Last September I published my favored indicators for predicting a potential recession. I wrote in the article that I follow a "criteria based" approach when examining the prospects for the economy over the forthcoming six month period.

In building a case for a potential recession, I concentrate on six key indicators. Last fall, these indicators were primarily positive, leaving me constructive on the equity markets. If my criteria list indicates a possible recession in the future, I would be less inclined to remain at a market weight for equities.

Indicators (click to enlarge images):

1. Copper: I consistently measure the price of copper to gauge the health of the global economy. As I mentioned in my last article, this is a very popular indicator, also known as Dr. Copper, for the metal's ability to predict future economic growth. China now has a very large impact on the price of

PepsiCo Inc. (PEP) is a diversified beverage and snack company that sells a wide assortment of brand name products including Pepsi, Diet Pepsi, Mountain Dew, Gatorade, Aquafina, 7UP, Tropicana, and Sierra Mist. It also markets food products such as Doritos, Tostitos, Lays, Ruffles, Cheetos, Fritos, and additional products like Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker Chewy granola bars, Quaker grits, Cap’n Crunch cereal, Life cereal, and Quaker rice cakes. PepsiCo was founded in 1898 and is headquartered in Purchase, New York. I feel that the company is one of several large cap firms within the consumer staples sector that offer a great opportunity for share appreciation. My positive investment thesis for PepsiCo is based upon nine key criteria, which include:

Key Selection Criteria

1. A market capitalization over $10 billion.
2. A leadership position within a growing industry.
3. A dominant, or large, market share within its product mix.
4. A strong

I recently wrote a positive article on the merits of Roche (RHHBY.OB) due to its dominant position in cancer care and diagnostics. Roche continues to be my favorite European pharmaceutical company. In the U.S., several drug stocks have done very well in the past twelve months, including Pfizer (PFE), Eli Lilly (LLY), and Bristol-Myers (BMY). Merck (MRK), however, has struggled. Since topping out at $48 a share in October, Merck's share price has declined by 14%. At the current discounted price level, Merck now offers the highest appreciation potential of any of the U.S. drug companies. To build a strong case for Merck, I examine nine key selection criteria, which include;

Key Selection Criteria

1. A market capitalization over $10 billion.
2. A leadership position within a growing industry.
3. A dominant, or large, market share within its product mix.
4. A strong position internationally.
5. A strong balance sheet and high credit rating.

My favored technology plays for 2013 are primarily in the semiconductor and software names. Semiconductors have maintained poor performance in 2012, dragged down by slow growth in Asia and Europe. Within semiconductors, Xilinx (XLNX) and Broadcom (BRCM) are my favored companies. Xilinx is my top selection based upon its leading industry position, strong free cash flow generation, and 15% annualized dividend growth. Here are my complete nine key criteria for any potential stock selection:

Key Selection Criteria

1. A market capitalization over $10 billion.
2. A leadership position within a growing industry.
3. A dominant, or large, market share within its product mix.
4. A strong position internationally, especially in emerging markets.
5. A strong balance sheet and investment grade credit rating.
6. A high growth rate of free cash flow.
7. A low historical relative valuation as measured by price/sales and/or price/cash flow ratio.
8. A strong dividend growth rate.
9. A catalyst of new revenue

Bond fund sales around the world are continuing at a record pace with $350 billion in net inflows during the first half of 2012. This continues the pace of the prior two years as investors continue to seek the safety of bond funds. Taxable bond assets have more than doubled since the end of 2008, increasing to $2.1 trillion from $1 trillion. Combining these massive fund flows and a very accommodative Federal Reserve has resulted in bond yields collapsing to levels last seen over 50 years ago. The current yield on a 10- year U.S. Treasury bond is now 1.6%. In looking at historical precedent, the period that most closely mirrors 2012 is the 1940s. Throughout the Great Depression of 1929-1933, Treasury bond yields declined as economic growth and inflation turned negative. Under the New Deal in the 1930s, the U.S. Treasury issued new bonds at low interest rates to

The energy sector should always have a prominent place in any investor's portfolio. As I wrote about in my focus article on the energy sector, the sector has maintained the third-highest return (10.54%) of any major sector since 1986. The sector also maintains a high degree of inflation protection and has a very low cross-correlation with the other major sectors. My first candidate within this compelling sector is Apache (APA) Apache's share price has fallen 8% this year after a 23% price decline in 2011. Apache stands out within the sector not only for its low historical valuation, but also for its dominant market position in exploration, high level of international sales, excellent sales per share expansion, and increasing dividend growth.

As a review from earlier articles, here are my nine key criteria for consideration;

Key Selection Criteria - Energy

1. A market capitalization over $10 billion.
2. A

The energy sector should be a key component of any savvy investor's portfolio. In general, the energy sector today is one of 1) heightened competition; 2) increased capacity and higher operating costs - both driven by dramatic leaps forward in technology; and 3) heightened demand from emerging nations like China, Brazil, and India - and thus restricted supply, typically leading to higher prices. Energy stocks currently represent a 11.3 percent weighting of the benchmark S&P 500 Index. The sector has delivered exceptional investment returns over the 24-year period ending December 31, 2010. According to data from Lipper/S&P and published in The Sector Strategist by Wiley Publishing, the energy sector has returned 10.54% on an annualized basis over this period. This is the third highest of any of the nine major sectors.

Additionally, the sector provides excellent diversification through low cross correlations. For example, in the past decade, the energy

The healthcare sector should always have a prominent place in any investor's portfolio. The sector has not only maintained the second highest return since 1986, but also has strong defensive characteristics during periods of economic weakness. Last month I highlighted two seasoned healthcare companies that should have a place in a diversified stock portfolio; Zimmer (ZMH) & Roche (RHHBY.OB). In addition to Zimmer and Roche, Becton Dickinson (BDX) also stands out within the sector for its dominant market position, high level of international sales, excellent sales per share expansion, and impressive dividend growth. The firm is positioned to benefit from several healthcare spending trends in the next decade including an increased focus on safety in the delivery of drugs, diabetes prevention, and enhanced accuracy in testing.

As a review, here is my 9 key criteria for consideration;

Key Selection Criteria - Healthcare

1. A market capitalization over $10 billion.

In part 1 of my positive thesis on Roche ADR (RHHBY.OB), I concluded that Roche met my initial three investment criteria. This included a leadership position in its industry, strong international revenue, and robust free cash flow generation. I also described in detail the generic implications for Roche and the questionable risks of competitive biosimilar products. In part 2 of my examination, I will focus on Roche's relative valuation, dividend history, and pipeline of new products.

Relative Valuation

My preferred method to evaluate pharmaceutical firms is on relative valuation based upon sales, or price/sales analysis. As for relative sales valuation, Roche is trading toward its lower range in history. Roche has traded at a price/sales ratio range of 2.3 to 5.0 over the past decade. The highest price/sales ratio in the past ten years occurred in August of 2006. At that point in time, Roche traded at a

Roche (RHHBY.OB) is one of the premier drug companies for the next decade, with a dominant position in cancer care and diagnostics. One of Roche's key competitive advantages is that two thirds of its products are biologics. Biologics are much harder to replicate than typical small molecule products. There has been concern within the investment community about the long-term effects of new legislation allowing for new generic biotech drugs (biosimilars). Last February, the U.S. Food and Drug Administration (FDA) published biosimilar guidelines as a follow-up to the Biologics Price Competition and Innovation Act of 2009.

The Biosimilars Act established two distinct categories of generic biologics; biosimilars and "interchangeable" biologic products. Only the "interchangeable" biologic products are required to have new clinical trials to be considered legitimate as a suitable replacement. These "interchangeable" products will account for most of the new biosimilar drugs released over the next decade.

A biosimilar product

In a previous article on the merits of Zimmer, I followed a clear and precise format for the selection of the stock through criteria based investing. A company had to be a leader in its industry, have the largest percentage market share in its niche, maintain strong international revenue, possess a low historical relative valuation, maintain strong dividend growth, and a clarified new revenue source. When analyzing the prospects of the economy, I follow the same "criteria based" approach.

Quantitatively, no single economic index is foolproof. Many economists will prefer one economic statistic over the next, and have sufficient evidence to back his or her story. In my mind, building evidence of an eminent turndown in the economy is very difficult. You should not be worried about accurately predicting each recession on the horizon. You should let the evidence inform you on the "odds" of a potential recession.

In

In my opening dialogue about the merits of healthcare, I discussed the long-term historical annual return of 11.3%. This was second highest of any major sector, just behind consumer staples. The healthcare sector also has the advantage of a lower than average beta for most stocks within the industry. Since 1986, the healthcare sector has only suffered five losing years (see table). This is the lowest number of negative return years of any of the major sectors within the S&P 500 stock index. Due to the impressive long-term returns along with strong defensive characteristics, I generally will maintain an above market weight in the sector versus the market.

Healthcare Sector: Losing Years since 1986

Source: Standard & Poor's Data

Within healthcare, several areas stand out. One of the most promising over the next decade is the medical supply and

Since the beginning of the last decade, a major transformation has been underway in the equity markets. A new class of growth stocks that were created in the 1990s has been transitioning from a period of high growth to low growth. Classic healthcare growth stocks such as Pfizer (PFE), Eli Lilly (LLY), United Healthcare (UNH), Amgen (AMGN), and Cardinal Health (CAH) have now moved into new territory as valuation compression has taken hold. The lofty price/earnings ratios that were once awarded to these companies are no longer viable as the revenue and earnings growth expectations have been permanently altered. As these classic growth stocks have faltered, the healthcare sector weight in the S&P 500 has slowly declined. The sector weight advanced to a 50-year high in 2002, registering a 15 percent weight of the S&P 500. But in the past 10 years, as many healthcare stocks have suffered, the sector