were down 3.2% to $62 per share.

While these two stocks currently have yields around 3%, we think it’s best to avoid adding more to positions in these two stocks until the recapitalization plans are clear. Who knows, maybe the investment bankers can help the GSEs attract some of that Far East excess capital. It may seem less risky an investment from abroad.

Speaking of the Far East and companies with foreign business franchises, this week American International Group (AIG) sold $1 billion in 30-year hybrid bonds to fund its $8 billion share repurchase program. It joins a variety of financial services companies, including Travelers (TPK) and Liberty Mutual, that are using the debt markets to raise capital that qualifies as a form of equity with the rating agencies.

If the AIG repurchase program is completed during 2007, this would represent 4.5% of the shares outstanding.

It’s clear that AIG President Martin Sullivan wants holders of junior bond securities to pay off shareholders while the company figures out where its excess capital is and how to get at it.

Those with long memories will recognize this debt-to-equity approach as a very successful strategy used by the formerly public American General, a company that is now part of AIG’s U.S. operations. As American General’s debt came to maturity, bondholders took the stock and increased shareholder value.

Unfortunately, no guarantee of the same excess returns for investors is baked into the new hybrid securities. While AIG management appears to have a recapitalization plan based on computer simulations, the challenge here will be to get key regulators, major agencies and shareholders to understand that less is more.

Over the last year, AIG shares have returned only 5%. Being the pragmatic types, AIG management also announced that we should expect acquisitions and divestitures that should free up capital too.

For those looking for a real buyback program, we recommend a closer look at Prudential (PRU) , which also has the benefit of a Far East connection with its significant life operations in Japan.

International business accounted for 25% of total 2006 revenue. The company appears to be hitting on all cylinders now and has returned 20% over the last year. Over the last year, Prudential shares returned 20%.This one looks like a more appealing use of shareholder capital.

Some managers recruit talent one person at a time. Mark Metz hires en masse. In 2001, Metz, the chief executive of Optimus Solutions, a Norcross (Ga.) outfit that sells and services corporate computer systems, recruited a team of 10 people from a local information technology consulting firm. Two years ago, after luring a manager at a network equipment provider, Metz went on to hire the manager’s 30-person team in one swoop. This team strategy has been a part of Optimus since Day One. Within...

Weekend Reading

Many investors and most media outlets are looking to the next round of corporate earnings as the key to the coming week. The earnings parade does hit full speed in the days ahead (highlights below), and the suddenly less-confident bulls are hoping quarterly results will be better received than in the week just passed.

Traders, meanwhile, are turning their attention to Tuesday’s State of the Union address — specifically, to expectations President Bush will once again highlight America’s “oil addiction” and the need for alternative energy solutions.

“Based on all we’re hearing, he wants to try to get ahead of this [alternative energy] bandwagon,” says Greg Valliere, chief Washington strategist at Stanford Financial Group. “His main goal is to take some attention away from Iraq. Republicans are scared about further losses [in 2008] , and they have to change the subject. What better issue than this?”

Unlike Social Security reform or tax credits for private health insurance, alternative energy initiatives have the advantage of enjoying true bipartisan support. There is even talk in Washington circles that the president will sign the House bill passed Thursday aimed at rolling back billions of oil-industry subsidies, provided it clears the Senate.

“Bush will be conciliatory on the subject,” Valliere says. “He is starting to soften a bit on the issue of global warming [and] alternative energy.”

After Bush’s “addicted to oil” comment in his 2006 State of the Union, alternative energy stocks soared en masse, and many traders are looking for a repeat performance from names such as Evergreen Solar (ESLR) , SunPower (SPWR) , Pacific Ethanol (PEIX) and the often-controversial Xethanol (XNL) , which recently got a new CEO. Each was up solidly amid Friday’s otherwise lackluster tape.

Meanwhile, alternative energy stocks such as Hoku Scientific (HOKU) , the beneficiary of a polysilicon contract with Sanyo Electric, and DayStar Technologies (DSTI) , which restructured its debt Friday, were big winners last week, an otherwise difficult period.

Other winners last week included Terra Industries (TRA) and Terra Nitrogen (TNH) .

However, one money manager sees these agricultural chemical plays declining in the coming week because they had previously benefited from weakness in natural gas, which he believes will resume Friday’s bounce of 57 cents to $6.89 per million British thermal units.

Crude also rebounded Friday, as did energy stocks such as Schlumberger (SLB) and Anadarko Petroleum (APC) . Whether the traditional energy sector continues to rebound will be another key theme of the coming week — and another factor in whether alternative energy stocks can rally, since falling energy prices had previously damaged their appeal.

Indeed, “the big story going into next week is alternative energy — solar, wind power, ethanol, carbon energy,” says the fund manager, who requested anonymity. “People are going to start writing about it on Monday and Tuesday going into the speech, and you’ll see nothing but strength going into that.”

The fund manager is wary of corn-based ethanol plays such as VeraSun Energy (VSE) because of rising corn prices, but is bullish and long Environmental Power Group (EPG) , which owns and operates renewable energy production facilities; he believes the stock will benefit if President Bush does return to the alternative energy theme.

Another option for those seeking exposure is the PowerShares WilderHill Clean Energy (PBW) ETF, whose largest holdings can be found here.

Whatever alt-energy vehicle you prefer, don’t wait until after Bush’s speech Tuesday night if you want to make a bet on the SOU. The folks on Wall Street are already lining up their proverbial ducks.

One final thought on energy investing comes from Ken Fisher, CEO of Fisher Investments, a $35 billion investment management firm.

“You want right now to look at energy and say to yourself: What would not do badly if energy prices go down but do well if energy prices go up, and what would not do badly if energy prices went up but do really well if energy prices go down, and put those two together,” Fisher said in an interview on TheStreet.com TV Friday.

Saying “the set is stronger than the individual pieces,” he prefers StatOil (STO) in the former category and Agrium (AGU) in the latter, calling it a “reverse energy play” and citing the “negative correlations” between the two. Fisher’s firm is currently long both stocks.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Environmental Power Group, DayStar Technologies and Hoku Scientific to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices. Earnings Onslaught

Corporate earnings will dominate attention in the coming week, but a few key economic releases concerning the housing sector could steal a headline or two.

On Thursday, the National Association of Realtors will announce December existing-home sales data. The consensus estimate is for a rate of 6.3 million sales on an annualized basis, up slightly from the rate of 6.28 million in November.

New-home sales figures for December are set for release on Friday, along with the durable goods orders for the month. Economists are looking for new-home sales to have climbed to 1.053 million from 1.047 million the prior month. Durable orders are expected to show a rise of 1% vs. growth of 1.9% in November.

The earnings cascade resumes Monday with reports from Eaton (ETN) , Pfizer (PFE) and American Express (AXP) .

Chipmaker Texas Instruments (TXN) also will report Monday amid a rough spell for the semis. The company has already warned that sales were below its original expectations.

Tuesday’s highlights include reports from Bank of America (BAC) , DuPont (DD) , Johnson & Johnson (JNJ) and Advanced Micro Devices (AMD) .

Yahoo! (YHOO) is on tap to report earnings after the bell Tuesday. Analysts are looking for the Internet giant to post earnings of 13 cents a share, down from 16 cents last year, on sales of $1.22 billion.

Among some of the notable names on Wednesday’s earnings docket are Corning (GLW) , ConocoPhillips (COP) , eBay (EBAY) , McDonald’s (MCD) and General Dynamics (GD) .

The action remains hot and heavy on Thursday with reports from AT&T (T) , Bristol-Myers Squibb (BMY) , Ford Motor (F) and Lockheed Martin (LMT) .

Microsoft (MSFT) will also be reporting its second-quarter earnings on Thursday. Wall Street expects the software giant to post earnings of 23 cents a share, down a dime from a year ago, on revenue of $12.06 billion.

The frenetic pace cools off a bit on Friday, but there will still be some big hitters stepping up to the plate, including Dow components Caterpillar (CAT) and Honeywell (HON) .

Staff reporter Gregg Greenberg contributed to this story.

1 What would best describe your stance heading into the coming week of trading?

Bullish
Bearish
Neutral

2 Which of these sectors do you think is set to move up in the coming week?

3 Which of these sectors do you think is set to move down in the coming week?

EIGHT climbers on three mountain ranges in Scotland were rescued yesterday as severe weather conditions prompted the busiest weekend for search and rescue teams so far this year. Amid heavy snowfall that presented “very demanding conditions” for rescuers, three military helicopters and search teams were sent out to the separate incidents. Two ice climbers were found by search teams in Torridon, Wester Ross, along with three others in Glencoe and three walkers missing in the Killin...

Weekend Reading

The market will look to recover from its New Year’s hangover in the coming week.

Stocks have slumped since the market reopened for business after an extended break. In 2007’s three days of trading, the Dow fell 65 points, or 0.5%, and the S&P 500 was down 8 points, or 0.6%. The Nasdaq, meanwhile, rose about 19 points, or 0.8%.

Although it’s easy to slough off a holiday-shortened week of trading, market strategists are wary of starting the year on the wrong foot. According to Miller Tabak senior market strategist Phil Roth, “the first five days of January tends to forecast the month as a whole, and January tends to forecast the year, especially down Januarys.”

Stocks took an especially hard dive on Friday after an unexpectedly strong jobs report that appeared to diminish the chance of an interest rate cut anytime in the near future.

Traders have been hoping the Fed will cut the fed funds target, the rate banks charge each other for overnight loans, sometime this year. The target has been at 5.25% since June, and the Fed has gone four meetings leaving it unchanged.

Interest rate worries overrode the market’s other big story last week which was the downward spiral in oil prices. Crude prices fell roughly 8% over the week and closed Friday at $56.31 a barrel.

Oil could continue to influence trading in the coming week, as could the government’s retail sales report and the first big-name earnings release for the fourth quarter. Earnings Turnaround

Dow component Alcoa (AA) , whose report is often viewed as the unofficial kickoff to earnings season, will release its results on Tuesday.

Analysts surveyed by Thomson First Call expect the aluminum giant to post earnings of 66 cents a share, up from 35 cents last year, on revenue of $7.63 billion.

To start the week, Horizon Health (HORC) , Spectrum Control (SPEC) and Schnitzer Steel Industries (SCHN) will be reporting earnings on Monday.

Aside from Alcoa, Tuesday will bring reports from Emmis Communications (EMMS) , Ruby Tuesday (RI) , Audiovox (VOXX) and WD-40 (WDFC) .

Genentech (DNA) will highlight Wednesday’s earnings lineup. Analysts are expecting the biotech powerhouse to report a fourth-quarter profit of 55 cents a share, up from 34 cents last year, on revenue of $2.53 billion.

On Thursday, M&T Bank (MTB) , Stride Rite (SRR) and XM Satellite Radio (XMSR) will be on the earnings docket. Economic Checkup

The health of the U.S. consumer will be examined on Monday, when consumer credit for November is released. Economists expect a rise of $5.5 billion, compared with a drop of $1.2 billion in the prior month.

Despite the projected spike in credit card debt, Wachovia economist Gina Martin says the consumer is holding up far better than anticipated, primarily due to wage growth.

“People have not needed to take out as much credit because they have seen their incomes rise,” says Martin.

Meanwhile, Wednesday will spotlight the health of the nation’s finances with the release of the November trade balance. Economists are predicting the nation’s trade deficit will widen to $59.5 billion for the month from $58.9 billion in October.

Wholesale inventories for November also will be released on Wednesday. Economists are projecting a 0.5% rise, after 0.8% growth in October.

The December Treasury budget will be delivered on Thursday. Economists will be looking for the nation’s coffers to expand by $21 billion, up from $11.2 billion the month before.

The consumer returns to the spotlight on Friday with the release of December retail sales. The consensus estimate is for a rise of 0.7%, down from a 1% jump in November. Excluding autos, retail sales for the month are expected to rise 0.6%, down from the 1.1% increase the prior month.

“Retail sales may not look that strong at first glance, especially compared to last year, which was the strongest since 1999,” says Wachovia’s Martin. “But it’s still going to be a strong season.”

Also scheduled for release on Friday are import and export prices for December, as well as business inventories for November.

1 What would best describe your stance heading into the coming week of trading?

Bullish
Bearish
Neutral

2 Which of these sectors do you think is set to move up in the coming week?

3 Which of these sectors do you think is set to move down in the coming week?

The chief executive of a Boston private equity firm that is under investigation by the U.S. government for its connection to groups that allegedly finance Islamic extremists has said his company is not linked to terrorism. “We do everything appropriately and by the book, and we adhere not just to the letter of the law, but to the spirit of the law,” James Godec, head of Overland Capital Group, said Wednesday. “I am extraordinarily cautious about this kind of stuff.” The...

Weekend Reading

By now you’re probably tired of predictions for 2007, so I’ll spare you my thoughts on where the market is headed this year. However, in the course of conducting our research on exchange-traded funds, we’ve arrived at a few conclusions that are contrary to the prevailing wisdom.

Value continues to outperform growth. Value stocks have outperformed growth stocks for six consecutive years, about as long as growth predominated in the late 1990s. As a result, many strategists are forecasting an imminent reversal in fortune in favor of growth. But I believe that the excesses of the late 1990s were such that growth stocks are still relatively overvalued.

It’s a dirty little secret, but the methodology used in selecting constituents for inclusion in the iShares S&P 500 Growth Index (IVW) and iShares S&P 500 Value Index (IVE) funds isn’t particularly good at separating companies with fast earnings growth from those with slow earnings growth.

What it primarily seems to do is separate expensive stocks from cheap ones, on the apparent presumption that expensive ones are priced that way because they will deliver rapid earnings growth — in a sense putting the cart before the horse. But since 2000, stocks in iShares S&P 500 Value have delivered faster compound earnings growth than the stocks in iShares S&P 500 Growth!

That’s not to say growth stocks won’t ever increase earnings faster than value stocks. In fact, this year companies in the iShares S&P 500 Growth Index are expected to grow earnings 10.6%, compared with growth of just 8.1% for companies in the iShares S&P 500 Value Index (although the value fund trounced the growth fund in 2006, with earnings growth of 18% and 11%, respectively).

But the point is that stocks in the growth index cannot be depended on to produce superior earnings growth over the long term. So it is unlikely that, in an environment of overall slowing in earnings growth, (S&P 500 EPS growth is expected to slow to about 9% in 2007 from about 14% last year) where estimates are cut more often than they are raised, investors will be patient waiting for the ethereal promise of growth to materialize.

The iShares S&P 500 Growth Index currently trades at about 16.4 times estimated 2007 EPS, compared with 13.9 times for the iShares S&P 500 Value Index. Remember, just because you “pay up” for earnings growth doesn’t mean you’ll get it.

Price-to-Earnings Ratio on 2007 EPS

Source: AltaVista Independent Research

With the exception of China, emerging markets continue to do well.. It’s almost an article of faith on Wall Street that emerging markets are overdue for a fall. Citing the phenomenal performance of these markets over the past few years, and the fact that historically they have been very volatile, many strategists conclude that there must be a reversion to the mean, and therefore a nasty correction is coming.

Lucky readers who’ve doubled or tripled their money in emerging markets may want to take some profits to rebalance their portfolios, but we advise against abandoning the sector. The components of the iShares MSCI Emerging Markets Index (EEM) still have a cheaper average P/E ratio than that of the constituents of the S&P 500, but it offers faster earnings growth.

I realize most would argue that emerging markets deserve a lower P/E ratio, but iShares MSCI Emerging Markets is composed of world-class competitors such as Samsung, many of which got to be that way by beating the pants off American (or Japanese) companies.

Further, the majority of stocks in this ETF are in the form of American depository receipts and thus are subject to the same accounting and disclosure requirements as, say, General Electric (GE) . We’d argue that Samsung’s fortunes and the performance of its stock have more to do with worldwide demand for the company’s products, and less to do with the fact that its headquarters are in Seoul.

One emerging-market fund we would avoid is iShares FTSE/Xinhua China 25 (FXI) , which is dominated by financial, telecom and energy firms, all of whose fortunes are tied to Chinese domestic demand.

While China’s economy is growing at a blistering pace, iShares FTSE/Xinhua China 25 now trades at nearly 17 times estimated 2007 EPS, and expected 2007 growth for the fund is just 4%. That makes the fund more expensive and slower-growing than iShares MSCI Emerging Markets. It is also more risky, in our estimation, owing to its single-country focus and the lack of any internationally known companies in the fund.

Estimated 2007 Earnings Growth

Source: AltaVista Independent Research

Fundamental indexing proves its mettle. A lot of indexing gimmicks have been introduced over the past few years, but one innovation that has real value, in my opinion, is fundamental indexing. This strategy seeks to avoid the Achilles’ heel of market-cap-weighted indices, which are by definition overweight stocks that later prove to be overvalued, and underweight stocks that later prove to be undervalued.

Although there are several approaches to fundamental indexing, I like the PowerShares FTSE RAFI 1000 (PRF) , which weights about 1,000 large- and mid-cap stocks according to sales, earnings, dividends and book value. Though the ETF has existed for just over a year, the back-testing results for fundamental indexing I’ve seen are impressive — and not just for this single diversified product but sliced and diced across sectors, market-cap segments and geographic regions, in both bull and bear markets.

It’s real-world results that matter, however. Compared with the iShares Russell 1000 (IWB) fund, which has, by and large, the same constituents, but is purely market-cap weighted, the PowerShares FTSE RAFI 1000 outperformed by over 3.0 percentage points last year. The difference in performance is more than enough to compensate for the difference in expenses between the two funds (the PowerShares FTSE RAFI 1000 has an expense ratio of 0.60% while the iShares Russell 1000 charges 0.15%).

Fundamental Indexing Proves Its Mettle
PowerShares FTSE RAFI 1000 outperforms iShares Russell 1000

Note: Rebased, December 2005=100

I realize that one year of results is probably not enough to convince the skeptics, many of whom will maintain that it’s too early to tell. But I believe the gap in performance between the PowerShares FTSE RAFI 1000 and the iShares Russell 1000 will continue to widen in 2007, proving the mettle of fundamental indexing. At any rate, I think the PowerShares FTSE RAFI 1000 could be an excellent choice for “set it and forget it” investors who seek to outperform the market over the long term by systematically avoiding market excesses.

The moves, which will be focused on the production side of the business, were announced as Astra said annual profits rose 28% to $8.54bn (4.36bn). Delivering a performance in line with City expectations, Astra said sales of its five key growth products - including cholesterol-lowering product Crestor - had been strong. But it warned that the company, as well as the industry, needed to face up to the challenges posed by patent expirations and pricing pressures brought about by governments...

Weekend Reading

The market will look to recover from its New Year’s hangover in the coming week.

Stocks have slumped since the market reopened for business after an extended break. In 2007’s three days of trading, the Dow fell 65 points, or 0.5%, and the S&P 500 was down 8 points, or 0.6%. The Nasdaq, meanwhile, rose about 19 points, or 0.8%.

Although it’s easy to slough off a holiday-shortened week of trading, market strategists are wary of starting the year on the wrong foot. According to Miller Tabak senior market strategist Phil Roth, “the first five days of January tends to forecast the month as a whole, and January tends to forecast the year, especially down Januarys.”

Stocks took an especially hard dive on Friday after an unexpectedly strong jobs report that appeared to diminish the chance of an interest rate cut anytime in the near future.

Traders have been hoping the Fed will cut the fed funds target, the rate banks charge each other for overnight loans, sometime this year. The target has been at 5.25% since June, and the Fed has gone four meetings leaving it unchanged.

Interest rate worries overrode the market’s other big story last week which was the downward spiral in oil prices. Crude prices fell roughly 8% over the week and closed Friday at $56.31 a barrel.

Oil could continue to influence trading in the coming week, as could the government’s retail sales report and the first big-name earnings release for the fourth quarter. Earnings Turnaround

Dow component Alcoa (AA) , whose report is often viewed as the unofficial kickoff to earnings season, will release its results on Tuesday.

Analysts surveyed by Thomson First Call expect the aluminum giant to post earnings of 66 cents a share, up from 35 cents last year, on revenue of $7.63 billion.

To start the week, Horizon Health (HORC) , Spectrum Control (SPEC) and Schnitzer Steel Industries (SCHN) will be reporting earnings on Monday.

Aside from Alcoa, Tuesday will bring reports from Emmis Communications (EMMS) , Ruby Tuesday (RI) , Audiovox (VOXX) and WD-40 (WDFC) .

Genentech (DNA) will highlight Wednesday’s earnings lineup. Analysts are expecting the biotech powerhouse to report a fourth-quarter profit of 55 cents a share, up from 34 cents last year, on revenue of $2.53 billion.

On Thursday, M&T Bank (MTB) , Stride Rite (SRR) and XM Satellite Radio (XMSR) will be on the earnings docket. Economic Checkup

The health of the U.S. consumer will be examined on Monday, when consumer credit for November is released. Economists expect a rise of $5.5 billion, compared with a drop of $1.2 billion in the prior month.

Despite the projected spike in credit card debt, Wachovia economist Gina Martin says the consumer is holding up far better than anticipated, primarily due to wage growth.

“People have not needed to take out as much credit because they have seen their incomes rise,” says Martin.

Meanwhile, Wednesday will spotlight the health of the nation’s finances with the release of the November trade balance. Economists are predicting the nation’s trade deficit will widen to $59.5 billion for the month from $58.9 billion in October.

Wholesale inventories for November also will be released on Wednesday. Economists are projecting a 0.5% rise, after 0.8% growth in October.

The December Treasury budget will be delivered on Thursday. Economists will be looking for the nation’s coffers to expand by $21 billion, up from $11.2 billion the month before.

The consumer returns to the spotlight on Friday with the release of December retail sales. The consensus estimate is for a rise of 0.7%, down from a 1% jump in November. Excluding autos, retail sales for the month are expected to rise 0.6%, down from the 1.1% increase the prior month.

“Retail sales may not look that strong at first glance, especially compared to last year, which was the strongest since 1999,” says Wachovia’s Martin. “But it’s still going to be a strong season.”

Also scheduled for release on Friday are import and export prices for December, as well as business inventories for November.

1 What would best describe your stance heading into the coming week of trading?

Bullish
Bearish
Neutral

2 Which of these sectors do you think is set to move up in the coming week?

3 Which of these sectors do you think is set to move down in the coming week?

TOKYO - Toyota Motor Corp. is open to a broader partnership with Ford Motor Co. if the struggling U.S. auto maker asks, the Nikkei business daily reported on Wednesday, citing an interview with its president. Toyota President Katsuaki Watanabe told the paper that if the two auto makers formed a tie-up, it would likely focus on an alliance in technological development, but he said no talks had taken place yet. Toyota spokeswoman Shiori Hashimoto said Toyota executives always meet with heads...

Weekend Reading

By now you’re probably tired of predictions for 2007, so I’ll spare you my thoughts on where the market is headed this year. However, in the course of conducting our research on exchange-traded funds, we’ve arrived at a few conclusions that are contrary to the prevailing wisdom.

Value continues to outperform growth. Value stocks have outperformed growth stocks for six consecutive years, about as long as growth predominated in the late 1990s. As a result, many strategists are forecasting an imminent reversal in fortune in favor of growth. But I believe that the excesses of the late 1990s were such that growth stocks are still relatively overvalued.

It’s a dirty little secret, but the methodology used in selecting constituents for inclusion in the iShares S&P 500 Growth Index (IVW) and iShares S&P 500 Value Index (IVE) funds isn’t particularly good at separating companies with fast earnings growth from those with slow earnings growth.

What it primarily seems to do is separate expensive stocks from cheap ones, on the apparent presumption that expensive ones are priced that way because they will deliver rapid earnings growth — in a sense putting the cart before the horse. But since 2000, stocks in iShares S&P 500 Value have delivered faster compound earnings growth than the stocks in iShares S&P 500 Growth!

That’s not to say growth stocks won’t ever increase earnings faster than value stocks. In fact, this year companies in the iShares S&P 500 Growth Index are expected to grow earnings 10.6%, compared with growth of just 8.1% for companies in the iShares S&P 500 Value Index (although the value fund trounced the growth fund in 2006, with earnings growth of 18% and 11%, respectively).

But the point is that stocks in the growth index cannot be depended on to produce superior earnings growth over the long term. So it is unlikely that, in an environment of overall slowing in earnings growth, (S&P 500 EPS growth is expected to slow to about 9% in 2007 from about 14% last year) where estimates are cut more often than they are raised, investors will be patient waiting for the ethereal promise of growth to materialize.

The iShares S&P 500 Growth Index currently trades at about 16.4 times estimated 2007 EPS, compared with 13.9 times for the iShares S&P 500 Value Index. Remember, just because you “pay up” for earnings growth doesn’t mean you’ll get it.

Price-to-Earnings Ratio on 2007 EPS

Source: AltaVista Independent Research

With the exception of China, emerging markets continue to do well.. It’s almost an article of faith on Wall Street that emerging markets are overdue for a fall. Citing the phenomenal performance of these markets over the past few years, and the fact that historically they have been very volatile, many strategists conclude that there must be a reversion to the mean, and therefore a nasty correction is coming.

Lucky readers who’ve doubled or tripled their money in emerging markets may want to take some profits to rebalance their portfolios, but we advise against abandoning the sector. The components of the iShares MSCI Emerging Markets Index (EEM) still have a cheaper average P/E ratio than that of the constituents of the S&P 500, but it offers faster earnings growth.

I realize most would argue that emerging markets deserve a lower P/E ratio, but iShares MSCI Emerging Markets is composed of world-class competitors such as Samsung, many of which got to be that way by beating the pants off American (or Japanese) companies.

Further, the majority of stocks in this ETF are in the form of American depository receipts and thus are subject to the same accounting and disclosure requirements as, say, General Electric (GE) . We’d argue that Samsung’s fortunes and the performance of its stock have more to do with worldwide demand for the company’s products, and less to do with the fact that its headquarters are in Seoul.

One emerging-market fund we would avoid is iShares FTSE/Xinhua China 25 (FXI) , which is dominated by financial, telecom and energy firms, all of whose fortunes are tied to Chinese domestic demand.

While China’s economy is growing at a blistering pace, iShares FTSE/Xinhua China 25 now trades at nearly 17 times estimated 2007 EPS, and expected 2007 growth for the fund is just 4%. That makes the fund more expensive and slower-growing than iShares MSCI Emerging Markets. It is also more risky, in our estimation, owing to its single-country focus and the lack of any internationally known companies in the fund.

Estimated 2007 Earnings Growth

Source: AltaVista Independent Research

Fundamental indexing proves its mettle. A lot of indexing gimmicks have been introduced over the past few years, but one innovation that has real value, in my opinion, is fundamental indexing. This strategy seeks to avoid the Achilles’ heel of market-cap-weighted indices, which are by definition overweight stocks that later prove to be overvalued, and underweight stocks that later prove to be undervalued.

Although there are several approaches to fundamental indexing, I like the PowerShares FTSE RAFI 1000 (PRF) , which weights about 1,000 large- and mid-cap stocks according to sales, earnings, dividends and book value. Though the ETF has existed for just over a year, the back-testing results for fundamental indexing I’ve seen are impressive — and not just for this single diversified product but sliced and diced across sectors, market-cap segments and geographic regions, in both bull and bear markets.

It’s real-world results that matter, however. Compared with the iShares Russell 1000 (IWB) fund, which has, by and large, the same constituents, but is purely market-cap weighted, the PowerShares FTSE RAFI 1000 outperformed by over 3.0 percentage points last year. The difference in performance is more than enough to compensate for the difference in expenses between the two funds (the PowerShares FTSE RAFI 1000 has an expense ratio of 0.60% while the iShares Russell 1000 charges 0.15%).

Fundamental Indexing Proves Its Mettle
PowerShares FTSE RAFI 1000 outperforms iShares Russell 1000

Note: Rebased, December 2005=100

I realize that one year of results is probably not enough to convince the skeptics, many of whom will maintain that it’s too early to tell. But I believe the gap in performance between the PowerShares FTSE RAFI 1000 and the iShares Russell 1000 will continue to widen in 2007, proving the mettle of fundamental indexing. At any rate, I think the PowerShares FTSE RAFI 1000 could be an excellent choice for “set it and forget it” investors who seek to outperform the market over the long term by systematically avoiding market excesses.

WE’VE HAD the ecstasy, now for the agony. Plans to bring a best-selling Irvine Welsh novel to the big screen have been hit by delay following the sacking of the Scottish crew. The filming of Welsh’s Ecstasy, billed as a Trainspotting for the 21st century, was supposed to begin last November. But shooting will not now begin until March at the earliest and there are fears the project will not happen at all. Scots actors originally attached to the film - such as The Lord Of The...

Weekend Reading

The market will look to recover from its New Year’s hangover in the coming week.

Stocks have slumped since the market reopened for business after an extended break. In 2007’s three days of trading, the Dow fell 65 points, or 0.5%, and the S&P 500 was down 8 points, or 0.6%. The Nasdaq, meanwhile, rose about 19 points, or 0.8%.

Although it’s easy to slough off a holiday-shortened week of trading, market strategists are wary of starting the year on the wrong foot. According to Miller Tabak senior market strategist Phil Roth, “the first five days of January tends to forecast the month as a whole, and January tends to forecast the year, especially down Januarys.”

Stocks took an especially hard dive on Friday after an unexpectedly strong jobs report that appeared to diminish the chance of an interest rate cut anytime in the near future.

Traders have been hoping the Fed will cut the fed funds target, the rate banks charge each other for overnight loans, sometime this year. The target has been at 5.25% since June, and the Fed has gone four meetings leaving it unchanged.

Interest rate worries overrode the market’s other big story last week which was the downward spiral in oil prices. Crude prices fell roughly 8% over the week and closed Friday at $56.31 a barrel.

Oil could continue to influence trading in the coming week, as could the government’s retail sales report and the first big-name earnings release for the fourth quarter. Earnings Turnaround

Dow component Alcoa (AA) , whose report is often viewed as the unofficial kickoff to earnings season, will release its results on Tuesday.

Analysts surveyed by Thomson First Call expect the aluminum giant to post earnings of 66 cents a share, up from 35 cents last year, on revenue of $7.63 billion.

To start the week, Horizon Health (HORC) , Spectrum Control (SPEC) and Schnitzer Steel Industries (SCHN) will be reporting earnings on Monday.

Aside from Alcoa, Tuesday will bring reports from Emmis Communications (EMMS) , Ruby Tuesday (RI) , Audiovox (VOXX) and WD-40 (WDFC) .

Genentech (DNA) will highlight Wednesday’s earnings lineup. Analysts are expecting the biotech powerhouse to report a fourth-quarter profit of 55 cents a share, up from 34 cents last year, on revenue of $2.53 billion.

On Thursday, M&T Bank (MTB) , Stride Rite (SRR) and XM Satellite Radio (XMSR) will be on the earnings docket. Economic Checkup

The health of the U.S. consumer will be examined on Monday, when consumer credit for November is released. Economists expect a rise of $5.5 billion, compared with a drop of $1.2 billion in the prior month.

Despite the projected spike in credit card debt, Wachovia economist Gina Martin says the consumer is holding up far better than anticipated, primarily due to wage growth.

“People have not needed to take out as much credit because they have seen their incomes rise,” says Martin.

Meanwhile, Wednesday will spotlight the health of the nation’s finances with the release of the November trade balance. Economists are predicting the nation’s trade deficit will widen to $59.5 billion for the month from $58.9 billion in October.

Wholesale inventories for November also will be released on Wednesday. Economists are projecting a 0.5% rise, after 0.8% growth in October.

The December Treasury budget will be delivered on Thursday. Economists will be looking for the nation’s coffers to expand by $21 billion, up from $11.2 billion the month before.

The consumer returns to the spotlight on Friday with the release of December retail sales. The consensus estimate is for a rise of 0.7%, down from a 1% jump in November. Excluding autos, retail sales for the month are expected to rise 0.6%, down from the 1.1% increase the prior month.

“Retail sales may not look that strong at first glance, especially compared to last year, which was the strongest since 1999,” says Wachovia’s Martin. “But it’s still going to be a strong season.”

Also scheduled for release on Friday are import and export prices for December, as well as business inventories for November.

1 What would best describe your stance heading into the coming week of trading?

Bullish
Bearish
Neutral

2 Which of these sectors do you think is set to move up in the coming week?

3 Which of these sectors do you think is set to move down in the coming week?