By Timothy Lutts, Chief Investment Strategist and Editor of Cabot Stock of the Month Report
From Cabot Wealth Advisory 3/8/10  Sign up for free Cabot Wealth Advisory e-newsletter

Last week our intermediate-term market-timing indicator flashed a buy signal. This means all our indicators are once again unanimously positive. There's no better time to make money than now.

But where should you invest?

I think semiconductor chips are a great sector, and there are three good reasons why.

First, business is improving. The vast majority of companies in the sector--both those that design the chips and those that manufacture them--are enjoying fast-growing sales and earnings, and expanding profit margins.  Individuals and institutions are loosening their purse strings and buying again. Consumers are buying cell phones, computers, televisions and cars. Companies are buying computers, networking equipment and equipment that enables closer tracking of inventories, productivity, efficiency, etc.  And the government is buying more of everything.

Second, the chip sector is notorious for its cyclicality. When times are good, companies in the industry expand, spending more money so they can keep up with demand. But demand eventually slows, leaving the companies with too much overhead. So as orders slow, they cut back (often drastically), reducing payrolls to stay profitable, some more successfully than others. Prices fall, and eventually, demand picks up again, margins boom, and companies scramble to keep up.

In short, companies in the chip industry tend to overreact when they expand, and they overreact when they cut back. And they have to, because the timing of every phase is different throughout the decades, so there's no way of knowing how long each phase will last as it evolves. The risk is that failure to adapt could be more costly than adapting too vigorously. So the cycle goes on.

And then there's the stock market, which is guilty of exactly the same overreaction. Seeing margins plummet in a contraction phase, as we had in 2008, investors dump chip stocks like hot potatoes. They get dirt cheap. And when the turnaround comes, these stocks climb fast, as margins boom and projections of future growth are ratcheted higher and higher. That's the phase we're in now. No one knows how long it will last.  But I do know that it's a great phase for making money, provided that you take care to exit when the trend ends.

Editor's Note: From the market's bottom in March 2003 to the low in March 2009, the S&P 500 lost 18% in total and the Nasdaq lost 3.5%. Cabot Market Letter, however, left them in the dust: Advancing a total of 94% during the past six years (nearly 12% per year). Cabot Market Letter has called every bull market since 1970. In fact, Timer Digest recently named Cabot Market Letter one of the Top Ten Timers for the last one, three, five and 10 years! Don't miss what our indicators have to say next! Click here for more information.

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